By Richard Daughty, on April 30th, 2010
Toby Connor has an essay posted at goldseek.com with a title that I find very intriguing, namely “The Strong Hand Theory” because it sounds like it could be all sorts of terrific things, ranging from a new Sherlock Holmes mystery to “How to destroy brick buildings with a karate chop with your bare hand and impress girls!”
Unfortunately, Mr. Connor does not offer either any help in impressing girls by demolishing random commercial property, or entertainment with a story of the famous detective noticing the strength of a man’s handshake and goes brilliantly on from there to cleverly solving a murder mystery using mere wisps of clues, unlike the Securities and Exchange Commission that can’t even recognize blatant frauds even when they are repeatedly pointed out and the evidence is dumped on their desks.
It reminds me of how that little snot Arnold, from the accounting department, keeps showing my boss his stupid charts and stupid printouts that prove, so he says, that I am the worst employee the company has ever had, and my stupid boss wants to know if I can explain any of that, and I say, “Of course I can explain it! Arnold hates me, and he is a lying piece of crap that likes to hang around playgrounds and talk to cute little boys about joining the Nazi Party!” and of course Arnold, all flustered and upset, says, “That’s not true! None of it!”
Naturally, my back is against the wall, afraid to go home to face my wife and tell her that I have been fired from yet another job, I pressed the attack by replying, “That’s just what you filthy Nazi pedophile bastards always say! Fire him! Castrate him! Kill him!” which must have been a better retort than I thought, because he never brought it up again when I was in the room!
Anyway, this is not about Arnold, but that you, as an American, should be buying gold, silver and oil in response to the governments of the world, especially that of the USA, deficit-spending double-digit percentages of GDP, all financed by the central banks of the world creating the huge expansions in money, and how inflation in prices will soar in response to all of this new money, making gold, silver and oil go up in a huge, multi-decade hell of roaring inflation, starvation and murderous social discord, worse and worse, misery upon misery, until a Strong Hand arises to seize control of the world, and all people fall to their knees to worship The Mighty Mogambo (TMM)!
Okay, Mr. Connor did not say that, but since I am sure that gold, silver and oil will be worth whole multiples of their current prices, “the only way to lose money in a secular bull market is by trading” which is, as funny as it seems, pretty much exactly right!
And if you want to know the one investing strategy that always comes out best over the long-term when investing with a secular trend, it is Dollar Cost Averaging, a mindless system where you invest the same number of dollars each month, regardless of price.
And that is only part of the reason why I extol the virtues of the Mogambo Can’t Miss Portfolio (MCMP), loaded to the gunwales with gold, silver and oil, and, bristling with all the firepower that the Second Amendment allows, gives one the courage to say, “Whee! This investing stuff is easy!”
The Strong Hand of Silver originally appeared in the Daily Reckoning.
By Claus Vistesen, on April 15th, 2010
With so much going on at the moment and so many themes fighting to claim the main market discourse, I am in the mood for some random shots. First of all and to my continuing regret I have never actually got to thank Niels C. Jensen from Absolute Return Partners for the nice coverage I got way back in October 09 when Mr. Jensen discussed my thoughts on demographics and the life cycle.
So, let me repay by pointing towards Jensen’s recent two monthlies which form the basis for this round of random shots. Both are very much worth reading and in some sense they go together to form a common narrative, but especially the second one where Niels is blowing echo bubbles is mandatory reading I think. The themes taken up by Niels are well known and so is the underlying narrative, but this does not mean that it is not worth repeating; I will Niels set the scene;
In last month’s letter I looked at the challenges confronting the world’s baby boomers based on the assumption that we are in a structural equity bear market, which implies below average returns for equity investors for several more years to come. Central to this forecast is my expectation that household de-leveraging, which is now underway on both sides of the Atlantic, has much further to run. In other words, we are in a balance sheet recession. When that happens, debt reduction becomes the priority. Savings rise and consumption falls at the expense of economic growth.
Please note that this forecast is predicated on a 5-10 year time horizon. Within a structural bear market – which is characterised by falling P/E ratios – it is certainly possible to have cyclical bull markets, so it is by no means one-way traffic. As you can see from chart 1, since the 1982-2000 structural bull market came to and end, we have enjoyed two powerful cyclical bull markets; however, global equity prices remain at 2000-levels.
(…)
However, this is not the same as saying that it will always be a losing proposition to invest in equities. Equities can, in fact, do quite well for long periods of time despite the negative undercurrent. This is what the perma-bears do not understand. They assume that structural bear markets equal negative returns and that is not necessarily the case.
Thus and to clarify, what is referred to here as an echo bubble is the rally we have seen since March 2009 and thus evidence that while structurally, deleveraging and low trend growth will be the main driving force, that does not mean that equities cannot and will not perform extraordinarily well for long passages of time. I mean, who wouldn’t wish that they bought with everything they got back in March (I know I myself feel a bit peeved over not piling in).The broader issue of course is that while smart money may very well learn to navigate such an environment the smart dumb money (i.e. those who buy and holds the market) may realize that the reward from such a strategy may turn out to be less than splendid. And since this is basically a proxy for the return on savings, it means that permanent income will fall which means that consumers will need to save relatively more to compensate, and then we get the problem of a lack of consumption and aggregate demand and … on and on we go!
On this, I agree that deflationary v inflationary forces will feature a tug-of-war for many years to come and, like Niels, I tend to favor the former. However, when pointing to Japan as an example of how continuous attempts have failed to spur inflation (and is still failing) I do think it is important to qualify that this goes strictly for domestic inflation. In this sense, what has become known as the Yen carry trade (and recently USD carry trade perhaps?) is merely a proxy for much broader and structural tendency which signifies how central banks have lost control over where the liquidity they provide is applied. This goes in both direction. In Japan, the liquidity create slips through the back door and ends up e.g. in Brazil or New Zealand who, in order to combat domestic inflation, are busy increasing interest rates only to that it sucks in more liquidity (or, if you will, purchasing power).
Clearly, with US rates stuck at near zero this provides a huge push for global liquidity and even though I think that the US (and the UK) will eventually succeed in getting inflation (and quite possibly, a lot of it), the fact that these economies may withdraw liquidity slower rather than faster represents strong sheet anchor for excess global liquidity and thus although we may be in a structural bear market, it is also a market with a high level of volatility.
This leads me to the following three themes I am following at the moment inspired not only by Niels’ thoughts but also by the recent themes laid out in Variant Perceptions monthly (which is sadly not available online).
1. I accept the idea of a structural bear market but interpret it as investment lingo I guess for broader macro reality that we are now in a situation where we need to delever and that will be deflationary in domestic OECD economies (i.e. this is German austerity writ large). This, I would assume, is tightly connected to lower trend growth. In this sense, demographics (which I tend to focus on) and the defacto excess leverage (regardless of underlying capacity) serve as a ball and chain and it represents a structural break both in terms of behaviour by part of economic agents but also in terms economic growth.
2. Higher volatility. Why? Because just as Japan may fail in creating domestic inflation and just as the US/UK may find it hard to create domestic inflation (although at some point they will, for sure!) they may all create inflation and bubbles elsewhere. Please do read this again if you did not have the chance.
I guess it goes back to the premise that while we may in a situation where growth and equity returns (beta!) are sluggish, we will still see bull markets that lasts (well the current one is running on a year now no?) and more importantly; there will be economies who are able to suck up excess liquidity but they are outnumbered by economies with a desire of excess (external savings) and this is what leads to volatility in asset markets and the real economy.
3. Who is running the deficits? This is an old time hobby horse of mine, but still one which is extraordinarily important. In short; where will bubbles form and why? Emerging markets seem certain. But more importantly and using demographics as a yardstick the equilibrium is changing. Thus, we are all ageing, so we are all moving towards the same “preferences” for a high level of desired external savings as well as more and more economies will struggle with domestic deflation. How this ends is still an open question and it is also the straight line my theoretical work draws into the real world.
Lastly, and now moving with some truly random shots, I think Niels has some interesting points on investors and commodities and how these markets are not really suited for the kind of activity they are seeing. This is of course a direct effect of all those who really think that we are heading to hell in an express elevator and that the fiat system is collapsing etc. You all know the story I guess. Yet, after having looked recently at Chile and thus copper, I am sure that here is a metal which looks very, very bubble prone! Finally, Niels touches on China and the fact, as we have talked about, that as China moves into a trade deficit would a freer Yuan actually appreciate? Or would it in fact depreciate? Well, we will see soon enough I guess since it turns out that Niels was right here. Consequently, news has just come in off the wire that China posted its first trade deficit in six years in March as the trade print came in at a $7.24 billion deficit. Q1-10 is still a surplus but is this the first signs of true and real rebalancing? Well, color me (very) skeptical here that China will be pulling the global economy anywhere through a trade deficit that is not based e.g. on stockpiling of base metals and other commodities, but the ball is in my court as a skeptic with these latest numbers I fully accept this.
By Richard Daughty, on March 18th, 2010
I got a disturbing email from Bianco Research which showed a chart of “Private Credit Market Debt” which they say shows “Total credit market creation not including Treasury Debt, Municipal Debt and Agency Debt”.
It is actually a horror that the level of private debt peaked last year at about $36 trillion, which is certainly a lot of money, especially since total GDP of the Whole Freaking Country (WFC) is only $14 trillion (and falling!).
In some kind of bizarre “good news/bad news” joke, total private debt has now actually fallen by a couple of trillion dollars to $34 trillion, which is bad news for an economy that depends on consumption, but is good news in that people have lighter debt burdens.
David Stevenson of the Money Morning newsletter at moneyweek.com notes that it’s not just us, but “private borrowing is slowing everywhere” and that “US consumer credit has shrunk for a record 11 months in a row.”
The interesting thing is that the Bianco chart goes back to 1952, and there has never, ever been a time when private credit market debt fell by as much as a dime! Although it, sometimes, did not go up for short periods, nevertheless, it has never gone down. Never!
Until now. Oops!
Note that the soundtrack has gotten all gloomy, which makes sense, because if total private debt has – gasp! – gone down, then the money supply is not expanding because people are not borrowing to buy and invest. Oops!
Parenthetically, the money supply is not actually shrinking that much, as you would expect, because the asinine neo-Keynesian theory says that the government should replace private spending with deficit-spending, which they do, thanks to the Federal Reserve creating the money, which is another whole subject about which usually results in a loud Mogambo Scream Of Outrage (MSOO), which is, I think, more of a wail of anguish and crushing despair than a scream, although it usually concludes with me howling, wolf-like, “We’re freaking doooooooooommmmed!”
That’s, unfortunately, the bad thing that happens at the end of long booms produced by constant monetary stupidity, especially of the kind of stupidity found at the Federal Reserve, which explains why I say, with a loud, irritating repetitiveness that makes people run screaming from the room every time I open my mouth, to buy gold, silver and oil as your only defense against rampant government stupidity and insane levels of monetary over-creation of money and credit, as redundant as that actually is because of how incestuous they are.
I assume that you now understand the depth of the ignorance, stupidity and depravity of the government and the Federal Reserve (and, indeed, all the central governments and central banks of the world), and you are saying to yourself, “Hey! The Loud Mogambo Idiot (LMI) is right! Maybe he is not as stupid as everyone says!”
Fortunately, that knowledge is all that is required to be a Junior Mogambo Ranger (JMR), and now that you have begun on your path to economic enlightenment, I can let you in on a little secret; it’s going to get worse. Much worse. Much, much worse. Worse than anything, even that time when your First True Love (FTL) dumped you and started going out with that jerk from the baseball team, and how you still hate him for it, even after all this time, and you still love her in spite of it, even after all this time.
But you are not here to listen to my tale of love gone wrong, desperately loving someone who doesn’t love you, and rejects your aching heart over and over, and when you call her on the phone, her father answers and says, “My daughter says you are a creepy little rat-faced creep, so why don’t you just give up, kid?”
And so I did, on the spot, saying a final goodbye to her, through him, and with a tearful, heart-broken voice, and I told him to tell that scheming little lying two-faced cheating slut he calls his daughter, as a parting gift of wisdom from me, to “Buy gold, silver and oil when your idiotic government allows unrestrained creating of money and credit, and especially when the government deficit-spends said money to expand itself”, thinking, you know, that I would leave her with a fabulous piece of advice by which she could always remember me fondly.
Instead of him saying, “Well said, intelligent young man! I shall be honored to relay your wise advice to my daughter, and I shall act upon it at once myself!” he said, “What in the hell is that supposed to mean, you little punk?”
So I told him that he was obviously a moron about monetary policy, fiscal policy and raising demonic daughters and, judging by his reaction, burned another bridge behind me.
But I won’t need it! Hahaha! I have gold, silver and oil, and with them I can build all the new bridges I want, with riches untold, when his precious dollars and dollar-denominated assets turn into the crap that fiat currencies always become.
And his daughter, the tramp Carol? Now it shall be I who says, “Scram! Ya creep me out, loser weirdo!” Hahahaha!
Private Debt Decline: Good For US Bad for the Economy originally appeared in the Daily Reckoning.
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By Richard Daughty, on March 15th, 2010
I was laid out on the couch, which I remember distinctly because my wife was yelling, “If you’re going lay down on the couch instead of doing something around the house to help me out, at least take your damned shoes off!” and I was using the remote to idly flip through the channels on TV, hoping to catch something in the vein of happy mindlessness, maybe something in the Gilligan’s Island-Bewitched genre, so that I did not have to keep track of a complicated plot and/or a bewildering cast of multi-faceted characters.
I needed this kind of mental break to take my mind off of, for one thing, the sheer horror of today’s economic situation and how we are So Freaking Doomed (SFD).
Finally, I happened to catch a moment on CNBC just where Larry Kudlow was correctly making fun of Greece for saying that it will raise taxes and cut spending in an effort to get its ludicrous deficits and preposterous budget under control, and he had a deliciously snotty, supercilious, sarcastic attitude (the True Mogambo Way!) towards the idea of raising taxes and reducing spending as an economic stimulus of some kind! Hahaha!
I was with him all the way, too! And I had a few choice things that I wanted to say to Greece, too! Most of my complaints about Greece are about how Greek salads always seem to come with a damned oil and vinegar dressing that is terrible until you add some sugar, then it’s pretty good, so why in the hell don’t they add sugar to start with, the lazy bastards? God knows they had the money!
And then to add sour ripe olives to the mix – which is more of the same, only worse! – makes me want to jump to my feet and shout, “What is the matter with Greeks that they would they would do such a terrible thing to an otherwise delicious salad?”
So with Mr. Kudlow on the case to make sure that Greece gets its act together, I am sure that their deficit problem will soon be resolved, and this salad dressing thing will soon be a thing of the past, too, which may be part of the reason why I thought he was really good for about, oh, three seconds, which is about as long as the average period of time that I usually agree with Mr. Kudlow, or my wife, or my kids, or my boss, about anything.
The aforementioned three seconds during which I agreed with Mr. Kudlow is because he said something scornful in a rapier-like rebuttal, something like “Raising taxes and cutting spending is not the answer!” which is true.
But it is only true because there IS no answer! To even ridiculously assume that someone can come up with a plan to dissolve consumers’ debt and simultaneously pay off their creditors – the fabled “win-win” situation! – is ludicrous! Hahaha! Beyond ludicrous! Hahaha!
Mr. Kudlow and his little panel of “experts”, however, ignore my scornful laughter and the way that Icky Mogambo Spittle (IMS) shot from my lips, and implied that there really is a solution to this problem out there, somewhere, anywhere, maybe over here, maybe over here, which would marvelously, and magically, enable debtors to get rid of their debts without paying anybody anything, and creditors to get all their money back without being paid anything by anybody! Hahahaha!
But I understand that it’s Mr. Kudlow’s job to take positions on monetary, fiscal and economic policy that are the opposite of mine, because my job is to stay away from the majority, and his job is to get people to join the majority.
My position is so antagonistic because in these three cases, “the majority is always wrong.”
The majority is wrong in encouraging monetary insanity by always yammering for more and more monstrous Federal Reserve money-creation to buy the fiscal insanity of Congress’s avalanche of new government debt to fund Obama’s spendthrift imbecilities, which will cause inflation in prices, which is The One Big Freaking Thing (TOBFT) that you don’t ever, ever, ever want to have, which means that you can never, never, never allow excessive amounts of money to be created in the first place.
The majority is wrong on economics because they still, laughably, believe in the proverbial “free lunch”, a childish fiction where somebody gets something and nobody has to pay for it, and the majority are willing to bankrupt themselves, and destroy their own country, by letting Congress try to provide a free lunch to anyone and everyone who walks up with a hand out or a sad story.
And the biggest reason to go against the majority is in investing, because it’s less than a zero-sum game, and thus the majority must lose money and be bled dry by a ghoulish financial services industry (that is so large that it makes up 70% of all profits made in the country, and thus pays most of the taxes, which are actually paid by the “investors”) so that a minority of people (hopefully, me!) can make money despite being bled dry by the financial services industry and despite paying taxes on the gains. “Investing for the long term!” Hahahaha! I snort with derision! Snort!
So you can see why my natural anti-establishment makes me pound the table for gold and silver simply because the majority ignores them!
Okay, the real reason is that today’s dire economic condition, due to a staggeringly incompetent government and incompetent citizenry, has been played out thousands of times in the last 4,500 years, and in each case, the only thing that saved anyone’s butt was gold and silver.
There are those, of course, who say, “That explains why you are buying gold and silver, but it does not explain why you are always screaming at people to invest in oil, as well as in gold and silver.”
Well, since you asked, I say invest in oil because it has the most energy per cubic centimeter, and now that it is used in practically everything everywhere, nobody in the industrialized world can live without lots and lots of it, with guaranteed continual rising demand, but it is being rapidly depleted. Rising demand and falling supply? Who could ask for more in an investment?
As for those who go on to say, “Well, that is pretty convincing, alright, but it doesn’t explain why you are such a hateful, disrespectful, little creep”, I admit that, no, it doesn’t.
Bet Against the Majority. Buy Gold. originally appeared in the Daily Reckoning.
By Claus Vistesen, on March 9th, 2010
Well, it might appear that my smug headline in the post below may not have been so appropriate after all. At least I find the news from the FT today that Eurozone members, headed by France and Germany, are considering to set up an internal IMF type fund very significant.
(from the FT)
Germany and France are planning to launch a sweeping new initiative to reinforce economic co-operation and surveillance within the eurozone, including the establishment of a European Monetary Fund, according to senior government officials.
Their intention is to set up the rules and tools to prevent any recurrence of instability in the eurozone stemming from the indebtedness of a single member state, such as Greece. The first details of the plan, including support for an EMF modelled on the International Monetary Fund, were revealed at the weekend by Wolfgang Schäuble, the German finance minister.
“I am in favour of stronger co-ordination of economic policies in the EU and in the eurozone,” Mr Schäuble told newspaper Welt am Sonntag.
If France and Germany can agree on such proposals – long urged by Paris – they are likely to set the basis for the most radical overhaul of the rules underpinning the euro since the currency was launched in 1999. The German thinking emerged as George Papandreou, the Greek prime minister, flew to Paris to seek the support of Nicolas Sarkozy, French president, for his government’s drastic austerity programme.
“We must support Greece, because they are making an effort,” Mr Sarkozy said before the meeting. “If we created the euro, we cannot let a country fall that is in the eurozone. Otherwise there was no point in creating the euro.”
His words appeared to underline the greater readiness in France than in Germany to provide some sort of financial support or guarantee for the Greek economy. Angela Merkel, the German chancellor, insisted that no such support had been sought or discussed when she met Mr Papandreou on Friday.
Both France and Germany agree Greece should not turn to the IMF for support, so the idea of an EMF has clear attractions for Paris, though it could hardly be set up in time to help Greece. Mr Schäuble said: “We are not planning a competitor . . . to the IMF, but we do need an institution for the internal equilibrium of the eurozone that would have at its disposal both the experience of the IMF, and comparable intervention mechanisms.”
According to German thinking, the plan could include tough penalties for eurozone members that fail to curb deficit spending or run up excessive government debt. Ideas include cutting off countries that fail to curb deficit spending from EU cohesion funds, temporarily removing their right to vote in EU ministerial meetings and suspension from the eurozone.
Those may prove very difficult for France to swallow, given its own record of greater fiscal laxity than Germany.
Needless to say, this would draw the wrath from Euro skeptics and those, in general, opposed to tighter cooperation among Eurozone member countries. However, as Munchau argues splendid in another FT piece today; a monetary union needs a tight political and fiscal supranational framework to really make it work. Now, we must choose which solution we prefer.
By Richard Daughty, on February 23rd, 2010
Eric Fry here at The Daily Reckoning is “reporting from the Golden State with the tarnished finances”, which was a riddle that I instantly knew was, of course, California. But, for some reason, I never get asked a question when I know the answer. I usually get asked, instead, something like, “For 40% of your final grade, what is the principal export of California and total tonnage exported, expressed in kilograms per fortnight?”
Well, as much as I have enjoyed this jaunt down memory lane, the fact is, as Mr. Fry points out, that California “is facing a budget deficit this year of about $40 billion, which is roughly equivalent to 2% of the state’s $2 trillion economy (GSP). That’s”, he says, “dismal.”
At that display of stoic calmness, I held aloft a shot of tequila and toasted his amazing serenity in labeling California’s $40 billion budget deficit to be merely “dismal”, mostly because there are less than 100 million workers in the entire private sector of the US, and this $40 billion represents $400 for each and every one of us private-sector workers in the Whole Freaking Country (WFC)!
My voice a sudden peal of thunder, I shout, “In the Whole Freaking Country (WFC)!”
Immediately, I thought Mr. Fry’s eyes would glaze over in one of those, “Oh, hell! The Mogambo is yammering about something and he never shuts up!” expressions of disrespect and outright loathing, but instead he decided to just change the subject, and with that, he left this global hemisphere, and went to Greece, completely on the other side of the globe!
As my brain skidded to a shuddering stop at the sudden change of vector, he went on, “But over on the Mediterranean, Greece’s budget deficit is on track to hit $50 billion, which is a very big number for an economy that is one fifth the size of California’s. In fact, that’s a horrific number.”
At this point, I think that vomit, tinged with blood, coming out of my mouth and crapping all over myself in pure terror about such financial calamity speaks more eloquently than mere words allow, and Mr. Fry filled the sudden void with, “What’s more, Greece’s accumulated debt totals $443 billion – a whopping 113% of GDP.” Gaaaahhhh!
So, to distract both you and me from any acts of hysteria caused by such fiscal insanity, I ask you the following question, that will constitute 40% of your final grade: “If you were the prancing, preening, know-nothing, government-leech blowhard who wanted a shot at fame and glory by fixing what cannot be fixed, with lots and lots of other people’s money, while paying yourself and your friends handsomely, what would you do?”
Well, since this constitutes 40% of your final grade, I decided to get a little help to make sure I knew the answer, and I emailed Mr. Fry this very question. Either he did not know, or he just rudely decided not to answer either my original email or the follow-up phone call where his stupid answering machine said that he was “not available” and that I could leave a message “at the beep” and that he would call me back, which I did, and where I said, quite plainly, so there would be no mistake, “Call me back, and if I am not here, keep calling me and leaving messages proving that you called, or I’ll kick your butt, Fry! I’m not kidding!”
Well, whether or not this means anything, he does seemingly answer the question when he writes, “Well, the correct answer is the pricing of credit default swaps (CDS) on 5-year bonds from California and Greece. (Simply stated, a CDS is an insurance policy against default. The higher the CDS price, the higher the cost of the insurance).”
Of course, I understand none of this because I am tragically stupid, pathetically ignorant, am too lazy to do anything about it, and thus totally disinterested in the whole concept, which means that it all sounds like gibberish to me, especially since the bottom line is always the same; losses are on the books, somebody is going to have to take the hit.
Fortunately, mastery of such complexity is unnecessary for me, as I just buy gold, silver and oil, which will benefit mightily as the government and the Fed ruin everything with their deficit-spending of more and more fiat money. Whee! This investing stuff is easy!
Calm in the Face of Fiscal Insanity originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”
By Rok Spruk, on December 7th, 2009
Douglas Holtz-Eakin, former CBO director, discussed the negative effects of the new fiscal policy in the U.S (link).
By Claus Vistesen, on November 23rd, 2009
“In my view … it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s.” Bernanke (2009)
Executive Summary
- Compared with the average quarterly value of GDP in 2007-08, the first two quarters of 2009 are down in nominal terms to the tune of 15.9%, 15.4% and 10.5% in Lithuania, Estonia, and Latvia respectively.
- The average quarterly current account deficit of the Baltics from Q3 2008 to Q2 2009 was mill 500 Euros. This amount to just 18% of the average quarterly current account deficit two years prior to the crisis. Consequently, the Baltics have delevered to the tune of 80% over the course of less than 1 year.
- In the two first quarters of 2009 (relative to Q1-2006 to Q4-2008), imports have contracted 16%, 33% and 11.5% more than exports in Lithuania, Latvia and Estonia respectively.
- In Euro terms, the Baltics have lost external financing to the tune of bn 1.87 Euros in the first half of 2009 compared to the peak of the boom which amounts to 12.6% of the entire region’s GDP in the same period.
The quote above from Fed chairman Bernanke is ripped from the introduction of a recent conference paper drafted by international economics icons Kenneth Rogoff and Maurice Obstfeld who suggest that the financial and economic crisis that is currently making its presence felt across the global economy, at least in part, has something to do with the notion of global current account imbalances. Now, and in all modesty, this is something I have argued extensively at this space and in this way I welcome the likes of Messieurs Rogoff and Obstfeld in the fold. I tend to go, of course, for the big prize in my stubborn persistence on the link between global ageing, global imbalances and thus by way of deduction the economic crisis as we have come to know it.
Now, I am not going to treat this link here but merely point to the rather obvious question at this point in time, in the form of whether in fact the crisis itself has been a catalyst of re-balancing? At a first glance this would clearly seem to be the case. In a crisis driven decisively by a violent process of deleveraging, those economies who had hitherto relied on borrowing have now been forced to scale back (and essentially correct either through a debasement of their currency, internal price correction, or a combination of these two) and the nations that had delivered the funding have likewise been forced to accept that their external surpluses have shrunk in a comparative manner.
So far so good then, but what happens when we have to get the patient out of intensive ward; who will run the deficits and surpluses and what size will the imbalances, if any, be. This is a difficult question to answer, but it appears that with the US economy now being effectively forced to correct its external imbalance (be it with Europe, China, Japan et al kicking and screaming or not), we have a situation with a lot of would be exporters and very little importers.
If this is the general set piece, it was with some interest that I read this VOX.eu piece by Mr. Richard Baldwin and Ms Daria Taglioni which dryly submits the thesis that although it may appear that rebalancing is occurring, this is only as a byproduct of the crisis. From ther horse’s own mouth;
Global imbalances are shrinking at a fabulous rate. This column argues that these improvements are mostly illusory – the transitory side-effect of the greatest trade collapse the world has ever seen. A global recovery will almost surely return the US, Germany, China and others to their old paths.
Not exactly the prospect we were all hoping for, but in the main I agree with this point except of course the small and important qualifier that the US economy will have to deleverage and reduce the external (and indeed internal) borrowing. Whether Germany, Japan, China will also need to export … well, this is ultimately a question of finding a customer.
Rebalancing the Baltics?
The obvious question to arise at this point is obviously what all this has to do with the Baltics? Well, in a direct sense not a whole lot since as the Economist so famously put it, the Baltics remain piqsqueaks and whether we observe current account positions, of either negative or positive pedigree, at some 20% of GDP it won’t do much to affect the global imbalances. However, in the light of the idea of rebalancing on the back of the economic crisis and whether this is sustainable let alone feasible, the Baltics become very interesting not least since they have chosen (or have been led into) a process of rebalancing through internal price deflation (devaluation) as their currencies, for now, remain fixed to the Euro. In that vein, I thought it interesting to have a look at how the Baltics have faired so far with a specific focus on the external balance.
Beginning however with a general view of the correction so far the picture is definitely one of a hard landing on the back of the economic crisis.
Most of the readers of this space will be well acquainted with travails of the Baltic economies (and in particular, the near collapse observed in Latvia earlier this year). In all three Baltic economies the Euro value of their GDP peaked in 2007-08 and has since fallen back dramatically. Compared with the average quarterly value of GDP in 2007-08, the first two quarters of 2009 are down in nominal terms to the tune of 15.9%, 15.4% and 10.5% in Lithuania, Estonia, and Latvia respectively. The Baltic economies have lost bn. 2.2 Euros worth of GDP in 2009 from the GDP output observed in 2007-08 which amounts to a loss of some 21% of the average value of the quarterly GDP output for all Baltic economies combined from 1999 to 2009. In short; these economies have taken some blow to the kidneys and even if we can safely say that the levels of nominal GDP observed in 2007-08 were unsustainable the way down is still rough, very rough.
On the price front the correction has indeed begun and the graph above actually underestimates the current bout of price deflation as it smoothes away, as it were, the fact all three Baltic economies are in deflation on a m-o-m basis. Only Estonia registers deflation on my representation with Latvia basically hovering at the 0% line and Lithuania still producing inflation rates at some 2%.
Moving on to the external balance it is worthwhile splitting up the analysis by having a look at first the import/exports picture and then grinding down to the income level and finish off with a look at the financial accounts and thus the inflows used to finance the deficit (or how the surplus is invested abroad).
This is perhaps the best picture of the Baltic correction there is and nicely illustrates the point emphasised by Baldwin and Taglioni that the correction of imbalances, at this point in time, has been very much forced upon the deficit economies. Consider consequently the average quarterly current account deficit of the Baltics from Q3 2008 to Q2 2009 at mill 500 Euros; i.e. at the point when the crisis made its mark decisively.This amount to just 18% (!) of the average quarterly current account deficit two years prior to the crisis. This means that the Baltics have delevered to the tune of 80% relative to the level of the current account deficit observed up to the crisis. Again and with the benefit of hindsight, we know that these levels were unsustainable, but please do remember that it was only back in the H02 2008 that we were discussion whether the Baltics were going to have a hard or a soft landing. It is remarkable to note the example of Latvia here which has gone from a current account deficit of -17.6% of GDP in the period 2007-08 to a current account surplus of 14% of GDP (mill 681.3 Euros) in Q2 2009 due mainly to the fact that imports and GDP have plunged.
This point in particular is important to emphasize since the extent to which we are able to talk to about a sustainable (or benign if you will) process of rebalancing rather than one entirely driven by a sharp correction in internal demand and thus imports. The intuition tells us that Baltics are currently subject to the latter form of rebalancing and thus it remains to be seen whether there is a virtuous circle of increasing competitiveness and rising export shares (and values) on the back of the current vicious circle. But just how vicious is the current circle then?
The graph to the right attempts to answer this question as it plots the equally weighted average of the evolution of exports and imports in the Baltics. The time series corresponds to the value of exports and imports in million of Euros of the three Baltic economies and is indexed with the average quarterly value between Q1-1999 and Q2-2009 of imports and exports as 100.
The graph easily shows how imports have contracted much more than exports and it is consequently here that we must look for the driver of rebalancing in the Baltics. If we take Q1-2006 to Q4-2008 as the peak of the boom (in terms of the external deficits), exports are down 10.8% in the first half of 2009 whereas imports are down a full 33.4% in the same period. This suggests that more than anything that rebalancing in the Baltics are currently driven by a sharp contraction of domestic demand. Splitting up the result on the three economies and looking exclusively at the second quarter of 2009, imports have contracted 16%, 33% and 11.5% more than exports in Lithuania, Latvia and Estonia respectively.
Another way to look at this is to approach the external deficit from the financing side and consequently have a look at the inflows used to finance the external deficits. In principle, you would normally and in the perfect world mainly look at portfolio and investment flows, but in the case of the Baltics we cannot neglect credit flows which, through all those Euro denominated loans supplied by Scandinavian banks, have been instrumental in driving the external deficits during the peak of the boom. If we begin with the inflows as a share of GDP we observe the drastic way in which the financing have been withdrawn in the context of the crisis.
Observe in particular the Latvian situation where an external surplus has been forced upon the economy, proxied here by “negative” inflows and thus outflows. In Lithuania, the total sum of important inflows had declined, as a share of GDP, to 60% in Q2-2009 relative to value recorded during the peak of the boom (Q1-2006 to Q4-2008). The corresponding figure for Estonia is 23% whereas for Estonia it has changed signs all together due to the fact that financing here has come to a complete standstill. In Euro terms, the Baltics have lost external financing to the tune of bn 1.87 Euros in the first half of 2009 compared to the peak of the boom which amounts to 12.6% of the entire region’s GDP in the same period.
As noted extensively above, this process is natural since we can say with some confidence that whatever the level (and flow) of incoming investment and credit during the peak years it was not sustainable. However, when it happens with such force in the context of the global financial crisis and, moreover, in relation to fixed exchange regimes and thus internal devaluation the obvious question that begs is what the risk is of pushing these economies into a hole from which they cannot emerge. One particularly important point here is what kind of general (and domestic!) credit and financing environment we will see as the external funding is ground down and thus, in some sense, what kind of domestic environment the Baltics will have to stage a recovery in.
This last point is perhaps the most important underlying theme to think about when assessing the situation in the Baltics. We could almost say that the extent and pace to which the Baltics’ growth path has crumbled is also the extent to which expectations of convergence, Euro membership, underlying growth potential etc have crumbled. Where we go from here is consequently anybody’s guess. A lot of unresolved question still clouds the horizon not least the continuing unravelling in Latvia where the IMF has so stuck with the country despite the increasing dire outlook as long as the currency peg remains. What I can tell you however is that the Baltics are going to rebalance, but the key is the extent to which it happens so as to allow the Baltic economies to enter a virtuous circle somewhere down the road.
So far, a preliminary assessment suggests that while the Baltics are indeed rebalancing, they are only doing so because internal demand has caved in. We are yet to see whether the dose of internal devaluation/deflation will bring back competitiveness in due time to turn a vicious cycle into a virtuous one.
By Thersites, on September 1st, 2009
In a recent New York Times Op-Ed entitled “Till Debt Does Its Part,” Nobel Prize-winning economist Paul Krugman rebuffs those few reactionary souls who argue that all this debt we are incurring is a bad thing. He assures us,
…don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.
Sometimes you really have to wonder what the standards are for winning a Nobel Prize. We have an economy built on consumer debt which relative to disposable income increased from a low in 1945 to its peak in 2007. As the Daily Reckoning further notes, we have $20 trillion in excess debt to work through over the coming years. Yet while on the private side, we need to pay for our sins, liquidate our debts, allow malinvestments to go belly up and start over on more solid fiscal ground, apparently the public sector can just keep on trucking.
As the sage Mr. Krugman notes,
Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic. The only real reason for concern is political. The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity. Need I say more?
Explain this to me exactly. When are deficits a help to an economy in distress? If the whole reason we are in economic distress is because of a glut of debt, then why is the answer to pour more gasoline on the fire? Any company that still functions in any semblance of a free market knows that if it can’t service its debt, it will be forced to make difficult decisions, potentially opting for bankruptcy. It cannot continually slop at the trough of the debt market.
But Krugman seems to think that the government can have its cake and eat it too. Where a sober person might argue that in hard times, a government must tighten its belt, like an business or a man, cutting back to the bare minimum, Krugman seems to think that incurring more and more debt, in essence stretching out the inevitable painful liquidation whilst creating another debt/currency crisis down the road is better. Why have one financial crisis when you can have two or three stretched out over a longer period of time? You get the sense that Krugman’s agenda is more political than economic sometimes.
Which brings me to my next point. Krugman believes the only reason for concern over the debt is “political.” Proud of this claim, Krugman states “Need I say more?” Well yes, I think you need do so. Our currency, and the debts run up by our government denominated in our currency are backed by the full faith and credit of the United States government; which is to say our money and debt are backed by our economy, our people. If we are in for a prolonged period of negative growth, high unemployment and increased intervention in all aspects of life, especially our economy, how can Krugman make the assumption that the ability to continue adding to our debt solely rests on the “maturity” of the politicians? Can Barney Frank snap his fingers and suddenly make the world buy our paper?
If the government wishes to be “immature,” it can do so through intervention and coercion. Alternatively, if the politicians wish to be mature, they can remove themselves from the private sector, slash their spending and taxes, let whole swaths of industry go belly up and allow people to foreclose on their homes.
But Krugman as one might expect opts for the former, immature route. Mind-numbingly, he proclaims:
If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression. As I said, deficits saved the world.
In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.
Krugman, going along with all the other Keynesians and socialists under the sun forgets about all of the interventionism even before his idol FDR ever got into power during the Depression, in addition to the misguided policies (which he of course advocated) over the last two decades in Japan. The same illogical government gobbledygook that merely prolonged the Depression has been followed to a tee, all the way up to “cash for clunkers”, the modern day equivalent of FDR’s forced killing of crops and slaughtering of pigs in order to raise the price of agricultural products. Mr. Krugman seems to think that interventionism is what saves economies. Might I ask then, why not intervene from the start? If the state is so good at managing crises, why not let it manage all industry in good times as well? Is the free market only sufficient when the Dow is rising? And if deficits are the cure-all, then why do nations ever default on their debt? Why is Zimbabwe the way Zimbabwe is? Could it be that perhaps the central planners are not so divine after all?
To be fair, Krugman, digressing notes:
But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might thinkHere’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.
Even though all this debt we’re adding on might not actually be so great, we have a huge economy. Ah, the panacea of the huge (albeit shrinking) economy – an economy based on consumption, services and debt, the hallmarks of any economic powerhouse. He also argues that a rise in debt/GDP of 40% is OK, since this debt will only be 5% of federal revenue, which doesn’t sound so overwhelming. So essentially, because it’s only 5% of a massively-sized federal government which will have ever-decreasing tax revenues necessitating continued debt financing (to pay for more boondoggles), we should be OK to pay off our debt (with devalued dollars I suppose?).
What might our lenders think about that? Krugman has an answer for this too.
Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.
I would challenge the assumption that the US government’s credit will remain good. As Krugman notes, our debt/GDP is going to rise significantly, “
The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years,” and as I mentioned government is intervening in the economy on an unprecedented scale, but relax, our friends in the Far East will continue to bankroll us. Krugman should take a page from Milton Friedman’s playbook (along with pages from the playbooks of Hayek, von Mises and Bastiat) and remember that there is no such thing as a free lunch. All government can do for “revenue,” is directly tax, or indirectly tax through issuing debt (taxing future generations and/or devaluing the currency) or printing money.
While Krugman argues that the people “making bets” don’t seem worried about our solvency, as numerous publications have noted, the Chinese are buying less treasuries and stockpiling commodities (however short-lived the Times may think it will be), indicating that they are diversifying out of dollar-denominated assets. Meanwhile, the government has had to take the drastic measure of purchasing its own Treasuries, with the Fed committing to buy $300bn in notes (i.e. printing $300bn) and also monetizing the debt more discretely. In other words, the government has had to keep its own borrowing costs down artificially, making up for the lack of demand of its primary dealers by bidding for its own debt. But look at the YTD yield curve for the 10-Year Treasury, and tell me that the markets aren’t reacting at all to our fiscal recklessness:
Moreover, just because rates haven’t spiked by 500bps in the last year, does that mean that market participants really aren’t scared about our solvency? Markets can stay irrational for long periods of time, just look at the housing bubble or any of the other bubbles which after the fact we have said were obvious. Further, I would argue that creditors like China are being perfectly rational. They are trying to shift their money towards assets with real tangible value like commodities, while doing as little as possible to spook the government debt markets, because doing so would hurt the value of their own paper. If they flooded the markets with Treasuries, all of their dollar-denominated assets would plummet in price. It’s not in their interest for there to be a run on the US government yet. But that doesn’t mean that they won’t slowly but surely make their exit from US paper assets, leading to higher borrowing costs for our government and less confidence in our dollar. As I mentioned, there is no free lunch.
Krugman notes that other governments with comparable profligacy like Belgium and Italy never faced financial crises in the early 1990s, but there are obvious notable differences. We are the biggest economy in the world, and were the most prosperous one. We have the world’s reserve currency. Our people are not used to the kind of fiscal stagnancy faced in Europe. I just do not see Krugman’s comparisons hold water. A more apt comparison in my eyes would be the US versus the Roman or British Empires circa their collapses.
Regardless, I want to return to the fundamental point that going into more debt to solve a problem caused by too much debt makes no sense. One might argue that sometimes debt can be beneficial and not cause long term harm. One might cry that parents are right to take out a mortgage on a house to raise their children. If the family can reasonably expect to generate the cash flows to retire this debt over time, then this will certainly be fine. But the US is like one giant family of drug-addled deadbeats looking to buy a mansion in the Hamptons, having already foreclosed on its subprime mortgage, maxed out all of its credit cards and traded in its Rolex’s to the local pawn shop.
Debt is OK if you can reasonably expect to pay it off. To incur even greater debt in the face of debt that you will already be unable to service is downright immoral and will lead to severe consequences for the people.
These deficits in and of themselves are not productive. They represent a stealing of wealth from future generations. As I mentioned, the only way to pay down the debt will be to tax future generations, either directly or indirectly through inflating the money supply and thus devaluing the currency. Further, regarding what the deficits are actually being used to finance, as I have argued in accordance with sound Austrian economics, the deficits used to bail out failing ventures stop the market from naturally adjusting, and lead to less productive if not downright destructive “jobs” being diverted from the private sector.
So in some respects again, Krugman is right that our politicians need to be mature. But the people get the government they deserve, and as of yet though there have been some bright signs, the majority of people don’t seem to want to deal with the pain that mature servants of the citizenry would allow them to withstand today for a brighter tomorrow.
It is worth noting that in Krugman’s delusion, he actually makes a redeeming comment noting,
Over the really long term, however, the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.
He actually has me for a second, until the subsequent stanzas:
That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.
But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”
Keep it classy, Paul.
By Bron Suchecki, on July 20th, 2009
Continuing the theme of my recent posts. This from Troy Schwensen at The Global Speculator:
Australia’s Prime Minister, Kevin Rudd, has recently delivered an address to the nation providing details on his second stimulus package. Within this briefing, there was a number of sniping remarks about the so called “failure of free markets”. This apparent failure has forced the government to step in and clean up the mess. … It seems free markets cannot be trusted to spend money wisely, so it is up to the government to spend our money for us. I want to make a couple of points.
Firstly, free markets work fine. The global problems we have experienced in the credit markets were caused by easy monetary policy. Many argue the cause was a lack of financial sector regulation. The more pertinent question to ask is why does the financial sector need so much regulation in the first place? Why is it that free markets work well in other industries but fail so dismally when it comes to the financial sector? The answer is quite simple. The financial markets are anything but free! We have a government entity called a central bank that essentially sets the price of money. It decides the level of interest rates under the flawed belief that the market is incapable of performing this function on its own. …
The second point I want to make is governments are incapable of investing money smarter than individuals and companies. By deficit spending, they are drawing funds away from the capital markets and effectively competing with businesses for money. Over the longer term, this will put upward pressure on interest rates exacerbating our economic problems. What Australians should be doing right now is saving and paying down debt. At some point this will inevitably have to happen anyway. By lowering interest rates to historically low levels, the message central banks are sending is don’t save, borrow and spend. Governments are releasing stimulus packages encouraging us to spend and “save the economy”. You cannot save an economy via consumption. All you are doing is prolonging the agony. Individuals and organizations need to clean up their balance sheets and save.
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