What If the EU Fractures, China Stagnates, or the U.S. Economy Worsens?(1)

There are no economic and financial seers. No one, as far as we can tell, has access to future facts. At best, we have clever opinions based on imperfect reasoning and partial understanding of even present and past facts. However, we are all obliged to act in some fashion to make or preserve income and wealth. Action entails having some view of the world as it may unfold within an investment horizon. The search for a consensus view is both futile and often most harmful.

The paragraph above establishes the context for this essay, which is an exercise in supposal and conjecture. Suppose certain big things happened in the world economy - what consequences would ensue and what investment actions would then be required?

The Supposals

1. EU Fractures: German money is the EU’s cement. Germany, however, is only a middle sized nation with a second tier economy. Germany’s 80 million people cannot bail out Latvia, Estonia, Lithuania, Romania, Bulgaria, Austria, Italy, Greece, Spain, Portugal and Ireland, as well as finance the $145 billion “Germany Fund” to prop up listed companies and also meet continuing large regular payments to the EU. The German economy is contracting even faster than the US economy. Many Germans feel they have atoned enough for the Nazis and German guilt cannot be monetized endlessly by its neighbors. In the absence of a great deal of German money, the EU will crack, then fracture and perhaps split into a small core with one set of rules and a much larger periphery with another set of rules but no common foreign or defense strategies or even alliances. NATO will become a talking club at best. The Euro will cease to exist as nations seek to regain currency/interest rate control as instruments of economic policy. European unemployment will reach the low teens, with some nations seeing unemployment in the high teens.
2. China Barely Grows: A heavily export dependent economy cannot be vigorous while global trade is shrinking, domestic fixed investment is falling and consumers are conserving cash. There are no growth drivers. China’s economic growth rate falls to between 1% and 5% per annum for several quarters, resulting in sharply rising rural poverty, urban unemployment, real estate distress and rising violence. This compels the Chinese Communists to turn increasingly and repressively inward, run larger and larger budget deficits, use its SWF and other agents of the State to buy scores of billions of dollars of commodity assets abroad (and use this buying power to further Resource Imperialism) and substantially increase military spending to ensure the loyalty of its military, intimidate neighbors and dominate sea lanes in Asia. The US-China economic nexus frays badly and China becomes increasingly intolerant of US hectoring.
3. US Economy Worsens: from a state of rising unemployment, low interest rates and negligible inflation or mild deflation to a multi-quarter period of unemployment above 10%, high interest rates and high inflation as public policy steadily debases the dollar and chokes innovation.

Consequences

Given the supposals above what might be some of the consequences over the next few years? Those delineated below are illustrative and far from exhaustive.

1. Global Fragmentation: Interference with the free flow of trade, capital and labor increases while global trade compresses significantly. As a result regional, sub-national, linguistic, ethnic, sectarian, cultural and even tribal identities become more attractive for billions of people and several current nation states either become even more decentralized or break up entirely. The number of so called ”sovereign” states grows appreciably as politicians and tribalists exploit fragmentation.

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