Things are moving so fast in the markets and global economies that most writers I follow are complaining of the same thing – there is so much of value being written that it is near impossible to keep up.  When top writers such as John Mauldin and George Friedman complain of the volume of their reading you realise that everybody has the same problem.

Add to that the speed of change within the strategies of individual governments and you have the situation where very important changes can occur and be totally missed, and so I thought I’d do my best to elaborate on really significant things I read over the two months that are sure to have some impact in the months and years to come.

USA – the most significant thing I saw was the move on Christmas Eve by the Federal Reserve and Treasury together (and not Congress who should have decreed such a move) to open the flood gates in their unlimited support of the GSE’s Fannie Mae and Freddie Mac over the next three years.  John Hussman has written 2 essays on the topic, calling it a fiscal ‘Coup d’etat’.  “In short the Fed is now engaging in unlegislated, back-door fiscal policy”. And “If Congress does not forcefully defend [it’s legislative] prerogative it will have relinquished the power of fiscal policymaking into the hands of unelected bureaucrats”.

It seems to me that this is the move that allows Bernanke to claim the ‘stimulus’ actions including “Quantitative Easing” have been successfully ended, which is clearly a nonsense, to add to all the other nonsense flowing from the man. What is more to the truth as pointed out by Bloomberg is that the US authorities have increased debt by close to $US10 Trillion in all without delivering a sustainable lift in the economy apart from during each stimulus action as it occurs.  Once the action ceases so does the supporting evidence of change.  The simple truth is the banks are not lending and the people are not spending, so any stimulus action that has taken place is just being hoarded to no-one’s benefit but the financial elite. Or to put it another way ‘the brain is being flooded by its drug of choice (near-free money) but the body of America is slowly dying of starvation.’

A further change occurred in late January when the Supreme Court ruled that corporations can run political adverts during an election campaign – and in so doing in one move guaranteed that corporations can bully or intimidate politicians at will.  This is surely the end of any semblance of a democracy responsive to the average American.  As the UK Independent said in an article describing the above, Senator Dick Durbin says “The banks own the senate” ……..and the fossil fuel industry owns Congress.  So what’s really changed? – In practical terms, nothing.

Now hold on, wasn’t it in the name of spreading democracy that the US went to war in Iraq?

Probably the most fascinating piece of research was the study by Robert J Barro that analysed the multiplier effects of both stimulus payments and taxation, and the results have implications that are quite stunning – The money multiplier in USA has apparently fallen to below 1 – it is now NEGATIVE and furthermore the multiplier effect of taxation may be as high as three according to Barro.

So this suggests money taken in taxation and then spent by government in current conditions has a negative impact of greater than three times the size of the meddling.  Now isn’t that a vote for smaller government.   It tells us that rather than directing stimulus activity governments would do a better job just to reduce the size of government, reduce taxation and leave the solutions to the people – now who didn’t already know that!

Nevertheless given the money multiplier in the late 1980’s was three the drop to below one is quite an alarming change.

China. Following on from my recent China blog I discovered a far less glowing comment from a leading Chinese economist Yu Yonding reported in the blog of Michael Pettis – he was particularly scathing about the stimulus and had this to say – “When a country has an investment rate over 50 per cent [of] GDP and rising, you say this country is not suffering from overcapacity! … are you serious? ”To judge whether there is overcapacity you cannot just do a head account. With a 1.3 billion population and human greed, China’s needs are unlimited, you can say that China will never suffer from overcapacity!”

He believes China is trapped in a cycle where constantly rising growth in investment is constantly increasing China’s supply, but consumption has conspicuously failed to grow fast enough to absorb it. And so China is forced to increase investment in order to provide enough demand to absorb the previous round of increased supply, thus creating ever-widening cycles of oversupply.

In this manner, the investment share of gross domestic product has increased from a quarter of GDP in 2001 to at least half.  “There is sort of a chase – demand chasing supply and then more demand is needed to chase more supply,” he says. “This is of course an unsustainable process.”

“From 2005 China’s overcapacity problem had been “concealed” by ever-increasing net exports – but that strategy was interrupted by the financial crisis. Then came last year’s globally unprecedented stimulus-investment binge, which might not have been so worrying if it were delivering things that people needed.  But the Government’s hand in resource allocation has grown heavier since the crisis without reforms to make officials more responsible for what they spend.

“As a result of the institutional arrangements in China, local governments have an insatiable appetite for grandiose investment projects and sub-optimal allocation of resources,” as Yu previously said, in his Richard Snape lecture for the Productivity Commission in November.

So there are now airports without towns, highways and high-speed railways running parallel, and towns where peasants are building houses for no reason other than to tear them down again because they know that will earn them more compensation when the local government inevitably appropriates their land”.

So this certainly adjusts my thinking somewhat as does the very obvious fact that there is a raging debate going on inside China, and not the consensus that most Westerners assume. There is definite concern expressed by many Chinese commentators that the level of stimulus and particularly bank credit growth is particularly dangerous coming on top of the historically high growth trend.

A further fascinating analysis from the Pettis blog comments on the fact that it a misconception to assume that because China has accumulated near $US3 Trillion of reserves it is therefore unassailable. It pointed out that twice in history reserves have been accumulated to this magnitude (USA in the late 1920’s and Japan in the 1980’s), and that clearly having reserves of 5-6% of global GDP is no guarantee of only good things to come!  In both cases referred to their stock market lost more than 80% of its value during the next decade.

Greece The following email was sent to and reported by John Mauldin and is very interesting.

“I am an avid reader and I just wanted to correct you about a comment in one of your articles, “The Pain in Spain”, specifically:  ‘Somehow they forgot about the German government paying 115 million deutschmarks in 1960 — not a small sum back then.’

“This repayment of 1960 is undeniable. But the total amount owed was $10 billion ($3.5 billion for the return of the gold stolen and the repayment of the war loans Greece was forced into giving Germany, and $7 billion in war reparations awarded to Greece in 1946). As the DM/$ parity was then four for one, this means they gave Greece $29 million out of the $10 billion owed.

Germany also proclaims that they have given Greece over the years, in one form or another, €16.5 billion. But the fact of the matter is that despite these alleged payments, the issue of the war loans and gold is still not settled. Greece has never stopped asking for the money to be paid back … it is estimated that this sum owed now totals $70 billion [I assume the Greeks want interest – JM]. So even taking into account the €16.5 billion, more than $50 billion is still owed.

Helmut Kohl refused to even discuss the repayment, presenting as an excuse that this amount was owed by the whole of Germany and until Germany is unified the issue could not be discussed.          Guess what, Germany is unified….”

Now how much of that is true? – It’s a new one on me, but certainly both sides of the political divide in Greece have joined forces to claim the Germans still owe substantial wartime reparations, so maybe the story is a bit more complicated than we know.

It seems to me that without the help of the major countries at the centre of Europe (Germany and France, or the IMF) the Greece story is going to be very tricky.  Because while Greece only represents 2.5% of Europe the rest of the PIIGS constitute a very significant proportion of the Euro block, and what happens in Greece will be looked at very hard by others such as Spain with her current 20% unemployment for example resulting from a significant austerity programme.  The problem of ‘moral hazard’ rears up again, and will be much harder to ignore when the problem is cross-border, and borders that have been crossed militarily over time.

The key deadline for Greece is March 15/16, and so the next week will be interesting here – I don’t personally expect the Euro-block to fall at the first hurdle, but they have many and higher hurdles to come yet as the combination of sovereign and banking exposures collide in a tight funding market.

(A further thought of course comes from the impact that the Greek problem has had on the Euro, and clearly a move from $US1.50 to $US1.35 as has happened over the past month is a bit of a ‘godsend’ to European exporters, with the major moaners a month or two ago being France and Germany.  So not all bad, huh!)

However one of the most fascinating things I’ve noticed about the Euro block is not one member country is operating under the 3% deficit required by the Maastricht Treaty, not even Germany. Similarly there are few if any well behaved ‘Euro-blockers’ when we look at the debt-to-GDP maximum of 60%, also required by the Treaty.

Even so the focus on Greece is a strange one as it represents only 2.5% of Europe and is the first in real trouble; when we seem to have forgotten about California which is 12.5% of the entire USA, in far worse shape, and one of around 40 States in trouble.  (Must be something to do with how much money there is to be made in kicking them around a bit!)  News today tells us that the decrease in State revenue from Oct 2008 to Sept 2009 was $US87 Billion, the largest in history.  So State tax increases, here we come!

Something I noticed which may be a guide to what’s coming is this – a list of headlines I saw on the Sharechat website the other day – look at this unedited list:

Toyota Motor Corp.’s president endured three hours of questioning by US lawmakers, pledging to restore consumers’ trust without shedding new light on the company’s handling of safety recalls…. More»

The chairman of US bank Morgan Stanley, John Mack, says that bankers are still paying themselves too much.… More»

Royal Bank of Scotland reports a loss of £3.6bn for 2009, but is set to pay bonuses totalling £1.3bn to its staff…. More»

Bankers in London’s financial center, which Mayor Boris Johnson called a “leper colony,” are battling to justify their right to make money and to prove their social value after British taxpayers assumed liabilities of more than 800 billion pounds ($US1.23 trillion) to bail out the country’s lenders…. More»

Federal Reserve Chairman Ben Bernanke told the Senate Banking Committee on Thursday that the central bank is looking into Goldman Sachs’ and other U.S. financial firms’ role in Greece’s debt problems.… More»

So is this a signal that the next phase is going to be dominated by blame shifting from the politicians onto the bankers? – Now that should be fun!!   Although the possibility does remind me a bit of the famous comment from Oscar Wilde about fox-hunters – “the unspeakable in full pursuit of the uneatable.”

Japan: A very interesting piece here from William L Anderson which explains it all in one paragraph – always worthwhile.

For a brief moment in 1990, the Japanese stock market was bigger than the US market. The Nikkei-225 reached a peak of 38,916 in December of 1989 with a price-earnings ratio of around 80 times. At the bubble’s height, the capitalized value of the Tokyo Stock Exchange stood at 42 percent of the entire world’s stock-market value and Japanese real estate accounted for half the value of all land on earth, while only representing less than 3 percent of the total area. In 1989 all of Japan’s real estate was valued at US$24 trillion which was four times the value of all real estate in the United States, despite Japan having just half the population and 60 percent of US GDP.

William L Anderson – Mises.org

Australia: I’ll get on to Australia more formally in a couple of weeks, but enough to say I’m not fully convinced by the Aussie dream either.  A recent analysis of housing ‘un-affordability’ by Mike Shedlock, (looking at the US, UK, Ireland, Canada, Australia and New Zealand) found that 12 Australian cities counted in the top 20 as the least affordable to live in.  New Zealand was second, with Auckland and Tauranga the most expensive.  Whereas the historic maximum norm was 3 times income, Australia had a median multiple of 6.8 and NZ 5.7.  Dangerous to say the least!  This was a silver medal we didn’t really want.

Secondly the December 2009 current account deficit came in at $Au 17.459 Billion which is a very large figure when one comprehends that Australia is reaping the best trade conditions of its history.  So much depends on their relationship with China and as has been pointed out above there are real problems with the unsustainable level of Chinese capital expenditure.  Given the long lead time in mineral extraction developments Australia could easily find themselves over-exposed to a collapsing minerals market, particularly when you look at their vastly enthusiastic expectations for a larger and larger market with China.

Lastly the Reserve Bank of Australia in their year-end analysis confirm a 7% decrease in business credit, which clearly confirms a contraction in money supply is underway, whilst the banking system also faces the prospect of rolling-over $Au 514 Billion in the next 12 months in the global debt markets, over one half of their total exposure.

Tags: Think Global, Wayne Lochore

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