Q: Where are we in the economic recovery?
A: There is an overall slowdown of global growth. Europe is in a recession in the periphery countries, and it's getting worse. There is a double-dip recession in the United Kingdom, sluggish growth in Japan, and the data from many emerging markets are also suggesting a slowdown in China, Russia, Brazil, India and places like Turkey, Mexico and South Africa.
- Q: What about the U.S.
A: We have positive economic growth, but it's below trend — barely 2%. Job creation is still anemic. The recovery is still anemic because the painful process of de-leveraging has not even started in the public sector. And next year there will be some fiscal drag because of the fiscal cliff that's coming up.
Q: Explain what you mean by fiscal cliff.
A: Many things are expiring at year end. All the tax cuts on income, on dividends, on capital gains, on estates. There's an expiration of the payroll tax (cut). There is a reduction or expiration of transfer payments to state and local governments, to unemployment benefits. There is the expiration of infrastructure spending, and then there are the automatic cuts on discretionary spending, which came about because we failed to reach an agreement for reducing the budget deficit.
Q: What about Europe?
A: The European recession is getting worse. There's fiscal austerity that, in the short run, makes the recession worse. Second, the value of the euro is too strong for the countries on the periphery that have lost competitiveness. Third, you have a credit crunch because the periphery banks don't have enough capital, and they will be forced to cut credit. Fourth, you have the effects of high oil prices, and Europe depends 100% on oil imports. And now politics in Europe are an issue, as we saw from the Greek elections, French elections, the Italian elections and German elections, and the collapse of the government in the Netherlands.
Q: Wow. How long will this sustain?
A. You have on one side austerity fatigue, because these countries are finding that austerity makes the recession worse. The austerity fatigue is spreading to France and the Netherlands. On the other side, you have bailout fatigue in places like Germany or Finland or Austria. These Germans tell me, 'These Greeks have a big fat Greek wedding not for a weekend, but for the last 20 years. We give them one bailout, then a second bailout. We cut their foreign debt by 75% in the debt restructuring, and they still don't want to do any fiscal austerity and structural reforms.' So they say, 'Enough is enough, let's pull the plug.' "
Q: What will happen to Greece?
A: The risk is that you'll have Greece exiting the eurozone with all the collateral damage. Also the risk is that many other countries will find it difficult to do austerity. There is a significant sociopolitical and policy uncertainty in Europe that affects the global markets. So, to me, the eurozone looks like a slow motion train wreck. Slow motion is not going to collapse overnight. But Greece is not going to be the only country that's going to restructure. Greece by next year might exit the eurozone. If one or two of the smaller countries restructure their debt and exit, like Portugal or Cyprus, the eurozone survives. But if the contagion spreads through Italy and Spain, the third- and fourth-largest economies, it could lead to a breakup of the eurozone three or four years down the road.
Q: So, how does all of this affect the U.S.?
A: First, there is huge exposure of U.S. companies to Europe because they have factories and businesses there. If Europe goes into recession, the profits of these multinationals are cut. About half of all the profits of U.S. S&P 500 firms are coming from their foreign operations, many of them in Europe. Second, whenever there is risk of disorderly financial conditions in Europe, there is not just a sharp correction of European stock markets, but also of U.S. markets. When Greece was first in trouble in the spring of 2010, you had a 20% correction in the European stock market, and a similar correction in the U.S., in Asia, in emerging markets. Same thing last year between August and October. So financial contagion becomes instantaneous because of sentiment, exposure of U.S. financial institutions to European ones, and because of these links between the U.S. businesses and their own activities in Europe. No country is an island.
Q: What are you expecting from the markets in the next year and how do you invest in the face of this?
A: We see it being flat for the rest of the year, like it was flat last year, given all these uncertainties and given there is a fiscal cliff and there is more gridlock. I don't expect the stock market to tank this year. But I don't see, from current levels, much upside. The emerging markets are a long-term story. Their growth rate in the long run is 6%, while in advanced economies (including the U.S.) is 2%, 2.5%. So if you are willing to invest for the long run, yes on emerging markets. But if you're thinking about what's going to happen in the next few months, no country is an island.
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