by Bill O’Grady

Being the global superpower is a great burden.  There are military, political, economic and financial obligations that are costly to maintain.  At the same time, history shows that when there is no dominant hegemon the world tends to suffer from instability and chaos.[1]  Although the superpower may wish to abandon the encumbrance, the consequence of an unstable world isn’t an attractive alternative.

Since the fall of the Berlin Wall in 1989, the U.S. has been the sole superpower.  The costs of that position have become increasingly apparent to Americans, leading to political factions calling for a retreat from the role.  So far, the political elites remain committed to the hegemonic role, but it is unclear if it can be maintained.

One possible solution to the superpower problem would be to “shrink the world.”  In other words, some nations may opt out of the international system the U.S. crafted since WWII, which includes open trade, free markets and democracy. As we saw during the Cold War, the communist bloc created a “smaller world” where economies were closed, markets were managed and authoritarianism was the primary governmental structure.  Although the creation of a new bloc in opposition to the U.S. may appear to be a retreat from America’s hegemonic role, it may actually make the burden more manageable.

This week’s report will review the burdens of superpower role.  We will examine growing opposition to U.S. hegemony and discuss the impact of “shrinking the world” by allowing the creation of a competing superpower.  As always, we will conclude with market ramifications.

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[1] The best analysis of the key role of the superpower is from Kindleberger, Charles, P., The World in Depression, 1929-39, University of California Press, Los Angeles, 1973.

by Bill O’Grady

Since the initial Greek financial crisis in 2010, economic and financial problems in the Eurozone continue to periodically emerge.  The most recent issue is that the Eurozone may soon face deflation; price levels continue to decline.  The current yearly CPI is up a mere 0.3%.  Although the Eurozone did experience a bout of deflation in 2009 in the aftermath of the Great Financial Crisis, the current flirtation with deflation is due to weak growth in the Eurozone.

Traditional Keynesian prescriptions for deflation include expanded fiscal spending and accommodative monetary policy.  However, there is no unified fiscal policy in the Eurozone, and the European Central Bank (ECB) has an unclear mandate to execute unconventional monetary stimulus measures.  Complicating matters significantly is German opposition to both fiscal and monetary stimulus measures.

Germany’s opposition to reflation policies are usually attributed to simple national interests (Germany is a creditor nation and benefits from deflation) or due to the lingering effects of the post-WWI hyperinflation.  However, we believe that a more careful examination of the historical record suggests that the experience after WWII and the Wirtschaftswunder (economic miracle) that lasted into the early 1960s has played a larger role in shaping current German policy.

This week we discuss German history from 1946 into the late 1950s with a focus on how German leaders shaped the economy and rebuilt the nation after the war.  We will pay particular attention to the economic model that German leaders constructed and show how the Merkel government is trying to impose that model on the entire Eurozone.  As always, we will conclude with market ramifications.

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by Kaisa Stucke & Bill O’Grady

Very few countries have seen as spectacular of a decline in its economic standing over the past 100 years as Argentina has.  The country started the 20^th century as one of the richest in the world, but has fallen behind as a result of its turbulent political history and inconsistent economic policies.

Argentina has been in the international headlines recently due to its sovereign debt default.  This default is the eighth default in the history of the country.  Additionally, Argentina is facing capital flight, rising inflation and dwindling dollar reserves.  The government’s response has been to tighten its grip on the economy, instituting trade barriers to protect its domestic industries and restricting capital outflows to support its official currency peg.  While this is a serious issue for Argentina and a possible concern in the general trade policy for Latin America, we do not believe that this situation will persist in the rest of emerging markets.  More than anything, Argentina’s extensive government interventions and resulting economic calamities might serve as a cautionary tale for other countries that may be considering deglobalization.

This week we will look at Argentina, its long history of economic booms and busts, its political background, and its extensive chronicle of sovereign debt defaults.  As always, we will conclude with market ramifications.

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by Kaisa Stucke & Bill O’Grady

During the first round of Brazilian presidential elections on October 5, the incumbent Dilma Rousseff of the Workers’ Party received 42% of the votes while Aecio Neves of the Social Democracy Party received 34%.  Since none of the candidates received more than 50% of the vote, the second round of runoff elections will be held on October 26.  Currently, Rousseff leads the polls, signaling a likely continuation of state-centric policies.

The results from these elections are significant for the Brazilian domestic economy as well as foreign investors.  Whether Rousseff or Neves wins, the next president will inherit a low growth and high inflation environment.  Additionally, the incoming president will have to deal with high government spending while maintaining the high social spending that the ruling party has relied on for populist support.  The growing domestic middle class is demanding an end to corruption and better social services.

Foreign investors are also closely watching these elections as a win for Neves could signal a more market-friendly political environment with better government fiscal responsibility and political transparency.

This week, we will look at the Brazilian presidential elections along with the current political and economic environment in the country.  We will briefly describe the recent political history of the country and look at the specifics of Brazil’s economic development.  As usual, we will conclude with market ramifications.

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by Kaisa Stucke & Bill O’Grady

On November 9, the Catalonia region of Spain is due to hold a referendum for independence.  The referendum had previously been approved by the regional government; however, it was ruled unconstitutional by the Spanish Supreme Court.  Currently, it is unclear whether the November 9 referendum would result in a different outcome.

This week, we will look at the separatist movement in Catalonia.  We will start by giving a brief overview of the region’s history and politics, then look at the roots of the independence movement.  We will explore the probability of independence, the potential future relationship between the region and the central government, and the role of the EU and the Eurozone.  As always, we will conclude with market ramifications.

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by Kaisa Stucke & Bill O’Grady

Last week marked six months since the Ebola outbreak was identified in the African country of Guinea.  The current Ebola epidemic is the largest, most severe and most complex outbreak of the disease in the history of the virus.  More cases have been diagnosed and more people have died than in all the prior outbreaks combined.  All 24 of the previous outbreaks have occurred in Central Africa.  The virus was able to spread undetected for months as this is the first episode of the virus to take place in West Africa.  Complicating the initial diagnosis was the fact that the symptoms of Ebola are identical to many other diseases in the region.

Ebola is a viral hemorrhaging fever that attacks the blood vessels, causing internal bleeding and leading to multiple organ failure.  Fast-spreading and fatal in more than half the cases, the virus can be easily spread through direct contact with an infected person’s bodily fluids or contact with contaminated items.  The symptoms start after an incubation period of two to 21 days, and it is believed that a person is only contagious after symptoms appear.

Since the disease is so fast-spreading and healthcare facilities so strained, it is hard to keep an accurate running count but as of the time of this writing the World Health Organization (WHO) estimates the case count is currently at 6,574 and the death count is 3,091.  Global observers believe that this number is underestimated.  The Centers for Disease Control (CDC) estimated last week that the total number of cases could reach between 550,000 and 1.4 million by January 2015.  Without a significant improvement in fighting the disease, the number of cases could double every 20 days.  We note that this estimate does not account for the recently announced funding support from the U.S. to combat the disease.

This week, we will explore the Ebola outbreak, looking at the origin of the disease, how it has spread and how it has developed into a serious epidemic.  Although it is hard to find comparable epidemics due to the complexities of the disease, we will look at a couple of other disease outbreaks in order to gain a better understanding of the scale of the current Ebola epidemic.  As always, we will finish with geopolitical and market ramifications.

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by Kaisa Stucke & Bill O’Grady

When ECB President Mario Draghi was asked at a recent press conference if the central bank would consider a negative deposit rate, Draghi answered that the institution has approached the question “with an open mind.”  This topic is fascinating in terms of alternative options in monetary policy as well as the possible geopolitical ramifications if a major currency country undertakes a below-zero rate program.  Looking back at recent history, there are two examples of European countries that have instituted negative term deposit rates since the 2008 crisis.  Denmark first utilized a negative deposit rate of -0.2% in July 2012 and then adjusted it in January 2013 to slightly less negative, but it has remained at -0.1% since.  Sweden employed a negative term rate between July 2009 and September 2010.  In both cases, the rate cut was a reaction to the appreciating currency due to large capital flows out of the Eurozone and into the perceived safety of non-Eurozone European Union countries.

We will turn our attention to Denmark to study its decision to undertake the below-zero rate, the specifics of the situation that prompted it and the effects of the negative rate on financial conditions and the broader economy.  We will then briefly look at the possibility of a below-zero rate policy for the ECB and, most importantly, the geopolitical ramifications of the decision by the world’s second largest currency block to ease into unknown consequences of negative rates to stimulate the economy.

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