 | | The Daily Reckoning | Tuesday, January 17, 2012 |
- Borrowing costs soar as Europe’s debt crisis worsens,
- Hard landing, or soft? The year ahead for the Middle Kingdom,
- Plus, Bill Bonner on the death of growth, the land of the unfree and plenty more...
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|  | | | | Slip Sliding Away | | How “Adjusting for Slippage” Adds to Sovereign Debt Woes | | |  | | Eric Fry |
Reporting from Laguna Beach, California...
Sacré bleu!... Last Friday, the French gained yet one more reason to grumble — over their midday galettes and Gauloises — about those annoying Americans. Standard & Poor’s, the American ratings agency, downgraded the French government’s credit rating from AAA to AA+.
“AA+ is also not a bad rating,” reassured German Chancellor Angela Merkel. The French were not so eager to agree with Merkel’s patronizing assessment...and neither were any of the other nine Eurozone governments that received a rap across the knuckles from S&P.
Although Finland, the Netherlands and Luxembourg still hung onto their AAA ratings, S&P placed these three sovereign issuers on “negative watch.” They were the lucky ones. Austria lost its triple- A rating, while Cyprus, Italy, Portugal and Spain were all cut by two notches. The latest downgrades placed Portugal deep into “junk” territory and Italy to near-junk.
S&P dispersed enough “bad juju” to annoy almost every country on the European continent. No surprise that one influential European finance minister said he plans to huddle up with his fellow Eurozone members to create a European rating agency.
But the facts are what the facts are... and the facts are that many pupils in this class are receiving a failing grade. Eliminating “F’s” from the grading scale won’t improve their command of the subject matter. Many pupils would still be insolvent...and moving toward a default.
A few days ago, for example, Spain disclosed that its budget deficit would be a wee bit larger than expected — 8% of GDP, rather than the expected 6% of GDP. Apologizing on Spain’s behalf, European Commission Vice President Olli Rehn said he “regret[s] the sizable fiscal slippage.”
This comment bore an eerie resemblance to the comment Greek Finance Minister, Evangelos Venizelos, uttered three months ago to describe his nation’s downwardly revised budget deficit forecast. We are “adjusting for slippage,” the Greek money man explained. The deficit that was supposed to total a hefty 7.6% of GDP for the 2011-12 fiscal year “slipped” to an even heftier 8.5%.
“Adjusting for slippage” is the latest government fashion...and it is expensive. “Governments of the world’s leading economies have more than $7.6 trillion of debt maturing this year,” Bloomberg News reports, “with most facing a rise in borrowing costs.”
Japan and the United States account for the lion’s share of this $7.6 trillion refinancing tab, as the chart below shows. Within Europe, Italy has the most amount of debt coming due this year. The Italians have to scratch together nearly half a trillion dollars in 2012 to satisfy maturing bonds. After Italy, France has the most amount of debt coming due in Europe at $367 billion, followed by Germany at $285 billion.
But these numbers tell only part of the grim story. $7.6 trillion is only the amount required to repay maturing bonds, plus accrued interest. This tally does not include thenew borrowing needed to plug massive government deficits. After adding new borrowing to the total of maturing bonds, the total financing required in 2012 will be more than $10 trillion.
That’s a lot of borrowing. But again, even these numbers don’t tell the entire story. Borrowing costs are soaring for the governments that can least afford it. The chart below shows the year-over-year percentage change in 10-year borrowing costs for various governments. The Italian government, for example, must pay 6.62% per year to borrow money for ten years — an interest rate that is nearly 40% higher than the 4.75% rate the Italians paid one year ago to borrow money for ten years.
“Sizable fiscal slippage” is not automatically expensive...as the falling interest rates on US Treasury securities attests. But it is very expensive for those countries that have lost the faith of investors.
Europe’s sovereign borrowers are finding themselves in one of two camps: the “haves” or the “have-nots.” Because Italy and Portugal, for example, “have not” the confidence of bond investors, these two governments also “have not” any buyers of their bonds at low interest rates. As a result, Italian and Portuguese bond yields are soaring, even while the bond yields of Germany, the US and other “flight-to-quality” issuers are falling. Amazingly, German and US 10-year yields are both down more than 40% year-over-year.
When the news of the S&P downgrades crossed the newswires Friday, most European stocks and bonds traded lower. One conspicuous exception was the German 10-year government bond, which traded higher on the news — pushing the yield all the way down to a record-low 1.76%.
As the last remaining “stable AAA” sovereign borrower in the Eurozone, German government bonds are attracting brisk “flight to safety” demand — a trend that has been under way for many months. But while Germany’s interest costs are plummeting, many European countries are struggling with rapidly rising interest costs...and for good reason.
Italian interest rates are rising because Italy is strapped for cash. And so are many other Western nations... including the United States. In fact, the US just made the wrong sort of headlines by announcing that its debt-to-GDP just topped a Greek-like 100%. America’s staggering $15 trillion debt load may not be fatal, but it is not the kind of headline you want to print in big block letters “above the fold” of The New York Times.
The US Treasury must be hoping that Oscar Wilde was right when he said, “The only thing worse than being talked about is not being talked about.”
More than likely, however, Irish writer, Brendan Behan’s adaptation of Wilde’s quote is closer to the mark when talking about America’s debt load or Treasury bonds: “There’s no such thing as bad publicity...except your own obituary.”
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| | The Daily Reckoning Presents | | China’s Cinderella Story | | |  | | Chris Mayer |
Everyone knows that when the clock strikes midnight for Cinderella, the carriage turns back into a pumpkin, the horse into mice and the jeweled gown into rags. The spell is broken and reality returns. I keep thinking of China in this context.
One of the big questions of the year is whether China blows up or not. Hard landing or soft? When will the clock strike midnight on the Chinese? Things are slowing down, and it feels like it’s getting late.
But first, why does this matter? China matters because China is big. If this were 1980 — when China’s economy was about one-seventh the size of the US’s economy, no one would care. Today, the appetite China has for raw materials is no secret, and is one of the main reasons why miners and oilmen are flush with cash. So if you invest in miners and oil companies, then the answer to the hard landing question decides the fate of your portfolio.
For some ideas on this front, I turned to my friend Ben Simpfendorfer, founder of the Hong Kong-based Silk Road Associates (and author of an excellent book, The New Silk Road). He also writes a very good letter focused on China called China Insider. Ben speaks both Mandarin and Arabic and has traveled extensively in Asia and the Middle East. As such, he has an inside look on two cultures that few Westerners will ever see.
I admire his work for these reasons, and also because he is critical and thoughtful about China’s prospects, whereas many others are either unfailingly sunny or permanently apocalyptic.
In his latest letter, which just hit my inbox this morning, Ben addresses the very question I open with: hard landing or not?
“I expect no hard landing in 2012,” Ben writes. As for 2013-15, Ben is much more bearish. As with any prediction, though, the reasoning is more important (and more interesting) than the conclusion. The key is to understand that China still has a lot of spending power. Let’s take a look...
“China could afford to go on another debt binge in the event that the economy appears to slow abruptly,” Ben writes. “Sure, it has implications for medium-term growth (and I’ll get to that in a moment), but the ability to continue borrowing, or further relax fiscal and monetary policy, does rule out the risks of a hard landing in 2012.”
In the past, China was able to skirt the financial crisis because it simply commanded its state-owned banks and state-owned firms to embark on big projects. It has the firepower to continue to do so in 2012. One place it will certainly focus on is housing. Housing prices are falling nationally. But housing markets are intensely local. You should be suspicious of attempts to aggregate them. Ben appreciates this.
“A look at major city clusters around the country shows that property sales have collapsed in areas centered on Beijing, Shanghai and Hangzhou,” he writes, “even as they remain steady in places such as Chongqing, Hefei and Shenyang.”
Ben continues:
“My own experience — traveling through nearly a dozen second-tier cities over the past six months — echoes the data, with some cities clearly about to suffer a horrible property crash even as others look more balanced owing to less supply, but also a stronger local domestic economy (typically the coastal provinces) that is less reliant on fiscal stimulus.”
As to that stimulus, China’s government plans to build 7 million public housing units annually over the next five years. This is a big increase from the 3 million units China’s state-owned units built in the years 2008-10. And it’s also a lot bigger than the 5 million units the private sector created over that time.
But think what this means. It’s an artificial stimulus. Its goal is mainly to keep people working. However, the market itself clearly does not support such an increase. Ben peels back some of the numbers on the profits earned by builders.
The five large state-owned firms earn profit margins of only 8%, according to data compiled by SouFun (a leading real estate data provider). This compares with 15-25% profit margins for private companies in recent years. I’m taking these at face value, though my suspicion is that the data overstate the profitability of the public firms.
You know, though, how economics works. As profit margins shrink, this is the market’s signal that the capital is perhaps best used elsewhere. Governments can ignore this signal, at least in the short term. But private firms cannot. They must serve the wishes of consumers or they will go out of business eventually. They also have owners who will see that the profits no longer compensate for the risks. They will pull back. And this is what’s happened.
This next chart is telling. It shows you the number of units built each year by private and public firms. You can see the big jump in public construction, which was part of China’s stimulus plan. But look at that blue line. It’s leveled out and declined last year:
“In effect,” Ben sums up, “the shift toward construction of more public housing implies that state-owned firms, operating at smaller margins, will capture an ever-larger share of economic activity...at the expense of the more-dynamic private sector.”
So more and more of China’s economy becomes dependent on government spending. We know that such government spending leads to bridges to nowhere. Or, in China’s case, empty office buildings, empty condo towers, empty malls and, indeed, empty cities. That’s a big problem — but it’s probably not a 2012 story.
Ben concludes: “Whether because of chances that a property crash is limited to certain parts of the country, or because of China’s ability to pump more credit into the economy, the odds are that 2012 turns out to be surprisingly dull, with the economy slowing, but still growing at above an 8% rate...”
It’s also an election year in China. Senior leadership will change in China in late 2012. All the more reason to expect massive spending from government coffers to keep the spell unbroken, if only for another year.
The time frame just beyond 2012 is the problem. Maybe the government spends so much that it produces reasonable-looking economic numbers and keeps people employed, but the resulting economic growth would have been a fantasy. Economies exist only to satisfy human wants and needs. They do not exist to produce numbers that look good in economic reports. China’s economy will have failed, just as other state-directed economies have failed, in its essential task of serving consumers. It becomes, then, an expensive fiction. China’s coffers, as rich as they appear, are also not inexhaustible. All of this means there is an inevitable quality to the collapse here, though the timing is hard to call.
At least for 2012, it seems investors can count on China coming to the table with its usual gusto to spend money. But the clock is ticking and midnight approaches.
Regards,
Chris Mayer
for The Daily Reckoning
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| | | | | Bill Bonner | | Unsolvable Insolvency | | |  | | Bill Bonner |
Reckoning from Melbourne, Australia...
Time and time again, Europe solves its debt problems... and every time they don’t get solved at all.
Italian bond yields are edging back up. And Greece is negotiating a default. They want to avoid a naked, noisy default...so they are dressing it up as “voluntary” or ‘soft.’ But they can’t disguise the fact that Greece has bills it can’t pay. On the 20th of March it needs to come up with 14.4 billion euros, followed by billions more in the months following. That is more than 6% of national GDP. It would be as though the US had to pay a trillion dollars.
Where’s the money to come from? The European Central Bank? The IMF? The Germans? Maybe. But little by little, even the fixers are beginning to realize that this is a problem than can’t be fixed with Band-Aids and bailouts. Greece has too much debt. About 100 billion euros worth of it will have to go away or the country will never be solvent.
In the German magazine Der Spiegel:
“When it comes to Greece, it’s clear that it’s hopeless. It would be better for the country to finally leave the euro and transform its foreign debts to drachma, than to constantly beg for new aid and set itself up for lasting charity”. The fixers and the fixees are meeting, trying to figure out who takes the loss. It is a little like a divorce. If they can get everyone to cooperate, the whole thing will go fairly smoothly. If not, it could be a disaster. The resulting tussle could bring down not just Greek debt, but the debt of Italy, Spain...and even France.
Across all OECD countries, public debt-to-GDP ratios now average 100%. This leaves them all vulnerable. At 5% interest, they have to devote one 20th of their output to servicing old debt. If they have tax revenues of 20% of GDP, it means that a quarter of their revenues must be used to cover the debt. If interest rates don’t rise, they can hold on. But if they are still running deficits larger than their growth rates, the situation is hopeless.
In America, for example, the deficit — in terms of GDP — is increasing at three times the rate of the economy beneath it.
Already, most of the big banks in Europe and America are probably insolvent. Without artificial support from the authorities, they would probably be unable to survive a crisis. Trouble is, the authorities have no real support to give. Most of the nations of the developed world are insolvent too. They can shuffle along now...but could not survive a run on their bonds.
The great hope of the feds is that they can stave off a crisis — by supplying beaucoup cash to the banks...who use much of the money to buy the feds’ bonds. The longer they can prevent a day of reckoning, the more likely these debtors will be able to grow their way out of trouble.
But debt suppresses growth. When debt-to-GDP levels rise to over 90%, growth declines, sharply.
Wait, there is more... Even before debt became such a big problem, real growth had already begun to disappear from the developed world. There has been none in Japan for the last 20 years...and almost no real growth in the US private sector for the last 10 years. In Europe, grosso modo, the story is similar. And in America, all the glories of technology, capitalism, financial engineering and democracy have been unable to add a single penny to the average working man’s hourly wages over the last 40 years.
Why? Nobody knows for sure. We have a two-part hypothesis:
1) Zombification. The process of decline was described by professor Mansur Olson of the University of Maryland. Special interests and lobbyists manage to subvert the political system so as to get favors for themselves. These giveaways and privileges cost money and lower output. The economy gradually becomes less dynamic and less able to increase wealth.
Another professor, Meghnad Desai, from the London School of Economics, says western capitalism has gone “geriatric.” “Dynamic capitalism, with its energy, innovation and sheer greed for growth has moved east,” he says.
A geriatric, zombified economy cannot produce real growth.
2) Declining marginal utility of oil. A modern economy is the fruit of oil. But the oil-burning machines that make the economy so productive were almost all invented before we were born, and put into service, in the developed countries, after WWII. Since the ’70s, improvements in the machinery have been incremental...and insufficient to offset the rising costs of oil.
If these hypotheses are correct, there will be no significant growth in the developed world — not until the zombies are thrown out...and/or a new technological breakthrough dramatically increases productivity.
And more thoughts...
We were suspicious of the recent improvement in the unemployment numbers. And of the news that consumers were going into debt to shop, again. The data were inconsistent with the “Great Correction.”
Besides, US bond yields have kept going down, with the 10-year US note reaching a yield of only 1.87% last week. Bonds were confirming the Great Correction, in other words.
David Rosenberg explains:
Everyone focuses so much on the “headline” data points that they miss what is happening beneath the surface. In actuality, the jobs market in the US remains in horrible shape. It has now been 30 months since the recession officially ended, and the labour force has contracted by nearly 1 million — 170,000 in just the past two months! This is unprecedented and is not about aging boomers dropping out of the workforce since they are being forced to try to extend their careers because they so desperately need the income as an antidote to the lost wealth endured by two bubbles that burst barely eight years apart.
This phenomenon speaks to throngs of discouraged people withdrawing from the work force. What is normal — the average of the past nine recoveries — is that by now, 3.5 million folks have entered the labour force to find a job because opportunity abounds. That is missing this time around, and now we see the Challenger data suggesting a drop in hirings, the JOLTS data showing a pickup in firings and the NFIB survey pointing to a renewed decline in job openings. The labour force participation rate was 65.7% when the recession ended, and today it is 64% — this is totally weird and explains why the unemployment rate is now a meaningless statistic — it is really closer to 12% than the posted 8.5%.
And it is this weak labour market that explains why it is that during this recovery, real median incomes are down 5.1% which, by the way, is even more profound than the 3.2% drop during the recession itself (according to a new Sentier Research report). *** At The Washington Post, Jonathan Turley, gives us:
10 reasons the US is no longer the land of the free
Every year, the State Department issues reports on individual rights in other countries, monitoring the passage of restrictive laws and regulations around the world. Iran, for example, has been criticized for denying fair public trials and limiting privacy, while Russia has been taken to task for undermining due process. Other countries have been condemned for the use of secret evidence and torture.
Even as we pass judgment on countries we consider unfree, Americans remain confident that any definition of a free nation must include their own — the land of free. Yet, the laws and practices of the land should shake that confidence. In the decade since Sept. 11, 2001, this country has comprehensively reduced civil liberties in the name of an expanded security state. The most recent example of this was the National Defense Authorization Act, signed Dec. 31, which allows for the indefinite detention of citizens. At what point does the reduction of individual rights in our country change how we define ourselves?
The list of powers acquired by the US government since 9/11 puts us in rather troubling company.
Assassination of US citizens
President Obama has claimed, as President George W. Bush did before him, the right to order the killing of any citizen considered a terrorist or an abettor of terrorism. Last year, he approved the killing of US citizen Anwar al-Awlaqi and another citizen under this claimed inherent authority. Last month, administration officials affirmed that power, stating that the president can order the assassination of any citizen whom he considers allied with terrorists. (Nations such as Nigeria, Iran and Syria have been routinely criticized for extrajudicial killings of enemies of the state.)
Indefinite detention
Under the law signed last month, terrorism suspects are to be held by the military; the president also has the authority to indefinitely detain citizens accused of terrorism. While the administration claims that this provision only codified existing law, experts widely contest this view, and the administration has opposed efforts to challenge such authority in federal courts. The government continues to claim the right to strip citizens of legal protections based on its sole discretion. (China recently codified a more limited detention law for its citizens, while countries such as Cambodia have been singled out by the United States for “prolonged detention.”)
Arbitrary justice
The president now decides whether a person will receive a trial in the federal courts or in a military tribunal, a system that has been ridiculed around the world for lacking basic due process protections. Bush claimed this authority in 2001, and Obama has continued the practice. (Egypt and China have been denounced for maintaining separate military justice systems for selected defendants, including civilians.)
Warrantless searches
The president may now order warrantless surveillance, including a new capability to force companies and organizations to turn over information on citizens’ finances, communications and associations. Bush acquired this sweeping power under the Patriot Act in 2001, and in 2011, Obama extended the power, including searches of everything from business documents to library records. The government can use “national security letters” to demand, without probable cause, that organizations turn over information on citizens — and order them not to reveal the disclosure to the affected party. (Saudi Arabia and Pakistan operate under laws that allow the government to engage in widespread discretionary surveillance.)
Secret evidence
The government now routinely uses secret evidence to detain individuals and employs secret evidence in federal and military courts. It also forces the dismissal of cases against the United States by simply filing declarations that the cases would make the government reveal classified information that would harm national security — a claim made in a variety of privacy lawsuits and largely accepted by federal judges without question. Even legal opinions, cited as the basis for the government’s actions under the Bush and Obama administrations, have been classified. This allows the government to claim secret legal arguments to support secret proceedings using secret evidence. In addition, some cases never make it to court at all. The federal courts routinely deny constitutional challenges to policies and programs under a narrow definition of standing to bring a case.
War crimes
The world clamored for prosecutions of those responsible for waterboarding terrorism suspects during the Bush administration, but the Obama administration said in 2009 that it would not allow CIA employees to be investigated or prosecuted for such actions. This gutted not just treaty obligations but the Nuremberg principles of international law. When courts in countries such as Spain moved to investigate Bush officials for war crimes, the Obama administration reportedly urged foreign officials not to allow such cases to proceed, despite the fact that the United States has long claimed the same authority with regard to alleged war criminals in other countries. (Various nations have resisted investigations of officials accused of war crimes and torture. Some, such as Serbia and Chile, eventually relented to comply with international law; countries that have denied independent investigations include Iran, Syria and China.)
Secret court
The government has increased its use of the secret Foreign Intelligence Surveillance Court, which has expanded its secret warrants to include individuals deemed to be aiding or abetting hostile foreign governments or organizations. In 2011, Obama renewed these powers, including allowing secret searches of individuals who are not part of an identifiable terrorist group. The administration has asserted the right to ignore congressional limits on such surveillance. (Pakistan places national security surveillance under the unchecked powers of the military or intelligence services.)
Immunity from judicial review
Like the Bush administration, the Obama administration has successfully pushed for immunity for companies that assist in warrantless surveillance of citizens, blocking the ability of citizens to challenge the violation of privacy. (Similarly, China has maintained sweeping immunity claims both inside and outside the country and routinely blocks lawsuits against private companies.)
Continual monitoring of citizens
The Obama administration has successfully defended its claim that it can use GPS devices to monitor every move of targeted citizens without securing any court order or review. (Saudi Arabia has installed massive public surveillance systems, while Cuba is notorious for active monitoring of selected citizens.)
Extraordinary renditions
The government now has the ability to transfer both citizens and noncitizens to another country under a system known as extraordinary rendition, which has been denounced as using other countries, such as Syria, Saudi Arabia, Egypt and Pakistan, to torture suspects. The Obama administration says it is not continuing the abuses of this practice under Bush, but it insists on the unfettered right to order such transfers — including the possible transfer of US citizens.
These new laws have come with an infusion of money into an expanded security system on the state and federal levels, including more public surveillance cameras, tens of thousands of security personnel and a massive expansion of a terrorist-chasing bureaucracy.
The framers lived under autocratic rule and understood this danger better than we do. James Madison famously warned that we needed a system that did not depend on the good intentions or motivations of our rulers: “If men were angels, no government would be necessary.”
Benjamin Franklin was more direct. In 1787, a Mrs. Powel confronted Franklin after the signing of the Constitution and asked, “Well, Doctor, what have we got — a republic or a monarchy?” His response was a bit chilling: “A republic, Madam, if you can keep it.”
Since 9/11, we have created the very government the framers feared: a government with sweeping and largely unchecked powers resting on the hope that they will be used wisely. Regards,
Bill Bonner,
for The Daily Reckoning
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