Jed Brewer's quarterly economic forecast

Leading economist remains upbeat for convenience as his previous forecasts regarding recovery come to fruition.

Last year in this letter (April 2009), I wrote about the peculiar difficulties Europe might face in recovering from the financial crisis. The major concerns I had were the shaky fiscal conditions and the degree of indebtedness of some European nations and the fallout that could move throughout Europe should these debts default, which then could easily dampen a European recovery. At that time it was clear there were many issues that needed to be dealt with on the horizon but it was unclear which nation or region might ultimately pose the most significant problem to overall European stability or how far away that horizon was.

In that letter I asked the rhetorical question, “Where will the funds come from to cover these debts if and when they default?” Principally I was concerned about the lack of a mechanism within the European Union to handle sovereign nation crises. As I stated, “The European Central Bank (ECB) is a relative infant in handling cross-border issues of this magnitude.” It caused me to ask, “How effective will it be in withstanding internal pressures and making tough decisions, which may come at the expense of a sovereign member nation?”

Today we are approaching a tipping point within Europe. We now know it is Greece that poses the most significant present threat to European stability. But frankly it could almost as easily have been Spain, Portugal, Ireland, or others. We also are gaining a better understanding of how difficult it is to solve cross-border issues when monetary policy is unified but fiscal policy and cultural norms are far from unified.

Greece has limited opportunities with not really any good ones to choose from. The normal process for handling a domestic crisis would be for the IMF to intervene by offering bridge loans at high rates coupled with a devaluation of the domestic currency. Currency devaluation is not possible since Greece is using the euro. So pressure would be placed on prices and wages to deflate, and wage reductions are rarely received favorably. IMF support may also undermine confidence in the euro more generally and increase yields on its bonds.

Bailouts from other EU members are another possibility. But they are being understandably vehemently resisted. Not only do others not want to bailout Greece for missteps the country has made, others also have limited ability to take on more debt when they are already in a precarious financial position. Over-extension could also undermine confidence in the euro and drive up yields.

Another resolution would be for Greece to exit the European Union, reissue a sovereign currency, and subsequently devalue it. The devaluation will essentially cram-down debt at the expense of Greek bondholders. But what kind of precedent would an exodus from the European Union set? Would the union employ the same strategy when others face trouble? We do know others will face trouble. So if that is the game played in times of crisis, then why even have a union at all? A severe recession probably can’t be avoided in the country under any of these options but in the latter option it might be avoided throughout the union as a whole.

It will be interesting to see how the situation in Europe develops over the next several months, which option is chosen, if the European Union becomes increasingly strained, and what the impact will be on business in the area. We need to be prepared for the possibility of even tighter private-credit conditions throughout the area. Thankfully fuel prices are not at their 2008 peaks.

While I am still concerned about the risks in the global economy at large (especially Europe), I am persistently sanguine about the prospects for the convenience retail and retail fuel industries. In the US, at least, inside gross profit dollars have shown steady per store growth the last couple of years in difficult economic conditions, and retail fuel volumes have shown more correlation with the level of fuel prices than with overall economic activity. Consequently, per store fuel volumes have been rising recently and fuel margins are gravitating around their long-term norms.

Uncertainty creates winners and losers. The challenge of the entrepreneur is to wade through the sea of the unknown and create or position a product or service that will succeed in any eventuality. The entrepreneurs in this industry to date have shown an ability to do just that.

Dr. Jedidiah Brewer is vice president of FRMC, Inc. (www.studygroups.com)

Jed Brewer: uncertainty creates winners and losers