Saturday, January 24, 2015

Unemployed Students Buying New Cars

Many People Are Jumping Into New Cars
For a long time I have had a problem as economist and others have pointed to the auto industry as proof that the American economy is on the mend. Today in America we see a land where even unemployed students are buying new cars. Claims that the auto market is hitting on all cylinders with annual sales topping 16.4 million, the highest since 2006 is a simplification of the situation and not giving enough focus as to where the sales are coming from or originate.

The facts behind what is pushing this market forward are very disturbing. Over 31% of all new auto loans this year were to subprime borrowers. Subprime loans now account for 36.5% of all outstanding auto loans. The easiest way to become a subprime borrower is by defaulting on previous debt obligations. In a shocking development, auto loan delinquencies surged by 13% in the last quarter, remember this is in a quarter the government claimed showed a solid 5% growth in the GDP. This means subprime loan delinquencies now stand at 18%. Issuing billions of debt to subprime borrowers for housing proved to be a disaster and going forward we should expect the same trend to reveal itself in autos.

Pretending to sell automobiles to people either dependent on money from the government or no means to pay for that automobile is not a good business idea. When you have huge financial lenders and the rest of the Wall Street banking consortium doling out 7 year 0% loans and subprime  loans as if it were candy it’s easy to move inventory. Sadly, while this may temporary boost the GDP the issuing of what is destined to become more bad debt always comes back to haunt us in the long run. A big problem is that often this increases the monthly obligations of someone who is already struggling.

We keep hearing about sales not about soaring profits. If the auto business is indeed healthy and booming why have GM profits fallen from $9.2 billion in 2011 to $5.4 billion in 2013, and on course to fall to $4 billion in 2014? Record levels of channel stuffing produces sales gains, but no profits. Why is their stock well below its 52 week high and near where it was in 2010 during its IPO and after it was rescued by Obama. We see the same thing with Ford as their profits have fallen by 35% versus last year and they are lower than they were in 2010. Another sign of problems is the rumbling coming out of Honda claiming the market has become a cutthroat low profit nightmare.

Auto loan debt continues to ratchet higher every month and is at an all-time high of $950 billion, up 33% since 2010 when the Fed, Wall Street, and the political class in Washington decided they needed new debt bubbles in auto loans and student loans to jump start our moribund economy. Recent figures showed that there are 65 million auto loans outstanding, and the average debt now stands at $17,352. Currently over 30% of auto “sales” are actually leases. The rest are financed over an average of 65 months. This means that virtually all new car sales are nothing more than 3 to 7 year rentals, this is a shocking way to look at what many people spin as proof that the economy has regained its footing.

The average student loan debt is now $33,000. Until the Obama administration went Keynesian much of student loan debt was primarily held in the private sector. When Obama entered the White House total student loan debt was $620 billion and delinquencies totaled $50 billion. There are now $1.3 trillion of student loans outstanding, with the Federal government accounting for $830 billion and guaranteeing a large portion of the rest. Delinquencies have skyrocketed to $125 billion and is not aging well. Going forward it is clear another taxpayer bailout beckons.

While I have focused on student and auto loans I'm aware this subprime buying binge has broadly spread to a wide range of consumers. Is was best said by someone who wrote "Only a University of Phoenix African Studies major is more of a subprime risk than the millions of ecstatic Escalade drivers cruising around our urban ghetto paradises." The Federal Reserve has been pumping in trillions of dollars of liquidity into the economy and much of it has resulted in pulling future consumption forward. These polices will soon become a headwind to both future sales and growth. This is more proof of just what an infusion of money from the Fed can produce and how it adds to the great distortion.

Sunday, January 18, 2015

Relevant Value Trumps Inflation or Deflation

Several years ago while grabbing a sandwich at McDonalds to get me through the work day I found myself having a conversation with another man in line. The subject of the government debt came up and I was somewhat shocked that not only did this man have absolutely no concern over the growing deficit but he went on to state "The government will never run out of money, they will just print more." The part I found troubling was that he didn't seem to connect the dots as to the ramifications of such a policy or simply did not care. It still shocks me that recent polls show many Americans agree with his attitude and view.

I would like to share a comment from a fellow named Art in response to both a recent article I posted and in regard to comments by other readers, it can be found below;
                ArtJanuary 16, 2015 at 9:45 AM    You guys know double entry accounting, right? Those govt liabilities are someone else's asset, to the penny. Thus, an aging and/or contracting population might require MORE govt liabilities, not less. And as long as they are denominated in the debtor's currency, solvency is essentially a non-issue. The constraint is inflation, which is nowhere in sight, despite what look like "high" levels of debt. 
Also, have you ever heard of a corporate bond analyst comparing a company's debt level to its income? Normally, you compare debt levels to assets, and debt service to income. We should do the same when looking at govt debt. And by that measure, the U.S. is mighty far away from problematic debt levels, unfunded liabilities and all. 

To say I differ with Art's opinion is an understatement, especially when he included "unfunded liabilities and all." You may believe what you want, but I caution you if you have any thoughts that the government or central bankers are anything resembling transparent. Both have been superbly entrepreneurial when it comes to generating Ponzi schemes and advancing the art of pseudo-economics. Over the years economic hocus-pocus has masked reality and allowed the current situation to develop. All these games have stirred up a great number of questions to what is real and muddied the water making it almost impossible to get a clear picture of what lies ahead. All the variables and moving parts have made this very confusing and difficult to get one's head around.

The crux of what is before us may hinge on relevant value rather than inflation or deflation. It is possible this is more multifaceted than most people realize and we have been misled into arguing and debating the wrong issue or are viewing the subject in the wrong light. In what is often referred to as the "end game" or the time the global economy will be forced into resetting, I believe the situation will focus on issues of currency and debt valuations. These "debt valuations" will include both government and private obligations. If someone is caught holding a worthless currency or is owed money that is washed away or not "properly repaid" they will suffer greatly. This means some people and countries will be big losers as value and wealth shifts to the "flavor of the day" driven by demand or searching for a safe haven.

 A very interesting bond exist between value and wealth. It becomes visible when you dive into the issue of where and how wealth is stored. A surprise to many people is where wealth is stored varies from country to country, this is very important. The reason for this variance may be cultural, based on historic values, in reaction to how an economy developed, or because of tax policies. The example I like to use that illustrates this is house prices in China, they are very important to that country because that is where almost 75% of household wealth is stored. Here in America a very large share of household wealth, approximately 71% is stored in financial instruments. This means the end of the housing bubble in China has the potential to become a huge deflationary "house of cards" while in America it appears financial instruments are more likely to be our "Achilles Heel."

One possible reason that inflation has not raised its ugly head or become a major economic issue in America is because we are pouring such a large  percentage of wealth into intangible products or goods. This includes currencies. If faith drops in these intangible "promises" and money suddenly flow into tangible goods seeking a safe haven inflation will soar. Another possibility is that the dollars role as the world reserve currency and cross-border money flows has acted as a shock absorber lessening the impact of our Federal Reserve policies. Like many of those who study the economy, I worry about the massive debt being accumulated by governments and the rate central banks have expanded the money supply.

This is all rather complex and even our terminology tends to get us in trouble, for example, it is really not an "end game", but rather more of a reset with the game resuming under new rules. Another point is that inflation or deflation often has to do with how it is figured or calibrated and can fluctuate greatly. The root issue being one of relevance, meaning what something is worth in relationship to another item. This can be a difficult concept to convey, it is also hard to internalize by people seeking easy answers. We must realize "relevant values are in constant flux" and this situation is unending as we move forward. By that measure, it is foolhardy for anyone to close their eyes and hope to prosper on luck when we live at a time when values can change in a blink of an eye. 

We must make a central part of our overall financial planning the idea that as we move forward we continue to replace diminishing assets for those higher up the chain. If not we risk "dying" a financial death that can come slowly, as value erodes, or quickly such as in the case where we have been scammed or robbed. As I fleshed out this post I found myself questioning exactly how much meat or relevance it contains, but it is clear the concept of "relevant value" is more important than the debate about inflation or deflation when it comes to protecting our wealth.  Remember it is a dangerous world out there where few people hold your financial interest above their own.

 Footnote; Added Sept.11,2015  Your comments are welcome and encouraged. If you have time check out the archives for another post that may be of interest to you. The two post below delve deeper into how the value of money can quickly change,


Saturday, January 17, 2015

Currency Markets Reflect Diminished confidence!

Currency markets are beginning to reflect diminished confidence in the system central banks have created. As the currency games continue to ratchet ever higher it is becoming more apparent that we are standing on shifting sand. This was emphasized when the Swiss National Bank surprised markets and eliminated its exchange-rate cap a key source of support for the euro. The euro quickly plunged 3.5 percent against a basket of currencies, the most since its 1999 debut and hit an 11-year low against the dollar, and has fallen ever since. The schemes bankers have used for years to hide and transfer debt are coming under attack, if they crumble under the assault it will culminate in a reset of the economic system across the globe. It must be noted that this will not please many people who will feel deeply abused and totally betrayed by how it is accomplished.

A Very Important Chart In Understanding The Dollar
The chart to the left is very important. Today four major currencies dominate the world stage, they are the pound, the euro, the yen, and of course the dollar. The yen and the euro are in trouble, with the pound being very vulnerable to contagion. The remaining currencies remain small bit players in the over all scheme of things. The status gained by the dollar being deemed the "reserve currency" by which all others are weighed and in someway pegged does not make the dollar infallible or guarantee it will remain strong, but the liquidity of such a large market does add a resilience to the American dollar.

John Maynard Keynes said By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there are a slew of  Currency Vigilantes and they are ready to make their presence known. Weakness in the value of the Yen, Pound, and Euro must not go unnoticed as they are a precursor to the wealth fleeing the countries that use them in everyday life. What is occurring in the currency markets has been a long time coming, the cross-border flow of money leaving Japan and Europe is one reason some stock markets have remained so resilient.

As the Euro-zone self destructs the falling Euro has overshadowed the death of the Yen that makes up only 3.2% of worldwide reserve holdings. The Yen is more of a  harbinger of what is to come and as the value of the Yen spirals downward the myth that advanced Democratic countries are immune to hyperinflation will be destroyed.  Soon after that people will realize that the Euro, Pound, and even the Dollar are not safe from the effects of a currency that is falling in relevant value. This means that people will want to get out of bonds in these countries as well.  This will result in a huge monetization in these countries and then hyperinflation. These four currencies make up about 95% of the Central Bank reserves backing other currencies. Faith in paper money in general will be shattered, Japan will be the first domino to fall, but not the last. The dollar is not immune, but protected by its position as the worlds reserve currency and massive size should be the last too crumble.

The way the global economy is structured the dollar is the linchpin of global fiance thus, it has guaranteed itself a place at the table until dethroned. This means that countries like Japan and China which hold a lot of American bonds or dollars will be able to offset some of the pain of a weakening national currency. Unfortunately, many countries are not in such a position, and to make matters worse countries that are mired in debt often have tied or pegged that debt to the dollar. This means a lot of economic pain if the dollar grows stronger their debt is magnified and these countries will find themselves under a great deal of pressure just to survive. Recent currency moves should again bring into focus the fact that debt does matter and raise questions as to the validity of Modern Monetary Theory that often attempts to sidestep this core economic principle.

Unstable currency markets can be a precursor to massive shifts in value and a sudden drop in confidence. It is logical to think that in such a situation insiders would be the big winners. The main reason the world has chosen a "reserve currency" is to have some benchmark to peg currency values to and lessen the impulse of countries that have accumulated massive debts to attempt to address their problems by just printing more money, This results in devaluing their currencies but often fails to address the root cause of their problem. Just printing more money is not sustainable and little comfort should be garnered from assets or pensions being pegged to future inflation because history shows promises are easily broken and rules often rewritten for what is called the greater good.

The collapse of any currency causes wealth to flee that currency and often the country of the failing currency in search of any safe haven within reach. The bottom-line is that while many people go about their daily lives giving little thought to currency valuations they leave themselves open to the whims of those that control, manipulate and play in this important area of the global economy. Ten percentage points higher or lower against a foreign currency can have a great deal of impact on how your net worth stacks up against someone across the world. This rapidly becomes apparent to anyone doing a great deal of travel or buying foreign goods. It also highlights why all of us should be very concerned where we stand when the smoke clears from the currency wars before us. While most people remain totally oblivious to these dangers do not underestimate the forces in play or the great risk of economic damage through contagion.

Because we  are all interconnected for better or worse it has become difficult to contain defaults in one country from affecting another. This is why some people have been calling for a "world currency" for years. In this respect the saying "one should never let a good crisis go to waste" means a meltdown with high levels of fear would present a perfect opportunity and catalyst to advance this agenda down the field. Remember, many people with agendas have a lot to gain when a major shift in the currency markets takes place. Even with some countries not participating in such a currency dislodging the American dollar as the world reserve currency represents such a shift.  If the world stumbles into an economic hell the noise could become deafening because people and their leaders tend to look for easy answers.

Footnote; Your comments are encouraged. Other recent articles concerning what is happening in the currency markets are listed below, also in the archives you will find several articles dealing with why inflation will win out over deflationary forces.

Thursday, January 15, 2015

A Bridge Over Troubled Waters, How Safe Is This Bridge?

Is Getting Across Based On Hope And Prayer?
I would be a lot more excited about what has been recently herald as good economic news if I felt it was built on a solid and stable foundation. Using the analogy of a bridge, if you are unable to get to the other side you often have a problem. A plank breaking under your feet may spell a problem and the collapse of the total structure a real disaster. Planning to cross a bridge and getting to the other side is not the same thing. If obstacles develop in the process it is possible the goal may never be accomplished.

The rate and ease at which traffic flows across a bridge can change dramatically if faith in the structure is lost or becomes an issue. Much of how society reacts is based on faith in its institutions. A very serious concern should be that many economist have lost or discounted the strong connection between savings and the important role it plays in society. This has skewed and undercut the core beliefs of many hard working people responsible for driving the economy. It is becoming apparent that higher interest rates produce a higher quality of growth. Low interest rates coupled with easy money policies increase risk and encourage a misallocation of funds by investors searching for higher yields.

How people tend to view the economy is based on the performance of prior years. This benchmark has become ingrained in us, and we always expect economic improvement. If last year was good but this year is no better the momentum is gone. Remember the quality of this growth is just as important as the quantity or the fact will come back to haunt us. We must not be distracted into thinking the long-term ramifications of an unsustainable economy built on debt and government deficit spending has much of a future. With a large number of people unemployed and living on government payouts the burden on society will become to heavy and much like the bridge it will eventually fail.

In recent years what have been considered economic norms have been altered and rules have been changed to shore up the crumbling financial foundations of countries across the world. In the past the cost of government normally included a reasonable market rate or carrying cost. This was also known as interest on the debt. As of late savers have been thrown under the bus. The free market has had less influence in determining the rates nations pay on their bonds and central banks have taken the lead. If this is not contained it leaches over into the real economy poisoning both growth and stability, and that is happening today.

Over past decades government's increased role in the economy almost guarantees that deflation will not become a major issue. I consider most of the major countries of the world to now have government centered economies and if you consider what a government employee receives as a salary as a "benchmark" wage it becomes difficult to envision a major drop in compensation to other workers. This would not be tolerated by society as non-government workers would simply stop working or seek more support from government and institutions to level the playing field. This seriously reduces the possibility of deflation, just yesterday the White House announced plans for another "stealth wage increase" in the form of a new law granting workers paid sick time.

It is important to remind ourselves it hasn't always been this way, but this can be difficult because when we look back at history the vision we see is always distorted by who tells the story. Currently, the media controlling and spreading information about the economy is linked at the hip and intertwined with the government. As we cross this bridge over troubled waters we should have no illusions that the path is sound or safe. After years of extraordinary intervention by both central banks and governments we have an unstable structure built in haste and untested. A structure built for their short term benefit and not for the people.

Today the economy of both America and the world is being forced to undergo a major transformation as mankind begins to mature. Over the last two hundred years we have filled the world with our ever growing population and shortened the distance between lands that were once far apart. These factors of change have stimulated economic growth in a positive way, but at some point devising an economic system that is sustainable long term has a great deal of merit. This would be much easier if governments stopped squandering and wasting the low hanging fruit. Optimism of this occurring should be contained to avoid major disappointment.

 Footnote; Please feel free to explore the blog archives and as always comments are encouraged. This article ties together several post I have made over the last few months. More in the article below concerning how currency markets are beginning to show concern about the future.

Saturday, January 10, 2015

UK Economy Is Showing Cracks

British Shoppers Have Been Buying A Lot!
It seems the world continues to have an over-sized image as to the importance of the UK economy because of both its influence in the financial markets and its close ties to America. I also think a bit of an "aura" remains from the years when Britain was an economic powerhouse and the pound sterling was the world reserve currency. Currently the pound makes up around only 4.4% of world wide reserve holdings. I have written several articles about the economy in the UK and consider the country rather uncompetitive for an advanced economy and guilty of importing far more than it exports.  Its inability to pay its way in the world matters, it means they either have to take on more debt or sell their assets to the rest of the world on a large scale and this is getting harder to do.

The pound has been hammered on currency markets as of late making this an opportune time to reassess the strengths and weaknesses of the country going forward. Early last year I reported about a massive amount of money that was being poured into the UK economy. The story placed much of the recent strength from the fact that thousands of Britons were receiving compensation for Payment Protection Insurance (PPI). Most Americans reading about the pickup in Britain's economy never even heard of the PPI. The total paid out until that time had been £13.3bn or about 22 billion American dollars and constituted a huge economic boost to the country of around 65 million people.  This money entered under the radar of many economist giving the impression that the country was undergoing a strong recovery. This false illusion is now beginning to vanish and the momentum from the infusion of cash has begun to ebb.

Figures recently released show the deficit widened to 6% of national income or gross domestic product (GDP), in the three months ending in October. That means the current account deficit has been well above 5% of GDP for 15 months, which is the worst it's been since records were first collected in the early 1950s. Making the situation even more bleak this comes at a time when the UK's total debts (household, business, financial and government) are more-or-less hitting an all time high of around 500% of GDP. It should be noted that it is almost impossible to get the debt burden down when there's a large and negative current account deficit. It is important to remember, for all the talk of a revival in manufacturing, in all reality the UK would be completely sunk without its strong financial sector that bolsters the service sector. Unfortunately, it is not uncommon for the banks and trading companies that comprise this crucial part of the economy to carry a great deal of risk this makes them very vulnerable when the global economy is unstable or debt and loans cannot be repaid.

More important and the real story concerning the gap in the UK and its current account isn't about trade, it is caused by the collapse in what's could be called its "primary income", which is largely the balance between the income the country receives on investments abroad and what is paid out to foreign owners of investments in Britain. For as long as anyone could remember Britain has enjoyed a surplus on its primary income, but in the second quarter of 2012 their primary income balance went into deficit, and that deficit has become progressively worse. In the fourth quarter of 2011, the surplus on net income from investments was 0.7% of GDP, but that went negative, to the tune of 0.2% of GDP, in the second quarter of 2012. And in the third quarter of 2014 the primary income balance was in deficit by 2.8% of GDP. In other words, over three years there has been a dramatic negative swing from surplus to deficit of 3.5% of GDP in the UK"s primary income balance. 

While much of their current economic woes might be blamed on problems in the Euro-zone which have caused investments in the region to yield progressively worse returns. The overall current account deficit with the European Union was up slightly in the most recent quarter meaning for now the worsening must be attributed to a deteriorating trade picture. With the euro-zone locked in a death spiral the UK should harbor no false illusions of help from across the channel. Just the opposite, if anything they should brace for a wave of contagion that might soon sweep over its shores. Just as troubling is that their primary income balance with countries outside the EU went into deficit of $3.4bn from a surplus of $3.6bn. Simply put these investments don't appear to be able to generate a net profit anywhere in the world. As the pound weakens the country will become more competitive and be able to export more, but it will cost more to purchase all those goods that continue to flow into the country making this a no win situation.

The ugly truth is the deficit in goods has continued to increase while the economy was supposed to be "re-balancing" towards manufacturing, only a growing surplus on services has kept the numbers from becoming ugly. There was a $34.29bn surplus on trade in services, up from $31.33bn. Sadly, the deficit in goods trade was a large $47.85bn, up from $45.16bn. The only silver lining is  a recent big increase in the profits of foreign-owned UK companies, from $14.4bn to $19.4bn. This means the UK can fund its huge current deficit by continuing to sell what some see as their crown-jewel companies and other assets to foreigners,but selling off the best assets of the country is not a fix or long-term solution to their financial woes.

While currently considered relatively stable at some point the indebtedness of the UK will reach a level where foreign investors will question its ability to service or repay its debt. This is especially true if there is not a huge unexpected revival in UK productivity, or the efficiency of workers and businesses. At that point, foreigners would not wish to hold sterling causing the pound to plummet and bringing on a rout in the sterling. This would be similar to what happened in September of 1992 during what has become known as the infamous Black Wednesday crisis. So although it is extremely fashionable, especially in the the financial sectors of London to simply ignore the growing record current account deficit it has become a cancer eating away at the future of Britain. At some point this will all come back to haunt the UK and they will rue the fact they have continued consuming more than they can afford.

Footnote; Please feel free to explore the blog archives and as always your comments are encouraged. This article ties together several post I have made over the last few months. More in the article below concerning the PPT and how for a time it gave the illusion the UK was on the mend.

Sunday, January 4, 2015

Euro-zone Doomed By Lack Of Action

Debt Is Growing As Growth Stalls
When will the Euro-zone finally gets it's act together? It appears the answer may be on the 12th of never. More and more it looks like the Euro-zone is doomed by its inability to act. In March of 2013 I penned an article titled "The Euro has problems, big problems" and little has changed.  The two main reason the euro holds together is fear of financial and economic chaos on an unprecedented scale if it is allowed to fail, and the other is to defend the decades long investment in the project.  Today we see the parties involved say they remain committed to propping up nations such as Greece. Germany's chancellor Angela Merkel has even gone so far as to state its departure would be "catastrophic" yet, she is not ready to take the action needed to save the euro once and for all.

This means the currency and the European Union remains vulnerable to new shocks. Currently the Euro-zone is engaged in an unending "talkathon" with nothing being done whenever the fear of an immediate collapse is off the table. The members of the Euro-zone much like their counterparts in America just talk about solutions without any action. For us in America news from across the pond dribbles out in small doses often with injections of hope from a media that glazes over the problems and issue promises that better days of growth are just around the corner. It is only when Greece again starts talking about default and politicians begin bantering around anti-austerity solutions they say will create a painless path to put all this ugliness behind us that the situation again garners our attention.

Recent elections in Greece have again put the country front and center with talk and speculation as to the euro's future as a currency. Markets still worry about the risk of sovereign defaults, unsustainable deficit spending and of a partial or total collapse of the euro. It is possible that the euro is built on such an unstable foundation and so flawed that it can't continue. Common sense suggests that leaders might make better use of their time thinking about how to manage a break-up. Some may be doing so, but having described a split as bringing economic Armageddon, leaders dare not be seen planning for it. Greece is not alone, several countries with austerity wracked economy's are expected to muddle forward, but economists remain skeptical that growth will pick up in 2015 as had been forecast.

Muddying the water is the fact some people see what is happening in Greece as the answer and say scaremongering campaigns on the part of German and European officials make no sense. These people see the leftist Syriza party not as a threat to Europe but a breakthrough. Syriza's program advocates a substantial write-off and renegotiation of the bail-out agreements, accompanied with what is called a "development clause". Leaning towards a Keynesian, rather than a monetarist approach, Syriza opts for balanced rather than surplus budgets, and advocates a return to the minimum wage and a relief program for all affected by the crisis in order to stem the humanitarian fall-out. It also advocates a fair taxation system and ending corruption. All well said but it should be noted we have not yet seen a concrete reform program concerning institutional renewal and how the nightmarish state machine of Greece would be reorganized and put right.

Without the fear of an acute crisis that might endanger the euro it appears Germany has little leverage to move reform along. In the past, countries desperate for Germany’s financial backing quickly agreed to treaty changes to  satisfy Angela Merkel and fill her need to placate her constituents. Germany has pushed the idea that countries should sign binding contracts with European institutions concerning promised reforms in exchange for additional economic help. Northern hawks  like the Netherlands and Finland continue to be adamantly opposed to additional transfers, fearing they might become permanent. Southern doves rejected the idea of yet more control and over-site of reforms imposed from Brussels, especially if only small amounts of money and aid come with them. The result is a “negative coalition” of the rival camps who opposed the German idea for completely different reasons.

Another problem is that when it comes to reforms the concept of austerity has been skewed and painted as evil. Governments have found it easier to cut deficits by raising taxes than reducing spending or address the rigidities in the labor and product markets that retard growth. The best two explanations for reform-aversion are; structural reforms run into organized opposition from groups that enjoy benefits, while raising taxes causes only generalized grumbling. Second, European rules focus primarily on controlling debt and deficits and not the underlying workings of the economy. Countries that have been forced to seek bailouts have already enacted major reforms, in truth these contracts are really aimed at vulnerable countries like Italy and France that have not come under official programs. Enrico Letta, the former Italian prime minister took the line that “the time was not right”. France has gone so far as to say the commission should not “dictate” the shape of reforms.

Problems in the Euro-zone ultimately stem from the loss of competitiveness in the countries of the periphery where wages have outrun productivity. Germany wants structural reforms to labor and product markets to have more growth. Voluntary initiatives, starting with the Lisbon Agenda seeking to make Europe more competitive and dynamic have achieved little. The Euro Plus Pact of early 2010, where countries made voluntary pledges that were to be reviewed yearly by peers has produced little fruit. The commission’s “country-specific recommendations” have been generally ignored. Today many leaders fear the unpopularity of such moves will feed the rise of anti-establishment, anti-EU and anti-immigrant parties. The idea of these contracts have been repeatedly pushed off since autumn of 2012. Merkel will now begin a waiting game, only when they need Germany to commit more money to stabilize the Euro-zone will she be able to push her contract agenda through, but remember getting someone to sign a contract and meeting its terms are two totally different issues.

At some point we must circle back around to the issue of the long awaited Banking Union, the absence of a permanent burden sharing agreement to end the doom-loop between weak sovereigns and weak banks remains elusive and progress towards the necessary institutional framework is not the same thing as completion. A banking union is no panacea for the euro zone’s ills, but it would ensure that taxpayers of individual countries are not called upon to save the banks. Currently, there is agreement on a bail-in scheme for banks that will involve creditors if a bank fails, but still there is no pan-European deposit insurance or resolution scheme with a single Euro-zone deposit-guarantee system similar to America’s FDIC. What has been agreed to would transfer to European authorities the supervision of Euro-zone banks and the power to handle their liquidation if necessary yet fails to address key issues. Even the IMF has warned that such a piecemeal banking union would fail and leave the most troubled countries vulnerable to bank runs. 

Unfortunately, without a crisis little gets done, it appears the Euro-zone and the world has been lulled into complacency by all their constant talk coupled by central banks printing and promising easy money for the foreseeable future. It seems many people have already forgotten the lessons of the 2008 financial crisis that debt does matter. All this has set the stage for more problems in the near future. If the government's of the Euro-zone do not come up with solutions that the people can accept and buy into we should be prepared to continue seeing unrest play out on the streets of that troubled region of the world. The problems are many and the economic obstacles facing the Euro-zone are massive, the other thing that is certain, is that they are not going away. Instead the issue of how to make economies more sustainable will soon be visiting even more countries across the globe.

   Footnote;  As always comments are welcome and encouraged. This article goes hand in hand with several others on the Euro-zone, the article below looks at how currency trading is about to get very wild.

Thursday, January 1, 2015

Retail Sales Most likely To Disappoint!

They Had A Sale, But Nobody Came!
The elephant in the room that both bulls and the media appear reluctant and unexcited to talk about is retail sales during this rather short holiday season. The number of shopping days between Thanksgiving day and Christmas has in the past been talked about as a big deal, but not this year. Instead they continue to throw out claims of fast growth during the third quarter where the GDP surged to 5%. This was not consumer driven, but the result of a 10% jump in federal spending, mostly on Pentagon hardware. This "pre-election" spending was the biggest increase in federal spending since 2009 when the Obama administration put in place a huge economic stimulus package.  Reports from the local malls and surrounding stores on the morning of Black Friday indicated problems from the start.  

Not only were the parking lots empty but many of the stores had more employees working than customers. My office is across from the second largest mall in my state so as I went into work an unplanned visit seemed in order. Foot traffic inside the mall was far less than I imagined, most of the shoppers were younger women and older girls. These are considered the "core" and most diehard of shoppers. Many were carrying few if any bags, this indicates little in the way of buying. Animal spirits in reaction to Black Friday were far less enthusiastic than in the past. The stores did fill as the day wore on but reports that were more or less ignored showed a drop in sales of about 11%. It now appears the lack of enthusiasm displayed in the days leading up to the holiday have leached into post holiday sales. This will have a huge impact on sales as well as margins as retailers are forced to slash and discount goods to clear shelves for spring merchandise.

I walked the entire mall several times in recent weeks to gauge shopping activity and see for myself what was happening, I have decided to rate sales dismal at best. As usual the media presented stories on the news of robust shopping, this includes scuffles in stores in the UK. In reality what happens in one store matters not, it is what is taking place in a majority of  this country's retail locations that will determine whether this Christmas season is a boom or a bust. We are repeatedly told by the media of America's changing buying habits, about the massive shift to online buying from a lazy public seeking convenience. Add to this stories about how the malls are dying and failing to attract shoppers who need a compelling draw to wow them and not just run of the mill goods and services. Personally, I think the shift in how people buy is all a bit more complicated than that.

 In recent weeks the crowing about strong sales has ebbed and speculation as to whether this has been a big shift to online buying or if the consumer has simply gone AWOL (absent without leave). Despite large sale promotions and steep discounting activity on the sales floor in stores across much of America has been rather quite. Stories instead focus on stock market gains and lower gas prices being the spark that will ignite the animal spirits of consumers. Almost two years ago in a television interview on Bloomberg, Harvard economist Steven Roach put a retail sales consultant in her place who was crowing about strong retail growth.  Roach pointed out that after discounting for inflation growth in retail sales compared to past years is mostly an illusion. His statement remains true today. While the media continues to pump out the message all is well and the economy is growing it is hard to overlook the fact that consumers are not enthusiastic.

Interestingly, this is all occurring at a time the government continues to pour out billions of dollars each month in student loans, many of these loans will never be repaid. This is in a way a stealth "stimulus" package that proves we are on the wrong path. The chart below lends credence to the idea that as the Fed's credit injection is reduced someone must assume their role or consumption will fall. If you take away student and car loans the remaining credit creation is not nearly enough to push US consumption higher.

It appears the credit card buying spree from late spring is long gone and revolving credit has fallen a considerable amount. Comparing the recent "recovery" period to the "healthy" credit card purchasing days of 2007 confirms this weakness. It is very troubling that after several months of depository institutions and banks funding the bulk of credit needs, the past two months have reverted to the old normal, where Uncle Sam is the sole provider of consumer credit. This is only one of many problems facing brick and mortar stores that now have to deal with online competition.

I have written several articles about Amazon and how the online retailer often abuses and exploits the brick and mortar stores that line streets throughout America. I was unhappy when Washington failed to force the collection of sales tax by online companies. This was supported by real estate owners and most business owner because it gives online retailers an unfair advantage. While Amazon sends out the signal that their customers are smart, forward thinking, and upscale the company exploits America. What consumers save in money it may cost them many times over in damage to their local business community. Words like "evolving" have been used to describe Amazon's business model, a better word might be undefined. A major key weakness is that new competition can now cheaply and easily replicate the most profitable parts of Amazon and cherry pick much of their future potential. This may be the year that competition has struck back hitting Amazon head on in a game Amazon cannot win.

Another issue is what consumers are buying continues. Recently we are witnessing a shift from general consumer goods to more purchases of autos and healthcare. Far to much has been made of auto sales and how they create jobs as well as the positive affect of Obamacare during recent months. It can be argued that these so called economic drivers have major flaws. In the case of auto sales 31% are currently underwritten by sub-prime loans that leave the buyer even more strapped and deeper in debt, when it comes to healthcare, major increases in premiums due to Obamacare are smashing into the budgets of many Americans. Both these factors leave the consumer with far less disposable income. If indeed auto sales are roaring up double digits at the same time healthcare spending has increased substantially it is only fair to assume most small businesses or someone else is taking a beating.

The market should be very concerned that no retailers are coming out boasting of great holiday sales. It is possible that a combination of many consumers simply being "tapped out" and with their closets full are finally learning to live with less and are unenthusiastic about buying more. As for online shopping we should remember some of the things that will effect their sales and bottom-line. Many of the poor lack a "good credit card" and as brick and mortar retailers cut prices to move merchandise, online companies like Amazon will be forced to do the same. This will squeeze margins and profits. Many of the big box stores have beefed up online sales and services with the advantage of allowing customer pick up and returns that companies dealing only with online cannot provide.  All in all expect this years retail sales to be OK at best to very disappointing or unimpressive, and profits are likely to be the same or worse.

Japan Is About To Enter A Crisis Of Faith

The Sun Is Setting Over The Land Of The Rising Sun
Across the world many people have given a big thumbs down on Japan's great economic experiment. The recent re-election of Prime Minister Shinzo Abe indicates the people of Japan still have faith in their government, why, and for how long are the two big questions we must ask. Abe hopes his electoral victory will give him a mandate to tackle the more difficult elements of his “three arrows” reform agenda and get the economy moving. Meanwhile Fitch Ratings recently said it expects to downgrade Japan’s credit rating sometime early next year after the government delayed a sales tax hike, this would follow a similar downgrade by Moody’s as concerns grow about the country’s unprecedented debt pile. Fitch wants to see what type of budget Japan compiles for next fiscal year but has conceded that there is little chance the government will cut spending enough to offset revenue lost from the tax hike delay.

The Japanese Prime Minister's victory in elections this month is seen as an endorsement of his economic policies and increased his chances of staying in office until 2018 in a nation with little diversity or dissent. To date, Abe has successfully focused on infusing the market with cash through fiscal stimulus, and job creation via central bank policy. Much tougher will be restructuring Japan’s change resistant economy through political reforms. Abe’s decision to delay a sales tax hike has proved popular with voters, but it has eliminated any chance of meeting the government’s deficit reduction targets. The tax hike planned for October 2015 has been delayed for 18 months after an earlier tax increase in April 2014 helped push the economy into recession. The governments target of halving the primary budget deficit as a ratio of GDP during the next fiscal year now appears unreachable and Japan’s second target of eliminating this budget deficit in fiscal 2020 is becoming less credible with each passing day.

 It should be noted that Japan would be sitting in far worse shape if it were not for the transfer of wealth shifted from America to the small island nation each year. America spends billions each year defending Japan and puts much of this money directly into the economy, America also supports Japan by purchasing many of the goods the country produces. The massive trade deficit America has with Japan feeds large amounts of money into Japan, without this money the massively indebted nation would be in even more trouble. Thus far the current Bank of Japan policy has quietly and systematically distorted financial markets across the planet. As this unfolds investors and the mega-banks are drastically reducing their Japan Government Bond (JGB) holdings. The risk of who gets hurt in the case of a default has shifted from the private sector to the people of Japan as the BOJ splurges on government bonds.

Years ago Japan was considered to have much better control of its destiny than many other countries because its bond were owned by the people of Japan and not controlled by outsiders such as is the case in America where other countries own a large share of its debt, but it should be noted the dollar as the world reserve currency makes America somewhat a unique situation. In the past, many economists argued that high debts would not trigger a crisis, because Japan's ample current account surplus made it a net creditor to the world. Now that the current account surplus is deteriorating, this has brought unwanted attention to the pile of debt and on Japan's ability to service it. Today Japan faces a wall of debt that can only be addressed by printing more money and debasing their currency. This means they will be paying off their debt with worthless yen where possible and in many cases defaulting on the promises they have made. Japan's public debt now stands at around 230% of its GDP and is the highest in the industrialized world.

Currently, the primary budget deficit excludes debt servicing costs and income from bond sales, if not the situation would be even more foreboding. The best advice you can offer someone who is creating a big hole of their own making is to tell them to stop digging, this is the advice someone should offer up to Japan, but in this case it is probably to late. Neither monetary nor fiscal policy will adequately solve Japan's problems. Continuing to run fiscal deficits only means that government debt is pushed onward and upwards leading to a variety of possible scenarios on what the end game will be. We are seeing fostered upon the world one of the biggest Ponzi Schemes of modern economic history. The Japanese stock markets soared towards a six-year high recently as the yen tumbled because the Bank of Japan again boosted stimulus. All this occurs as the nation’s pension fund props up this market saying it will buy more shares.

An interesting footnote is that as the economic noose continues to tighten around Japan a new law deemed the "Specially Designated Secrets Act" came into force a matter of days before the election. Under the new law, citizens possibly including both whistle-blowers and journalists, can be jailed for up to 10 years for revealing state secrets. Critics fear the law has the potential for misuse, and could be used to curtail press freedom. Reporters Without Borders called the new law “an unprecedented threat to freedom of information” other comments include, "They are gathering puppets as audiences at their unpopular election campaigns" and "PM Abe is controlling the mass media with threat & money".  It is becoming more obvious Abe is on a mission and if a crisis of faith develops he will not hear the voices of the people making the situation even more dire in a land where the culturally homogeneous population often finds it is in agreement.

At some point a person has to question the reason behind the euphoria surrounding Abe's policy because a weaker yen means it is more costly to import fuel and other commodities into the resource poor country. The expansive monetary policy by Japan at some point is likely to end its deflation and lead to price increases. That is the good news, the bad news is that the evidence so far on QE2 and QE3 is not reassuring and it is questionable if Abenomics’ monetary loosening will significantly raise the long term growth rate of Japan’s real GDP, this monetary policy carries substantial risk and side effects.  Ever since the Yen went into play many economist have said what Japan is doing is actually quite dangerous. As the people of Japan begin to realize they are marching in lock step over a financial cliff faith will be lost and a crisis will develop. When they finally break ranks the concern is that a loop will develop that feeds on itself. As the yen falls and people in Japan realize that it is liable to continue, more and more people will want to put their money abroad, at that point the yens fall may become unstoppable.

Much of this can be blamed on the Bank of Japan's attempt to force a reallocation of capital from Japanese Government Bonds further out on the risk curve. As they continue down this path it is only a matter of time before the credibility of the BOJ is lost and the yen will take its final plunge. As investors in Japan's government bonds begin to believe that Abenomics will be successful in bringing back inflation it is logical for owners of  JGB's to move out of low yielding securities and buy foreign bonds or equities. The moment the Japaneses stock market fails to rise enough to offset anticipated inflation this will turn into a tsunami of  money fleeing Japan and constitute the end of the line for those left holding both JGB's and the yen. This has been a long time coming and when Japan does finally crumble it will be felt across the world.

We must not forget that in our modern world money can cross a border with the press of a key on a computer. Money has gained wings, it can flee and move about with rapid speed, and it can leave destruction in its wake. The financial news flowing from Japan has become so loaded with conflicts of interest and internal deals created to prop up one weak institution with another that it would be called comical it the ramifications were not so serious. This incestuous financial behavior where excessively close institutions resistant to outside influence work hand in hand to manipulate and create the impression that growth and prosperity is just around the corner will not end well.  I contend the cross-border flow of money leaving Japan is well on its way and is the reason some stock markets have remained so resilient . Simply put, the fundamentals for Japan are lousy. We should assume that as confidence fades a panic will start with the big  questions being, where will this wealth go, and into what kind of asset?

Footnote 8-18-2015,   Note the yen remains a freckle off its multiyear bottom and could make new lows at any time.  Since writing this article several more post concerning Japan have been posted a few that you may find interesting can be found below.