The U.S. 'debt doomsday' opportunity

Whenever I hear about economic policies in the West, be it the draw-out Greek rescue, or the US policies (of the socialist-lite Obama administration): "... eventually, you run out of other peoples money". That, of course, is the problem with socialism, according to Margaret Thatcher. A very steep price in lives has been paid to observe the historical veracity of this phase. The juxtaposition of the moral and fiscal hazards is not merely cynical, it's insightful. For example, USSR ran out of moral justification for the one-party rune long before it's financial collapse.

I see the same fate befalling countries in the West, as the slide off towards greater 'collectivization', such as the increasing EU control over the Greek economy as a price for the second bailout. U.S. has also been sliding in the socialist direction. U.S. has recently surpassed 100% debt-to-GDP ratio.

The U.S. debt may exceed $16.4 trillion debt ceiling before the 2012 presidential election. Politico.com characterized this scenario in an article "Debt doomsday may come sooner than expected". However, with various accounting tricks, the U.S. Treasury could delay the absolute deadline until February 2013. Charles Krauthammer recently called Obama the lawless president, and the Obama administration will undoubtedly do everything legal and semi-legal to try to avoid face the reality of its unsustainable largess. Meanwhile, the U.S. external per capita debt exceeds that of Greece, for example, and is the highest in the West.

The debt ceiling debate is a crucial opportunity to check the growth of government, because it exposes the fiscal bankruptcy of the socialist malaise brought about by the Obama administration. This fiscal failure is readily apparent and can easier to attack than the ethical bankruptcy of socialist policies for weak-need politicians. However, the socialist nature is egregious and should be denounced in its own right - it pits the majority against minorities, for example different generations against each other. Obama's use of short-term borrowing for political gains, which benefits the old, comes at the expense of financial future of the youth, saddled by vast debts.

Regrettably, the U.S. is at a point, where a painful debate about the ethics and finances of government largess before the 2012 elections is the best medicine we can hope for.

Fake statistics makes great news

Great news! "Jobless rate at 3-year low as payrolls surge!" Announces jubilant Reuters.

Nonfarm payrolls jumped 243,000, the Labor Department said on Friday, as factory jobs grew by the most in a year. The jobless rate fell to 8.3 percent - the lowest since February 2009 - from 8.5 percent in December.

Another 4 years, anyone?  

As the saying goes: "There are lies, damn lies, and statistics." This jobless
rate falls in the last category. That's  because we're fed the official, heavily-massaged U-3 unemployment rate. The labor force participation rate has fallen to a 30-year low (see figure). Fewer people in the workforce means the percentage of unemployed people in the workforce drops.


The drop in labor participation was due to 1.2 million dropping out of the labor force last month!

This sounded so bad I had to check it. It's true, as you can see in this video from Rick Santelli of CNBC Business News network.

So, to recap: 243,000 jobs created, 1.2 million left the workforce has been presented as great news.

Identifying the problem to exacerbate it

Some 1,600 economic and political leaders, including 40 heads of states and governments, will be asked to come up with new ideas as they converge at Davos, chic ski station in eastern Switzerland, for the 42nd annual World Economic Forum (WEF), which opens coming Wednesday.

"The main conversation will be about a deficit of leadership in Europe as a prime problem," said John Quelch, the dean of China European International Business School.

There's have been dozens of meetings, initiatives and promises in Europe. So, there is plenty of leadership; what it lacks is coherence, and most importantly, honesty. The leaders seem to admit there exists a credibility gap, but deny their role in bringing it about:

"We have a general morality gap, we are over-leveraged, we have neglected to invest in the future, we have undermined social coherence, and we are in danger of completely losing the confidence of future generations," said Klaus Schwab, host and founder of the WEF. "Solving problems in the context of outdated and crumbling models will only dig us deeper into the hole", he added.

Klaus Schwab. Worried at Davos.

At the upcoming meeting the economic and political elites will seek ways to reform a capitalist system they believe is "outdated and crumbling." EU is crumbling, sure, but to call capitalism outdated is another attempt to avoid responsibility; Europe has given up on capitalism some time ago. Over a decade ago it decided to pursue the so-called "Third way", between capitalism and socialism. (Check out this prescription by Tony Blair and Gerhard Schroeder from 1999).

An article from the semi-official 'Third Way' website published in October 2011 admits the problem: "Ten years ago, Europe faced a looming debt crisis but economically, fiscally, and demographically they buried their heads in the sand, were afraid to confront voters with the truth about their fiscal situation, and now face draconian measures that may not even be enough."

I'm sure blaming the current mess on "outdated, crumbling capitalism" will work out better this time around.

Suicide EU: blogging ahead of the curve

I'm still looking for this site to be indexed; and came across an article by a financial market analyst Charlie Fell, who writes the column 'Serious Money' for Irish Times.

Charlie Fell wrote an article today entitled Europe's suicide pact pointing out that "The summit’s proposals reveal that the EU’s political leaders remain in denial or are blind to the true nature of the crisis that afflicts the euro-zone."

Charlie mentions the incongruity between the problem and proposed solution:

"The EU’s leadership continues to believe that profligate government spending among the euro-zone’s periphery is the central problem and, insist that fiscal austerity is the only path to future stability. With this in mind, the summit proposed that euro-zone members adopt constitutionally-binding debt brakes requiring states to maintain balanced budgets, defined as structural deficits of no more than half a percentage point of GDP."

I have been writing about the same idea, and even took the same name for the blog to make my point inescapable. I have no special knowledge or training in finances. What I do have is sufficient boldness to use common sense to analyze the proposed solutions, and to suggest that they will exacerbate the disease.

This is not merely a figure of speech, but a reference to the restrictive bonds of common monetary policy that are supposed to be tightened by mutual promises in the smaller core EU.
To add something new to my prior analysis, I'd like to comment on the idea of austerity. It is a involuntary reduction in government (over) spending, imposed upon profligate members of the EU by the collective. This has the possible benefit to greatly shrink government expenditures on the periphery, but therein lies the difficulty, also. Greece, for example, would need to reduce its government expenditures by 21% to eliminate annual deficit while keeping the euro. Italy and Portugal would need to cut government expenses by at least 10% and 14%, respectively. These are average, 'across the board' cuts, targeting some cuts would require others to be even deeper. Think about the scope: these cuts affect everything from education and research to transportation and health services. Ten percent or more may not sound like so much until you think about your own occupation and its budget.

I do not believe that vague promises in the name of EU unity will conjure up the political will to cut that much. It will be really healthy, if they do. In the meantime, Germany, the Netherlands are among a few not obligated to undergo austerity. Bringing down the question of austerity to the level of an individual, I would ask you, gentle reader: "Would you go on a (lengthy) diet, if you neighbor told you to, as he continues to live large?"

Land down under is coming up

The country's government debt to GDP is the lowest among Organisation for Economic Co-operation and Development (OECD) countries. While US continues to look attractive for investment compared Europe, it as comparison between bad and worse.

Australian government is one of the most frugal among the OECD:

These revenues and expenditures above by Australia are from 2005. The balance sheet looks similar in 2011. Australian government consumes a smaller portion of GDP than majority of OECD countries, and operate with a small surplus.

Two additional factors help Australia, location near hot Asian markets, and a relatively light regulatory burden.

Europe and US are suffering from a number of ills of being rich and lazy: excessive regulation, high taxes, relatively inflexible labor markets in EU, and prohibitive social spending.

Australia, on the contrary, does not even have a social security tax. They have not had the time to accumulate all the warts of a old democracy, including tax code, which is too cumbersome even for the IRS, activist EPA, not to mention about $100 trillion of unfunded liabilities in the US alone.

Australia has a bright future, and is benefiting from the implosion in Europe by acting as a magnet to young, mobile professionals. This trend will only accelerate as fiscal crisis continues, and also with the ageing of population in Europe ages. Traditionally, this used to be America's role, but it is no longer the top destination for your professionals. That title belongs to Australia now.

The Australian stock market has a lot of potential also. The average Price/Earnings of Australian stocks is about 15, close to half of that in US, which became relatively expensive in the mid-80's as shown below.



Economic weakening of UK: look who's talking

The French are more vocal in their expressing dislike of UK for snubbing the EU, than the Germans.

Yesterday the governor of the Bank of France, Christian Noyer, said: 
"Great Britain is in a very difficult economic situation, a deficit close to the level of Greece, debt equivalent to our own, much higher inflation prospects and growth forecasts well under the eurozone average. It’s an audacious choice the British government has made," referring to rejection of updated EU treaty.

French policymakers were angered last week when Standard and Poor’s, a ratings agency, threatened to downgrade eurozone nations — including France — if leaders did not act urgently to address the single currency crisis. In an interview with Le Télégramme, a French regional newspaper, Mr. Noyer said the downgrade did not appear “justified in regard to the economic fundamentals”.

“Otherwise, they should start by downgrading Britain which has more deficits, as much debt, more inflation, less growth than us and whose credit is collapsing,” he added.

I trust the three ratings agencies to judge the financial situation more than politicians interested in preserving appearances. And the ratings agencies are suggesting that it is France, and other continental nations that need to be reviewed. Today Fitch Ratings lowered France's outlook, and is reviewing ratings for Italy and Spain, citing failure of EU leadership to find a “comprehensive solution” to the debt crisis.

The last part is the part that amuses a cynic like me the most. The agreement reached by 26 European nations (EU minus UK) is all about promises to maintain fiscal discipline, which is nothing but wishful thinking that ignores that underlying problems that lead to the deficits in the first place. The truth about EU as a suicide pact is revealed by the shady behavior of it's leaders. You may think, despite my statement of the emptiness of new EU agreement, that it there is merit in the fact that 26 nations reached agreement. Actually, three of them are uncommitted, and only promised to try to ratify the new treaty. Here's the real kicker, and why statement about lack of 'comprehensive solution' is mild: there is no agreement, there's only an agreement to agree. The 'new EU' rules are still being put together, and should be worked out by ... March. After that, all EU member states will bring the new rules up for a ratification in national assemblies.

This is just great. These EU bureaucrats think they after they surpassed the legal boundaries of past agreements, by directly bailing out Greece among others, they can come up with new and and more extensive regulations on the fly. The real absurdity is that these 'means justify ends' are destroying the last vestiges of faith in all EU agreements by over-reaching their mandate and trampling on national sovereignty. What is to stop EU from changing rules again in another couple years, while financially stronger 'core' nations dictate to the weaker ones?

Agreements at the heart of EU necessarily are win-lose for different member states. That is why the union is unstable economically, and political disharmony is likely to get significantly worse during the breakup of EU with layers of rules, debts and obligations. This entanglement of money through an unnavigable web or rules makes the slicing up of sub-prime home loans that precipitated the mortgage crisis in the US look like an orderly and well-thought out process.

The shrinking EU core and PIIGS (US)

Bloomberg news recently commented on convergence of Netherlands and Germany. Curiously, Netherlands has almost three times as much trade (90 billion euro) with Germany than with France (32 billion euro).

Dutch Finance Minister Jan Kees de Jage said: "Trade between Germany and the Netherlands isn’t only extensive, it is enormous. It is flourishing today thanks to the internal market and the euro. If there are two EMU countries that should logically stand together, they are Germany and the Netherlands.”

A breakup of the euro bloc would cut exports of Dutch products by 25 percent next year, ING Groep NV (INGA) economists Teunis Brosens and Dimitry Fleming said in a Dec. 6 note to clients. “As a trading nation with large pension funds and an international financial sector, we’re closely tied to the euro zone” and may be the country with the biggest interest in maintaining the currency, they wrote.

Is this a counter-example of the badness of EU, which I describe as a suicide pact?

No, it supports that unfortunate thesis. I wanted to find out why Netherlands in particular stands to lose so much from breakup. Netherlands is the 6th largest exporter worldwide, and the 3rd in Europe, just a hair behind a much more populous France. I put together a little table from publically available data to illustrate what I'm always referring to in writing.

Country	Exports (M)	Population (M)	Per capita	Imports (M)	Exp - Imp (M)	(E-I)/capita
Germany	1337	81.729	16.4	1099	238	2.9
Netherlands	485.9	16.847	28.8	429	56.9	3.4
France	517.3	65.027	8	590.5	-73.2	-1.1
Portugal	46.27	10.561	4.4	68.22	-21.95	-2.1
Italy	448.4	60.706	7.4	473.1	-24.7	-0.4
Ireland	115.7	4.581	25.3	70.36	45.34	9.9
Greece	21.14	10.787	2	44.9	-23.76	-2.2
China	1506	1339.7	1.1	1327	179	0.1
US	1289	312.7	4.1	1936	-647	-2.1
	2010 est.	2011 est.		2010 est.	2011 est.

The imports, exports and 2010 estimates, while populations are estimates from 2011, but the newborns will not seriously jeopardize this argument. I grouped PIIGS in red. Clearly, Irelands' fiscal difficulties are of temporary nature, while for Portugal and Greece problem are more fundamental. Of course, the per capita annual deficits do not show outstanding debt, which makes even Italy's relatively modest deficits unsustainable. Italy's bond rates about 7-7.5% while comparable German bonds are about 2-2.5%.

My initial purpose was to show similarity between Netherlands and Germany: they are both major net exporters, with a huge market in the EU. The net trade deficits in the rightmost column mean that net importers would need to subsidize their imports through debt, because allowing currencies to adjust to market conditions would make exports very expensive. What benefits the Northern Europe hurts the South, when they are tied by a common monetary policy. Not surprisingly the northerners would like to simply ignore this difficulty, or to overcome it by speaking about fiscal responsibility. There has been vast overspending by the politicians; however, there is a bigger fundamental issue.

The suicide pact is what happens when the desperate North and South try to band together for short-term gains despite the likelihood of long-term pain. The alternative proposed by the North: severe cuts in social services and government jobs, called 'austerity' to address accumulated deficits together with a cultural and economic revolution that puts the entire union on par with the core, such as Germany and the Netherlands.

The leaders in Brussels will be the last to admit the reality of differences between the North and South of Europe. Economically weaker nations are likely to be pushed off the new band-wagon, until the entire periphery (South) is stripped from the core (North). The pressure for this separation will be great. After this separation, the benefit of common currency will no longer benefit the Germans and the Dutch by making their exports more affordable in Greece and Portugal. I was very impressed by the 25% reduction in trade mentioned in the article above, because it appeared to contradict my point about the detrimental economic consequences of the euro. Following up on this revealed that the benefit occurs at someone else's expense. The win-lose is a fundamental characteristic of a common currency: it helps some and hurts others making the system unsustainable.

One last point, the PIIGs are us(US). Look at the plot of the per capita trade deficit (E-I)/capita in the table:

The numbers above reflect the amount of borrowing, per capita, in dollars. US is bleeding far more red ink that Italy, for example. Is US trying to replicate Greece? How do you explain US following down the same path, but expecting a different result - Insanity or Arrogance? Because it cannot be Ignorance.

The euro plunges faster than its support in EU

Below are comments from three analysts indicating the outlook for the Euro is totally negative:

“It’s hard to see a positive scenario for the euro,” said Kumiko Gervaise, an analyst in Tokyo at Gaitame.com Research Institute Ltd., a unit of Japan’s largest online currency margin-trading company.

"Absent any commitment from the European Central Bank to buy more sovereign debt, I think the outlook remains weak for the euro," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey.

"The euro is unlikely to rebound in a clear manner unless the European Central Bank lowers its interest rate further and takes quantitative easing measures," said Yuji Kameoka, managing director of the investment strategy and research department at Daiwa Securities Co.

Don Surber cites the following averages for the support of euro:

41% want are content the way things are

42% want ideas behind the euro reviewed

12 % want to get out immediately

5% don't know

That means only 1 in 8 Europeans on average are in favor of action to get out from under a falling brick. The rest, minus the totally ignorant ones (5%), are evenly split between being content with status quo despite the warning signs, and another half want to think about it. Do they seriously think the bureaucrats in Brussels are going to review the raison d'etre in an honest way, which may result in conclusion that ideas behind the euro are fundamentally flawed? That the experiment is in danger unless underlying agreements can be re-negotiated? The only answer they can produce is the solution of doubling down on all the initial bets, and hoping that the magic of public ceremonies of commitment to fiscal discipline will by themselves cure unrelated, fundamental problems resulting from trade imbalances?

It's a sad spectacle there, across the pond from the US, but for me realizing the motivations of the players makes it more of a farce than a tragedy. After all what can be a more reliable than bad consequence from continuous self-delusion?

British benefit from selfishness

The British are beginning to break with EU. The benefits of their leaving what is increasingly becoming a suicide pact should not be long in coming. Europe's financial future looks bleak. There British are explicitly modeling themselves after the independent Swiss, rather than partaking in the common problems of EU.
A suicide pact is like Jamestown at the end its road; you drink the poisoned cool-aid willingly, or you're helped to overcome the weakness. Attempts to leave the club at such a time are resented.

Predictably, many European commentators took out their frustration on David Cameroon, after he vetoed changes to EU regulations last week. As I mentioned in an earlier post, the British were seeking unique protections for the financial activities in London, and can be legitimately criticized for that, however, that's not the main issue take up by critics like the German magazine 'Der Spiegel' sugguests that Cameroon's decision would backfire at home and abroad.

Indeed, EU is moving to sideline and even to punish UK for its independence, and in UK there is strong polarization between Euro-philes and Euro-spectics/Euro-phobes. However, a poll taken in UK after the veto shows conservatives have benefited from standing up to EU, despite taking their stance over selfish financial reasons.

The prediction for domestic unpopularity resulting from Cameroon's distancing UK from EU appears to have been wishful thinking on the continent. What about the reality in EU? EU ratified a new union, based on stronger set of rules by 26 nations; everyone besides the UK.

Below: Mercozy (Angela Merkel + Nicolas Sarkozy) were all smiles about their tighter union last week.

'Der Spiegel' hurried to proclaim the formation of a 2-speed Europe, implying no doubt that the new, stronger union would move at a faster speed, and outdistance UK. The rest of the article seems to belie this hope; it admits political costs of the fracture, as well as the fact that additional regulations don't help the immediate problem - dramatic escalation of borrowing costs in the EU. There have already been wealth transfers to Ireland, Portugal and Greece that were never imagined by the Germans and the French when they ratified EU treaties. That's the point - the rules needed to be amended, on the fly. The initial rules, in fact, the union itself, were not very well thought out. Who has the confidence that European leaders came up with a sound resolution under this time pressure, one that will not backfire?

According to the reasoning that I've been laying out on this blog, the European Union is deeply, fundamentally flawed, and should be abandoned. The loss of face for the bureaucrats is one of the reasons preventing that from consideration until all other options are explored, including running the risk of a messy joint bankruptcy.


Leadership of a cult that has lost a member, directs full fury on the traitor, but also tightens the bonds that bind its remaining members. It both ways the response of EU to individualistic, selfish concerns of UK mirrors the attitude found in Jamestown, after several members escaped.

Not only is new regulation not dealing with the immediate underlying financial crisis, it seeks to resolve imbalances in trade between members of EU through the most unlikely method of expecting the Italians and Greeks to produce like the Germans, they present the newly-forged chains that bind the collective more tightly together as evidence of its impending success.

The markets appear to know better, than the delusional EU leaders, and the euro has plunged again today to multi-month lows.

Shackled to economic corpses

After committing to WWI the Germans lamented that they were 'shacked to a corpse' of Austria-Hungary.

The EU treaty has shackled the economic corpse of Greece to Germany's ankle, as well as a few others. There is another sad connection: Austria-Hungary was a multi-ethnic union, but it was a prison for nations. The internal fractures in Austria-Hungary included resentment in Serbia, which eventually led to assassination of Duke Ferdinand in Sarajevo, which started WWI. This unfortunate analogy may prove very apt if EU introduces rules which are seen as oppressive bonds imposed by non-elected bureaucrats in Brussels.

The shackling of modern Germany that I'm referring to is a fitting analogy, because many other European countries such as Portugal, Ireland, Italy, Spain, and Greece (PIIGS) are all financial corpses.

I see more equality in the foolishness of both parties despite their financial asymmetry, because this shackling reminds me a dark stories from days of German occupation of Russia, when prisoners or hostages were bound together to save bullets by drowning some of the victims bound to corpses. The point is that last one alive still perishes - the shackling is fatal to everyone. Will Germans want to trade the obligation to lend money to Greece for the power to increase their retirement age in to be commensurate with that of Germany? Or to enforce some other measure of austerity? Economic success is doubtful, but political failure is almost guaranteed: people would not part with their sovereignty in either Greece or Germany with the ease elites envision.