"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises

Saturday, January 29, 2011

Jim Rickards on Quantitative Easing... Currency War... Inflation... Political Instability

Jim Rickards pretty much sums up what we have been discussing: how the poorest of the world are bearing a disproportionate burden in this crisis, especially those in unstable areas of the developing world.  And how QE2, that is, Bernanke's monetary easing, is creating not only inflation elsewhere in the world, but is also indirectly causing political instability as well.  In my view the unresolved financial crisis is causing unintended geopolitical consequences that may prove even more costly than the original crisis.  The world is becoming a much more unstable and dangerous place.

Friday, January 28, 2011

Egypt Crumbling Into Chaos

I am no expert on Egypt, but I know a client state when I see one.  Egypt is the second largest recipient of US Foreign aid - only Israel receives more.  And this is no accident, the two have been historic rivals, only to be at peace with each other under Carter's Administration with the Camp David Accords.  The US, more than any other nation, is extremely influential in the Middle East - a region, due to its oil reserves, that has been described by US policy planners as "history's greatest prize."

Oil, you see, goes hand in hand with money.  The two are strategic assets.  To have the world's reserve currency means you also control, or at least influence the most oil rich region in the world.  Dick Cheney once said at a 1999 speech at the Institute of Petroleum in London:
Oil is unique in that it is so strategic in nature. We are not talking about soapflakes or leisurewear here. Energy is truly fundamental to the world’s economy. The Gulf War was a reflection of that reality. The degree of government involvement also makes oil a unique commodity. This is true in both the overwhelming control of oil resources by national oil companies and governments as well as in the consuming nations where oil products are heavily taxed and regulated. 
Essentially, the petroleum industry deals with extreme risk and with billions of dollars on the line. Oil is produced in distant lands as a result of huge risk and enormous capital outlays, it is transported over vast distances, refined in expensive refineries with very heavy outlays required to protect the environment and to comply with strict and expensive regulations, distributed through a wide network of pipelines, trucks and wholesale outlets and sold at stations in prime locations and taxed heavily. 
It is the basic, fundamental building block of the world’s economy. It is unlike any other commodity. 

I was never a big fan of Cheney, but the man understands what makes the world work.  I know many bloggers have covered this Egyptian crisis.  But there are many aspects to it.  There is the political aspect, the human rights aspect, and there is also the aspect of contagion.  But as far as the focus of this blog, the global monetary system, this crisis represents a challenge to the US: a challenge of national security, energy, and as a result, the US Dollar.  Let us not forget that a large portion of the recent run up of the national debt has been due to the wars in Iraq and Afghanistan.  Thus, the Egyptian crisis falls at an extremely inconvenient moment.  It is so inconvenient, that Vice President Joseph Biden said when asked if he would characterize Mubarak as a dictator:
“Mubarak has been an ally of ours in a number of things. And he’s been very responsible on, relative to geopolitical interest in the region, the Middle East peace efforts; the actions Egypt has taken relative to normalizing relationship with – with Israel. … I would not refer to him as a dictator.” 
When it comes to foreign policy, there is little difference between Republicans and Democrats that inhabit the White House. Biden's answer is how the White House views client regimes - they are a necessary evil in order to effectuate US policy. The US needs Mubarak, just as it once needed these guys:

President Eisenhower with Cuba's Batista, later to be overthrown by Castro

Vice President Nixon, with King Idris of Libya, later to be overthrown by Khadaffi

President Carter and the Shah of Iran and his wife, during Ayatolla Khomeini's rise

All of the above "transitions in power," and there have been many more, were big setbacks for US foreign policy.  What is compounding the issue today with Egypt is the ongoing global financial crisis, as well as the ongoing wars in Afghanistan and Iraq.  The US, financially, is not in the same state as it was during the cold war, when it only had to face the USSR with little debt, or at least, had a greater ability to finance military operations and foreign governments.  I know that MMT'ers will say, the US is not debt-constrained technically, and that is true.  But the US nonetheless has financial limits that affect the execution of its foreign policy.

Thus, this crisis in Egypt is worrisome for the US, and by extension, the US global monetary system which also relies on the US maintaining influence in the Middle East.  

For the purposes of this blog, I am not viewing this crisis in a moral or patriotic context.  I am viewing this crisis in a geopolitical context, based on realpolitik, and how it can affect the current global order, and by extension, the current global monetary system.

Thursday, January 27, 2011

Will Greece Restructure its Debt? A Tale of Two Greeks: Dimon and Papandreou

There is much discussion in Greece about a possible debt restructure, that is to say, some form of default involving senior creditor (bank) losses. From Reuters:
German EU Liberal: Greek Restructuring Must Happen
Greece should restructure its debts within a year, a prominent member of the European Parliament from Germany's junior governing partner told Reuters, saying his party would not oppose such a move.
Wolf Klinz is among the first to clearly outline the position of Germany's liberal Free Democrats (FDP) on the controversial issue of restructuring. Their coalition partners in Berlin, the center-right Christian Democrats, have played down any debt restructuring and Greece opposes it.
"Greece will not make it without restructuring," said FDP member Klinz, who chairs the European Parliament's committee examining the response to the financial crisis.
"It must be done quickly -- over the next 12 months," he told Reuters in an interview late on Tuesday.
"With a restructuring, it is important to move fast and take the initiative, rather than letting the markets get in control."
...A restructuring of Greek debt, a move viewed by some as risky as it might knock confidence in the euro zone, would see bondholders suffer losses in order to make Athens' debt pile -- approaching 150 percent of gross domestic product -- more manageable.
It could also put the FDP at odds with Chancellor Angela Merkel, who has said such a move is not being considered now.

Merkel calls the shots right now, not some German Euro Parliament member, and so far, she is opposed to such a plan.  Yet there are many in Greece that actually believe this could happen, and Greek Prime Minister George Papandreou's refusal to consider a debt restructuring is seen as foolish.

I agree, that Greece would benefit from a restructuring - what country wouldn't like to see a good chunk of its debt wiped out?  But let's be realistic here.  Just as "no man is an island" so too, is no country an island, especially in a financially interconnected world.  There are many unintended consequences that come to mind if Greece were to default, bringing to mind the Lehman Brothers and Bear Stearns contagion fiasco of 2008.

But let's be really honest here.  Who really calls the shots?  Is it not the bankers?  One only needs to look at how Ireland's crisis was handled to understand who gets rescued and who gets stuck with the bill.  The Irish Financial sector was extremely irresponsible, as were their foreign bank counterparties.  So who got rescued, and who got stuck with the bill?  The Irish banks were bailed out, which in my view was a bailout of every other counter party (UK, French, German, etc... banks) and the Irish people got stuck with the costs.

The subtitle of this post is "A Tale of Two Greeks."  Well, we know the first Greek is George Papandreou, so who is the other Greek?  It's Jamie Dimon, CEO of one of the most powerful banks in the world: JP Morgan.  From BBC News:
Davos 2011: Dimon Warns of Debt Restructuring Risk 
Forcing eurozone countries to restructure their debt would be "far too risky", the head of US bank JP Morgan Chase has warned. 
Jamie Dimon said doing so could result in banks taking losses and needing to be rescued. 
Mr Dimon was speaking on day two of the World Economic Forum in Davos. 
...Mr Dimon said: "I think Europe did the only good choice, which is to get through this crisis, because if you don't fix it here, you're going to fix it there, which is in the banking system. 
"I think that would be far too risky," he added. 
He said that allowing a eurozone debt restructuring could trigger a run on the banks, requiring governments to step in to help banks that hold eurozone debt. 
The EU has so far refused to allow Greece or the Irish Republic to default, instead providing billions of euros in emergency loans to allow them to refinance their debt. 
But there are plans for a permanent mechanism to help any eurozone nation crippled by debts to come into force in 2013, which would require private sector bondholders to share the cost of any debt restructuring on a case-by-case basis. 
Speaking separately at the forum, Greece's Prime Minister George Papandreou admitted that the question of restructuring had been raised. 
But he said: "I can say that we're not going to default. I also say we're not moving to restructuring."

So for now, I just don't see any restructuring happening.  Not unless there is a mechanism involved to shelter the European Banks from any possible fallout - after all, it's not just a sovereign debt crisis that the EU faces, but a banking crisis as well.  The fallout in the Euro banking sector,  I believe, would be severe.  See my post:  Are Euro Bailouts Really German Bank Bailouts?  But to be fair to German banks, it is not just them, but most of the European banking system that is still fragile.  My focus on the German banks was due to them having by far the highest leverage of all other European banks.  They say that the Greek government was irresponsible - but  you know what?  German banks were as well.  There is a lot  of blame to go around, and  unfortunately, the people that ultimately pay for these sins, the little people, are the most blameless.

I'm not exactly the most religious person in the world, but there is a saying that comes to mind from Matthew 5:5:

"Blessed are the meek: for they shall inherit the earth."

 Wish it were so:

Let's Forget, for a Moment, About Economics. How About Some English Literature? George Orwell, Perhaps?

I don't know if students today are aware of the English writer George Orwell.  But back in the early to mid 1980s, when the US-USSR Cold War still ongoing, George Orwell's novel Nineteen Eighty-Four, was often required reading.  You see, we in the West looked at this dystopian novel as an example of the evils of Communism, of Soviet Russia, and of what to avoid.

For those not aware of the novel, here is a brief summary by Wiki:
Nineteen Eighty-Four (sometimes written 1984) is a 1949 dystopian novel by George Orwell about an oligarchical, collectivist society. Life in the Oceanian province of Airstrip One is a world of perpetual war, pervasive government surveillance, and incessant public mind control. The individual is always subordinated to the state, and it is in part this philosophy which allows the Party to manipulate and control humanity. In the Ministry of Truth, protagonist Winston Smith is a civil servant responsible for perpetuating the Party's propaganda by revising historical records to render the Party omniscient and always correct, yet his meagre existence disillusions him to the point of seeking rebellion against Big Brother, eventually leading to his arrest, torture, and reconversion.

Why do I bring this up?  There was always one passage in the novel that struck me.  And occasionally, after watching the news, especially after reading statistics such as unemployment figures, GDP, or even watching the stock market, I can't help but recall a passage from the novel Nineteen Eighty-Four.

This is the passage:
But actually, he thought as he re-adjusted the Ministry of Plenty's figures, it was not even forgery. It was merely the substitution of one piece of nonsense for another. Most of the material that you were dealing with had no connexion with anything in the real world, not even the kind of connexion that is contained in a direct lie. Statistics were just as much a fantasy in their original version as in their rectified version. A great deal of the time you were expected to make them up out of your head. For example, the Ministry of Plenty's forecast had estimated the output of boots for the quarter at one-hundred-and-forty-five million pairs. The actual output was given as sixty-two millions. Winston, however, in rewriting the forecast, marked the figure down to fifty-seven millions, so as to allow for the usual claim that the quota had been over-fulfilled. In any case, sixty-two millions was no nearer the truth than fifty-seven millions, or than one-hundred-and-forty-five millions. Very likely no boots had been produced at all. Likelier still, nobody knew how many had been produced, much less cared. All one knew was that every quarter astronomical numbers of boots were produced on paper, while perhaps half the population of Oceania went barefoot. And so it was with every class of recorded fact, great or small. Everything faded away into a shadow-world in which, finally, even the date of the year had become uncertain.
I'm not saying that we live in such times.  We don't.  But sometimes I fear that we are trending toward such an era.

Wednesday, January 26, 2011

A Central Banker has a Moment of Clarity: Standard of Living to Plunge at Fastest Rate Since 1920s

Mervyn King, Bank of England's Chief, had some sobering words in a speech at Newcastle upon Tyne.  What I found interesting is his allusion to a central bank constraint, or "trap" as I see it between rates/inflation, and unemployment.  I hope Bernanke is watching the UK.
Mr King insisted that the Monetary Policy Committee could not have increased interest rates from their current record low level to tackle the rise in inflation. 
“If the MPC had raised the Bank Rate significantly, inflation might well have started to fall back this year, but only because the recovery would have been slower, unemployment higher and average earnings rising even more slowly than now,” he said. 
“The erosion of living standards would have been even greater. The idea that the MPC could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking.” 
He added: “Monetary policy cannot be based on wishful thinking. So, unpleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal.”
King also said:
“In 2011, real wages are likely to be no higher than they were in 2005,” he said. “One has to go back to the 1920s to find a time when real wages fell over a period of six years. 
“The squeeze on living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.” 

But do not fear.  The good George Osborne, British Chancellor of the Exchequer, blamed the UK's recent dip in gdp on... get this -  snowflakes and cold weather.  That should make every Briton feel confident and much better.

But the Telegraph reports otherwise:
Mr Balls accused him of making up “excuses about the weather”. Economists also raised doubts about the cuts.  Jonathan Loynes, of Capital Economics, said: “Although heavily affected by the weather, the UK’s shockingly bad fourth quarter GDP figures raise serious concerns over whether the economy is in a strong enough position to withstand the fiscal tightening.” Howard Archer, an economist at IHS Global Insight, added that the figures reinforced concern over the economy’s ability to grow “in the face of spending cuts and tax hikes”.

Spending cuts and tax hikes...  sounds like deflation to me.  Europe, meet your cousin, the UK.  Good luck to you both.  or you can take a page from your other cousins across the pond, the Americans: print away, spend away, and kill your currency to "save your economy!  Well, at least buy some time.

God save the Queen?  No!  God save us all!


Jobs, Jobs, Jobs

A recent article I read has gotten me thinking about a topic that weighs on many minds - jobs. Writing for the National Journal, Jim Tankersley covers this topic in the article The Phantom 15 million.

Following  are some portions of the article.  First, Tankersley defines the issue:
The Great Recession wiped out what amounts to every U.S. job created in the 21st century. But even if the recession had never happened, if the economy had simply treaded water, the United States would have entered 2010 with 15 million fewer jobs than economists say it should have 
Somehow, rapid advancements in technology and the opening of new international markets paid dividends for American companies but not for American workers. An economy that long thrived on its dynamism, shedding jobs in outdated and less competitive industries and adding them in innovative new fields, fell stagnant in the swirls of the most globalized decade of commerce in human history. 
Even now, no one really knows why. 
This we do know: The U.S. economy created fewer and fewer jobs as the 2000s wore on. Turnover in the job market slowed as workers clung to the positions they held. Job destruction spiked in each of the decade's two recessions. In contrast to the pattern of past recessions, when many employers recalled laid-off workers after growth picked up again, this time very few of those jobs came back. 
These are the first clues--incomplete, disconcerting, and largely overlooked--to a critical mystery bedeviling a nation struggling to crawl out of near-double-digit unemployment. We know what should have transpired over the past 10 years: the completion of a circle of losses and gains from globalization. Emerging technology helped firms send jobs abroad or replace workers with machines; it should have also spawned domestic investment in innovative industries, companies, and jobs. That investment never happened--not nearly enough of it, in any case.

If we can't figure out why, we may be doomed to a future that feels like a long jobless recovery, no matter how fast our economy grows. "It's the trillion-dollar question," says David E. Altig, senior vice president and research director for the Federal Reserve Bank of Atlanta, where economists are beginning to explore the shifts that have clubbed American workers like a blackjack. "Something big has happened. I really don't think we have a complete story yet." 
 And then he provides some factors that contributed to low employment:
"Most of the jobs added during the recovery have been new positions in different firms and industries, not rehires," they wrote. "In our view, this shift to new jobs largely explains why the payroll numbers have been so slow to rise: Creating jobs takes longer than recalling workers to their old positions and is riskier" when recovery still appears fragile.

In other words, American companies had adopted a more cold-blooded attitude toward recessions, one that fit the new model of globalization and automation. Technology made it easier to lay off your 100 least-effective workers and ship their jobs to India, or to replace them with a software program that made your remaining workforce dramatically more productive.

...The simple truth is that American firms are either returning the spoils of globalization and technology to their shareholders, spending them on new projects abroad, or both. "Globalization isn't the problem," says Howard F. Rosen, a labor economist and visiting fellow at the Peterson Institute. "U.S. companies are investing in plants and equipment, just not in our borders.... They are privatizing the gains of globalization. That's really it. They're our gains!"
I know some will say that it is better for the US to have the high tech engineering jobs, and letting emerging economies actually produce the product has minimal impact to an economy, but this fact in the article may prove otherwise:
A recent paper by researchers at the Asian Development Bank Institute concluded that the iPhone, one of the United States’ top innovations of the past decade, actually contributes nearly $2 billion to our trade deficit because it is almost entirely produced and assembled in Asia. The paper also raises a conundrum for lawmakers and business leaders alike: If Apple moved its assembly line to the United States and created domestic jobs but didn’t raise the cost of the iPhone, the company would still turn a 50 percent profit on every one it sold.
To most, that sounds like Apple is being greedy. But companies need to chase margin wherever, whenever they can. They never know when the next product will prove to be a turkey that consumes a large amount of R&D for little or no gain. And that's when companies rely on every bit of gain they can capture from past successful products. So yes, I'll defend Apple here. The article continues:
Some free-market economists say that we could encourage more domestic investment by cutting corporate tax rates, although it's fair to note that the jobs breakdown of the 2000s coincided with hefty tax cuts under President Bush. Still, liberal and free-market analysts alike have argued for a sweeping reform of America's corporate tax code--one that would reduce rates while eliminating many deductions and provisions that give companies incentives to spend their global profits outside the United States. More narrowly, groups such as the Association for Financial Professionals have urged Congress to lower America's tax rates on repatriated income, to levels closer to international competitors.
I don't think corporate tax rates could ever compete with labor costs - at least not for the foreseeable future. Labor costs are the largest costs, and no tax policy in my mind can level the differences in wages between a Chinese worker and an American worker.

Yet others say that the globalization process takes a long time to balance out, and maybe they are right:
Autor, the MIT economist, says that there’s no guarantee the gains from globalization and automation will appear as immediately as the costs—or that everyone in America will benefit equally from them. “What people tend to not appreciate is how large the adjustment costs are and how long adjustments take,” he said in an interview, adding later: “There are things we can do to help people adjust. But we’re not very good at this.”
The entire article can be found HERE. 

So where does this leave us?  I agree with many of the points above, and some to an extent. I think we are entering a post industrial era that just can not produce the jobs at a rate other economies at a prior, different stage can. Technological improvements too, play an enormous role. For example, during the Great Depression, roughly 25% of the US popualtion lived on a farm. Today, only 2-3% are farmers, and they produce more food than ever before. And that is just one industry.

So what does this mean to our economy, and to a monetary system that is reliant on debt that needs to be serviced at a certain rate of interest. A rate of interest, that also needs a corresponding rate of employment growth to function? I am being rhetorical here, because honestly, I don't know the answer. I can only speculate that our monetary system can not keep up with such low employment growth.  Hence the need for budget busting deficits.

And we can't overlook the wage differences between East and West either. And those differences do not end there either. There are also debt differences. Which reminds me of an old interview I saw on CNBC back in November 2009 where Damon Vickers, CIO of Nine Points Capital Partners addresses these issues of imbalances and concludes that a global currency and a global banking governance structure of sorts is inevitable.  In that I disagree, because I just don't see that kind of global cooperation.  Not even Europe itself can get its act together, let alone the US, along with China, Russia, Brazil, etc...

One way or another, the imbalances will correct, the question is will it be a smooth process?

Marc Faber: Only Liars attend Davos

Someone finally tells the truth about the so-called economic recovery.  Granted, Marc Faber is an Austrian School economist and he doesn't take into consideration Modern Monetary Theory - the realities of the current system. And so I ould disagree with some of his analysis. But overall, I agree with his characterization that "excessive printing" has disastrous consequences.

But no worries!  As Bloomberg reported recently: Wall Street Partying in Davos as Crisis Angst Fades.  These bankers and their stooge politicians really believe they have it figured out.  That is when I began to start worrying - when the bankers' arrogance gets the best of them.  That's when real crises hit - not when policymakers are preparing for a potential crisis, but when they paper over a crisis with the same debt that caused it and begin to actually believe they solved the problem.

Unless, of course, the problem the bankers feared was the size of their bonuses.  And small bonuses mean small political donations... so the politicians were worried too.  So if that was really the issue, then mission accomplished.  The world is in balance once again - at least in the eyes of bankers and politicians.

Let the partying commence!

Tuesday, January 25, 2011

Angela Merkel's Support for the Euro

Recently, Angela Merkel stated that Germany will do whatever it takes to save the Euro.  Germany, after all, has profited immensely from the Euro, well, at least up to the crisis.  Here is a case in point, showing trade between Greece and Germany, before and after Euro introduction:

One could argue that German exports to the periphery were vendor financed to a degree - very similar to the US-China trade relationship.  But is it sustainable?

But Merkel faces her own domestic challenges.  And so, as Mark Grant of Southwest Securities points out, the "jury is still out" on Merkel's ability, or opinion, on handling the Euro crisis.

Monday, January 24, 2011

Are Euro Bailouts Really German Bank Bailouts?

One thing I have noticed in the debate on Euro bailouts is the single focus on the irresponsibility of periphery countries. But there is also something else that is lacking in this debate.  It is the state of the European banks - particularly, German banks.

Before I proceed, I want to describe once again the concept of double entry book keeping in a debt based monetary system.  We have to understand that banks do not wait for you and I to make a deposit in order for them to make a loan.  If banks only lent money that was deposited, they would not be the financially successful and powerful businesses they are today.  Their lending would be constrained by their deposits.  Banks create money by lending that which does not exist today; they look for reserves after the loan is made. Credit is created, it is not something that is re-lent, say, like me lending you $10 from my wallet.  Which assumes I have the ten dollars in my wallet in the first place.  Banks don't look in their "wallet" when they make a loan.  That's why they're banks!

I covered this in my post on Australian Economist Steve Keen:  How is Money Created? A Look Back at Economist Steve Keen's "The Roving Cavaliers of Credit." 

But back to double entry book keeping.  Think of it this way: when a bank lends money to a borrower, the transaction affects the balance sheets of two parties.  One entry is the loan - a liability - which exists for the borrower.  The other entry, on the part of the lender, is an asset - a promissory note, a loan due to them.  This asset also has a rate of return; the interest rate paid to the owner of the debt.  So loans created and held by banks are assets, loans owed by borrowers, whether they be individuals or countries, are liabilities.

The two need to co-exist.  If the borrower can no longer pay off the loan, the asset that sits on the bank's balance sheet loses value - or becomes worthless.

Thus, any bailout given to any country, whether it is Greece or Ireland, is not only "maintaining" the borrower's ability to pay the loan, but it is "maintaining" the value of the loan, as an asset, on a bank's balance sheet.  So whenever you read about a bailout, I think it's important to understand that there are two parties to a loan - a lender, and a borrower, and BOTH parties are being supported by a third party - the IMF, the ECB, the Fed, etc...

And this concept has been indirectly brought to attention recently by Italy's Economy Minister Giulio Tremonti.  From the Wall Street Journal's blog, "The Source":
But Economy Minister Giulio Tremonti ramped up the decibels after yesterday’s meeting of European finance ministers, taking a shot at Germany by noting that banks in the bloc’s largest economy stood to gain seven times more than Italian lenders from an enlarged European Financial Stability Fund. 
Tremonti said: 
“Everyone is saying how good and generous and euro-patriotic they are. Well, we can reply to countries with triple-A ratings complaining of the [bailout] burden by pointing out that our banks are exposed to Ireland for 22 billion, yours for 180 billion.” 
Those figures, in dollars, represent the exposure to Irish debt of Italian and German banks respectively, according to the latest data from the Bank for International Settlements.  
The article continues:
Italian Foreign Minister Franco Frattini has lamented that informal meetings aimed to plot out EU strategy, especially between French and German officials, are unfair. Tremonti called last week’s huddle of the euro-zone’s six triple-A-rated nations a “merely technical meeting.”  
That meeting took place as part of an ongoing debate about how to expand the EU’s firepower in responding to the sovereign-debt crisis. Many of the higher-rated nations are worried they will be forced to pony up more funds or guarantees to various bailout facilities.  
“It can’t be that six countries bear the burden and that the others profit from that,” German daily Handelsblatt cited German Finance Minister Wolfgang Schäuble as saying.  
With such views increasingly passing as established wisdom, Italy’s Tremonti pointed out that the bailout schemes offer generous benefits to creditor countries whose banks made loans that now appear to have been unsound.  
Italy’s contribution to the European Central Bank’s capital base, one measure of EU members’ commitments to the bloc, is 12.5%, compared with 19% for Germany.  
But German banks account for around 37% of the impaired assets in Ireland, compared with less than 5% for Italian lenders. Insofar as the Irish rescue package boosts the value of Irish debt — which is its point — German banks benefit disproportionately.
But here's the number that surprised me:
The latest BIS data, released in December and reporting claims as of June 30 last year, show that the combined exposure of French and German financial institutions to Portuguese, Irish, Greek and Spanish debt was $923 billion, while that of Italian lenders was $76 billion.
But there is one caveat to the numbers given above:
Still, the BIS data focus on gross numbers and have been contested. Germany’s Bundesbank said last November that German bank exposure to Ireland is in fact only €25 billion, six times less than reported by the BIS, implying that many loans are located there only for legal or tax reasons but aren’t subject to Irish default risks.

Nonetheless, German, and other banks, were party to this debt game. But I pick on German banks because of this:

SOURCE (Note: the data above was compiled June 2010)

So where am I going with this?  I am not going to absolve the Greek government of massive irresponsible mismanagement and corruption.  I just believe that the debt debate should cover all parties.  I do actually feel bad for Ireland.  Their citizens, already over-leveraged, are paying for the sins of their banks.  I wonder if Germans, one day, may be forced to pay for the sins of their banks?

Friday, January 21, 2011

Volcker Out, Immelt In... and the Corporate Takeover of USA, Inc. Is Just About Complete

When Obama won the Presidential election in 2008, he soon after appointed Paul Volcker, former Federal Reserve Chairman, as his Chairman of the Economic Recovery Board.  Volcker is a heavyweight, and well remembered for his tough handling of the dollar crisis of the late 1970s.  He was able to raise interest rates to fight inflation.

Soon after becoming Obama's Chairman of the Economic Recovery Board, he was marginalized by Timothy Geithner and Larry Summers. From Bloomberg, 2009:
Paul Volcker has grown increasingly frustrated over delays in setting up the economic advisory group President Barack Obama picked the former Federal Reserve chairman to lead, people familiar with the matter said. 
Volcker, 81, blames Obama’s National Economic Council Director Lawrence Summers for slowing down the effort to organize the panel of outside advisers, the people said. Summers isn’t regularly inviting Volcker to White House meetings and hasn’t shown interest in collaborating on policy or sharing potential solutions to the economic crisis, they said. 
You want to know why Volcker was only to be used as window dressing, to just make the Obama Administration look good, while Wall Street via Summers and Geithner took over? Because this giant tells it like it is. Back in December of 2009, Paul Volcker was addressing the Wall Street Journal Future of Finance Initiative and said:

“I wish somebody would give me some shred of evidence linking financial innovation with a benefit to the economy.” 
Mr. Volcker’s favorite financial innovation of the past 25 years? The ATM. “It really helps people, it’s useful.” 
In addition, he railed against financial system compensation plans and said it had grown too large. 
His idea of reform? A return of something like Glass-Steagall. Commercial banks should be tightly regulated as well as protected. Trading, speculation and financial innovation should live outside those companies so that if they fail, they fail. 
While many resist this idea, Mr. Volcker had few doubts. “I’m not alone in this and I think I’m probably going to win in the end.”


Unfortunately, it doesn't look like Volcker's views prevailed.  So now, Obama has appointed someone else to replace a sidelined Volcker.  Introducing:

This is Jeffrey Immelt, former CEO of General Electric.  A Captain of Industry.  So whhat are his accomplishments?

Here are some headlines:

How a Loophole Benefits GE in Bank Rescue Industrial Giant Becomes Top Recipient in Debt-Guarantee Program

GE is quiet bailout recipient

You see, GE is not just a manufacturer of light bulbs and jet engines. It also owns GE Capital - which was an over-leveraged, speculative, sub-prime lending, derivative cranking financial piece of garbage of a "bank" that needed taxpayer money to survive.

And this guy is going to help the average American unemployed worker?

Modern Monetary Theory Economist L Randall Wray: "The Banks Are Toast"

Just last week, I wrote on the phantom income gains from $1.4 trillion in defaulted loans - which is bad enough.  But after reading this article by L. Randall Wray, it's actually worse. There's more to it.  Professor L. Randall Wray, a Professor of Economics, and one of the foremost Modern Monetary Theory (MMT) thinking economists, this week wrote about the condition of the largest US Banks.  He sums up his diagnosis thusly:  "You are Toast."

Some of his commentary:
The big banks are reporting that profits are up. Citigroup is celebrating a 46% gain in share prices and net income of $1.31 billion. Wells Fargo just reported strong profits.Yet there are many reasons to doubt the good news. As I've said before, it is more likely that they are toast.  
First, the income reports result in large part from reductions to loan loss reserves. Yes, banks are partying like it is 1999—everything is hunky-dory so there is no reason to sock away reserves against possible defaults. Heck, no one is going to default in 2011. Right? Move those reserves into the profits column.  
Banks are not making any money in traditional lines of business—that is, by making loans. No one wants loans. The economy is down for the count. Other than pulling money out of loan loss reserves, banks can only make profits by revaluing assets. The write-downs of trashy mortgages need to be reversed. Banks trade trash with each other at higher prices, recording profits. They sell trash to the government at inflated prices—more on that below. And they jack up late fees on homeowners, credit card users, and other debtors. Even though none of those borrowers can actually pay the late fees, the banks book the revenue now.  
Wray continues:
But here is the much bigger problem: the banks are getting sued from here to Pluto by homeowners, soldiers and sailors, Fannie and Freddie, PIMCO, the NYFed, and just about anybody with access to a lawyer. And, increasingly, the banks are losing.  
Wray then proceeds to describe the various legal methods defaulting homeowners are employing against the big banks, with increasingly positive results. He also describes fraudulent or irresponsible activity on the part of the big banks against the GSEs Freddie Mac and Fannie Mae and even against US Military personnel!

Wray's conclusion:
And that makes the banks toast. Forget anything you read about their income, their profit rates, their recovery. They've got to take back the unbacked mortgage securities—they do not meet the “reps and warranties”. And there is no property behind them, so foreclosure is out of the question. They can pursue homeowners in court—but homeowners lost their jobs and in any case could not afford the houses the lender fraudsters put them into. Yet, they get to stay in the homes, can claim their titles, and can negotiate for better terms with banks that are failing.
The next several years will be fun. Bet on the lawyers.
For a detailed reading of the article, the link is HERE.

David Stockman, Former Reagan Budget Director, Describes the Ponzi Trap

In my previous post, The US Debt Ceiling and Modern Monetary Theory, I gave a justification for growing the debt.  That is, we face a choice between immediate deflationary collapse, and eventual currency destruction.  Personally, if I were a politician I would be a deficit spender.  I wouldn't be proud of it though.

But most people don't understand that debt backed money in a post industrial economy that relies on ever increasing asset valuations needs a certain level of debt growth to sustain itself.  That's the crazy world we live in.  And this type of economy has also influenced our trading relationships with other countries - we consume what they produce, and we give them an IOU in return.  Thus, if the US were to stay within the debt ceiling, it would trigger an immediate deflationary depression, taking down the rest of the global economy with it.  That's the ugly truth. There would be less money in the system to service all existing debts, public and private, and the system would collapse on itself in a deflationary death spiral.  So as a politician, I would unfortunately vote for more debt.  To do otherwise would be a career ender.  Why?  Because most people don't understand our monetary system and would think I caused the deflationary collapse on my watch.

So we're stuck in a Ponzi Trap.  Get out of the Ponzi, it collapses today.  Keep it going, and there is a .0001% chance of getting out of it.  Well maybe I'm being optimistic.  All Ponzis collapse, no?

Which brings me to David Stockman's recent interview, which I posted the link to earlier this week.  Here's something he said that puts the situation in perspective, emphasis mine:
"If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months." 
Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth. 
"When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said. 
"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."
So there you have it.  Another public admission, this time from a former high level White House official, that those in Washington believe the system needs to grow or else face collapse.  I think that threat is very real.

So what do you do?  I visit many financial sites which have their own "solutions", and I am still not convinced.  Some bloggers believe in a combination of solutions.  Many harp on what I call the "Morality" issue I recently wrote about.  They say that if we prosecute the villains, if we re-regulate the system, all will be solved.  Sorry, I don't buy it.  And it's not that I am anti morals, or that we shouldn't prosecute fraud - I'm just admitting that mathematically, the system needs immorality and loopholes to function.  Ponzi systems, by their nature, are reliant on con men and naive suckers as well as impossible mathematics to function.  Unfortunately, Ponzi systems, as Nicole Foss has put it, are "self limiting;" they self destruct.

Other bloggers say we must stop spending.  Well, we have just addressed that.  Stopping spending now kills the mathematical growth the Ponzi system relies on to exist.

I'm not going to give you a "solution" if by "solution" you expect a return of the status quo - that is, the year 2005 and beyond.  Why?  It doesn't exist.  We are faced with a debt bomb of historic proportions that can not be diffused.

So what can you do?  You take care of yourself and your own.  You try to get the hell out of the way as best you can, given your own unique circumstances.  You adjust your own lifestyle - whatever that means for your situation.  You prepare for the worst, yet try to live business as usual.  It's a difficult balancing act.  That's the best "solution" I can come up with.

I'm not going to say all will be fine if we just "do this."  It won't.  We are facing a massive correction and global rebalancing that could even involve war.  Look, I'm just an anonymous blogger.  I'm not some public figure analyst or bank CEO or employee - I don't have to worry if CNBC doesn't invite me back, or if I lose clients, or if what I say affects my career or the stock price of a company.  I have none of those worries.  I have the freedom to speak my mind in my own little corner of the internet.

Best of luck,


Thursday, January 20, 2011

Barron's Roundtable Discussion: Notable Comments by Felix Zulauf, Bill Gross, and Marc Faber

In today's article I am posting comments made by three great investors:  Felix Zulauf, of Zulauf Asset Management, AG, Bill Gross, Co-CEO of the world's largest bond fund, PIMCO, and well known contrarian Marc Faber of Marc Faber, Ltd.

The full article is available online at Barron's.  Here is some commentary I found interesting:
Zulauf: There are two worlds—the industrialized world and the emerging world. The industrialized world continues to live in a fiction: that it can afford its current lifestyle by going further and further into debt. At some point, the bond markets will riot against that. The private-household sector, not only in the U.S. but in several industrialized countries, remains stretched financially and will continue to deleverage. The public sector is leveraging up, and thus will support the economy. The U.S. economy will muddle along, probably growing by 2.5% to 3% this year. Inflation isn't a problem yet in the industrialized world. 
The emerging world has experienced high levels of growth, but it is entering a period of rising inflation. How emerging economies handle that inflation will be the decisive factor for the industrialized world. If they decide to fight inflation with really restrictive monetary policies, we're in trouble. If they hike interest rates only a little to restrain growth, the cycle can be extended. But that means later on, perhaps in a year or two, they will have much higher inflation and will have to crunch it. The choice is between more growth in the short term and then a crunch, or a more serious bear market now. 

Gross: The developed world is coping with the excesses of the past 20 to 30 years. The deleveraging cycle isn't just a one-to-two-year thing. The proportions of the excess, and now the attempts to deal with it, have a number of consequences. For one, growth will be slower, and inflation will be lower. In the U.S., we're seeing unacceptably high levels of unemployment—not just the published 9.4%, but 16% to 17%. The question is, can a debt crisis be solved with more debt?
In Portugal, Greece, Ireland and Spain, which lack the ability to devalue their currencies, a debt crisis can't be solved with more debt. Japan appears to have done a good job so far, because its debt is 200% to 250% of GDP, much higher than here. The U.S. has the advantage of being a reserve currency, which means it can print its way out of this situation. But that requires a willing acceptance on the part of creditors that the money it is printing is of decent value. Current interest rates, including a federal-funds rate of only 0.25%, are unacceptably low. Real [inflation-adjusted] interest rates are negative. Printing your way out of this, or kicking the can, is possible for some countries, but the solution isn't to create paper. It is to create goods and services the rest of the world wants to have.
Zulauf: All other industrialized countries, almost without exception, have focused on cutting deficits. The U.S. alone hasn't addressed the problem. If you eliminate public-sector tax revenue and spending, the U.S. economy would have grown in only two of the past 10 years. Public deficits have been supporting this economy for the past decade. The country has been suffering from under-saving and under-investment. Markets would cooperate fully if the government decided to pursue large, multiyear investment programs financed by debt. That would create a future return, and jobs.
Bill Gross touches upon the political and economic power of corporations:
Gross: Corporations are probably at the peak of their domination. They dominate versus labor in terms of their ability to export jobs and production overseas. They dominate now in terms of Washington, given the Republican electoral victory and the Obama administration's moving toward the center. 
They even dominate with regard to the Supreme Court, as evidenced by the recent ruling removing limits on corporate donations to election campaigns. This is all good for the market, but not for Main Street in the long run.
Zulauf: You also have a tremendous social division. In the U.S., the top 20% of the population owns 93% of the financial assets. That tells you the average guy is in bad shape. He spends what he makes, and, at the end of the month, he's even. 
And now, for my favorite analyst of the three, Marc Faber. In my view, he gives a good dose of reality:
Marc, you have been very quiet. What are you worrying about? 
Faber: Have you got an hour? You are all wrong. You say you would do this or that if you were policymakers, but nobody says "I wouldn't do a thing. I would let the market correct itself." The crisis in the U.S. happened largely because of government intervention that began 25 years ago. The government continuously implemented policies to boost consumption, when everyone should know that an economy will grow in a sustainable way through the implementation of policies that foster capital formation—that is, spending on infrastructure, R&D, education and the acquisition of plant and equipment. By fostering more baseball games, more TV shows, more talk shows, you aren't going to create a vibrant, growing economy. 
The government didn't create more baseball games.
Faber: But it created policies to borrow more money. Through artificially low interest rates, it created a huge credit bubble, which led to a bubble in consumption, a symptom of which was the growth in the trade and current-account deficit from $150 billion in 1997 to more than $800 billion in 2006. Now it is around $600 billion, but if these policies continue it will remain at this level or grow.
So you're really saying it's the Fed's fault.
Faber: What I am saying is that Archie lives in a dream world. I admire you all but you are all dreamers. The Federal Reserve was founded in 1913. Before that, throughout the 19th century, the U.S. had strong per capita income growth in a deflationary environment.
It also had huge financial panics.
Faber: That refreshes the system. Worldwide, we have two economies. Rich people and resource producers are doing incredibly well. The ordinary people aren't doing all that well. In 1970 the U.S. controlled 28% of world manufacturing output and China had 4%. In 1990 the U.S. still had 22%, but Japan had come up in the ranks and China still had only 4%. Now the U.S. says it has 20%, and China, by its own account, has 19%. In the U.S., not much happened in the past 20 years. But in China, India, Vietnam, Russia and Brazil you can see huge progress. That said, I agree with Archie that U.S. stocks might outperform other stock markets—once in a century.
Faber: History has shown that giant countries on the way down are very dangerous because they are desperate. But this year the U.S. has stabilized and is going to grow modestly.
One more thing: Janet Yellen, vice chair of the Federal Reserve, said about a year ago that if it were possible to push interest rates into negative territory, she would vote for that. This is a very important statement because it implies that the Fed will keep real interest rates negative as far as the eye can see. Negative real rates amount to expropriation and destroy one function of money: to be a store of value and a unit of account. If you measure the stock market not in dollars but gold, it is down 80% since 1999. I no longer regard the U.S. dollar as a valid unit of account. People shouldn't value their wealth in dollars because one day, in dollars, everyone will be a billionaire.
Gross: I agree with Marc on many things, though not everything. I don't know if the U.S. has reached a desperate point, but it is employing instruments and vehicles and policies that smack of desperation. We are not looking at a default here, but at years of accelerating inflation, which basically robs investors and labor of their real wages and earnings. We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential. And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default. Ultimately creditors and investors are at the behest of a central bank and policymakers that will rob them of their money.
Faber: It is much easier for a government to print money and default in the way Bill just explained than to come out and say "we aren't going to pay half our debts." Also, one of the big debates these days is between the deflationists and the inflationists. The deflationists claim the Dow will drop to 1,000 or less and the economy will contract sharply, and therefore you should be in government bonds, not commodities, equities or real estate. But if China and India continue to grow and car makers do better, as Mario said, commodities will do OK.
In a deflationary environment, tax revenues go down and fiscal policy remains expansionary. Deficits stay high, and even increase. Interest rates on government debt go up, and the quality of that debt declines. In a disaster scenario, I would rather own equities than government bonds. Since I am ultra-bearish, my preferred assets are equities and hard assets: real estate, commodities, precious metals and collectibles.
Zulauf: In the late 1970s and early 1980s, Paul Volcker [then the chairman of the Federal Reserve] crunched inflation by applying very high real interest rates for several years. Now we are getting the same process, just in reverse. Just as it took several years for the market to see that Volcker's policies would lead to declines in inflation and interest rates, it will take several years for the market to realize the Fed's current policies are highly inflationary. They will lead to a debasing of the currency, which is happening to varying degrees in most of the industrialized countries.
Zulauf: At its 1980 peak of $850 an ounce, gold represented 3% of the market capitalization of global equities, bonds and money-market assets. Today it is 0.6%. The price has a long way to go.
At one point, Marc Faber makes this statement:
Faber: I'm very bearish about the ultimate outcome. 
So what does Marc Faber believe is the ultimate outcome? Well, I dug up this interview that I recall from the summer of 2009. I think it's important to review past opinions of analysts to see how accurate they are, not just in the short term, but in the long term as well. Is the world still proceeding in the direction that Marc Faber describes here?

To be honest, I extracted most of the bearish views found in the interview, which I mostly agree with.  Other analysts disagree, and I recommend a full reading of the interview HERE to see their opinions.  At the end of the interview the analysts discuss what they own, or will buy this year.

Wednesday, January 19, 2011

Marc Faber Believes US and Europe Will Outperform Emerging Markets in 2011

This is not because of fundamentals, mind you.  Faber's forecast is based on inflation caused by Western countries printing money.  This western, mostly US inflation is being exported to the East, or emerging countries, affecting the weakest population segments of their economies.

To me, this looks like an East versus West full blown currency war.  Faber also discusses the US Military presence in the East, and how it is viewed there, particularly by China.  He is also bullish on oil for various scenarios that could play out.

Rick Santelli and Jim Rickards on CNBC

Short post today.  Earlier today (US Eastern Standard Time) Jim Rickards was on CNBC discussing the US-China Economic and currency situation. He also touches upon a possible endgame to the US China Economic relationship.  Rick Santelli, as usual steals the show for a moment with some common sense.

Tuesday, January 18, 2011

China Rising

President Obama greets Chinese President Hu Jintao during the Nuclear Security Summit. (AP/Susan Walsh)

The Financial Times today has an article titled: "China: A Strategy to Straddle the Planet," which covers many of the trade and currency strategies employed by China this blog has commented on.  At the end of the day, these strategies represent a significant risk to the dollar's dominance.  The risk is not necessarily one that the dollar is replaced by the Yuan, but a risk of the dollar slowly losing its relevance in global trade, which to me, could have severe inflationary and national security consequences for the US.  Here are portions of the article, emphasis mine:
Welcome to a new era of globalisation, China-style. As the financial crisis recedes, one of the big fears is that the process of increasingly closer links among big economies worldwide will go into reverse as governments and countries look inward. The message coming from the world’s second-largest economy for the past year has been clear: China wants to accelerate the integration of the global economy, but on its own terms. 
Over the past few decades, China has benefited hugely by hitching itself to a process of globalisation where the rules were written in Washington and the American consumer was the buyer of last resort. China prospered by making first the socks, then the washing machines and finally the iPods sold at Walmart. 
Coming out of the crisis, China wants to forge a new phase of globalisation where many of the roads – financial, commercial and perhaps eventually political – converge on Beijing. China is not seeking a rupture with the international economic system (although some foreign companies are fearful of a technology grab). But it is looking to mould more of the rules, institutions and economic relationships that are at the core of the global economy. It is trying to forge post-American globalisation. 
In recent years, a range of important countries have found that China rather than the US is their principal trading partner, from neighbouring Japan and South Korea to commodity-rich Australia and Brazil. At times over the past year, Chinese imports of oil from Saudi Arabia have exceeded Riyadh’s shipments to the US. 
With the help of its considerable financial firepower, China is deepening these links. Beijing is establishing trade relationships that allow it to sell not just clothing and consumer products but more sophisticated goods such as power equipment. Its banks are helping to expand infrastructure and energy supplies in other developing countries in ways that will accelerate their growth, boost two-way trade and bind them closer to the Chinese economy. Beijing is also looking to establish a role for its currency in the international monetary system, in part at the expense of the dollar.
the article continues...
Beijing’s global push is helping to open new markets for Chinese goods and also serves a broader strategic goal for Beijing, reducing dependence on the US. The American consumer may still be one of the main driving forces in the global economy, but about half of China’s exports now go to developing countries. The big ticket loans also further China’s efforts to diversify foreign exchange reserves away from the dollar. 
Some of China’s post-crisis objectives represent a more explicit challenge to US leadership of globalisation. Take, for instance, China’s long-term plans to internationalise its currency, which have been sharply accelerated over the past year. The immediate goal is to make the renminbi the main currency for trade in Asia, reducing costs for Chinese exporters. Some of the loans to Mr Ambani’s empire are in renminbi – with the Chinese offering to help hedge the currency exposure.
But among Chinese officials and scholars, there is a widely held view that the US has been abusing its position as controller of the main reserve currency by pursuing irresponsible economic policies. Nor do they hide the underlying geopolitical objective of the currency push – to place limits on the role of the dollar in the international monetary system. “The financial crisis ... let us clearly see how unreasonable the current international monetary system is,” Li Ruogu, head of China EximBank, said last year. Jiang Yong, at the China Institutes of Contemporary International Relations, puts it more starkly: ending US dominance of the monetary system is “as important as New China’s becoming a nuclear power”.
And on China's "neo-mercantilism":
China’s investment largesse also risks sparking a backlash. In some resource-rich nations, such as Australia, its form of state capitalism raises fears that the mining sector will be the Trojan horse that leads to Beijing’s control of commodity prices. In Africa, where China has done deals with some of the weakest governments, there are signs of a backlash by groups protesting at corruption or poor working conditions. “Western companies [in Africa] have cleaned up their act in the past decade, but China is turning the clock back,” says Paul Collier, an Oxford Africa expert. “It is no defence to say: ‘You plundered the poor, so now it is our turn’.”
Misthos here.  This, in my opinion, is where the US and China may be heading towards a collision course.  The US has used this strategy of partnering with corrupt regimes with significant repercussions, often called "blowback."  The view is that at first a larger developed country invests in what used to be called a "third world" country, and to protect its investments, it would partner with a corrupt regime - a "client" government that received exhorbitant aid.  Over time, the corruption bled the local population to such a degree that radicalization of the population ensued.  More corruption produced more radicalization, which produced brutal police state tactics by the regime in power to suppress any popular revolts.  Eventually, such regimes are toppled, or replaced, but not without  external military involvement - Iraq is a perfect example.  Sometimes the corruption produces a non-cooperating regime with long lasting consequences such as the Shah of Iran being replaced by the Mullahs, or a Khaddafi or Fidel Castro.

If and when China faces such obstacles, will it be ready to send the Chinese Red Army to Africa?  When that happens, I assure you, overnight, it will become a very different world.  The US will respond in ways that few can imagine. Because of China's enormous population and corresponding resource needs, the potential US-China rift could make the US-USSR Cold War look tame by comparison.  China will fight to feed her people, for she still remembers the Tianamen Square uprising.

The article touches upon this geopolitical, military empire trend:
Perhaps the biggest risk to China’s ambitions lies in the security tensions they are provoking in its own backyard. Just as quickly as Asian countries are integrating with China’s economy, they are also rushing into the arms of the US for military protection against a more assertive Beijing. 
Vietnam invited the US navy to hold a joint drill in the South China Sea last summer. During a bruising diplomatic dispute between Japan and China in the autumn after the Japanese coast guard arrested a Chinese fishing boat captain, China appeared to halt exports of rare earths to Japan. For the rest of Asia, it was a chilling reminder that their economic links with China could leave them exposed if they have a political falling-out with Beijing.
For all the economic optimism coursing through Asia at a time when much of the developed world is still struggling, it is worth reflecting on another important difference: while defence spending is under pressure in the west, in Asia it is rising strongly. China is the reason for that, too.
I have written on China in the past, and these articles are still relevant:

The Next Largest Nuclear Powers, China and Russia, Openly Challenge US Economic Supremacy

Is China Preparing for the Ultimate Fiat Collapse by Grabbing All the Gold It Can?

Pat Buchanan Asks: Who Fed The Tiger?

But we should not forget, China has headaches of her own:

George Soros Warns China of Global Economic Collapse

Chanos on China's Bubble...

And I have written on what the US can do in retaliation to a Rising China. Gold could settle things militarily, economically, and geopolitically overnight should the US find itself in a corner:

Don't Discount the US or the Dollar Just Yet...

As Napoleon once said of China:

"Let her sleep, for when she wakes, she will shake the world."

Either way, prepare for some economic and geopolitical tremors this decade.

Monday, January 17, 2011

Chinese President Hu Jintao: "The current international currency system is the product of the past"

Hu Jintao's comment is no surprise really.  All global currency systems are borne of power struggles and reflect the status quo.  From Rome, to the Spanish and British Empires, to the current US Superpower, a global currency has always been adopted after much bloodshed.  Having a global currency is the reward one "earns" by winning wars and globally projecting power.  At least that's what history tells us.

And so President Hu Jinato's comment is describing a new world order.  China is saying that the post World War II and post USA-Soviet eras are OVER.  A new multilateral world is slowly emerging.  But, he also tempered his statement by saying that the Chinese Yuan would take a long time to become an accepted global currency.  Why?  Because he still wants the Chinese Yuan to be artificially low and pegged to the US Dollar for trade purposes, and he also wants the US Dollar to maintain its value to ensure the value of China's US Denominated holdings.   Those are two conflicting goals.  Good luck with that.

The US has no choice but to devalue the dollar.  That's what is keeping the economy afloat - negative real interest rates.  So long as interest rates are below inflation, and that's how Bernanke wants it, the US Dollar will continue to devalue over the long haul. which means that China's vast holdings will be devalued as well.

So what is really going on here?  It's geopolitical maneuvering.  Both the US and China have engaged in a trade relationship based on recycled dollars.  China sells things to the US, and in return, re-invests its surplus in US debt to keep selling things to the US.  It is a vicious, unsustainable cycle.  A surplus grows in China, and an usustainable debt load grows in the US.   This system only has two futures:

A slow unwind; a managed rebalancing, if you will, or,

a breakdown.

Everything else Hu Jintao and Obama discuss this week is just noise.

Sunday, January 16, 2011

Weekend Reads

Some interesting recent material:

Hedge Funds Bet China is a Bubble Close to Bursting (Telegraph)

Irish Bailout to Total More than Ireland Received from the EU (Independent.ie)

IMF Sends Special Unit to Evaluate Spain's Solvency (Bloomberg)

World Bank Makes Case for New Reserve Currency (Globe & Mail)

Saturday, January 15, 2011

Happy 14 Trillion Dollars!

From Yahoo!/Associated Press:
US debt passes $14 trillion, Congress weighs caps
WASHINGTON – The United States just passed a dubious milestone:Government debt surged to an all-time high, more than $14 trillion. 
That means Congress soon will have to lift the legal debt limit to give the nearly maxed-out government an even higher credit limit or dramatically cut spending to stay within the current cap. Either way, a fight is ahead on Capitol Hill, inflamed by the passions of tea partyactivists and deficit hawks. 
Today's debt level represents a $45,300 tab for each and everyone in the country.

Keep in mind, this is just Federal Debt, it does not include private debt, corporate debt, financial sector debt, or even state and local municipal debt and pension obligation.  But what is more worrying to me than the number 14 Trillion, which in itself means nothing without context, is this:

The national debt is the accumulation of years of deficit spending going back to the days of George Washington. The debt usually advances in times of war and retreats in peace. 
Remarkably, nearly half of today's national debt was run up in just the past six years. It soared from $7.6 trillion in January 2005 as President George W. Bush began his second term to $10.6 trillion the day Obama was inaugurated and to $14.02 trillion now. The period has seen two major wars and the deepest economic downturn since the 1930s. 
With a $1.7 trillion deficit in budget year 2010 alone, and the government on track to spend $1.3 trillion more this year than it takes in, annual budget deficits are adding roughly $4 billion a day to the national debt. Put another way, the government is borrowing 41 cents for every dollar it spends.

Can you imagine?  Nearly half of today's national debt was run up in just the past six years!  The US Economy, as measured in GDP has not grown at that same accelerated rate - no where near it.

Now those that are aware of MMT understand that the US Government is not revenue constrained.  However, the US economy, and the US currency, the Dollar, exist in  an interdependent world.  There is this thing called the market that arguably is bigger than the Federal Reserve, and it gets to vote every day on the value of the dollar.  Trading partners too, get to "calibrate" the value of their currency using various means such as trade regulations and capital controls, against the US Dollar.

So what will the market and trading partners eventually do in the face of this growing, yet perversely necessary debt?  Will they put up with this "free lunch" of massive deficit spending by the US?  How will they react to a devaluing dollar?  Those question are hard to answer.  We live in a very complex world, and there are so many moving parts, it is difficult to forecast how this debt will affect the world economy, or the US dollar.

But if we look at the past few years, we see a trend.  We see a growing currency war evident in the implementation of capital controls by many countries, central bank interest rate manipulations, trade restrictions, and a breakdown in agreements during G20 conferences.

Eventually, the cognitive dissonance that exists between business as usual and basic math will disappear.  More and more people will understand that when the economy's growth is vastly outpaced by the debt growth required to keep that economy sluggishly growing, that an endgame is unavoidable.  The math no longer makes sense, and the farce that constitutes our paper debt based fiat monetary system becomes understood by all.

Have a Great Weekend

The original Men in Black: