Warning Signs are dangerous for 2011. Caveat is here to stay.
Do you witness all of the warning signs that are flashing all around you? These days it seems like there is more bad economic news in a single week than there used to be in an entire month. 2011 is already shaping up to be a very dark year for the world economy per se. We would have food crisis in 2011 and history would be repeated. The price of food is shooting through the roof and we have already seen violent food riots in countries like Egypt, Algeria and Tunisia. World financial markets are becoming increasingly chaotic/ unstable as the sovereign debt crisis continues to get worse in Europe, Japan, UK and USA. Meanwhile, the number of Americans applying for unemployment benefits is up, foreclosures are up and poverty continues to spread like a plague throughout the United States. What we are starting to see around the globe is a lot like the "stagflation" of the 1970s. High inflation and high unemployment. All of the crazy money printing [ Quantitative easing or Monetary accommodation] that has been going on is overheating prices for agricultural commodities and precious metals [ Gold/ Silver], but all of this new money is not doing much to help the average man or woman on the street. QE wont fix the economy. Infact, it would create asset market inflation in the emerging economies.
Do you remember what the economy was like in America during the 70s? Richard Nixon was heading the government. It had high unemployment and high inflation at the same time. It was horrible. Well, all the warning signs are there for a stagflation repeat. Unemployment is at epidemic levels over 10% and it isn't showing any signs of decreasing much any time soon. Meanwhile, the crazy money printing that the Federal Reserve and other central banks have been doing is starting to cause significant inflation. The price of oil is about to cross the $117 per barrel mark and the UN is forecasting that the global price of food is going to increase by 37 percent by the end of the year.
So, yes, there are some really, really good reasons to be incredibly concerned about the global economy in 2011. This year would be much more dangerous than 2010.
Meanwhile, the only solutions that global leaders seem to be offering are more money printing, more government debt and more financial control by international organizations. are these solutions viable? I doubt.
The truth is that we have a real mess on our hands. The following are 20 economic warning signs that should be of great concern to the global decision makers ....
#1 Over the past seven days, the price of wheat has risen by 17 percent as concerns about food shortages continue to grow around the world.
#2 The price of corn is up a staggering 97 percent since June-2010.
#3 The United Nations is projecting that the global price of food will increase by 37 percent in 2011.
#4 According to the U.S. Department of Labor, the number of Americans applying for unemployment benefits rose last week to the highest level since last October.
#5 According to the Pew Charitable Trusts, of the 15 million Americans "officially" unemployed in December, 30% of them had been unemployed for one year or longer. According to Nobel Laureates Paul Krugman at Princeton University and Joseph Stiglitz at Columbia University, these are turbulent signs for the economy.
#6 Beginning in the month of March-2011, the U.S. Postal Service will begin shutting down up to 2,000 post offices across the United States.
#7 In an absolutely stunning move, Standard & Poor's has downgraded Japanese government debt from AA to AA-. Please read Bloomberg News
#8 73 percent of the major metropolitan areas in the United States had more foreclosures in 2010 than they did in 2009.
#9 Approximately 5 million homeowners in the United States are at least two months behind on their mortgages, and it is being projected that over a million American families will be booted out of their homes this year alone.
#10 According to the Congressional Budget Office, the Social Security system will run a deficit of 45 billion dollars this year. When the new payroll tax breaks are factored in, the projected "Social Security deficit" for this year swells to 133 billion dollars.
#11 The U.S. money supply has been rising at a pace that is absolutely unprecedented.
#12 Right now, money is flowing out of bonds at an absolutely staggering pace. Bond market is risky and is in a default like situation.
#13 The U.S. Bureau of Labor Statistics says that the price of food increased 50 percent faster than the overall rate of inflation during 2010.
#14 According to the U.S. Conference of Mayors, visits to soup kitchens are up 24 percent over the past year.
#15 During the last school year, almost half of all school children in the state of Illinois came from families that were considered to be "low-income". I have studied from University of Chicago and spent my time there.
#16 Those living in the town of Discovery Bay, California will soon not be permitted to use cash to pay for any public services. Could this be another disturbing step in the direction of a cashless society? 41 States in USA are acting like Greece and Ireland.
#17 French President Nicolas Sarkozy says that the IMF should be given the power to enforce new rules that would be designed to prevent "global economic imbalances" from happening. Monetary dumping should be stopped by the USA i.e. Quantitative Easing or Monetary Accommodation.
#18 The U.S. government is currently borrowing about 40 cents of every single dollar that it spends.
#19 According to the Congressional Budget Office, the U.S. government will have the biggest budget deficit ever recorded (approximately 1.5 trillion dollars) in 2011.
#20 It is being projected that the U.S. national debt will increase by $150,000 per U.S. household between 2009 and 2021. Household debt to GDP ratio is 122%.
So is there any good news?
Well, yes there is.
U.S. Representative Ron Paul has introduced a new bill to audit the Federal Reserve. Let's hope that the move to audit the Fed fares better in the 112th Congress than it did in the 111th Congress. It would be wonderful if the American people could actually learn what has been going on inside the Fed all this time.
But mostly the news about the global economy is really bad. There have been some people that have been warning for decades that all of this money printing and all of this government debt would eventually catch up with us. Now it has almost reached the moment of reckoning that the doomsayers have been warning about for so long, and it is going to be really painful to go through it.
Thanks to the greatest debt bubble in the history of the world, living beyond the means for decades in USA. When "times were good" it was not because either the Republicans or the Democrats were doing something right. The truth is that both political parties have been horribly addicted to government debt[ $14 TRILLION right now]. The debt-fueled prosperity that USA politicians purchased is starting to come to an end, and an economic implosion is coming that most Americans will never see coming. But hopefully most of the readers of this article are much wiser than the average American. Warning signs are there. Now is the time to take action and get prepared.
Disclaimer: This is just a research report and not an investment advice. Investors are encouraged to execute their own due diligence before making any strategic investment or decisions.
Friday, January 28, 2011
Monday, January 24, 2011
Three Major Macro Economic Issues Coming in 2011---By Shan Saeed
Three Major Macro Economic Issues this year: What’s Coming in 2011
By Shan Saeed
Christmas ended on a docile note. The New Year’s celebrations were held privately in most part of the world on a somber way as well. There are lots of headwinds in the global financial markets and as we navigate through turbulent times, markets do hold some opportunities for smart and savvy investors.
Firstly, the biggest macro-economic story of 2010 was Europe: It’s falling apart, and there doesn’t seem to be anything that’s going to stop this collapse or default like situation. In 2011, its going to be a real challenge.
The second biggest macro-economic story of the year—though not by much—was the successful monetization of 75% of the U.S. Federal government deficit [$14 trillion] by Ben Bernanke and the Federal Reserve. I use the word “successful” in a morality-free, completely pragmatic sense: Bernanke achieved monetization with minimal market disruption. In fact, a lot of people would argue that QE-lite and QE-2 were not policies of debt monetization—that is how successful Bernanke has been. The real confidence level is very low…….This “success” has allowed the U.S. Federal government to continue to avoid making necessary, critical budgetary decisions—paradoxically accelerating the U.S.’s deteriorating fiscal situation. Stimulus would continue to provide breathing space to the US economy.
The third biggest macro-economic story of 2010 has been the inexorable rise in commodity prices. Everyone’s been paying attention to silver and gold, but the real story has been industrial metals—especially copper/Uranium—and agricultural commodities—especially grains—especially Wheat, Rice, Sugar, Soya bean and corn, corn, corn!
To be sure, there were other important stories in 2010—the Mortgage Mess, Wikileaks, Wayne Rooney. But these three issues—auguries of EMU collapse; successful Fed monetization, and commodity price rises—are the ones that mattered on a macro-economic level this past year. In 2011, every other financial story will be either a cause or consequence of one of these three issues: Guaranteed.
Europe
Europe is in deep mess. Some people might call it deep shit—there’s really no polite way to say it.
Back in the spring of 2010, Greece went down the tubes, as its sovereign debt collapsed in price, and its ability to borrow money from the open markets—and thereby continue to operate—for all intents and purposes ceased.
Then in November/December of 2010, the Irish sovereign debt also began to tumble, as it became increasingly clear that Ireland simply does not have the wherewithal to backstop it’s disproportionately large—and insolvent—banking sector. All banks in Europe passed the sham STRESS TEST. It was an illusion and ineffective to control the storm. Angela Merkel’s less than clever words in an interview [to the effect that Irish debt holders might have to take a haircut] sparked a rise in Irish debt yields, squeezing Ireland’s ability to borrow fresh cash to keep its insolvent banks afloat—thereby creating the need for a rescue package from the IMF, the UK, the European Union, and the European Central Bank.
What was painfully apparent in 2010 was that the Eurozone and the European Union had no mechanism to handle a crisis in one of its member states. Nor is it moving forward to correct the single biggest weakness of the euro scheme—namely, the ability of each member state to issue its own debt. Internal Devaluation, and printing of money could have been the remedy provided they had not joined Euro currency.
In May of 2010—over a decade since the introduction of the euro—the EU finally came up with a mechanism to salvage the broken economy of one of its member states, the European Financial Stability Facility (EFSF).
Stability Facility: Even its very name sounds funny, cartoonish and silly—which fits with the general cartoonishness of the European crisis response, first to Greece, then to Ireland, Portugal, Spain and Italy.
The concept of the EFSF—at least in theory—is for the member states to contribute to a €440 billion fund. In reality, the EFSF has no money, but rather, it will issue debt. Therefore, what’s really happened in the case of Greece and Ireland is that their bad debts were taken over by the EFSF—so in a sense, no one has been bailed out: Rather, the bad debts have been transferred to the European Monetary Union as a whole.
This is the European model of bailouts: In exchange for handing over their fiscal sovereignty and having tough austerity measures put in place—but without harming a single hair on the head of a single sovereign bond holder—Greece and Ireland had their debts taken over by the EU. Which is fine—for the smaller countries with their smaller economies, and their weaker political pull.
But what about a big country? What about a country like Spain? It requires $600 billion in bail out funds. Huge drag on the economy and threat to the stability of Euro. After the Greek and Irish bailouts, it looks like Portugal and possibly Belgium / France are up next in this perverse game of musical chairs played to the tune of sovereign debt—but these smaller countries are dwarfed by Spain: Spain, as I argued here, is where the European game is really at.
As I pointed out, Spain is twice the size of Greece, Ireland and Portugal combined—Spain is roughly half the size of Germany—Spain has a fiscal deficit of over 11% of GDP for 2010, unemployment rate of 21% and a total debt of over 80% of GDP. I am counting the accumulated debt of comunidades autónomas, which is so far 10.2% of GDP and steadily rising. In short, Spain is trouble.
Not “Spain is in trouble”—that’s obvious, but that’s not my point: Spain is trouble. Trouble for the German banks that own so much of the Spanish debt. Trouble for Germany, which is propping up its insolvent banks [What, you think German politicians are any less craven than American politicians?]. Spain is trouble for the European Union, for what a German banking crisis might mean for the EU as a whole and as an institution. More than anything, Spain is trouble for the European Financial Stability Facility, because Spain is too big to be saved—and there’s really no way to finesse that hard fact.
In the case of Europe, the lynchpin can come off awfully fast—think of Ireland. A few impolitic words from Angela Merkel, and suddenly the Irish bond market panics. Suddenly, Ireland is teetering on the brink of insolvency, unable to meet its funding needs. And that was Ireland—all due respect to those wonderful people, but we’re talking a GDP of a paltry $227 billion. Ben Bernanke takes a morning dump bigger than that. What’s Ireland’s $227 billion when compared to Spain’s economy of $1.5 trillion?
Spain: During 2011, Spain will be the flash-point—so you want to keep one eye on Spanish sovereign bond spreads, and one eye on Brussels: When Spanish debt spreads over German bunds creep into the 3.5% to 4% range, you know trouble is coming. And when the Spanish spread decisively crosses 4.25% over the German 10-year, then you know trouble’s arrived—and it won’t be leaving town ‘til it’s had its chance to run riot in the streets. How the EU and the ECB handle an eventual Spanish sovereign debt crisis will determine the very future of the European Union.
Because there will be a Spanish sovereign debt crisis—it’s inevitable. The Spanish balance sheet is not improving fast enough, even with so-called “austerity” measures, because even though the Spanish government might be cutting spending, the comunidades autónomas—roughly analogous to states or regions—are expanding their budgets in order to take up the slack, and thereby increasing the Spanish deficit. Don’t believe me?
So when Spain goes into crisis—which should take place no later than June-August 2011, and perhaps as early as this coming March—the European Union’s collective and institutional reaction to this crisis event will determine whether a smaller, healthier European Monetary Union continues to exist, or whether the whole concept of EMU is ripped to shreds by events.
If the EU and the ECB are clever, and brave, and humble in the face of failure, then they’ll expel Greece, Ireland, Portugal, Spain and Italy from the European Monetary Union. The euro will remain the currency of the stronger economies—France, Holland, Germany—while the weaker economies will go back to their original currencies, and immediately devalue, reschedule the debt and follow internal devaluation so as to kickstart their economies.
If, however, the European Union and European Central Bank leadership proves to be stupid, cowardly, and arrogant—as is very likely, considering their confused, self-defeating actions and reactions to the Greek and Irish crises—then there will be some sort of European-wide convulsion, when the bond markets panic, and leave Spain locked out of any funding. This is the key event of 2011: Whether the European Monetary Union survives. Survivability of Europe is the key in the global financial markets. Unless Brussels gets its collective shit together and realizes it has to cut the weaker economies loose from the euro, odds are high the euro goes out of the roof in crisis situation.
U.S. Fiscal Situation—Local, State and Federal
There is a limit to sympathy: You can feel sorry for someone—but only up to a point. In so far as the United States’ fiscal situation is concerned, that point has been reached, at least for me: I can no longer feel sorry for the American people.
Americans want more services and entitlements, but with less taxes—and then they’re all surprised when their local, state and Federal governments cross the edge of insolvency, and into the nightmare land of feverishly staving off bankruptcy. California, Illinois, Michigan and Florida are facing Greece like situation. 41 states in USA are acting like Greece and Ireland.
During 2010, the Federal government debt finally crossed the 100% of GDP mark—and continued rising non-stop. Actually, the debt’s growth accelerated. Why? Because the Bush tax cuts of 2001—implemented when there was an expectation of surplus, with clear sunset provisions, and no massive war expenditures—were extended by the mindless Republican Congress and the spineless President, Barack Obama.
So the U.S. Federal government will continue to add to the debt, at the rate of 10% per year for 2011, 2012, 2013 and 2014. Some might argue with the 2013 and 2014 extrapolations. I’ll concede them: But that still leaves the U.S. Federal government with a debt burden of 120% of GDP by 2012—those are Greek levels of debt. And even if by some miracle tax receipts increase after 2012, so that the deficits in 2013 and 2014 are not 10% of GDP, what will they be? 7% of GDP? Maybe even 5% of GDP? So total debt would be $20 trillion by 2014 will be only 130% of GDP, instead of 140%. In FY2010, the government paid $414 Billion in interest expenses which equates to 17% of revenue. When you account for the $14 Trillion in total debt, that works out to be 2.96% in interest. In FY2007, total debt was $8.95 Trillion, but the interest expense was $430 Billion and 17% of revenue. That accounts for an interest rate of 4.80%. Luckily, rates have stayed low for the past two years.
However, in the next 24 months the situation could grow dire. At least $2 Trillion will be added to the national debt. At an interest rate of only 4.0%, the interest expense would be $600 Billion. Even if we assume 7% growth in tax revenue, the interest expense would total 22% of the budget. An interest rate of 4.5% would equate to 26% of the budget.
And that’s not counting the State and Local governments.
In late 2010, we finally started to notice something which has been festering for years, like one of those yucky worms that winds up eating your brains and driving you mad: The financial condition of the U.S. States and municipalities—they’re bankrupt.
For fiscal year 2010, the states’ combined budget shortfall is $191 billion. Of that figure, $68 billion is offset by the Recovery Act—Obama’s stimulus. Currently, the 2011 combined deficit of the States will be in the neighborhood of $160 billion—but that doesn’t seem credible, considering the ongoing unemployment. Regardless, $59 billion of those will be offset by the Recovery Act—which still leaves at least $100 billion up in the air. However you look at it, the States have a huge collective hole in their budgets. And this hole is going to get worse, before it gets any better—just like the Federal government’s massive yearly deficit.
Which brings me to Federal Reserve policy in 2010—specifically the announcement and implementation of further rounds of “Quantitative Easing”.
Call it QE, call it “liquidity injections”, call it “interest rate stabilization”, call it “Fed balance sheet expansion”, call it “monetary accommodation”—whatever clever name you give it, it’s basically money printing, plain and simple: The Federal Reserve “implements” QE by simply creating money out of thin air, then going out and buying bonds with that new money. Actually, it’s even better than printing money—no bothers with printing presses and such. QE is going global to other ZONES like Japan, UK, Europe
There were two rounds of QE in 2010: QE-lite in the early summer, whereby the Fed reinvested the excedent of it Mortgage Backed Security holdings into Treasury bonds, which will total between $200 and $300 billion between August 2010 and August 2011; and QE-2, whereby the Fed began purchasing Treasuries directly, in $75 billion monthly increments over the eight months between November 2010 and June 2011, Ben and the Fed reserving for themselves the right to continue—or expand—their Treasury bond purchases as the drones as the Eccles Building see fit.
Now, why did Ben Bernanke and his Federal Reserve smart people implement QE-lite and Quantitative Easing 2? The [mainstream] answer is, As a way to prop up the U.S. economy by keeping interest rates low via liquidity. The [mainstream] reasoning is, By keeping interest rates low, Ben and the Fed want to encourage borrowing, and thereby reactivate the economy. But let’s ask a different question—an It’s a Wonderful Life counterfactual history question:
If Ben and the Fed had not been there to buy up Treasury bonds via QE-lite and QE-2, what would the U.S. Treasury Department have had to do, in order to fund the Federal government? In other words, Would the Federal government have been able to finance itself without Federal Reserve purchases? Without QE-lite and QE-2?
It all depends on the numbers: What’s the Treasury shortfall, and what’s the size of QE-lite and QE-2.
Well—and this is just back-of-the-envelope numbers—the Federal government deficit is about $1.3 trillion. Meanwhile, between August 2010 to August 2011, QE-lite [$200 to $300 billion] and QE-2 [$600 billion] will add up to at least $1 trillion in Treasury bond purchases by the Federal Reserve. One could say that the Federal Reserve is monetizing between 63% and 71% of the Treasury’s issuance for FY 2011. So, a $1.3 trillion shortfall and $1 trillion in money printing . . .
Not only that, they did it with minimal market disruption—and in the case of the equities markets, Fed monetization actually improved those markets: Just like really expensive make-up applied to a dead guy, Bernanke’s monetization gave a false sense of corporate health and vigor to the stock market.
Bernanke’s successful monetization of the bulk of the U.S. Federal government deficit in 2010 was not a one-off: It will continue unabated for the foreseeable future—horrible public policy tends to follow Newton’s laws of motion.
That was the story of America’s finances in 2010: The United States officially became a printing money republic—with nukes.
Look at the evidence: The budgetary questions in Washington are not either/or—they are both/and: Stimulus spending and Bush tax cut extensions and never-ending wars and health care reform and the creation of a police-state. The clowns in Washington have been able to eat their cake and have it too, with nary a thought as to cutting spending. Ben Bernanke’s successful monetization of 75% of the new Treasury debt issuance is the direct cause of this policy mentality.
It’ll only be a matter of time before the bankrupt States take advantage of this both/and mentality—and in no time at all, the political pressure from the States to have the Federal government bail them out will become an overwhelming clamor: Especially as pensions—and therefore pensioners, who always vote—become increasingly affected. Therefore—as a direct byproduct of Bernanke’s “successful” monetization of the U.S. Federal deficit, and the resultant lack of need on the part of the political class to make true budgetary decisions—I am confident in predicting that in 2011, there will be another round of “stimulus”.
Don’t act so surprised: The State budget bailout package will be a “little” stimulus in the $400 to $500 billion range—but it will be explained away as being both “necessary” and “targeted”, with the explicit aim of propping up the bankrupt States and municipalities. This “targetting” will make it politically popular, and therefore insure its passage.
Now, the Fed’s monetization of the deficit should have some incidence on the Treasury bond market—shouldn’t it? Here—I confess—I’m at a bit of a loss:
On the one hand, Treasury bond yields ought to rise, as the Federal government continues to spend like there’s no tomorrow, and slowly but inexorably positions itself to take over State and municipal liabilities, especially pension liabilities [which is what’s really killing the State balance sheets].
On the other hand, since the Federal Reserve is the buyer of 75% of the debt the Treasury Department issues, the Fed ought to be able to squeeze yields whichever way it wants to—which is exactly what it seems to have done: During 2010, the 10-year Treasury bond yield fluctuated between 2.41% (in October) and 4.01% (in April); today as I write it’s at 3.50% even.
This would seem to prove that the Fed has the yield curve well in hand—therefore, if this really is the case, then the Treasury bond market is useless as a sign of anything. Just like the equities market, Treasuries are a rigged game that signify nothing.
What asset class is reacting more or less rationally to what has been going on in Europe and the United States? Commodities.
Commodities
Commodities rose drastically all throughout 2010: Every single commodity class, every single one of them rising by double digit percentage points—at least.
You can talk to me about wheat rising because of wildfires in Russia, oil rising because of the BP spill in the Gulf of Mexico, copper rising because of the trapped miners in Chile, silver rising because JP Morgan tried to do like the Hunt brothers, gold rising because a lot of Chinese want gold for their teeth fillings or investment in portfolio instead of porcelain, corn rising because Martha Stewart and Nigella Lawson simultaneously declared it their favorite ingredient.
—or I could argue that commodities of all classes are rising because the markets are afraid of Treasury bond weakness and continued irresponsible monetary policy, so they’re looking for a safe haven to replace Treasuries. Commodities of all strategic classes have been steadily rising—are it because a whole host of various causes have led these myriad commodities all to rise? Or is it because a single common cause is driving them all up?
Now, I think that commodities are rising because of market fear of the U.S. fiscal profligacy. I can argue that position from the commodities’ side of the equation—no sweat. But I just can’t prove my case when I cross over to the Treasuries’ side.
I can’t prove it because there has not been the movement in Treasury bonds which would signal that that is the case. I could point to Treasury yields rising 100 basis points since the October—but that’s what you call evidence, even if you deign to call it “evidence”. A decisive break-out in yields above 4% on the 10-year over the next two-to-three months—that would be sort of compelling. But a drift up from 2.5% to 3.5% at the end of the year? That’s nothing.
My own thinking is, the reason there hasn’t been a drastic, unequivocal fall in Treasury bond prices is because of the aforementioned Fed grip on yields: It is neither the Fed’s strategic intent nor in its interest to have Treasury bond yields widen. What with a 75% market position in new debt issuance, it ought to be a snap for Ben and the Fed to keep yields low.
Therefore, I think that market participants are going into commodities for safe haven, even as they are exiting Treasuries. I do not think there is a correlation between commodities’ rise and equities’ rise: I think equities are the speculative play, with the market riding the bubble Bernanke is blowing, whereas commodities are where the market is going as the safe haven play. Strange but true—all because of Bernanke’s manipulation of the Treasury yield, and cornering of the Treasury market. Commodities are hedge are uncertainty and chaos.
I think this is happening—but I hate to rest my argument on such an inference, a teleological inference: I sound like a conspiracy theory specialist —“The Fed is doing it! The Fed is manipulating T-bond prices! The Fed is behind The Conspiracy!” The Fed manipulating the Treasury bond yields to the point where they sit on their hind legs and beg for a crunchy cookie.
Commodity Price Rise: What To Pay Attention To In 2011
I know I have the reputation for being bullish on commodities. You don’t have to buy any of bullishness argument to acknowledge the fact that,
a., commodity prices have experienced a sustained and enormous rise in their prices, and
b., this sustained rise in the prices of commodities will inevitably hit consumers at all levels of the economy.
Therefore, I would expect food, heating oil, precious metals, industrial metals and gas prices to rise considerably over the winter of 2011—that is, now. This will be a knee to the ‘nads of the American economy—indeed, to the world economies. There’s really not much more to say, about the issue: A sharp rise in consumer spending on essentials would shove the American and world economies firmly back into recession, this time potentially with negative growth.
Bottom Line in 2011
My strategic analysis takes me to a situation where, the EMU situation will come to a head this year, likely before the summer, and it will be because of Spain.
As to commodities, their strong, steady rise in price will reach the wider economy starting this winter, and shove it down into a recession, likely deeper than the last one. [Possibly—even likely—this slow-down will trigger the Spanish crisis]
The wild car in this trio is Bernanke and the Fed: Extend QE-2 indefinitely, as they’ve hinted, or grow some balls and force the Congress, the White House and the political establishment to get serious and cut spending? No surprise, my money is the people of the Eccles Building extend QE-2, and continue with their 75% monetization of new Treasury issuance.
So bottom line: It’s looking like 2011 is going to be very exciting. At least two of these three story-lines are going to come to their respective climaxes this year—so 2011 might well suck, but at least it’ll be exciting! I take my cheer where I can find it.
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 investments or entering into any financial transactions / contracts.
By Shan Saeed
Christmas ended on a docile note. The New Year’s celebrations were held privately in most part of the world on a somber way as well. There are lots of headwinds in the global financial markets and as we navigate through turbulent times, markets do hold some opportunities for smart and savvy investors.
Firstly, the biggest macro-economic story of 2010 was Europe: It’s falling apart, and there doesn’t seem to be anything that’s going to stop this collapse or default like situation. In 2011, its going to be a real challenge.
The second biggest macro-economic story of the year—though not by much—was the successful monetization of 75% of the U.S. Federal government deficit [$14 trillion] by Ben Bernanke and the Federal Reserve. I use the word “successful” in a morality-free, completely pragmatic sense: Bernanke achieved monetization with minimal market disruption. In fact, a lot of people would argue that QE-lite and QE-2 were not policies of debt monetization—that is how successful Bernanke has been. The real confidence level is very low…….This “success” has allowed the U.S. Federal government to continue to avoid making necessary, critical budgetary decisions—paradoxically accelerating the U.S.’s deteriorating fiscal situation. Stimulus would continue to provide breathing space to the US economy.
The third biggest macro-economic story of 2010 has been the inexorable rise in commodity prices. Everyone’s been paying attention to silver and gold, but the real story has been industrial metals—especially copper/Uranium—and agricultural commodities—especially grains—especially Wheat, Rice, Sugar, Soya bean and corn, corn, corn!
To be sure, there were other important stories in 2010—the Mortgage Mess, Wikileaks, Wayne Rooney. But these three issues—auguries of EMU collapse; successful Fed monetization, and commodity price rises—are the ones that mattered on a macro-economic level this past year. In 2011, every other financial story will be either a cause or consequence of one of these three issues: Guaranteed.
Europe
Europe is in deep mess. Some people might call it deep shit—there’s really no polite way to say it.
Back in the spring of 2010, Greece went down the tubes, as its sovereign debt collapsed in price, and its ability to borrow money from the open markets—and thereby continue to operate—for all intents and purposes ceased.
Then in November/December of 2010, the Irish sovereign debt also began to tumble, as it became increasingly clear that Ireland simply does not have the wherewithal to backstop it’s disproportionately large—and insolvent—banking sector. All banks in Europe passed the sham STRESS TEST. It was an illusion and ineffective to control the storm. Angela Merkel’s less than clever words in an interview [to the effect that Irish debt holders might have to take a haircut] sparked a rise in Irish debt yields, squeezing Ireland’s ability to borrow fresh cash to keep its insolvent banks afloat—thereby creating the need for a rescue package from the IMF, the UK, the European Union, and the European Central Bank.
What was painfully apparent in 2010 was that the Eurozone and the European Union had no mechanism to handle a crisis in one of its member states. Nor is it moving forward to correct the single biggest weakness of the euro scheme—namely, the ability of each member state to issue its own debt. Internal Devaluation, and printing of money could have been the remedy provided they had not joined Euro currency.
In May of 2010—over a decade since the introduction of the euro—the EU finally came up with a mechanism to salvage the broken economy of one of its member states, the European Financial Stability Facility (EFSF).
Stability Facility: Even its very name sounds funny, cartoonish and silly—which fits with the general cartoonishness of the European crisis response, first to Greece, then to Ireland, Portugal, Spain and Italy.
The concept of the EFSF—at least in theory—is for the member states to contribute to a €440 billion fund. In reality, the EFSF has no money, but rather, it will issue debt. Therefore, what’s really happened in the case of Greece and Ireland is that their bad debts were taken over by the EFSF—so in a sense, no one has been bailed out: Rather, the bad debts have been transferred to the European Monetary Union as a whole.
This is the European model of bailouts: In exchange for handing over their fiscal sovereignty and having tough austerity measures put in place—but without harming a single hair on the head of a single sovereign bond holder—Greece and Ireland had their debts taken over by the EU. Which is fine—for the smaller countries with their smaller economies, and their weaker political pull.
But what about a big country? What about a country like Spain? It requires $600 billion in bail out funds. Huge drag on the economy and threat to the stability of Euro. After the Greek and Irish bailouts, it looks like Portugal and possibly Belgium / France are up next in this perverse game of musical chairs played to the tune of sovereign debt—but these smaller countries are dwarfed by Spain: Spain, as I argued here, is where the European game is really at.
As I pointed out, Spain is twice the size of Greece, Ireland and Portugal combined—Spain is roughly half the size of Germany—Spain has a fiscal deficit of over 11% of GDP for 2010, unemployment rate of 21% and a total debt of over 80% of GDP. I am counting the accumulated debt of comunidades autónomas, which is so far 10.2% of GDP and steadily rising. In short, Spain is trouble.
Not “Spain is in trouble”—that’s obvious, but that’s not my point: Spain is trouble. Trouble for the German banks that own so much of the Spanish debt. Trouble for Germany, which is propping up its insolvent banks [What, you think German politicians are any less craven than American politicians?]. Spain is trouble for the European Union, for what a German banking crisis might mean for the EU as a whole and as an institution. More than anything, Spain is trouble for the European Financial Stability Facility, because Spain is too big to be saved—and there’s really no way to finesse that hard fact.
In the case of Europe, the lynchpin can come off awfully fast—think of Ireland. A few impolitic words from Angela Merkel, and suddenly the Irish bond market panics. Suddenly, Ireland is teetering on the brink of insolvency, unable to meet its funding needs. And that was Ireland—all due respect to those wonderful people, but we’re talking a GDP of a paltry $227 billion. Ben Bernanke takes a morning dump bigger than that. What’s Ireland’s $227 billion when compared to Spain’s economy of $1.5 trillion?
Spain: During 2011, Spain will be the flash-point—so you want to keep one eye on Spanish sovereign bond spreads, and one eye on Brussels: When Spanish debt spreads over German bunds creep into the 3.5% to 4% range, you know trouble is coming. And when the Spanish spread decisively crosses 4.25% over the German 10-year, then you know trouble’s arrived—and it won’t be leaving town ‘til it’s had its chance to run riot in the streets. How the EU and the ECB handle an eventual Spanish sovereign debt crisis will determine the very future of the European Union.
Because there will be a Spanish sovereign debt crisis—it’s inevitable. The Spanish balance sheet is not improving fast enough, even with so-called “austerity” measures, because even though the Spanish government might be cutting spending, the comunidades autónomas—roughly analogous to states or regions—are expanding their budgets in order to take up the slack, and thereby increasing the Spanish deficit. Don’t believe me?
So when Spain goes into crisis—which should take place no later than June-August 2011, and perhaps as early as this coming March—the European Union’s collective and institutional reaction to this crisis event will determine whether a smaller, healthier European Monetary Union continues to exist, or whether the whole concept of EMU is ripped to shreds by events.
If the EU and the ECB are clever, and brave, and humble in the face of failure, then they’ll expel Greece, Ireland, Portugal, Spain and Italy from the European Monetary Union. The euro will remain the currency of the stronger economies—France, Holland, Germany—while the weaker economies will go back to their original currencies, and immediately devalue, reschedule the debt and follow internal devaluation so as to kickstart their economies.
If, however, the European Union and European Central Bank leadership proves to be stupid, cowardly, and arrogant—as is very likely, considering their confused, self-defeating actions and reactions to the Greek and Irish crises—then there will be some sort of European-wide convulsion, when the bond markets panic, and leave Spain locked out of any funding. This is the key event of 2011: Whether the European Monetary Union survives. Survivability of Europe is the key in the global financial markets. Unless Brussels gets its collective shit together and realizes it has to cut the weaker economies loose from the euro, odds are high the euro goes out of the roof in crisis situation.
U.S. Fiscal Situation—Local, State and Federal
There is a limit to sympathy: You can feel sorry for someone—but only up to a point. In so far as the United States’ fiscal situation is concerned, that point has been reached, at least for me: I can no longer feel sorry for the American people.
Americans want more services and entitlements, but with less taxes—and then they’re all surprised when their local, state and Federal governments cross the edge of insolvency, and into the nightmare land of feverishly staving off bankruptcy. California, Illinois, Michigan and Florida are facing Greece like situation. 41 states in USA are acting like Greece and Ireland.
During 2010, the Federal government debt finally crossed the 100% of GDP mark—and continued rising non-stop. Actually, the debt’s growth accelerated. Why? Because the Bush tax cuts of 2001—implemented when there was an expectation of surplus, with clear sunset provisions, and no massive war expenditures—were extended by the mindless Republican Congress and the spineless President, Barack Obama.
So the U.S. Federal government will continue to add to the debt, at the rate of 10% per year for 2011, 2012, 2013 and 2014. Some might argue with the 2013 and 2014 extrapolations. I’ll concede them: But that still leaves the U.S. Federal government with a debt burden of 120% of GDP by 2012—those are Greek levels of debt. And even if by some miracle tax receipts increase after 2012, so that the deficits in 2013 and 2014 are not 10% of GDP, what will they be? 7% of GDP? Maybe even 5% of GDP? So total debt would be $20 trillion by 2014 will be only 130% of GDP, instead of 140%. In FY2010, the government paid $414 Billion in interest expenses which equates to 17% of revenue. When you account for the $14 Trillion in total debt, that works out to be 2.96% in interest. In FY2007, total debt was $8.95 Trillion, but the interest expense was $430 Billion and 17% of revenue. That accounts for an interest rate of 4.80%. Luckily, rates have stayed low for the past two years.
However, in the next 24 months the situation could grow dire. At least $2 Trillion will be added to the national debt. At an interest rate of only 4.0%, the interest expense would be $600 Billion. Even if we assume 7% growth in tax revenue, the interest expense would total 22% of the budget. An interest rate of 4.5% would equate to 26% of the budget.
And that’s not counting the State and Local governments.
In late 2010, we finally started to notice something which has been festering for years, like one of those yucky worms that winds up eating your brains and driving you mad: The financial condition of the U.S. States and municipalities—they’re bankrupt.
For fiscal year 2010, the states’ combined budget shortfall is $191 billion. Of that figure, $68 billion is offset by the Recovery Act—Obama’s stimulus. Currently, the 2011 combined deficit of the States will be in the neighborhood of $160 billion—but that doesn’t seem credible, considering the ongoing unemployment. Regardless, $59 billion of those will be offset by the Recovery Act—which still leaves at least $100 billion up in the air. However you look at it, the States have a huge collective hole in their budgets. And this hole is going to get worse, before it gets any better—just like the Federal government’s massive yearly deficit.
Which brings me to Federal Reserve policy in 2010—specifically the announcement and implementation of further rounds of “Quantitative Easing”.
Call it QE, call it “liquidity injections”, call it “interest rate stabilization”, call it “Fed balance sheet expansion”, call it “monetary accommodation”—whatever clever name you give it, it’s basically money printing, plain and simple: The Federal Reserve “implements” QE by simply creating money out of thin air, then going out and buying bonds with that new money. Actually, it’s even better than printing money—no bothers with printing presses and such. QE is going global to other ZONES like Japan, UK, Europe
There were two rounds of QE in 2010: QE-lite in the early summer, whereby the Fed reinvested the excedent of it Mortgage Backed Security holdings into Treasury bonds, which will total between $200 and $300 billion between August 2010 and August 2011; and QE-2, whereby the Fed began purchasing Treasuries directly, in $75 billion monthly increments over the eight months between November 2010 and June 2011, Ben and the Fed reserving for themselves the right to continue—or expand—their Treasury bond purchases as the drones as the Eccles Building see fit.
Now, why did Ben Bernanke and his Federal Reserve smart people implement QE-lite and Quantitative Easing 2? The [mainstream] answer is, As a way to prop up the U.S. economy by keeping interest rates low via liquidity. The [mainstream] reasoning is, By keeping interest rates low, Ben and the Fed want to encourage borrowing, and thereby reactivate the economy. But let’s ask a different question—an It’s a Wonderful Life counterfactual history question:
If Ben and the Fed had not been there to buy up Treasury bonds via QE-lite and QE-2, what would the U.S. Treasury Department have had to do, in order to fund the Federal government? In other words, Would the Federal government have been able to finance itself without Federal Reserve purchases? Without QE-lite and QE-2?
It all depends on the numbers: What’s the Treasury shortfall, and what’s the size of QE-lite and QE-2.
Well—and this is just back-of-the-envelope numbers—the Federal government deficit is about $1.3 trillion. Meanwhile, between August 2010 to August 2011, QE-lite [$200 to $300 billion] and QE-2 [$600 billion] will add up to at least $1 trillion in Treasury bond purchases by the Federal Reserve. One could say that the Federal Reserve is monetizing between 63% and 71% of the Treasury’s issuance for FY 2011. So, a $1.3 trillion shortfall and $1 trillion in money printing . . .
Not only that, they did it with minimal market disruption—and in the case of the equities markets, Fed monetization actually improved those markets: Just like really expensive make-up applied to a dead guy, Bernanke’s monetization gave a false sense of corporate health and vigor to the stock market.
Bernanke’s successful monetization of the bulk of the U.S. Federal government deficit in 2010 was not a one-off: It will continue unabated for the foreseeable future—horrible public policy tends to follow Newton’s laws of motion.
That was the story of America’s finances in 2010: The United States officially became a printing money republic—with nukes.
Look at the evidence: The budgetary questions in Washington are not either/or—they are both/and: Stimulus spending and Bush tax cut extensions and never-ending wars and health care reform and the creation of a police-state. The clowns in Washington have been able to eat their cake and have it too, with nary a thought as to cutting spending. Ben Bernanke’s successful monetization of 75% of the new Treasury debt issuance is the direct cause of this policy mentality.
It’ll only be a matter of time before the bankrupt States take advantage of this both/and mentality—and in no time at all, the political pressure from the States to have the Federal government bail them out will become an overwhelming clamor: Especially as pensions—and therefore pensioners, who always vote—become increasingly affected. Therefore—as a direct byproduct of Bernanke’s “successful” monetization of the U.S. Federal deficit, and the resultant lack of need on the part of the political class to make true budgetary decisions—I am confident in predicting that in 2011, there will be another round of “stimulus”.
Don’t act so surprised: The State budget bailout package will be a “little” stimulus in the $400 to $500 billion range—but it will be explained away as being both “necessary” and “targeted”, with the explicit aim of propping up the bankrupt States and municipalities. This “targetting” will make it politically popular, and therefore insure its passage.
Now, the Fed’s monetization of the deficit should have some incidence on the Treasury bond market—shouldn’t it? Here—I confess—I’m at a bit of a loss:
On the one hand, Treasury bond yields ought to rise, as the Federal government continues to spend like there’s no tomorrow, and slowly but inexorably positions itself to take over State and municipal liabilities, especially pension liabilities [which is what’s really killing the State balance sheets].
On the other hand, since the Federal Reserve is the buyer of 75% of the debt the Treasury Department issues, the Fed ought to be able to squeeze yields whichever way it wants to—which is exactly what it seems to have done: During 2010, the 10-year Treasury bond yield fluctuated between 2.41% (in October) and 4.01% (in April); today as I write it’s at 3.50% even.
This would seem to prove that the Fed has the yield curve well in hand—therefore, if this really is the case, then the Treasury bond market is useless as a sign of anything. Just like the equities market, Treasuries are a rigged game that signify nothing.
What asset class is reacting more or less rationally to what has been going on in Europe and the United States? Commodities.
Commodities
Commodities rose drastically all throughout 2010: Every single commodity class, every single one of them rising by double digit percentage points—at least.
You can talk to me about wheat rising because of wildfires in Russia, oil rising because of the BP spill in the Gulf of Mexico, copper rising because of the trapped miners in Chile, silver rising because JP Morgan tried to do like the Hunt brothers, gold rising because a lot of Chinese want gold for their teeth fillings or investment in portfolio instead of porcelain, corn rising because Martha Stewart and Nigella Lawson simultaneously declared it their favorite ingredient.
—or I could argue that commodities of all classes are rising because the markets are afraid of Treasury bond weakness and continued irresponsible monetary policy, so they’re looking for a safe haven to replace Treasuries. Commodities of all strategic classes have been steadily rising—are it because a whole host of various causes have led these myriad commodities all to rise? Or is it because a single common cause is driving them all up?
Now, I think that commodities are rising because of market fear of the U.S. fiscal profligacy. I can argue that position from the commodities’ side of the equation—no sweat. But I just can’t prove my case when I cross over to the Treasuries’ side.
I can’t prove it because there has not been the movement in Treasury bonds which would signal that that is the case. I could point to Treasury yields rising 100 basis points since the October—but that’s what you call evidence, even if you deign to call it “evidence”. A decisive break-out in yields above 4% on the 10-year over the next two-to-three months—that would be sort of compelling. But a drift up from 2.5% to 3.5% at the end of the year? That’s nothing.
My own thinking is, the reason there hasn’t been a drastic, unequivocal fall in Treasury bond prices is because of the aforementioned Fed grip on yields: It is neither the Fed’s strategic intent nor in its interest to have Treasury bond yields widen. What with a 75% market position in new debt issuance, it ought to be a snap for Ben and the Fed to keep yields low.
Therefore, I think that market participants are going into commodities for safe haven, even as they are exiting Treasuries. I do not think there is a correlation between commodities’ rise and equities’ rise: I think equities are the speculative play, with the market riding the bubble Bernanke is blowing, whereas commodities are where the market is going as the safe haven play. Strange but true—all because of Bernanke’s manipulation of the Treasury yield, and cornering of the Treasury market. Commodities are hedge are uncertainty and chaos.
I think this is happening—but I hate to rest my argument on such an inference, a teleological inference: I sound like a conspiracy theory specialist —“The Fed is doing it! The Fed is manipulating T-bond prices! The Fed is behind The Conspiracy!” The Fed manipulating the Treasury bond yields to the point where they sit on their hind legs and beg for a crunchy cookie.
Commodity Price Rise: What To Pay Attention To In 2011
I know I have the reputation for being bullish on commodities. You don’t have to buy any of bullishness argument to acknowledge the fact that,
a., commodity prices have experienced a sustained and enormous rise in their prices, and
b., this sustained rise in the prices of commodities will inevitably hit consumers at all levels of the economy.
Therefore, I would expect food, heating oil, precious metals, industrial metals and gas prices to rise considerably over the winter of 2011—that is, now. This will be a knee to the ‘nads of the American economy—indeed, to the world economies. There’s really not much more to say, about the issue: A sharp rise in consumer spending on essentials would shove the American and world economies firmly back into recession, this time potentially with negative growth.
Bottom Line in 2011
My strategic analysis takes me to a situation where, the EMU situation will come to a head this year, likely before the summer, and it will be because of Spain.
As to commodities, their strong, steady rise in price will reach the wider economy starting this winter, and shove it down into a recession, likely deeper than the last one. [Possibly—even likely—this slow-down will trigger the Spanish crisis]
The wild car in this trio is Bernanke and the Fed: Extend QE-2 indefinitely, as they’ve hinted, or grow some balls and force the Congress, the White House and the political establishment to get serious and cut spending? No surprise, my money is the people of the Eccles Building extend QE-2, and continue with their 75% monetization of new Treasury issuance.
So bottom line: It’s looking like 2011 is going to be very exciting. At least two of these three story-lines are going to come to their respective climaxes this year—so 2011 might well suck, but at least it’ll be exciting! I take my cheer where I can find it.
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 investments or entering into any financial transactions / contracts.
Saturday, January 22, 2011
Gold is going through Cold Spell---By Shan Saeed
Gold is having a resting time and looking for some investors to start buying at the dip......Upsurge will happen after February/ March-2011
Gold bull run will continue in 2011. My conservative estimate is $1547/ounce for 2011. What's funny about bull markets is that no matter what the sector [ Energy, technology, Mines, airlines, gold, Wheat etc.], they always trade the same way. Pull back and consolidation are part of all financial transactions. Commodities are not different from them.
This means that bull markets climb [a wall of worry]. Every time there is a dip in the bull market, people begin to cry wolf and scream, "The sky is falling!" Is the sky really falling? The answer is yes on countries like Ireland, Greece, Spain, Portugal, Belgium, France, UK and USA where economies are deep in debt and fiscal mismanagement......
Investors think the bull market is over. Fear creeps into the minds quickly and they forget about fundamentals. What I find funny is how fast the sentiment has turned against Gold, Silver and Copper. I am still bullish on these commodities as financial markets would remain uncertain and volatile for the next 2-years till 2012
Gold, after all, just hit an all-time high last month with 1431/oz on 7th Dec-2010 and has just dropped about $77, or 6 %, from its high. People are acting like the sky is falling and the bull market is over. But, I think its a brilliant buying opportunity for the long run...These times won't come back.
STRATEGIC ANALYSIS OF GOLD.
Lets analyze it strategically and look at the commodities prices especially Gold.
In the past 10 years, seven of the 10 yearly lows for gold have occurred in January or February. Gold often sees weakness early in the year. You bet..Its happens always
For example, in 2009 gold dipped to $810 in the first quarter then finished the year at $1,096 an ounce. Last year in 2010, gold bottomed at $1,044 on 26 February and finished the year at $1,370. Therefore, as we can see, if you buy these dips early in the year it usually pays off as the gold price usually rises throughout the rest of the year.
We should remember that despite the talk of improving economies and rate increases in Brazil and China, nothing has really changed. China, Japan and Russia have got $2.9 trillion, $1.4 trillion and $900 billion respectively the reserves in their kitty. Euro solvency crisis has yet to be resolved. Spain, Italy, Portugal, Belgium, France are all in Red in the balance sheets. Fiscal indiscipline and profligacy would continue to slow down their economies.
QE has gone global with ECB, BOJ and BOE are all following the same road map as laid down by FED Chairman Ben Benanke. Printing money to keep the economies moving. You call it printing money or increase in monetary base, or interest rate stabilization or balance sheet expansion or quantitive easing or monetary easing/accommodation. Governments are still spending like crazy. The U.S. deficit is still going to be far north of $1 trillion this year i.e. 2011. US overall deficit would touch $20 trillion by 2014. The disasters of Medicare and Medicaid, in the form of unfunded liabilities, are still to come. US dollar would stay weak in 2011 against all major currencies like Yen, Canadian, Aussie Dollar and Pound sterling
This is just a normal correction in gold and excellent buying opportunity for the long run in commodities. Buy Gold, Silver, Oil, Palladium, Copper, Uranium, Wheat, Rice, Cotton, Corn, Soybean and Natural Gas.....Chinese consumers, Russain consumers, Arabs Central Bank, Hedge funds in USA and big players like Marc Faber/George Soros are all buying Gold and Silver. These are REAL CURRENCIES/ASSETS.....
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence and research work before making strategic investment or taking decision in the short or long run. Research is the key for any investment.
Gold bull run will continue in 2011. My conservative estimate is $1547/ounce for 2011. What's funny about bull markets is that no matter what the sector [ Energy, technology, Mines, airlines, gold, Wheat etc.], they always trade the same way. Pull back and consolidation are part of all financial transactions. Commodities are not different from them.
This means that bull markets climb [a wall of worry]. Every time there is a dip in the bull market, people begin to cry wolf and scream, "The sky is falling!" Is the sky really falling? The answer is yes on countries like Ireland, Greece, Spain, Portugal, Belgium, France, UK and USA where economies are deep in debt and fiscal mismanagement......
Investors think the bull market is over. Fear creeps into the minds quickly and they forget about fundamentals. What I find funny is how fast the sentiment has turned against Gold, Silver and Copper. I am still bullish on these commodities as financial markets would remain uncertain and volatile for the next 2-years till 2012
Gold, after all, just hit an all-time high last month with 1431/oz on 7th Dec-2010 and has just dropped about $77, or 6 %, from its high. People are acting like the sky is falling and the bull market is over. But, I think its a brilliant buying opportunity for the long run...These times won't come back.
STRATEGIC ANALYSIS OF GOLD.
Lets analyze it strategically and look at the commodities prices especially Gold.
In the past 10 years, seven of the 10 yearly lows for gold have occurred in January or February. Gold often sees weakness early in the year. You bet..Its happens always
For example, in 2009 gold dipped to $810 in the first quarter then finished the year at $1,096 an ounce. Last year in 2010, gold bottomed at $1,044 on 26 February and finished the year at $1,370. Therefore, as we can see, if you buy these dips early in the year it usually pays off as the gold price usually rises throughout the rest of the year.
We should remember that despite the talk of improving economies and rate increases in Brazil and China, nothing has really changed. China, Japan and Russia have got $2.9 trillion, $1.4 trillion and $900 billion respectively the reserves in their kitty. Euro solvency crisis has yet to be resolved. Spain, Italy, Portugal, Belgium, France are all in Red in the balance sheets. Fiscal indiscipline and profligacy would continue to slow down their economies.
QE has gone global with ECB, BOJ and BOE are all following the same road map as laid down by FED Chairman Ben Benanke. Printing money to keep the economies moving. You call it printing money or increase in monetary base, or interest rate stabilization or balance sheet expansion or quantitive easing or monetary easing/accommodation. Governments are still spending like crazy. The U.S. deficit is still going to be far north of $1 trillion this year i.e. 2011. US overall deficit would touch $20 trillion by 2014. The disasters of Medicare and Medicaid, in the form of unfunded liabilities, are still to come. US dollar would stay weak in 2011 against all major currencies like Yen, Canadian, Aussie Dollar and Pound sterling
This is just a normal correction in gold and excellent buying opportunity for the long run in commodities. Buy Gold, Silver, Oil, Palladium, Copper, Uranium, Wheat, Rice, Cotton, Corn, Soybean and Natural Gas.....Chinese consumers, Russain consumers, Arabs Central Bank, Hedge funds in USA and big players like Marc Faber/George Soros are all buying Gold and Silver. These are REAL CURRENCIES/ASSETS.....
Disclaimer: This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence and research work before making strategic investment or taking decision in the short or long run. Research is the key for any investment.
Friday, January 7, 2011
New reserve currency: Renminbi-Yuan by Shan Saeed
Chinese Yuan or Renminbi would be one of the currencies where central banks most likely park their funds going forward. Apart from Gold and Silver which are REAL CURRENCIES, Yuan would take a market share in reserves of central banks very quickly.
Make no mistakes, existing global financial system depends on the widespread use of fiat currencies issued by insolvent governments of advance economies. Wealth of the world’s large financial institutions requires that there be currencies with sufficient size and circulation to absorb massive capital flows.
The current system is based primarily on the dollar; with a $14.3 trillion economy, the United States was for years the only country in the world with a sufficient money supply and financial infrastructure to take in the preponderance of the world’s wealth.
It is for this reason commercial loans, commodities contracts like oil payments, international reserves [62% in USD], and cross border settlements have traditionally been denominated in US dollars.
Competing reserve currencies arose with the advent of the euro and Japan’s post-war rise; while the dollar has continued to remain dominant, these three are the only currencies which have the necessary supply and credit rating.
With trillions of dollars floating around the global financial system, managers are constantly making capital allocation decisions or asset allocation in their portfolios, moving funds in and out of various instruments like bonds, commodities, equties and currencies. The reserve currencies play a big role in this because unallocated capital is frequently parked in their bond markets. Bond market is very bearish and sovereign default risk is high as the moment. Yield curves are the perfect predictive of the future growth of economies.
For example, large corporations or banks that are sitting on billions of dollars in cash typically purchase short-term US or European government bonds because the low default risk. But game has changed. Sovereign default risk is going of the roof. New challenge for IMF.
The dollar, euro, and yen have bond markets of such size that getting liquid is never a problem, even for billions of dollars. There is always a market for treasury securities, hence they are considered ‘cash equivalents’.
You couldn’t execute the same thing in the Kingdom of Bhutan with its tiny $3.7 billion economy. If you tried to move $100 million into Bhutan, its currency [the ngultrum] would spike. In the US, Europe, and Japan, $100 million barely registers a blip.
Over the last few years, though, the confidence has begun to fade quickly, and the reserve currency issuing governments are starting to be viewed with increasing skepticism.
The thing that’s missing right now is an acceptable alternative. There’s really nothing out there in large enough scale to withstand massive capital flows, and as I have written before, the game is now one of judging the ‘least worst’ of these three major currencies.
In what seems to be a 6-month cycle, the dollar and euro have been jockeying for the ‘worst of the worst’ title; markets focus on Greek woes for a few months, Ireland, Spain is coming soon, then turn their attention back to California and Obamanomics. Spain/Italy/Portugal/Belgium/France are all in the line of fire. Fiscal mismanagment and Budegt deficits are all messed up in these countries. Euro single currency would be a toast for the next 6-months ending on 30 June 2011. While Dollar would be a toast for the remaining part of the year ending on December 31, 2011. US dollar would losr 9-10% of its value against Pound Sterling, Yen, Canadian Dollar and Euro
With Bernanke’s “100% certainty” and nonsensical economic numbers coming out of the America’s Media and Press, it seems to be back in a period where the markets are more concerned with Europe. I think that Japan will be called to the carpet before too long as well.
As such, in an almost ritualistic cycle, financial markets are shifting funds around these currencies… the analogy I like to think of is like a series of buckets.
Imagine three buckets and an increasing volume of water. Capital allocators are essentially dumping the contents of one pail into another– from the dollar bucket into the euro and yen bucket, and from the euro bucket back into the dollar bucket.
Each time this happens, though, a little bit of water spills out into smaller buckets– Gold, Silver, Switzerland, Norway, Canada, Chile, Australia, etc.
All throughout, central bankers are standing there keeping the spigot at full blast, pumping more water into the system while bankers desperately try to find the least leaky balance.
What’s required is a new bucket that bankers view as strong, sturdy, and large enough to handle the volume. The most likely candidate is the Chinese renminbi… but not yet.
China’s economy is set to be the largest in the world in a matter of years in 5 years time, and it has the money supply to match. While its economic and monetary fundamentals are far, far from perfect, China is arguably in a much better financial position than the west.
It’s going to take several years for the renminbi to overtake the dollar, euro, and yen as a serious contender for the world’s main reserve currency… but it can happen. The major roadblock is that China’s renminbi is not free-floating– the government has imposed severe exchange controls. Capital controls are the big impediment.
I’ve written before that we are seeing the early signs of relaxing controls. China doesn’t do anything overnight, and I think there is a strategic / long-term plan in place that Chinese leadership is working upon. I admire Chinese leadership and its strategic economic insight.
We have already seen China agree with other sovereign nations to introduce currency swap arrangements, so there are now several countries holding renminbi. Furthermore, the Hong Kong gold exchange recently announced its plans to launch a new gold contract denominated in renminbi.
To be clear, China already has its own gold exchange, but having one in Hong Kong opens up renminbi-denominated gold contracts to the entire world since Hong Kong has no exchange controls. Shanghai Gold Exchange was set up in 2001 and one of the busiest exchange centres around the world. PBC [ the chinese central bank] has allowed 5 banks to make Gold and Silver related transactions for clients.
On that note, the mainland authorized Hong Kong’s banks to establish cross-border settlement accounts in renminbi last year, effectively providing a way for people to open a renminbi bank account. In fact, we have one.
Each of these measures to reduce exchange controls is one step closer to the renminbi being introduced as a global reserve currency.
Perhaps the most obvious step, though, came in just the last few days. Beijing has already allowed several multinational companies like McDonald’s and Caterpillar to issue renminbi denominated bonds. Now the World Bank, that unfortunate staple of the financial system, is issuing its own two-year renminbi bond. Chinese government has started doing trade with Malaysia, South Korea, Russia and Indonesia in Yuan related transacations. All reported in big press.
This is a big deal… and I think that we’re going to continue to see bigger and bigger steps like this taken throughout 2011 and in the coming years.
China’s government has been very clear that by 2020, it wants Shanghai to be a leading global financial center… and Chinese policymakers know that for Shanghai to be a financial center, the renminbi must be freely convertible. The deadline is all set to be followed. If you haven’t started making decisions to preserve your capital, I strongly urge you to start now. Ponder upon Chinese Yuan in the evening
Disclaimer: This is just a research piece and not an investment advice. Investors are strongly encouraged to execute their own due diligence before making any investment or strategic asset allocation of their portfolios.
Make no mistakes, existing global financial system depends on the widespread use of fiat currencies issued by insolvent governments of advance economies. Wealth of the world’s large financial institutions requires that there be currencies with sufficient size and circulation to absorb massive capital flows.
The current system is based primarily on the dollar; with a $14.3 trillion economy, the United States was for years the only country in the world with a sufficient money supply and financial infrastructure to take in the preponderance of the world’s wealth.
It is for this reason commercial loans, commodities contracts like oil payments, international reserves [62% in USD], and cross border settlements have traditionally been denominated in US dollars.
Competing reserve currencies arose with the advent of the euro and Japan’s post-war rise; while the dollar has continued to remain dominant, these three are the only currencies which have the necessary supply and credit rating.
With trillions of dollars floating around the global financial system, managers are constantly making capital allocation decisions or asset allocation in their portfolios, moving funds in and out of various instruments like bonds, commodities, equties and currencies. The reserve currencies play a big role in this because unallocated capital is frequently parked in their bond markets. Bond market is very bearish and sovereign default risk is high as the moment. Yield curves are the perfect predictive of the future growth of economies.
For example, large corporations or banks that are sitting on billions of dollars in cash typically purchase short-term US or European government bonds because the low default risk. But game has changed. Sovereign default risk is going of the roof. New challenge for IMF.
The dollar, euro, and yen have bond markets of such size that getting liquid is never a problem, even for billions of dollars. There is always a market for treasury securities, hence they are considered ‘cash equivalents’.
You couldn’t execute the same thing in the Kingdom of Bhutan with its tiny $3.7 billion economy. If you tried to move $100 million into Bhutan, its currency [the ngultrum] would spike. In the US, Europe, and Japan, $100 million barely registers a blip.
Over the last few years, though, the confidence has begun to fade quickly, and the reserve currency issuing governments are starting to be viewed with increasing skepticism.
The thing that’s missing right now is an acceptable alternative. There’s really nothing out there in large enough scale to withstand massive capital flows, and as I have written before, the game is now one of judging the ‘least worst’ of these three major currencies.
In what seems to be a 6-month cycle, the dollar and euro have been jockeying for the ‘worst of the worst’ title; markets focus on Greek woes for a few months, Ireland, Spain is coming soon, then turn their attention back to California and Obamanomics. Spain/Italy/Portugal/Belgium/France are all in the line of fire. Fiscal mismanagment and Budegt deficits are all messed up in these countries. Euro single currency would be a toast for the next 6-months ending on 30 June 2011. While Dollar would be a toast for the remaining part of the year ending on December 31, 2011. US dollar would losr 9-10% of its value against Pound Sterling, Yen, Canadian Dollar and Euro
With Bernanke’s “100% certainty” and nonsensical economic numbers coming out of the America’s Media and Press, it seems to be back in a period where the markets are more concerned with Europe. I think that Japan will be called to the carpet before too long as well.
As such, in an almost ritualistic cycle, financial markets are shifting funds around these currencies… the analogy I like to think of is like a series of buckets.
Imagine three buckets and an increasing volume of water. Capital allocators are essentially dumping the contents of one pail into another– from the dollar bucket into the euro and yen bucket, and from the euro bucket back into the dollar bucket.
Each time this happens, though, a little bit of water spills out into smaller buckets– Gold, Silver, Switzerland, Norway, Canada, Chile, Australia, etc.
All throughout, central bankers are standing there keeping the spigot at full blast, pumping more water into the system while bankers desperately try to find the least leaky balance.
What’s required is a new bucket that bankers view as strong, sturdy, and large enough to handle the volume. The most likely candidate is the Chinese renminbi… but not yet.
China’s economy is set to be the largest in the world in a matter of years in 5 years time, and it has the money supply to match. While its economic and monetary fundamentals are far, far from perfect, China is arguably in a much better financial position than the west.
It’s going to take several years for the renminbi to overtake the dollar, euro, and yen as a serious contender for the world’s main reserve currency… but it can happen. The major roadblock is that China’s renminbi is not free-floating– the government has imposed severe exchange controls. Capital controls are the big impediment.
I’ve written before that we are seeing the early signs of relaxing controls. China doesn’t do anything overnight, and I think there is a strategic / long-term plan in place that Chinese leadership is working upon. I admire Chinese leadership and its strategic economic insight.
We have already seen China agree with other sovereign nations to introduce currency swap arrangements, so there are now several countries holding renminbi. Furthermore, the Hong Kong gold exchange recently announced its plans to launch a new gold contract denominated in renminbi.
To be clear, China already has its own gold exchange, but having one in Hong Kong opens up renminbi-denominated gold contracts to the entire world since Hong Kong has no exchange controls. Shanghai Gold Exchange was set up in 2001 and one of the busiest exchange centres around the world. PBC [ the chinese central bank] has allowed 5 banks to make Gold and Silver related transactions for clients.
On that note, the mainland authorized Hong Kong’s banks to establish cross-border settlement accounts in renminbi last year, effectively providing a way for people to open a renminbi bank account. In fact, we have one.
Each of these measures to reduce exchange controls is one step closer to the renminbi being introduced as a global reserve currency.
Perhaps the most obvious step, though, came in just the last few days. Beijing has already allowed several multinational companies like McDonald’s and Caterpillar to issue renminbi denominated bonds. Now the World Bank, that unfortunate staple of the financial system, is issuing its own two-year renminbi bond. Chinese government has started doing trade with Malaysia, South Korea, Russia and Indonesia in Yuan related transacations. All reported in big press.
This is a big deal… and I think that we’re going to continue to see bigger and bigger steps like this taken throughout 2011 and in the coming years.
China’s government has been very clear that by 2020, it wants Shanghai to be a leading global financial center… and Chinese policymakers know that for Shanghai to be a financial center, the renminbi must be freely convertible. The deadline is all set to be followed. If you haven’t started making decisions to preserve your capital, I strongly urge you to start now. Ponder upon Chinese Yuan in the evening
Disclaimer: This is just a research piece and not an investment advice. Investors are strongly encouraged to execute their own due diligence before making any investment or strategic asset allocation of their portfolios.
Thursday, December 23, 2010
US Treasury and Municipal Bonds are losing values. Dangers ahead...By Shan Saeed
Yield curves are the powerful indicator of the future. By Shan Saeed
This is the most important development since November-2010 in the US financial history. Long long-term U.S. Treasury bonds have fallen 7% in value. That's not supposed to happen. But it's happening. Municipal bond market has fallen 6%. That, too, isn't supposed to happen. But it's happening at a precarious time of the global financial turmoil.
For most of the last century, the whole world has believed the obligations of the U.S. government – and the obligations of thousands of states, cities, towns, and other municipalities in the U.S. – were the safest investments in the world. These "safe" investments aren't supposed to crash. The reason U.S. Treasurys and municipal bonds are crashing is by far the most important financial development of 2010. The crash has affected and will continue to affect the value of every stock, bond, exchange-traded fund... every type of investment there is.
If you've already looked for the reason bonds are crashing, it hasn't been hard to find. The reason bonds were crashing was on the front page of all the major financial websites. It's been there since November 3, when the Federal Reserve announced it would print $600 billion between now and June 2011 and buy Treasury bonds with it.
First week of November-2010, newspapers were hot. Headline from
1. Financial Times' website read, "Fed maintains asset purchase plan"
2. The Wall Street Journal's website read, "Fed Sticks To Bond-Buying Policy."
3. And Bloomberg's site read, "Fed Retains $600 Billion Bond Buying Plan to Boost Economy.
It all means the same thing: The Federal Reserve will keep printing money. QE2 will go global with countries getting enamored of BEN BENANKE latest escapade. ECB, BOE, BOJ will increase monetary base to buy bonds and long term assets to keep their economies moving. US dollar will continue to get weaker. The bond market will continue to fall. Interest rates will continue to rise. Yield would go up. Watch out for US dollar bubble and Government debt bubble. Make no mistake about it — the Obama administration is embracing massive inflationary deficit spending. Ben Bernanke has released unheard of measures of "quantitative easing" — intentionally devaluing the dollar as a risky gamble to restart the economy. In the meantime it has only eroded the value of your savings and decreased the returns you can get on safe investments like CDs, Money Market accounts, and bonds. President Obama has committed the government to at least $7 trillion in new spending and warned the American people to expect trillion-dollar deficits for the foreseeable future.
Decades ago, Famous Nobel laureate from Uni. of Chicago Milton Friedman answered these questions clearly and precisely in his insightful book, Money Mischief: Episodes in Monetary History. In Money Mischief, Friedman even warned that the coming inflation could "destroy" US economy. Furthermore, he wrote: "Inflation is a disease, a dangerous and sometimes fatal disease that, if not checked in time, can destroy a society." [Money Mischief, Page 191]
You see the end result of that process in countries like Zimbabwe today, where prices double every day, and it now takes a $10 billion Zimbabwe note to buy a single loaf of bread - assuming you can find one.
Could America suffer the same fate? Friedman wrote ominously, "The fate of a country is inseparable from the fate of its currency." He shared his strategy how the U.S. and the West could still avoid hyperinflation, even with unbacked paper currency.
Fortunately, the bond market remains more-or-less immune to swings in
policymakers need to justify their action in whatever language the
current times demand. The track record of the yield curve as a
predictor of future growth is more-or-less perfect, especially in the
United States.
Why is it that the yield curve is such a powerful predictor of the
future? Because the spread between short rates and long rates
basically dictates the profit margin of banks: the cost of funds is
basically the deposit rate paid to customers, while those deposits are
invested in longer-term loans and mortgages to the private sector, or
bonds purchased from the government. Simply put: the wider the gap
between short rates and long rates, the bigger the profitability of
the banks, and the bigger the profitability, the more eager they get
to lend, which in turn makes it easier for private entrepreneurs or
households to borrow. The rise in leverage creates growth as people
build new homes, companies invest in new factories and employ more
people.
Conversely, when the curve flattens, the cycle goes into reverse:
banks’ profitability drops, they become less eager to lend, credit
begins to slow down etc. An inverted curve is the extreme case: now
banks lose money on their basic business, so the contraction cycle
goes into overdrive. So, by flattening the yield curve, the Federal Reserve
is now following directly in the footsteps of the Bank of Japan, in my
personal view. It is risking a significant and possibly permanent
decline in the future growth rate of the economy: flattening the curve
by buying treasuries, central banks remove the incentive for long-term
risk taking. Long-term investment becomes less attractive and leverage
ratios decline. is the USA heading for LOST DECADE like Japan seems likely?
Moody's Investors Services publishes bond ratings. A low rating means a bond is more likely to default. A high rating means a bond is unlikely to default. The highest bond rating is triple-A. During the financial crisis in 2007-2009, Moody's damaged its credibility by giving junky mortgage securities the coveted triple-A rating. Now it's desperate to get some of that credibility back.
U.S. Treasury bonds are rated triple-A, the highest rating there is. But that might be about to change. Moody's doesn't like the implications of the new $858 billion tax cut deal worked out between President Obama and Congress. Recently, Moody's said, "Unless there are offsetting measures, the [new tax] package will be credit negative for the U.S. and increase the likelihood of a negative outlook on the U.S. government's triple-A rating during the next two years."
That means Moody's is thinking about lowering the U.S. government's triple-A rating. The lower your credit rating, the higher the interest rate you have to pay on your debts. The U.S. has about $14 trillion of debt. If interest rates go high enough, it could bankrupt the country. As usual, the American ratings agencies are late to the party. U.S. Treasurys have already been downgraded to double-A by analysts in two of the largest, fastest-growing emerging economies in the world: China and Brazil.
Brazil's economy is larger than all other South American countries combined. It's an important trade partner with the U.S., China, and many other countries around the world. What Brazil thinks of the U.S. government's credit rating is important.
China is the largest holder of U.S. Treasurys. It has no economic incentive to allow U.S. Treasurys to be downgraded. But it can't afford to ignore reality, either.
Just weeks ago, China and Russia announced they would no longer use U.S. dollars in their trading with one another. In 2010, the Bank of China reported a doubling of its gold holdings. Right on the cover of the November 8 issue of Barron's magazine, an ominous subhead reads, "With the dollar more vulnerable, China for the first time is investing more overseas in hard assets, like copper, oil, and iron, than in U.S. government bonds."
That's not what you do if you believe in the ultimate safety and sanctity of the U.S. government's credit rating. When foreigners start questioning the credit rating of the United States, they're essentially rejecting the U.S. dollar. It's as if a billion Coke drinkers have suddenly decided they're better off with orange juice. Imagine what would happen to Coke's stock and bonds...
In short, the jig is up. The world knows the Federal Reserve is compromising the country's credit rating. The more money the Fed prints, the higher the interest rate bond holders will demand to compensate them for the risk taken, the lower bond prices will fall.
Bonds crisis is ominous and risky. Investors should consider off-loading some of their bond investments which face the same problems as Treasurys and municipal bonds. When interest rates rise, these investments decline in value. If you're an income-focused investor, I urge you to focus on dominant dividend paying companies instead. Buy Gold and Silver to get insurance of your wealth. Real Assets are here to stay. Stocks can go down to zero but not commodities. Invest in Copper, Oil, Gold and Silver...Remember COGS
Disclaimer: This is just a research piece and not an investment advice. Investors are highly encouraged to execute their own due diligence for their investment strategy and decision.
This is the most important development since November-2010 in the US financial history. Long long-term U.S. Treasury bonds have fallen 7% in value. That's not supposed to happen. But it's happening. Municipal bond market has fallen 6%. That, too, isn't supposed to happen. But it's happening at a precarious time of the global financial turmoil.
For most of the last century, the whole world has believed the obligations of the U.S. government – and the obligations of thousands of states, cities, towns, and other municipalities in the U.S. – were the safest investments in the world. These "safe" investments aren't supposed to crash. The reason U.S. Treasurys and municipal bonds are crashing is by far the most important financial development of 2010. The crash has affected and will continue to affect the value of every stock, bond, exchange-traded fund... every type of investment there is.
If you've already looked for the reason bonds are crashing, it hasn't been hard to find. The reason bonds were crashing was on the front page of all the major financial websites. It's been there since November 3, when the Federal Reserve announced it would print $600 billion between now and June 2011 and buy Treasury bonds with it.
First week of November-2010, newspapers were hot. Headline from
1. Financial Times' website read, "Fed maintains asset purchase plan"
2. The Wall Street Journal's website read, "Fed Sticks To Bond-Buying Policy."
3. And Bloomberg's site read, "Fed Retains $600 Billion Bond Buying Plan to Boost Economy.
It all means the same thing: The Federal Reserve will keep printing money. QE2 will go global with countries getting enamored of BEN BENANKE latest escapade. ECB, BOE, BOJ will increase monetary base to buy bonds and long term assets to keep their economies moving. US dollar will continue to get weaker. The bond market will continue to fall. Interest rates will continue to rise. Yield would go up. Watch out for US dollar bubble and Government debt bubble. Make no mistake about it — the Obama administration is embracing massive inflationary deficit spending. Ben Bernanke has released unheard of measures of "quantitative easing" — intentionally devaluing the dollar as a risky gamble to restart the economy. In the meantime it has only eroded the value of your savings and decreased the returns you can get on safe investments like CDs, Money Market accounts, and bonds. President Obama has committed the government to at least $7 trillion in new spending and warned the American people to expect trillion-dollar deficits for the foreseeable future.
Decades ago, Famous Nobel laureate from Uni. of Chicago Milton Friedman answered these questions clearly and precisely in his insightful book, Money Mischief: Episodes in Monetary History. In Money Mischief, Friedman even warned that the coming inflation could "destroy" US economy. Furthermore, he wrote: "Inflation is a disease, a dangerous and sometimes fatal disease that, if not checked in time, can destroy a society." [Money Mischief, Page 191]
You see the end result of that process in countries like Zimbabwe today, where prices double every day, and it now takes a $10 billion Zimbabwe note to buy a single loaf of bread - assuming you can find one.
Could America suffer the same fate? Friedman wrote ominously, "The fate of a country is inseparable from the fate of its currency." He shared his strategy how the U.S. and the West could still avoid hyperinflation, even with unbacked paper currency.
Fortunately, the bond market remains more-or-less immune to swings in
policymakers need to justify their action in whatever language the
current times demand. The track record of the yield curve as a
predictor of future growth is more-or-less perfect, especially in the
United States.
Why is it that the yield curve is such a powerful predictor of the
future? Because the spread between short rates and long rates
basically dictates the profit margin of banks: the cost of funds is
basically the deposit rate paid to customers, while those deposits are
invested in longer-term loans and mortgages to the private sector, or
bonds purchased from the government. Simply put: the wider the gap
between short rates and long rates, the bigger the profitability of
the banks, and the bigger the profitability, the more eager they get
to lend, which in turn makes it easier for private entrepreneurs or
households to borrow. The rise in leverage creates growth as people
build new homes, companies invest in new factories and employ more
people.
Conversely, when the curve flattens, the cycle goes into reverse:
banks’ profitability drops, they become less eager to lend, credit
begins to slow down etc. An inverted curve is the extreme case: now
banks lose money on their basic business, so the contraction cycle
goes into overdrive. So, by flattening the yield curve, the Federal Reserve
is now following directly in the footsteps of the Bank of Japan, in my
personal view. It is risking a significant and possibly permanent
decline in the future growth rate of the economy: flattening the curve
by buying treasuries, central banks remove the incentive for long-term
risk taking. Long-term investment becomes less attractive and leverage
ratios decline. is the USA heading for LOST DECADE like Japan seems likely?
Moody's Investors Services publishes bond ratings. A low rating means a bond is more likely to default. A high rating means a bond is unlikely to default. The highest bond rating is triple-A. During the financial crisis in 2007-2009, Moody's damaged its credibility by giving junky mortgage securities the coveted triple-A rating. Now it's desperate to get some of that credibility back.
U.S. Treasury bonds are rated triple-A, the highest rating there is. But that might be about to change. Moody's doesn't like the implications of the new $858 billion tax cut deal worked out between President Obama and Congress. Recently, Moody's said, "Unless there are offsetting measures, the [new tax] package will be credit negative for the U.S. and increase the likelihood of a negative outlook on the U.S. government's triple-A rating during the next two years."
That means Moody's is thinking about lowering the U.S. government's triple-A rating. The lower your credit rating, the higher the interest rate you have to pay on your debts. The U.S. has about $14 trillion of debt. If interest rates go high enough, it could bankrupt the country. As usual, the American ratings agencies are late to the party. U.S. Treasurys have already been downgraded to double-A by analysts in two of the largest, fastest-growing emerging economies in the world: China and Brazil.
Brazil's economy is larger than all other South American countries combined. It's an important trade partner with the U.S., China, and many other countries around the world. What Brazil thinks of the U.S. government's credit rating is important.
China is the largest holder of U.S. Treasurys. It has no economic incentive to allow U.S. Treasurys to be downgraded. But it can't afford to ignore reality, either.
Just weeks ago, China and Russia announced they would no longer use U.S. dollars in their trading with one another. In 2010, the Bank of China reported a doubling of its gold holdings. Right on the cover of the November 8 issue of Barron's magazine, an ominous subhead reads, "With the dollar more vulnerable, China for the first time is investing more overseas in hard assets, like copper, oil, and iron, than in U.S. government bonds."
That's not what you do if you believe in the ultimate safety and sanctity of the U.S. government's credit rating. When foreigners start questioning the credit rating of the United States, they're essentially rejecting the U.S. dollar. It's as if a billion Coke drinkers have suddenly decided they're better off with orange juice. Imagine what would happen to Coke's stock and bonds...
In short, the jig is up. The world knows the Federal Reserve is compromising the country's credit rating. The more money the Fed prints, the higher the interest rate bond holders will demand to compensate them for the risk taken, the lower bond prices will fall.
Bonds crisis is ominous and risky. Investors should consider off-loading some of their bond investments which face the same problems as Treasurys and municipal bonds. When interest rates rise, these investments decline in value. If you're an income-focused investor, I urge you to focus on dominant dividend paying companies instead. Buy Gold and Silver to get insurance of your wealth. Real Assets are here to stay. Stocks can go down to zero but not commodities. Invest in Copper, Oil, Gold and Silver...Remember COGS
Disclaimer: This is just a research piece and not an investment advice. Investors are highly encouraged to execute their own due diligence for their investment strategy and decision.
Friday, December 17, 2010
USA ECONOMIC OUTLOOK FOR 2011--By Shan Saeed
ECONOMIC OUTLOOK
The US economic outlook remains sluggish as economy would require time to recover. Might achieve a sub-par growth in 2011. In 2011, the U.S. economy will grow significantly more slowly than during recovery from previous recessions and unemployment will remain high. Business would hire few workers going forward. Its just like you are comparing it with the weather today: partly cloudy with a
chance of intense storms coming down the line, because we still have a
lot of fragilities out there. Recovery figures illustrate softness in the economy.
The projected “reasonable, but not extremely robust” growth of 3%
percent in real GDP and in optimistic terms, the country will weather
the current storms. However, the United State will be stuck
in low growth for a very long period of time because of high umemployment, high leverage and negative debt of the balance sheet of most corporates which are swimming in cash.
I spoke to some top executives in NEW YORK recently and there has been incredibly strong investment in equipment and software. Firms are still willing to invest, and part of the reason for that is productivity has remained quite high. The
bottom line is that the basic production machinery of the economy is
not broken.”
A 3 percent increase in consumption will power the recovery, but the country will see very little growth in jobs. Businesses are reluctant to hire permanent workers because of uncertainty about taxes, a ratio of government spending to GDP that is 2 percent higher than in the previous 50 years and is paired with declining revenue,
and concerns over health care costs.
DOLLAR OUTLOOK FOR 2011
Dollar may drop 9% percent versus the euro in 2011 as investors shun U.S. assets and drive bonds lower. It’s a bearish U.S. asset dynamic led by the bond market. This period has a set-up that is amazingly like what we saw in the 1970s, and is similar to what we saw around 1993.
The dollar will follow trading patterns from the 1970s, when the housing market experienced a decline similar to the recent drop, and the 1990s, which also saw a slump in the bond market. U.S. two-year yields doubled from a low of 3.7 percent in September 1993 to a high of 7.7 percent in December of 1994, pushing bond prices lower. Treasury yields would go higher in 2011 sending negative impact to the markets players in the global markets.
During 2011 the U.S. economy will be slowed by the effect of disillusioned behaviors causing the misallocation of economic resources during the boom years that preceded the recent recession. Housing prices will not recover in 2011 or anytime soon. It’s just not in the data. We are basically going to get many years of normal housing price growth, which is essentially zero to 1 percent in real terms. This is probably going to happen for the next decade. Recovery from this recession will continue to be less robust than after previous recessions because Americans must deleverage their
overspending during the economic boom and build up assets. Houshold debt to GDP ratio is 122%. In order to get this ratio down to 100% of GDP, would require $5-6 trillion and drag on the economy. Empirically proven.
It doesn’t mean we’re going to be sluggish forever; it just means we’ve got some work to do and it’s going to take a little bit of time. Unemployment will remain relatively high in the short run because the housing boom created a glut of construction workers — and, in some states, of mortgage workers — who must be retrained to meet demand in new fields. “The bulk of the unemployed are construction workers, but nobody’s hiring construction workers anymore.
Stockmarket investors should also think carefully before they celebrate too wildly over rising bond yields. After all, bulls were previously arguing that low yields were good news for equities, as they encouraged investors to move out of fixed-income assets in search of higher returns. On the best long-term measure, the cyclically adjusted price-earnings ratio, Wall Street looks overvalued on a multiple of 22, some 37% above the historic average. That already seems to price in a significant rebound in corporate profits.
The fundamental problem remains. In a normal American economy, with 2% inflation and 3% real GDP growth, government-bond yields ought to be around 5%. But yields at that level would be too high for the health of the housing market, the stockmarket and for other governments worldwide. The markets are no closer to resolving that dilemma than they were at the start of 2010.
Nature of economic recovery in the U.S. and Europe is quite worrisome. 41 states in USA are acting like Greece/Ireland. California, Florida, Michigan are experiencing default like situation. Moody's might cut the sovereign debt rating in the 12-18 months.
According to the survey and interviews with various amercians. People with incomes of $75,000 or more are more optimistic about the economy, while unemployment for people with college degrees is half as high as for those without degrees
These divisions across geographic and income segments cause a deterioration in political dialogue. In the U.S., the left does not want to talk to the right, which is a recipe for gridlock. In the past, government not working may not have been a bad
thing. But government not working when your fiscal deficit is 10 percent of GDP is not a good idea. Much needs to be done to bring things back under control, and that requires cooperation.
Disclaimer: This is just a research piece and not an investment advice. Investors are highly encouraged to execute their own due diligence before making any investment strategy or implementation.
The US economic outlook remains sluggish as economy would require time to recover. Might achieve a sub-par growth in 2011. In 2011, the U.S. economy will grow significantly more slowly than during recovery from previous recessions and unemployment will remain high. Business would hire few workers going forward. Its just like you are comparing it with the weather today: partly cloudy with a
chance of intense storms coming down the line, because we still have a
lot of fragilities out there. Recovery figures illustrate softness in the economy.
The projected “reasonable, but not extremely robust” growth of 3%
percent in real GDP and in optimistic terms, the country will weather
the current storms. However, the United State will be stuck
in low growth for a very long period of time because of high umemployment, high leverage and negative debt of the balance sheet of most corporates which are swimming in cash.
I spoke to some top executives in NEW YORK recently and there has been incredibly strong investment in equipment and software. Firms are still willing to invest, and part of the reason for that is productivity has remained quite high. The
bottom line is that the basic production machinery of the economy is
not broken.”
A 3 percent increase in consumption will power the recovery, but the country will see very little growth in jobs. Businesses are reluctant to hire permanent workers because of uncertainty about taxes, a ratio of government spending to GDP that is 2 percent higher than in the previous 50 years and is paired with declining revenue,
and concerns over health care costs.
DOLLAR OUTLOOK FOR 2011
Dollar may drop 9% percent versus the euro in 2011 as investors shun U.S. assets and drive bonds lower. It’s a bearish U.S. asset dynamic led by the bond market. This period has a set-up that is amazingly like what we saw in the 1970s, and is similar to what we saw around 1993.
The dollar will follow trading patterns from the 1970s, when the housing market experienced a decline similar to the recent drop, and the 1990s, which also saw a slump in the bond market. U.S. two-year yields doubled from a low of 3.7 percent in September 1993 to a high of 7.7 percent in December of 1994, pushing bond prices lower. Treasury yields would go higher in 2011 sending negative impact to the markets players in the global markets.
During 2011 the U.S. economy will be slowed by the effect of disillusioned behaviors causing the misallocation of economic resources during the boom years that preceded the recent recession. Housing prices will not recover in 2011 or anytime soon. It’s just not in the data. We are basically going to get many years of normal housing price growth, which is essentially zero to 1 percent in real terms. This is probably going to happen for the next decade. Recovery from this recession will continue to be less robust than after previous recessions because Americans must deleverage their
overspending during the economic boom and build up assets. Houshold debt to GDP ratio is 122%. In order to get this ratio down to 100% of GDP, would require $5-6 trillion and drag on the economy. Empirically proven.
It doesn’t mean we’re going to be sluggish forever; it just means we’ve got some work to do and it’s going to take a little bit of time. Unemployment will remain relatively high in the short run because the housing boom created a glut of construction workers — and, in some states, of mortgage workers — who must be retrained to meet demand in new fields. “The bulk of the unemployed are construction workers, but nobody’s hiring construction workers anymore.
Stockmarket investors should also think carefully before they celebrate too wildly over rising bond yields. After all, bulls were previously arguing that low yields were good news for equities, as they encouraged investors to move out of fixed-income assets in search of higher returns. On the best long-term measure, the cyclically adjusted price-earnings ratio, Wall Street looks overvalued on a multiple of 22, some 37% above the historic average. That already seems to price in a significant rebound in corporate profits.
The fundamental problem remains. In a normal American economy, with 2% inflation and 3% real GDP growth, government-bond yields ought to be around 5%. But yields at that level would be too high for the health of the housing market, the stockmarket and for other governments worldwide. The markets are no closer to resolving that dilemma than they were at the start of 2010.
Nature of economic recovery in the U.S. and Europe is quite worrisome. 41 states in USA are acting like Greece/Ireland. California, Florida, Michigan are experiencing default like situation. Moody's might cut the sovereign debt rating in the 12-18 months.
According to the survey and interviews with various amercians. People with incomes of $75,000 or more are more optimistic about the economy, while unemployment for people with college degrees is half as high as for those without degrees
These divisions across geographic and income segments cause a deterioration in political dialogue. In the U.S., the left does not want to talk to the right, which is a recipe for gridlock. In the past, government not working may not have been a bad
thing. But government not working when your fiscal deficit is 10 percent of GDP is not a good idea. Much needs to be done to bring things back under control, and that requires cooperation.
Disclaimer: This is just a research piece and not an investment advice. Investors are highly encouraged to execute their own due diligence before making any investment strategy or implementation.
Europe's economy would become 1/3 of the global economy in the next 3-years.-Threat to Euro By Shan Saeed
Europe's economy would become 1/3 of the global economy in the next 3-years. Spending cut would be a huge drag on the economy. US companies would suffer most....Threat to Euro
By Shan Saeed
Its like a train coming at you and you are not going to stop it by standing in its way…..The series of events in Euro zone were nerve shivering. Just when the market seemed to have got over its sovereign debt jitters, the Irish crisis has come back to haunt us all. Thanks to its €750 billion stabilization fund, Europe is better equipped to deal with the situation than it was earlier this year.
However, Euro zone’s economy will become weak going forward with series of bail outs and sovereign debt risk going out of the roof. Euro economy would become 1/3 of the global economy for sure.
The Greek bailout did nothing for the country's bond yields, however, which are still 9.09% higher than their German equivalents. Ireland's sovereign spread is not all that much lower, at 6.83%. Bond yields are going up, prices are down. Moody’s is cutting Spanish Sovereign rating. Investors are nervous at this topsy-turvy situation. E.U. officials had hoped the
Irish rescue, and greater clarity on future rescues, would quell
market fears of contagion spreading to other heavily indebted euro
countries, like Spain and Portugal. Spain bail out would cost $617 billion to the European Monetary Union and sleepless nights for economic managers.
Unlike Iceland, which pulled out of its own debt crisis in part by
devaluing its currency to increase exports, euro countries like
Greece, Portugal and Ireland cannot use devaluation as a way to
stimulate growth. That makes their prospects for escaping a debt
crisis look bleak because the cuts needed to control budget deficits
also depress growth. Austerity plans, belt tightening and fiscal authority have never worked because governments need to spend more , come out with stimulus to keep the economy moving .
“It’s very hard for any economy to flourish in the teeth of fiscal
austerity of this magnitude — let alone those that can’t devalue. These levels suggest a high probability that debt will not be repaid in full. So is restructuring on the cards? This is the only solution to send positive signal to the market. Bail out is not working to calm the markets or the investors.
US & EUROPEAN MARKETS. Key lessons.
Contagion from the European debt crisis could infect U.S. markets, and
if it does, it will happen fast. Most of the US companies drive their profits around 53% from Europe. The U.S. stock market is recovering although not in a stellar fashion,
with earnings growing in line with overall economic growth. I don’t see anything that’s rapidly going to increase the rate of U.S. growth and world growth.
The 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.
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.
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.
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.
The Germans have recently reduced labor market regulation, increased wage
flexibility and taken strong measures to balance budgets.
In the U.S., policy makers inherited a different economic model, one
that also has certain advantages. It fosters disruptive innovation (of
the sort useful in Silicon Valley). It also has certain disadvantages
— a penchant for over-consumption and short term thinking.
STRESS TEST ---AN ILLUSION
Banking stress tests were not stringent enough to sustain this pressure. Classic case studies of 2 banks in Ireland that succumbed to the pressure of sovereign debt risk. Bank of Ireland and Allied Irish Bank were asked to raise capital to remain safe and secure in the financial market. Although they did clear the stress test.
EUROPE’S FUTURE.
Markets, meanwhile, continue to suffer from fears that Europe won't contain its debt woes. Europe’s economy will become 1/3rd of the global economy and getting into the sluggish mode.
European markets have taken a beating lately due to concerns that
economic crises in Ireland will spread to countries such as Spain and
Portugal. Spain crisis would be the real stress for the policy makers taking into account the size of its economy i.e. GDP size $1.47 trillion twice the size of Greece, Portugal and Ireland. In other words, close to half of Germany’s GDP $3.35 trillion
And what is Spain’s fiscal deficit? Last year, it was officially 7.9% of GDP—twice the EU limit. Not Irish or Portuguese or much less Greek numbers, but still up there—officially. Why do I say “officially”? And now put “officially” in scare quotes? Because of a very disturbing anonymous paper, released last September on 30 2009.
It basically said that the Spanish GDP numbers for 2009 were cooked—and then went ahead and showed the whys and hows of this analysis. FT originally ran the piece—and it was picked up by everybody, freaking everyone out. But then FT retracted under political pressure, excusing their cowardice by saying “life is too short”. Let’s look at Greece and Ireland:
Originally it was thought that €45 billion would be enough to bail out Greece—but the final tally for that looked to be something like €90 billion [about $122 billion]. At this time, bailing out Ireland is going to come to something similar over the next 3 years—€90 billion—assuming, of course, there aren’t any hidden nightmares in the Irish banking sector, which is the reason Ireland is going under. In both these cases, essentially three times the yearly deficit was the ballpark figure for the European bailouts.
Therefore, to bail out Spain, and plug up its fiscal balance sheet hole over the next three years would cost €450 billion—minimum. That’s about $600 billion.
Look at that number again—look at it closely, and take your time: €450 billion.
That’s twice the size of Ireland’s total GDP for 2009. In order to figure out how much each party would have to shoulder of this €450 billion price tag.
According to Paul Krugman, it was essentially advocating war as a fiscal stimulus solution...But figures are fudged. Taking into account, the considerable bad things about Greece, regarding faked GDP data[ Courtesy Goldman Sachs ] —and knowing the Spanish—I wouldn’t be a bit surprised that Spanish GDP figures have been faked in Madrid, in order to keep everything copacetic. Compare Spain and USA. What’s striking about Spain, from an American perspective, is how much its economic story resembles liKe US. Like America, Spain experienced a huge property bubble, accompanied by a huge rise in private-sector debt. Like America, Spain fell into recession when that bubble burst, and has experienced a surge in unemployment. And like America, Spain has seen its budget deficit balloon thanks to plunging revenues and recession-related costs.
But unlike America, Spain is now going deep into debt crisis. The U.S. government is having no trouble financing its deficit, with interest rates on long-term federal debt under 3 percent. Spain, by contrast, has seen its borrowing cost shoot up in recent weeks, reflecting growing fears of a possible future default. Why is Spain in so much trouble? In a word, it’s the euro.
Spain was among the most enthusiastic adopters of the euro back in 1999, when the currency was introduced. And for a while things seemed to go swimmingly: European funds poured into Spain, powering private-sector spending, and the Spanish economy experienced rapid growth.
Through the good years, by the way, the Spanish government appeared to be a model of both fiscal and financial responsibility: unlike Greece, it ran budget surpluses, and unlike Ireland, it tried hard (though with only partial success) to regulate its banks. At the end of 2007 Spain’s public debt, as a share of the economy, was only about half as high as Germany’s, and even now its banks are in nowhere near as bad shape as Ireland’s.
But problems were developing under the surface. During the boom, prices and wages rose more rapidly in Spain than in the rest of Europe, helping to feed a large trade deficit. And when the bubble burst, Spanish industry was left with costs that made it uncompetitive with other nations.
Now what? If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.
And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems. What all this means for Spain is very poor economic prospects over the next few years. America’s recovery has been disappointing, especially in terms of jobs — but at least we’ve seen some growth, with real G.D.P. more or less back to its pre-crisis peak, and we can reasonably expect future growth to help bring our deficit under control. Spain, on the other hand, hasn’t recovered at all. And the lack of recovery translates into fears about Spain’s fiscal future.
Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”
But even if they haven’t been, it’s not as if the official numbers are painting a rosy picture: Spain has nearly 20% unemployment, near 10% yearly fiscal deficit to GDP, and no clear way how to get out of this hole that it is in. So much of Spanish growth over the last decade was fueled by real estate development and over-leveraging, that there’s no clear way forward for the Spanish economy.
Ireland has accepted a bailout package to rescue its banking sector,
but the problem with European bailouts is that
those countries aiding their neighbors are dealing with their own
economic problems as well.
I look to Europe, and I’m wondering who’s supporting who over there.
These are not wealthy nations, any of them, and they are supporting
their weakest members. I don't see how it could help but
be contagion. Whether we like it or not we live in a global world and any kind of
contagion is going to spread very quickly.
BRADY’S PLAN IS REQUIRED IN EUROPE IN THE NEAR FUTURE.
Another idea that has gained some ground recently is a Brady plan for
indebted European economies. The plan was recently put forward by a
former Treasury secretary, Nicholas F. Brady, who led an effort in
1989 to help Mexico and other Latin American economies restructure
their debt — requiring bondholders to take a loss of 30 percent in
exchange for new, longer dated debt instruments that had lower rates
and were backed by 30-year United States zero-coupon bonds. Much
criticized at the time, the plan is now seen as the first step of
Latin America’s recovery.
FUTURE OUTLOOK FOR EUROPE.
The worry is that Ireland won't mark the end of the eurozone crisis
and with the economies of Portugal and Spain looking less than robust,
markets are worried that we could be talking about potential bailouts
once again in the not-too-distant future. European officials concede that, for euro-zone nations unable to
devalue, the process of adjustment may be long and painful. Internal devaluation would be a drag on the economies opting out of Euro Single Currency. Their
strategy is to push structural changes and new rules based on the
lessons of the crisis, in hopes of preventing such divergences in the
future.
European Central Bank policymaker are increasing their efforts to bolster
market confidence in the eurozone's rescue for Ireland, informing the cagey
investors they should have faith in the plan's success. They are goading the investors as they are dealing with Ireland to bring down Dublin's borrowing costs to more normal levels. "There is no reason to doubt the recovery plans of the two countries. But market reaction showed investors thought the crisis that started with Greece's budget blow-out more than a year ago was far from over.
I don't think this is going to be a silver bullet. I think there are
still going to be some question marks on Portugal and Spain. Moody’s is cutting the AA rating on Spanish sovereign bonds, thus sending ripples in the financial market. One of the questions that has been dogging markets for weeks and
helped drive Ireland off the cliff was whether and under what
circumstances private bondholders could be made to take losses, or
"haircuts," on eurozone government debt. Overall economic growth in the euro zone is expected to be 1.51 percent in 2011, slightly lower than the projection for 2010. .
Even as the yields on the 10-year bonds of Greece, Ireland, Portugal
and Spain are going higher and bond holders are looking elsewhere to diversify their risk and get of the market, EU officials haave been lackluster in their approach to solve this pressing issue. Rising
yields reflect increased risk in the eyes of investors as well as
inflationary expectations. Not that anyone expects Germany, by far
Europe’s most powerful economy, to come close to defaulting on its
debt. And neither Italy nor Belgium is considered in the same boat as
Greece, Ireland and Portugal, since their deficits are lower and they
borrow primarily from domestic lenders. Instead, the fear is that
Europe’s strategy so far — painfully drawn out step-by-step bailouts
of Greece and Ireland — has failed to impress the markets and that the
burden to finance even larger rescues for Spain and perhaps even Italy, Belgium or Portugal would be too much for Germany to bear, both financially and
politically.
Current cycle of soaring bond yields among European economies to the
series of competitive devaluations that led to the collapse in the
early 1990s of the European Exchange Rate Mechanism, the precursor to
today’s monetary union that binds the 16 nations in the euro zone.
We can clue from someone [ De Grauwe] who proposed transforming Europe’s rescue facility into a
European equivalent of the I.M.F., but other specialists advocate that
Europe is not prepared to undertake the long and political challenging
treaty revisions that would be required to bring it to life. Still
others acknowledge that some form of restructuring is crucial.
just as investors of Dubai World were required to
share the pain in return for a rescue by Abu Dhabi, so should
bondholders in Irish banks. It was not easy, but in the end all the creditors accepted it.
Disclaimer:
This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making an investment decision or strategy implementation.
By Shan Saeed
Its like a train coming at you and you are not going to stop it by standing in its way…..The series of events in Euro zone were nerve shivering. Just when the market seemed to have got over its sovereign debt jitters, the Irish crisis has come back to haunt us all. Thanks to its €750 billion stabilization fund, Europe is better equipped to deal with the situation than it was earlier this year.
However, Euro zone’s economy will become weak going forward with series of bail outs and sovereign debt risk going out of the roof. Euro economy would become 1/3 of the global economy for sure.
The Greek bailout did nothing for the country's bond yields, however, which are still 9.09% higher than their German equivalents. Ireland's sovereign spread is not all that much lower, at 6.83%. Bond yields are going up, prices are down. Moody’s is cutting Spanish Sovereign rating. Investors are nervous at this topsy-turvy situation. E.U. officials had hoped the
Irish rescue, and greater clarity on future rescues, would quell
market fears of contagion spreading to other heavily indebted euro
countries, like Spain and Portugal. Spain bail out would cost $617 billion to the European Monetary Union and sleepless nights for economic managers.
Unlike Iceland, which pulled out of its own debt crisis in part by
devaluing its currency to increase exports, euro countries like
Greece, Portugal and Ireland cannot use devaluation as a way to
stimulate growth. That makes their prospects for escaping a debt
crisis look bleak because the cuts needed to control budget deficits
also depress growth. Austerity plans, belt tightening and fiscal authority have never worked because governments need to spend more , come out with stimulus to keep the economy moving .
“It’s very hard for any economy to flourish in the teeth of fiscal
austerity of this magnitude — let alone those that can’t devalue. These levels suggest a high probability that debt will not be repaid in full. So is restructuring on the cards? This is the only solution to send positive signal to the market. Bail out is not working to calm the markets or the investors.
US & EUROPEAN MARKETS. Key lessons.
Contagion from the European debt crisis could infect U.S. markets, and
if it does, it will happen fast. Most of the US companies drive their profits around 53% from Europe. The U.S. stock market is recovering although not in a stellar fashion,
with earnings growing in line with overall economic growth. I don’t see anything that’s rapidly going to increase the rate of U.S. growth and world growth.
The 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.
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.
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.
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.
The Germans have recently reduced labor market regulation, increased wage
flexibility and taken strong measures to balance budgets.
In the U.S., policy makers inherited a different economic model, one
that also has certain advantages. It fosters disruptive innovation (of
the sort useful in Silicon Valley). It also has certain disadvantages
— a penchant for over-consumption and short term thinking.
STRESS TEST ---AN ILLUSION
Banking stress tests were not stringent enough to sustain this pressure. Classic case studies of 2 banks in Ireland that succumbed to the pressure of sovereign debt risk. Bank of Ireland and Allied Irish Bank were asked to raise capital to remain safe and secure in the financial market. Although they did clear the stress test.
EUROPE’S FUTURE.
Markets, meanwhile, continue to suffer from fears that Europe won't contain its debt woes. Europe’s economy will become 1/3rd of the global economy and getting into the sluggish mode.
European markets have taken a beating lately due to concerns that
economic crises in Ireland will spread to countries such as Spain and
Portugal. Spain crisis would be the real stress for the policy makers taking into account the size of its economy i.e. GDP size $1.47 trillion twice the size of Greece, Portugal and Ireland. In other words, close to half of Germany’s GDP $3.35 trillion
And what is Spain’s fiscal deficit? Last year, it was officially 7.9% of GDP—twice the EU limit. Not Irish or Portuguese or much less Greek numbers, but still up there—officially. Why do I say “officially”? And now put “officially” in scare quotes? Because of a very disturbing anonymous paper, released last September on 30 2009.
It basically said that the Spanish GDP numbers for 2009 were cooked—and then went ahead and showed the whys and hows of this analysis. FT originally ran the piece—and it was picked up by everybody, freaking everyone out. But then FT retracted under political pressure, excusing their cowardice by saying “life is too short”. Let’s look at Greece and Ireland:
Originally it was thought that €45 billion would be enough to bail out Greece—but the final tally for that looked to be something like €90 billion [about $122 billion]. At this time, bailing out Ireland is going to come to something similar over the next 3 years—€90 billion—assuming, of course, there aren’t any hidden nightmares in the Irish banking sector, which is the reason Ireland is going under. In both these cases, essentially three times the yearly deficit was the ballpark figure for the European bailouts.
Therefore, to bail out Spain, and plug up its fiscal balance sheet hole over the next three years would cost €450 billion—minimum. That’s about $600 billion.
Look at that number again—look at it closely, and take your time: €450 billion.
That’s twice the size of Ireland’s total GDP for 2009. In order to figure out how much each party would have to shoulder of this €450 billion price tag.
According to Paul Krugman, it was essentially advocating war as a fiscal stimulus solution...But figures are fudged. Taking into account, the considerable bad things about Greece, regarding faked GDP data[ Courtesy Goldman Sachs ] —and knowing the Spanish—I wouldn’t be a bit surprised that Spanish GDP figures have been faked in Madrid, in order to keep everything copacetic. Compare Spain and USA. What’s striking about Spain, from an American perspective, is how much its economic story resembles liKe US. Like America, Spain experienced a huge property bubble, accompanied by a huge rise in private-sector debt. Like America, Spain fell into recession when that bubble burst, and has experienced a surge in unemployment. And like America, Spain has seen its budget deficit balloon thanks to plunging revenues and recession-related costs.
But unlike America, Spain is now going deep into debt crisis. The U.S. government is having no trouble financing its deficit, with interest rates on long-term federal debt under 3 percent. Spain, by contrast, has seen its borrowing cost shoot up in recent weeks, reflecting growing fears of a possible future default. Why is Spain in so much trouble? In a word, it’s the euro.
Spain was among the most enthusiastic adopters of the euro back in 1999, when the currency was introduced. And for a while things seemed to go swimmingly: European funds poured into Spain, powering private-sector spending, and the Spanish economy experienced rapid growth.
Through the good years, by the way, the Spanish government appeared to be a model of both fiscal and financial responsibility: unlike Greece, it ran budget surpluses, and unlike Ireland, it tried hard (though with only partial success) to regulate its banks. At the end of 2007 Spain’s public debt, as a share of the economy, was only about half as high as Germany’s, and even now its banks are in nowhere near as bad shape as Ireland’s.
But problems were developing under the surface. During the boom, prices and wages rose more rapidly in Spain than in the rest of Europe, helping to feed a large trade deficit. And when the bubble burst, Spanish industry was left with costs that made it uncompetitive with other nations.
Now what? If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.
And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems. What all this means for Spain is very poor economic prospects over the next few years. America’s recovery has been disappointing, especially in terms of jobs — but at least we’ve seen some growth, with real G.D.P. more or less back to its pre-crisis peak, and we can reasonably expect future growth to help bring our deficit under control. Spain, on the other hand, hasn’t recovered at all. And the lack of recovery translates into fears about Spain’s fiscal future.
Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”
But even if they haven’t been, it’s not as if the official numbers are painting a rosy picture: Spain has nearly 20% unemployment, near 10% yearly fiscal deficit to GDP, and no clear way how to get out of this hole that it is in. So much of Spanish growth over the last decade was fueled by real estate development and over-leveraging, that there’s no clear way forward for the Spanish economy.
Ireland has accepted a bailout package to rescue its banking sector,
but the problem with European bailouts is that
those countries aiding their neighbors are dealing with their own
economic problems as well.
I look to Europe, and I’m wondering who’s supporting who over there.
These are not wealthy nations, any of them, and they are supporting
their weakest members. I don't see how it could help but
be contagion. Whether we like it or not we live in a global world and any kind of
contagion is going to spread very quickly.
BRADY’S PLAN IS REQUIRED IN EUROPE IN THE NEAR FUTURE.
Another idea that has gained some ground recently is a Brady plan for
indebted European economies. The plan was recently put forward by a
former Treasury secretary, Nicholas F. Brady, who led an effort in
1989 to help Mexico and other Latin American economies restructure
their debt — requiring bondholders to take a loss of 30 percent in
exchange for new, longer dated debt instruments that had lower rates
and were backed by 30-year United States zero-coupon bonds. Much
criticized at the time, the plan is now seen as the first step of
Latin America’s recovery.
FUTURE OUTLOOK FOR EUROPE.
The worry is that Ireland won't mark the end of the eurozone crisis
and with the economies of Portugal and Spain looking less than robust,
markets are worried that we could be talking about potential bailouts
once again in the not-too-distant future. European officials concede that, for euro-zone nations unable to
devalue, the process of adjustment may be long and painful. Internal devaluation would be a drag on the economies opting out of Euro Single Currency. Their
strategy is to push structural changes and new rules based on the
lessons of the crisis, in hopes of preventing such divergences in the
future.
European Central Bank policymaker are increasing their efforts to bolster
market confidence in the eurozone's rescue for Ireland, informing the cagey
investors they should have faith in the plan's success. They are goading the investors as they are dealing with Ireland to bring down Dublin's borrowing costs to more normal levels. "There is no reason to doubt the recovery plans of the two countries. But market reaction showed investors thought the crisis that started with Greece's budget blow-out more than a year ago was far from over.
I don't think this is going to be a silver bullet. I think there are
still going to be some question marks on Portugal and Spain. Moody’s is cutting the AA rating on Spanish sovereign bonds, thus sending ripples in the financial market. One of the questions that has been dogging markets for weeks and
helped drive Ireland off the cliff was whether and under what
circumstances private bondholders could be made to take losses, or
"haircuts," on eurozone government debt. Overall economic growth in the euro zone is expected to be 1.51 percent in 2011, slightly lower than the projection for 2010. .
Even as the yields on the 10-year bonds of Greece, Ireland, Portugal
and Spain are going higher and bond holders are looking elsewhere to diversify their risk and get of the market, EU officials haave been lackluster in their approach to solve this pressing issue. Rising
yields reflect increased risk in the eyes of investors as well as
inflationary expectations. Not that anyone expects Germany, by far
Europe’s most powerful economy, to come close to defaulting on its
debt. And neither Italy nor Belgium is considered in the same boat as
Greece, Ireland and Portugal, since their deficits are lower and they
borrow primarily from domestic lenders. Instead, the fear is that
Europe’s strategy so far — painfully drawn out step-by-step bailouts
of Greece and Ireland — has failed to impress the markets and that the
burden to finance even larger rescues for Spain and perhaps even Italy, Belgium or Portugal would be too much for Germany to bear, both financially and
politically.
Current cycle of soaring bond yields among European economies to the
series of competitive devaluations that led to the collapse in the
early 1990s of the European Exchange Rate Mechanism, the precursor to
today’s monetary union that binds the 16 nations in the euro zone.
We can clue from someone [ De Grauwe] who proposed transforming Europe’s rescue facility into a
European equivalent of the I.M.F., but other specialists advocate that
Europe is not prepared to undertake the long and political challenging
treaty revisions that would be required to bring it to life. Still
others acknowledge that some form of restructuring is crucial.
just as investors of Dubai World were required to
share the pain in return for a rescue by Abu Dhabi, so should
bondholders in Irish banks. It was not easy, but in the end all the creditors accepted it.
Disclaimer:
This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making an investment decision or strategy implementation.
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