Are we frogs in boiling water?
Here’s How Today’s Model Looks: China works, saves and builds. The West borrows, buys and consumes. They drive 5-year urbanization and employment targets, generating low wages, long hours, high education standards and 24/7 productivity. We have high-paid unions working 35-hour weeks; over-leveraged consumers defaulting on $10 billion a month in mortgage payments and paying off credit cards to buy new iPads; and a messy democracy beholden to special interests, and apparently incapable of making complex policy choices until forced by crisis. Chinese consumption is 35% of GDP, and they save half of their disposable income and have no real government benefits. We consume twice as much, save a fraction, and rely on entitlements that add up to a multiple of our GDP. Our nation owes China almost $1.5 trillion; and we, and many of our G-7 sovereign friends are sporting seriously distressed balance sheets.
Our Kids' Legacy
Now the Hangover. The Western debt balloon has migrated from homeowners to their banks, and now across governments, in an epic process of balance sheet contamination [El Erian term]. Yet, while moving debt around or paying it off with more debt helps short term liquidity, it does nothing good for solvency. The brand new European circuit breaker is already melting. It doesn’t really matter whether Eurozone politics converge on a set of conditions that will be either hard enough for the Germans, or easy enough for the peripherals--because every scenario looks bad for the Euro. Strong conditions probably intensify civil unrest and an early demise of the EMU, while weaker ones would lead down a more painful, drawn out path to the same place. We’re bearish on the Euro and Euro sovereign debt. U.S. Treasuries and risk assets look like a good short term safe haven, but it’s really just swinging from vine to vine.
