The American presidential elections produced the expected result and have created the predicted further uncertainty in financial markets mainly because of the stalemate in congress which is still controlled by the Republican Party.
In effect, this means the Democrats and Republicans have to agree on the budget for America for the next year, referred to as the ‘fiscal cliff’, which is causing reservations amongst investors who have little faith in compromise being achieved before the final hour.
The USA government cannot increase the amount of government bonds that can be issued without the consent of Congress. Therefore, before permission can be given to the USA Treasury to instruct the Federal Reserve (the central bank) to issue bonds to cover the fiscal deficit, agreement must be reached. The fiscal deficit is the difference between the amount of tax raised and the forecast expenditure by government for the next fiscal year which for 2013 is estimated to be about $1000 billion.
You might say ‘well what has that got to do with us here in the UK?’ The reason is that the USA economy is still the largest in the world and does have an effect around the world purely by the impact of the purchasing power of government and business that affects all other countries worldwide.
Although the emerging market economies are expanding, they are still partly dependent on American imports to maintain that growth. Any doubt about this is reflected in financial markets and depresses confidence.
In Europe, the USA election has not changed anything dramatically; however public reaction to the austerity being imposed in the Mediterranean countries is beginning to dominate the news causing concern for the politicians. We will have to see whether this resistance to the severe government cutbacks becomes more intense to make a judgement on the effect it will have on decision making and the survival of the Euro itself.
That is a brief summary of the markets and the general economic situation in the last week.
There have been various articles in the FT about the amount of oil and gas in the ground in the USA that they can now extract which will make the country self-sufficient in about ten years. Looking at the long term picture this will turn the USA into the largest oil and gas producer in the world and eliminate the trade deficit transforming the economic fundamentals of the country.
In my view, these facts will have a big impact on current decision making by Congress. Although there is no talk of another round of expenditure by government, this will mean that there is more flexibility in the discussion about the current fiscal deficit. I expect to see President Obama accommodating some of the Republican demands because the tax revenue from oil and gas production in the near future and the decrease in the trade deficit will be taken into account.
I would expect to see the markets recover the recent decline over the next month and confidence in the USA to improve enormously. It is feasible that next year will be the real turning point in this long lasting recession and that this will spread to the UK and Europe as well providing events elsewhere do not become unmanageable.
The one caveat is the Middle East. If events start to get out of control, the whole world will be drawn into the mire and that would be catastrophic for markets and economies killing off any recovery. There is one fact about the USA oil and gas situation and that is they will not be so reliant on Middle East supplies which in my view removes some of the hostility from the attempts to find a resolution.
The long term outlook is that China becomes the biggest buyer of oil from the region and replaces the USA as the main player which is an unknown quantity at the moment. The dispute about the Japanese islands is all to do with potential oil discoveries in that area and the Chinese are being very forceful over this matter. That clearly does not make one feel comfortable about them having the major influence in the Middle East in the years to come if they continue along that track.
That’s it for now, more observations next week.
16th November 2012