Bonner, Denning
From Dan Denning at the Old Hat Factory:
--This is shaping up to be one of those weeks (or months...or years) in which geopolitics has a big influence on stock markets. The Australian corporate earnings season isn't in full throttle yet. And there's not much data coming out this week that gives us more insight into the economy.
--But how much more insight do we really need? We know the world is in the early stages of recovering from the greatest debt binge of all time. The central bankers are trying to keep the party going and prevent debt deflation. But the accumulated liabilities from the boom have to be written down or written off. Balance sheets must be rebalanced.
--And we also know that markets are giving way to politics. The free market is waning. Government run markets, on the other hand, are waxing.
--For example, it appears China is beginning to throw its considerable economic weight around. It's doing so in a tentative, experimental manner, not sure if it will offend but not seeming to care all that much. And why should it? The world is perfectly happy to do business with the largest emerging market of the next fifty years. Other issues-human rights, the environment, and the Rule of Law-are secondary.
-- It should be interesting to watch. If economic Empires were like teenagers, they'd be temperamental, volatile, and inscrutable. And so China-which to be fair is a venerable 5,000 year old culture-is entering its economic adolescence. Proud, confident, and slightly unpredictable.
--For instance, is China trying to put Australia in its place by arresting Rio Tinto executive Stern Hu? Is this a not-so-veiled message that if Australia wants to benefit from China's industrial growth and stimulus pending, it had better be more compliant on things like, oh...say...iron ore pricing? Is Australia just now discovering that the new economic order comes with certain terms and conditions that are not negotiable?
--And here's the really interesting question: If China is flexing its economic muscle, can it simply change the rules of global capitalism? China's market is large. Its savings are legendary. And the Western model of capitalism doesn't have a lot of moral authority and the moment. So will businesses be willing to do business in China, on Chinese terms, at the risk of landing their executives or workers in jail if they run afoul of ambiguously defined laws?
--From a Chinese perspective-and we're only imagining here-it must be a bit too much to be lectured by anyone in the West on the Rule of Law or corporate ethics. After all, there's been plenty of Law breaking/flouting/changing in capitalist economies over the last few years. Does China's government intervene, intimidate, and manipulate any less than governments in America, Britain, France, Germany , and Russia?
--The fact that we're even asking that question-unless it's a really dumb question-is not good for markets. It means that in currency matters, business matters, regulatory matters, and tax matters, investors have less and less certainty about the environment they're operating in.
--Not that investors ever have total certainty. But the more variable and unpredictable (and capricious) the action of the State is, the more you can expect investors to lay up their stores in cash and sit on the sidelines. When you can't trust a currency or a sovereign bond...well then you're probably going to become very conservative about your future capital spending (and borrowing). All of which argues for either a second dip to the American (global) recession or anemic economic growth.
--And then there was this bit of dollar subterfuge from the G-8 summit in Italy. "We should have a better system for reserve currency issuance and regulation so that we can maintain relative stability of major reserve currencies' exchange rates and promote a diversified and rational international reserve currency system," said Chinese State Councilor Dai Bingguo, according to today's Age.
--How about that? China has 70% of its foreign currency reserves in U.S. dollars. It's walking a fine line. It would clearly like to rattle its currency saber in order to keep American deficit spending (and potential dollar devaluation) from threatening the value of those investments. But by repeatedly brining up the dollar's weaknesses, it does the very thing it wants to avoid; threatening the value of its dollar-based investments.
--Free markets-one simple. Now complicated.
--French President Nickolas Sarkozy tried to defuse the situation, but he only managed to sound like a moron. "These are complex subjects whre positions have to evolve, but we can't remain based on a single currency," he said.
--Then, proving that politicians knows more about dating leggy models than running an economy economics, he added, "We have to ask ourselves: Shouldn't a politically multi-polar world correspond to an economically multi-monetary world?"
--If the Lion is the King of the Jungle, should he not also be King of England?
--You can argue about where political power comes from. Some say trade. Some say sound institutions governed by the Rule of Law. Some say the barrel of a gun. For example, a nation can have a small economy. But with a small nuclear arsenal, it's going to punch above its weight geopolitically.
--But economic power is not based on exclusively on coercion or the ability to intimidate your trading partners/strategic rivals. A "multi-monetary" world would be fine by us if it meant there was a free market in money. You would be free to use whatever money suited you best, and you would judge that money on its stability and its utility.
--Yet as we begin the week, it's becoming plain to see that there's no such thing as a "multi-monetary" world right now. It's really a "bi-monetary" world. There is government printed (fiat) money-backed by nothing except the economic potential of the economy from which it comes (or the coercive power of the State which issues it). And there is free market money.
--Free market money-at least in a world rife with mistrust about government money-is going to be gold and silver. In a geopolitically influenced market, a bi-metallic view on money may turn out to be the biggest winner.
--And for what it's worth, we believe the larger cost of the credit bubble-in addition to the trillions in household wealth wiped out and trillions more in misallocated capital-is how far from its traditional roots Western capitalism has strayed. When people are free, when rules are clear and fair, when money is sound, and when private property is respected and money is not confiscated by the State, political liberty and economic liberty thrive side by side. Indeed, one is not possible without the other. More on the subject this week.
And now over to Bill Bonner in London, England:
"In a fundamental shift, consumers are saving rather than spending," notes the Los Angeles Times.
This is the shift we've been talking about for months. The great credit expansion of 1945-2007 is over. Now cometh the great credit contraction.
During the bubble years, more and more credit produced less and less real prosperity. It was as if you were borrowing more and more, to invest in your business or merely to increase your standard of living, but your income didn't rise fast enough to keep up with the interest payments.
In 2005, Americans saved nothing. Not even aluminum foil or string. Now, the savings rate is approaching 5% of disposable income - a big turnaround.
We know from logic and experience that saving money - not spending it - is the key to getting wealthier. Saving money gives you capital. And it's capital accumulation - in the form of factories, roads, ships, buildings, machines...and raw savings - that gives people the ability to produce more. It may take a man with a shovel a whole day to dig a decent grave. Give him capital - in the form of a backhoe - and he can bury everyone in town. That's why capitalism works. It rewards the fellow who saves his money.
Yet every yahoo economist in the year of our Lord 2009 takes news of rising savings rates like the death of Michael Jackson. If households don't consume, they reason, how can a consumer economy grow?
The problem is that you can't really grow an economy by borrowing and spending.
Recent history proves it. Despite the biggest splurge of borrowing and spending in history, the US consumer economy barely grew at all.
"In the five years to December 2007," reports Grant's Interest Rate Observer, "America's credit market debt climbed by nearly 57%, to $18 trillion. However, in the same half-decade, nominal GDP was up by only $3.3 trillion."
For every five dollars people borrowed, they only increased their incomes by $1. Imagine that the borrowing had an average effective interest rate of 10% (credit card debt can be much more expensive). At that rate half of the additional income earned between 2002 and 2007 had to be used just to pay the interest.
This was not the kind of growth that was likely to last. In fact, it didn't. The whole thing came crashing down in '07 and '08. And now, the consumer has had a cup of coffee. He's looked at himself in the mirror. He's sorted through his pile of bills. And he's made up his mind: that's enough of that!
"The ratio of cash held by households as compared with assets has been rising sharply," says James Saft in The New York Times.
"Companies, households and banks all want to pay down debt and...prefer to hold cash rather than assets, partly because the outlook for those assets is poor and partly because after a decade of excess, everyone now looks a bit over- extended.
"This is exactly what happened in Japan during its lost decade, when a balance sheet recession, one characterized by the paying down of debt and liquidations of assets, was self-reinforcing and very difficult to stem."
And now this from David Rosenberg:
"The ultimate question is where all this cash is going to be deployed, and we believe it will ultimately be diverted toward debt repayment."
Let's see. We can figure this out from the numbers above. American consumers must have added about $7 trillion in extra debt during the Bubble Epoque, 2002-2007. Now, instead of buying things, they use their money to pay it down. The average household has about $43,000 worth of income. Let's keep the math simple by saying there are 100 million households in the United States...and that they save 5% of their income. And let's say they use every penny of savings to pay down debt. Hey...it will only take about 30 years to pay it off! Get ready for a long, long slump.
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Yesterday, stocks went nowhere. Oil went nowhere. And the dollar went down as gold went up.
The reason for the dollar's decline and gold's rise was given in the front-page headline of today's Financial Times. China launched a "new dig" at the dollar, it says. As near as we could tell, China merely stated the obvious - that the world is going to have to find a better monetary system. The US dollar won't be king of the hill forever. And China, which is up to its neck in dollars, would like to find a solution sooner rather than later - that is, before the dollar goes the way of all paper.
The dollar will eventually give way to inflation and devaluation, but probably not soon.
"I'm absolutely worried about inflation," says John B. Taylor.
But here at The Daily Reckoning, it is not inflation that worries us...it's the lack of it. Making a long story short, as long as the feds see no inflation they will continue trying to create it. In the end, they will get more than they wanted.
And where will investors flock when that day comes? You guessed it - to our favorite yellow metal.
Though, right now, instead of inflation, we have deflation. Today's New York Times tells us that deflation in Ireland has reached 5.4% - the highest since the Great Depression of the '30s.
You know the reasons for deflation as well as we do. The world suddenly has too many people who borrowed too much money buy too many things they really didn't need and really couldn't afford. This caused the world's producers to greatly over-estimate the 'real' demand. Their customers began to disappear in 2007. Their factories are still standing.
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"Is it always so cold in July?" asked an American visitor yesterday. London has been cold, windy and rainy for the last week. It comes as a shock to American tourists, who inevitably show up in shorts and t-shirts.
Europe has a milder climate than North America. Our guest comes from Ottawa, Canada.
"Everybody thinks it is so cold in Canada. But it's much hotter there than it is here. A lot of houses in Ottawa have air conditioning. Here, almost no one has it. And I guess they don't need it."
But in the winter, the streets of North American cities turn bitter cold and bums freeze up on the sidewalks. That doesn't happen in Europe. It rarely gets cold enough to freeze a bum here. Maybe that's why there are so many of them.
Around the corner from our office is something we had never seen before. A mother-daughter team of 'street persons.' Dressed in black rags, they sit with their bags and talk. They are there when we get to the office in the morning. They are there when we leave in the evening.
The daughter appears to be in her 20s or early 30s. She is a pretty girl, as near as we can tell. The mother must be in her 50s...maybe 60s. The two look very similar - like the mother/daughter combinations you see in skin cream advertisements. They dress the same. They have the same very English faces. They have the same expressions and same postures...sitting on the sidewalk with the backs to the wall. Whenever we pass, they are chatting with each other - happily, it appears.
Keep reading for today's essay, below...
Bill Bonner
for The Daily Reckoning Australia
[Editor's Note: Bill Bonner & Lila Rajiva's new book, Mobs, Messiahs and Markets, is now available in Australia from The Educated Investor. Order here for a 15% discount.]
The Daily Reckoning Presents: Why do smart people do such stupid things? Why couldn't the créme de la créme of the economic world see the runaway train that was the credit and consumption bubble racing toward them at warp speed? Bill Bonner examines these questions - and more - in today's essay, below...
Bubble Deniers
by Bill Bonner
"War Criminal says Sorry, Sobs," was the headline in the Nation on February 9th, 2004. Robert McNamara had just done something extraordinary for Secretaries of War: with tear in his eyes, he apologized for his role in the Vietnam War. The war made ghosts out of 58,000 American soldiers. On the Vietnamese side, the total was over a million. This week, McNamara went to meet them.
Why do smart people do such stupid things? The French had already shown what Western powers were up against in Indochina. De Gaulle had warned Kennedy that it was a "rotten" country. Still, the United States sent in troops...and McNamara, to his credit, spent the last 40 years of his life regretting it.
We do not disrespect the shades here on the back page. But once they are down, we can hardly wait for the autopsy report. We want to know what was wrong with them. McNamara had a brain "like a computer," say the morticians. Too bad. He needed more than that.
Robert McNamara was described in the obituaries as the "architect" of the Vietnam War. This is libelous to real architects; as near as we could tell, the war went on without plans or blueprints. Instead, Robert McNamara took an economist's approach to war. His formula had only three numbers: how much damage he could inflict on the enemy; at what price; and how much pain the Vietcong/North Vietnamese could stand. Later, he discovered that the enemy wasn't even counting.
Long gone are the days when economists thought deeply about how life actually works. Adam Smith, Adam Ferguson, Anne-Robert Turgot - the great "moral philosophers" - all died hundreds of years ago. Since then, the trade has gone bad. They're all numbers guys now. An economist, of the modern variety, is a statistician...an extrapolator...and a mountebank. If numbers go up two months in a row, he predicts they will go up another one. He rarely stops to ask whether his numbers really make any sense. Instead, he merely adds them up and rolls them out. Thus - at the bubbly top in 2006 - he was he able to describe the likelihood of default on a certain derivative instrument as a "Six Sigma event" without laughing. A Six Sigma event happens once every 2,500,000 days. Then again, when the Bubble of 2002-2007 popped, they happened once a week. The blogs are full of chatter on the subject. What good is the economics profession, asks Paul Samuelson, if it cannot foresee the biggest single economic event in at least a quarter-century?
Yet, those same economists - who had failed so miserably at diagnosis and prevention - they barely hesitated. Rather than spend months in drunken shame, contemplating their own incompetence, and wondering what a bubble really is, they denied the wild bubble side of life altogether...and tried their hands at prescription. President Obama's economics advisors went to Congress last autumn to predict that without the stimulus measure joblessness in the United States could rise to 8%! Bernanke made it seem that if the bill wasn't passed that day, the economy may cease to exist all together. How he could know the future, when he demonstrably knew so little about the recent past, was a mystery. Still, the politicians responded by enacting the biggest bank bailout boondoggle in history.
What would have happened had the legislators failed to jump when economists threw them a bone? We don't know. But we know what happened after the stimulus measures were passed - they failed to stimulate. The employment numbers for June showed that economists had misjudged both the direction and the speed of the oncoming bus. Instead of shifting down, the rate of job losses increased to 9.5% in the United States. Instead of going forward, the economy was backing up!
Do these setbacks cause economists to stop and wonder if their theories are bogus and their numbers are nonsense? Nope, they do what McNamara did. They turn up the heat. They propose to spend more money they don't have on more programs that don't work. Predictably, Obama advisor Laura Tyson now suggests that the stimulus thus far is "too small." Other economists too are talking about a "son of stimulus," that will offer even more credit to the debt-saturated consumer. Only trouble is, neither consumers, businesses nor banks cooperate. Despite trillions in cash and credit to the financial system, lending is still going down.
Robert McNamara was as smart as any of today's number crunchers. A Harvard "whiz kid' with a 'can do' attitude, he was one of the 'brightest and the best,' the kind of American that makes you proud to be one. He was an efficiency expert. But everything has its place. Poetry is not much in demand from bridge builders. In love, war and bubbles, on the other hand, rational efficiency is at best a second tier concern.
When asked to take the job at the Defense Department, McNamara replied to John Kennedy that he was "not qualified." That was the last thing he was right about. As to everything else, he missed the point completely.
Sometimes it is the brain that fails. Sometimes, it is something else.
Until next time,
Bill Bonner
for The Daily Reckoning Australia |
