The best, or worst, one
can say about the outcome of the debt ceiling issue is that this may
have been a case in which having no deal may have been preferable to
the deal Obama eventually settled for (‘the mountain laboured &
brought forth a mouse’). Once again he proved himself long on vision
but short on execution & willingness to fight for his vision, thereby
confirming the Tea Partiers’ belief he is a wuss. He would have been
better off following Bill Clinton’s advice to use in Article XIV (4)
of the Constitution, that reads in part that “The validity of the
debt of the United States ... shall not be questioned”, to unilaterally
impose an increase in the debt ceiling & challenge his opponents
to take it to the Supreme Court. While markets might not have liked
that much, they wouldn’t have had much choice but to go along, &
at the very least it would have put the Tea Partiers, & the world,
on notice that there was a limit to his tolerance for abuse.
While the politicians
fought like spoiled brats over how to reduce public spending by a couple
trillion dollars over the next decade (but not right away because the
economy couldn’t take it -there never is a good time to do unpleasant
things), two percent higher interest rates/borrowing costs could cost
the US Treasury as much as US$300BN per year more than likely budgeted
for.
While a default may have
been avoided, a downgrade of the US credit has now moved from what once
was a (long shot) possibility & then a probability to a near-certainty,
and the interest rate impact thereof may well do a great deal more harm
to the economy than if the the bull had been taken by the horns &
the bullet bitten; for the proposed lengthy uncertainty as to what,
if any, taxes may be, or may not be, cut will do little to restore confidence
in an already seriously compromised US dollar, or to make US businesses
shift from their growth-damaging policy of preserving cash & refraining
from new hiring. Add to that the detrimental effect of near-zero, if
not outright negative, growth in public sector employment at all three
levels, & the prospects of creating enough jobs to keep up with
the growth in the nation’s work force, never mind reducing unemployment,
are abysmal.
Given all the bluster
of Republican hardliners, it is worth remembering that when Bill Clinton
turned the keys to the White House over to George W. Bush in January
2001, the Budget was balanced & federal spending accounted for 18.2%
of US GDP, whereas when the latter vacated it to make room for the Obamas
the deficit was in the US1.5TR range, federal spending accounted for
24.6% of an albeit slightly smaller GDP, and Washington’s spending
was 40% funded by borrowing, all of this due to three reasons, two of
which were 100% of Bush’s making, foreign wars & tax cuts, &
only one of which was not due in its entirety to his flawed judgments.
And while the Obama Administration’s spending in the past 1½ years
may not have helped matters much, this was due, in part at least, to
his perpetuating the flawed policies of Messrs. Bush & Paulson.
One the most inane headlines
in a very long time was one on the front page of the Toronto Globe &
Mail of Wednesday August 3rd. It read “American turn the page on debt
crisis.” Hell, they’ve barely gotten into the Introductory Section
of the debt crisis book!
While overall US consumer
spending is at best anaemic (at last report it had actually declined
marginally on a MoM basis), the ‘rich’ are spending like money is
going out of style : sales of luxury items have now increased for 10
months in a row, in July by no less than 11.6% - so the overall consumer
spending number understates the situation on Main Street.
Recent polls showed,
among others, that Americans’ disapproval rate of Congress is now
at an all-time high 82%, and that they want job creation to take priority
over spending cuts - as regards the latter see below in the third item
in the body of Gleanings proper.
GLEANINGS VERSION
II
No. 421 - August,
4th, 2011
U.S. DEBT CEILING
RAISED BUT REAL CRISIS STILL LOOMS
(Postmedia News, Ian
Lee)
- The price of having the debt
ceiling raised by US$2½BN, i.e. until after the November 2012 Presidential
election, was agreement to cut federal spending by a similar amount
(60% of it to be determined later, by the onset of the 2012 election
campaign, by a 12-person bilateral panel). But the bond rating agencies
warned earlier that, unless federal spending was cut by US$4TR over
10 years, the US credit rating would be downgraded (& they cannot
help but take a dim view of this a-bit-now-and-a-lot-later approach).
And the deal ducks the problem of the cash-gobbling entitlement programs
& makes no provisions for increasing revenues, no matter how carefully
targeted those proposed by Obama may have been to affect only what the
hoi polloi would consider “fat cats”.
- Ten years ago already Pete
Peterson in his book Grey Dawn postulated that the greatest crisis facing
the US in the 21st century would be the aging of the entitlement generation.
Last week the Washington Post’s Robert Samuelson said “it’s the
elderly stupid”, pointing out that Medicare, Medicaid & Social
Security account for almost one-half of all federal spending &
are bound to grow exponentially in the future. PIMCO’s Bill Gross
in his recent article Skunked pointed out the unfunded liabilities of
those three are US$22.8TR, US$35.8TR & US$8.0TR respectively. And
Mary Meeker estimated that USA Inc., if analysed as if a corporation,
would have a negative Net Worth of US$35-US$40TR.
The deal, such as
it is, creates uncertainty. And if there is anything business &
markets abhor, it is uncertainty, and their resultant tendency to
‘play it safe’ is not conducive to economic growth. So it
was not surprising that on August 2nd, the day after the deal was announced,
the price of gold jumped 40 dollars (2½%) after having risen
‘just’ 11% in all of July. And while a downgrade, won’t necessarily
be the end of the world as we know it, it will be another nail in the
coffin of the US post-WW II pre-eminent status therein. This it will
fuel isolationist tendencies in the US (especially since the outcome
of debt ceiling crisis suggests a shift of power from a historically
always more ‘internationalist’ White House to an always instinctively
more isolationist Congress). And while in the pre-WW
II period this led to the Great Depression, now that the US accounts
for less than half the share of global GDP it did then, it will have
less of an effect on the rest of the global economy.
IN THE WORLD’S
EYES, MUCH DAMAGE HAS ALREADY BEEN DONE
(NYT,
David E. Sanger)
- The bitterness, divisions
& dysfunction that became evident as the US lurched towards default
has suggested to the world that the US is approaching Japanese levels
of political gridlock, and diminished America’s aura as the world’s
economic haven & the one country capable of leading the world out
of financial crisis & recession. And it has eroded the global status
of President Obama who was once celebrated as someone who would end
an era of American unilateralism (causing him to get the Nobel Peace
Price before he even had been able to settle in comfortably in the White
House).
- The brush with default has
added another dimension. It has left America’s creditors & allies
wondering what had changed in American politics to make a significant
part of its political establishment willing to jeopardize the nation’s
reputation as the safest place in the world in which to invest, and
raised doubts in the minds of decision makers everywhere whether America’s
military & economic dominance is something the country is still
willing (& able?) to pay for. According to Prof. Jeffrey Garten
of the Yale School of Management the challenge for the US will not end
with this crisis, even if the deal eventually arrived at were to pass
muster with the rating agencies; for the US is seen to lack credible
fiscal & growth strategies, and a clear pathway for making the debt
sustainable & for dealing with a whole range of critical issues
from infrastructure to education.
- Warnings about an American
decline are nothing new; they have been around ever since Vietnam. But
with Europe consumed by its own economic crisis & Japan trying to
recover from the earthquake & the tsunami, investors have few other
places to go with their money. This helps to explain why there has been
no real run on the US dollar.
The latter observation
is another version of the belief “the US dollar is still the best-looking
horse in the glue factory”; while a consoling thought in the short
run, longer term the end is the same.
THE SECOND GREAT
CONTRACTION (G&M, Ken Rogoff)
- The term “The Great Recession”
implies the economy is in a typical, albeit unusually severe,
recession and therefore amenable to conventional Keynesian ‘pump-priming’.
But what we have faced is a overleverage-driven financial crisis such
as occurs once every 70 or 80 years, the only real solution to which
is a major transfer of wealth from creditors to debtors through defaults,
financial repression or inflation. And, as Prof. Carmen Reinhart &
I demonstrated in our 2009 book This Time Is Different, it typically
takes an economy at least four years to recover from it. With the No.
1 problem being too much debt, the best way of compressing the period
of deleveraging & slow growth is a period of moderate (4%-6%) inflation,
which, while involving an unfair & arbitrary transfer from
savers to debtors & regarded by some as heresy, is the most direct
approach to a faster recovery.
- The big rush to jump on the
“Great Recession” bandwagon was a function of policy makers making
decisions on the basis of assumptions that have been proven painfully
wrong. Acknowledging this to have been the case is a prerequisite to
finding a solution, and dumping all references to the “Great
Recession” a helpful first step in this process.
Meanwhile rumours
have it the Fed is getting set to initiate another (vain?) attempt to
invigorate the economy by traditional means (Einstein once defined insanity
as “doing the same thing over & over again, and expecting different
results). These rumours were given substance by a call by three former
members of the FOMC for it to consider a QE3 bond buying program at
its August 9th meeting (the term “financial repression” is used
to describe government policies that seek to
“crowd out” other, often economically more deserving, borrowers
from the market, & was coined forty years ago by two Stanford economists
in the aftermath of President Johnson’s
“Guns & Butter” fiscal policies & prior to the onset of
the world’s financial system being flooded with surplus oil dollars
(which led to the Latin American debt crisis & the double digit
inflation of the early 1980's) - Rogoff is not your average
‘talking head’ : he teaches at Harvard, & at various times in
his career worked at the Fed & was Director of Research at the IMF.
BARROSO WARNS DEBT
CRISIS IS SPREADING (BBCNews)
- Amidst rumours that the ECB
was buying Irish & Portuguese government bonds, EC President Jose
Manuel Barroso warned, in a letter to Eurozone governments dated August
3rd, that the souvereign debt crisis is spreading beyond the periphery
of the Eurozone, and called on them to give their “full backing”
to the Euro & to support the proposed changes to the EFSF (European
Financial Stability Fund) agreed to on July 21st to widen its scope
& allow it to intervene in the the market. He also described the
bond markets’ treatment of Italy & Spain as a “cause of deep
concern.”
To the extent his
letter was directed at Germany, he wasted his breath; for the official
reaction of the German Finance Ministry was
“it is not clear how reopening the debate only two weeks after the
summit would contribute to the calming of markets.”
MANUFACTURING IN
U.S. MOVING AT A SNAIL’S PACE (Reuters, Lucia Mutikani)
- The Institute for Supply Management
reported on August 1st that its Index of National Factory Activity had
slid from 55.3 in June to 50.9 in July (its lowest level in two years),
vs a median forecast of 54.9. This followed reports the economy had
slowed to a crawl in the First Half, growing by 0.4% in the First- &
1.3% in the Second-, Quarters.
This led Paul Dales
of Capital Economics in Toronto to opine
“The recent easing in economic growth is increasingly looking more
like a sustainable slowdown than a short-lived soft patch.”
DEMAND FOR U.S.
GOODS SINKS (Reuters)
- On July 27th the Commerce
Department announced durable goods orders had declined 2.1% in June
(after increasing by 1.9% in May) as non-defence capital goods orders,
a proxy for business spending, slipped 0.4% after rising by 1.7% in
May.
Economists are
concerned this drop in ‘core spending’ heralds a slowdown in business
spending on equipment & software in the Third Quarter.
U.S. SERVICE INDUSTRIES
DATA REVEAL SLUGGISH GROWTH (Bloomberg)
- They expanded in July at their
slowest rate in 17 months, as the Institute of Supply Management’s
Index of Non-Manufacturing Businesses (covering 90% of the economy)
came in at 52.7, vs 53.3 in June & a median forecast of a marginal
increase to 53.5. Economic data in the last two weeks have included
weaker home sales & factory orders, waning consumer confidence &
the first decline in household spending (down 0.2% in June) in two years
(i.e. immediately following the official end of the recession).
None of this is helping
the unemployment picture (the official number for
which likely understates reality because of the growing number of people
too disillusioned to look for work), while with the passage of each
day more people run out of unemployment benefits of any kind & are
forced to survive on ...?
CHOP STICKS TO
CHINA (DT)
- A shortage of suitable wood
has led to a shortage of chopsticks in China. So Americus, Ga.-based
Georgia Chopsticks, an eight months-old company, is now exporting 2MM
sets of chopsticks a day to China, going flat-out to meet the demand
& expecting to ramp up production five-fold by yearend so as to
be able to export 10MM sets.
And in a deliciously
ironic turn of events, each set carries a label saying
“Made in USA”. Once upon a time
“carrying coal to Newcastle” &
“selling refrigerators to Eskimos” were part of the everyday lexicon;
to that we can now add “selling chopsticks to China”.
ISRAEL APPROVES
900 EAST JERUSALEM HOMES (BBC News, Wyre Davies)
- The Interior Minister (a member
of the ultra-orthodox Shas party) has given final approval to the building
of 930 more housing units in the East Jerusalem settlement of Har Homa,
the largest (with 9,000 inhabitants) & most controversial Jewish
settlement in East Jerusalem, previous expansions of which drew criticism
from the US, UK & other countries. They will effectively cut the
Palestinian town of Bethlehem off from East Jerusalem, and while the
expansion was defended by the Minister as needed to help address the
country’s housing shortage, his critics describe it as a “cynical
exploitation” thereof.
With new household
formation running at a 50,000 annual rate, it is not altogether surprising
that there is a housing shortage & that house prices are beyond
reach of many young Israelis. But in the overall scheme of things, 930
units are all but irrelevant except as an
“up-your-nose gesture” & a sop to the country’s radical right.
And with the West pre-occupied with crisis management, the timing (for
Netanyahu et. al) was just too good to pass up.
PEOPLE FIRST WOULD
BE A LEAP (Frank Ching)
- The deadly crash involving
two bullet trains near Wengzhou suggest Bejing’s approach to development
not unlike Mao’s Great Leap Forward half a century ago. It too aimed
at rapid industrialization, exhorting the Chinese people to do “more,
better, faster and cheaper” so as to surpass other countries’ economies
& become second only to that of the US. Thus a front page article
in the People’s Daily of December 14th put Li Dongxiao on a pedestal
for learning to drive a bullet train in just ten days, whereas his German
instructor had said it would take two or three months, by sleeping only
three hours a day & compressing three days’ learning into one,
so as to enable him to train the first generation of China’s high
speed train drivers before the onset of its 2008 ‘marquee project,
the Summer Olympics.
- And in the aftermath of the
crash, Beijing’s three priorities seem to have been to offer
the families of those killed lots of ‘hush money’, to tightly control
all media reports & to get the trains up & running again. The
Great Leap Forward proved a useful learning experience & the lesson
Bejing should take away from this accident should be to put people’s
lives ahead of train schedules.
Beijing is caught
between a rock & a hard place. On the one hand, it must
‘make hay while the sun shines’, i.e. max out its economic growth
potential in the short-to-medium term before its demographic time bombs
will make that more difficult, while on the other hand, it has few,
if any, options but to proceed at breakneck speed to avoid the social
unrest that might ensue if it were unable to meet the Chinese people’s
skyrocketing expectations.
CHINESE AUTO SALES
(Bloomberg)
- Contrary to the common wisdom,
they increased at a double digit rate in June, faster than in any month
since January. Sales for the year as a whole are now expected to be
in the 10.4MM range, up 10.6% YoY (in part due to a government incentive
program giving rural owners US$2,800 for trading in older models) &
to rise to 25MM by 2020. Most sales involved luxury models, over 25%
of them European brands, prompting German automakers to plan to invest
another US$15BN in China over the next few years.
Meanwhile, Sergio
Marcionne, the Windsor, Ont.-born CEO of Fiat/Chrysler, earlier this
week, at the Center for Automotive Research Annual Conference in Traverse
City, Mich., an major annual industry event, warned that in a few years
China’s auto industry will start wreaking havoc with the US &
European auto industries, saying it was already starting to export cars
on a significant scale, among others to Brazil, traditionally a key
market for Fiat. And he took issue with critics of the proposed new
long-term 54.5 mpg fuel efficiency target, saying it was eminently feasible.
ITALY UNDER FIRE
IN WIDENING EURO DEBT CRISIS (Reuters, Giselda Vagnoni)
- On August 2nd financial market
pressure on Italy intensified, prompting emergency meetings in Rome
& other European capitals. As Italian & Spanish bond yields
hit 14-year (i.e. pre-Euro) highs, five year Italian bond yields
rose to match Spain’s, suggesting that Italy is overtaking Spain as
the main focus of investors’ concerns about debt sustainability. While
Alessandro Giansanti, ING’s Amsterdam-based strategist said “The
fear of the market is that the world is going into recession again”,
the EC said Madrid & Rome were taking the action needed to keep
their economies on track & “we are confident in their abilities”,
and OECD Secretary-General Angel Gurria told Reuters Italy had its public
finances under control & was taking the right steps to reduce its
deficit, and “doesn’t need foreign savings to finance its deficits
and therefore it is OK.” But the fact remains that Italy’s debt
to GDP ratio is 120%, second in the Eurozone only to Greece’s 160%
& that the political instability in its centre-right government
is of growing concern to the market with the Prime Minister on trial
for alleged tax evasion & sexual relations with a minor & the
Economy Minister under investigation for alleged corruption.
Italy is Europe’s
second-largest debtor nation & the Eurozone’s third-largest economy.
And while Prime Minister Berlusconi proclaimed Italy to be
“up to the task” of tackling the debt crisis & promised to speed
up the process of eliminating the deficit, and told Parliament
“If to our deficit, we add the savings of our families, we’d be
second in the European Union in terms of solidity”, the problem is
that his credibility is lower than a snake’s belly & that this
is largely irrelevant to any dealing with the national debt (&
while his government may seem better positioned than others in the Eurozone’s
‘soft southern underbelly’, since much of its debt is held by Italians,
rather than foreigners, to the extent it is held by Italian banks that
could prove problematic. And while Winston Churchill once observed
‘the human spirit can endure an incredible amount of pain as long
as people feel the burden is being shared fairly by all’, Italian
politicians were careful not to infringe on any of their perks (which
won’t help the bitter medicine go down with an Italian voter universe
that, as in many other European countries, feels that it is entitled
to its entitlements).
FAIRFAX BET ON
BANK OF IRELAND AVERTS GOVERNMENT CONTROL
(G&M, Tara Perkins)
- After other big private equity
had looked, & turned their noses up, at the Bank of Ireland,
Toronto-based Fairfax Financial Corp. mobilized a small group of US
investors to take a combined 35% stake in the bank that, along with
some other funding initiatives by the bank, will reduce the Irish government’s
stake in the bank from a potential 66+% percent to 15%. Fairfax
CEO & controlling shareholder Prem Watsa believes that Europe &
the US still have a lot of pain ahead of them but is bullish on the
longer term outlook for Ireland.
It’s hard to argue
with success; under Watsa Fairfax’s book value has grown at a 25%
compound annual rate, & its shares at a 21% rate, since he took
control over two decades ago (& he made a bundle after shorting
the US real estate market before it collapsed).Media reactions in Ireland
were mixed with some merely saying the government gave them too good
a deal & others worrying that, when the bank is eventually sold
to a bigger (foreign) bank, as they think is inevitable, Watsa &
colleagues will make a bundle in a short time. And
true enough, the bank’s shares are down about 97% from their pre-crisis
high & it passed the latest stress tests.
SNOW, RAIN HIT
WORLD’S DRIEST DESERT (AP)
- In July, storms dumped 5x
the average annual amount of rain & snow on the world’s driest
desert in Northern Chile, promising spectacular floral displays in the
weeks to come.
In this case the
“average annual amount” of precipitation is a fraction of an inch.