Think negative

Investors begin 2013 as they did 2012, somewhat fatter and back-loaded with ennui. Five years have passed since the GFC-induced global recession but still there’s no sense of an ending.

A few important but related differences between this New Year and last do come to mind, though. First, central bankers savaged savers in 2012. Second, like many other markets, the ASX All Ordinaries Accumulation Index rose significantly in 2012 (19% compared with -11% in 2011) as investors pulled on the wellies and went yield hunting.

The handsome returns don’t much tally with events. Over the fiscal cliff suggested Obama would get his deal. It was, however, good only for NASCAR, which pocketed US$70m, electric scooter manufacturers and those earning $250,000-$400,000 per year. The deal does nothing to address the long-term structural issue of US debt, which now stands at about 105% of GDP, and will probably make it worse.

Economists like Steve Keen and Paul Krugman argue the debt isn’t a problem right now. With 10-year US Treasuries yielding 1.89%, they have a point. But the impasse had the potential to get the process of dealing with it underway by reversing the hugely expensive Bush-era tax cuts. Instead, Obama blinked and now the prospect of huge and damaging spending cuts that could stymie the US’s economic recovery is very real.

Debt ceiling pantomime

The pantomime resumes in a few months when the debt ceiling again needs to be raised. Then Obama will find his position weakened and the wingnuts emboldened. As John Cassidy said in the New Yorker, 'In the ideologically-driven Republican Party of today, many congressmen won’t let the family dog drown to save their wives and children.'

In the US at least, the bipartisan post-war political consensus is over. We can no longer expect commonsense to eventually prevail. So, in the midst of this balmy interregnum, enjoy the tranquillity while you can. The new political reality is one of perpetual tumult.

In Europe, too, extremists are enjoying something of a comeback. There are 754 seats in the European parliament. Depending on how you count them, about 120 support assorted right-wing extremists. There would have been one more, a Hungarian from the Jobbik party, but he was forced to resign after his Jewish background was revealed.

At the other end of the spectrum, France has elected a socialist who is trying to raise the top marginal rate of tax to 75%, which seems an extreme way of getting rid of Gerard Depardieu. In Greece, Syriza, a coalition of the radical left and the country's major opposition party, is gaining in popularity amid a crumbling social fabric. Meanwhile, in The Guardian Maria Mararonis writes of the rise of Greek neo-Nazi party Golden Dawn, ‘Their MPs give fascist salutes, while on the streets black-shirted vigilantes beat up immigrants. And some of their most enthusiastic supporters are in the police.’

Life in some European countries is becoming unbearable. Greek hospital patients are asked to bring their own bedding and in three years the suicide rate has doubled. In Spain, the unemployment rate is 25% and youth unemployment double that. The Economist quotes Maria Gil Ulldemolins who, with two degrees, believes that she ‘trained for a world that doesn’t exist’. And Ireland’s self-appointed biggest property website, called Daft—I kid you not—claims that since the market peak, average property prices have fallen 53%.

Diabolical circle

From Finland to Turkey and Portugal to Poland, extremists on the left and right are basking in a new legitimacy. Saving the Euro may be the least of the continent’s problems.

But fear not. The high-tone, educated European political elites have it covered, replacing domestic leaders with their puppets in election-free coups, printing more money to save the banks and imposing austerity on everyone else. Stability and recovery is assured. All that is required are bigger dollops of the same failed policies.

The media may not be talking about a Grexit any more, or worrying about bond rates in Italy and Spain, but the problems, like turds under autumnal leaves, are out of sight not mind. These economies are shrinking at a pace faster than their debt is being reduced, exacerbating the ability of each to finance its obligations.

It’s a diabolical rather than virtuous circle, and yet the investment atmosphere is one of relief, optimism even, at last year’s returns and an apparently slow climb out of giant hole. That belies a few fundamental truths.

Appropriate policy responses now seem further beyond the reach of political possibility. No matter the question, the answer is to print more money, make it cheaper, and let the banks take care of the rest. Alan Greenspan’s policies, like the man himself, live on as if nothing happened.

Fortunately for Australian investors, Chinese communists aren’t such ideological sticklers. The party happily pulls on the spending lever when property investors become restless. Yes, the waste and corruption is scandalous, but Europe and the US have that too. What they don't have are high-speed rail lines, huge new universities and burgeoning new industries pushing along an economy at an 9.1% clip. The communists certainly know their Keynes.

The problem is the solution

The differences between the Chinese and western approach can be simplified thus: In the US and Europe they print; in China they spend. And yet both systems share a common thread. The GFC revealed a banking system that was so intertwined and leveraged that it couldn’t withstand bank failure. In China, economic growth is skewed towards often-unproductive investment at the expense of consumption.

These features make both systems fundamentally fragile. In the years since the GFC, policymakers have done very little to reduce that fragility.

Indeed, when the answer to a balance sheet recession is more debt and the problem of an investment-reliant economy is more investment, the potential for calamity increases. Throw a few dysfunctional parliaments and restless populations into the mix and watch that New Year’s optimism evaporate like spilt vodka on a Kings Cross pavement. Aren’t you glad you’re reading this on your holidays?

Actually, we’re not trying to spoil the fun but have more of it. If the next 12 months are to be chaotic, volatile and traumatising, let’s raise our glasses to that prospect.

On Thursday, via a hyper-smart Lebanese American that refuses the calming hand of a good editor, and the Victorian concept of willpower, we’ll explain how volatility can make you and your portfolio stronger. Yes, stronger.

Part two will offer a step-by-step guide on how best to overcome your evolutionary programming to panic and hide and the positive thinking clap-trap of the past few decades, to embrace the power of negative thinking and welcome the chaos and stress of a fragile system (there’s a clue there). Look out for it.

Happy New Year to one and all.