Saturday, December 12, 2009

There is no recovery

Greeting good citizen,

The weekends are usually tough because the financial world takes them off…depriving us bloggers of ‘low hanging fruit.’ But listen to me cry…you’d think nothing else was going on in the world!

Or worse, the world begins and ends with things that are important to me and me alone…and we both know that’s not true! Okay, I do get to set the agenda in this particular space (but only the space between the headline and the signature, the rest belongs to our gracious host.)

It’s Saturday night and the Holiday Season as well. My wife is attending an ‘adults only’ Christmas Party this evening at her brother’s house…since I can’t carry a tune with a crane, I’m home here with the kids, where I’ll do the least amount of harm.

See, stick me with a big open weekend and I babble!

So without further adieu, we proceed to tonight’s offering Where Ilargi sounds off on my favorite Hobby Horse, the ‘invisible’ recovery.

December 11 2009: There is no recovery

Ilargi: Jim Rogers is right. There is no recovery in the American economy. Things have only gotten worse, and a lot too. Still, Rogers can’t help seeing the world through his own subjective eyes either, distorted by his age and his professional views. He makes money as an investor, and can’t imagine a world in which investors like him are not part of the landscape. [This is what I was referring to earlier, the tendency to see things the way we think/are taught they ‘must be’ rather than opening our minds to the many possibilities there are!]

And that’s the big blind spot for most analysts, publications and websites that occupy themselves with finance and the economy. They're written by people who make a living because the economy is organized a certain way, and they see a situation in which that will mostly continue to be so, with some more or less minor tweaking. Rogers understands a lot of what’s coming, but he stops short of pondering himself as a victim. This may be completely natural and logical, but it does potentially cloud his vision. For him, the question is where to invest, not whether to invest at all. [Much of the ‘craziness’ in the markets has been due to too many investors and too few opportunities, driving ‘mal-investment’.]

But, again, he's right. There's no recovery. A Bloomberg piece this morning illustrates why. It says that China's Q3 output was up 19.2%, with exports down 1.3%, and imports up 26.7%. [Understand that this is the same economy that counts cars as ‘sold’ as soon as they drive off the assembly line, this in a world where nobody is buying new cars!]

China’s growth accelerated to 8.9 percent in the third quarter on the record lending and a $586 billion, two-year stimulus package, helping Asia to lead the recovery from the global economic slump.

The Chinese government injects a comparatively gigantic amount of money into the economy, which the banks use to hand out record loans. And that, all by itself, says Bloomberg, makes Asia (re: China) lead the recovery from the slump. This is the gospel according to Washington, the gospel of Barack Obama and George W. Bush. The first is on record claiming that the US can "spend its way out of the recession", the second became famous for encouraging people to go shopping in the face of economic hardship. In other words, as Jim Rogers phrases it:

"The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grown-ups would stand there and say that." [Never mind ‘adults’, this is the ‘Leader of the Free World’ blowing it out their collective backsides here!]

Well, Jim, grown-ups in governments ranging throughout history and across the globe have stood there, and today stand there, saying exactly that. By the way, if I were you, I would, but that's just me, in the light of the Chinese embrace of the Washington "spend and borrow your way out of debt" gospel, perhaps take another look at your own embrace of the Chinese economic model.

It would feel more consistent, since China, of course, has no genuine recovery either. Its exports are still falling, but its output rose 19.2%. In other words, the Chinese will have to buy their own products. Problem is, they don't feel like doing it. According to Michael Pettis, Chinese household consumption is 35% of its economy, vs 55-65% in Europe and 70-72% in the US. And its consumption isn't rising fast, if at all, either. What is rising are savings, presently at 26%, vs a negative savings rate in the US until recently. Pettis asks an intriguing question about China:

"Crises seem to drive the household consumption rate down, even though bull markets don’t seem to drive it back up. Is that because crises cause households to worry about risk (although if that were true they wouldn’t go permanently down, would they)? Or is it because the government responds to crises by increasing the amount of misallocated investment, the consequence of which is to reduce future consumption?"

So what would it take to drive Chinese consumption upwards towards levels that might sustain at least part of its economy if and when American and European export markets don’t rise from their ashes? Pettis says:

Just to return consumption to 40% of GDP over the next five years (and even that level is widely considered to be way too low, and probably unprecedented in the world excluding recent Chinese history), 8% average annual growth rates in GDP would require a tad under 11% annual growth in consumption. [..] [And that would do absolutely NOTHING for the stalled US (and European) economies!]

To bring Chinese consumption in 20 years up to 50% of GDP, which is the low end for other high saving Asian countries, and far lower than any other large economy in Asia (and remember that large economies are less able to rely on exports to fuel growth than small countries), 7% annual GDP growth would require average annual consumption growth of just under 9% for twenty years.

In other words while GDP growth slows significantly from its 12-13% rate of the past several years, consumption will nonetheless have to surge at rates far in excess of the 8-9% growth rates of recent years in order for even a small, partial re-balancing to take place.

One thing should become clear now: China won’t be able to run its economy on domestic demand for many years to come. Until then, it will rely on western consumers, who are broke, and on government subsidies, i.e. consumption of its own flesh. Whatever the choice may be, a 19.2% increase in Q3 2009 output looks a lot like despair. Who will buy all that extra output? There are no extra clients anywhere on the horizon.

Just as is the case in the US, people like the Bloomberg reporter quoted above confuse government funding with credit. Of course, if you ask no questions, both may look pretty much the same. But that doesn’t mean they are. You can't be both the seller and the buyer of your own products and still claim you’re making a profit.

The Chinese are trying to kick-start economy with their own reserves. But once the engine runs, if it does, it’ll need somewhere to go, someone to purchase its products. That someone will have to have a trade surplus, i.e. money to spare. The Americans don’t have any. They are trying to kick-start their economy with borrowed money, which means they are increasing their already sky-high debt levels. Which is why Jim Rogers is dead-on when he says that there is no recovery, and things have only gotten worse in the past year.

You wouldn't know it from looking at the stock markets yet, but if you imagine the economy as a closed system, which in the thermodynamics definition can exchange heat and work (energy), but not matter, with its surroundings, it becomes clear that whatever happens inside the system doesn’t solve any problems, but merely transfers wealth (heat) from one part of the system to the other. That is, while banks and investors have been making money over the past 6-month rally, someone everyone else has been losing out.

To figure out who, you need look no further than the record numbers of American citizens who are unemployed, homeless and/or living on foodstamps. The system as a whole shows no recovery, just parts of it do due to increased misery in other parts. Moreover, what does enter the system from outside is borrowed money that needs to be repaid. This should also make clear why printing money cannot solve any of the existing problems. For one thing, America's largest creditor is China, which has its currency pegged to the dollar. No gains there.

In more general terms, much, if not most, of what is seen as wealth consists of nothing but leveraged bets. Which is how a home that cost $100,000 to build comes to sell for $500,000. This wealth will have to be deleveraged, until things are worth what they are, i.e. they have a price someone is willing and able to pay for them. In the absence of cheap and abundant credit, that is.

All countries are chasing the same remaining pieces of the pie, which can only be obtained by increasing one’s exports, or, more correctly and comprehensively, one’s trade balance. And since the world economy as a whole can also be considered a closed system, the only possible turn of events in this case too is wealth transfer. Which can be achieved, as noted, by an increase in exports, or possibly through warfare. It cannot be achieved by printing one’s own currency. That could function (temporarily, until hyperinflation sets in) only if the system were what thermodynamics defines as an isolated system, i.e. no exchange whatsoever with the outside world.

Since the US depends on the money it borrows from outside its borders, it is as yet far from being an isolated system. It can try to devalue its currency, but so can any other country. The US has an added disadvantage in the fact that the US dollar is the world reserve currency, which means people will flee to it in times of global stress and uncertainty. Which in turn will push up the dollar’s exchange rate.

Once the US is cut off from the rest of the global economy, either forcibly or voluntarily, it may or may not go the way of Weimar and Zimbabwe, both more or less isolated systems in an economical sense. That moment, though, is years away.

Until then, to quote Jim Rogers once more, things will only get worse if the present "spend your way out of misery" gospel continues to rule our ways. Just look at how much more debt, most of which is owed to foreigners, the US has compared to a year ago. It runs in the trillions. In just one year.

Rogers is right again when he notes that Obama was merely a community organizer just 6 years ago, doesn't understand economics, and relies entirely on the people he nominated in his economic team. But that is not a valid excuse.

A headline in French weekly Le Point yesterday said : "Warlord Obama receives his Nobel Peace Prize". Being the President of the United States means you can't wreck the nation's economy and plead innocence or ignorance. Neither does it mean you can send 30,000 extra young Americans into battle and pick up a Peace Prize one week later. He could have refused the prize. And probably should have. Or, as someone suggested, sent an unmanned drone to pick it up for him.

Jim Rogers is buying American dollars. You?

If you wish to hear for yourself what Mr. Rogers has to say Here are a couple of links…

Um, I’m going to guess Ilargi’s last remark is ‘rhetorical’ in nature, most of us have no choice but to ‘buy’ dollars, it’s what they use to pay us.

If you’ve been following the financial news religiously then you know Mr. Rogers created a stir some time ago when he was selling his dollars after moving to Singapore. It’s kind of weird to see him buying after the commotion he caused by dumping his dollar holdings.

But this returns us to Ilargi’s central premise…are investors ‘wrong’ for assuming there will always be investment opportunities, given the destructive power so recently displayed by rampant mal-investment?

If it were up to me, I’d be making a case for A.) A limit on the number of investors and B.) Conditions to be met for legitimate investments. Lacking either of these ‘restrictions’ leaves the door open for investors to make more money from failure than could be had by success!

Failure doesn’t pay…except in the situation we currently find ourselves in, where the moron regulators failed to ban destructive practices that should never have been allowed in the first place.

What an interesting little experiment it would be if these highly destructive investments had a death sentence attached to them…how many do you suppose would try to collect then?

Thanks for letting me inside your head,


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