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A Year of Great Political Risk

2016 is shaping up to be fraught with political risk.

For one thing there’s a U.S. presidential election. Meanwhile, the Middle East has descended into an even bigger mess than usual, and nobody has any expectation that it’ll improve soon.

Vladimir Putin is likely to take chances, seeing a weak U.S. administration in its last year.

Japanese debt is increasingly a worry, and could go critical in 2016.

Finally, there’s a distinct possibility of a credit crisis, probably in the fall before the U.S. election, the traditional season for them.

Hillary or Trump?

The likelihood is that the next U.S. president will be a protectionist supporter of crony capitalism.

Unfortunately, my crystal ball is too cloudy to tell whether that president’s name will be Donald Trump or Hillary Clinton.

But both candidates are protectionists who believe in erecting barriers to international trade (some of Hillary’s barriers are environmental and regulatory, but that makes very little difference).

Both candidates are also crony capitalists, having innumerable friends (and in Hillary’s case, contributors) among Big Business.

And both believe in some of the more egregious ripoffs of recent years, such as the 2005 Supreme Court decision in Kelo vs. New London that allowed governments to seize your house and replace it with some business’s pet project.

The small chance of a non-crony capitalist outcome is dwindling quickly and will be gone by March.

Globetrotting

Internationally, the main trouble spot will be the Middle East, where nothing good ever seems to happen.

Without strong U.S. leadership, ISIS will continue to grow, and terrorist atrocities will likely recur.

Vladimir Putin will be unhelpful in Syria and will seek to expand his control as far as possible in the last year of the Obama presidency. Putin learned from his experience in 2008 that the U.S. is almost always weakened before a presidential transition.

I’d probably rather be Ukrainian than Syrian in 2016, but not by much.

Iran will also expand its influence, although quietly, since it wants to build up its oil export business and get hold of the $100 billion worth of international reserves blocked in Western banks.

The one saving grace is that, for oil exporters like Russia and Iran, cash will be short while oil prices remain low.

Latin American economic performance will probably improve, as the commodity-exporting countries adjust to lower commodity prices, President Macri stabilizes the Argentine economy, President Rousseff pursues orthodox economic policies in Brazil (and is boosted by the Olympics), and the opposition Congress takes control of Venezuelan economic policy.

Unfortunately, it may be a case of too little too late.

Latin America has for years frittered away the proceeds of high commodity prices that ought to have brought rapid growth. Now, better policies may only produce a marginal improvement in performance.

Still, for foreign investors, every little bit helps, and the improved climate should lead to big increases in investment in Argentina, in particular.

Alas, Japan’s economic performance won’t improve. The country may well exceed a public debt ratio of 250% of GDP at the end of 2015, and it shows no sign of cutting deficits or getting the growth it needs to reverse the steady increase.

The chance of a Japanese debt default in 2016 is probably small, no more than 10%, but on present trends that chance will increase steadily thereafter.

If we have a global downturn, default seems inevitable, which will affect the global economy only moderately. But by wiping out Japanese domestic savings, it will make Japan once again a relatively poor country.

Finally, Europe probably won’t break up in 2016. However, 2017 is a different story…

Credit Concerns

A small junk bond fund has already been forced to liquidate, and there are doubtless more such events to come.

The rise in U.S. interest rates that seems inevitable won’t have much direct effect, but if there’s bad news, it may well cascade.

The Fed would then reverse its slow interest rate rises (which are unlikely to reach more than 1% or so in 2016, lower than inflation).

While much of the U.S. corporate sector is highly liquid, it’s also heavily indebted because of the steady stream of buyouts since 2010. Thus a full-scale “credit crunch” is likely, probably in the fall, making an expected Hillary Clinton victory over Trump much less certain.

One can only hope that it won’t lead to a tsunami of job losses as in 2008-2009, which would make 2017 a thoroughly miserable year.

Good investing,

Martin Hutchinson