Long term troubles for the US and Europe despite year end breather. Who will win?

The events of the past few weeks suggest that a forceful attempt to get things right by year end will only last for so long. The authoritative approach by frustrated central banks; Germany's clever stalling strategy with Spain; and corrections in Canada's housing market, all point to a much awaited year-end breather. This is what we want to see, but the long term outlook is still troubling.

Let's start with Spain.

On Thursday, Spain announced its budget and economic reform measures which includes planned spending cuts for 2013. The government stated that the 2012 revenue target will be met, but plans to tap 3bn euros from the Social Security reserve fund to cover pension payments was quite the shocker. 

The fact that the demographic make up of Spain skews towards the elderly, coupled with high youth unemployment means that these crucial reserve funds are not growing at a sustainable rate to accommodate the pace of payouts.  Austerity measures will lead to further slowdown with no major growth in employment, and Spain will need to find a way to meet its liability needs; a larger pool of government dependents being one of them. Policymakers need to remember that most Spanish households actually rely on the retirement payments from the elderly family member to stay afloat.

Rumors about a possible bailout request were quickly shut down by Spain's PM Rajoy, but the backdoor discussions were brought to light in exclusive reports by Reuters. A spokeswoman for Spain's PM stated that "what we are focused on is to get the decisions of the June summit on the banking union implemented...which would send a strong message of confidence to the markets." This statement indicates that Spain is getting its act together, albeit by Germany's command. Sources are hinting that Germany is signaling Spain to wait  on a bailout request. This move is highly strategic for Germany as it helps policymakers assess Spain's ability to handle its own matters. 

Furthermore, Moody's is set to announce its ratings review on Spain later this month, which was due in September. Judging from a generally positive market reaction to Spain's economic reforms, we can expect a stable outlook on Spain from Moody's. Additionally, with the ECB's new collateral rules, Spanish banks can use Spanish bonds as collateral to borrow from  the ECB. We know from Spain's stress test that the liquidity problems are not as bad as expected. Currently, the country is just one notch into investment grade at Baa3 by Moody's. However, keep in mind that a downgrade would surely cause a stir in the market. 

Global uncertainty and the US QE downplay by the rest - the winners

Shifting focus to the export based economies gives us a good idea of global growth and demand. Unfortunately all of the signs point to a slowdown. Despite China's shift in strategy causing a clear cool-down in growth, the hope for the West to comeback with demand remains bleak. The fact of the matter is that resource growth, building activity, and a strong middle class are based in the emerging world and sourced by China. Based and sourced are key words to explain the strategy - China is directly fueling the boom in countries like Australia and Brazil, but the recent demand slowdown due to a shift in focus on domestic stability in China is causing the dependent countries to follow suit and stimulate their own domestic demand.

Australia cut rates, citing global economic uncertainty, amidst worries about the end of a resource boom. The concerns are justified but short sighted. Resource demand reached its peak, but it remains strong enough to prevent a hard landing. Countries like Australia are working to boost investment at home while Brazil is implementing a comprehensive stimulus package and is working hard to foster a middle class of its own. The bottom line is that China's trading partners (mainly emerging countries) are reigning in to support a solid comeback which will be sooner than the West.

Following Canada's dovish outlook on Western friends, it was quite amusing to read the snark remarks by New Zealand's Finance Minister about the US QE program. While providing indications that the New Zealand economy has softened, FM English also stated in an interview with Dow Jones:

"It's my view that while printing money has some shorter-term benefits, there is a lot of uncertainty about the longer-term damage."

As I stated in earlier posts, the long term outlook of this snapshot efficiency is troubling. The Fed's exit strategy will be difficult and if it does produce growth in employment and housing, it will be artificial, failing to address the fundamental flaws. US private sector savings are still high relative to other countries which indicates that there is growing uncertainty to invest despite the excessive monetary stimulus measures.

Buy Gold and Silver 

My bullish stance on Silver remains. Further problems in the US and Europe and the long term resource demands from China and the emerging world all point to a rise in Silver and other hard commodities. Supply constraints in Gold and central bank easing tactics are also providing a boost. Despite Bernanke talking down inflation worries as a result of QE, the market understands that the long term prospects remain bleak, and the incentive to protect assets is stronger.  

According to GoldCore, there is a bullish 'golden cross' in Silver which points to a rally. Morgan Stanley also likes Silver. It is important to note that there are concerns about Silver being overbought at this level (matching previous highs).