At last…..Spain

There’s that song, you know, it starts with “at last”….I can never remember the rest, but the tune gets in your head.  Those are the words that came to mind with this article.  As I have written extensively on this blog, the EU austerity policies are a disgrace for those imposing them, and a travesty for the depression era living standards being experienced by the millions in Europe at the receiving end.  These policies are nothing more than a wealth grab by the wealthy.  All credit to the author. 

Ambrose Evans-Pritchard is one of the better writers on issues in Europe.  Less so elsewhere.  Pithy, insightful, and old enough to know what’s best.  

In this article, about as clear as you can get on the macro issues in Euro zone, he writes of the statements of the Spanish Premier Mariano Rajoy.  In that he “point blank” refuses to comply with the Euro enforced austerity measures.  

Ambrose E-P writes in The Telegraph:

In the twenty years or so that I have been following EU affairs closely, I cannot remember such a bold and open act of defiance by any state. Usually such matters are fudged. Countries stretch the line, but do not actually cross it.

With condign symbolism, Mr Rajoy dropped his bombshell in Brussels after the EU summit, without first notifying the commission or fellow EU leaders. Indeed, he seemed to relish the fact that he was tearing up the rule book and disavowing the whole EU machinery of budgetary control.

He is surely right to seize the initiative. Spain’s economy will contract by 1.7pc this year under his modified plans and unemployment will reach 24pc (or 29pc under the 1990s method of counting). To compound this with manic fiscal tightening – and no offsetting devaluation – is intellectually indefensible.

There comes a point when a democracy can no longer sacrifice its citizens to please reactionary ideologues determined to impose 1930s scorched-earth policies. Ya basta.

What is striking is the wave of support for Mr Rajoy from the Spanish commentariat.

This one from Pablo Sebastián left me speechless.

My loose translation:

"Spain isn’t any old country that will allow itself to be humiliated by the German Chancellor."

"The behaviour of the European Commission towards Spain over recent days has been infamous and exceeds their treaty powers… these Eurocrats think they are the owners and masters of Spain."

"Spain and other nations in the EU are sick and tired of Chancellor Merkel’s meddling and Germany’s usurpation – with the help of Sarkozy’s France and their pretended "executive presidency" that does not in fact exist in EU treaties."

"Rajoy must not retreat one inch. The stakes are high and the country is in no mood to suffer humiliations from a Chancellor who is amassing all the savings of Europe and won’t listen to anybody, as if she were the absolute ruler of the Union. Merkel and the Commission should think hard before putting their hand into the sovereignty of this country – or any other – because it will be burned."

This then is the fermenting mood in the fiercely proud and ancient nation of Spain in Year III of depression, probably the worst depression the country has seen since the 1640s – or have I missed a worse one?

As for the "Fiscal Compact", it is rendered a dead letter by Spanish actions.

Gracias a Dios. If the text were enforced, the consequences would be ruinous. It enshrines Hooverism in EU law, and imposes contractionary policies without the consent of future parliaments – including any future Bundestag. Indeed, it probably violates the German constitution.

But it won’t be enforced in any meaningful sense because the political realities of the EU are already intruding, and will intrude further. A president François Hollande of France will rip it up.

The Latin Bloc is awakening.

All hail the hero!!  Both the Premier and A E-P.  

Guns a proxy for the economy

Lawd luv ‘em.   The gun club in the USA. 

This came to me via Zerohedge.  In a release by ammo.net they claim "American firearm sales and concealed handgun permit applications are at all-time highs since the 2008 election of President Barack Obama."

That’s the first sentence of the release.  It then goes on to claim that the massive rises are attributable to the President.  

Aw gee, you know, what else happened at the same time as the election of President Obama?  Could something else have put the fear of massive social tension in the hearts and minds of the population of the USA?  Let me think.

How about a global financial crisis where banks aren’t safe, your jobs aren’t safe, and in every newspaper they are writing of economic Armageddon?  

I mean who believes this stuff?  It would be good for a laugh if it weren’t the fact that guns kill.  

Anyway it is worth having a look at the numbers because it will tell you how the USA population is thinking about there personal security which is a good proxy for the economy.  

• 98% increase in Ruger quarterly firearm sales since 3Q08 from $117m to $232m
• 33% increase in Winchester Ammunition’s annual sales since 2007, from $431m to $572m
• $4 billion is the size of the USA commercial gun and ammunition market
• 48.3% rise in Federal excise taxes collected on the sale of new firearms over the past five years (well that IS good news)
• January 2012 is the 20^th straight month of firearm background check increases yoy (so still rising then;  not good for economy then)
• December 2011 1.41 million national instant criminal background checks, most ever for any single month
• 129,166 background checks on November 25^th 2011, the most over in one day and 32% over the prior peak
• 2011 increase yoy background checks are up 14.4%; January 2012 vs 2011 17.3%
• Nobody knows how many gun Americans own as a nation – somewhere between 270- 300 million.  Say, about 9 guns for every 10 citizens
• And permits to carry concealed weapons are up substantially in many states over a similar period
• And Ruger’s stock price is up 510% since Obama took office
• And on and on it goes

You’d think that this group would be rooting for Obama to be re-elected wouldn’t you.  But somehow they are able to attribute the massive increase in guns to Obama [and the resultant wealth creation in this sector] but at the same time twist the tale to make it the reason NOT to elect him again.  Go figure.

This is a country of very frightened citizens.  And this news has just blown a hole in my recent theory that the economy is looking up in the USA.  No, they are looking right down the barrel of a gun.

Someone always says it better

A big thanks to one of my readers for sending me this erudite representation.  Frequent followers will have follwed my comments "trickle up trickle down and squeeze" and "trickle up austerity". 

Trickle up austerity

If you are sitting in the US, UK, Greece, Europe and so on, and you are a member of the middle class, then you are being squeezed.  Indeed the articles are prolific in number that point to a disappearing middle class.  

And they are wrong.  It is not disappearing (well, except in your own back yard) they are in fact expanding exponentially as a global structural shift occurs.  It is expected that the global middle class will have doubled by 2050 as China India and Brazil (etc) middle classes grow.

And of course all that is about polarisation.

Income and wealth polarisation may be the late development stage of unrestrained capitalism.  Unrestrained being the operative word.

For example in the Asian economies it could be argued that as they develop the emerge(d) middle class reflects what occurred in the so called developed economies as they industrialised and the wealth spread more evenly through the economy.    

This late stage polarisation has all sorts of implications.  

Obviously, as has been discussed internationally ad nauseam, the wealth polarisation keeps growing.  As evidence of this graph for the US up to the beginning of the bubble.

And we see a consumption strike occurring by the middle class, which has material impact for retail listed companies.  However, we are also seeing the growth in dollar / euro / pound stores at the one end, and the booming high cost brands at the other.  Which is an extension of the polarisation in incomes and wealth.

So everything is either flipping or polarising; both between economies and within countries.  A disappearing regional middle class, but exploding global middle class.  Within developed economies, a polarisation of wealth at both extremes.  And the resultant polarisation of consumption. 

Now back to the unrestrained part.  The best economic period for the developed economies was when economic equilibrium was achieved as evidenced by the 50’s and 60’.  This is before these countries introduced the “trickle down” policies which we blogged about here. Called "trickle up trickle down and squeeze".

Trickle down policies tax the poor and give to the rich; whilst trickle up policies tax the rich and give to the poor.  “Tax” in one disguise or another. 

We argued that trickle down policies have irrevocably failed and it was time for a trickle up policies to be introduced.  That is, give the money to the poor rather than the rich and the wealth will trickle up through increased consumption.  Proven economic success.

But this blog has introduced another term which we like:  Trickle up austerity.  Using that new term, it can be applied to our trickle up trickly down and (middel class) squeeze theory.  In the developed economies, Trickle up austerity is what you get when you unrestrainedly crush the middle class with trickle down policies and fail to restrain the rich with trickle up policies.  Economic Armageddon.  

Greece please

Russell Short of the John Adams Institute in Amsterdam took an on the ground tour of Greece and published his observations of the effect of its three years of economic grief on the people.  This is real reporting, in the face of those faceless economists and EU policy wonks.  Please read it.

He wrote a balanced and thoughtful piece, filled with stories of people and how they are compromising  / adjusting or indeed thriving in this environment.

However if you want to see what sticking with the Euro can do to a population (think Ireland, Italy, Spain, Portugal, Latvia etc), I have picked out only a few of his words.  

A quarter of all Greek companies have gone out of business since 2009, and half of all small businesses in the country say they are unable to meet payroll. The suicide rate increased by 40 percent in the first half of 2011. A barter economy has sprung up, as people try to work around a broken financial system. Nearly half the population under 25 is unemployed. Last September, organizers of a government-sponsored seminar on emigrating to Australia, an event that drew 42 people a year earlier, were overwhelmed when 12,000 people signed up. Greek bankers told me that people had taken about one-third of their money out of their accounts; many, it seems, were keeping what savings they had under their beds or buried in their backyards. One banker, part of whose job these days is persuading people to keep their money in the bank, said to me, “Who would trust a Greek bank?”

It’s not uncommon to see decently dressed Greeks discreetly rummaging through garbage bins for food.

The crucial difference is that now well-educated young people — future doctors, teachers and engineers — are leaving, suggesting that what is taking place is the hollowing-out not only of an economy but also of a whole social system.

The loss of young people worsens another problem facing this country: the birthrate is among the lowest in the world — and was even before the crisis manifested itself — making it unable to maintain population levels.

As the Greek government adds new taxes and surcharges onto its citizens, they respond with protest or evasion.

And on a more optimistic take on the events: 

Zacharias says the troubles have rallied like-minded Greek businesspeople. “The crisis gives us the opportunity to clean the market of everyone who was trying to make something out of nothing. Then we can focus on what works: creating a real product, using real methods.”

A lot of people seem to be coming around to Zacharias’s way of thinking. According to the Greek farmers’ union, between 2008 and 2010 — even before the crisis reached its height — 38,000 people lost or gave up their jobs, as their dream of euro-capitalism died, and returned to the land, often to their home villages on the islands. Former accountants and Web designers are growing potatoes on Naxos, collecting resin from mastic trees on Chios and tending wheat fields on Crete.

Many of those who have lost jobs in the city therefore have rural homes to retreat to, though whether there is income once they get there is another matter.

And Ambrose Evans-Pritchard wrote more recently in the Telegraph:

In 2011, the Greek economy contracted, not by the forecast three per cent, but by six per cent. Sixty thousand small firms closed, and unemployment rose to 20 per cent. As bank accounts are emptied, Greeks are reverting to barter. Farmers are bringing eggs and vegetables to their cousins in urban areas. Well-dressed people are to be found discreetly rummaging in bins for food…….Remaining in the euro guarantees a generation of poverty and emigration.

Suicide rate in a country has always been a strong indicator of an economy's performance, sad but true.  But the big trends are decimation of the population with respect to its savings and future prospects as the elite educated youth move off-shore.  Communities and families re-bonding.  Abandonment of the consumption at any price philosophy.  And a return to essentials, of food, health, water and self reliance in the country. 

Which is why I keep banging on about inflation of the essentials.  It is reported elsewhere that in some parts of Greece, even Aspro or equivalent is not available.  Is that inflation?  (Theoretically no).

It is not worth it Greece.  

Default Latvia, Save Yourself

Sometimes when you go looking for trouble you find it.  Poor Latvia!! Wonderful advanced nation, intellectually and culturally,  brought to its knees by these crazy austerity policies.  

And please accept my apologies for not learning of what has been occurring there before.  Mea culpa, too much main stream media. 

So I went out and did some research on the Latvian economy over the last 5 years.  Thriving growth, with systemic flaws built in so that it could not withstand the GFC (See later).  When I think of a growth comparison, I think of China, which successfully (so far?) has avoided the painful contraction experienced by Latvia.  Evan though it is effectively pegged to the US$ (but closed capital flows).  Then when I think of its flaws, I think of Hong Kong, the pegged exchange rate (to the US$) which brought HK to its knees in the late nineties.  (With open capital flows).

Prof Michael Hudson and Prof Jeffrey Sommers of Global Research wrote about it in February 2010, referring to the policies implemented as “Latvia’s Neoliberal Policies”.  They suggest that “It is not only economic, but demographic. Its 25.5 percent plunge in GDP over just the past two years (almost 20 percent in this past year alone) is already the worst two-year drop on record.”

Then this very comprehensive report (well worth a read), speaks to the fact that it is highly unlikely to overcome its economic problems.  Written in May 2011, it first discusses the “BELLS (Bulgaria, Estonia, Latvia and Lithuania) who in their wisdom decided to adopt and then stick "come hell or high water" to a currency peg with to Euro.”

Rather than referring to the label Neoliberalism, the report refers to the country adopting an “internal devaluation”.  It used to be known as “wage and price deflation”, and is widely disparaged. This is the alternative to an “external devaluation”, ie breaking the peg to the Euro.  In the former the collective population suffer and it is severe and long.  In the latter, the pain is spread far more widely around the world, and is shallow and brief.  

We get an update on the above, with it being reported that “Latvian GDP expanded by a quarterly 1.5% in Q3 2010, by 0.9% in Q4 and by 0.2% in Q1 2011. Thus Latvian GDP has been steadily slowing, and this despite the fact that the export environment in the first three months of this year was exceptionally positive, and Latvian exports were booming. Latvian GDP fell by around 25% during the crisis, and has subsequently rebounded by 5% (over 5 quarters). We are far from a "V" shaped recovery, and pardon me if I mention it, but it is precisely the sort of thing most macroeconomists were imagining would happen.”

But it also provides the most horrific data of all, that 85% of Latvian mortgages are in Euro denominated currency.  So in effect, Latvia may not use the mechanism of an external devaluation – which is a proven successful policy path or 85% of its mortgagors will default and potentially lose their homes.

This report (again, May 2011) then goes on to show that CPI and PPI is rising, as GDP “rebound” – more like a dead cat bounce – is slowing.  That is called stagflation:  rising CPI and falling GDP.  And for growth it is reliant on exports, which represent only 10% of the economy, and of which 70% go to Europe – itself a mess.  Almost hopeless.  It is locked into a boom bust economy with a downward spiral. 

And official data shows that the population fell by 13% from 2000 and 2011.  As its youth look overseas for better paid work.  Unemployment is high at around 14%.  This WSJ also reports, that the IMF lowered its forecast GDP to 1.5% because of the worsening outlook in Europe.  

In this recent interview on the BBC of the Latvian Prime Minister gives a seemingly rational argument for internal devaluation, but who in the end wears the cost?  It has been horrific.  “Low government spending has kept unemployment high, at over 16%, which is more than in Greece. And even those still in work say that wages are often too low to survive on.  "Over the last two years, 200,000 people have left the country, and a lot of households remain deeply in debt, unable to pay," says economist Alf Vanags. "Huge numbers of people are at risk of poverty when they otherwise wouldn't have been."  Also the people seemingly have virtually no effective trade unions, so no one other than the government to fight their corner.  And it is locked into do or die EU relationship.  

Default I say, forgive % of the mortgages or go 1:2 conversion so the relationship to earnings and loans is reasonable, and let the banks go bust.  They are mostly Nordic or Swedish anyway.  Then set up banking co-operatives:  they are always more successful (well there are some bad stories, but if managed to the spirit of co-operative financial services, they are the best model.  AND they are owned by the people, not the global institutions).  

And as with many things there is an unlikely precedent.  In the late 90's Asian crisis, the South Korean economy remained in the doldrums.  The government introduced through its banking system [local] credit cards for all, and I recall there were tax deductions for interest rates.  This policy was intended to encourage consumption to give the economy a boost.  And it did.  But of course it then went too far, and people could not repay the new debts - being a country of savers and few debts, they were not prepared for the discipline of debt.  So the debt recovery experts for the banks started to get heavy with the defaulters, there was mass outrage from the people, then there was mass defaults.  Effectively a credit card repayment strike across the country.  You guessed it.  The banks in the end had to write off massive losses. 

I mean, if 85% of Latvian mortgages are in Euros to external banks, what's the loss?  If you all go on strike, then some resolution will have to be reached. 

85% of mortgages in EURO is a significant systemic flaw.  Currency risks should always only sit with those that have the wherewithal to manage them.  That is not the general population.  Default Latvia I say.  Let go of the peg, and let the losses fall where they may.  And you will have a vibrant economy again real soon.

Which is of course the last thing the French / German doom mongers want.  Because you would then be competing for their business. 

Inflation inflation everywhere

We have been writing about the quickest way to resolve the Euro crisis, and in the UK and increasingly less so, in the USA.  There is a long history of taking your losses within a broken economy hard and fast.  There is then generally a real hit to GDP, many people out of work, government steps in with funding to finance new job growth as the private sector contracts, and within a short space of time there is a turnaround in the economy and it starts moving up.  Not rocket science.

During this period the central bank cleans out those banks that have made the lending mistakes, supporting those that will survive by pumping funds into the financial system for liquidity purposes, and pushes down official interest rates with the intention that lower rates will flow through the financial system into the economy to bolster consumption. 

So far so normal.  The key point is that there is a sharp contraction, and then a quick turnaround.  The McKensey Global Institute report ran the numbers and proved what us old hands already knew.  

This time round though, there have been a few problems.  First of all the GFC was bigger than previous crisis, so the pain to be taken deeper.  And the central bank in the USA, EU and UK ran out of short term rates to bolster the economy.  In the UK, it was so bad the government stepped in to take over the broken system.  And in Europe, they are taking the proven wrong road of actually taking no losses at all and saving all the financial institutions whether or not they are rotten or not. Plus counter growth policies of austerity. 

And that is how we got the new “normal” central bank economic bolster of Quant Easing.  

Well we all know this right? 

But this will be the outcome.  Inflation.  Written so eloquently by Nick Carn in Prospect Magazine.  He says it is either “bad debts or inflation”.  Meaning, Europe especially, either write off the bad debts and take the pain or expect rampant inflation as you pump money into the system.

And he is not alone, including your scribe.  But the central banks using quant easing (or derivatives of) are all playing along the yield curve, pushing down market expectations of inflation, and inflation is also not being seen in the official data.  As I have written previously.

I believe that the inflation genie is still there.  With the central banks dancing up and down the yield curve, one thing is very obvious:  the extensive money being pumped into the system is not leaving the balance sheets of the banks and entering the whole economy.  Yet.  But it will.  For the moment there is a serious credit crunch in most developed countries.  

Instead, for example, in Europe, UK and USA, the quant easing money is being used by the banks to buy up government debts / gilts.  Some suggest this is for better liquidity buffers within the system.  But that will not fix the broken economies.  Nor the banks for that matter.  The weak should fail.  

So in our view it is inflation delayed not averted.  And there are a host of problems waiting to emerge.  

Of course, as Lord Molson said (1903-1991): "I will look at any additional evidence to confirm the opinion to which I have already come." So I would agree.

So let’s look at another perspective.  Very interesting analysis here on the blog Macrobusiness.

In the blog he applies futurist Ray Kurzweil’s exponential IT curve to the financial sector.  When it has entered other sectors (than IT) it has seen the costs of products reduced to near zero.  Think the music industry and recordings, the price of which are now nearly negligible.

The problem he observes is that the problem with this effect in finance, is that it leads to self referring feedback loops that don’t occur in other industries.  Because the product in financial sector is of course:  money. This is because we measure the value of money, with money.  “And because something cannot be measured by itself, then we have lost the most important role of money — its function as a store of value. To measure the value of something effectively, by definition you have to have something else with which to measure it. “

Well I agree with the latter, and fall into the camp bemoaning the loss of gold as a store of value against which the production of money could be measured.  But it is all too late now, the genie is out of the bottle and being printed like there is no tomorrow.  We are literally drowning in money.

So I am going to take his argument further.  What does this mean for inflation?  If the price of money (unfortunately measured against itself) is going to fall and fall and fall as the price of other sectors that have experienced the IT exponential curve, then there is no inflation unless it can then be measured against what money can buy you.  So you would then expect that it would take more and mroe money to buy the same things, ergo inflation.  But this inflation is not showing up in the official statistics (yet?).

Of course another way to describe that is just devaluing the savings of the population; or deflating values of assets and income.  And we know that is already happening in most developed economies. 

It explains a lot about finance and its massive growth without seeming inflationary effect (so far).  But again I think that this is also illusory. As the value of everything in monetary terms falls in price, so then does the value of essentials rise in my view.  Especially with the rising middle class (in this generation to be 4.8 billion) and the shift in dietary wants to protein dense food.  

So I am going to return to the essentials.  Here I wrote about the potential bubble in farmland prices.  But what of the price of food, water, energy, and health?

I will end on this graph from good old trusty Investmenttools.com for the feeder cattle futures in the USA.  That looks like food price inflation to me.  Click on the graph to see a larger version.

And another tip.  If you put a US$1,000 in the bank you will earn interest rate of maybe 1%.  If you buy a cow for that amount, you will get an 80% annual return from each calf.  Now that is real investment returns, huh!

And social instability rising from this devaluation of all our money?  This erudite summary of what occurs, what has occurred, and the timing, is another of those “why write what has already been written so well”.  But it is not good news.  Although he does argue that there is a consumption strike by the general population who have been so unfairly treated in the distribution of the wealth of the economies in trouble.  That could suggest why inflation is benign, indeed in the assets and revenue of the general population there is deflation.  But he warns so clearly that this dissatisfaction will soon grow into collapses of those economies, whereby the elite also suffer. 

But they will still need food, energy, health services and shelter.  The essentials.

Australia economic decline confirmed

Whilst on the subject of Australia, we wrote about the dramatic rise in Australia’s unemployment rate in our blog.

Now this is being confirmed in other areas.  There is quire a severe credit crunch occurring.  It is either from lower demand, or it is from banks adjusting their lending criteria so that the hurdle is higher.  Either way this is going to seriously hurt the economy.

Credit is growing at the slowest rate in recorded history, 34 years.

Property prices are also off, in some areas by more than 30%, a psychological threshold for mortgage lenders.  Like they used to say in the USA, house prices have never fallen in all states before.  Well Australia’s rule of thumb is house prices have never fallen 30%.  Official data shows that they are down 8% nationally in real terms in the past 12 months. 

And the RBA has now cut the economic forecasts, but not lowered its interest rate as many expected.  The latter lack of action is simply to enable it to have big firing power should the global economy tank, with rates presently at 4.25%, one of the highest rates in the developed world.  If it has to fire the gun, then it has ample room to do so to recharge and protect the economy.

However, this action is less and less a successful tool for the RBA, as the banks grapple with rising cost of funds and pass it on to borrowers.  Just as with Asia before the Asian crisis, much of the banks borrowing is from offshore, and they are wearing the margin expansion caused by the Euro Crisis.  They are price takers in the global financial system, and despite the government guarantee, their costs of financing are rising.  Who knows what they would be without the guarantee, but the government is unlikely to allow that to be learnt.

And household borrowers in Australia have the highest debt in developed economies of 105% of GDP.   Substantially greater than the European countries about which we are all so worried.

After all, it is pretty obvious what happens if the RBA shoots that interest rate bullet and fails.  The next step is Quant Easing and who knows what future.  If there has been any benefit to UK, USA and Europe from QE, it is hard to find.  

So all you European and Brittish people wanting to move to Australia for work and sunshine, take a good look before leaping.

Pear Shaped in AU

Travelling in the EU last year, it was difficult to avoid the Euro crisis and the recession in the UK.  Everybody had both on their minds.

Especially in the UK, young people were speaking of moving to Australia for jobs.  And probably the weather.

In the meantime, over late summer things deteriorated evan further in Europe and the UK, just as things appeared to be settlng down in the USA. 

The Aussie dollar is rising again as the boom to gloom sentiment in China is now back to boom.  As China goes, so goes Australia.  But what my compatriots in the UK failed to realise is that Australia is experiencing a two speed economy.  It is being hollowed out by the resources boom / China.  Not dissimilar to the hollowing out of other countries' economies when China turns up.  Think Asian crisis.

Australia:  Boom in resources, gloom in all other sectors.  Which are in contraction.  This is confirmed by the central Bank, the RBA, dropping interest rates twice over the past few months.

Which has not affected the Aussie dollar oddly enough.

If any further data was necessary, Australia got it overnight.  Unemployment has reached a high of 10.3%.  That is 1,278,000 people out of work.  Australia's highest ever number of unemployed, and the highest unemployment rate for a decade.

It gets worse.  A further 7.5% of the workforce were under employed:  937,000 people.   Yep, that makes a total of 2,215,000 un/deremployed, 17.8% of the workforce.

This data is provided by Roy Morgan, a renowned research company in Australia, and the graph of the last ten years is here.  With further analysis.

As goes unemployment so goes property values.  And Australia had its first national decline in 2011 in many years.  There are many doomsayers about the property market in Australia.  And certainly at a price of 5.6 times average salary (down from over 6 times) it is one of the priciest in the world.  But those analysts overlook the oligopoly banking sector in Australia, that has a much greater capacity to manage the downside because of the closely held nature of the mortgage risk.  Just four banks, more than 80% of mortgage lending, and they all learnt the lesson of the early 1990's when they all four rushed to dump their security [homes] on the market at the same time.  Since then, it has been a seemingly collusive approach to loss management.  And consumer laws are far more restrictive when compared to USA for example.

All the same, odd that everybody sees what they want to.

Also overnight, the USA unemployed rate fell to 8.3%.  Well below that of Australia (although the measure above is unofficial).  Yet in my travels I still here how well Australia is doing. 

Maybe it is all that vitamin D from too much sunshine?

Baffling Belief in Government Promises

It is election year in the USA and elsewhere and, again, we will vote for the leaders of the free world.  Politicians will make promises, and depending on our age, we will believe them.  Then the politicians will break those promises, sometimes because there has been a dramatic change in circumstances.  But inevitably, promises are more often than not broken. 

And the USA and Japanese governments, and elsewhere, will issue their government bonds.  To pay for the fiscal deficits or to repay (rollover) previous bond issues.  Or in the case of the UK, gilts.  These bonds are a “promise” to repay the principal and interest (coupons) at some time in the future to the investors that buy the bonds.  They are unsecured. 

Given that governments have an overt track record in “not” keeping their promises, why do we keep believing them?  Its baffling.

Japan has recently experienced its first balance of trade deficit for 31 years, or since 1981.  That is, the value of its imports was greater  than its exports.  Its current account remains in surplus, because international investments made over time continue to pay returns.  This latter means its income from exports and offshore investments in aggregate are still greater in value than its imports.  However the balance of trade is a big indicator of its future capacity.    

In mid 2011, its debt to GDP was 512% and most of that is the government’s with 226% of GDP.  By way of contrast, USA is 80%, Ireland 85% and UK 81%.  However it owes approximately 95% of that to its own population so it does not have to stare down the international investing community as Greece and Italy do.  The Japanese believe their government will repay the debts. 

What has stirred up the hornets nest however is the expectation that Japan over the near term will develop current account deficits (“CADs”) as well as trade deficits.  And then they will need to use the investment capacity of international investors to fund those deficits.  There are many reasons for this and it is covered well by Reuters and The Japan Times.

CADs are not necessarily a bad thing if you have the future capacity to repay the debt used to fund the deficits.  This could come from raising taxes, economic growth, or printing new money.  However, Japan is not in this position.  Hence the raging debate that it may soon not be able to pay as promised.

Yet it is not alone.  Over decades in international banking, many countries have defaulted on their debt.  Wikipedia has a comprehensive list of the defaults going back centuries, but would it shock you to know that of all the countries in the world only 8 have not defaulted in the last century.  They are:  Sweden, Portugal, The Netherlands, France, England, Malaysia, Denmark and Australia.

Countries that have defaulted, in some cases multiple times include Africa (22 nations), Americas (27), Asia (14) and Europe (22).  So when considering the EU crisis, or the Japan potential crisis, and government defaults, remember that it is easier to list those that have not defaulted than those who have.

Pesek of Bloomberg wrote last week of a debate occurring between Krugman and Fingleton about Japan.  What is extraordinary about this article is that he ends it with this statement “It doesn’t take a Nobel Prize to know that paying off debt gets harder when you’re running out of people”.  Referring to Krugman, of course, whom he supports in the debate.

There it is.  There is the red flag.  We know today that Japan already has little hope of paying on its promises.  Yet merrily we go on our way believing the promises of governments all over the world.  

Given the extraordinary number of defaults over the centuries, the probability is that governments are not going to pay it back by honouring their promises.  Is it a case of get out or get over it? 

Take losses hard and fast

As any good trader will tell you, take your losses hard and early.  Another is take losses and let your profits run.  Another is the first loss is the best loss.  

A recent report by McKensey Global Institute makes this point (with far greater research) strongly when it comes to turning around collapsing economies after a banking crisis. It considers debt and deleveraging, the pace of same, and the road to recovery depending on its pace and its depth.  

This is the first bit of contemporary research that points the finger directly at what is wrong with the EU response to their problems.  It states the bleeding obvious.  Here, I referred to the single most important symptom.  Once the diagnosis has been made, then the medicine can be taken.  And in this case the medicine is writing off all the bad debt that is unlikely to be repaid.  Do it quickly, and painfully, and then move on.  The report concludes:

“…history shows that, under the right conditions, private-sector deleveraging leads to renewed economic growth and then public-sector debt reduction.”

And again this is not rocket science.  This is what has occurred in most successful economic turnarounds in the past fifty years.  I know because I was there [along with many others of course].  And this is why it is so difficult watching the machinations in Europe.  Not only have the wrong symptoms been identified, but the wrong medicine is being applied in the form of austerity measures.   

What occurred last August was a liquidity crisis.  That has now been appeased by the ECB.  But the underlying illness is massive losses sitting on the balance sheets of all the banks.  The deleveraging the McKinsey report refers to, is not just people / companies paying off loans.  It is includes massive write-off of bad debts. 

McKinsey concludes that “deleveraging proceeds in two stages. In the first, households, the financial sector, and nonfinancial corporations reduce debt, while economic growth remains very weak or negative. During this time, government debt typically rises as a result of higher social costs and depressed tax receipts. In the second phase, economic growth rebounds and then the longer process of gradually reducing government debt begins.”

Their examples illustrate that an “economy is ready to resume sustained growth after private-sector deleveraging when certain conditions are in place: the financial sector is stabilized and lending volumes are rising; structural reforms are in place to boost productivity and enable GDP growth; credible medium-term public deficit reduction plans have been adopted and restore confidence; exports are growing; private investment resumes; and the housing market is stabilized and residential construction is reviving.”

As mentioned here, austerity programs don’t work.  Governments increase debt during the difficult times – when markets have failed – and decrease debt during the good times.  

There are some other conclusions to draw as well from the report.  USA has been pretty swift in taking losses, and indeed continues to do so right at the retail level.  Indeed, its economy looks to be far more advanced than I anticipated and suggests an earlier recovery than many realise.

Frankly, the UK looks very troubling; however this was covered comprehensively by The Telegraph.  And especially as its debt level has just passed GBP 1 trillion for the first time.

And another standout is Australia.  It has the lowest government debt by far (21%), but it has a jaw-dropping 105% household debt to GDP.  Substantially greater than Spain (82%), Italy (45%) and Greece (62%) and ranks second only to Ireland at 124%.  And as Macrobusiness analyses in some depth, since the GFC, household debt has increased A$222 billion.   Makes that aussie dollar look a little wobbly frankly. 

Back to the EU.  Let the banks stop fiddling their balance sheets and go bust. 

Italy beggared

If you glanced at Ambrose Evans-Pritchard’s column today (The Telegraph), you would have felt your blood pressure rise.  What an absolute shocking graph – with data that would make most central bankers and knowledgeable pollies sick with worry.

The graph shows that Italian M1, M2 and M3, all measures of money supply, at the end of last year were all negative.  In fact severely negative.

A E-P calls this horrendous; and that Italy is forced into this position, criminal.  And I agree.  He superbly summarises in one sentence the entire scope of the problems and causes of the Euro crisis  “This is a direct result of the misguided pro-cyclical austerity polices imposed by Angela Merkel and the ECB – the infamous Trichet letter – without offsetting monetary and exchange stimulus.”

As an international investment banker, if a client sought advice about investing in Italy, I would say “never”.  It was renowned as a wholly insider traders market [what ever the assets or market or region] and lawless.  It was impossible to obtain all the relevant information required for a successful investment – that is – to make a fully informed investment decision.  It was the only country about which I had this point blank refusal to deal.

A little over a week ago, Confesercenti (a prominent employers association in Italy) released a report outlining how the mafia is now the country’s biggest business, including with cash reserves of 65 billion Euro.  The Telegraph outlined all the horrific details.  And this goes to the heart of why I would never deal in Italy.  The mafia, who is now gobbling up legitimate assets by the truck load, on the cheap, at the expense of the local populace.

Also railing against the country, is Ms Merkel and her cohorts:  Dumb and dumber!!  She actually praises Italy publicly for implementing its tough austerity reforms;  that we know are driving the country's assets into the arms of the mafia at a faster pace than any other strategy / policy could.  

Or maybe she and Sarkozy are keen to buy up Tuscany on the cheap for themselves. 

This austerity policy exercised in the EU – to crush everything so that in the end it is forecast everything comes out okay  - has been definitively disproved as a policy on numerous occasions.  That statement can be confirmed by back testing:  no other countries has successfully done this.

In Asia during the late 1990’s crisis, the Asian crisis as it became known, several countries were forced into a similar horrific austerity policy by the World Bank, or was it the IMF, before they would receive a bailout.  It crushed the economies, the people, and heads of governments (think Suharto) and Indonesia, Thailand and the Philippines are only now really gaining traction.  More than a decade later.

Malaysia could see that the cost to the people would be too harsh, and effectively closed its borders, implemented capital controls,  and told the IMF and its austerity policies to f-off.  How the world leaders jumped up and down spitting fire.  Its recovery was faster, its people less distressed, and its international standing returned to its former glory.  Indeed it had only one year of GDP contraction.

Sarkozy and Merkel could learn from Asia.  But they won’t.  Elitism at its finest. Instead they will beggar the Italian population, hand their assets to the mafia, and have cheap holidays.  Poor Italy!!

The Euro Crisis and the Media Exposed

Any attempt to wade through the media reports and political quotes on the Euro crisis would have left you more befuddled than ever.  As I wrote Will Someone Please Inform British Prime Minister Cameron, the terminology used, and media reporting, was almost unintelligible for any senior banker.  Let alone the general populace.

And when the various EU governments had a final crisis meeting in November, I all but gave up.  

My favourite self exposing quip was President Sarkozy suggesting that banks could borrow from the European Central Bank (“ECB”) at 1% and lend to Euro governments at 6%.  Like he had just invented the wheel.  I mean that’s what banks do for goodness sake.  Maybe he had only just realised it? 

In my blog I diagnosed the Euro problem as “This is a global sovereign and systemic liquidity crisis.  Underlined individually because each word has a specific meaning in finance.”

First up, Mario Draghi, the new President of the ECB made an announcement of a major bail out for the banks on 8 December; due to commence on 22 December.  He didn’t call it that, but that is what it was as I will explain later.  He at least understands the issues.  And he did confirm my diagnosis as this being a liquidity problem;  without the correct diagnosis, you cannot fix it. He said:

“In its continued efforts to support the liquidity situation of euro area banks, and following the coordinated central bank action on 30 November 2011 to provide liquidity to the global financial system, the Governing Council today also decided to adopt further non-standard measures. These measures should ensure enhanced access of the banking sector to liquidity and facilitate the functioning of the euro area money market.”

His speech in full is here, and for anybody interested in the facts as opposed to what has been reported, it is well worth a read.  The actual ECB press release is probably too complex for non bankers, but it is here.  

But what does it all mean?    Well the only media report that I read that made sense and was accurate was by Floyd Norris of the New York Times.  And I would highly recommend it.  He wrote ”It would do only what central banks normally do. It would lend to banks. It turns out that may be enough to stem the European crisis for at least a few years, and go a long way to recapitalizing banks in the process.”

And I agree with his conclusions.  This action has pretty much finalised (wrong word), stabilised the Euro crisis as it has become known; for a period.  

Mr Norris did make one error however; he referred to this as “normal”.  It is not normal practice.  Banks should not be bailed out for liquidity purposes.  The raison d’être of the entire financial regulatory system is to ensure that there is not a liquidity problem.  Ever. From risk management, through to all the capital and liquidity ratio hurdles banks are meant to maintain.  

And there is another issue.  Bloomberg has battled with the Fed Reserve to obtain full disclosure on how much that central bank used to liquefy its banking system (including off-shore banks – European).  During 2007-2009 crisis, at its peak it lent a total of US$1.5 trillion to 407 banks.  That is an average of US$3.7b per bank.  Although the calculations are more complex than this simple averaging and the full article should be read.

The ECB’s offer is for unlimited funding up to a maximum of 3 years maturity.  And on the day it commenced it gave 523 banks a total of US$640 billion.  Or a simple average of US$1.2 billion each.  Not a lot frankly, but its scale as in the number of banks who tapped the borrowing is frightening.   

But the bad news is this.  Despite bailing out the banks, and the mini boom (or dead cat bounce as it is called) the Fed’s response did not save the economy.  It went on to use Quantitative Easing – dancing up and down the yield curve on a further two occasions during 2010 and 2011; and still people are only talking of a green shoot economic recovery.  Hardly encouraging for Europe. 

What is most extraordinary about the Euro bailout though is that it did not happen before it reached the critical stage.  I mean, it is not as though they were re-inventing the wheel.  It has been done recently, by the Fed Reserve.  That is in recent memory exactly the same bailouts occurred.  In fact, the solution is so obvious in banking terms, it beggars belief.