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Don't Worry, Be Happy!

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As the Bobby McFerrin song goes.

I never thought the day would come when I was so nauseatingly sanguine about the prospects for markets and for many major economies (although not the Eurozone, of course). Let's start with China.

I definitely do not fall into the camp that believes China is a powder-keg waiting to explode, leading to global financial and economic Armageddon. The reason the western banking system was almost able to achieve this was that the bursting of the mortgage-backed securities bubble also split asunder the virtuous circle of over-indebtedness, both private and public, that could only ever stay inflated in an era of unbounded confidence. Confidence in all its forms -- confidence in the unlimited supply of cheap funding, confidence that borrowers, public and private, were solvent and able to repay, confidence that house prices could only ever rise (a view apparently supported by Bernanke as, in 2005, he said, rather embarrassingly in retrospect: "We've never had a decline in house prices on a nationwide basis".)

Now, institutional over-indebtedness may well have become endemic in China, but certainly not amongst individuals, and the whole pack of cards is, as ever, dependent on the same 'confidence trick.' Although China's sensible determination to rebalance its economy away from investment-led growth and towards consumption is no doubt weighing down on headline GDP, in the Chinese tradition the measures will be introduced gradually and pragmatically, as evidenced this week by senior leaders' comments. Whilst Vice Premier Zhang Gaoli said that the government would "expand domestic demand," he also assured us they would "try every method to provide funding to support SMEs, exporters, and technology firms." Premier Li Keqiang was quoted as saying that the government would "prevent economic growth from slipping below the lower bound."

However, the real difference is that the Chinese administration has an embarrassment of riches at its disposal, amongst which are its foreign exchange reserves. Let's suppose the Chinese banking system managed to wipe out its entire capital base of roughly $1.5trn as a result of property loan losses. China has $3.3trn in foreign exchange reserves alone, which it could quietly use to rescue the banks. I suspect we'd never even know anything had happened. Don't worry.

But what about the Eurozone? Portugal, Greece, Cyprus, even France, surely we face a summer of popular discontent on the streets? Nope. The lesson of the Eurozone crisis is 'don't worry,' the Germans and the ECB will ride to the rescue. Sure, there'll be a to and fro over austerity measures, wrestling with the balance between creation of moral hazard in the South and ensuring the Euro's survival, and the ECB can only go just so far without driving the Bundesbank over the edge, but I believe the complicated nexus of self-interests means we have reached a state of equilibrium. This is admittedly an inherently unstable equilibrium because of the absence of a fiscal union but, once Merkel has won her election that, and its sister, banking union, will be front and centre and suddenly on the cards. Right now she can't say so, because of the election, but she knows the Euro won't survive another five years without them. Don't worry.

But what about Ben, he's letting go of the cyclic isn't he? The helicopter's going to be grounded. Probably, but actually not definitely, as he was at pains to emphasise in the Q&A session, following his recent speech at a National Bureau of Economic Research conference. It all depends on the data and, oh, he assures us they are actually also worried that inflation may be too low. I think we've seen the bulk of the rally in Treasury yields for now, meaning the next couple of months, with 2.40 percent/2.80 percent the probable range for 10-yr Notes, but Q3 will see less fiscal headwind, impressive economic data, heightened expectations for the rapidity of QE tapering, and yields heading through 3.0 percent, on their way to 4 percent by this time next year. For the next few months, I think the stock markets can live with this scenario -- if data is weak, QE will go on longer, if data is strong, then companies are going to be more profitable. Taper-shock is rapidly fading . S-weet. Don't worry.