Headlines will soon shift from the sexcapades of Rep. Antony Weiner to the debate over the debt ceiling extension. The outcome of this debate could have a profound effect on the markets.
Here's what's at stake. The U.S. government is out of money and needs to borrow more by Aug. 2 to continue to function. The Treasury says it needs a $2 trillion increase in the previously imposed $14 trillion debt limit.
Republicans are holding out for meaningful spending cuts as a condition of the extension. But Treasury Secretary Timothy Geitner, President Barack Obama as well as China and two credit rating agencies are all warning of dire consequences if the debt limit isn't raised by the deadline.
They argue that by not increasing the debt limit, the government could be forced to default on its debt payments and such a default would wreak havoc in the financial markets by sending the dollar plummeting and interest rates skyrocketing. But, the risk of a short term technical default pales in comparison to the risks of not getting spending under more control.
The $2 trillion requested is in addition to the nearly $5 trillion of debt racked up in just the last two years. The national debt has already ballooned more than 55 percent since President Obama took office. Monthly deficits now approach the level of last decade's yearly deficits.
If the government doesn't stop the out of control spending, the U.S. economy could be destroyed. Hyperinflation and a plummeting dollar could doom the U.S. standard of living as we have known it. The wreckage could take decades to repair, if it can be repaired at all. US dollar has lost 50% of its value in the last 26 years against major currencies
While just about everyone claims to understand this problem, Democrats have displayed no intention of cutting spending and have resisted measures to cut spending at every turn. Only the leverage provided by the debt ceiling can force the issue and bring them to the table. Aside from preventing a longer-term disaster, meaningful spending cuts would benefit the economy and the markets in the near term as well.
The U.S. economy right now is like the stock of a company perceived to be going nowhere. Both domestically and abroad, the U.S. economy is viewed to have massive debt problems that government seems incapable of solving. Doing business in the United States is fraught with regulations, huge healthcare expenses and high taxes. The future seems to hold slow growth at best and financial disaster at worst.
Much better investment opportunities exist in the emerging markets, and that's where investments and jobs are going. In order to revive the economy, this commonly held view must be changed. Real spending reform now could tip critical mass in a positive direction.
It would signal to the world that the United States is getting serious about deficits and begin to change the current narrative. These spending reforms won't turn things around all by themselves but will have started down the road to recovery. Down this road the trillions in cash held by U.S. corporations may start to be put to work. Foreign companies might once again see the United States as a good prospect for the future. And, banks might begin to lend again.
An indication that the US government has the will to solve the current problems could quickly change the longer term perspective of the market. The outcome of this debate could determine if the last two years was a bear market rally or the beginning of a long-term bull market. This is an emergency and have no choice but to risk short term turbulence in order to avoid long term disaster. The US is headed for 100 miles per hour toward a brick wall and needed to turn the wheel and risk a fender-bender.
If there is a technical default at some point and it does result in a downgrade of U.S. debt and wreaks havoc in the markets, it will serve as just a small taste of what is to come if the US government don't get spending and deficits under control. Maybe being "scared straight" is exactly what American economy actually needs.
Disclaimer: This is a just a research piece and not an investment advice....
Saturday, June 18, 2011
Friday, June 17, 2011
The New Gold Standard: Myths and Realities----By Shan Saeed
Its not surprising that US state of UTAH has declared Gold and Silver as official medium of exchange......
With various states debating measures to elevate the monetary status of gold, the gold standard is more politically relevant now than it has been in decades. When the LA Times (to pick just one example) runs an article stating matter-of-factly that "economists" uniformly oppose gold, you know the defenders of the current system are getting nervous.
Precisely because a gold standard is such a hot topic lately, it's important for people to understand its rationale. I will few facts with you to try to clear up a few misconceptions.
Do All Economists Oppose the Gold Standard?
I realize I am betraying my naïvete by admitting this, but I was very surprised at the depth of falsehood in the LA Times article mentioned above. Here is the blurb below the title, "Pushing for a Return to the Gold Standard":
The idea to make the precious metal legal tender has gained currency in more than a dozen state capitals, aided by Tea Party support and other efforts to rein in federal power. Economists say the plan would be disastrous.
I suppose the final sentence is technically true, but it's very misleading. It's a bit like saying, "Baskin-Robbins offers 31 flavors, but customers buy chocolate." Yes, some economists say a return to the gold standard would be disastrous, and I'd grant that perhaps even a large majority do. But the blurb above makes it sound as if virtually all economists oppose the move, which isn't true.
The writer in LA times, reinforces this misconception in two other places. He quite clearly tries to pit the rube businessmen and tea-party politicians against the professional economists. First he writes,
The ultimate goal is to return the nation to the gold standard, in which every dollar would be backed by a fixed amount of the precious metal. Economists of all stripes say the plan would be ruinous, but that view is of scant concern to Pitts [a South Carolina state representative].
"Quite frankly, I think that economists from universities are thinking within the confines of their own little world," Pitts said. "They don't deal with the real issues." (emphasis added)
Just to make sure the reader gets the point, Popper writes later in the article:
The United States and most of the rest of the world operated on a full gold standard until the Great Depression. Economists generally agree that the policy helped cause the depression and earlier severe downturns by limiting the amount of money the government could create, constraining its ability to stimulate the economy.
Scholars say moving to a gold standard now would be likely to slow the economy's already meager growth. Some are talking about sub-par growth which is happening in advance economies.....
"At some point someone may be crazy enough to try it, but they won't stay with it any more than they did in the past," said Allan Meltzer, a Carnegie Mellon University economics professor and a critic of the Fed's current monetary policy.
Given the lack of support from mainstream economists, activists have turned a few texts written by outsiders into their bibles, such as "Pieces of Eight," an out-of-print book by [constitutional lawyer] Vieira.
In the entire article, he doesn't quote a single economist who is in favor of the gold standard, or even paraphrase his or her views. This might be acceptable, except for the fact that quotes or makes reference to businessmen, politicians, and the lawyer Vieira. (I am not familiar with Vieira's work, and it should go without saying that I'm not criticizing him.)
Now, it would be easy for me to accuse the writer of lying, but for all I know he was so sure of the stupidity of the gold standard that he didn't even try to find actual PhD economists currently teaching at colleges (some even at top-20 graduate schools) who would have nice things to say about the gold standard. I personally know at least 20 such people, so believe me, they're out there if he or other journalists actually want to give the case for gold a fighting chance.
As far as books touting the advantages of the gold standard, yes indeed there are volumes written by people with PhDs in economics. A classic text is Ludwig von Mises's The Theory of Money and Credit, while a newer, much more reader-friendly selection is Murray Rothbard's What Has Government Done to Our Money? plus other books like on the Great Depression exploded the myth that the gold standard had something to do with it.
Did Gold Cause the Great Depression?
Before moving on, let me quickly address that particular claim. I've written a longer response here, but for now we have to wonder: If the gold standard caused the Great Depression, what else was going on? After all, the gold standard wasn't implemented in the 1920s. Although there had been plenty of industrial crises or financial panics in the previous hundred years, there had been no prolonged global depression approaching the experience of the 1930s — even as more and more countries joined the growing worldwide market of gold-based economies. So clearly it's not enough to point to the "golden fetters" of the monetary system to explain what happened in the Great Depression.
Thus, to blame the Great Depression on the gold standard is just as nonsensical as blaming it on the "laissez-faire" policies of Herbert Hoover, who (even if we take the caricature of him seriously) was no different from all his predecessors. It would be like explaining a particular airplane crash by citing gravity.
As a final point, let's not forget that FDR abandoned the gold standard in 1933. The Great Depression thus lingered on – after leaving the allegedly awful gold standard – for at least another 8 years (and I would say 13 years, because I think World War II "fixed" the economy), in what was still the worst economic period in US history. It's odd that the gold standard could wreak so much havoc in the early 1930s – even though it had never done anything comparable earlier in US history – and then could continue to "cause" the Great Depression, from 8 to 13 years after abandoning it. It starts to make you wonder whether the "economists of all stripes" know what they're talking about.
"You Can't Eat Gold!"
One of the most absurd objections to returning to a gold standard is that "You can't eat gold." I am not making this up; Dave Leonhardt of the New York Times actually said that to Ron Paul when he defended the idea on the Colbert Report.
Dr. Paul didn't really get a chance to answer (Colbert instead made a funny joke about idolatry), but it would have been delicious had he quickly asked the cynic, "Oh, so you make sandwiches out of Federal Reserve notes?" (We also would have accepted, "Oh, so I take it you are proposing a hamburger standard for the dollar?")
The utter absurdity of the objection – namely that you "can't eat gold" – is that gold actually is a useful commodity even for nonmonetary purposes. It's true, you can't eat gold, but you can wear it, you can fill cavities with it, and you can treat arthritis with it. In contrast, all you can do with fiat paper currency is use it in exchange, and you'd better not keep a large fraction of your wealth in actual paper dollars, since their purchasing power constantly erodes with the passage of time.
Don't Austrians Favor Market Choice?
Ironically, in addition to ill-informed critiques such as those emanating from the LA Times, the gold standard has critics from the purist libertarian camp. Such critics often ask, "What's so special about gold? Why do Ron Paul and so many other alleged fans of the free market favor the federal government telling us what the money should be?"
Of course Murray Rothbard – and as far as I know, every living Austrian economist – would prefer that money and banking were returned to the private sector, receiving neither special regulations nor privileges distinguishing them from any other industry. That means banks would be free to issue their own paper notes (backed by gold reserves) if they wanted, but if they issued too many and got caught in a "run," the government wouldn't declare a "bank holiday" and relieve the irresponsible institution of its contractual obligations.
What Rothbard and his modern followers believe is that gold almost certainly would be the free choice of individuals all over the world, if they were allowed to settle on a money without government legal-tender laws and other interventions stacking the deck.
In the meantime, given that there is a Federal Reserve (and other central banks), many Austrians (though here the agreement is not universal) believe that restoring the convertibility of the dollar to a fixed weight of gold would be a move in the right direction, even though it would still not be perfect.
The purpose of repegging the dollar to gold would be to remove what is euphemistically called "monetary policy" (a more sinister description would be "legalized counterfeiting") from politics and special-interest corruption as much as possible. People laud the current Fed as being "independent," but of course that is absurd. The Fed as it currently operates is clearly a cartelization device that shoves new money into the pockets of rich bankers, and that allows the government to finance massive deficits much more cheaply than would otherwise be possible.
"So You Want the Government to Set Prices?"
Related to the above criticism, some purists also ask, "Why don't you favor a market-driven price for the dollar and for gold? Just let supply and demand determine prices, not some rigid number picked out of a hat by the politicians."
This objection sounds plausible at first, but it too misses the mark. If the Fed were to say, "We are now announcing a new policy objective of maintaining the price of gold at $2,000 per ounce, from now until the end of time, and we will begin accumulating stockpiles of gold to reassure investors that we will be able to maintain the target," this would not be analogous to the federal government saying, "We are establishing a minimum price of labor at $7.25 per hour."
Under a genuine gold standard, when the Fed "sets" the dollar price of gold it isn't threatening people with fines or jail time if they want to trade gold at a different price. Rather, the Fed (or the government in general, if there were no central bank) would adjust the quantity of dollars in existence to maintain the target. If the forces of supply and demand were such that the market price of gold had drifted upward to, say, $2,025 per ounce, then the Fed (assuming a $2,000 target) would need to sell off some of its gold holdings,[1] which would (1) flood the market with more gold and (2) shrink the amount of dollars in the financial system. This contractionary policy would push down the price of gold toward the peg of $2,000.
On the other hand, nobody would be so foolish as to sell his gold for less than $2,000 per ounce, if the Fed (or the Treasury) had a standing invitation for anyone to trade in an ounce of gold in exchange for $2,000 in Federal Reserve notes. Why sell your gold to another private citizen for (say) $1,950 an ounce, when the US government stands prepared to buy unlimited quantities of gold at a fixed price of $2,000 per ounce?
Finally, a critic could (and actually did, on my blog) ask how this arrangement differs from the current one? After all, right now Bernanke "sets" interest rates, but not through literal price controls. Instead, the Fed adjusts the quantity of reserves in the banking sector such that the "market-determined" federal funds rate is close enough to the Fed's target for this interest rate. So isn't this basically the same thing as the gold standard, with a different "good" serving as the monetary commodity?
There are two problems with this sophisticated objection. First, in the current system the Fed has a moving federal-funds target. At best, then, it would be analogous only if the Federal Open Market Committee said after each meeting, "We are now setting the target price of gold at such-and-such dollars. However, if unemployment begins rising and core CPI is under 2 percent, we will begin raising the target price of gold in $10 increments over the next few meetings." That system would be nothing like the classical gold standard.
Yet the deeper problem with the analogy is that on a classical gold standard, the government is (imperfectly) mimicking what would happen if the money were actually gold, with people walking around with gold coins in their pockets, and merchants quoting prices not in dollars but in grains or ounces of gold. The classical gold standard, by fixing the dollar as convertible into a definite and constant weight of gold, doesn't introduce another price: the dollar is supposed to be a claim-ticket to gold. This isn't really "price fixing," any more than defining a foot as 12 inches is "central planning."
n contrast, what would be the free-market analog of the Fed's current strategy of targeting short-term interest rates? The only thing I can think of is if the money commodity in a community weren't something tangible like gold, silver, or tobacco, but rather overnight bonds issued by banks. Yet what is a bond but a promise to deliver money? So how could the money itself be a short-term bond? At this point I am dropping the analogy, lest I become permanently cross-eyed.
Conclusion
As the Fed's debasement of the currency reaches literally unprecedented levels, more and more regular Americans are waking up to the merits of commodity money. Yet this isn't some populist fad; there is a whole tradition of excellent academic scholarship touting the virtues of the gold standard. If he returns to the subject, I hope critics like the LA Times's Popper will give gold a fairer hearing
Disclaimer: This is just a research piece and not an investment advice..Investors are encouraged to execute their own due diligence before making any investment or entering into any financial contract or obligation. All financial transactions carry a RISK.
With various states debating measures to elevate the monetary status of gold, the gold standard is more politically relevant now than it has been in decades. When the LA Times (to pick just one example) runs an article stating matter-of-factly that "economists" uniformly oppose gold, you know the defenders of the current system are getting nervous.
Precisely because a gold standard is such a hot topic lately, it's important for people to understand its rationale. I will few facts with you to try to clear up a few misconceptions.
Do All Economists Oppose the Gold Standard?
I realize I am betraying my naïvete by admitting this, but I was very surprised at the depth of falsehood in the LA Times article mentioned above. Here is the blurb below the title, "Pushing for a Return to the Gold Standard":
The idea to make the precious metal legal tender has gained currency in more than a dozen state capitals, aided by Tea Party support and other efforts to rein in federal power. Economists say the plan would be disastrous.
I suppose the final sentence is technically true, but it's very misleading. It's a bit like saying, "Baskin-Robbins offers 31 flavors, but customers buy chocolate." Yes, some economists say a return to the gold standard would be disastrous, and I'd grant that perhaps even a large majority do. But the blurb above makes it sound as if virtually all economists oppose the move, which isn't true.
The writer in LA times, reinforces this misconception in two other places. He quite clearly tries to pit the rube businessmen and tea-party politicians against the professional economists. First he writes,
The ultimate goal is to return the nation to the gold standard, in which every dollar would be backed by a fixed amount of the precious metal. Economists of all stripes say the plan would be ruinous, but that view is of scant concern to Pitts [a South Carolina state representative].
"Quite frankly, I think that economists from universities are thinking within the confines of their own little world," Pitts said. "They don't deal with the real issues." (emphasis added)
Just to make sure the reader gets the point, Popper writes later in the article:
The United States and most of the rest of the world operated on a full gold standard until the Great Depression. Economists generally agree that the policy helped cause the depression and earlier severe downturns by limiting the amount of money the government could create, constraining its ability to stimulate the economy.
Scholars say moving to a gold standard now would be likely to slow the economy's already meager growth. Some are talking about sub-par growth which is happening in advance economies.....
"At some point someone may be crazy enough to try it, but they won't stay with it any more than they did in the past," said Allan Meltzer, a Carnegie Mellon University economics professor and a critic of the Fed's current monetary policy.
Given the lack of support from mainstream economists, activists have turned a few texts written by outsiders into their bibles, such as "Pieces of Eight," an out-of-print book by [constitutional lawyer] Vieira.
In the entire article, he doesn't quote a single economist who is in favor of the gold standard, or even paraphrase his or her views. This might be acceptable, except for the fact that quotes or makes reference to businessmen, politicians, and the lawyer Vieira. (I am not familiar with Vieira's work, and it should go without saying that I'm not criticizing him.)
Now, it would be easy for me to accuse the writer of lying, but for all I know he was so sure of the stupidity of the gold standard that he didn't even try to find actual PhD economists currently teaching at colleges (some even at top-20 graduate schools) who would have nice things to say about the gold standard. I personally know at least 20 such people, so believe me, they're out there if he or other journalists actually want to give the case for gold a fighting chance.
As far as books touting the advantages of the gold standard, yes indeed there are volumes written by people with PhDs in economics. A classic text is Ludwig von Mises's The Theory of Money and Credit, while a newer, much more reader-friendly selection is Murray Rothbard's What Has Government Done to Our Money? plus other books like on the Great Depression exploded the myth that the gold standard had something to do with it.
Did Gold Cause the Great Depression?
Before moving on, let me quickly address that particular claim. I've written a longer response here, but for now we have to wonder: If the gold standard caused the Great Depression, what else was going on? After all, the gold standard wasn't implemented in the 1920s. Although there had been plenty of industrial crises or financial panics in the previous hundred years, there had been no prolonged global depression approaching the experience of the 1930s — even as more and more countries joined the growing worldwide market of gold-based economies. So clearly it's not enough to point to the "golden fetters" of the monetary system to explain what happened in the Great Depression.
Thus, to blame the Great Depression on the gold standard is just as nonsensical as blaming it on the "laissez-faire" policies of Herbert Hoover, who (even if we take the caricature of him seriously) was no different from all his predecessors. It would be like explaining a particular airplane crash by citing gravity.
As a final point, let's not forget that FDR abandoned the gold standard in 1933. The Great Depression thus lingered on – after leaving the allegedly awful gold standard – for at least another 8 years (and I would say 13 years, because I think World War II "fixed" the economy), in what was still the worst economic period in US history. It's odd that the gold standard could wreak so much havoc in the early 1930s – even though it had never done anything comparable earlier in US history – and then could continue to "cause" the Great Depression, from 8 to 13 years after abandoning it. It starts to make you wonder whether the "economists of all stripes" know what they're talking about.
"You Can't Eat Gold!"
One of the most absurd objections to returning to a gold standard is that "You can't eat gold." I am not making this up; Dave Leonhardt of the New York Times actually said that to Ron Paul when he defended the idea on the Colbert Report.
Dr. Paul didn't really get a chance to answer (Colbert instead made a funny joke about idolatry), but it would have been delicious had he quickly asked the cynic, "Oh, so you make sandwiches out of Federal Reserve notes?" (We also would have accepted, "Oh, so I take it you are proposing a hamburger standard for the dollar?")
The utter absurdity of the objection – namely that you "can't eat gold" – is that gold actually is a useful commodity even for nonmonetary purposes. It's true, you can't eat gold, but you can wear it, you can fill cavities with it, and you can treat arthritis with it. In contrast, all you can do with fiat paper currency is use it in exchange, and you'd better not keep a large fraction of your wealth in actual paper dollars, since their purchasing power constantly erodes with the passage of time.
Don't Austrians Favor Market Choice?
Ironically, in addition to ill-informed critiques such as those emanating from the LA Times, the gold standard has critics from the purist libertarian camp. Such critics often ask, "What's so special about gold? Why do Ron Paul and so many other alleged fans of the free market favor the federal government telling us what the money should be?"
Of course Murray Rothbard – and as far as I know, every living Austrian economist – would prefer that money and banking were returned to the private sector, receiving neither special regulations nor privileges distinguishing them from any other industry. That means banks would be free to issue their own paper notes (backed by gold reserves) if they wanted, but if they issued too many and got caught in a "run," the government wouldn't declare a "bank holiday" and relieve the irresponsible institution of its contractual obligations.
What Rothbard and his modern followers believe is that gold almost certainly would be the free choice of individuals all over the world, if they were allowed to settle on a money without government legal-tender laws and other interventions stacking the deck.
In the meantime, given that there is a Federal Reserve (and other central banks), many Austrians (though here the agreement is not universal) believe that restoring the convertibility of the dollar to a fixed weight of gold would be a move in the right direction, even though it would still not be perfect.
The purpose of repegging the dollar to gold would be to remove what is euphemistically called "monetary policy" (a more sinister description would be "legalized counterfeiting") from politics and special-interest corruption as much as possible. People laud the current Fed as being "independent," but of course that is absurd. The Fed as it currently operates is clearly a cartelization device that shoves new money into the pockets of rich bankers, and that allows the government to finance massive deficits much more cheaply than would otherwise be possible.
"So You Want the Government to Set Prices?"
Related to the above criticism, some purists also ask, "Why don't you favor a market-driven price for the dollar and for gold? Just let supply and demand determine prices, not some rigid number picked out of a hat by the politicians."
This objection sounds plausible at first, but it too misses the mark. If the Fed were to say, "We are now announcing a new policy objective of maintaining the price of gold at $2,000 per ounce, from now until the end of time, and we will begin accumulating stockpiles of gold to reassure investors that we will be able to maintain the target," this would not be analogous to the federal government saying, "We are establishing a minimum price of labor at $7.25 per hour."
Under a genuine gold standard, when the Fed "sets" the dollar price of gold it isn't threatening people with fines or jail time if they want to trade gold at a different price. Rather, the Fed (or the government in general, if there were no central bank) would adjust the quantity of dollars in existence to maintain the target. If the forces of supply and demand were such that the market price of gold had drifted upward to, say, $2,025 per ounce, then the Fed (assuming a $2,000 target) would need to sell off some of its gold holdings,[1] which would (1) flood the market with more gold and (2) shrink the amount of dollars in the financial system. This contractionary policy would push down the price of gold toward the peg of $2,000.
On the other hand, nobody would be so foolish as to sell his gold for less than $2,000 per ounce, if the Fed (or the Treasury) had a standing invitation for anyone to trade in an ounce of gold in exchange for $2,000 in Federal Reserve notes. Why sell your gold to another private citizen for (say) $1,950 an ounce, when the US government stands prepared to buy unlimited quantities of gold at a fixed price of $2,000 per ounce?
Finally, a critic could (and actually did, on my blog) ask how this arrangement differs from the current one? After all, right now Bernanke "sets" interest rates, but not through literal price controls. Instead, the Fed adjusts the quantity of reserves in the banking sector such that the "market-determined" federal funds rate is close enough to the Fed's target for this interest rate. So isn't this basically the same thing as the gold standard, with a different "good" serving as the monetary commodity?
There are two problems with this sophisticated objection. First, in the current system the Fed has a moving federal-funds target. At best, then, it would be analogous only if the Federal Open Market Committee said after each meeting, "We are now setting the target price of gold at such-and-such dollars. However, if unemployment begins rising and core CPI is under 2 percent, we will begin raising the target price of gold in $10 increments over the next few meetings." That system would be nothing like the classical gold standard.
Yet the deeper problem with the analogy is that on a classical gold standard, the government is (imperfectly) mimicking what would happen if the money were actually gold, with people walking around with gold coins in their pockets, and merchants quoting prices not in dollars but in grains or ounces of gold. The classical gold standard, by fixing the dollar as convertible into a definite and constant weight of gold, doesn't introduce another price: the dollar is supposed to be a claim-ticket to gold. This isn't really "price fixing," any more than defining a foot as 12 inches is "central planning."
n contrast, what would be the free-market analog of the Fed's current strategy of targeting short-term interest rates? The only thing I can think of is if the money commodity in a community weren't something tangible like gold, silver, or tobacco, but rather overnight bonds issued by banks. Yet what is a bond but a promise to deliver money? So how could the money itself be a short-term bond? At this point I am dropping the analogy, lest I become permanently cross-eyed.
Conclusion
As the Fed's debasement of the currency reaches literally unprecedented levels, more and more regular Americans are waking up to the merits of commodity money. Yet this isn't some populist fad; there is a whole tradition of excellent academic scholarship touting the virtues of the gold standard. If he returns to the subject, I hope critics like the LA Times's Popper will give gold a fairer hearing
Disclaimer: This is just a research piece and not an investment advice..Investors are encouraged to execute their own due diligence before making any investment or entering into any financial contract or obligation. All financial transactions carry a RISK.
Wednesday, June 15, 2011
Marginal Productivity of Debt---By Shan Saeed
It is as simple as ABC if you analyze the balance sheet of any country and make a forecast. Its simple statistic that continues to warn of huge economic problems ahead for the US economy. Some economists call it the ‘marginal productivity of debt [MPD].’ It relates the change in the level of all debt (consumer, corporate, government etc.) in a country to the change in its gross domestic product (GDP). However, due to the message it is delivering, most US economists employed in financial institutions, governments and private industry, as well as financiers and politicians, want to simplify it or ignore it for some reasons.
And for the US economy and government finances, the MPD (and related variants of it) is continuing to indicate extremely difficult economic times ahead. Default cant be ruled out at this point of time. With QE2 finishing on June 30th and Debt ceiling $14.3 trillion yet to raised and deadline of August 2, is approaching fast, things are looking ominous...
I have vague recollections of the MPD concept from my economics classes two years ago. But I was re-introduced to it around 2010 by a renowned economist Nobel Laureate Prof Gary Becker at Uni. of Chicago, USA during my deliberation with him. I follow him and President Reagan economic adviser Milton Friedman. Another Nobel Laureate from Uni. of Chicago, Booth School of Business, USA
I wrote an article on my blog titled, Is the US heading for lost decades? and how debt productivity decline coming to a bad end? I found that, “for decades, each dollar of new debt has created increasingly less and less national income and economic activity. With this ‘debt productivity decline,’ new evidence suggests we could be near the end-game… ”
Another way of viewing the debt productivity problem is to look at it in terms of how many dollars of debt it took to help create total national income, which is the wages, salaries, profits, rents and interest income of everyone. Again, from my above mentioned article, i shared my analysis.
In 1957 there was $1.86 in debt for each dollar of net national income, but [by] 2006 there was $4.60 of debt for each dollar of national income – up 147 per cent. It also means this extra $2.74 of debt per dollar of national income produced zilch extra national income. In 2006 alone it took $6.32 of new debt to produce one dollar of national income.”
Such data helps explain why US exponential debt growth—after reaching certain limits—collapsed in 2008 and contributed massively to the global financial crash.
However, whereas the US private sector debt has marginally ‘de-leveraged’ (retrenched) since that crash (which might now be reversing), the US government, as everyone knows, has run up mammoth deficits to purportedly keep the country’s economy from imploding. Thus, the US’s MPD is marching to another, perhaps even more frightening tune, suggesting government financial insolvency and/or debt default.
One fascinating way of looking at the declining MPD of US government debt has just been presented by Rob Arnott on May 9, 2011, in his post, Does Unreal GDP Drive Our Policy Choices? What Mr. Arnott does is to subtract out the change in debt growth from GDP, and refers to this statistic as ‘Structural GDP.’ He finds that, “the real per capita Structural GDP, after subtracting the growth in public debt, remains 10 per cent below the 2007 peak, and is down 5 per cent in the past decade. Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.”
In its effort to counter the significant economic difficulties since 2008, the US government has added, or will have added, around $4 trillion in deficits (financed by new debt) in its three fiscal years 2009, 2010 and 2011. Yet, all this massive government deficit spending has failed to really ignite economic growth. Most likely this is because of the enormous dead weight loss of unproductive and onerous private sector debt, particularly that of consumer debt. Hence, real US GDP will have increased probably less than $1.5trn during these years. Including some further economic benefit in the years thereafter, a total GDP benefit of only about $2trn is probable.
So, $4trn borrowed for $2trn in GDP gains. Thus, in very rough round numbers, each new one dollar of US government debt might only produce $0.50 in new economic activity and probably only about $0.08 in new federal tax revenue. (Federal tax revenue as a percentage of GDP is around 15 per cent.) Therefore, the economic marginal return for each new dollar of US government debt is possibly around -50 per cent! If you loaned someone $10 million and they gave you back $5m, you would not be happy!
Hence, it might not be long before those holding or buying US government bonds perceive the reality that the US government, and US economy, are losing massively on government borrowings. This will result in much, much higher US government bond yields and interest costs. Most importantly, it may make the rollover of US debt and new debt issuance incredibly difficult unless either US taxes rise stratospherically to cover the deficits, and/or the US Federal Reserve money printing goes into hyper-drive to purchase the debt the markets will not buy. (Of course US banks, pension funds etc., could also be forced to buy them.) Thus, the idea that US government debt continues to be ‘risk-free’ is absurd. PIGS is a live case study in Europe to change that perception now. For this, and for many other reasons cited above, is why the US financial and political elites want to keep hush-hush about what the MPD and its variants reveal!
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making any investment decision or entering into financial contract. All financial transactions carry a RISK
And for the US economy and government finances, the MPD (and related variants of it) is continuing to indicate extremely difficult economic times ahead. Default cant be ruled out at this point of time. With QE2 finishing on June 30th and Debt ceiling $14.3 trillion yet to raised and deadline of August 2, is approaching fast, things are looking ominous...
I have vague recollections of the MPD concept from my economics classes two years ago. But I was re-introduced to it around 2010 by a renowned economist Nobel Laureate Prof Gary Becker at Uni. of Chicago, USA during my deliberation with him. I follow him and President Reagan economic adviser Milton Friedman. Another Nobel Laureate from Uni. of Chicago, Booth School of Business, USA
I wrote an article on my blog titled, Is the US heading for lost decades? and how debt productivity decline coming to a bad end? I found that, “for decades, each dollar of new debt has created increasingly less and less national income and economic activity. With this ‘debt productivity decline,’ new evidence suggests we could be near the end-game… ”
Another way of viewing the debt productivity problem is to look at it in terms of how many dollars of debt it took to help create total national income, which is the wages, salaries, profits, rents and interest income of everyone. Again, from my above mentioned article, i shared my analysis.
In 1957 there was $1.86 in debt for each dollar of net national income, but [by] 2006 there was $4.60 of debt for each dollar of national income – up 147 per cent. It also means this extra $2.74 of debt per dollar of national income produced zilch extra national income. In 2006 alone it took $6.32 of new debt to produce one dollar of national income.”
Such data helps explain why US exponential debt growth—after reaching certain limits—collapsed in 2008 and contributed massively to the global financial crash.
However, whereas the US private sector debt has marginally ‘de-leveraged’ (retrenched) since that crash (which might now be reversing), the US government, as everyone knows, has run up mammoth deficits to purportedly keep the country’s economy from imploding. Thus, the US’s MPD is marching to another, perhaps even more frightening tune, suggesting government financial insolvency and/or debt default.
One fascinating way of looking at the declining MPD of US government debt has just been presented by Rob Arnott on May 9, 2011, in his post, Does Unreal GDP Drive Our Policy Choices? What Mr. Arnott does is to subtract out the change in debt growth from GDP, and refers to this statistic as ‘Structural GDP.’ He finds that, “the real per capita Structural GDP, after subtracting the growth in public debt, remains 10 per cent below the 2007 peak, and is down 5 per cent in the past decade. Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.”
In its effort to counter the significant economic difficulties since 2008, the US government has added, or will have added, around $4 trillion in deficits (financed by new debt) in its three fiscal years 2009, 2010 and 2011. Yet, all this massive government deficit spending has failed to really ignite economic growth. Most likely this is because of the enormous dead weight loss of unproductive and onerous private sector debt, particularly that of consumer debt. Hence, real US GDP will have increased probably less than $1.5trn during these years. Including some further economic benefit in the years thereafter, a total GDP benefit of only about $2trn is probable.
So, $4trn borrowed for $2trn in GDP gains. Thus, in very rough round numbers, each new one dollar of US government debt might only produce $0.50 in new economic activity and probably only about $0.08 in new federal tax revenue. (Federal tax revenue as a percentage of GDP is around 15 per cent.) Therefore, the economic marginal return for each new dollar of US government debt is possibly around -50 per cent! If you loaned someone $10 million and they gave you back $5m, you would not be happy!
Hence, it might not be long before those holding or buying US government bonds perceive the reality that the US government, and US economy, are losing massively on government borrowings. This will result in much, much higher US government bond yields and interest costs. Most importantly, it may make the rollover of US debt and new debt issuance incredibly difficult unless either US taxes rise stratospherically to cover the deficits, and/or the US Federal Reserve money printing goes into hyper-drive to purchase the debt the markets will not buy. (Of course US banks, pension funds etc., could also be forced to buy them.) Thus, the idea that US government debt continues to be ‘risk-free’ is absurd. PIGS is a live case study in Europe to change that perception now. For this, and for many other reasons cited above, is why the US financial and political elites want to keep hush-hush about what the MPD and its variants reveal!
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making any investment decision or entering into financial contract. All financial transactions carry a RISK
Monday, June 13, 2011
I am bullish on energy ---By Shan Saeed
Shared from Economist Magazine ...Proves my point why energy demand will continue to upsurge going forward....
GLOBAL oil production posted its biggest increase since 2004 last year but it was a relatively weak performer in a bumper year for energy growth, according to BP’s latest annual Statistical Review of World Energy. Although oil production grew by 2.2% in 2010, oil consumption grew by 3.1% and energy demand across the board shot ahead by 5.6%, the biggest annual gain since 1973.
Growth was above its long-term trend in every region of the world and almost every fuel reached record levels of use (see chart). Coal consumption grew by 7.6%; gas by 7.4%; hydroelectricity by 5.3%; other renewables by 15.5% (though from a titchy base). The only fuel not consumed at record levels was uranium: although nuclear power grew a little, it still fell short of its 2006 level, a high-water mark which, after the Fukushima disaster in Japan, looks set to stand for some time.
Mix Picture* Million tonnes of oil equivalent 2010
World Energy Consumption
Oil 4,028
Coal 3,556
Natural Gas 2,858
Hydro-electricity 776
Nuclear Energy 626
Renewals 159
Part of this is cyclical. As Christof Rühl, BP’s chief economist, notes, energy demand tends to fall faster than GDP when things go wrong, and grows faster when the situation improves. That is because energy responds to changes in investment, industrial production and transport, which rise and fall by more than the economy as a whole. This helps explain why energy consumption handily outstripped 2010’s 4.9% growth in global GDP. But there is also a structural change at work. Economic activity is growing faster in developing countries, in general less efficient energy users, than in developed ones. Even if global GDP were static, this shift would increase consumption.
Growth in developing countries is the main reason why coal consumption rose so much. The wealthy countries of the OECD still consume more oil than the rest of the world, but non-OECD countries use 69% of the world’s coal—two-thirds of that in China. This is a big part of the reason why energy-related carbon-dioxide emissions have been growing even faster than energy use. In 2010 they grew by 5.8%—the highest rate since 1969.
The fuel that gets people most excited, though, is natural gas. The boom in American shale gas—it now represents 23% of that country’s gas production, up from 4% five years ago—has kept the price low in America, inspired exploration for similar fields elsewhere and allowed liquefied natural gas (LNG) production originally intended to serve America to seek other markets. Over the past five years global production capacity for LNG has increased by 58% and its share of the international gas trade has risen from 23% to 31%, helping the world to shift towards more integrated and flexible markets: the average number of markets served by each gas exporter has risen from five to nine. An extrapolation of these trends published by the International Energy Agency on June 6th showed gas’s share of energy provision overtaking coal’s in less than 20 years.
*Sources BP
GLOBAL oil production posted its biggest increase since 2004 last year but it was a relatively weak performer in a bumper year for energy growth, according to BP’s latest annual Statistical Review of World Energy. Although oil production grew by 2.2% in 2010, oil consumption grew by 3.1% and energy demand across the board shot ahead by 5.6%, the biggest annual gain since 1973.
Growth was above its long-term trend in every region of the world and almost every fuel reached record levels of use (see chart). Coal consumption grew by 7.6%; gas by 7.4%; hydroelectricity by 5.3%; other renewables by 15.5% (though from a titchy base). The only fuel not consumed at record levels was uranium: although nuclear power grew a little, it still fell short of its 2006 level, a high-water mark which, after the Fukushima disaster in Japan, looks set to stand for some time.
Mix Picture* Million tonnes of oil equivalent 2010
World Energy Consumption
Oil 4,028
Coal 3,556
Natural Gas 2,858
Hydro-electricity 776
Nuclear Energy 626
Renewals 159
Part of this is cyclical. As Christof Rühl, BP’s chief economist, notes, energy demand tends to fall faster than GDP when things go wrong, and grows faster when the situation improves. That is because energy responds to changes in investment, industrial production and transport, which rise and fall by more than the economy as a whole. This helps explain why energy consumption handily outstripped 2010’s 4.9% growth in global GDP. But there is also a structural change at work. Economic activity is growing faster in developing countries, in general less efficient energy users, than in developed ones. Even if global GDP were static, this shift would increase consumption.
Growth in developing countries is the main reason why coal consumption rose so much. The wealthy countries of the OECD still consume more oil than the rest of the world, but non-OECD countries use 69% of the world’s coal—two-thirds of that in China. This is a big part of the reason why energy-related carbon-dioxide emissions have been growing even faster than energy use. In 2010 they grew by 5.8%—the highest rate since 1969.
The fuel that gets people most excited, though, is natural gas. The boom in American shale gas—it now represents 23% of that country’s gas production, up from 4% five years ago—has kept the price low in America, inspired exploration for similar fields elsewhere and allowed liquefied natural gas (LNG) production originally intended to serve America to seek other markets. Over the past five years global production capacity for LNG has increased by 58% and its share of the international gas trade has risen from 23% to 31%, helping the world to shift towards more integrated and flexible markets: the average number of markets served by each gas exporter has risen from five to nine. An extrapolation of these trends published by the International Energy Agency on June 6th showed gas’s share of energy provision overtaking coal’s in less than 20 years.
*Sources BP
Tuesday, June 7, 2011
The chinese impact on the global inflation---By Shan Saeed
THE CHINA DOMINO HAS FALLEN!---By Shan Saeed
Here's a caveat. China’s structural inflation is going to begin negatively impacting the USA. They say the inflation dominos are falling as I speak and should translate to higher rates of inflation in the coming years in the USA: As China moves into a cycle of generating autonomous structural inflation, it is widely anticipated that China will export this inflation to the rest of the world. Here is how the dominos will fall.
FIRST INDICATION
The first domino is China creating autonomous structural inflation:
China attempts to rebalance economy away from investment/exports towards consumption. In March, inflation hit a 32-month high of 5.4% yoy. Policy makers remain well behind the curve. That domino has already fallen.
SECOND INDICATION
The second domino (in the process of falling) is proffered to be that China will then export this inflation to the rest of the world. This dynamic seems as inevitable as gravity itself.
THIRD INDICATION
The third domino is teetering.
Domestic inflation rising in China. Pace of Yuan appreciation stepping up in Q2-11.
Import price indices from China, for the developed economies, are turning up. Given the “stickiness” of supply, the world will remain a China “price-taker”. The past two decades of outsourcing that turned China into the world’s factory were long term trends. Manufacturing production cannot simply be transplanted quickly to another economy.
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making any strategic decision or entering into financial obligations/contracts. All financial transactions carry a RISK
Here's a caveat. China’s structural inflation is going to begin negatively impacting the USA. They say the inflation dominos are falling as I speak and should translate to higher rates of inflation in the coming years in the USA: As China moves into a cycle of generating autonomous structural inflation, it is widely anticipated that China will export this inflation to the rest of the world. Here is how the dominos will fall.
FIRST INDICATION
The first domino is China creating autonomous structural inflation:
China attempts to rebalance economy away from investment/exports towards consumption. In March, inflation hit a 32-month high of 5.4% yoy. Policy makers remain well behind the curve. That domino has already fallen.
SECOND INDICATION
The second domino (in the process of falling) is proffered to be that China will then export this inflation to the rest of the world. This dynamic seems as inevitable as gravity itself.
THIRD INDICATION
The third domino is teetering.
Domestic inflation rising in China. Pace of Yuan appreciation stepping up in Q2-11.
Import price indices from China, for the developed economies, are turning up. Given the “stickiness” of supply, the world will remain a China “price-taker”. The past two decades of outsourcing that turned China into the world’s factory were long term trends. Manufacturing production cannot simply be transplanted quickly to another economy.
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making any strategic decision or entering into financial obligations/contracts. All financial transactions carry a RISK
Saturday, June 4, 2011
US is heading for recession in 2012---by Shan Saeed
Fed, Congress Can’t Stop Recession in ‘Miserable’ 2012 by Shan Saeed
The United States is headed for another recession as the Federal Reserve and Congress have no more tools left to keep the economy moving enough to avoid another slowdown.
The economy is due to cool off anyway, as the last recession began in 2007, and an end to money printing and stimulus spending will send the economy tanking anew.
I am curious that cutting the deficit means cutting final demand. It means the economy is going to slow. It might not be a bad thing to cut the deficit but unfortunately, when you cut the deficit, you’re going to get a recession — you’re going to get a slowdown. The more you cut the deficit, the worse it’s going to be.
I must say that next year is going to be truly miserable.
A recession will boost Republicans’ chances of taking back the White House in the 2012 elections, even if their spending-cut policies help throw the country back into recession. Furthermore, the Federal Reserve might try more quantitative easing (QE), where it prints money in hopes banks take that money and fuel economic growth, but such polices haven’t worked in the recent past and won’t work in the future.
I don’t think QE works very well because basically it puts money into the banks’ hands, and the banks aren’t lending it out. The banks are investing in markets and driving market prices up. QE is creating equity and housing bubble in the emerging economies esp China, driving up interest rates and inflation in those regions. Analyze China, Brazil, Korea, Thailand, Vietnam.
In other words, only the markets here and abroad benefit from quantitative easing, but not normal people. It is not putting money into the hands of the consumer or of the small-business man. Nevertheless, such a scenario will unveil a counter-intuitive trading opportunity: the U.S. dollar. US Dollar is a bubble that will eventually bust. Politicians will be forced to act and prep the economy for more long-term recovery.
The more troubling issue is the debt ceiling. The stronger the bond market will be and the stronger the dollar will be. I am referring to the $14.3 trillion government debt limit, which was recently broken and currently under analysis by lawmakers for an upward revision. And that is something obviously that’s going to really drive the dollar up. Europe can’t do anything, Europe is falling apart. US might be able to handle the austerity and for the long run.
Bond markets are showing that many market players feel darker times are around the corner thanks to continued high unemployment rates, weak housing prices and sluggish economic growth in general.
BUBBLE WARNING
Housing Bubble
Private spending bubble
Future Bubble Warning
1. US Dollar is a bubble
2. US Debt is a bubble
3. Unemployment is a bubble
The yield on the benchmark 10-year Treasury note fell below 3 percent recently, the first time since December, on evidence the economic recovery is losing momentum — and losing it fast. It does look like US is heading for all these bubbles to be busted.
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before entering into financial contract or obligations. All financial transactions carry a RISK......
The United States is headed for another recession as the Federal Reserve and Congress have no more tools left to keep the economy moving enough to avoid another slowdown.
The economy is due to cool off anyway, as the last recession began in 2007, and an end to money printing and stimulus spending will send the economy tanking anew.
I am curious that cutting the deficit means cutting final demand. It means the economy is going to slow. It might not be a bad thing to cut the deficit but unfortunately, when you cut the deficit, you’re going to get a recession — you’re going to get a slowdown. The more you cut the deficit, the worse it’s going to be.
I must say that next year is going to be truly miserable.
A recession will boost Republicans’ chances of taking back the White House in the 2012 elections, even if their spending-cut policies help throw the country back into recession. Furthermore, the Federal Reserve might try more quantitative easing (QE), where it prints money in hopes banks take that money and fuel economic growth, but such polices haven’t worked in the recent past and won’t work in the future.
I don’t think QE works very well because basically it puts money into the banks’ hands, and the banks aren’t lending it out. The banks are investing in markets and driving market prices up. QE is creating equity and housing bubble in the emerging economies esp China, driving up interest rates and inflation in those regions. Analyze China, Brazil, Korea, Thailand, Vietnam.
In other words, only the markets here and abroad benefit from quantitative easing, but not normal people. It is not putting money into the hands of the consumer or of the small-business man. Nevertheless, such a scenario will unveil a counter-intuitive trading opportunity: the U.S. dollar. US Dollar is a bubble that will eventually bust. Politicians will be forced to act and prep the economy for more long-term recovery.
The more troubling issue is the debt ceiling. The stronger the bond market will be and the stronger the dollar will be. I am referring to the $14.3 trillion government debt limit, which was recently broken and currently under analysis by lawmakers for an upward revision. And that is something obviously that’s going to really drive the dollar up. Europe can’t do anything, Europe is falling apart. US might be able to handle the austerity and for the long run.
Bond markets are showing that many market players feel darker times are around the corner thanks to continued high unemployment rates, weak housing prices and sluggish economic growth in general.
BUBBLE WARNING
Housing Bubble
Private spending bubble
Future Bubble Warning
1. US Dollar is a bubble
2. US Debt is a bubble
3. Unemployment is a bubble
The yield on the benchmark 10-year Treasury note fell below 3 percent recently, the first time since December, on evidence the economic recovery is losing momentum — and losing it fast. It does look like US is heading for all these bubbles to be busted.
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before entering into financial contract or obligations. All financial transactions carry a RISK......
Euro is still better than US Dollar ---By Shan Saeed
Euro Still Better Than the Dollar, Despite its Problems---by Shan Saeed
What I find funny about bull markets is they really do climb a wall of worry...If you read anything about the euro, all you hear are the negative things: The socialist governments in Europe, how all of the countries can’t get along and the PIIGS (Portugal, Italy, Ireland, Greece, Spain).
There are also a lot of good things about the euro and European union. I can share some interesting facts about EU. The common union and elimination of borders is great for travel and economic trade. In addition, Germany, the driver of Europe, wasn’t really all that affected by the economic crisis and is seeing near-record exports. If I were to analyze Germany and USA, there would be marked difference in the strategic approach to the economy.
Americans borrowed an amount equal to 6 percent of G.D.P. in an attempt to stimulate growth. The Germans spent about 1.5 percent of G.D.P. on their stimulus. This divergence created a natural experiment. Who was right?
The early returns suggest the Germans were. The American stimulus package was supposed to create a “summer of recovery,” according to Obama administration officials. Job growth was supposed to be surging at up to 500,000 a month. Instead, the U.S. economy is scuffling along.
The German economy, on the other hand, is growing at a sizzling (and obviously unsustainable) 9 percent annual rate. Unemployment in Germany has come down to pre-crisis levels.
Results from one quarter do not settle the stimulus/austerity debate. Many other factors are in play. For example, Germany is surging, in part, because America is borrowing. Essentially, the Americans borrowed from everyone, spent some of that money on German machinery, and ended up employing German workers.
But the results do underline one essential truth: Stimulus size is not the key factor in determining how quickly a country emerges from recession. The U.S. tried big, but is emerging slowly. The Germans tried small, and are recovering nicely.
The economy can’t be played like a piano — press a fiscal key here and the right job creation notes come out over there. Instead, economic management is more like parenting. If you instill good values and create a secure climate then, through some mysterious process you will never understand, things will probably end well.
The crucial issue is getting the fundamentals right. The Germans are doing better because during the past decade, they took care of their fundamentals and the Americans didn’t.
The situation can be expressed this way: German policy makers inherited a certain consensus-based economic model. That model has advantages. It fosters gradual innovation (of the sort useful in metallurgy). It also has disadvantages. It sometimes leads to rigidity and high unemployment.
Over the past few years, the Germans have built on their advantages. They effectively support basic research and worker training. They have also taken brave measures to minimize their disadvantages. As an editorial from the superb online think tank e21 reminds us, the Germans have recently reduced labor market regulation, increased wage flexibility and taken strong measures to balance budget
The European Union also doesn’t run a current account deficit, whereas the U.S. deficit is higher than PIIGS percent of GDP. In addition, because Europe has such huge, ridiculous welfare states it is going to be much easier for them to cut spending and get their deficits down.
Finally, Europe doesn’t have to pay for foreign ventures and being the policeman of the world like the United States. Therefore, don’t count out the euro. Despite of all the perceived problems, the euro has still climbed to $1.48 by year end. And I think in the long run it will continue to climb against the U.S. dollar.
Disclaimer: This is just a research piece. Investors are encouraged to execute their own due diligence before entering into any financial contract or obligation. All financial transacations carry a RISK....
What I find funny about bull markets is they really do climb a wall of worry...If you read anything about the euro, all you hear are the negative things: The socialist governments in Europe, how all of the countries can’t get along and the PIIGS (Portugal, Italy, Ireland, Greece, Spain).
There are also a lot of good things about the euro and European union. I can share some interesting facts about EU. The common union and elimination of borders is great for travel and economic trade. In addition, Germany, the driver of Europe, wasn’t really all that affected by the economic crisis and is seeing near-record exports. If I were to analyze Germany and USA, there would be marked difference in the strategic approach to the economy.
Americans borrowed an amount equal to 6 percent of G.D.P. in an attempt to stimulate growth. The Germans spent about 1.5 percent of G.D.P. on their stimulus. This divergence created a natural experiment. Who was right?
The early returns suggest the Germans were. The American stimulus package was supposed to create a “summer of recovery,” according to Obama administration officials. Job growth was supposed to be surging at up to 500,000 a month. Instead, the U.S. economy is scuffling along.
The German economy, on the other hand, is growing at a sizzling (and obviously unsustainable) 9 percent annual rate. Unemployment in Germany has come down to pre-crisis levels.
Results from one quarter do not settle the stimulus/austerity debate. Many other factors are in play. For example, Germany is surging, in part, because America is borrowing. Essentially, the Americans borrowed from everyone, spent some of that money on German machinery, and ended up employing German workers.
But the results do underline one essential truth: Stimulus size is not the key factor in determining how quickly a country emerges from recession. The U.S. tried big, but is emerging slowly. The Germans tried small, and are recovering nicely.
The economy can’t be played like a piano — press a fiscal key here and the right job creation notes come out over there. Instead, economic management is more like parenting. If you instill good values and create a secure climate then, through some mysterious process you will never understand, things will probably end well.
The crucial issue is getting the fundamentals right. The Germans are doing better because during the past decade, they took care of their fundamentals and the Americans didn’t.
The situation can be expressed this way: German policy makers inherited a certain consensus-based economic model. That model has advantages. It fosters gradual innovation (of the sort useful in metallurgy). It also has disadvantages. It sometimes leads to rigidity and high unemployment.
Over the past few years, the Germans have built on their advantages. They effectively support basic research and worker training. They have also taken brave measures to minimize their disadvantages. As an editorial from the superb online think tank e21 reminds us, the Germans have recently reduced labor market regulation, increased wage flexibility and taken strong measures to balance budget
The European Union also doesn’t run a current account deficit, whereas the U.S. deficit is higher than PIIGS percent of GDP. In addition, because Europe has such huge, ridiculous welfare states it is going to be much easier for them to cut spending and get their deficits down.
Finally, Europe doesn’t have to pay for foreign ventures and being the policeman of the world like the United States. Therefore, don’t count out the euro. Despite of all the perceived problems, the euro has still climbed to $1.48 by year end. And I think in the long run it will continue to climb against the U.S. dollar.
Disclaimer: This is just a research piece. Investors are encouraged to execute their own due diligence before entering into any financial contract or obligation. All financial transacations carry a RISK....
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