Italy!

Market and Economic Update –  Week Ending 1st June 2018

“If you have one economist on your team,
it’s likely that you have one more than you’ll need.” 

Warren Buffett

• I mentioned last week that Italy was starting to look a bit unstable politically, which may not sound important, however the make up of a government, particularly in the case of Italy, can have a significant impact on the direction of an economy. For example (I am oversimplifying), a newly formed government appealing to populist ideals can be voted into power in a country but not necessarily hold the country’s economic situation in high regard.  In other words, they can be busy appealing to the masses by doing things that actually hurt the economy and ultimately (ironically), hurting the very people that they are trying to appeal to.  It is a funny world we live in – isn’t it?! 

• The reason the market reacted this week to what is going on in Italy is because of the so-called ‘contagion threat.’ In short, the risk is that Italian politicians might stop following the rules of the Euro zone or possibly even look to ditch the currency.

• Italy is the third largest economy in the Euro zone and it counts for 15% of the region’s economic activity (as measured by GDP).  The point here is that they are much bigger than Greece, which was one of the causes of the last Euro zone crisis.  With political turmoil in Italy, we have uncertainty, which the market does not like.  The problem is that a yet to be formed government could do things for the people but to the economy that are damaging. 

• Italy’s history of stagnation and lack of reform has seen Italy’s debt increase to more than 130% of annual economic output. As the chart above shows, Italy is one of the most indebted nations in the world – not good when they are as large as the Italian economy.  Obviously, should Italy’s direction not line up with Euro zone policy or in perhaps a more extreme case, should Italy decide to exit the Euro zone or stop using their currency, that contagion effect starts to look more real. 

• Global debt has been talked about of late, with the numbers, depending on who you listen to, coming up at around $164 trillion or 225% of global GDP. What is interesting is that this number was as at the end of 2016. 

• How is this for a number? US national public debt stands at US$21,078,301,250,985.42 as at the end of April 2018.  It is without doubt a large number.  That said, as I have mentioned on previous occasions, whilst accumulating debt is less than ideal, the US has a unique package that will enable it to continue to manage the debt on an ongoing basis. 

• Sure, there is any amount of internet jockeys proclaiming the end of the US economy because of the amount of debt that has built up. Maybe that is true one day, however that has been talked about for decades.  Also, whilst those same internet jockeys argue that central bankers are losing their grip and ability to control the markets, I am not convinced.  Governments and central banks have a vast array of macro prudential tools at their disposal.  There are a significant number of tactics that they can deploy and I would argue that the so-called ‘day of reckoning’ for the US economy is unlikely to be something that we will see in our lifetime.  This does not mean that there may not be short term crises that emerges from time to time.  My view is that the American economy, because of its unique package (let me know if you would like to know more about that) will sort it. 

• Back here in New Zealand, mycoplasma bovis looks like a serious matter and has certainly been in the news of late. Without doubt, it is having a significant impact on some farmers.   It cannot be easy for them. Although we will need to wait and see how it plays out, this does not look as though it will be the downfall of the New Zealand economy anytime soon.  I do wonder about the government’s actions of culling cows from the point of view of the disruption to milk supply. 

• As you know, the New Zealand Government has decided to contain and eradicate the disease. In my opinion, if they think they have got a shot at it, then why not give it a go? The reality of course, is that it appears to be easier said than done.  Mycoplasma bovis is a tricky disease that is not easy to deal with. 

• The government has undertaken a ‘phased eradication’ of mycoplasma bovis. There is provision that those farmers significantly affected under this type of emergency should not be left out of pocket because of it. Hopefully that is true because after all, particularly those smaller farmers are business people and every day kiwis just like you and I. 

• On the other hand, I suspect if WISEplanning fell into financial difficulties because of a global financial crisis, the government would pile yet more complexity, legislation, regulation and costs upon our business and not bail us out anytime soon! Anyway, many other countries live with this cattle disease and life goes on.  Whether or not the New Zealand Government can contain it and eradicate it, remains to be seen but good luck to them if they can.  Either way, this disease at this stage is not harmful to humans and apart from the disruption to milk supply and other issues that I have not considered in the short term, whilst this is without doubt a very serious matter, I do not believe it will significantly impact on the New Zealand economy in the long run, at least the way things look at the moment.  In the short term though, it is a difficult issue and will prove interesting for the government, the farmers and the bankers as they attempt to navigate their way through the challenges of the mycoplasma bovis disease. 

• Elsewhere in the world, it appears that trade tariffs are back in fashion with the US applying tariffs to the European Union, Canada and Mexico just yesterday. I have been suggesting that I do not believe it will come to much but right now.  It is definitely still on the table and it will be interesting to see how it continues to play out. 

• Should trade tariffs turn into trade wars, then we have a real threat to global economic growth. Basically, trade tariffs or trade wars slow down economic growth and is not what the world economy needs.  At the same time though, there is no point in worrying about things that have not even happened yet.  The global economy is growing at a reasonable pace and whilst trade tariffs turning into trade wars is a potential black swan, I do not see that happening (not that I can predict the future) and at this stage, I still do not see any sign of other ‘black swans’ on the horizon in the immediate future.  Steady as we go …