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Macroeconomic Update – No double dip but slower growth…

The risk of a double dip recessionary event has increased in the last quarter mainly because of the increased problems with sovereign debt and how troubled nations will respond to the challenge of fixing their households. The reduced spending from governments will result in slower growth rates, but the deficits of many countries have reached a level which is simply unsustainable. The situation in Europe and the U.S. is similar although the reaction to the problem is different. While many European nations have announced rather aggressive spending cuts in recent weeks, the U.S. response to this challenge is much more moderate and actually more spending is planned. From an economic point of view this attitude is understandable and a number of well known economists, such as Paul Krugman, call for even larger spending from governments in order to make sure the economy is not falling back into a recession. We strongly disagree and oppose such an approach. While we see that additional government spending, especially when done in a counter cyclical manner, can help to balance economic growth, such a strategy is not an option when governments are already heavily over-indebted. So while additional government spending does help to balance overall supply and demand, it is not a sound strategy in today’s situation.
In order for governments to balance income and expenditures, it is essential that an efficient and lean structure is kept. However, many western nations have created welfare states by overpromising the supply of public goods such as healthcare and pension benefits. While the overpromising of public goods tends to win votes, it is a recipe for disaster long-term and can only go on for a certain period of time, eventually crisis will force change. We believe that many western nations have entered the first phase of this adjustment process. The initial response is often to try and raise tax revenues, but this is very difficult given the relatively high tax level in many countries. Long-term government spending and revenues can only be balanced by reducing benefits while keeping revenues constant. This however, will be difficult to accomplish, just think of the huge problems that France has faced in talking their people into raising the retirement age above 60 years. From an economical point of view, most western nations need to prepare their people for a higher retirement age, given the demographic changes, a retirement age of 70 would be appropriate. It is going to be very difficult to convince people to accept this and it will create serious socio-political tensions.
While failure to address the above mentioned issues will certainly impact growth negatively long-term, the short-term macro economic outlook is relatively good. The risk for a double dip recession has increased lately but still remains relatively small, we only see this as a 20% or less likelihood. So while growth in western economies remains fragile and moderate, where is global growth coming from? The IMF still sees global GDP growth of 4.6% for the current year with a risk of slightly slower growth in 2011. We are less optimistic on the headline number but remain very optimistic on growth in emerging economies. With a rising share of total GDP coming from these countries, they will be the global growth engine in coming years. While this is certainly positive for western nations short-term, it also means that the global geopolitical landscape will change dramatically and emerging countries such as China, India and Brazil will have more say in the future.
The emergence of these nations is a big opportunity for many international companies. This can be seen in the results of many companies, that dealing with lackluster business conditions in home markets, are rapidly expanding business in emerging markets. The same approach should be used by investors by diversifying in new markets and currencies to reduce risk and improve returns long-term.

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