Quotes For A Future Decade

• The best way to predict the future is to create it.  Peter Drucker

• I do not want to foresee the future. I am concerned with taking care of the present. God has given me no control over the moment following.  Mahatma Gandhi

• Do not dwell in the past, do not dream of the future, concentrate the mind on the present moment.  Buddha

• The future ain't what it used to be.  Yogi Berra

•  Every saint has a past and every sinner has a future.  Oscar Wilde

•  Real generosity toward the future lies in giving all to the present. Albert Camus

• Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you against the present.   Marcus Aurelius
  
  
•  The future enters into us, in order to transform itself in us, long before it happens. Rainer Maria Rilke

•  There is no prophet of the future for mortal men.  Sophocles

•  Cease to inquire what the future has in store, and take as a gift whatever the day brings forth. Horace 

•  God doesn't play dice.  Albert Einstein 

• ,,, but he sure as hell loads them.  Hellasious   

  

Happy New Year!!

Greece Got Run Over By a Reindeer

What gives with Greece?  If we look at only one, narrow, set of the statistics, i.e. government debt and official GDP figures, and compare them with other nations, then by all means Greece is essentially bankrupt - just as so many fear-mongering "analysts" claim.

But... Disraeli's saying "lies, damned lies and statistics" is always a good piece of advice.  Even if he actually never said it himself.

So what should we look at?  Two facts:

1. Greece has one of the lowest total debt to GDP ratios amongst OECD nations.  Yes, that's right, lowest;  because even though government debt is very high at 127% of GDP (end of 2009 and going higher, probably to 140% by the end of 2012) private debt (i.e. corporate plus household) comes to only 108% of GDP, making for a total debt to GDP ratio of only 235%.  That's lower than Switzerland (313%), Canada (259%) or, gasp!, ever-so-self-righteous Germany itself (285%).
2. Greece has a very large, but very real, "shadow" economy due to widespread tax-evasion and corruption.  The IMF estimates it at 27% of GDP, by far the highest of any OECD nation (average is estimated at 11%).  This means that officially reported Greek debt/GDP ratios are grossly overstated.

Below is a table I constructed based on data from McKinsey for total debt (2009) and the IMF for the shadow economy.  The adjusted figures include the shadow economy in the total debt to GDP ratio.

 See anything grossly out of line?  

 One has to wonder how "the market" operates sometimes, eh?  Looks like Greece got run over by a reindeer this Christmas.  On purpose..?

It's The Politics, Stupid!

Everyone's taking potshots at the eurozone these days and  given the number and  clumsiness of European "leaders" running around in the open it's like a turkey shoot down at the country fair.  Even those who couldn't hit a barn at 100 ft. can go home feeling like sharpshooters.

 

Nevertheless, analysts from outside Europe's "hard core" have it all wrong.  They presume the eurozone to be all about finance and monetary policy and, having made this fundamental mistake, conclude that the euro is untenable, no more than a rickety structure about  to crash as weak-link peripheral countries like Greece and Ireland (or even - perhaps - Spain ) buckle under the strain of their large debts.

However, the establishment of the European Union over fifty years ago and the adoption of a common currency are not guided by money and economics, but a common vision for peace and prosperity after centuries and centuries of constant, bloody war.  Since 1300 AD (at least) there has never been a period of 50 consecutive years of peace in Europe - except now (excluding the "police action" in former Yugoslavia).  That alone says a lot.

There is no way that Europeans and their leaders are going to let the euro and the EU collapse;  there is simply way too much at stake.   Does anyone seriously think the Germans - to name only one nation - want the EU to fall apart?  The Europeans who arguably suffered the most as they lost not one, but two world wars? C'mon..

To paraphrase Bill Clinton, it's the politics, stupid!

So,  here's my wish for Christmas 2010 : Peace On Earth.

Have a wonderful holiday, all.

The Stupidest Cut Of All

Unlike the French, the British are most definitely not a nation of active protesters and rioters.  So when they take to the streets, smash shop windows, throw chunks of steel-reinforced concrete, set fires and attack Prince Charles's Rolls Royce (a smashing counterpoint to austerity, old boy) you know something is terribly wrong.

All this is caused by the conservative government's decision to cut university funding by an astonishing 80%, passing the bill on to students and resulting in doubling and tripling of tuition fees.  Since most students can't afford such a massive hike, they will end up with - what else - taking up loans of up to $63,000 for three years of study (the normal course in a UK college).

I won't elaborate much on why slashing education spending is the stupidest cut of all because I consider it to be self-evident to anyone who can fog the mirror and count past ten without the aid of his fingers.

But I will say this:  we have all of us in the West rolled up our manufacturing and unceremoniously packed it off to China (why else do you think China's energy use soared 100% in a mere five years?).  Instead, we were supposed to become post-modern vibrant economies based on technology, design, know-how, smarts;  in a word: education.

Well, Mr. Prime Minister Cameron, to quote from one of your famous countrymen, Goodbye To All That. Robert Graves was educated in Oxford just like you were, so I'm sure you understand my allusion to the needless slaughter of an entire generation of young men during WWI,  and the figurative parallel with today. 

The question is, will your children?

Energy: A Tale Of Four Nations

I do an occasional post on Green/Low Carbon/Sustainable matters.  The following four charts are quite illuminating, in my opinion (source: IEA).  Click on each to enlarge.

Total primary energy supply by type

USA: The Dirty Carbo(n)ation

Germany: They're Trying

Denmark: They're Doing It Fast

I have saved the "best" one for last.  What is going on in China is best described as scary as, well, Hell.

China: Heaven Help Them (And The Rest Of Us)

Final note: Notice how Danish total energy consumption remained essentially unchanged in almost 40 years, yet at the same time real GDP grew by 70%.

Chart: Statistics Denmark

 What did Denmark do so right? Looking at its energy chart above we observe a tremendous shift away from oil and coal and into natural gas and renewables.  That was no accident;  and it resulted in, among other things, Vestas becoming the world's largest wind turbine company. It's very definitely possible to go green and prosper..

ECB Is Listening.. (?)

It's been just a few days since my "Modest Proposal" post and the ECB is (finally) poised to intervene in the government bond market, looking to buy PIG(S?) debt in the secondary market.  Excellent decision, if I may say so myself (insert false modesty).  And to be really effective it should be a massive, knock-out blow.  Hopefully ECB has some canny market operators in its staff who know how to act for maximum effect.

But as my proposal detailed, it's not enough for the ECB to just buy and hold existing government bonds on its books.  The second step in this process, the exchange of old bonds for new ones at cost resulting in a reduction of debt by 30-50%, ought to follow immediately.  The benefits to the national economies from a lower debt load and smaller interest payments would be very significant, making the market's reaction to the ECB operation even more pronounced.

Better yet, if the ECB exchanged the national bonds with Euro-bonds that are - almost certainly - coming, we would be talking about a Perfect Storm hitting the shorts.

Barbarians At The Gate

As an old hand in the sovereign bond market I can understand - though in no way do I condone - "the market's" attacks on Greece and Ireland, even Portugal.  They are small countries at Europe's economic periphery who borrowed more money from foreign lenders than was good for them and thus left themselves wide open to speculative attack.

 Pygmies And Giants

But now things are getting serious:  "the market" is attacking Spain, the world's eighth largest economy with a GDP of 1.1 trillion euro ($1.4 trillion). And "the virus" is spreading to Italy, Belgium and even to that paragon of financial probity, the most admired country in the world, Denmark.  Yes, Denmark.

Take a look at the Credit Default Swaps (CDS) charts below (all from CMA).

Italian Sovereign CDS

Belgium Sovereign CDS

Denmark Sovereign CDS

(To make things clear: Denmark isn't even a member of the Eurozone! It's a full member of the E.U. but it still uses its own currency, the krona.  It's debt/GDP ratio at 42% is tiny.)

So what is going on?  Not to mince words, a concerted attack on the viability of the euro and thus on the very foundation of the EU itself.  The existence of a common currency for the world's largest economic block is a threat to the US Dollar Hegemony, i.e. anathema for those who wish to prolong the world as we knew it, a modified construct from the Bretton Woods era.

The barbarians are at Europe's gate, threatening to tear down and pillage what took nearly three quarters of a century to construct.  But it's not going to happen.  Like Hannibal's elephants ante Rome's portas, the big financial institutions that are behind this ill-advised campaign are themselves vulnerable.  They need massive amounts of cheap liquidity as fodder (only the Fed is supplying it at the moment) and risk-taking leveraged customers to piggy-back their positions (essentially, hedge funds). 

They also rely on the complete absence  of meaningful oversight and regulation for credit derivatives, an inexcusable condition for which European politicians are entirely to blame.

What is the solution? Starve the beasts.

1. Immediately withdraw all public pension funds from ALL alternative investment managers.
2. Prohibit any financial institution that has ANY activity in the EU from having ANY position in EU sovereign CDS.  This includes banks, brokers, insurance companies, hedge funds, etc. that are either domiciled, have rep offices or raise funds in the EU.  And when I say ANY activity in the EU I mean it: not even advertising would be allowed, no articles written by its employees, no interviews, nothing. NO-THING.

Bottom line: you want to play?  OK let's play.  But the rules of the game are  going to be for the benefit of the people, not to attack the people.  Because moral hazard should be, above all, moral.

Let's Try Some Perspective

The drumbeat against the euro is increasing daily.  It will fall apart, it will be limited to a hard core of Northern countries, it was a bad idea to begin with, you can't have uniform monetary policy without uniform fiscal policy, etc etc. The cacophony is so loud it is making common sense impossible to break through, particularly since "the free market" is screaming at the top of its lungs.

Let's try some perspective on that "free market", eh?  

• Gross Folly #1: How come the eurozone's financial center is... London?!!  What this means in practical terms is that a scrum of bottom-line-is-everything bonus-hungry twenty-somethings hardly out of school are running the show.  And to top it off, they and their country (the U.K.) are not even members of the eurozone. They don't use it, they don't believe in it and, if anything, they hate its guts.  Literally.  This like trusting a bunch of juvenile delinquents who amuse themselves with setting cats on fire to run the pet shelter. 

• Gross Folly #2:  We let those same kids deal in sovereign bond CDS (credit default swaps) in an unlimited amount, without any regulation, in a completely opaque OTC market.  They don't have to hedge their positions with the underlying sovereign bonds, they don't have to account for their actions to anyone but their immediate boss - who is also in line to make a huge bonus from their profit - and they don't give a damn if they push some poor country into bankruptcy and its people into starvation.  Literally.  This is like giving the nuclear missile launch keys to a bunch of manic-depressives and telling them they have to compete amongst themselves for their meds.

•  Gross Folly #3: We have allowed huge amounts of public and private pension monies to be managed by "alternative-investment" firms, e.g. hedge funds who are compensated on the outrageous 2/20 schedule.  (The US Social Security is still OK, as it can only invest in Treasurys, but it came close to succumbing a few years ago.)  This is like giving a bunch of convicted arsonists a tank-farm full of gasoline, asking them to put it to profitable use.

• Gross Folly #4:   The people of Europe have entrusted management of the whole shebang to politicians, their appointees and committees of clueless bureaucratic mandarins who wouldn't know the difference between a CDS and a CDO if it sat up and hit them in the face. (Again, the US is somewhat better at this since key government positions are frequently filled by experienced financiers.)  This is like staffing Bedlam with a bunch of  South Italian city managers, soviet-era Russian chefs from Vladivostock and over-sized German nurses named Helga.  All overseen by the ghost of Joe McCarthy come back to life.  No doctors.  Oh, and only Wagner allowed in the rec room.

Have a nice weekend...

PS  A friend in the business sent me this picture today.  While I may not exactly agree with it, it is definitely indicative of sentiment towards Germany these days...

European Family Photo

How To Restructure PIGS Debt - A Modest Proposal

With Ireland in political turmoil over its application to receive bailout funds, it is becoming obvious that we are getting caught between a rock and a hard place: on one side, markets (a euphemism for the unholy alliance of public pension money and the private money of the ultra-rich) are no longer willing to roll over the existing debt of the over-indebted, never mind increasing their exposure, at anything approaching reasonable interest rates.  On the other, austerity programs attached to bailouts are causing  high unemployment, pay and benefit cuts, tax increases and service cuts.  

How long can this go on before things get seriously crushed, resulting in one or more massive unplanned defaults by sovereign borrowers, or massive social upheavals? Or both?  It is my opinion that time is running out.

A solution must be found, and the sooner the better.

Let's lay some ground rules:

          1.  A solution should include structural reforms, where appropriate.  For example, Greece must radically reform its public governance which is shot through with graft, corruption and ridiculous inefficiencies and raise the competitiveness of its economy so that it can produce goods and services attractive and attractively priced to the global marketplace.  Ireland should re-think its corporate tax policy and start generating significant domestic savings to fund itself locally, instead of relying on foreign portfolio investors who can - and do - disappear at the first hint of trouble (Ireland sports an external debt of 1,000% of GDP).

          2.  A solution should not trigger a credit event for credit default swaps (CDS).  Apart from not rewarding vulture speculators who bear significant onus for the current mess in sovereign bond markets, there is a systemic reason for avoiding a credit event.  Before the explosion of the CDS market a default would result in well-defined losses: debt outstanding minus recoveries.  For example, a "haircut" of 50% meant that lenders lost half  their capital.

Today, however, there is at least $2.4 trillion outstanding in sovereign CDS,  $2.2 trillion of which  is sold by dealers, i.e. big global banks.  If a credit event is triggered no one knows who will be pushed over the cliff by the tumbling dominoes, all happening in a matter of days (remember AIG?).  Most positions are "offset" in dealers' books, of course, but no one gives a damn about offsetting  when counterparty risk enters the equation in times of crisis (remember Lehman? or Bear? or Merrill? or Citi?).  Here's what it is: under no circumstances is Goldman going to offset positions with Deutsche today if it thinks there's a risk of the latter filing for bankruptcy tomorrow, and vice versa.

CDS Prices For PIIGS 

By allowing unrestricted CDS activity on sovereign debt we have increased credit exposure (more "debt" outstanding) and we also included more participants on the possible default list (the issuers of CDS).  Oh, and if sovereign CDS comes second in amounts outstanding with $2.4 trillion, guess who is first?  Oh yes, financial institutions, with $3.3 trillion.  The systemic collapse that will follow a large sovereign default is too scary to contemplate.

          3.  A solution should provide for meaningful debt relief, i.e. result in the cancellation of 30% to 50% of debt outstanding and, soon thereafter, resumption of borrowing from free markets at reasonable rates.

How is this to be accomplished?

Step One: The European Central Bank (ECB) purchases in the open market sovereign bonds of the countries most at risk.  Right now, this means Greece and probably Ireland.  Depending on maturity, Greek Government Bonds (GGBs) are trading around 55 to 75 cents on the euro.

Step Two: ECB returns the bonds to the issuing country at cost and accepts as replacement new bonds of face amount equal to the ECB's cost.  Maturity and interest rates remain the same.

Example: ECB buys 10 billion face amount of 30 year GGBs with a coupon of 4.60% at the current market price of 53, for a cost of 5.3 billion euro.  It returns them to the Greek state and gets 5.3 billion face of new 30 year bonds bearing a coupon of 4.6%.  Resulting debt reduction: 4.7 billion euro.

The operation is entirely voluntary for original bond holders, who don't have to sell.  However, given that the ECB is going to be in the market all the time, bond dealers will have to sell, or raise their offers in order not to be lifted.  Either way, the market will achieve a balance consisting of part debt reduction, part higher bond prices.


Benefits: debt reduction, bond market stabilization, CDS market coming back to earth, lower borrowing costs (eventually) for troubled countries, minimum political wrangling amongst EU nations, fast action.

Downsides: 

• Troubled countries may rely on ECB interventions and not implement needed structural reforms.  That's why the ECB should act only in conjunction with requirements already in place, moving deliberately and stepwise as reforms are enacted. 
• Bond prices may jump inordinately under ECB's buying program.  If this happens then ECB just doesn't buy, leaving the market to function on its own. Some patience and lots of market savvy are definite requirements for this plan (but not much money!).
• The ECB's balance sheet will expand, at least initially.  But it already boasts 1.9 trillion euro in assets, so even if it bought half of all GGBs and Irish Government bonds outstanding at a discount, it would only have to spend some 100 billion euro.  With markets being what they are, I doubt it would even have to be that much.

Objections:

• It's not ECB's business to bail out nations.  Oh really? Is it its business to bail out only financial institutions, then?  Let's keep in mind that central banks are, above all else, public institutions working for the benefit of the people.  And in such a plan the ECB is not really performing a bailout but a financial intermediation.
• ECB may be stuck with too many sovereign bonds for too long.  This will happen only if nations themselves don't quickly put their finances in order.  Reforms being a necessary condition for participation in the solution, this should not be a serious problem.  Once primary budgets are balanced and markets work smoothly, ECB will be able to sell the bonds - perhaps even at a profit.

One final point from the market-participants' point of view: CDSs are wasting assets, i.e. if a credit event doesn't happen within the period specified in the contract (typically 5 years) holders will lose their entire investment.  By today's prices of Greek sovereign CDSs, that's $5,000,000 (five annual $1 million payments), paid for covering $10 million face amount of bonds.  If ECB adopts this plan it is certain that CDS prices will collapse as dealers try to get out of positions as quickly as possible, further normalizing bond markets.

Ireland (Plus Mrs. Merkel)

Ireland is about to become the second country in the EU to get a bailout (Greece was first). News and analysis  on the subject can be found everywhere, so I'll just throw in a few charts.

Until recently Irish public debt was quite low, around 30% of GDP.  But when the property and banking bubble burst things changed very fast.  Government liabilities exploded from 60 to 140 billion euro in less than three years (see chart below).

 Chart: Central Bank of Ireland

Irish Government Liabilities

The main culprit of Ireland's demotion from prince to pauper is its failed banking system. Ireland boasts  a GDP per person that is second highest in the EU (in purchasing power parity terms) and yet... why did they go so massively in debt?  The private sector is in debt to the tune of some 350 billion euro (~175% of GDP), with home mortgages alone accounting for 110 billion (see table below - click to enlarge).

Chart: Central Bank of Ireland

Home prices are now slumping across Ireland, but as the chart below shows the bubble was a long time forming.

 Chart: ESRI

TSB/ESRI House Price Index

So, what happened in Ireland?  In a word, hubris.  When it entered the European Union in 1973, Ireland was a poor agricultural society - indeed, the poorest country in western Europe.  In a determined effort to bootstrap itself, Ireland focused on education and started attracting foreign (mostly American) manufacturers of high tech equipment and services, offering ultra-low corporate tax rates as an inducement.  It worked marvelously well, turning the country from pauper to prince.

And it all went to their head in the end,  as it always does in the human race.  Dublin became a must-got-to place, a sort of Rome-in-the-Guinness-belt.  Home prices soared and kept on soaring, despite the fact that incomes could not possibly keep up with spiking prices.  Irish home buyers borrowed heavily and in turn their banks borrowed from abroad, particularly from Germany (note the imbalance between debt and domestic deposits in the table above). 

It is estimated that German lenders currently hold about 150-180 billion euro worth of Irish liabilities, making the Irish Problem a very serious one indeed for the German financial system.   And it serves as a poignant counterpoint for Mrs. Merkel, the German Chancellor who has made so much political hay at home at the expense Greece, even though German banks hold only some 30-40 billion of Greek bonds.

P.S. A final prediction, for what predictions are worth: Europe is going to go the way of the US in bailing out its economy (-ies) and Mrs. Merkel is not going to make it past April 1, 2011 as Germany's Chancellor.

The Tri-Polar Era

The Bretton Woods agreement of 1944 established the preeminence of the U.S. dollar as the world's sole reserve currency.  The six decades that followed were the Unipolar Era for matters monetary, even after  Richard Nixon in 1971 unilaterally canceled the dollar's convertibility into gold.

The Maastricht Treaty of 1992 set forth the requirements for the creation of the euro, the European Union's common currency, which started circulating officially in 2002.  Thus began the Bipolar Era, a time of increasing concern for the United States since the euro challenged its monetary preeminence and threatened the very foundation of The Dollar Empire.  

America's serial troubles with the stock market crash of 2000, the 9/11 terrorist attacks, the Iraq and Afghanistan wars and the housing and debt implosion which started in 2007 and is still ongoing, have  only added to the dollar's woes, since Americans have chosen to combat their intractable socio-economic problems with a mere placebo, an anodyne as it were.  To wit, the loosest possible monetary policy and increasingly massive quantitative easing, i.e. the printing press.  

Naturally the dollar is losing value against the euro, prompting virulent  and under-handed attacks against the latter's credibility by American and allied economists, bankers analysts and associated flotsam and jetsam.  For example, the hugely disproportionate negative publicity surrounding Greece's public budget deficit - a laughable 0.25% of the EU's combined GDP.
 
Much more dangerous for American living standards, however, is the loss of the dollar's value against wheat, corn, copper, gold, oil and all other commodities.  The CRB index has zoomed back to its all-time highs not because of strong current or incipient demand from industrial users - the global economy  being still quite weak - but because the dollar is increasingly viewed with well-founded suspicion (see chart below).

CRB Commodity Price Index

And that's where the third pole comes in: China has become the world's second largest economy, but when it comes to its currency it is still acting like a poor, underdeveloped country.  The yuan's hard peg against the dollar is not exactly a sign of national economic confidence, never mind pride.  It's like a 6 ft. tall teenager feeling so unsure about riding a bike that he keeps the side-wheels on. 

An economy of such magnitude and global importance as China's cannot and should not use another country's currency, as it is effectively doing now through the yuan's peg to the dollar.  "It just ain't natural"- and what's more, it's clearly no longer in  China's best interest.  To use but one adverse example, what are the likely consequences of QE2 on the roaring Chinese property bubble?

It is time for China to completely un-peg its currency from the dollar and allow it to float freely, thus causing the world to enter the Tri-Polar Era.  From the perspective of balancing trade and geopolitical power, the existence of three major globally and freely traded currencies is more desirable than only one, and even better than two (the third will act as a buffer).

Furthermore, a tri-polar exchange regime is far superior to antiquated gold benchmark notions currently being thrown about (hopefully containing no serious intent).

Bernake As Greenspan

What is Mr. Bernanke doing with QE2 (quantitative easing part two)?  By his own admission, he is unleashing a flood of money into the system in order to forestall deflation.  And how is more (fiat) money going to help the so-called "real economy"?  Again by his own admission, by pumping up asset prices (i.e. stocks),  creating a wealth effect and thus giving birth to a virtuous cycle of confidence, consumption and investment.  

Here's an excerpt from  the link above, an op-ed Mr. Bernanke wrote for the Washington Post a few days ago.

"And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion." 

That's an astonishing statement of intent, coming as it does from the Federal Reserve, but let's accept it at face value (but, really, could you ever imagine that a head of the nation's central bank would act as a stock jobber for the S&P 500?).

Still, is Mr. Bernanke's asset-bubble strategy any different from what Mr. Greenspan did following the dotcom whump-and-dump of 2000-02?  Oh, not really - except that Uncle Alan chose housing and crappy mortgages, while Brother Ben's choices are shares and Treasurys.  I guess the former was burned by his correct but ill-timed Irrational Exuberance comment (and in markets timing is, after all, everything), whilst the latter has no such inhibitions.  Yet.

What can I say...? Does it matter what you drink, if you end up face down in the gutter in an incoherent alcoholic stupor?

One more time: what we need, and what needs to be seriously targeted by all concerned, is higher earned income (wages and salaries), not more debt-inflated asset prices.  

Period.

Common Sense

For today's elections I have only one thing to say.. OK, two:

1. Smart people don't cut off their nose to spite their face.
2. Remember the Alamo (you know... Bush?).

Enjoy the balloting.

P.S.  Here are some rather shocking data on wage distribution in the U.S.A. from the Social Security Administration. (Data refer to 2009 during which there were a total of 150 million wage earners.)

• The largest group of wage earners - a massive 24 million or 16% of the total - made between 1 red cent and $4,999.99.  On average they earned $2,016.
• The average wage for everyone was $39,054, but the median was a mere $26,261.  Two thirds of all workers made less than $40,000.

  Middle class? What middle class?  Look at the data...

An Excellent Idea

According to Bloomberg: "President Barack Obama will make the case that his proposal to let companies take immediate tax deductions for the full cost of new equipment will help the economy grow and create jobs by encouraging about $50 billion in new investments through 2011."

I think that's an excellent idea.  It should be expanded and embraced by other countries, as well.

In my opinion, if the developed world (US, Europe and Japan) is to transform its bankrupt consumer spending economic model (which ultimately involved unsustainable borrowing) it must undertake and sustain very large capital investment, preferably in energy and transportation infrastructure.  For example, investing in upgraded electricity grids, instead of shopping malls and ski chalets.

By definition, such an economy involves more knowledge, more technology, more highly skilled workers and more value added per hour worked.  That's exactly what "developed" is all about - or should be, anyway.  And that's exactly what our resource-stretched, environmentally-challenged world needs, right now.

It would also rather quickly reduce pernicious trade imbalances which are spilling over into the foreign exchange battleground (that's code for US-China relations and the yuan peg).

Congress should move immediately.

Making Real Things For Real People (tm)

Three years into the crisis we can say that the world did not come to an end, the economy did not fly off the cliff and markets are operating in "safe" mode.  Not to mention that Wall Street is smugly preparing to pay huge bonuses once again.  Credit must go to the Fed and Mr. Bernanke personally for making so much, well, credit available to everyone who asked for it and even to some who didn't.  

But is it, in fact, credit that we must give the Fed? 

During the past three years the Federal Reserve has assumed a role never envisaged by its founders or anyone who ever worked there - Mr. Greenspan included, I'm sure.  Despite his "heli-Ben" moniker, I even doubt if Mr. Bernanke himself ever truly believed that the Fed would have to go as far as it has under his guidance. 

Because it's one thing for the Fed to respond to challenging economic conditions by lowering interest rates down to ZIRP.  But it's quite another, a quantum leap (of faith?), to become the major shaping force of the economy by inundating it with so much money as to reverse the natural ebb and flow of capitalism, to forestall what Joseph Schumpeter called creative destruction.

They say that the road to hell is paved with good intentions, and I am afraid that we have all of us allowed Mr. Bernanke to lead us a merry journey that may end in a very hot place, indeed.  He has good intentions, undoubtedly: to "save us" from a financial meltdown which could have resulted in another Great Depression.  He has used monetary policy to an incredible extent, encouraged, it must be admitted, by an executive branch that was so intertwined with Wall Street as to be practically indistinguishable.

So, monetary and fiscal policy both opened up fire on the Great Recession using the only big guns they could bring to bear: money and government borrowing /spending.  They fired so many rounds of such heavy gauge that the "enemy" was stunned and is - at the moment - still dizzy from all the noise and smoke.

But the enemy is definitely not dead, because money-for-nothing and government spending are to him as effective as flash-bang grenades.  Lots of smoke, lots of noise - but no damage.

• Point: The real enemy is widening income inequality.  The vast majority of people have seen their real income remain stagnant for 40 years and had to burden themselves with ever-increasing debt to make ends meet.  

Massive debt is, therefore, but the proximate cause of the crisis.  It's actually a resulting effect of the ultimate cause, which is high income disparity (see chart below).

Chart: FRB Survey of Consumer Finances

Obviously, easier credit (more debt) and government deficit spending (even more debt) do nothing to solve the income inequality problem, which can be summarized thus: lower and middle income people spend a far greater percentage of their income than the rich, who amass wealth instead. Therefore, it is imperative for the former to have growing income to maintain their spending out of earnings and keep the economy healthy.

The obvious solution, most will say, is as as old as Robin Hood: take from the rich and give to the poor.  Really?  While the egregious favoritism shown to the rich in previous tax laws must definitely be rolled back, taxation alone cannot do the job of repairing decades of yawning income inequalities.  Instead, we should pay great attention to the most fundamental economic concept of all: adding value through peoples' work.

What I am trying to say is that real incremental wealth, and the social "fairness" that results from its more equitable distribution, cannot come about from re-distribution, but only from the creation of new useful real assets that generate added value for society at large.  For example, an upgraded electric grid that reduces losses and permits two-way power flow;  such an "asset" can be put to work immediately and will generate profits (added value) for all, i.e. it's useful to the vast majority of people.  Its design, construction and maintenance will create tens, even hundreds of thousands of new, skilled jobs that will command high wages, precisely because of the grid's profitability.  That's how income gaps get smaller (think Ford, Model T, etc.).

Contrast this with trading CDS's.  While there is a small theoretical benefit to society at large from such an activity (I could argue that it's actually a cost, but that's another discussion), the benefits that accrue are not real but purely actuarial or monetary, i.e. virtual.  Furthermore, because of the nature of the financial industry itself, those benefits end up in the hands of a tiny part of the population which is already super-rich.

In conclusion: we have reached, nay surpassed, the limits of monetary and fiscal policy in dealing with this Great Recession.  What we urgently need now is -gasp- an Industrial Policy.  Yes, that's making real things for real people (tm).

P.S.  There is at least one guy who "gets it".  Robert Reich was Labor Secretary under Bill Clinton and has just come out with a book about exactly this matter.  Aftershock: The Next Economy and America's Future is well written, well argued, brief and to the point.  It also includes several workable ideas on how to close the income gap.

The Peoples' Slice Of The Pie

Economists are forever trying to come up with theories to explain unemployment and wages.  It is always a "hot" topic, and the Bureau of Labor Statistics (BLS) monthly release on the employment situation is arguably the one statistic which can - and does - move markets most.

I won't go into the various economic theories on how wages, unemployment and inflation all come together to shape (or "clear"), the labor market.  I have a more fundamental question, instead:  How important are wages in today's economy, overall?  Or, to put it more precisely, how come we have allowed gainful employment and earned income to become so unimportant?

The following chart shows that wages and salaries as a percentage of GDP have been dropping steadily for 40 years, from a high of 54% of GDP in 1970 to a low of 43.5% this year (see chart below).  Including other forms of compensation like pension and medical benefits does not alter the picture appreciably: total compensation of employees went from 60% of GDP in 1970 to 54% this year.

Simply put, then, working people are getting a smaller slice of the economic pie.

Yeah, The Pie Is Bigger But Your Slice Is Smaller

This is as major of a transformation of the economy as it gets but it is almost never discussed by academic economists, who are forever trying to figure out how to model unemployment, or interest rates, or whatever econometric datum strikes their fancy.  It's like pondering the price of candle oil while Rome burns.  And they get Nobels for it, too!

(A small aside about the Nobel Prize for economics: it was not part of Alfred Nobel's will in 1895.  It was instituted and funded much later, in 1969, by Sweden's central bank;  it is formally known as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.  Considering its provenance in the depths of Money Central, it's highly unlikely that a more "radical" economist is ever going to be awarded one. )

Anyway, who's been eating the Peoples' Slice Of The Pie (TM) then?

Is it proprietors of small businesses or farms?  Hardly.  Their income as a share of GDP was 8% in 1970 and it's still around 7% today.

For a clue, look at the following chart of net dividends as a percentage of GDP: they have steadily climbed over the years and literally soared after 2003 to nearly triple what they were in the 70's.

If stock ownership was even somewhat evenly distributed amongst Americans I would have no real problem with this picture.  But, it isn't - not by miles and miles. The richest 10% families owned in 2007 a mean $700,000 worth of stocks, while the next 15% owned a mere $53,000.  The rest, i.e. 75% of the people, owned next to nothing at all (see chart and table below). 

 Chart: FRB Survey of Consumer Finances, 2007

The United States, indeed the entire West, has in recent times been transformed from a society defined by the constructively paired work-income relationship, to one oriented towards an asset-debt pair.  Even worse, most assets are now owned, controlled and exploited by an ever-shrinking minority of super-rich, forcing the vast majority of the people into virtual debt slaves.  That's what Virulent Capitalism is all about, in my opinion.

But does anyone really give a hoot?  Are important economists really screaming bloody murder?  Are politicians really taking notice? The short answer is no.

Notice my main recommendation on the right: Animal Spirits is an excellent book authored by George Akerloff and Robert Shiller, two economists who hardly fit the classical model.  For example, they make mincemeat of the deeply-ensconced theory that humans are constantly acting in their so-called "rational" self interest when they make economic decisions.  Akerloff ans Shiller are willing - and scientifically able - to tear down the entire foundation upon which classical economics has been resting for centuries.

And yet...

Whilst they correctly identify the causes of the current crisis and properly point accusingly to all the proper directions, what is it that they recommend as a solution?  That the Fed should target credit expansion, i.e. make as much credit available to the economy as possible.  Not a word about the huge deficit in earned income, not a peep about the enormous asset ownership gap.  Instead, more credit, more debt for the masses.   

Sorry guys, that's plain insane.

Don't get me wrong.  Animal Spirits is an otherwise excellent book, well worth reading for its spirited departure from classical metrics-based economic theory.  Buy it, read it, profit from it.  But, my point here is that even such forward-thinking economists atavistically fall back to old remedies when faced with financial crises.  It's like a modern day doctor correctly diagnosing TB and then prescribing a long stay in a Swiss mountain sanatorium as a cure.  Well, good luck with that...

(Maybe it's because Akerloff's wife is none other than Janet Yellen.  Yup, maybe he's being very rational, after all.  From a personal peace-in-the-family standpoint, of course.  Eh...)

P.S.  This post was written during the weekend, so I should seriously consider testing myself for ESP because the Nobel committee just announced its choices for the aforementioned Economics prize - and guess what?  They gave it to three economists for their work on unemployment, job vacancies and wages.  Same old, same old unfortunately. 

Where's The Yen Carry Trade Now?

Three years ago I was shaking my head at the yen carry trade (As The Yen Strengthens).  Today's decision by the Bank of Japan to formally ZIRP (Zero Interest Rate Policy) itself into a corner, to - as it hopes - stop the yen from strengthening further, underscores how far the yen carry has unraveled since then.

This so-called "strategy" of borrowing yen at low interest rates to speculate in financial markets all over the world was one of the major generators of hot money and, thus, a big enabler of the bubble finance that ended up as The Crisis.

In August 2007 I estimated the size of yen-carry money at around $1 trillion, based on data from the Bank of International Settlements (BIS).  The updated chart below shows what has happened since then - I call it the rise and fall of the yen carry trade and it largely confirms my initial estimate of $1 trillion.  Notice how nominal amounts of yen FX swaps and forwards spiked upwards by about $1 trillion at the top of the bubble folly, only to come down by the same amount as soon as the bubble burst.

Data: BIS

I thought the yen carry trade to be so risky as to be downright foolish, at the time.  It made no sense to assume very high currency risk (the yen was at multi-year lows) in order to place highly leveraged bets on instruments providing very small spreads over Treasuries and over borrowing costs.  One example was buying second-tier European debt (e.g. Greek government bonds) at minuscule spreads of 50 basis points over bunds.  What followed is history, and it is still unfolding.

But now is now, and if I was a betting man - which of course I am, being in this business - I would be quite interested in putting on some new yen carry trades at this juncture.  

For the record,

• JPY borrowing costs: essentially 0% (assuming, of course, that you can borrow at all).
• Greek 10-year bond spreads over bunds: 800 bp
• USD/JPY: 84

It Can Be Done: Part II

A few weeks ago I wrote about how fast Portugal developed its renewable energy sources (It Can Be Done, And Quickly) and referenced a NY Times article.  Today, another two articles caught my attention.

• Canada Produces Strain of Algae for Fuel details how a company set up to produce Omega-3 food supplements in Halifax, Nova Scotia stumbled onto a strain of algae capable of producing up to sixty times more triacylglycerol oil (a biofuel base)  than similar micro-organisms.

• Ancient Italian Town Has Wind at Its Back goes into how a small mountainous village in the center of Italy installed a few wind turbines and is now a net electricity producer, generating extra income for community purposes.

It is increasingly obvious that green/renewable energy is fast becoming a reality outside the U.S. , which is still stubbornly stuck in an energy Middle Age.  It's like Americans refuse to see past their own neck of the woods.  They are willfully blinded by the supply of cheap, but vastly inefficient, "timber" from their forest and cannot accept that "trees" are becoming scarcer and dearer in more ways than one.

Let's wake up and look things squarely in the eye: the only way to promote fast development of  renewable energy is to make it economically attractive via direct positive and negative incentives (guaranteed prices and taxation).  Everything else is wishful thinking and hot political air.

The second article says it well:

At the same time, the costs of renewable energy have been falling rapidly. And as in much of Europe, the lure of alternative power here was sweetened by feed-in tariffs — government guarantees to buy renewable electricity at an attractive set price from any company, city or household that produces it.

In the United States, where electricity is cheap and government policy has favored setting minimum standards for the percentage of energy produced from renewable sources rather than direct economic incentives like Europe’s feed-in tariffs, stimulating alternative energy has been only mildly successful. But in countries where energy from fossil fuels is naturally expensive — or rendered so because of a carbon tax — and there is money to be made, renewable energy quickly starts to flow, even in unlikely places like Tocco. 

Many will say that such policies and direct government interventions are not the way America does things, or that it makes no sense to raise energy prices and taxes during a crisis.  I strongly disagree.  We urgently need to look at alternative energy as a driver of growth, instead of as a drag.  As the world's biggest consumer of energy (see chart below), the United States can and should revamp its energy regime.

 Data: EIA

The sheer size of American energy consumption means that changing the outmoded energy infrastructure will take a long time to accomplish;  but that's is a good thing, it's a way to create millions of new jobs, technical know-how and investment spending, i.e. activity that will sustain the real economy for decades.

Notice how the renewable energy articles are ratcheting up to much bigger economies. It is  perhaps easy to dismiss developments in tiny Portugal (#37 by GDP) or Denmark (#31).  But Italy (#7) and Canada (#10) are the real deal, ladies and gentlemen.  If we continue to ignore such news, preferring instead to keep our heads in the sand, we will end up in the "Empires For Recycling" bin of history.  

Just ask the Athenians.  Or the Romans. Or the Brits.

The (Unholy) Trinity Of Money: Holy Smoke!

Money as religion?  Well, of course, since modern money is all about faith (lat. credo > credit) imposed by fiat (therefore, fiat currency).  Therefore, it strikes me as very funny that money exists in three concurrent states, just as Christianity has its own holy trinity to make up one god.  (If you are more scientifically oriented you may also draw a parallel with the triple point of water.)

Let's see:

• Money is a medium of exchange for goods and services.  This function of money is the oldest and most important in our daily lives, at least for the vast majority of us (see further below why it's not so for everyone).  Money-as-go-between goes back thousands of years to Mesopotamia and is at least as major a human invention as the written word and the wheel.  It greatly facilitates the smooth functioning of the barter part of every economy, allowing for the formation of cohesive societies.  It really does not matter what "money" is, as long as everyone agrees to a common convention and it has an element of scarcity.  Cowrie shells, salt, stone tablets, precious metals.. all can and have been used as money in the past. This is the state of money that everyone understands, even a six-year old.  Let's call this the Father State.

• Money is a storehouse of value.  This state came relatively quickly after money became widely accepted and circulated.  The Athenian silver owl was probably the world's first global reserve currency, right around the fifth century BC.  In this state, people accumulated money instead of valuable resources such as food, fuel, livestock or land.  They did so because money was easier to store (e.g. in a small strongbox instead of earthen jars full of wheat) and - very crucially - because they believed they could readily exchange it for valuable goods and services with minimal, if any, loss.  In simple terms, a silver coin minted by Athens was assumed and expected to always be exchangeable for a given quantity of wheat or timber, all other things equal.  This is when the concepts of inflation, seigniorage and debasement came into play, followed by monetary imperialism in the heyday of the Roman Empire.  Most people are familiar with this state of money, too, because they are still mentally stuck with popular images of vaults full of gold backing our money (it's not true).  Let's call this the Son State.

• Money is an asset.  An asset is something that produces regular, periodic returns: a piece of land   tilled or grazed by animals, a herd of domesticated animals, equity in an operating business that produces valuable goods and services, etc.  However, the concept of money itself as  asset (i.e. debt which produces interest), was not widely accepted until quite recently.  In fact, the world's two major religions, Christianity and Islam, considered lending of money at interest a major sin (Islam still does, even if only in theory).  This is money's most pernicious and least understood state, completely ignored by the vast majority of people.  Therefore, let's call this the Holy Smoke! State.  (Aptly enough, water also has a vaporous state.)

I obviously don't have a problem with money's Father and Son states, but Holy Smoke! gives me the willies.  How could money possibly be an asset, for example a bond?

Consider: a government issues an interest-bearing bond denominated in fiat money.  Ignore the principal for a minute, let's just assume it keeps getting rolled over at maturity.  But what about the regular, periodic interest that asset-holders demand?  Where is that going to come from, huh?

We have become so accustomed to such illogical nonsense for so long that we have come to think of  money-as-asset as common sense, day-to-day reality.  But if we stop and really think things through we come to the inescapable conclusion that we are dealing with smoke and mirrors.  Holy Smoke! by golly!


I previously said there are people - a class of people, really - for whom money as a medium of exchange is not very important.  What I meant is that there is a small minority of wealthy rentiers of Holy Smoke!  for whom the other two "states" of money are almost entirely insignificant.  Another way of saying it comes from Wall Street's past: Gentlemen prefer bonds.

As things have developed lately it is this small minority that is calling the shots for everyone else, i.e. the finance tail is wagging the entire economic dog, now more than ever before.  The borrow-consume-grow economic model that was espoused - and is still espoused in the guise of government "bailouts" - led to such an explosion of debt world-wide that Holy Smoke! is now the only form of money that really matters, the state that calls the shots, if you want.

This is completely unprecedented in economic/monetary history.  It is even entirely wrong to compare today with the Great Depression and to attempt to draw parallels, examples, lessons or possible solutions from it.  This is a new reality, so new as to have become invisible to politicians and economists who operate under the principle that if you can't "see" it, it doesn't exist.  (To be fair, that's how most of us operate day-to-day, anyway.)

And here we are today,  just like the Easter Islanders refusing to accept that building ever more stone edifices to our own Holy Smoke! deity does not constitute a real solution.

Moai In Easter Island

Default Is Class Warfare

Many people believe that debt is more-or-less equally distributed across all social classes and therefore cancels out amongst them.  The example that is frequently, if totally erroneously, used is that Joe Janitor borrows money from Pete Policeman who has deposited his savings at a bank.  Unfortunately,  this type of financial reality only exists in the movies - for example in "It's A Wonderful Life"  with its Bailey Building and Loan Association.  In the film bankers are the good guys who try to create social justice and equality by lending to one and all, while an evil slumlord is trying to bring them down.

However, "real" financial reality is much closer to a much older work of fiction: Dickens' "A Christmas Carol"  and the chasm separating Ebenezer Scrooge from Bob Cratchit.  That is to say, a small percentage of people (the "monied" class) hold as assets the debts of everyone else.

With this is mind, I maintain that the assumption, service and ultimate default of debt is best analyzed  and understood not in terms of straight economics but as aspects of political and social science, at least where household and public debt is concerned (public debt being another form of personal debt, since it is assumed in the name of the people).  Straight economics - if there ever was such a thing - is completely inadequate to help us understand the dynamics involved, particularly when debt exceeds a certain percentage of income and becomes onerous.

Most every politician and economist will forcefully say the same thing: default is equivalent to disaster.  Really?  Why?

If the "bottom" 90% of the people owe their debts to the "top" 10% and can no longer generate enough earned income to service them and maintain a decent lifestyle, isn't default a great benefit to them?  Doesn't the destruction of debt - if properly handled, mind you - create social and economic justice for the vast majority of the people?  Or should the 90% keep slicing off pounds of flesh?

Yes, default means that the top 10% will suffer a radical diminution to their accustomed living standards, but is this so bad?  To paraphrase: "Where Are The Peoples' Yachts?"

So far in this crisis we have fought fire with more fire as our collective governments have forced the people to assume even more debt, purportedly to "salvage" the likes of AIG and Greece.  But it isn't them who are being "saved", of course, but their creditors.  How fair is that?

One of these days "the people" will wake up and realize that properly managed debt default is far and away to their advantage but I am not holding my breath.  Social-political leaders and their media mouthpieces are default atavists - or, more precisely, are paid to be.

I'm Back. It's Nice To Be Missed

It's always a great compliment to be missed (and not misplaced).

My absence was caused by a combination of vacation (yes, Debra, it involved the love of my life, long walks along isolated sandy beaches, attempts at poetic expression and even a lovers' tiff or two), moving houses and a change of schools for the kids.  Now, that's what you call a killer combo - for blogs, anyway.

Rorvig

I managed to get my Internet service up and running again last night, so here I am - if more than a bit behind on global economic goings-on.  Though I will catch up in the next couple of days, it's comforting to know that the world does not float on a bed of hot air emanating from yours truly.

Till later...

It Can Be Done, And Quickly

As this article from the NY Times about Portugal makes very clear, transition to a renewable energy regime can be accomplished, and very quickly at that.

"Today, Lisbon’s trendy bars, Porto’s factories and the Algarve’s glamorous resorts are powered substantially by clean energy. Nearly 45 percent of the electricity in Portugal’s grid will come from renewable sources this year, up from 17 percent just five years ago."

Apparently, they have hit all the right buttons: grid modernization, emphasis on wind and hydro, two-way power flow to and from customers who have rooftop solar panels.

Yes, all it really takes is political will.  The rest is just money (and we know what that is really worth..).

By contrast, the real costs of relying on fossil fuels are:

1. Massive geopolitical risk, which translates into the cost of maintaining an enormous "defense" establishment and occasionally fighting energy wars, as we are doing right now.
2. Environmental degradation and climate change.
3. Losing our technological edge as other countries and entire continents (e.g. Europe) move towards more sophisticated energy regimes.  For example, the Portuguese electricity company EDP already owns wind farms in Iowa and sells electricity to the Tennessee Valley Authority.  Instead of moving ahead, the U.S. is dumbing-down.

In the 1950's and '60s rich American tourists visited remote villages in poverty-stricken Spain and Portugal, frequently snapping pictures of themselves riding donkeys and mules.  The poor locals were befuddled, since they would gladly have exchanged their picturesque animals for a tractor or - gasp - an automobile, if they could afford it.

I fear that in 2050 rich Spaniards will be visiting West Virginia or Utah to pixelize themselves driving ancient gasoline pickup trucks, which the locals would gladly exchange for a 300-mile range electric model, if they could afford it.

Global Warming? Nyet, Nyet..

No, there's no fossil-fuel induced global warning.  Absolutely not.  The 100 degree Fahrenheit (38 Celsius) temperatures in Moscow (25 F higher than normal, hottest since record-keeping began 130 years ago) is a direct consequence of sunspots, the tilting of the Earth's axis, too much vodka on the air and cow farting.

Well, OK.. there is some fire where the smoke is coming from and it is making life difficult for Muscovites. 

Photo: The NY Times

The Kremlin Shrouded In Smoke

The record heat and drought are threatening Russia's wheat production, prompting the government to suspend all wheat exports for a short period of time and setting off gyrations in futures markets.

But, hey, Muscovites should enjoy the haze since it protects them from sunburn;   as for the rest of us, we can all eat cake.

The Real Cost Of Oil

It is estimated that a total of 5 million barrels of crude oil have leaked from BP's Deepwater Horizon site, making it the worst oil spill in history.  And as of last night, the company's market capitalization was down a total of $62.5 billion when compared to before the disaster.  The loss was even bigger before the rebound, at $106 billion, see chart below.

Price of BP Shares

So what's the cost of a barrel of oil? For BP, it's definitely a case of crying over spilled crude: doing the division it comes to $12,500 per barrel - and it was even more before the bounce, at $21,250/bbl.

If we go a bit further and amortize the loss over BP's entire crude oil plus equivalents production for a whole year, it comes to $43/bbl.  And if we go all the way and amortize the market cap loss  over their entire proven reserves, it comes to $3.40/bbl. (Data from BP's 2009 Annual Report.)

Choose the number that best reflects "reality" in your view - it's only money, after all.  However, it does put a number on one of those "external" costs for oil.

Now... what's the cost for the Iraq and Afghanistan wars?... hmmm.