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Archive for June 2013

Archive for June, 2013

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Outside the Box: A Message from Lord Vader

By John Mauldin

 

As long-time readers know, I have a very eclectic group of friends and associates. Colorful, opinionated, generally both fun and funny, they make for interesting times and discussions wherever I go. I am not certain why they associate with such a mild-mannered, soft-spoken, Muddle-Through Texan like me, but most agree that I am at least good for comic relief. Next week I will be in the midst of some unabashed bulls, but today I offer up for your reading pleasure a note from a friend who is on the Dark Side of the fence, though he is hardly what you could call a conventional bear. He is Rich Yamarone, Chief Economist for Bloomberg.

Lately, Rich has become known in the trade as Lord Vader for his always enthusiastic but distinctly gloomy views, and he has assumed the persona with some gusto. You are about to be treated to a missive he writes from the Dark Side, where he is spending the summer, finding many things to worry about. And he backs up his concerns with a solid list of facts and data, as well as some of the findings from the Orange Book that he writes each month. The Orange Book is a summation of the economic notes from Rich’s conference calls with the CEOs and CFOs of the largest businesses in the S&P 500. It has become de rigeur reading for those looking for signals from the business community. And what those CEOs tell us is that the economy is soft – which, given that GDP growth is likely to be less than 2% for the year, is confirmation of what we’re hearing from other directions. Herein we learn that things might get bumpy on the ride ahead, but at least we are entertained by Mr. Yamarone even as we are forewarned.

Rich is part of dynamic group of economists who contribute to the Bloomberg Brief: Economics newsletter. Rich, along with my friend Tom Keene and five others, distills the day’s must-know information to about ten pages, every day. And Rich’s Orange Book is part of the deal. Check it out here.

And speaking of bumpy, I am waiting to get on a plane to Cyprus, which has experienced a rough ride of its own of late. I will report this weekend on what I find. On Thursday I will catch an irrationally early flight to Split, Croatia,  where I will be gathered by the notoriously colorful Irish economist David McWilliams, who will regale me and perhaps even alarm me with his tales (such wonderful stories they are!). But not before I wander around Split for a bit and make sure my weekly letter to you gets writ.

There was an unexpected pleasure this weekend. My long-time great friend (and the founder of Agora Publishing) Bill Bonner was in residence at his chateau in Normandy. Bill and I have both been in the writing game for over 30 years – he obviously more successfully than I – and we do enjoy comparing notes on the angst and travail of moving ideas from brain to page – first onto paper, in olden times, and now onto computer screens. I will admit to preferring the latter as a writing medium – I am not the least bit nostalgic for paper and pen.

I journeyed out by train from Paris to meet him, and he and his lovely wife, Elizabeth, showed me around another in their ever-growing collection of wonderful old stone piles. This one is also known affectionately as “the money pit.” But they truly enjoy challenging fixer-uppers (however odd this seems to me), and this one has needed a great deal of fixing; so they have got their money’s worth of enjoyment, if not actual recoverable value in the property itself. Still and all, it is turning out to be a marvelous place, rich in history; and as I wandered around I was brought back to a time when things were somewhat different and places like this were populated by aristocratic lords and ladies and such. Given that my ancestors were at the bottom rung of whatever ladder they jumped off to come out to Texas, I was not so much nostalgic for that lost era as grateful that my ancients had the good sense to repair to a place where people care less about where you came from than who you are in the here and now. It gave us poor peasants a chance.

And now it is time to hit the send button, as Air Cyprus will not hold the plane for either lords or Texans. Have a great week.

John Mauldin, Editor
Outside the Box

subscribers@mauldineconomics.com

A Message from Lord Vader

“There is no dark side of the moon really. Matter of fact, it’s all dark.”

Pink Floyd

A recent gut feeling about a global unraveling has forced the Prince of Darkness to issue the following statement regarding the economic climate (as well as provide an open invite to the annual Dark Side summer soiree): Emerging markets are in turmoil, Europe is spiraling deeper into recession and finance ministers in the region are scrambling to fix the seemingly never ending banking crisis. Turkey is the new hotbed of civil unrest, and central banks and sovereign nations are providing extreme monetary policy accommodation and engaging in currency wars to maintain some sense of stabilization. The World Bank reduced its global economic forecast to 2.2 percent in 2013 – lower than the 2.3 percent performance in 2012.

It was just a matter of time before the conditions started to break down. If you see a 500 lb. man eating a donut and smoking a cigarette, you needn’t be a genius to know the situation isn’t going to end well. Similarly, blistering gains in the equity indexes to record highs amid a sluggish economic performance are simply unsustainable. Look at the bifurcation between the CRB index and the S&P 500; that solid relationship between the market and economy broke down in December of last year, and it now looks as if the S&P will rejoin the commodity benchmark in its tailspin.

GDP advanced by a seasonally adjusted annual rate of 2.4 percent in the first quarter, resulting in a 1.8 percent increase over the previous year – which is usually a recession indicator. For now it’s likely that the economy continues to plod along at this subdued level until one of the many obstacles send it south.

We recently saw of a number of possible signals of a downturn.

The ISM’s PMI fell to 49 in May from 50.7 in April, the first sub-50 reading in the barometer since November (49.9) and the lowest level since Jun 2009 (45.8) when the U.S. economy was emerging from depression. Along the same lines, the key subcomponents of New Orders and Production fell to 48.8 and 48.6 respectively – indicating a contraction in business conditions. This slump doesn’t appear to be solely an American condition.

The difference between the New Orders Index (a proxy for future demand) and the level of existing inventories (expectations by businesses of future demand) was -0.2 in May. Historically a negative reading has been a recession indicator. This isn’t foolproof – there have been several negative postings with a downturn surfacing – but there have been six negative readings since the end of the 2007-2009 depression, which supports a somewhat tepid situation.

The other ISM indicator is the Price Index, which slipped below 50 to 49.5 in May. Below-50 readings are always experienced during recessions. The inability of businesses to raise prices in a challenging economic environment, in combination with a sub-50 reading in the headline PMI and a negative New Orders less Inventories index suggests a notable curtailment in economic growth.

Industrial production has peaked (8.5 percent) in mid-2010 to 1.95 percent today (another indicator that has fallen below that magical 2.0 percent recession level), and manufacturers are slashing jobs again. The regional Fed manufacturing indices are all lingering in crummy territory – at best. Electricity output has fallen in each of the last five weeks (on a year-over-year basis), and shipments of nondefense capital goods excluding aircraft plunged 1.5 percent in April – a messy beginning of the second quarter.

The average length of the last ten expansions is 60.5 months, and we are currently 47 months into the most recent recovery. It isn’t inconceivable that the economy contracts at this point, especially since it has been operating at a pace that has historically suggested recession.

If the global equity market sell-off is not a “Sell in May” event, but rather the beginning of the great unwinding then the economy, already skating on thin ice, is even more susceptible to a downturn.

There is something to consider with respect to the sluggish second quarter start: data revisions have an incredible ability to change the economic landscape and the determination of business cycle strengths and turning points. In 2008, the fourth quarter GDP was initial reported to have declined by 3.8 percent…nine revisions later the actual level stands at -8.9 percent. [Hat tip to my friends at Chilton Capital for bringing it to my attention.]

On July 31, the Bureau of Economic Analysis will revise the National Income Product Accounts (including the GDP report). What happens – pure speculation, but not entirely outrageous – if the final quarter 2012 GDP increase is downwardly revised from its current 0.4 gain to a 0.5 percent decline. And the first quarter 2013 increase of 2.4 is shaved a few basis points to a 1.8 percent increase, and the current quarter comes in negative? Will the chatter pick up about recession? Will a recession be declared? Will those folks at the ECRI be heralded as heroes? Will the Street flock to the Dark Side, and will everyone will want in on our glorious Dark Side picnic. Do we have enough chairs? Stay tuned, its less than two months away…

According to (82) economists polled by Bloomberg, U.S. GDP is expected to increase 1.9% in 2013, following a 2.2% gain in 2012. This is extremely weak by historical standards, and with the exception of one event, has resulted in recession every time since 1948.

This said, we are anticipating the addition of several Street economists to come over and join us here on the Dark Side as well as the annual picnic – we are fully prepared as we asked Beelzebub’s Catering and Party Tent Rentals to provide us with a few hundred extra chairs and tables. (Thanks guys.)

This year’s party might not be as exciting or entertaining as in previous confabs. Just as Fed Chairman Ben Bernanke will not be attending the annual central bank conference in Jackson Hole, Wyoming, we are afraid that a long-time Dark Side headliner (and a dear friend) Dave Rosenberg of Gluskin-Sheff, might not be partying with our Doom and Gloom set. This is a mighty blow – you’ll remember the 2004 and 2005 soirees when Mr. Rosenberg was undoubtedly the life of the Dark Side parties, forewarning all that would listen of the pending housing crisis and subsequent economic doom.

To date, the labor market recovery has been unimpressive. The number of Americans on nonfarm payrolls totaled 135 million in April, the same level as in late 2005. On this basis one can claim the U.S. has “turned Japanese” with a near lost decade of job creation. We should expect results that are similarly poor as in Japan in coming decades: we use the same policy prescription for the same ailment, why wouldn’t we have the same result? If you wrap avocado, cucumber, and rice in Nori with sesame seeds, it’s a California roll. Why would you think it’s something else? [For the record, there is no sushi in the Dark Side.]

It looks like 96,300 of the 175,000 new nonfarm jobs created last month were in very low wage industries (retail, 27,000), temporary, (25,600), leisure and hospitality (43,000). The industries with the two lowest hourly wages are leisure and hospitality ($11.76) and retail ($13.92). It isn’t clear how the world’s largest economy gets back on its feet with so many receiving such low incomes.

In the Dark Side wages don’t matter, everything here is free – it’s not that dark! The single greatest hurdle for the recognized U.S. economy however, is flat-to-declining wages. To some this may sound a tad like a broken record [Apparently vinyl records are more popular than cds right now see: http://bit.ly/1aWrtW3 ] but the only thing that matters to the economic recovery is incomes.

Real disposable personal incomes – the amount that consumers have to spend once adjusted for inflation and taxes – increased 0.1 percent in April, a mere 1.0 percent higher than year ago levels. Similarly, the amount of spending that Americans facilitated with that lowly income inched up 0.1 percent, or 2.1 percent from April 2012. Real disposable personal incomes had a history of advancing at 3.75 percent, which would boost spending by a similarly robust pace. As long as income growth is staid as it is, the economy will continue to spin its wheels in a sideways movement, and subsequently keep a lid on job creation.

Grab some food stamps…they don’t cost nothing. Some things don’t need to be examined to know what kind of an effect they will have on consumer psyches, spending habits, and ultimately aggregate demand. According to the USDA, there are more than 47 million Americans on the Supplemental Nutrition Assistance Program, more commonly known as food stamps. Since the end of the depression in June 2009, food stamp assistance has accelerated by 30.8 percent, dwarfing job creation of 3.8 percent during the same period. This said, it should come as no surprise grocery and health and wellness in aggregate make up about 66 percent of Wal-Mart’s revenues. More stores are adjusting space for the inclusion of groceries.

Anecdotes from the Bloomberg Orange Book – admittedly a far too bright colour for those residing here in the place of torment – point to a number of headwinds.

The Bloomberg Orange Book Sentiment Index has been below 50 (a reading of contraction) for eighteen consecutive weeks. Comments continue to paint a picture of souring business conditions.

Consumer companies complain:

Church & Dwight: “I have been a long-term pessimist about the business environment. The latest forecast of weak GDP growth, continuing high unemployment and weak same-sale stores (sic) [same-store sales] (10:30) growth by our major retailers provides little hope for near-term improvement in the U.S. economy.” “2013 is shaping up to be another very challenging year due to the weak consumer demand.”

Denny’s: “We faced significant headwinds in this quarter, as we lapped our strongest quarter of last year. And our customers felt the impact of higher payroll taxes, gas prices and delayed income tax refunds. As a result, we ended up with our first quarter of negative system-wide same-store sales in almost two years.”

Shoe Carnival: “The government’s delay to act on tax policy and their subsequent decision to raise payroll tax withholding rates had an immediate impact on our consumer. The decision the IRS made to delay accepting tax returns until January 30 also had an immediate and calculable impact on our sales results for the last 10 days of the quarter.”

Express Inc.: “At the same time, traffic is down noticeably compared to last year. Consumers appeared cautious due to the macroeconomic environment and uncertainty around budget cuts and also the impact of higher payroll taxes.”

Kona Grill: “During the quarter, the restaurant industry in general experienced a pullback in consumer spending due to the payroll tax increase, delays in income tax reform, and spiking gas prices, which impacted guest traffic and we were no exception.”

The catatonic state of affairs in Washington, DC is really upending many companies – kind of shocking that in the aftermath of depression, fiscal policy is so incredibly restrictive. Sequestration is on the minds of many companies, and it is not limited to the aerospace and defense industry:

Kelly Services: “We expect the current pace of growth will continue as the U.S. labor market remains fragile and unpredictable with no clear signs of momentum. Add to that there is ongoing uncertainty about the effects of sequestration and rising anxieties surrounding the impending Affordable Care Act, which is one of the most significant issues facing our industry today.”

Armstrong Worldwide: “On the commercial front, in the U.S., we anticipate a continuation of flat to slightly down commercial volumes, with ongoing weakness in education and, to a lesser extent, healthcare.”

Hertz Global Holdings: “In April, we experienced some softness in both the car and equipment rental businesses in the U.S. due to the holiday shift and the initial impact of the sequester. Volumes in our government businesses were down double digits this month, and our commercial accounts with exposure to government customers also cut back on travel.”

UPS: “Although the U.S. economy is poised for growth, it is being restrained somewhat by the tax increases and sequestration implemented during the first quarter. This will be a drag on 2013 GDP expansion with current expectations for about 2% growth.”

Lockheed Martin: “I think as we looked forward for the next three quarters, we do expect to see some pressures from sequestration. They’ve not played out at this point, but we do expect them to happen in the next three quarters.”

Internationally, Bloomberg Orange Book anecdotes have highlighted great concern:

Sealed Air: “As a Frenchman, I can tell you I’m very concerned about the French economy. It’s been moving towards Spain and Italy instead of moving towards Germany. And it shows in our equipment business, equipment and tools business.”

Air Products & Chemicals: “In North America we experienced modest growth; Europe sunk deeper into recession, with Southern Europe remaining particularly weak while the Northern Continent and Central Europe worsened; and in Asia there was a slower-than-expected ramp-up after the Lunar New Year holiday.”

Cooper Tire & Rubber: “China’s economy continues to grow at a slower pace than recent historical rates and Europe’s economy remains stalled. Combined, all of these challenges resulted in Cooper’s shipping volumes being 8% lower than the prior-year first quarter…”

Avis Budget: “Interestingly the markets that were weak last year Italy and Spain seemed to have stabilized thus far in 2013, while France and the UK continued to show some signs of weakness. Germany, which was the lone moderately strong performer last year, has softened this year in line with its softening economy.”

McDonald’s: “Japan’s performance for the quarter was negatively impacted by the difficult economy, a declining IEO industry, and ongoing consumer sensitivity to prices and promotions. Japan continues to evaluate and adjust its plans to complement existing value initiatives with new product news that drives long-term profitable sales and guest counts.”

Central banks all over the world are singing the song of unconventional monetary policy. Now we are all lead to believe that the Bank of Japan’s most recent announcement to adopt a $1.4 trillion quantitative easing program will be the magical elixir to its multi-decade ailments. This seems a little doubtful; as Tanya Tucker sang, “It’s a little too late to do the right thing now.”

The incomes and wage channel hold the answers to countless economic issues. Other than the obvious influences on confidence, spending, corporate profits, and hiring, there is the impact on policy prescriptions. As long as there is disinflation or deflation in average hourly earnings, the Fed should be expected to its foot on the accelerator, and refrain from tapering in the near term.

Many pundits are pointing to geopolitical uprisings as cause for concern to the U.S. economic recovery efforts. Economically speaking, the American consumer – the ultimate driver of aggregate demand – cares little about the goings on overseas. You’ll never overhear Mom pushing junior in a Wal-Mart or Target saying, “We’re not buying any toys today, there’s civil unrest in Turkey.” Investors should expect any meaningful impact from the strife in Cyprus, Syria, or any other nation that is not economically influential.

Our friend Lucifer of Lucifer’s Econometric Forecasting & Astrology informed us that this year might not be something to get excited over.  Earlier this year, the Chinese zodiac welcomed the Year of the Snake. Previous “snake years” haven’t been kind to the U.S. economy; of the last ten (1893, 1905, 1917, 1929, 1941, 1953, 1965, 1977, 1989, and 2001), the U.S economy had experienced two recessions (1953, 2001) and two depressions (1893, 1929). Other years experienced similarly profound bouts of calamity, i.e.; in 1917 the U.S. entered WW-I, and in 1941 entered WW-II. Snakes are seldom overlooked and have a tendency to strike sharply when ignored.

So while you are making your plans for this summer and the early fall, remember: here in the Dark Side there’s an open invite for the excellent assortment of dark beers for your consumption – they are warm. After all, this is the Dark Side.  There’s a wonderful dark chocolate cake for dessert, and Marilyn Manson is scheduled to be the warm-up band for Alice Cooper on Laborless Day, who will be performing at 5:00 pm in the Satan’s Den. Thanks again for considering, your table is ready.

Lord Vader

Richard Yamarone is an economist who focuses on monetary and fiscal policy, economic indicators, fixed-income, commodities, and general macroeconomic conditions for Bloomberg Brief: Economics, a daily newsletter that features analysis, data and news on the forces shaping the global economy. Mr. Yamarone and the Bloomberg Brief economics team provide in-depth analysis of macroeconomic data, policy, and trends and how they will impact financial markets.

You can download a sample issue of Bloomberg Brief: Economics here. Subscribers get Rich’s Orange Book as part of the deal.

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Things That Make You Go Hmmm: Call My Bluff

By Grant Williams  |  June 24, 2013

(Wikipedia): Call My Bluff was a long-running British game show between two teams of three celebrity contestants. The point of the game is for the teams to take it in turn to provide three definitions of an obscure word, only one of which is correct. The other team then has to guess which is the correct definition, the other two being “bluffs”.

Among the first things we learn in school are the rules of grammar — the building blocks of proper communication which underpin the English language.

Among the first things we forget when we leave school are the rules of grammar — the infuriating and extremely irritating rules rendered completely unnecessary in a world in which texting seems to be the most popular form of communication and where most sentiments can be adequately conveyed by acronyms, abbreviations, and the ubiquitous emoticon.

Source: Explosm.net

It’s amusing therefore to watch as “the market” (a collective expression of the grammatical competence of billions around the world) tries to dissect every utterance made by the likes of the Federal Open Market Committee, which itself spends an inordinate amount of time structuring its prose so as to convey, via the most intricate inflection imaginable, exactly what it intends to do.

Bizarrely, the reason it spends so much time on its statements is entirely because of the scrutiny afforded it by the market, and the reason the market scrutinizes the statements so assiduously is because it is looking for the tiniest nuance that might be a guide to the future actions of the FOMC.

Wouldn’t it all be so much simpler if the FOMC told the world, in plain English, exactly what it was thinking and the signs it was looking for that would cause it to change course?

But no. That would be far too easy. Why lay out what’s going on in plain language when you can hide behind nuance?

What we SHOULD get from the FOMC is a statement that looks something like this:

The committee feels that the economy is moribund and growth is faltering despite our best efforts at reviving it. We have kept rates at zero for the last several years and will be forced to do so for the foreseeable future — likely several years if the bond markets allow us to.

We fully realize that at some point we will have to work out how to wean the world off freshly printed money, but that day is a long way off; and so, for now, there is absolutely no need to worry about that eventuality.

We have said that we will begin to wind back QE once unemployment falls at least to 6.5%, but we very carefully said “at least” so that we had some wiggle room, because the chances are that, should we reach that target, things won’t actually be in a state where we can withdraw stimulus, and then we will need to change our language.

The Committee has decided to confiscate your savings through ZIRP and inflation so you will be forced to invest your money in risky assets, which policy we hope — oh how we hope — will stimulate some growth. We understand that you may think you have the right to live off the interest on the nest egg you have so carefully saved over your working life, but right now the needs of the many outweigh your own.

We will try to let you know when we are serious about pulling back on the monetary throttle; but in the meantime, get out there and spend, spend, spend.

Please.

The second a new communique from Ben Bernanke and the Hole in the Wall Gang is released, the race starts to be the first to publish the customary “comparison” (see example below, which I found in my trash can) and pick apart any tiny change in language or tone that might be instructive in trying to determine what the esteemed members of the committee are thinking.

Markets react according to the consensus assessment of the communique, and then the FOMC is forced to react to the market reaction if the market reaction isn’t in keeping with the reaction expected by the FOMC when they carefully craft the words that are disseminated to the expectant markets.

It’s all so tiresome.

Why the mystery? Why the intrigue? Why not just have a full and frank dialogue with the world so we all know where we stand?

Why? I’ll tell you why. Because then they would have no room to change course when it was proven that they had no idea what they were doing.

Actually, since this edition of Things That Make You Go Hmmm… starts off talking about the importance of the rules of grammar, I should perhaps amend that last sentence to include an independent clause in order to justify beginning it with the word because.

Try this:

Because the Fed has no idea what it is doing, it is much more sensible for it to be as vague as possible in its choice of language so as to leave itself room to change course when the magic pixie dust it is sprinkling on the world turns out to be largely ineffective.

To continue reading this article from Things That Make You Go Hmmm… – a free weekly newsletter by Grant Williams, a highly respected financial expert and current portfolio and strategy advisor at Vulpes Investment Management in Singapore – please click here.

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Thoughts from the Frontline: Austerity is a Four-Letter French Word

By John Mauldin

 

The France that I see as I look out from the bullet train today is far different from the France I see when I survey the economic data. Going from Marseilles to Paris, the countryside is magnificent. The farms are laid out as if by a landscape artist – this is not the hurly-burly no-nonsense look of the Texas landscape. The mountains and forests that we glide through are glorious. It is a weekend of special music all over France, and last night in Marseilles the stages were alive and the crowds out in force. The French people smile and graciously correct my pidgin attempts at speaking French. I have found it diplomatic not to mention that I think France is in for a very difficult future. Why spoil the party?

But for you, gentle reader, I will survey the economic landscape that I see on my computer screen. It shows a far different France from the one outside my window, one that resembles its peripheral southern neighbors far more than its neighbors to the north and east. The picture is not all bad, of course. There is always much to admire and love about France. But there are a lot of hard political choices to be made and much reform to be undertaken if this beautiful country is to remain La Belle France and not become the sick man of Europe. This week, in what I think will be a short letter, we’ll look at a few of the problems facing France.

A Great Deal If You Can Get It

Yesterday (June 20) the French called a Grand Summit of businesses, unions, and government officials to address the needed reforms to make France more competitive and its national budget more sustainable. Debt and deficits are high and rising as the country rolls into yet another recession in response to President Hollande’s hard left turn last year. One of the key issues is a very controversial plan to reform pensions.

Stratfor notes:

France spends roughly 12.5 percent of its gross domestic product on pensions, more than most almost any other Organization for Economic Co-operation and Development member. (For reference, Germany spends about 11.4 percent of its GDP on pensions, and Japan spends roughly 8.7 percent.)

[Note: elsewhere we find that France has a comprehensive social security (sécurité sociale) system covering healthcare, injuries at work, family allowances, unemployment insurance, and old age (pensions), invalidity and death benefits.  France spends more on ‘welfare' than almost any other EU country: over 30 per cent of GDP as a total entitlement cost. As a reference, that would be about $5 trillion in the US.]

The fact that an increasingly larger proportion of France’s population qualifies for pensions factors into the debate. In 1975, there were 31 workers paying contributions for every 10 retirees; today, there are 14 workers paying contributions for every 10 retirees. As the baby boomers from the 1950s and 1960s begin to retire in the next decade, the pressure on France’s coffers will grow substantially. The deficit of the French pension system is projected to double between 2010 and 2020, when it will exceed 20 billion euros.

It is hard for Americans to understand just how much it costs to support the average French worker (or to be self-employed). From Paris Voice:

Total social security revenue is around €200 billion per year and the social security budget is higher than the gross national product (GNP), i.e. social security costs more than the value of what the country produces. Not surprisingly, social security benefits are among the highest in the EU. Total contributions per employee (too around 15 funds) average around 60 per cent of gross pay, some 60 per cent of what is paid by employers (an impediment to hiring staff).  The self-employed must pay the full amount (an impediment to self-employment!)  However, with the exception of sickness benefits, social security benefits aren’t taxed; indeed they’re deducted from your taxable income.  Equally unsurprisingly, the public has been highly resistant to any change that might reduce benefits, while employers are pushing to have their contributions lowered.

And of course, almost the first thing that Monsieur Hollande did when he took office last year was to return the retirement age at which you qualify for a pension back to age 60 from the extremely controversial 62 that his predecessor, Sarkozy, had barely managed to push it to. Sarkozy’s “reforms” were greeted with massive protests, and Hollande used them to engineer a sweeping election victory for the Socialists. (I put “reforms” in quotes because nowhere else would a retirement age of 62 be seen as draconian, nor would the rest of the changes Sarkozy pushed through.)

Hollande faces a whole series of problems. Ambrose Evans-Pritchard notes:

The IMF’s Article IV Report on France published before the elections draws up the indictment charges: a state share of GDP above 55pc (or 56pc this year), higher than in Scandinavia, but without Nordic labour flexibility.

One of the rich world’s highest life expectancies but earliest retirement ages, a costly mix. Just 39.7pc of those aged 55 to 64 are working, compared with 56.7pc in the UK and 57.7pc in Germany. “French workers spend the longest time in retirement among advanced countries,” [the IMF] said. (the London Telegraph)

France has the highest tax and social security burden in the Eurozone and the second lowest annual working time. There has been a sharp rise in unit labor costs, making France even less competitive.

These developments have not gone unnoticed in Germany. A report by one of the conservative political parties there (the FDP) said, “French President Francois Hollande was trifling with reform, scarcely making a dent on the sclerotic labour market. Which is true of course. Hollande was elected in May 2012 on a campaign to preserve the status quo and protect the privileges of the French.” (Ambrose Evans-Pritchard, the Telegraph)

Not helping is the fact that France had a very anemic “recovery” after the Great Recession (never more than 1% a year) and is now back in full recession. Which means that tax revenues will go down, not up, and that deficits will swell.

And things are likely to get even worse. Charles Gave notes that French manufacturing is plummeting, and this has always led to further losses in GDP. The chart below from GaveKal shows the French Business Climate Survey advanced forward 9 months and the highly correlated GDP number, which follows. The IMF is now predicting a 2% annual recession in 2013, which means rising unemployment and very tepid 0.8% growth in 2014, not enough to really spur employment.

You can read a half a dozen reports and analyses of the French predicament, and they will all mention “labor rigidities” as being part of the problem. There is a high minimum wage cost, and it is hard to let employees go in difficult times, which discourages businesses from hiring young, inexperienced workers. New business start-ups, the source of real job growth, have fallen as a result of the relentless assault by the bureaucracy on entrepreneurs, not to mention the impredations of the tax-man. Corporate profit margins are thin in France, and companies are leaving for locales that afford them more-attractive cost options.

Debt servicing costs as a percentage of GDP have plunged in France from 3% in 1995 to 2% (today) even as the total amount of debt has risen four times. Low interest rates can be a thing of beauty if you want to lower costs, but when interest rates rise (and they would with a vengeance in the not too distant future if the ECB were not ready to step in, as the market clearly expects it to do) they can cripple a government already burdened with too large a deficit and unwieldy commitments. But without real reforms, how long will it be before the market sees France as another problem child, like Italy and Spain?

Austerity is a four-letter Anglo-Saxon – or even worse, Teutonic – word in socialist France, yet the market at some point is going to want to see a move toward sustainable budgets. Government bond investors are not philanthropists. They look for the least risk they can find. A realistic assessment will soon be made that France is no longer in the least-risky category.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

© 2013 Mauldin Economics. All Rights Reserved.

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Thoughts From the Frontline and MauldinEconomics.com is not an offering for any investment. It represents only the opinions of John Mauldin and those that he interviews. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest and is not in any way a testimony of, or associated with, Mauldin’s other firms. John Mauldin is the Chairman of Mauldin Economics, LLC. He also is the President and registered representative of Millennium Wave Advisors, LLC (MWA) which is an investment advisory firm registered with multiple states, President and registered representative of Millennium Wave Securities, LLC, (MWS) member FINRA and SIPC, through which securities may be offered. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB) and NFA Member. Millennium Wave Investments is a dba of MWA LLC and MWS LLC. This message may contain information that is confidential or privileged and is intended only for the individual or entity named above and does not constitute an offer for or advice about any alternative investment product. Such advice can only be made when accompanied by a prospectus or similar offering document. Past performance is not indicative of future performance. Please make sure to review important disclosures at the end of each article. Mauldin companies may have a marketing relationship with products and services mentioned in this letter for a fee.

Note: Joining The Mauldin Circle is not an offering for any investment. It represents only the opinions of John Mauldin and Millennium Wave Investments. It is intended solely for investors who have registered with Millennium Wave Investments and its partners at http://www.MauldinCircle.com (formerly AccreditedInvestor.ws) or directly related websites. The Mauldin Circle may send out material that is provided on a confidential basis, and subscribers to the Mauldin Circle are not to send this letter to anyone other than their professional investment counselors. Investors should discuss any investment with their personal investment counsel. John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private and non-private investment offerings with other independent firms such as Altegris Investments; Capital Management Group; Absolute Return Partners, LLP; Fynn Capital; Nicola Wealth Management; and Plexus Asset Management. Investment offerings recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor’s services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor’s interest in alternative investments, and none is expected to develop. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs may or may not have investments in any funds cited above as well as economic interest. John Mauldin can be reached at 800-829-7273.

Red and White target with three arrow

Thoughts from the Frontline: Banzai! Banzai! Banzai!

By John Mauldin

I shot an Arrow into the air
It fell to earth I know not where….

Henry Wadsworth Longfellow

As kids, not knowing that we were being politically incorrect on so many levels, we would shout “Geronimo!” when we were playing war or getting ready to do something reckless. (For those not familiar, Geronimo was a rather fearsome Apache chief who plagued Mexico and the American cavalry.) Sam Houston and his fellows cried, “Remember the Alamo!” as they rode down upon Santa Ana at San Jacinto. The British went to battle with “God Save the Queen [or King]!” Confederate soldiers took up the rebel yell as they charged live bullets and fixed bayonets. Every good war movie has its own memorable moment of the battle charge.

In Japan, the term Banzai! literally means “ten thousand years” and can be used to wish someone long life and happiness. But during World War II, “Banzai!” was shouted in battle. It was the Japanese equivalent of “Long live the king!” – but to soldiers on the other side it came to mean a suicidal, hell-for-leather attack.

If the central bankers of the world think they’re hearing a battle cry of “Banzai!” from the lips of their Japanese brethren, they may not be far from wrong, because the Japanese are indeed on a mad charge to fight deflation at all costs. As with all good suicidal charges, at least in legend and lore, once the cry has gone up and the thundering charge has begun, there can be no turning back.

For the last three weeks, I have been making what I personally think is a rather strong case that the Japanese have embarked on what may be simultaneously the most outrageous, intriguing, and desperate monetary policy experiment by a major economic power in history. (Those letters are here, here, and here). The Japanese are rapidly coming to their own Endgame, the end of their ability to borrow money at interest rates that are economically rational. If interest rates on Japanese bonds rise to a mere 2.2%, 80% of tax revenues will go just to pay the interest on their debt. At a 245% debt-to-GDP ratio, they are in desperate straits, and they know it. And desperate times call for desperate measures.

To get to where they want to go, to grow their way out of their deflationary problem, the Japanese need both inflation and real growth. Real growth can come from massively increased exports, and inflation can even come from an increase in export prices. Both results can be obtained by weakening the yen. As I have shown, they need to devalue the yen by 15-20% a year for many years in order to break through to the other side.

That should be easy, at least in theory. Inflation, Milton Friedman famously said, is “always and everywhere a monetary phenomenon.” If you want to create inflation and devalue your currency, just print more money. A second shift in the print shop is in order, and if that doesn’t produce the desired results a third shift can be arranged, and then you can run full tilt on weekends. And soon maybe it will be time to build another print shop.

But that is the theory. In practice it may be harder for Japan to grow and generate inflation than it might be for other major nations. Today we’ll focus on Japanese demographics. While the letter is full of graphs and charts, it does not paint a pretty picture. The forces of deflation will not go gently into that good night.

And now, let’s shout “Banzai!” together as we dive right into Japanese demographics.

The Demographics of Doom

Creating inflation is the goal, but Prime Minister Abe and Bank of Japan Governor Kuroda face a very difficult task. Unlike in Zimbabwe, Argentina, and a host of other countries with defunct fiat currencies, in Japan it is not simply a matter of racking up untenable amounts of debt and then printing tons of money. If it were that simple, inflation would be rampant in Japan, for the Japanese have borrowed more than any country in modern history (relative to their size). And while their efforts to create inflation have been futile, it is not for lack of trying: the Japanese have been actively pursuing quantitative easing for many years. Carl Weinberg of High Frequency Economics, writing in the Globe and Mail, gives us a very succinct summary of the Japanese dilemma:

The National Institute of Population and Social Security Research projects that Japan’s working-age population will decline over the next 17 years, to 67.7 million people by 2030 from 81.7 million in 2010. We select 2030 as the endpoint of today’s discussion because almost all the people who will be in the working-age population by 2030, 17 years from now, have been born already. Immigration and emigration are trivial. The 17-per-cent decline in the working-age population is a certainty, not a forecast. It averages out to a decline of 0.9 per cent a year. In addition, these official projections show a rise in the population aged over 64 to 36.9 million in 2030 from 29.5 million in 2010. If the labour-force participation rate stays constant, we estimate the number of people seeking work in the economy will fall to 56.5 million by 2030 from 65.5 million today and 66 million in 2010.

What happens when a nation’s population declines and the proportion of working-age people decreases? In the first, simplest, level of analysis, the production potential of the economy declines: Fewer workers can produce fewer goods. This does not mean GDP must decline; productivity gains could offset a decline in the labour force. Also, an increase in the labour-force participation rate could mute the effect of a declining working-age population. However, even if the labour force participation rate were to rise to 100 per cent by 2030 from 81 per cent today (which it cannot, because some people have to care for the old and the young, and some are disabled or lack adequate skills or education), there would be fewer workers available in 2030 than there are today.

With fewer people working, the burden of servicing the public-sector debt will be higher for each individual worker. We project that the debt-to-GDP ratio and the debt-per-worker ratio will grow unabated over the next 17 years and beyond. Also, the rise of the ratio of retired workers to 32 per cent of the population from 23 per cent means that people who are still working in 2030 will have to give up a rising share of their income to support retirees. The disposable income of the declining number of workers will fall faster than the decline of production and employment. Overall demand of workers will decrease – with their disposable income – faster than output for the next 17 years at least. Demand will also fall as new retirees spend less than in their earning years.

Based on demographic factors alone, the decline of aggregate demand between now and 2030 will exceed the decline of output, creating persistent and widening excess capacity in the economy. Prices must fall in an economy where slack is steadily increasing. In addition, advancing technology will likely increase output per worker in the future. With overall demand and output falling, productivity gains will lower labour costs and add to downward pressure on prices. Disinflation and deflation are the companions of demographic decline.

Andrew Cates, an economist for UBS, based in Singapore, published a penetrating study on the relationship between inflation and demographics this week. He notes that countries with older populations tend to have lower inflation. That is not what the textbooks suggest, but it’s what the data reveals:

Since ageing demographics will now start to feature more prominently in the outlook for many major developed and developing countries this is clearly of some significance for how inflation might evolve from here. By extension it could be of greater significance for monetary policy settings and the broader outlook for global growth and financial markets as well.

Let’s first look at the evidence. In the chart below we show average inflation levels over the last 5 years plotted against the 5-year change in the dependency ratio. The latter is the ratio of the very old and the very young to the population of working age. A shift down in that ratio implies that the population in a given country is getting younger (and vice versa). The chart therefore shows that those countries that have been getting older in recent years have typically faced very low inflation rates and, in the case of Japan, deflation. In the meantime those countries that have been getting younger in recent years, such as India, Turkey, Indonesia and Brazil, have faced relatively high inflation rates.

Cates looks not just at Japan but takes a more global view. However, Japan does stand out in this chart. (I do not have a link, as this work is just available from UBS for now.) I added the red box to highlight Japan:

And while correlation is not causation, the following graph of inflation vs. population growth in Japan does make you think.

And let’s throw in one more chart from Mr. Cates. He notes that textbook economics suggests that a falling workforce tends to put upward pressure on wages (labor is just an input resource on the supply side), and thus one ends up with cost-push inflation:

This, though, ignores other factors that are arguably of some relevance in the domestic inflation-generating process. Demographic influences for example will influence an economy’s natural demand for consumer durables, its housing stock and broader credit aggregates. The latter is certainly borne out by the reasonably close correlation that exists between credit and ageing in the chart below.

Finding Japanese Optimists

As negative as all of the above sounds, you can find those who think the Japanese economy can turn itself around, that inflation can be drummed up, and that Japanese interest rates – even given the amount of monetization they are contemplating – will not rise. Seriously.


To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

© 2013 Mauldin Economics. All Rights Reserved.

Thoughts from the Frontline is a free weekly economic e-letter by best-selling author and renowned financial expert, John Mauldin. You can learn more and get your free subscription by visiting www.MauldinEconomics.com.

Please write to subscribers@mauldineconomics.com to inform us of any reproductions, including when and where copy will be reproduced. You must keep the letter intact, from introduction to disclaimers. If you would like to quote brief portions only, please reference www.MauldinEconomics.com.

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Thoughts From the Frontline and MauldinEconomics.com is not an offering for any investment. It represents only the opinions of John Mauldin and those that he interviews. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest and is not in any way a testimony of, or associated with, Mauldin’s other firms. John Mauldin is the Chairman of Mauldin Economics, LLC. He also is the President and registered representative of Millennium Wave Advisors, LLC (MWA) which is an investment advisory firm registered with multiple states, President and registered representative of Millennium Wave Securities, LLC, (MWS) member FINRA and SIPC, through which securities may be offered. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB) and NFA Member. Millennium Wave Investments is a dba of MWA LLC and MWS LLC. This message may contain information that is confidential or privileged and is intended only for the individual or entity named above and does not constitute an offer for or advice about any alternative investment product. Such advice can only be made when accompanied by a prospectus or similar offering document. Past performance is not indicative of future performance. Please make sure to review important disclosures at the end of each article. Mauldin companies may have a marketing relationship with products and services mentioned in this letter for a fee.

Note: Joining The Mauldin Circle is not an offering for any investment. It represents only the opinions of John Mauldin and Millennium Wave Investments. It is intended solely for investors who have registered with Millennium Wave Investments and its partners at http://www.MauldinCircle.com (formerly AccreditedInvestor.ws) or directly related websites. The Mauldin Circle may send out material that is provided on a confidential basis, and subscribers to the Mauldin Circle are not to send this letter to anyone other than their professional investment counselors. Investors should discuss any investment with their personal investment counsel. John Mauldin is the President of Millennium Wave Advisors, LLC (MWA), which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS), an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private and non-private investment offerings with other independent firms such as Altegris Investments; Capital Management Group; Absolute Return Partners, LLP; Fynn Capital; Nicola Wealth Management; and Plexus Asset Management. Investment offerings recommended by Mauldin may pay a portion of their fees to these independent firms, who will share 1/3 of those fees with MWS and thus with Mauldin. Any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any CTA, fund, or program mentioned here or elsewhere. Before seeking any advisor’s services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Since these firms and Mauldin receive fees from the funds they recommend/market, they only recommend/market products with which they have been able to negotiate fee arrangements.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER. Alternative investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. Often, alternative investment fund and account managers have total trading authority over their funds or accounts; the use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequently, higher risk. There is often no secondary market for an investor’s interest in alternative investments, and none is expected to develop. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs may or may not have investments in any funds cited above as well as economic interest. John Mauldin can be reached at 800-829-7273.

22710

Things That Make You Go Hmmm: Deus Ex Machina

By Grant Williams

The tiny island of Salamis in Greece was the birthplace, in 480 BC, of one of the three great tragedians of the Classical Athenian era. Aeschylus and Sophocles were the other two, but the third member of that legendary triumvirate was not only the author of some 92 plays but also the subject of one of the earliest knock-knock jokes ever recorded:

Description: 2710.png

Knock-knock

Who’s there?

Euripides

Euripides who?

Euripides trousers? You menda dese trousers.

OK, so the Ancient Greeks in general (and Athenian tragedians in particular) were hardly renowned for their jokes; and certainly, modern-day Greeks have painfully little to laugh about as their country slides headlong into a depression, thanks to political intransigence amongst European politicians; nonetheless, Euripides was a man who made his mark on the theatrical world and, despite his reputation as one of the great tragedians, he is widely acclaimed for having pioneered dramatic devices that were later adapted to comedy:

(Wikipedia): Euripides is identified with theatrical innovations that have profoundly influenced drama down to modern times, especially in the representation of traditional, mythical heroes as ordinary people in extraordinary circumstances. This new approach led him to pioneer developments that later writers adapted to comedy, some of which are characteristic of romance. Yet he also became “the most tragic of poets”, focusing on the inner lives and motives of his characters in a way previously unknown. He was “the creator of … that cage which is the theatre of Shakespeare’s Othello, Racine’s Phèdre, of Ibsen and Strindberg,” in which “… imprisoned men and women destroy each other by the intensity of their loves and hates”, and yet he was also the literary ancestor of comic dramatists as diverse as Menander and George Bernard Shaw.

Euripides’ most famed works are familiar to anybody who studied the classics in school.

Heracles, The Suppliants, Helen, Medea, and Cyclops have all kept schoolchildren from having fun spellbound for hours, but there is one dramatic device with which Euripides became associated that has led to even his most celebrated works being heavily criticized by dramatic scholars (and by that I don’t mean scholars with a flair for the dramatic, but rather those who study… oh, you know what I mean) down through the ages.

That dramatic device is known as deus ex machina, which literally translates as “god from the machine”.

A deus ex machina plot device is something that solves a dramatic problem through the sudden (and often improbable) intervention of an outside agent in the form of a character, ability, object, or event.

(Wikipedia): Depending on how it’s done, it can be intended to move the story forward when the writer has “painted himself into a corner” and sees no other way out, to surprise the audience, to bring a happy ending into the tale, or as a comedic device.

Description: eus%20Ex%20Machina%20Apparatus.psd

The first recorded usage of the term deus ex machina is widely acknowledged to have come in Horace’s Ars Poetica, in which he warns aspiring poets never to use such a device to solve plot complexities. Horace makes reference to the usage of a primitive crane (mechane) by which the ancient Greeks used to lower actors playing gods onto the stage at opportune moments in order to resolve situations for which David E. Kelley himself could not have come up with a satisfactory plot twist.

Anybody not see where I’m going with this?

The massive global build-up of credit and leverage, fueled by cheap money, that was allowed to flourish in the years before the events of 2008 was as dead-end a plot progression as one could possibly imagine; and once the collapse post-Lehman manifested itself, it was clear that the only possible way to advance the story without having to go through an inevitable, even more painful second act, was through the use of a deus ex machina. And lo and behold, up stepped the world’s central bankers, all of whom were blissfully happy to be lowered by crane onto the stage with instructions to employ whatever means they felt necessary — no matter how improbable these might seem to the audience — to move the story quickly towards the happy ending so craved by those in attendance.

Of course, one of the beauties of such dramatic devices is that, human nature being what it is, the audience is nearly always complicit in their willing suspension of disbelief — which, incidentally, is another term coined by a writer, this time Samuel Taylor Coleridge, who concluded, quite rightly, that:

… if a writer could infuse a “human interest and a semblance of truth” into a fantastic tale, the reader would suspend judgment concerning the implausibility of the narrative.

Perhaps these writer fellows are onto something.

Certainly, since the events of 2008, the “audience” has been only too happy to accept as perfectly normal many situations that previously would have had them stalking out of the theatre in droves.

I have covered many of these improbable situations in the pages of Things That Make You Go Hmmm… as well as in my various presentations, but the key point bears reinforcement: we are living in the midst of a gigantic laboratory experiment with all the attendant possibilities of something going BANG!

The more I ponder the situation in which the world finds itself as we approach the fifth anniversary of the Lehman bankruptcy, the more it is apparent to me that the deus ex machinae being dropped into each and every market around the world right now by our central banks, are dangling from a very rickety crane indeed.

To continue reading this article from Things That Make You Go Hmmm… – a free weekly newsletter by Grant Williams, a highly respected financial expert and current portfolio and strategy advisor at Vulpes Investment Management in Singapore – please click here.

USA and Japan flag

Thoughts from the Frontline: Central Bankers Gone Wild

By John Mauldin

When Jonathan Tepper and I wrote Endgame some two years ago, the focus was on Europe, but we clearly detailed how Japan would be the true source of global volatility and instability in just a few years. “A Bug in Search of a Windshield” was the title of the chapter on Japan. This year, I wrote in my forecast issue that 2013 would be “The Year of the Windshield.” For the last two weeks we have focused on the problems facing Japan, and such is the importance of Japan to the world economy that this week we will once again turn to the Land of the Rising Sun. I will try to summarize the situation facing the Japanese. This is critical to understand, because they are determined to share their problems with the world, and we will have no choice but to deal with them. Japan is going to affect your economy and your investments, no matter where you live; Japan is that important.In bullet-point fashion, let’s summarize the dilemma that faces Abe-san, Kuroda-san, and the other leaders of Japan.

  1. Japan is saddled with a yawning fiscal deficit that, if it were closed too quickly, would plunge the country into immediate and deep recession. The yen would strengthen, and Japan’s exports would once again be damaged. Such is the paradoxical outcome if you suddenly decide to live within your means when you have been on a spending binge. The Japanese deficit is close to 10% of GDP. For my US readers, think about what would happen next year if the government cut $1.6 trillion from our budget.Japan has a GDP that is now close to 500 trillion yen (give or take a few tens of trillions). Their most recent budget calls for Y92.6 trillion in spending, almost evenly divided between Y43.1 trillion financed from tax revenues and Y42.9 trillion from the issuance of new bonds, adding to Japan’s massive public-sector debt that already totals nearly Y1 quadrillion. Say that with a straight face: 1 quadrillion. And this massive debt is not a recent phenomenon: it has been accumulating for many years.Tax revenues have been going down for decades, as the country has been mired in no-growth deflation for 24 years. Revenues are now down to where they were in 1985. By way of comparison, US tax revenues in 1985 were $734 billion (or $1,174 billion in constant 2005 dollars). Last year, US revenues were $2,450 – that is, more than double the 1985 total. (taxpolicycenter.org)The following chart is courtesy of my friend and Japan expert Kyle Bass at Hayman Capital Management. If this were a stock, would you be a buyer?

  1. Japanese ten-year interest rates exploded from just above 30 basis points to over 1% at one point in the past month. The Bank of Japan (BOJ) intervened, but rates closed today at 0.85%. Note that they are still down from the 1.3% where they stood two years ago.
  1. It costs the Japanese government 24% of its revenues just to pay the interest on its debt at current rates. According to my friend Grant Williams (author of Things That Make You Go Hmmm…), if rates rise to just 2.2%, then it will take 80% of revenues to pay the interest. Even at the low current rates, the explosion in Japanese debt has meant that interest rate expense has risen from Y7 trillion to over Y10 trillion. Note in the chart below (also from Kyle) that the Japanese government is now issuing more in bonds than it pays in interest. Somewhere, Charles Ponzi is smiling.

Just for fun, here is a picture of Mr. Ponzi writing a check (courtesy of Geert Noels).

    1. For 20-plus years, Japanese nominal GDP has barely risen. If your nominal GDP stagnates and you are running large deficits every year, then your debt-to-GDP ratio rises. For Japan, the ration will be a staggering, never-before-seen 245% this year.

 

  • The only way you can lower the rate of debt-to-GDP expansion – and perhaps convince investors to continue to buy your bonds – is to increase your nominal GDP while slowly lowering your deficit over time until the increase in your debt is less than the nominal growth of your economy.

 

  1. After years of running trade surpluses, Japan is now running a trade deficit. Basic economic accounting tells us that for Japan to get to its goal of sustainability, it absolutely must have a trade surplus. And as deep a hole as Japan is in, it needs seriously large trade surpluses. Like back in the good old days of only a few years ago. Not to mention that the country’s current account surplus is down by over half from its peak in 2007 and back to where it was 20 years ago. The trend is ugly.

  1. There are only two ways to get nominal growth. You can get real growth or you can create inflation. There are not many things that you can get Hayek and Keynes and every other economist to agree on, but this one thing is the universal answer to your fiscal problems: Growth, with a capital G. That is the remedy put forth by every economist and every politician : “We need to grow our way out of the crisis.” But there are two problems as Japan tries to get to growth.

Problem #1: Your nation is aging, and internal consumer spending is not going to be a source of real growth. You have to talk like that can happen, but you know it is just not all that realistic. You have been trying for 20 years to get your country to spend, and people are just not up to it. What you really need is for your export base to get with the program and massively increase its sales to the rest of the world. In fact, that is your only real option. And one of the easiest ways to do that is to drive down the value of your currency, especially against the currencies of competitor nations. That boost in exports can help relieve your chronic excess productive capacity and maybe, possibly, hopefully, engender a labor shortage and drive up the cost of labor, which will help stimulate inflation.

Problem #2: You are mired in deflation and have been for 20 years. Since there is no natural source of inflation in Japan – a nation of savers and an increasingly elderly population –you have to create inflation by increasing the prices of your imports. And the way to increase those prices is to drive down the value of your currency, especially against the dollar and the euro.

Hmmm, we see a possible strategy emerging here.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

Japanese piggy bank

Thoughts from the Frontline: The Mother of All Painted-In Corners

By John Mauldin

Alice laughed: “There’s no use trying,” she said; “one can’t believe impossible things.”

“I daresay you haven’t had much practice,” said the Queen. “When I was younger, I always did it for half an hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”

– Alice in Wonderland, Lewis Carroll

I wrote several years ago that Japan is a bug in search of a windshield. And in January I wrote that 2013 is the Year of the Windshield. The recent volatility in Japanese markets is breathtaking but characteristic of what one should come to expect from a country that is on the brink of fiscal and economic disaster. I don’t mean to be trite, from a global perspective; Japan is not Greece: Japan is the third-largest economy in the world. Its biggest banks are on a par with those of the US. It is a global power in trade and trade finance. Its currency has reserve status. It has two of the world’s six largest corporations and 71 of the largest 500, surpassed only by the US and comfortably ahead of China, with 46. Even with the rest of Asia’s big companies combined with China’s, the total barely surpasses Japan’s (CNN). In short, when Japan embarks on a very risky fiscal and monetary strategy, it delivers a serious impact on the rest of the world. And doubly so because global growth is now driven by Asia.

Japan has fired the first real shot in what future historians will record as the most significant global currency war since the 1930s and the first in a world dominated by true fiat money.

At the risk of glossing over details, I am going to try and summarize the problems of Japan in a single letter. First, a summary of the summary: Japan has painted itself into the mother all corners. There will be no clean or easy exit. There is going to be massive economic pain as they the Japanese try and find a way out of their problems, and sadly, the pain will not be confined to Japan. This will be the true test of the theories of neo-Keynesianism writ large. Japan is going to print and monetize and spend more than almost any observer can currently imagine. You like what Paul Krugman prescribes? You think he makes sense? You (we all!) are going to be participants in a real-world experiment on how that works out.

But first, I want to mention a very special event, that is of great relevance to this discussion, and that will be coming your way in just a couple weeks. I’m going to get together in New York with five of the most powerful investing minds in the world – Kyle Bass, Mohamed El-Erian, John Hussman, Barry Ritholtz, and David Rosenberg – and we’re going to totally take apart the New Normal environment in which we all find ourselves and then rethink and rebuild it in a way that will help you not only survive it but profit from it. Investing In the New Normal will feature a full hour of our unfiltered conversation and uncensored analysis. It will come to a computer screen near you on Tuesday, June 11, and you will want to be there! The event is free, and you can register here. Seriously, a full hour with those five guys. How cool is that? I will make sure you get a few powerful take-aways that will impact your thinking and your investing. And now, let’s take a look at that hard windshield and that big bug.

In no particular order, let’s look at some facets of the daunting task facing Prime Minister Abe and the country of Japan.

After the collapse of what might still be the largest economic bubble in history, in 1989, Japan is still mired in a 24-year non-recovery. Nominal GDP in 2011 was almost exactly what it was 20 years earlier, in 1991 (MeasuringWorth.com). You can find other ways to measure nominal GDP which indicate limited growth; but compared to the US and China, nominal growth in Japan has been paltry.

(Google Public Data Explorer)

That lack of growth takes on special importance because when we measure national debt-to-GDP we use nominal GDP as the denominator. If debt is growing and the economy is not, that debt-to-GDP ratio can grow very rapidly. From the Financial Times at the end of March:

Japan’s central bank governor has told parliament that the government’s vast and growing debt is “not sustainable,” and that a loss of confidence in state finances could “have a very negative impact” on the entire economy. The warning comes as Shinzo Abe’s administration attempts to drag Japan out of more than a decade of deflation with aggressive monetary and fiscal stimulus.

In January, weeks after taking office, the government unveiled a Y10.3tn ($109bn) spending package while leaning on the Bank of Japan to buy more of its bonds – a strategy described by Morgan Stanley MUFG Securities as “print and spend”. Speaking to lawmakers on Thursday, BoJ governor Haruhiko Kuroda noted that, while the government bond market has been “stable,” Japan’s gross debt to GDP ratio – expected to top 245 per cent this year, according to estimates by the International Monetary Fund – is “extremely high” and “abnormal”.

Japanese households and corporations are saving even as the government runs deficits close to 10%. As a way to compare, a 10% deficit in the US would be $1.6 trillion.

Damn the Torpedoes, Full Speed Ahead!

There are two and only two ways to grow an economy in real terms. You can grow your working population, or you can increase your productivity. That’s it. Japan does not have the option of growing its population (or has not chosen to), and it is actually quite difficult for an industrial economy to grow its productivity. If your population is actually shrinking (see chart below) and productivity growth is less than 1%, then real GDP growth is just not possible. We are going to revisit this uncomfortable fact later.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

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