Crunch Time, Addendum

I think it is instructive to provide a chart on what is going on in the Federal budget.  Government spending has been flat for almost five years and the deficit gap is narrowing fast.  Yes, part of the flattening out in spending has come from ultra-low interest rates on debt outstanding, but still...  Can't say that the Obama administration is a spendthrift..

Crunch Time

It is getting close to crunch time for the US and its Himalayan-sized mountain of debt.  Right now no one really believes that the world's most powerful and prosperous nation will default, thereby committing financial suicide, over an internecine legislative tiff. I certainly don't believe it myself. 

Well.. I don't want to believe it.

But I have a very bad feeling this time.  No, I am not predicting a default.  Rather, my unease stems from the sheer size and spread of the debt problem all around the world. I cannot see how this global FUBAR situation will be resolved without wrenching upheaval, given that political and financial leaders clearly do not want to address the problem at its core, never mind the common people.

I have frequently referred to Permagrowth as the root cause of the Debt Crisis, i.e. the single-minded expansion in the consumption of everything, fuelled by  ever more debt. Obviously, exponential growth within a closed system leads to disaster.  

If we do not willingly renounce Permagrowth as our leading economic paradigm what I fear is ahead is an involuntary and abrupt end, one that will result in chaos.

Think of putting a pressure cooker on the stove, with the safety valve closed...

Ding Dong Dammit!!

Congress has not (yet) approved the Federal debt ceiling increase necessary to keep the government running.  This fandango goes on regularly in the US, sometimes even resulting in shutdowns of  government operations.  No one really cares.. because everyone believes that after the requisite amount of hot air has been released into the political atmosphere, yet another huge slice of debt pie will be duly approved, baked and served a la mode to the indifferent public.


The debt ceiling process pits the power of the purse (Congress) against the power of the bully pulpit (the President), but it is the referee who always wins in the end.  The referee being the very real danger of default, the unspoken horror of Treasury bonds going from AAA to D in one fell swoop - call it MAD (Mutually Assured Destruction) of the post-Soviet world. (Come to think of it, there is a great resemblance between the overkill inherent in the tens of thousands of nuclear MIRVs, and that of trillions in debt bombs owed/held by just about all sizable economies).

Well, the ref always won - in the past.  And I say in the past because... accidents do occur (yes, Virginia shit happens).  What if the two contestants call each others bluff and thereby both smartly smack the ref, sending him reeling to the canvas?  I hear some hawks say that it would be ok to default, it would serve as a warning bell, etc etc.  Well, all I have to say to that is... here's a joke (if you blush at pink ones, you've been warned...).

It's nearing Christmas and a married woman is entertaining her lover in her own bedroom, when hubby unexpectedly comes home early...

Honeyyyyy, I'm hoooome !

Oh damn, quick, hide in here, rasps the unfaithful wife to her lover and brusquely shoves him inside a closet.  Unfortunately, in the rush her friend's - ahem - family jewels are caught by the door and are left dangling outside the closet, turning a crimson red.

Heeeeyy, what are those?.. asks the husband.

Ohhh, those? Err... oh they are Christmas bells, just ornaments, dear.

How cute... let me hear the sound they make... says the clueless husband and tinkles the.. bells. Obviously, not a sound.  He tries again and again, with increasing vigor in his smacks, puzzled at the lack of the bells' jingling.  The lover inside is in painful, insufferable agony.

Finally, the husband gives a mighty whack! at which point the lover moans..

Ding - dong damn it, ding-dong!!

Yes, ladies and gentlemen of Congress and the Executive, those are most certainly NOT Christmas ornaments hanging out there and we don't much appreciate your using them as bells, warning or otherwise.

The Big(ger) Picture

I went on a two week sailing vacation away from it all and what do you know..?  No news, no market quotes and no insta-charts to clutter my brain had the usual salubrious effect.  That is to say, the big picture is easier to see, from... the sea!

And what IS the Big Picture? Trade and Energy.  Having shifted just about all of our manufacturing to China and its satellites we can follow the current health of the global economy from just a couple of indicators: shipping activity and energy prices. 

Yeah, yeah.. I know:

•  Oversupply of newbuildings is glutting the shipping market and keeps charter rates down (see chart below).

Baltic Dry Index

Nevertheless, if the global economy had continued to expand as bubbleconomists projected some years ago the new ships would have found ready employment and rates would not have crashed as they did.

• Technical advances in oil extraction (eg frac oil) has raised non-OPEC production, particularly in the US, threatening a significant pullback in global petroleum prices.  Thus, in my opinion, the current Syrian crisis.  (I can't get the film "Syriana" out of my mind.  It was released in 2005 and I wonder why the title involved Syria, since the film has nothing to do with the country.)

 US Oil Production

My Big Picture conclusion?  The global economy is held up by a bunch of chicken wire and the duct tape of easy money. 

Oily Triple Top

Still on the short post mode.

Crude oil... Looks like a possible triple top going on here?? The EU is entering a recession, China is slowing down, the US is producing frac shale oil at record levels.. What's holding up prices? Political turmoil in the ME and the Saudis acting as swing producers. 

..and gold, a forerunner in my opinion, has broken down most decisively.

WiFi On The Fritz

We have just moved and our phone co. hasn't connected our wifi network yet... I'll be back asap, writing this from my phone... :)

In the meantime, I'm watching developments in China very closely.

The Big White Whale

In a comment to my post about Greek healthcare spending a reader (thanks rufus) urged me consider the "whale", i.e. the good old USA.  So, here's a chart of such spending as a percentage of GDP for all countries in the world.  The data comes from the World Bank.

Oh yes, the US is indeed a whale all of its own, when it comes to expensive healthcare - the Moby Dick. 

I have included Canada in the chart, the acknowledged world leader in public healthcare, the golden standard.  Astonishing, isn't it?  Everyone there gets quality care, and overall it costs 40% less than the US.

As for Greece, it is astonishing to see it spends nearly the same as Canada or Switzerland, but... never mind the care you get...

A Tale Of Two Depressions

The Greek crisis is often compared to the American Great Depression of the 1930's, usually because reported unemployment is currently so high in Greece, around 27%.  It had reached over 30% in the US back then.

One chart: A comparison of nominal GDP annual rates of change starting in 2009/1930.

I leave the interpretation to the reader.. fell free to use the comment button !!

Greece: What Sunk The Boat

Greece is for all practical purposes bankrupt, staying afloat only because its European partners and the IMF are continuing to extend loans until it can stand on its own - or finally sink to the bottom.

And to stand on its own Greece must:

a) Reform an astonishingly inefficient and corrupt public sector.
b) Reshape its economy from the Borrow-Import-Spend bubble to become much more productive.

Today, I will focus on part (a) by identifying the super-torpedo that hit Greek public finances.

Right off the bat: this torpedo was social spending, and in particular spending on health and pensions.

The country has a system that combines the two, i.e. it provides healthcare and pensions for all workers and retirees who pay or have paid contributions (depending on industry sector total contributions can be as much as 65-75% of salary).

Look at what happened after 2004: government spending on social benefits started growing fast from 15%  of GDP, to 23% today (Greece entered full crisis mode in mid-2010).  With everything else staying flat, this huge increase in such a short time really sticks out.

Narrowing the focus even further, lets look at healthcare.  First, some facts.

Per capita, Greece has more doctors and fewer nurses than just about every other country in the world.  Curious...

(Note: if the language is Greek to you, just look at the bars - the message is obvious)

Doctors per 1000 residents in OECD countries - Greece is FAR above everyone else

Nursing staff per 1000 residents - Greece is just about last 

Just twenty years ago, however, Greece had the same number of doctors as everyone else - and also had very few nurses.  Why did doctor numbers zoom up while nursing staff stayed flat? Curiouser still...

Doctors (green line) and nursing staff (red line) per 1000 residents

Adding another piece to the puzzle, the number of pharmacies and pharmacists is also off the charts.

Number of pharmacies and pharmacists per 1,000 residents

With all of the above, one would think that Greece must be a public healthcare utopia - but, of course, it isn't.  The very low number of nurses is pretty indicative.   So... what gives?

The final bits of information are crucial: 

• Total healthcare spending is 10% of GDP, with 60% of it funded directly by the state.
• In drugs, 90% of all spending is paid by the state.  Pharmacists enjoy FIXED profit margins approaching 33%.
• Until very recently all drug prescriptions were written, filled and filed manually.  Checks were essentially non-existent.

It's no longer curious.. Greece had become a haven for astonishing overspending and criminal graft in prescription pharmaceuticals, with compliments of the state.  Doctors and pharmacists made a huge bundle by writing and filling millions of bogus prescriptions, the pharmacists directly and the doctors through "black" kickbacks and bonuses, some from drug companies themselves.  Nurses could not be part of the drug honeypot "mafia", so there was no incentive to become one and their numbers stayed very low.

Damn the torpedoes Greece, and if you want to survive you best put the engines on "Hold" and throw the bums overboard...

Childhood's End

I admit it;   I am, and have always been, a fan of classic science fiction.  Thus, the title of today's post, a direct reference to the classic novel by Arthur C. Clarke, in which the Golden Age of The Overlords ends and Mankind has to deal with the aftereffects.  (Oh, please... no puns about science fiction and finance, I am the one who coined the phrase "sci-fi finance" (smile)!)

There may be no benign aliens in silver ships circling the skies above, but one could easily be forgiven a tendency to Utopianism when gazing at the following chart.  I mean, wtf? (sorry, I have two teen daughters..). Thirty year bonds at 3-ish percent?  Have people taken leave of their risk-awareness senses?

Oh no, will chime the pundits.. it's precisely because we think default risk is so high that we accept such piddly returns, at lows not seen since FDR and the Very Great Depression (the one we escaped came close to being GD Part II).

 

 Historical US Treasury Yields

And 10 year Bunds at less than 2%?  Mein Gott, deez ist nutz!

10-Year German Bund Yield

Seems that if there is a pig heaven for borrowers, this is it.

Assuming, of course, you are not a PIIGy,  in which case you have been occupying a seat in Hell's roller-roaster reserved just for you by Mrs. Merkel, guardian of the EU's not-so-pearly gates.  (Yeah, yeah, I know.. everyone is bashing the Germans.  Never mind, some of my best friends are Krauts.. er, Germans.)
   

 
Ok, what am I driving at?  This: If you own AAA/sovereign bonds you are paying WAY too much for credit protection and, conversely, you are accepting WAY too much market (inflation) risk.  In simple English, bonds are much too expensive.

No, I'm NOT expecting hyperinflation, I am not a gold bug, a survivalist or any such -ist, but I am an open-minded pragmatist.  The global economy will grind to a halt if credit is not made more freely available to the suffering economies of the West, and particularly in Europe which makes up one quarter of the world's GDP.

One way or another, money will have to be shaken out of "safe havens" and into the Real Economy, to finance much needed growth.

 To wit, ΙΜΗΟ interest rates are going higher.

Back From The Desert

It has been so long since the last post that I might as well have been perambulating in the desert!  Which, in a way, I have.

But, no matter, dear readers and friends, here goes.

I have been trying to think how the current situation will play out.  Brief description of what's happening today:

1. The US is stuck in Quantitative Easing (call me printing) to the tune of hundreds of billions yearly.
2. Europe is mired in deflationary misery and recession, with Germany calling all the shots and everyone else hating them.
3. China is the world's second largest economy, with serious contention for hegemony. 

There is an enormous imbalance in the global economy, and it needs to be corrected.

How will this be accomplished?  The key is China. After nearly two decades of massive growth, the country is no longer a bowl of rice a day economy. Far, far from it.  It is fast becoming wealthy, particularly in the major cities, and needs to protect and improve living standards for its burgeoning middle class. Up to now it has done so through being cheapest-to-produce in export goods, gutting the West's manufacturing base.  

 In my opinion, everyone understands that this game is over.  The current model of borrow-import-spend can't survive any longer and is in dire need of immediate replacement.  Something like a new Bretton Woods agreement is necessary to correct the imbalances, and recirculate China's vast reserves back into the global productive economy, and not as passive portfolio investments.

Chinese FX Reserves - $ Million

Here's a possible solution:

• China will gradually shift from being export-driven, to investing its reserves in productive assets abroad.  It will generate jobs within its western customer base AND recirculate its reserves into the real economy, instead of letting it sit in Treasurys and Bunds.  The current "bubble" in low interest rates for AAA borrowers and the (previous) bubble in gold prices also stems from that condition.

 10-Year US Treasury Yield

Gold

•  A significant revaluation of the yuan is probable in this scenario.

 Chinese Yuan per $US

•  Europe will introduce its own version of QE, probably laced with heavy doses of Germanic rectitude and fiscal righteousness.  But it will ease.

Everyone benefits under this scenario: The west is lifted from recession, the US can ease off its own QE pedal, and China can invest its reserves more safely than risking bond defaults and haircuts.

I believe we are already observing early signs of such a move:

1.  The US is hinting heavily of ending QE.
2. China is clamping down on domestic credit expansion, and is looking to invest in infrastructure abroad.
3. Europe realizes that deflationary politics are now fast becoming counterproductive, since they risk popular backlash.  Italy, in particular, could blow up without warning.
4. Japan is now on the QE wagon.

Key date: the German elections in September.