CFO – 1st Quarter: More warning lights on the dashboard!

Despite the recent encouraging developments in the USA, few of the fundamental structural gaps have actually narrowed around the world.  In  fact more warning lights have started to flash around us.  It reminds me of what the dashboard looked like before the 1997 financial crisis:  An unusual fragility in the system.

Positive pop from QE II

The first quarter of 2011 has confirmed the initial promise of QE II from the Fed:  The $60 billion program translated into $3 trillion of gain in stock market valuation, pulling away the American economy from the slippery tract of deflation.  Even the unemployment rate has managed to dip below 9%.   Indeed, the American economy has seemed to gain traction.   The excess liquidity has pushed up the inflation rate here and there, notably in emerging markets, but not anywhere close (yet) to a critical level. 

But medium term concerns remain

In the USA, the heavy weight deleveraging has been postponed, for good fiscal reason. But Congress has yet to find substance in a coherent program to reduce budget deficits and the national debt in the medium term.  Dollar watchers will be scrutinizing the end of QE II, scheduled in June.  Surviving the end of QE II should prove the hard test for the American economy in 2011. In the meantime raging deficits at state and municipal levels are biting into basic services.   And a fight between public unions and bond holders, over deficits in municipal pension fund has just been ignited.

Slow deployment in Europe

In Europe, the dangers of sovereign defaults across the continent have been at the center of a cat and mouse game between banks, governments and the financial market.  The latter has been particularly edgy with Ireland and Portugal, and to a lesser extent, Spain, but most bought the arguments from politicians about the birth of a new deal for the Euro.  Much is expected from a new Euro package marked for the end of March.  The second quarter will surely test the resolve of the players.  In the meantime, the US dollar and the Euro are playing yo-yo against each other, whenever the markets shift focus to a perceived weakness on one side or the other.

Faith in China

Despite a string of capital requirement measures for Chinese banks, inflation is stubbornly cracking the 5% level.  This is good news and bad news.  On the negative side, food inflation is a headache for authorities, as it traditionally brings social disruptions.  Wage inflation, on the other hand, is likely to act as the transmitter between the export side of the economy to the domestic consumption side.   Higher wages will slow exports, but boost consumption, thereby leading to a more balanced economy.  Now that China has captured the number one spot as the largest manufacturing nation on earth, thus ending the 110-year long reign of the Americans, the rest of the world is hoping the Chinese consumer will catch up.  But as ever, we will watch the show in China on a tightrope:  Too much inflation or not, or too much heating in real estate or not, or too much bad debt in the system or not. 

A spark in the Arab world

Like it or not, a spark was ignited in the Arab world.  It is hard to tell where it is going to end, but it is not going to die soon and for good.  The upheavals just showed us how hot the  temperature was in the cauldron. Putting back the lid will not remove the pressures.  Again diplomacy, military actions and the oil markets will oddly coexist for a while.  But I suspect that fringe groups, liberal and extremists, are likely to take advantage of a tepid reaction from the West, caught off guard, unable to articulate acceptable alternatives to the Arab peoples.  

Japan takes another hit

Regrettably nature struck again in Japan, further testing the hardened resilience and courage of a nation.  It reminds us that natural and man-made disruptions will not be the exceptions in this decade.  The number of climate disasters (as registered by the insurance industry) reached 950 in 2010, up from an annual average of 285 in the 1980s, and 450 in 1990s.  Natural disasters, pandemics, terrorist acts and mini economic crises will dot and shake the landscape from time to time. 

Flashing lights.

 André Du Sault.