Wednesday, May 30, 2012

The unseen but perhaps decisive grand alignment of the nations!

Original Link:

Summary: Yesterday’s post The end of the post-WWII world is not the end of the world discussed the large-scale processes at work now. Today we discuss the most astonishing — and seldom seen — aspect of these things.
The problems of the many individual nations in crisis have received ample attention from experts. The two global dimensions of the crisis have not. First, the global financial regime no longer works well (as seen, for example, in the faltering ability of the US to act as the reserve currency, the disinterest of other nations in replacing the US in that role, and the wild gyrations of currency values). Second, the large number of nations experiencing large-scale structural change. Here we look at the second — and least well seen — aspect.

  1. The grand alignment of the nations
  2. Cause of the grand alignment
  3. A tour of the nations
  4. For more information
(1) The grand alignment of the nations
What caused the disaster of the Titanic? There was no single cause, it resulted from a constellation of simultaneous events. Bad weather. Bad luck. Mistakes. Lost gear. Errors of judgement.
Similarly today we have the major nations of the world simultaneously at or near (1 or 2 years?) major inflection points: Eurozone, UK, Japan, USA, and China. In each case largely due to internal dynamics, as their current internal economic systems fail and require major reforms. It’s the geopolitical version of the planetary grand alignment (which allowed NASA to send the Voyager One and Two probes to tour the solar system).

This creates danger and opportunity for each nation (as in the legend of the meaning of “crisis” in Chinese), but also the possibility of global synergy in a bad way over the short-term. As shown in yesterday’s post, even successful transitions are painful. Most or all of the major nations in transition would depress the global economy and lead to geopolitical instability.
What about the long-term? It could be very good, if everybody works their way through to successful new regimes. Or very bad, if most major nations fail to do so.

(2) Causes
The odds of this synchrony are too great for this to result from coincidence. What systemic factor might account for it? These nations have different demographics, economic and political structures, social systems, and trade patterns.
My guess (emphasis on guess): the common elements are poorly managed debt and lax regulation of their financial industry — although in different ways. Debt excesses differ from nation to nation: internal or external loans, private or public sector debt, debt incurred for investment or consumption. It’s the debt supercycle (coined by Hamilton Bolton and Tony Boeckh of Bank Credit Analyst).
Ditto for the banks. Some got into trouble speculating. Some the old fashioned way, by excessive and imprudent mortgage and business loans. Some were ordered or pressured by governments to make bad loans (often to the government).
But no matter what the path, the result was debt that could not be paid back and wrecked banks. There may be no other path to the future other than mass defaults and rebuilding many of the world’s banks (at somebody’s expense). The new world will probably build a fundamentally different global financial system than ours, learning from our generation-long experiment with debt. It’s a useful tool but, like many powerful tools (opiates, nuclear power, nailguns) becomes a fearsome thing when misused.

(3) A tour of the nations
(a) The Eurozone
The Eurozone is furthest along of the major nations in the cycle of crisis and resolution, and exhibits many of the traits only dimly visible elsewhere. It might also be the template that other nations follow to disaster: incorrect diagnosis of their problem, dogmatic adherence to unworkable solutions, reluctance to confront their core structural problems, and a refusal to learn from either economic theory or history.
Worse, Europe’s leaders appear unwilling to address their core problem. Perhaps because Europe’s people are not yet willing to do so. As we see in the Greek polls: 80% want to stay, 80% don’t want to pay the price of staying. Polls in Germany show a similar contradiction.
Francisco Blanch (Global Investment Strategist, Bank of America Merrill Lynch) explains the first three problems:
To begin with, it should be apparent by now that forcing consumers, corporates and governments to delever all at the same time is a painful policy. With consumers, corporates and governments in Peripheral Europe all rushing to sell assets, GDP has nose-dived in Spain, Italy, Greece or Portugal, to name a few. With GDP contracting at a faster rate than overall indebtedness in Peripheral Europe, debt to GDP ratios are not showing much improvement and borrowing costs are soaring, pushing some economies into a debt deflation spiral.
… As European deficit countries face a similar current account problem to that of the US but lack a flexible currency, continued debt rollovers are only perpetuating the problem. Meanwhile, Germany has instead shown a similar position to China several years ago (Chart 15). Quite strikingly, Germany’s foreign position has barely budged, making it nearly impossible for Peripheral countries to regain competitiveness. Put differently, the core is fast absorbing capital and labor, and exporting misery to the periphery. Germany is having its cake and eating it too, for now.
… Unfortunately, this situation is unlikely to persist. World history is littered with ruinous experiments linked to a lack of exchange rate and monetary policy flexibility (Chart 16). The gold standard in the Great Depression, the lost decade in Latin America, and the Asian Financial Crisis are good examples of how exchange rate distortions led to economic ruin. … But in the absence of currency, monetary and energy flexibility, the European sovereign debt crisis is far from over and about to start its most dangerous phase.
In the New York Times of 20 May 2012 Paul Krugman explains the last of these problem, showing how today’s situation in the Eurozone is similar to that of the US-European situation at the end of WWI.
Read Keynes from Essays in Persuasion:
“Ultimately, and probably soon, there must be a readjustment of the balance of exports and imports. America must buy more and sell less. This is the only alternative to her making to Europe an annual present. Either American prices must rise faster than European (which will be the case if the Federal Reserve Board allows the gold influx to produce its natural consequences), or, failing this, the same result must be brought about by a further depreciation of the European exchanges, until Europe, by inability to buy, has reduced her purchases to articles of necessity.”
He {Keynes} then goes on to discuss the folly of American policy, which simultaneously demanded that the Europeans pay in full while denying them the ability to export enough to make those payments. So here too we are repeating ancient mistakes. But why does nobody learn?
The situation will eventually sort out. Despite the hysterical forecasts of doom, Europe will not sink forever like Atlantis. The process might be quick (these things tend to accelerate fast), but probably with much turmoil and pain. Here are some incisive recent articles about the Euro-crisis:
(b) Japan
Japan’s increasingly elderly majority have locked the nation into box of dyfunctional guaranteed to fail policies. Some experts believe their leaders have in effect given up on finding a solution, and just wait for the eventual singularity — wrecking the existing order and making possible a new Japan. The process probably will be painful. Here are two obituary notices:
(c) UK
The UK now confronts decades of errors: over-reliance on North Sea oil (rapidly depleting), a poorly managed and over-size financial sector, and large public debt and liabilities. Worse, their leaders and people appear clueless about their problems and possible solutions. For details about this bleak situation see “Thinking the unthinkable – might there be no way out for Britain?“, Dr Tim Morgan (Global Head of Research), Tullett Prebon (UK brokerage firm), July 2011 (large pdf) — An excerpt looks at their future:
Our analysis indicates that the British economy, as currently aligned, is incapable of delivering growth at anywhere near the levels required by the deficit reduction agenda. In the decade prior to the financial crisis, the UK economy became hugely dependent upon debt. Taking public and private components together, debts have increased at an annual average rate of 11.2% of GDP since 2003. The two big drivers of the economy have been private (mortgage and credit) borrowing, and huge (and debt-dependent) increases in public spending.
  • Three of the UK’s 8 largest industries (real estate, financial services and construction), which account for 39% of the economy, are incapable of growth now that net private borrowing has evaporated.
  • Another 3 of the top 8 sectors (health, education, and public administration and defence) account for a further 19%, and cannot expand now that growth in public spending is a thing of the past.
  • This means that 58% of the economy is ex-growth, a figure that could rise to 70% if, as seems probable, growth in retailing is precluded by falling real consumer incomes. a very British mess
Together, the severity of Britain’s indebtedness and the challenging outlook for the economy mean that the UK is now mired in a high-debt, low growth trap.
(d) China, India, and the US
All these are in earlier stages of the crisis cycle which will test their people and leaders. Some will be in effect voted out of the major league nations; others will become regional hegemons or even perhaps superpowers in the next world order. For more about China and India see the FM Reference Page listing all posts by nation.
(4) For more information
See these FM Reference Pages for other posts about these topics:

Tuesday, May 08, 2012

Investing in a G-Zero World...

The planet is ripe with investment opportunity, according to most of the speakers at an ETF conference I attended yesterday in Boston. From emerging markets to sector rotation to alternative betas, optimism abounds, attendees were told.
As usual at these type of events, focusing on what could go wrong was minimized, although in fairness I did moderate a session on risk management. In any case, it was hard to miss the penchant for seeing the investment outlook as flush with possibility. That’s a worthwhile perspective, up to a point, although as I listened to the speakers I kept thinking about Every Nation for Itself: Winners and Losers in a G-Zero World, Ian Bremmer’s new book that I read (most of it) on the train ride to Beantown.
Bremmer is the president of the Eurasia Group and a keen geopolitical analyst. In his latest book, he argues that the world is headed for a period for a “tumultuous transition” that’s bereft of the leadership that used to prevail when the U.S.-centric club of nations—the so-called G7, which evolved into the G20—kept the international system humming and put out the fires, or at least kept them from burning free. But those days are gone and “we have entered a period of transition from the world we know toward one we can’t yet map.” He writes that
This is not a story of the decline of the West or the rise of the rest. In years to come, none of these players will have the power to bring about needed change. The G20 doesn’t work, the G7 is history, the G3 is a pipe dream, and the G2 will have to wait.
Welcome to the G-Zero
What’s the G-Zero? “A world order in which no single country or durable alliance of countries can meet the global leadership.”
Bremmer’s argument is laid out in breezy fashion, covering the waterfront of macroeconomics, politics and international relations. It reads like an extended op-ed than with footnotes. But his view is certainly persuasive, in part because he provides numerous examples of how the geopolitical world order is evolving and what it means for the future.
For instance, the prediction by some that the rise of emerging markets will fill the vacuum left by a debt-laden U.S.-Europe-Japan power system may be expecting too much. As Bremmer explains, “the BRICS [Brazil, Russia, India, China, South Africa] countries now hold summits and talk publicly of shared interests, but there is much less to their partnership than meets the eye.”
These countries don’t have much in common beyond a shared desire to increase their international influence and to limit the ability of established powers to impose their will on everyone else. China and India are among the largest energy importers. Brazil and Russia are among the world’s most important energy exporters, giving them a very different view of policies and events that push crude oil prices higher. China and Russia are authoritarian countries that face internal ethic and religious challenges to their territorial integrity, while India and Brazil are genuine multiparty democracies with governments that must weigh the need for sometimes painful reforms against frequent fluctuations in public opinion. China and India are rivals for influence in South Asia. China and Russia compete for influence in Central Asia—and in Russia’s Far East. Brazil is the only BRICS country that lives in a relatively stable region. China, India, and Brazil each have far more trade with Europe and the United States than with Russia. South Africa, admitted to the group in December 2010, has virtually nothing important in common with any of them.
Do you see the obvious implications that flow from that multi-dimensional matrix of incentives, conflicts and challenges? Neither do I, and I suspect that it’s going to be hard for most folks to figure out what’s relevant, what’s not, and how to tell the difference. In fact, real-time events only strengthen Bremmer’s argument. For example, the latest political upset in the “revolt against austerity, cuts” in Europe is yet another sign that the rise of G-Zero world has momentum. Indeed, the triumph of Francois Hollande in the French presidential election threatens to complicate the tension between Paris and Berlin as the Continent struggles to solve its ongoing euro crisis and balance Germany’s preference for austerity with France’s new-found preference for fiscal stimulus. A similar conflict looks set to roll on for policymakers in the U.S., where divided already government reigns supreme and the possibility (likelihood?) of an extended run awaits after the November elections.
To the extent that geopolitics influences markets (and it does), investing isn’t going to get any easier in the years ahead. Geopolitical risk is almost certainly on the rise, and for lots of different reasons. True, it’s a different type of risk compared with the Cold War, but it’s a risk nonetheless. More importantly, it’s much more of a multi-faceted risk, which means that there are probably a lot more unknown unknowns out there.
The fact we live in a multi-polar world is no surprise at this late date. But as Bremmer’s book reminds, the multi-polarity may be even more nuanced and byzantine than we thought just a few years ago.
It’s easy to see a G-Zero world as favorable for investment opportunities, but it’s also a world filled with new and uncertain risks. That’s good news for talented managers who have the brains and the resources to navigate the shifting landscape. Well-run global macro strategies, for instance, may be well-positioned to exploit the world ahead. But history suggests that most investors (and institutions) will still have a tough time beating a benchmark of all the major asset classes. That’s been true for the past decade, as my recent review of the Global Market Index vs. multi-asset class mutual funds shows. Bremmer’s books implies that we should expect more of the same. In fact, if his worldview is correct, and I think it’s largely on the money, then the competitive profile of broad-minded asset allocation with simple rebalancing rules is going to remain a tough act to beat. Perhaps that’s the only constant you can count on when it comes to investment strategy.
This post originally appeared at The Capital Spectator

Friday, May 04, 2012

Spain Is The New Greece...

Author: Marshall Auerback

Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994.
Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.
Although I have warned on these pages before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Just take a look at this employment data
Spain First Quarter Unemployment: Summary (Table)
2012-04-27 07:00:00.13 GMT
1Q Quarterly Yearly
2012Net ChangeQoQ %NetChange YoY%
Both Sexes
Over 16s38,493.70-14.5-0.04%-18.4-0.05%
Active Workforce23,072.80-8.4-0.04%10.90.05%
Activity Rate59.94%0.00%n/a0.06%n/a
Unemployment Rate24.44%1.59%n/a3.15%n/a
16 to 6430,606.00-52.5-0.17%-171.4-0.56%
Activity Rate74.87%0.13%n/a0.44%n/a
Unemployment Rate24.59%1.59%n/a3.17%n/a
Employment Rate56.47%-1.09%n/a-2.03%n/a

Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic. But in light of these numbers, what kind of GDP decline should one realistically expect when employment falls two percent non annualized in a quarter? At least a four percent annualized decline. more likely much higher. Yet who is talking discussing that as a real possibility in Brussels? Nobody. Everybody remains asleep at the wheel.
For years, the Spanish GDP figures have been hard to square with the underlying collapse in industrial production and rise in unemployment, both of which were more realistically reflecting the scale of the country’s collapse into depression.
When I said a few months ago that the Spanish government was lying about their numbers, I was attacked by a few Spanish readers of this blog, who claimed I was a nefarious hedge fund manager, likely loaded up to the gills with CDSs on Spanish debt who was trying to foment panic. For the record, I have never bought a credit default swap in my life. If anything, I was trying to foment panic because I was horrified by the new ultra austerity stance adopted by the recently elected Rajoy Administration.
Now consider the reality: the economy is crashing, hence the unemployment rate rise. Yet German Chancellor Angela Merkel and the ECB President, Mario Draghi, continue to insist that one can have both fiscal restriction and a lower domestic price level despite the fact that Spain has a non financial private debt to GDP ratio of 230%.
Interestingly enough, Dutch levels of private debt to GDP are even higher, at 249%, the highest in Europe. By contrast, the Italians still have net household savings. So who are the real “profligates” in Europe?.
Those who embrace these ruinous austerity policies will soon be seeing the experiencing much the same kinds of conditions as the Spanish (albeit from less depressed levels) including the moralistic Dutch, whose finance minister has been a crusader in favour of even harsher fiscal rules than those embodied in the Stability and Growth Pact.We have also recently witnessed a big surprise decline in the German consumer confidence index last week as well as a collapse in an Italian retailing sentiment index. The austerity disease is intensifying the crisis, even in the core.
It is inconceivable to me that Super Mario Draghi won’t be changing his tune soon, in spite of what he and the Merkel government are now saying for public consumption. To continue with this present course will not only precipitate a collapse of the euro, but a political collapse across Europe.
There is no question that larger deficits are needed to support aggregate demand at desired levels. However, as all of us who have contributed to this blog have long noted, the problem is the national governments are currently like US states and as such are revenue constrained because they are USERS, rather than ISSUERS of the currency (as opposed to, say, Canada or the US, both of which are sovereign issuers of their own currency).
So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the national governments, which creates a solvency crisis of the kind we are experiencing today. Said another way, without the ECB the euro members are currently deep into ‘Ponzi’, as my friend, Warren Mosler has described it. In reality, they have all been in ‘Ponzi” since day one. But it took a crisis of the magnitude of 2008 to make this manifest for the markets.
At some level, the ECB understands that, as it always”writes the cheque” when a systemic crisis pushes the system to the brink. It can be no other way, as it is the sole issuer of the euro. But for the most part, Europe’s policy making elites remain in denial, as they continue to turn away from the one entity that could address the insolvency issue.
And let’s be clear once and for all. The US government does not face the same kind of crisis as the Spanish, the Greeks, the Dutch or even the Germans. The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. Whither the so-called “bond market vigilantes”?
The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that there is default risk attached to the paper issued from the EMU governments.
They also appreciate that with the non-elected eurocrats of Brussels insisting on a decade or more of austerity and implementing fiscal rules that these would ensure a crisis every time there has been a serious downturn in aggregate demand. And with that, the risk of default with government debt has risen. That is what we are seeing today across the euro zone. And in Spain it is writ large.
The mainstream austerity line is trapping Spain (as well, as Greece, Portugal, Italy, Ireland and soon the core of the euro zone) in a dangerous downward spiral of lost income and increased unemployment. I still think Francois Hollande’s likely election could well change the political dynamics in the euro zone, even though he generally buys into the mainstream neo-liberal euro line. Hollande is an “austerity lite” character, as opposed to being a genuine reflationist. But even he cannot be oblivious to the looming political and social dangers which await France, if he continues to pursue the policies embraced by the current President, Nicolas Sarkozy.
So far, Brussels has not let facts get in the way of a good neo-liberal theory, but it’s getting increasingly hard to ignore this emerging horror show.
This post originally appeared at New Economic Perspectives