By Walter Molano, Guest Columnist
With the ebbing of the European currency crisis, the market is shifting its gaze to what lies ahead. In Europe, there are signs of a constitutional crisis brewing in Spain.
The sudden decision by the Catalan regional parliament to hold a referendum on the issue of independence from Spain took many people by surprise.
There is growing sentiment for independence, and it is impossible to guess what the Catalans will decide.
At the same time, the referendum is part of a negotiating strategy by Artur Mas, the president of the Catalan regional government, to extract additional fiscal concessions from Madrid after it left empty-handed from a summit with Prime Minister Mariano Rajoy.
Catalonia is trying to obtain the same fiscal autonomy that was secured by the Basque country, which is greatly credited with its economic resurgence.
Anything can happen between now and the end of November, when the regional government holds the referendum. However, it is unlikely to materialise into anything more than a display of brinksmanship and Spanish machismo.
Unfortunately, a more dangerous prospect lies slightly further on the horizon. There is a movement by governments around the world to change their fiscal positions. The problem is that the simultaneous application of tighter spending policies could be tantamount to a fiscal precipice that could have dangerous implications for the global economy.
The rumblings about the US fiscal cliff have been part of the macroeconomic background for some time.
The combined expiration of US$600 billion worth of tax cuts and spending reductions will have a debilitating effect on the US economy that could shave as much as two per cent off of GDP growth. This is in a context whereby the economy should be growing 3-4 per cent y/y in 2013.
However, with the US presidential elections just a few weeks away, it is becoming part of the electoral battle. Both sides refuse to cede ground, and it will probably take several days of market panic before a compromise materialises.
Nevertheless, the two parties will be forced to arrive at an agreement that resolves the impasse. Of course, the final agreement depends on who wins the White House.
A Republican president will most likely rely on the restitution of tax cuts and the continuation of spending reductions; a Democrat president will probably allow more of the tax cuts to expire and trim back on some of the spending reductions.
While Washington may be able to swerve before going over the fiscal precipice, other governments are applying the accelerator as they careen towards the abyss.
In the past few days, Spain and France announced major reductions in government spending for 2013 and 2014.
The Spanish government approved an austerity budget for next year that reduces government spending and increases taxes.
Expenditures will fall by eight per cent y/y, or 0.77 per cent of GDP. Meanwhile, revenues will rise by 0.56 per cent of GDP.
The French government announced similar measures, cutting spending by almost €40 billion. This is the most austere budget in 30 years, and it will raise the top tax rate to 75 per cent.
Other governments around the world are taking similar measures, thus reversing many of the expansionary fiscal policies that dominated the planet in the aftermath of the Lehman crisis.
The problem is that the simultaneous application of tighter fiscal policies will add a negative multiplier that will stymie global output. This is on top of the ramifications produced by the slowing of the Chinese economy.
This is part of the reason why commodity producers are trimming back on their investment plans and warning about the end of the super cycle. It is not so much that the global demographics are changing for the worse or that the emerging market countries will stop consuming more natural resources, it is that governments no longer have the willingness to spend indiscriminately.
Sovereign debt levels, particularly in the developed world, are reaching unsustainable levels and governments can no longer continue to spend at the same pace. Therefore, they are being forced to trim back on infrastructure investment and social-spending programmes.
Politicians around the world are taking a hard look at their social policies and asking themselves whether they support their core constituencies. Unfortunately, they do not. Therefore, they are taking steps to trim back these programmes, thus sowing the seeds for a global economic slowdown, lower commodity prices and possible social unrest.
The implication for the emerging markets is grim. Even though the macroeconomic statistics of most emerging market countries look good on paper, they are grossly overstated due to their overvalued currencies. Declining commodity prices will allow these currencies to devalue and reveal the true situation that lies below the surface.
Therefore, beware of the global fiscal cliff because the precipice that lies beyond opens into a black abyss.
Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC. firstname.lastname@example.org