2017 Forecast: Skeptically Optimistic


As a follow up to John Mauldin’s post on 2017: What Could Go Wrong?, new article on his forecasts for 2017. Detailed summary below:

Help from Washington?

  • Markets have rallied since November on expectation that Trump and Republicans will enact growth-oriented economic agenda (tax cuts, regulatory relief, economic stimulus projects)
  • What is encouraging is that Republican majority does not have to start over. Already passed bills for the last 2 years (only to be vetoed by Obama) – with some minor updates, can quickly pass bills with better White House reception
  • GOP is intent on scaling back regulations – intend to employ Congressional Review Act to reverse some of Obama’s regulations
  • Tax cuts are almost 100% certain but we have no idea how it will play out; fixing taxes is difficult – every dollar government spends helps somebody, and whoever it is almost certainly has lobbyists on retainer
  • Long list of relatively uncontroversial bills that can be passed quickly to show progress; probably followed by a lull as Congress moves into more contentious issues like Social Security and healthcare reform
  • Taxes and healthcare reform may fall apart; Senate majority is narrow enough that a handful of defectors can stop any bill
  • Assuming no major surprises, tax and regulation changes can boost GDP growth in the final half of 2017 toward the 2.5% range – this may set the table for a bigger feast in 2018 and beyond

Energy Reversal

  • Energy stocks have been tearing higher since the election and with crude oil staying north of $50
  • OPEC supply quotas don’t apply to US shale producers and history of OPEC is they all cheat like crazy
  • For a commodity producer, higher selling prices or lower production costs improve your margin:
    • You can’t do anything about prices so cost reduction is the place to concentrate your attention
    • There are significant chunks of the US where $40 oil will not be a barrier to drilling
  • As I have said for 15 years, the whole Peak Oil thing is nonsense
  • If Trump permits more pipelines and export terminals, North American exports will rise considerably
  • Over time, falling energy price is not good for OPEC or Russia; lower prices will create geopolitical and economic challenges (this is obviously beyond the scope of an annual forecast)

Chinese Checkers

  • Pivotal year for China, having to deal with Trump is part of it – China has been defying gravity in many different ways and we will see if it can levitate another year in 2017
  • Not many realize that overnight rate for offshore yuan reached 105% at one point last week – created a massive short squeeze to maintain the value of the yuan
    • Natural direction for the yuan, if it were allowed to float, would be significantly lower against the USD than it is today
    • They are manipulating to maintain its current value but any precipitous move in the yuan can unsettle markets quickly
  • Some $2 trillion worth of Chinese currency has been converted into dollars and moved offshore – in the context of quantitative easing, this has almost as great an effect on the amount of money sloshing around the developed world as our central banks have; much of this money is in North America, driving up prices in real estate and other assets
  • 19th party congress in the fall and will almost certainly give Xi Jinping another 5 years at the helm
    • Xi may need to exercise all his power to maintain both economic growth and domestic order
    • Not sure if state-owned enterprises are turning a profit or operating at a loss due to generous benefits and subsidies – government is trying to keep the masses happy
  • Serious limits on amount of money that individuals can take offshore in a given year which means a lot of money in China looking for a home – asset bubbles rolling through regions and asset classes whose valuations follow no discernible logic
  • Ironically, both Xi and Trump agree they don’t want yuan to move down all that much in the coming years
  • Export-heavy model can’t work much longer and don’t have a way to create sustainable internal demand
    • Consumer economy is opposite of what China has been for the last 30 years; transition is going to be far more difficult than anything China has faced for a long time
  • China’s problems are everyone’s problems; saw a report estimating that $1.5 trillion in corruption proceeds escaped China between 1995 and 2013 (this is in addition to legal money coming out of the country) – most of it landed in US, Australia, Canada, and Netherlands where it helped to inflate asset bubbles

European Disunion

  • Our 50 states is essentially what EU founders wanted: giant free-trade zone with a currency union and fiscal union; works for us in part because we do not have centuries of cultural and linguistic diversity that Europe does
  • EU structure, specifically the European Monetary Union and the euro, is not the answer; 2017 will make this fact increasingly obvious especially if the worst happens in Italy
  • Italy’s banks are holding something like €350-400 billion in nonperforming loans – vast majority of it is not just temporary nonperformance but dead money; banks are pretending otherwise and government is letting them
    • Banks are borrowers too as most of their lending capital is not equity; if they can’t collect on loans they made, they can’t repay money borrowed, and the whole edifice collapses
    • Italy is in a near-impossible situation; huge imbalances with no mechanism to resolve
  • Inflation in Germany last month finally reached 1.7% and many will ask for tighter monetary policy – this is exactly the oppostie of what Italy and southern countries need. See the potential for conflict?
  • Four of the six founding members of EU have elections; Hollande accepted that he is too unpopular to run again as French president and there may be other regime changes
  • I suspect they can keep kicking the can down the road until 2018 or later, just not clear when they will run out of road – when they do, result will likely be a severe recession in Europe

Few Final Thoughts on 2017

  • Entered an era in which machines are learning how to do much of the work that provides our incomes and self-worth
    • US is manufacturing more materials and good than ever – increasing well over 2% a year but manufacturing jobs are not
    • Ball State University study calculated that it would take more than 8 million additional jobs to produce what we produce today if we were at the productivity levels of 15 years ago
    • Robots and their associated machinery have been about 4x more important in the loss of manufacturing jobs than offshoring of jobs has been
  • Real challenge is how to create new jobs in the face of this automation challenge
    • Korea may be 15-20% more productive than US in terms of costs due to pushing further and faster into automation process
    • All developed countries are seeing this trend and they will adapt to stay competitive
  • Gained appreciation for social and political crossroads we are at when we see “unprotected” voters who flocked to Trump and Sanders – both Trump and Sanders understand that unemployment doesn’t simply reduce people’s incomes, people want to be real contributors to the economy but the economy increasingly tells them they aren’t necessary
  • Part of the reason why Trump is pressuring companies to keep jobs in the US: he knows the numbers are small but he’s trying to force a wider change and the staff around him gets this
  • Lower costs and higher productivity are deflationary – this is why we’ve seen sluggish growth in the last decade; at some point, faltering growth may turn into outright contraction globally

“Quantity is being confused with abundance and wealth with happiness.” – Tom Waits

“The shift from sailing ships to telegraph was far more radical than that from telephone to email.” – Noam Chomsky

Full article: 2017 Forecast: Skeptically Optimistic

Image source: Geomarketing



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