Bridgewater Associates: Seeing Todays World From Two Views - June 2012

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Bridgewater Associates: Collection of Writings (1999-2012)

Bridgewater Associates: Collection of Writings (1999-2012)

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  • 1. © 2012 Bridgewater Associates, LP. Any publication or other use (including, without limitation, distribution via email or any internet posting) of Bridgewater Daily Observations™ without prior written consent from Bridgewater Associates, LP is prohibited by U.S. and foreign copyright laws. Bridgewater® is a registered service mark of Bridgewater Associates, LP. All rights are reserved. 1 Bridgewater ® Daily Observations 06/18/12 Bridgewater® Daily Observations June 18, 2012 ©2012 Bridgewater Associates, LP (203) 226-3030 David McCormick Karen Karniol-Tambour Alex Schiller Seeing Today’s Crisis From Two Worlds As we assess the ongoing G20 Leaders meeting in Mexico, and I reflect back on my experience since I was the US Undersecretary of the Treasury for International Affairs during the 2008 financial crisis, I believe that I now better understand something important that policy makers are missing. Over the past couple of years at Bridgewater I have had the opportunity to see how the economy and markets work through the eyes of adept practitioners. I see how the methodology that they use has allowed them to accurately describe the progression of the global debt crisis from the bubble in 2007 right up to the brink today. It is this level of granular understanding of how the economic machine works down to 1) who buys and sells goods, services and financial assets with what money and credit, 2) why they make these transactions, and 3) the implications of changing some things in order to affect others, that is hard to obtain and that policy makers are so often lacking. As we learned in 2008, it ultimately took a substantive policy response that dealt with the underlying fundamentals to stem the crisis, while today I fear that policy makers in Europe, while capable and well meaning, are thinking of the market in much vaguer terms and believing that if confidence is created, market participants will come. I now realize more than ever that this thinking is both inadequate and potentially dangerous. For policy makers gathering at the G20 meeting, the path ahead is uncertain, the political and economic stakes high, and the challenge in creating a comprehensive and confidence building policy response daunting. They have vague notions of how policy responses are likely to affect market confidence as opposed to a more granular understanding of cash flows. I don’t know whether we are on the edge or over it, but I now know that the European deleveraging crisis has progressed to the point that there is significant risk of the European and world economies slipping into a depression. While I stare at each day's developments along with my Bridgewater colleagues, I also still feel for and understand the enormous challenges facing my former colleagues who are now setting policy. I now 1) see the deleveraging process' progression within the context of how deleveragings work, 2) recognize that it was inevitable a couple of years ago that Spain would reach its current point of failure, 3) remember policy makers’ inaccurate beliefs and assurances that these problems would not occur (e.g., remember the misguided and misleading European bank stress test results) and 4) fear the consequences of them being inadequately equipped to deal with their challenges. Time Is Running Out and Policy Makers Still Don’t Have a Plan B In the face of rising funding costs, fundamental questions about the euro, and uncertainty about whether Greece will remain in the Eurozone, European leaders meet with their global counterparts today at the G20 in Mexico at an inflection point for the global financial crisis. We fear this meeting, and the European Leaders meeting that follows a week later, will fall short in describing the kind of comprehensive Plan B for dealing with the deleveraging’s progression that is needed and, as a result, the next and most painful phase will be unmanaged. The policy makers are hopeful that the combination of favorable election results in Greece, the bailout for Spain, the possibility of ECB support, and the longer term promise of a banking and fiscal union will build confidence and give
  • 2. 2 Bridgewater ® Daily Observations 06/18/12 them breathing room. Holding this misplaced optimism, rather than making the hard policy choices necessary, has been all too common over the past several years and is alarming. It’s Harder Now to Coordinate Policy than in 2008 In November 2008, I helped organize the first G20 Leaders meeting in Washington DC. While different in many ways, this week's G20 feels eerily similar to then in that the world is looking to policy makers for a comprehensive response to a growing crisis (in this case with the pressure aimed primarily at Germany as opposed to the United States as it was then), and also starkly different in that the challenge of coordinating a response is so much greater in Europe, where there are divergent economic interests among sovereigns, the lack of a central decision making authority, immature pan- European institutions, and an increasingly polarized political environment. By the 2008 summit, all the key players were largely aligned, they had coordinated a plan, and either put in place or laid the foundation for many of the key pieces. Bank recaps had already started in the US and UK and deposit guarantees had been increased in the US and European nations. These steps and the planning that went into the G20 allowed leaders to communicate a credible determination to take the bold actions required. The meeting concluded with a commitment to take “whatever actions are necessary,” to stabilize the financial system, provide monetary support, increase fiscal stimulation, and provide IMF liquidity facilities for emerging countries. Weeks later the US and Europe followed with more bank debt guarantees, bank recaps and a commitment from the central bankers to do whatever it took. So far the key policy makers in Europe have been unable to forge the underlying agreement necessary to deliver a plan anytime soon. At the heart of their disagreement lies the tension between German policy makers believing they first need to secure fiscal union and the ability to tax before agreeing to further debt sharing, with France, Italy, Spain and the other peripherals calling for more backstops sooner and not ready to give up fiscal sovereignty. Merkel and Hollande’s recent comments reflect strains in the French-German relationship and both Italy's Monti and Spain’s Rajoy are ratcheting up their rhetoric in the face of growing political pressures. Even if Europe’s leaders agree on the broad contours of a compromise, given the decentralized decision making in Europe, there is a tremendous amount of work that needs to be done before real fiscal and banking union can be realized. While we could be surprised, from everything we understand European policy makers are far from laying that groundwork and many months away from any final agreement on fiscal union. Something like an FDIC for Europe can only come after that, and then it will still be a question how far Germany will go to take on the losses. Leaders outside of Europe are increasingly worried that Europe will drag down their already slowing economies. The summit offers them a chance to try to help broker agreement among their European counterparts, while showing their constituencies that they are on top of the crisis. The US and China are especially concerned. President Obama has little room for stimulus and faces an upcoming presidential election. Ironically, as this crisis deepens, he and his advisers must be increasingly worried that Spanish bond yields will become a leading indicator of his election prospects. China's leaders must manage a transition later this year and are more reluctant to stimulate via a credit response like in 2008. In the weeks ahead of the meeting, we have already seen a coordinated set of statements by President Obama and UK Prime Minister Cameron to pressure Chancellor Merkel to act more decisively. However, there is a limit to the pressure non-EU leaders can exert, reflected by Merkel’s sharp rebuke to Cameron and calls for leaders outside Europe to stimulate their own economies. The IMF is the one institution where G20 leaders can put more skin in the game to protect against a European debt bust. So far we have only seen them commit to an anticipated increase in funds, not a larger share to Europe. A significant portion of this is likely to come from EM countries and it would be a mistake to read their commitment just as a reflection of their concern for Europe. They have been looking to leverage their resources into a larger voting share for years and will likely try to tie these conversations together, something Merkel has already pushed back on.
  • 3. What We Will Be Looking For For all these reasons, we are not expecting much in terms of concrete announcements from this G20, maybe some more specific and forward leaning support from leaders on more ‘fiscal and banking union’ in Europe, an increase in IMF resources and the language we have come to expect, expressing support for European policy makers and a commitment to global growth. We will more likely know whether any progress was made days later in the comments of key European policy makers and the output from the EU Leaders meeting the following week. Beyond vague commitments to a fiscal or banking union, we will be watching for specific indications that: (a) the French, Spanish and Italians are ready to accept common taxation and spending controls, and (b) the Germans are prepared to stomach more of the losses through the mutualization of sovereign debt and bank deposit guarantees. Finally, we will be looking for how much leaders outside of Europe are willing to help damp the global risk through such actions as (c) centralized central bank action (or promise of action) or (d) further IMF commitments, as insurance of a debt bust spilling over. While potentially complicated by quota conversations, the IMF is likely to get more specific commitments from EM countries (such as China) for the roughly ~€350bn ($430bn) that was announced earlier this spring in Washington DC, bringing IMF firepower to around ~€1tn ($1.3tn). But even if the IMF and G20 leaders agree to an increase of roughly this amount and compromise on giving a larger share of resources to Europe (say, 30% of lending vs. 16% which would be a meaningful shift), the upper bound of that commitment is likely ~€300bn (double our baseline). The problem is even this amount would bring total EFSF/ESM and IMF resources to €1tn, when to us the potential losses look much higher and the funding gaps remain. Ultimately, it will come down to Germany and the Europeans to decide who will take these losses and what their roadmap is to resolve the fundamental problems. Without those questions resolved it’s not clear who will fund them in the amounts they need. Policy makers in Europe have a particularly tough road ahead. The fragmented decision making process in Europe, the number of countries needing financial assistance relative to those who can provide it, the absence of a true fiscal union, and the limited amount of time that is left make the challenges of European policy makers much greater than those of American policy makers in 2008. Bridgewater Daily Observations is prepared by and is the property of Bridgewater Associates, LP and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. Additionally, Bridgewater's actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing and transactions costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This report is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. Bridgewater research utilizes data and information from public, private and internal sources. External sources include International Energy Agency, International Monetary Fund, National Bureau of Economic Research, Organisation for Economic Co-operation and Development, United Nations, US Department of Commerce, World Bureau of Metal Statistics as well as information companies such as BBA Libor Limited, Bloomberg Finance L.P., CEIC Data Company Ltd., Consensus Economics Inc., Credit Market Analysis Ltd., Ecoanalitica, Emerging Portfolio Fund Research, Inc., Global Financial Data, Inc., Global Trade Information Services, Inc., Markit Economics Limited, Mergent, Inc., Moody’s Analytics, Inc., MSCI, RealtyTrac, Inc., RP Data Ltd., SNL Financial LC, Standard and Poor’s, Thomson Reuters, TrimTabs Investment Research, Inc. and Wood Mackenzie Limited. While we consider information from external sources to be reliable, we do not assume responsibility for its accuracy. The views expressed herein are solely those of Bridgewater as of the date of this report and are subject to change without notice. Bridgewater may have a significant financial interest in one or more of the positions and/or securities or derivatives discussed. Those responsible for preparing this report receive compensation based upon various factors, including, among other things, the quality of their work and firm revenues.