Monday, February 29, 2016

China's Economy Policy Akin To Pushing On A string

How Do You Produce Growth In A Bubble?
Currently China's economic policy is akin to pushing on a string. Time and time again history has shown that when an economy has overbuilt, over leveraged, and over reaches a reset occurs. Numbers just released show activity in China's manufacturing sector shrank for the seventh month in a row in February and more sharply than expected. Things are so bad that central bankers and finance ministers from the Group of 20 major economies recently urged China to move towards increasing their fiscal deficit to propel growth forward. China's economy grew an annual 6.9 percent last year, the lowest in 25 years and analysts forecast it to slow further this year. It is anticipated Chinese Premier Li Keqiang will declare a lower growth target at the coming NPC meeting, likely a range of 6.5 percent.

While this sounds like good growth by the standards of countries across the globe few people trust the numbers China puts out. Concerns about how China deals with the issues that for years were masked by rapid growth loom large. Even as this piece was being written news stories of a "surprise" cut started flowing onto the internet.The People’s Bank of China just announced a 0.5 percentage point cut in the capital that banks are required to keep on reserve with the central bank, effective March 1. The measure to cut what is referred to as the RRR frees up an estimated $108 billion worth of funds. The latest move lowers the reserve ratio to 17 percent for major banks. This is the first across-the-board reserve ratio cut since October of last year, when the central bank also lowered it by the same margin. The cut comes immediately after this weekend’s G-20 meeting in Shanghai in which the members endorsed the game plan of China taking a more accommodating stance while urging Beijing not to devalue the yuan. This cut seems to meet both these goals.

The PBoC clarified in a statement on its website the RRR this move is aimed at maintaining liquidity and guiding the steady growth of money and credit. It is clear the central bank wants to make up for a shortage of liquidity and to stabilize the economy. However, we should consider this as further acknowledgment that a reliance on cheap bank loans has run its course or lost much of its magic as a method to boost the economy. As always when they discuss new solutions to support global growth the talk is spun to sound constructive. Both the G-20 and the central banks always claim to  include a focus on fiscal expansion and long-term reform rather than just credit-driven growth. Still the problem remains that persistent worries about Beijing's ability to manage China's slowdown remain and its affects on other economies continues to expand.

This action paves the way for China's State Council to widen the country's fiscal deficit to about 3% of gross domestic product this year from the current 2.3%, according to Chinese officials and government advisers close to the decision-making process. In a recommendation to China's top policy makers a senior official at the People's Bank of China wrote that the government should let the shortfall reach 4% or so because that would allow authorities to slash taxes on businesses to free up more of their funds for investments. "Fiscal policy hasn't been proactive enough," said Sheng Songcheng, head of the survey and statics department at the central bank and the lead author of the recommendation. "The concern over increasing the fiscal deficit is that it could lead to a fiscal crisis. But our research shows otherwise."

China's Money Supply Soared From $10 To $24 Trillion 
Instituting reform is easier said than done and while China is working through debts from massive stimulus spending during the 2008 global financial crisis they are far from turning the corner. As I have stated before it is the nature of political systems to mask their flaws and in the case of China years of rapid growth have made this easy. It is important to remember that much of the growth in China after 2008 came from a massive 6.6 trillion dollar stimulus program. This expanded credit and poured massive amounts of money into the system, but it also encouraged expansion and excesses in real estate and industrial capacity with little regard as to real demand or need.  Even today while many people concede that growth has slowed they still refuse to recognize just how much of past growth has been constructed on a foundation of sand and the misallocation of capital.

China is in a situation similar to what America faced in 1929 following a period of rapid growth and credit expansion. For years credit expanded rapidly in China, and now much of the country is mired in debt. It is important to remember lackluster demand means a heavily indebted corporate sector in China has little incentive to borrow more, and Chinese banks are wary of rising bad-loan levels. Corporate debt now amounts to 160% of China's gross domestic product, according to estimates by Standard & Poors, this is up from 98% in 2008. Also rising taxes have become a huge burden for Chinese companies. Surveys by the central bank of some 5,000 industrial companies show that their accumulated taxes from January 2012 to November 2015 jumped 30% while their total revenue grew by only 3.3% during that time. Corporate taxes are said to account for about 90% of government revenue, cutting corporate costs is a main goal in President Xi Jinping's "supply-side" reform agenda

This strategy involves closing down "zombie firms" including large employers such as steel mills mired in overcapacity and reducing the number of unsold homes. This has put the economy in a vise, complicating the situation is the fact that money that has flowed into the country for decades is leaving and taking with it much of the wealth it has produced. Interestingly, many people fail to understand how this great capital unwinding and the money that continues to leave China will affect both currencies and economies throughout the world. In fact many economist and investors are in a state of denial as to just how dire the situation has become. On a daily basis we still hear the faithful tout how China is still cranking out around 7% growth. I contend China is in far more dire straights than most people imagine and the reason it has gone unnoticed is because of the control their government has over the economy which makes it impossible to get accurate or specifically detailed numbers and information.

According to estimates, China’s banking system has grown from $10 trillion to $24 trillion since 2008, but now the reverse appears to be happening, and as the yuan weakens, the central bank will effectively have to buy its own currency using foreign reserves to maintain its peg. Senior Chinese officials say both its monetary and fiscal policies will remain "appropriately expansionary"  to prevent the economy from falling off a cliff during the time they attempt western economists advice to press ahead to remake the economy rely less on investment and exports and more on their own consumers. This is a major shift for China's economy, bottom-line is that we should not be surprised if China's leaders are unable to make the transition  in an orderly fashion.

Footnote; Below is another post concerning China that I consider very important.

Sunday, February 28, 2016

Nuclear Weapons - Putting the Issue In Perspective

The Reality Of A Nuclear Blast Unthinkable!
Like many people, I do not find what is known as the concept of Mutual Assured Destruction, or MAD to be reassuring. As a bit of a history buff, I found myself in deep discussion with a curious young lad of nine. While explaining to him how the airplane developed which included a rather important timetable, I noted that its development was pushed forward because planes could be used as a weapon in wartime. To my surprise, I found he expanded the conversation to include the nuclear bomb and this young lad had a general acceptance of its use. This could indicate people are losing some of the massive fear they had for the use of nuclear weapons. Fear was the "firewall" that kept these weapons from ever being used for many of us growing up during the cold war.                    

What the world would look like following a nuclear war is very murky, yet today it seems many people consider nuclear weapons as just another tool or option for us to use in our defense if we are attacked. More troubling is that some people even view and justify its use as an offensive weapon when deemed necessary. The unintended consequences of bringing nuclear weapons into the world as a usable form of warfare is a dangerous escalation that no sane person wants, but by tweaking and modifying weapons, we are on that path. This acceptance of the "nuclear option" opens a Pandora's box blurring and erasing what many people have in the past seen as taboo. Something most people are unaware of is just how close on various occasions we have come to annihilation and the end of life as we know it. Below is the description of such an incident;

[In 1995] President Boris Yeltsin was informed that a nuclear missile was speeding towards the heart of Russia. Russian nuclear forces, already on a hair-trigger alert, were put on even higher alert, ready to launch at his command.
The fate of the planet hung in the balance as hundreds of millions of people were going about their daily lives.
Russian policy called for a “launch on warning.” “Use them or lose them.”
Yeltsin wisely waited. And within those fateful moments, the Russians were able to declare a false alarm. An unimaginable nuclear disaster had barely been avoided.
Innovation In Arms Control: De-Alerting, America’s Defense Monitor, Center for Defense Information, December 26, 1999

It is no secret that at the dawn of the nuclear age, the United States hoped to maintain a monopoly on this new weapon, but the secrets and the technology for making nuclear weapons soon spread. Four years after the United States conducted its first nuclear test explosion on July 1945 and dropped atomic bombs on the cities of Hiroshima and Nagasaki in August 1945, the Soviet Union conducted its first nuclear test explosion. The United Kingdom (1952), France (1960), and China (1964) followed. In an effort to prevent the nuclear weapon ranks from expanding further, the United States and other countries negotiated the nuclear Nonproliferation Treaty (NPT) in 1968 and the Comprehensive Nuclear Test Ban Treaty (CTBT) in 1996.

As a result or since the inception of the NPT, several states have abandoned nuclear weapons programs, but others have defied the treaty. India, Israel, and Pakistan never signed the treaty and now possess nuclear arsenals. Iraq initiated a secret nuclear program under Saddam Hussein before the 1991 Persian Gulf War. North Korea announced its withdrawal from the NPT in January 2003 and has tested nuclear devices since that time. The countries of Iran and Libya have pursued secret nuclear activities in violation of the treaty’s terms. Today the use of nuclear power is fairly widespread, but only nine countries have nuclear weapons and only a few others are suspected of pursuing them.

A Trillion Dollar System To Maintain
The topic of these weapons quickly feeds into questions of where they play into the future of mankind and thoughts of the devastation they might wreak if they are ever used in a war. It is very likely that at some point in time the tiger will be unleashed and the potential of a dreadful result is very high. A large part of the nuclear weapons debate revolves around how many weapons are enough. Another is the cost of funding existing weapons and the upgrading of America's nuclear triad, this is a very costly investment. The nuclear triad refers to the nuclear weapons delivery of a strategic nuclear arsenal which consists of three components, traditionally strategic bombers, intercontinental ballistic missiles (ICBMs), and submarine-launched ballistic missiles (SLBMs).

Cato Institute!s Chris Preble has written that the Navy’s plan to build twelve next-generation subs has quickly begun to eat away at the Navy’s overall shipbuilding budget. Recent projections place the total cost of this program at between $93 and $100 billion. “The reliance on three nuclear delivery systems is a relic of Cold War bureaucratic politics, not the product of strategic calculation,” he writes. The Pentagon should look elsewhere within the nuclear arsenal for the money it needs. Eliminating the other two legs of the nuclear triad is his suggestion. Doing away with intercontinental ballistic missiles, or ICBMs and nuclear bombers would save American taxpayers around $20 billion a year that could be put toward replacing the Ohio-class sub. He also claims the sea leg of the nuclear triad by itself is a more powerful deterrent than that possessed by nearly any other nation in the world.

We Are Ready To Launch
Russia retains a relatively large arsenal, but no other country is capable of deploying more than a few hundred nuclear warheads. A single Ohio-class submarine can carry up to 192, this is enough for one submarine to "make its point and bring earth to its knees." Today nine countries have a total of over 15,000 nuclear weapons the U.S. and Russia together have over 14,700 of them. An important matter is far too many are actively deployed on missiles, bombers, and submarines, ready to launch at a moment's notice. It is rather ironic to ponder how much we have spent to create and now maintain this massive force of devastating potential that we hang over the heads of others, a force that could kill them many times over but also render the planet unlivable for generations for everyone. Call me silly, but I would feel a lot more comfortable if a lot of the weapons were dismantled and destroyed. 

Many Americans have become desensitized to human misery because of modern society's rather impersonal way of viewing anguish and death on a screen. Couple this with the hundreds of millions of people across the world playing violent video games and watching explosion after explosion in movies and it is little wonder fear of mass devastation has lessened. As noted earlier in this piece with so many nuclear weapons technical failures can and do occur, we are at constant risk and human error exacerbates the problem. This situation we live with every day and give little thought could suddenly explode and take over our lives. The nuclear deterrent we hold is a hundred times larger than needed to stop anyone sane or rational from attacking America, and for anyone else an arsenal of any size will be insufficient

Wednesday, February 24, 2016

Trump Must Start to Provide Specific Plans, Or Should He?

Trump May Become The Explainer And Chief
Trump's big win in Nevada may silence some of those political pundits and naysayers that have been in a tither over Trump not being brushed aside as a fad. A Wall Street Journal Headline recently caught my attention stating "Trump Must Start to Provide Specific Plans" to prove he has substance. Another starts out, “Hillary Clinton’s win in Nevada Saturday suggests that in the end Democrats aren’t going to indulge their inner socialist this year" alleging her potential to go all the way. One recent piece explains that if  Republicans want to win they should reconsider their Trump embrace or they will be diving into "who-knows-what”.  A piece in Market Watch  reported that Obama does not think Trump will be President sighting his "faith" in the American people to understand this it is a serious job. This is a sample of opinions and politics today.

Trump Has Faced Massive Ridicule
 The barrage is endless and the line of those loading on to discredit and undermine Trump is long. The media must make it clear that once the American people become "better educated and understand" they will reject this man. As far as the issue of a candidate providing "specific plans" since when and why would that be important? While people often say they want specifics it seems that more often than not it is so they can use them to tear the proposal apart. Seldom if ever do we see any of these ideas or plans adopted as proposed. Washington has a remarkable ability to turn something simple and clear into a complicated 2,000 page monster of loopholes and switchbacks that serves the lobbyist and elite. The sad reality is specifics don't matter and vision trumps promises. One message being made clear is that it would be wise not to underestimate the growing discontent and angst of the American people.

Politicians are not held in high regard. If you want to know how America views Washington you only need to watch an episode or two of the popular Netflix TV series House Of Cards. Politics is a snake pit where lies and misdirection run wild and an election is one of the few forums where people can make their anger heard. On February 17th a new Wall Street Journal/NBC News poll conducted after a combative debate performance claims that support for Donald Trump among Republicans has declined in the past month, leaving him slightly behind Sen. Ted Cruz in the race for GOP presidential nominee. Trump had enjoyed a double-digit lead over his rivals, but the new poll found support for him falling by seven percentage points since mid-January. Among registered voters who said they would participate in a GOP primary, he drew 26% in the new survey, narrowly trailing Cruz, who had 28%.

Under-preforming Would Cost Trump Prestige
The so far unrealized decline in support for Trump proclaimed by the poll comes after four other GOP candidates dropped out of the race. The claims are this winnowing of the field has benefited his remaining rivals. Following his win in South Carolina the New York businessman bashed both the poll and the paper saying the pollster should be fired. While far from the perfect candidate, Trump as a choice for the highest office does carry with it many interesting aspects. Having a bit of money in his own right Trump has alleged he need not steal or prostitute himself out to special interest. In all honesty if Trump is elected he has more to lose in prestige if he preforms poorly than anyone else currently running, I only wish all politicians were so motivated.

The poll also shows that if the primary came down to a head-to-head choice, both Cruz and Sen. Marco Rubio could beat Trump by double-digit margins. To some voters all this Trump bashing is being interpreted and reeks of the media and establishment politicians again trying to control who is eventually elected. Visions of prior races quickly come to mind and with the memories a picture of a powerful media that makes or breaks a candidate at will. Leading up to 2000 Bush was heralded as a smart capable leader. More recently most of us remember how Obama was portrayed as someone capable of healing the nation and bringing about change, he was the force that would bring us together and get a dysfunctional Washington back on track. Ironically, it is no longer a compliment for Marco Rubio to be dubbed by some as Obama 2.0, a reference to his skills to bedazzle us with a clean reasoned message.

During the last Presidential election we all remember how Mitt Romney was ridiculed for stating in a closed door meeting the simple truth, "There are 47% of the people who will vote for the president no matter what ... who are dependent upon government, who believe that they are victims. ... These are people who pay no income tax. ... and so my job is not to worry about those people. I'll never convince them that they should take personal responsibility and care for their lives." Romney spoke the truth but offended those demanding we be politically correct, but it is important to remember politics makes strange bedfellows and Trumps proven record of negotiating skills should be able to exploit this. Note the irony that both Trump and Sanders are both against the recent trade deal and see it as exporting jobs to distant lands, many Americans would love to see a situation develop where something gets done with both parties working together.

On occasion over the years like many people I have considered running for public office because of my frustration with how poorly government functions and the outright corruption or should we say crony capitalism that has flourished. It may be that I'm simply to busy or that looming in my mind are images that I would never pass the litmus test of pandering and political correctness, also I would not do well in an environment where I would have to deal with all the clowns we have placed in public office. The fact is I like responsible, self-reliant, people and find it difficult to pander to those who constantly ask for more and more help. Bottom-line is that whatever we do "it ain't enough" to fill the needs of those wanting more.

Footnote; This is not a full fledged endorsement or a declaration of love for Donald Trump, but rather the solid recognition that he would not be the most illogical choice American voters have ever made.

Saturday, February 20, 2016

Britain Forces Concessions To Stay In European Union!

Another Problem For The Weak Union
The Euro-zone faces several headwinds that threaten the very existence of the 28-nation alliance. One is whether Britain remains part of the struggling group.  Friday, British Prime Minister David Cameron won unanimous support from the European Union for concessions he sought from the bloc ahead of a referendum on Britain's continued membership in the group. Following two days of intense negotiations the deal which received unanimous support was announced from Brussels. Cameron negotiated the deal to give the U.K. special status in the EU that would allow it to opt out of an "ever-closer union," and that it would "never join the euro" currency. The deal also allows Britain to place "tough new restrictions" on foreigners using its welfare state.

Cameron said he would ask his cabinet to approve the deal on Saturday. "In my view, (this) is a time to stick together," Cameron said. "I think the British people would be safer (in the union) than out." As of now no date has been set for the referendum which may come as early as June. Polls show the British public is closely divided on the issue. Ironically, as we often see in the case of a bad marriage the area is bound together more out of the fear of what will happen if it dissolves rather than because the relationship is working well. Since the volte-face by Greek Prime Minister Tsipras last summer, and a temporary solution to the Greek debt crisis other problems have surfaced to stress the area. A flood of refugees and the issue of how to deal with their arrival as well as the security threats they might pose have taken center stage, but only over shadow the unresolved economic matters that continue to fester.

Greece has not caused a catastrophe so far, but problems within the Euro-zone are far from over. It is clear the pot is simmering and likely to boil over at any time, when it does boil over Greece will not really be the reason the Euro-zone crumbles. Instead we should be prepared to point the finger at the EU, ECB, and the IMF for their collective insistence that Greece, Italy and Spain pay back debt that will never be repaid instead of accepting the reality that concessions must be made. The limited contagion view is complete nonsense, the European debt problem is going to explode, and whether or not it becomes a earth shaking and economy halting event depends on how those in charge respond as events unfold. While it is not only possible, but likely that before long Greece will exit the EU or like Britain be granted "special status" the initial fallout should be limited.

It is clear Britain has forced these concessions upon the other members as the fragile coalition continues to be held together by a thread. It is only after Spain or Italy heads for the exit will bigger problems emerge. The longer the ECB and EU attempt to hold this mess together without debt write-downs the larger the catastrophe will be. The fact remains the Euro-zone economy is stuck in place and is going nowhere despite all the over the top efforts by the European Central Bank to stimulate the economy. As usual difficult structural reform is lacking and the only real effort being made by politicians is to give the impression that leaders are hard at work trying to arrive at how to correct the problem. It has become the chief pastime of those in power to project the illusion of progress, but action always seems to be lacking.

The Euro-zone Has Failed To Take Action In This Crisis
Haunted by slow economic growth much of the Euro-zone has struggled since 2008 and high unemployment has been the norm for years. Because of this not long ago France's President declared the French economy to be in a “state of emergency,” and announced a package worth about $2.2 billion to subsidize job creation and temporarily move half a million unemployed people off the welfare rolls. Critics immediately seized on the measure as having more political than economic meaning. And they questioned whether the new steps would have any more measurable impact than previous stimulus plans. We must note stories like those above are all over the place and this is even before we get to the issues growing from a massive flow of refuges into the Euro-zone.

People arriving  with nothing and often not even speaking the language has created conflict between not only countries already beleaguered by slow growth, high unemployment, and deficit budgets and their better off neighbors. Also, within many of its member countries tensions are growing, for years Gypsies in Italy have been considered by many Italians to be a problem. Italy and Spain already suffer from not enough jobs to bring about solid growth. Youth unemployment in Italy hovers just over 38% after reaching an all time high of 43.6% in August of 2014. Spain also suffers a high level of structural unemployment with the unemployment rate never dipping below 8% for decades. This makes Spain the OECD country with the highest unemployment rate. As in Italy the youth are most effected, youth unemployment in October and November of 2015 sat at north of 47% giving young people little hope.

This situation is not expected to get better anytime soon because the policies holding this mess together do not contain what can be seen as drivers and engines of growth. Just this week steel company managers and thousands of their employees from across the European Union descended on Brussels to protest the import of cheap Chinese products and to warn the 28-nation bloc not to open the doors further to Beijing. Again the steel industry is up in arms over China and its illegal export subsidies that allow it to sell products below production cost and the harm it does to the European steel sector. This only highlights the dire problems Europe faces as it tries to bring about economic growth in a competitive global market. After many attempts it seems real growth and reforms remain slow or nonexistent.

To say the Euro-zone is a dysfunctional mess is an understatement. A part of almost every proposal created by the leaders of the Euro-zone is loaded with efforts to try and convince Europeans that Europe is part of the solution and not the problem. Meeting after meeting often results in schemes that struggles to gain traction because they almost always require a transfer of wealth where the bloc’s healthier members and markets are asked to support its weaker ones. Of course as expected the elite calling the shots live in elegance as they spin their schemes to reflect hope of progress. Recently, supporters of deeper financial integration again hit a roadblock from Germany in their endless efforts to secure agreement on a common scheme to protect bank deposits, but that is expected in Euro-zone politics. It should be noted granting any country special privileges will only encourage other members to renegotiate terms in the future.

Footnote; Currently the thought of taking a holiday in Europe seems daunting. Attempting to travel through the area when facing closed borders, strikes, homeless refugees, and even violence has offset the excitement of tourist enjoying the weaker euro. As always articles on many subjects may be found in my blog archive, thanks for reading, your comments are encouraged.

Footnote #2; It should be mentioned the vote in Britain will be tremendously important to Ireland because of its special relationship to the UK.  

Friday, February 19, 2016

The Real Economy Beyond Our Financial Institutions

The Financial Sector Has Grown Too Large
The real economy exists somewhere far from Wall Street and can be seen in parts of America where most of us live. The fact is the real economy is neither vibrant or healthy and current trends should give us pause.  Issues like a 36% drop in farm income in 2015 should be a red flag signaling severe problems on the horizon even if you don't make a living farming. Farm income is not contained in a closed loop but spills into other parts of the economy. Because of this, we should expect double-digit declines in agricultural equipment sales over the next 12 months.

My point is our future has a way of being tied to reality and certain economic laws as well as laws of nature that hope and delusion cannot defy. While these bonds can be ignored for a time the force they have over us at some point will suddenly pull us crashing to the ground. Our economy continues to be propped up by a combination of unhealthy policies which include massive government spending on top of the artificially low-interest rates and easy money. This has allowed the mega-rich and politically connected to thrive while a huge majority of Americans wither on the vine. The price of stocks and action on Wall Street should not be confused with what is happening in homes across America. We should never underestimate just how far untethered computer-driven trading can distance itself from the true economy. We must consider the possibility we may simply be in another phase of the "Wash, Rinse, Repeat" cycle that flushes money away from the common man and into the hands of the 1% that eats our lunch.

Like a record replayed over and over, each month we wait in anticipation for announcements from the Fed. It is so very odd that even the delayed release of minutes from the last meeting sparks a market move as they are inspected for any hint of increased dovishness or the indication of a more hawkish tone in future policy. Only in a world where the financial sector is given rule over the real economy and over events happening in the shops and stores throughout the land should this be the force driving the markets. The truth is most Americans only get to smell the feast and have no seat at the table when the Wall Street elite dine. We get little more than the promise that our pension or 401 will be solvent when we need the money, that is if we are lucky enough to have either. Sadly, the average American is lucky if they are allowed even a few scraps that fall from the table, again highlighting why bankers have been reviled throughout history. It is ironic this massive sector of our economy produces nothing but holds such power.

Empty Storefronts, A Common Sight!
The Fed notes released on February 17th showed there was concern that the recent drop in stock prices could dampen consumer spending, which had been expected to power the economy through any global weakness. Only a small minority of Federal Reserve officials were willing to look past the stock market weakness that emerged after the U.S. central bank raised interest rates for the first time in almost a decade. These members argued that it could be the result of bringing equity valuations more in line with historical norms. In effect, the Fed is saying that propping up valuations may even be more important than the health of the economy and what is best for it in the long run.

Promises have been made, and expectations have been raised that the economy will power through, but are they realistic? After eight long years of near or zero interest rates, massive government deficits, and watching tons of money and stimulus being poured into the economy we remain mired in slow growth. In a prior article, I asked, what is so good? What is so much better? I then went on to note the weight of carrying a large number of unemployed and people who have dropped out of the workforce will wear down society through attrition. Often these people have little in the way of savings, this means the burden of caring for them will be transferred to society. If too many people shift into this category the fabric that holds us together as a nation and as a people will be shred to ruin. Matters have been made worse by new mandates and regulations flowing out of Washington and the lack of needed reform.

Today small business is having its clock cleaned by big businesses backed by Wall Street money, coupled with the cost of complying with new government regulations. Today we see a landscape of empty and under-leased buildings that once housed thriving businesses that provided Americans with good paying jobs. This makes it difficult to think things are getting better. When looking at new job formation details show the growth in low paying part-time jobs and many people have left the job market, many to retire early because their skills are no longer needed. To shed even more light on our flawed recovery we only need to take a closer look at auto sales, 31% of those buying cars are taking out sub-prime loans and these loans are being stretched out far longer than ever before. Student debt continues to grow at an alarming pace and will affect the disposable income of many of our youth for years to come.

In an effort to stay rooted in reality we should ponder the possibility that we are being played or duped. This includes not just how strong the economy really is, but as to the links and bonds we have with the economy through both financial institutions and the government. The real economy that lives beyond our financial institutions may be in a death struggle. Those in power tend to warp and skew both numbers and future projections in a self-serving way. A combination of low-interest rates, government spending, and easy money coupled with massive stock buybacks have given many people a false impression all is well, but looking at the numbers and beyond it becomes clear something is dreadfully wrong.

Sunday, February 14, 2016

Falling Off The Economic Wagon Easier Than You Think!

Becoming unhinged and falling off the economic wagon is easier than most people think. Those who have experienced the slip into an economic quagmire and rough times often will tell you, "I never thought it would happen to me." Some of us are kept vigilante because of what we have seen and the stories of  those who have moved from "riches to rags." Many of us have either witnessed or seen those close to us live through this often tragic transformation. Sometimes because of a financial misstep and sometimes because of what can be best described as simply bad luck we are dealt cards we would only wish on our enemies.

In the distant corners of our mind, we often salt away the stories of woe that consist of local town heroes who soared too close to the sun and fell back to earth in failure. One fellow that comes to mind is a man who built thousands of apartments across the nation only to go bankrupt when they were unable to make their mortgage payments. It could be that we try to forget such tales of misfortune because a similar fate might descend upon us at any time. I can think of several people who fall into this category, a few struggle on in a position far below their former status, such as becoming a salesman at a company of an old friend or starting a new company that soon fails. Reality is that many Americans including many of our youth have become disenchanted as they realize their economic future may not be as bright and friendly as they were told it would be.

Many articles have been written about the large number of Americans without any real savings that live paycheck to paycheck. Just last year Marketwatch reported approximately 62% of Americans have no emergency savings for things such as a $1,000 emergency room visit or a $500 car repair. A survey of 1,000 adults painted a dire picture, but what exacerbates this situation is so many people receive their so-called paycheck from the government. The number of people living on government transfers of wealth has grown over the years, as of today the National Debt Clock shows that over 161 million people are currently "receiving benefits" and 45 million Americans are food stamp recipients. In 2008 only 28 million people used this program, this speaks volumes as to the state of the union.

It is apparent many people exist with a razor-thin margin separating them from whether or not they can meet their financial obligations. This means if the accuracy of past predictions are any indication of what's to come and how future developments play out many of us might be just as well off flipping a coin to make decisions. My predictions, as well as those of others, are often based on possibilities, past experience, study, and logic tempered by intuition. However, it seems nobody is ever blessed with constantly being able to foresee the bizarre and unpredictable twist that is doled out as reality unfolds. The low price of oil and the oversupply of this black gold, as well as the introduction of negative interest rates, stand in mocking tribute to our inability to accurately look around the corner.   

History shows that trends can develop out of nowhere and that they can go on for years and years. Trends can feed back into how we react to the world and affect our appetite for risk. Currently, we are seeing the middle-class decimated as millions of workers have dropped out of the workforce or been forced to retire far before they are ready. Today we have created an interesting situation where the debate of whether the situation we have created is sustainable rages on. We are rapidly approaching the intersection where reality meets theory. This will become apparent if we suffer another financial setback equal in size or exceeding what we faced in 2008.

Problems in the economy are so intertwined with the markets and global picture that their impact will without a doubt spill over to affect pensions and other promises being made of future payments. In a logical world, stories of others falling under the economic ax would hasten a move to caution and work hard to save more, but it seems low-interest rates have lured many Americans to borrow more and venture into taking on debt. This is apparent in the auto sector where the number of subprime loans has exploded. Bottom-line is that when a person slips behind on payments penalties can quickly add up making it even harder to get back on schedule. We can expect this lesson to be issued again and again.

Sunday, February 7, 2016

Tesla So Much Attention, So Few Cars!

When Tesla's stock drops in value the company will have to give up far more to procure the funds to feed its massive cash-burn. To clarify, Tesla is in a capital-intensive business and has a poor record as to spending efficiently. It is amazing that the company garners so much attention while producing so few cars. The fact that Tesla has been able to borrow cheaply and the aura surrounding its charismatic CEO Elon Musk drives this company. Analysts estimate Tesla, which has consistently lost money, will eat through $11 billion in capital spending over the next five years. While it is easy for investors to get caught up in the hype of how electric cars will be the demise of the gasoline engine such claims have been slow to materialize. I recently stumbled across a copy of Time magazine from the 1990s where the front cover proclaimed the time of the electric car had arrived. The auto industry is a highly competitive and crowded sector where any misstep can be the disastrous for a company, especially one in Tesla's position.

Only About 1 In 5,000 Cars Is A Tesla!
In January 2016, Ford Motor sold 173,723 vehicles. This is far more than the 50,580 Tesla is said to have delivered in all of 2015. Ford with its current market cap of 45 billion dollars is a solid cash machine banging out solid profits and big dividends. This makes it hard to understand how Tesla that is spending big and burning cash has a market cap of over 21 billion dollars or around 42% of its much greater competitor. For those who really care the obvious elephant in the room is that Tesla stock is trading at incredibly high multiples, which should be contributed to the historically low interest rates and the luck of being in the "QE moment" rather then its financial success. Just how small is Tesla's footprint? The math shows only about 1 in 325 cars sold in America last year was a Tesla and of the over 250 million registered passenger vehicles in America only 1 in 5,000 sports its name. It is little wonder I have not seen a Tesla in the wild. While these cars roam the streets of Las Vegas as a "hot little rental" turning heads and continuing to "wow" the masses, here in the more conservative Midwest they remain as rare as hens teeth.

The stock has been under pressure lately as articles have circulated on as to how Pacific Crest Securities analyst Brad Erikson has become more cautious on the electric-car maker's stock. He recently increased his loss-per-share estimate for 2015 to $1.10 from $1.09, but more important he has slashed his 2016 earnings-per-share estimate to 27 cents from 76 cents. "Consistent with our October checks, our latest checks with U.S. sales centers indicate that Model X orders are still lagging expectations," Erikson wrote in a note to clients. "While getting the X to showrooms would help, we don't expect that to happen until later this spring due to production challenges" he said. Erikson doesn't believe the Model S promotional offer of 20% off the old lease cost has driven a significant sales increase. "We can't overstate the importance of the March 29 Model 3 unveiling, but we remain suspicious of underlying demand" he said then went on to reiterated his sector weight rating saying it was best to continue avoiding the stock.

Even Morgan Stanley analysts that have long been positive on Tesla admit they expect it to burn through nearly $1 billion in the next 12 months, but see its cash burn as outweighed by its “bigger mission.” It appears they feel Tesla may soon challenge Uber by "selling miles" and not just cars. Analysts at Morgan Stanley, led by Adam Jonas, seem to believe that Tesla is likely to begin to clearly communicate potential plans for a mobility service (selling miles, not cars) to investors. Assuming Tesla establishes itself as a leader in autonomous cars, Jonas sees a business case for selling driver-less cars to ride-sharing companies or even cut out the middleman and offer on-demand electric mobility services directly from the company’s own platform. Adam Jonas maintains an Overweight rating for the company, but reduced the price target from $450 to $333. It should be noted that even though Tesla recently rolled out a global, over-the-air software upgrade that added or upgraded semi-autonomous driving features to its cars Musk has said the company is three years away from a fully autonomous car.

Not everyone is so enthusiastic over Tesla's potential, in October 2015 Barclays' Brian Johnson detailed why the electric-car company's brand new Model X SUV may fail to meet the company's expectations for production and put pressure on margins. This caused Johnson and his team to lower their price target 5% to $180, and cut their rating to "Underweight" from "Equal-Weight." Last I heard Barclays analysts, among the biggest Wall Street skeptics toward the company, kept intact their sell rating on the stock and a price target of $180, as I write this Friday's close at $162  is well below that number.  Johnson indicates that estimates for Tesla's margins are likely overestimated, and the company is about to get a "reality check". He feels the Model X is will provide engineering challenges and manufacturing challenges causing the production ramp to slow, while difficultly in concurrent S/X production will also push margins below current consensus.

Winged Doors=Massive Headache
Rising cost and concern bolstered this argument as the Model X launch had been pushed back with CEO Elon Musk admitting the Model X's advanced technology has caused major delays. Musk claims the Model X was "the most difficult car in the world to build." The crossover has intuitive automatic futuristic "falcon wing" doors with built-in sensors to keep them from dinging nearby cars. A panoramic windshield that features what the company claims to be the largest single piece of glass ever installed on a car. And an air-filtration system with a "bio-weapon defense mode" all this comes together to create an insanely complex car. With more engineering challenges always waiting in the wings to will slow down manufacturing doubts also exist as to whether Tesla will release the forthcoming Model 3 on time in 2017. On top of all that Barclays also lowered their expectations for Tesla Energy. They see fierce competition in the power storage space, and they're not sold on the fact that Tesla's Power-wall battery is superior.

The attention to Tesla is not only because of its cars, Barclays views Tesla’s key strength is in its software prowess, such as its over-the-air technology updates and its driver-less features rather than producing and selling cars. This has lead the Barclays analysts to say, “We are concerned that the capital intensity of the core automotive business may further overshadow Tesla’s competitive edge in software.” They contend that if the company doesn’t become more efficient in making its planned mass-market car, the Model 3, it runs the risk of running out of money to invest in the software side of their business and the products that “truly differentiated” Tesla from all others in the field.  Pre-orders for the Model 3 are expected to begin in March, but production is about two years away. Tesla CEO Elon Musk has said he expects the car to cost $35,000, however even the Tesla enthusiast at Morgan Stanley say the cost is more likely to be between $55,000 and $60,000.

To some of us it is a real reach to think this small scale producer of electric-cars can suddenly blossom into a giant automotive force. Time is not the friend of Tesla as competitors ramp up in what will be a very competitive market if electric cars do indeed go main stream. Ironically, it is the bearish investors that doubted Tesla would hold together that have pushed up the stock as they were forced to run for cover. This has only added to the image that Musk lives a charmed life. Remember Tesla received a huge government low interest loan to kick start its existence and continues to feed at the trough of government tax incentives. The glamorous automotive sector is an area where many like icons such as DeLorean have failed. I have become predisposed to discount and grown massively adverse to "media hype", this is one reason I'm very skeptical as to how Tesla will fare going forward. As I wrote at the beginning of this piece, when Tesla's stock drops in value the company will have to give up far more to procure the funds needed to feed its massive cash-burn. This could create a massive negative feedback loop.

Footnote; As always your comments are encouraged and I invite you to explore the archives for other stories that may be of interest to you. In the way of full making full disclosure I'm short "five" shares of this stock "for fun, and so at some point in time I will have the right to say I played!" I consider this a very minor token investment, but my convictions compelled me to make a statement of protest to such market insanity.

Footnote #2; Since writing this piece I have posted an an article about fuel cells and how hydrogen powered cars may trump Tesla's vision of battery propelled vehicles. More recently I also wrote an overview of Musk and the company. The links are below.

Tuesday, February 2, 2016

Japan Is Falling Into An Economic Abyss

Japan Is A Failing Economy
The writing is on the wall. Japan is facing a mountain of debt that can only be addressed by printing more money and debasing their currency. This means paying off their debt with worthless yen where possible and in many cases defaulting on promises made. Japan's public debt, which stands at around 230% of its gross domestic product (GDP), is the highest in the industrial world.  While Japan's economy comprises 6.18 percent of the world's GDP it makes up a whopping 19.99 percent of the world's total sovereign debt. Often because of its geographical size people forget that little Japan is the world's third-largest economy making it a huge economic power with a big shadow.

I have written several articles about Japan over the years and how growing debt was poisoning its options, two years ago I voiced the opinion the country would continue to slide into an economic abyss. Now regional weakness and credit issues in China have begun spilling over to undercut Japanese growth, this is a force that will last for some time. It must be noted that Japan would be sitting in far worse shape if it were not for the wealth currently shifted each year from America to the small island nation. America spends billions each year defending Japan and puts much of this money directly into their economy. Another way we support Japan is that American consumers purchase many of the goods the country produces, in 2015 America's trade deficit was over 62 billion dollars. Through this massive trade deficit, America feeds large amounts of money into Japan, without this money the massively indebted nation would be in even more trouble.

It has been pointed out time and time again that Japan is faced with sour demographics that bode poorly going forward. The country is stuck with an aging and shrinking population that with each day becomes more expensive for the government to provide for. The budgetary impact of rising social welfare costs linked to an aging population has taken its toll. Adding to its woes the Fukushima nuclear disaster has shuttered its nuclear power plants and forced the country to import more expensive energy alternatives. All this means that neither monetary nor fiscal policy will adequately solve Japan's problems. Year after year Japan faces fiscal deficits and this means that government debt is pushed onward and upwards leading to a variety of possible scenarios as to the what the end game will be. Simply put, the fundamentals for Japan are lousy.

For years even decades the conventional wisdom has been that Japan is, or was in the unique situation of controlling its own fate because its debt was owned internally. Unlike America that sold its bonds to foreigners who at any time might pull out or demand payment this was considered a source of strength. It is important to recognize that over the years many new pathways have opened that now allows individuals to protect their wealth by moving it offshore. Back in June with little fan fair Japan Post said that it will significantly alter its investment strategy and invest more money outside the country. Because of the mere size of Japan Post Holdings, this is a signal of major importance and has far-reaching implications. Traditionally, with close ties to the government, the investment strategy of Japan Post has been very conservative with low-yielding JGBs making up more than half of its portfolio. This may someday be looked on as a watershed event as to how the Japanese began shifting  away from a falling yen to protect their wealth.
Yen Falling-It Takes More To Buy A Dollar

Unlike many other leading economies, Japan has been battling deflation or falling prices for the best part of the past two decades expect this to change as reality takes hold. As a response, Japan has undertaken a policy to weaken its currency and to strengthen its exports. America and other countries have remained mute in sympathy of the problems Japan is facing. Thus far the current BOJ policy has quietly and systematically distorted financial markets across the planet. As this has unfolded investors and the megabanks have quietly and drastically reduced their Japan Government Bond (JGB) holdings. The risk of who gets hurt in the case of a default has been shifting from the private sector to the public as the BOJ splurges on JGBs.

As Japan continues down this path it is only a matter of time before the credibility of the BOJ is lost and the yen will plunge. The financial markets have seen time and time again it is far easier for a country to weaken its currency than support it. As investors in Japan's government bonds begin to believe that Abenomics will be successful in bringing back inflation it would be logical for owners of  JGBs to move out of low-yielding securities and buy foreign bonds or equities. The moment the Japanese stock market fails to rise enough to offset inflation this will turn into a tsunami of  money fleeing Japan and constitute the end of the line for those left holding both JGBs and the yen. This has been a long time coming and when the end becomes apparent to all, events will pick up speed and the situation spiral out of control. When Japan crumbles the shock waves will reverberate around the world.  

Monday, February 1, 2016

Economic Efficiency Of Credit Is In Collapse

NIRP The Path To A Liquidity Trap
Negative interest rates move us down the path towards a "liquidity trap," a term that can be baffling and difficult to understand. This term has been used by Allen Greenspan and a few others, it represents a huge problem for the economy. It can have several components, but sooner or later all feedback into a loop that disrupts the flow of credit and impacts the real economy. At some point the return on loaning money to banks, governments, and others is simply not worth the risk! Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.

The Negative Interest Rate Policy (NIRP) punishes savers and encourages them to spend money, it also forces banks to lend money rather than hold it and bolster their reserves. In doing so it can also increase the velocity of money. However, at some point we reach a place where too much money or currency makes it a worthless commodity. At that point banks and governments are no longer willing to pay depositors for its use. This creates a real quandary, when inflation begins to exceed the rate of interest paid. The bottom-line is that it might soon become apparent the economic efficiency of credit is in collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward. The collapse of credit poses major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008. When this happens many of our economic policy options will vanish and we are at the end game or poised for a complete economic reset.

The policy of rapid credit expansion while an interesting concept often brings with it negative consequences. Currently it is being put to the test as new problems emerge in China where we saw the extra GDP growth generated by each infusion of money drop over the last four years. This should be taken as a warning that economic exhaustion and overcapacity results from continually priming the pump. In 2014 Wei Yao from Societe Generale warned the debt service ratio of Chinese companies has reached 30% of GDP the typical threshold for financial crises. This means many companies will not be able to pay interest or repay principal. She warned that the country could be on the verge of a "Minsky Moment" when the debt pyramid collapses under its own weight. "The debt snowball is getting bigger and bigger, without contributing to real activity," she said.

The total credit in China's financial system is estimated to be as high as  221% of GDP and has jumped almost eight-fold over the last decade. This means companies will have to pay out $1 trillion in interest payments alone this year. Chinese corporate debt burdens are much higher than those of other economies. Even then it was clear that much of the liquidity that existed in China's economy was being used to repay debt and not to finance output. The fact that new investment in factories has ground to a halt is probably a good thing because China is awash in overcapacity with many new factories idle because of weak demand. This has caused a large-scale capital outflow and the exodus of hot money is disrupting world markets.

While many people clam that China's Central government carries little debt on its books and this gives the central government the option to step in if a worse case scenario develops, local governments are in big trouble. The option of bailing companies out or putting them on life support as Japan did so many years ago is not a real solution. As things get worse China has had to take action to help real estate companies and even worse recapitalize the banking system, but this will not fix all the problems. I'm forced to reflect on how debt is directly effected by interest rates. In Europe the ECB has stepped in to halt the economic collapse of Spain, Italy and several other countries that were on the brink of collapse. By instituting false super low interest rates the ECB has allowed countries to service their national debt at below free market rates that would have led to default.

What you pay in interest on debt does matter except in the current manipulated land of  Modern Monetary Theory (MMT). Believers in MMT see it as a way to remove much of the economic uncertainty ahead and guarantee the economy will always be able to muddle forward by altering and changing the procedures and consequences of how we use the government-issued tokens of fiat money.  Newly acquired tools like derivatives and currency swaps  have allow us to print and  manipulate away problems or at least postpone the ramifications. Unfortunately, the part where you collect a debt that you are owed can be similar to a mirage that keeps moving away each time you approach it. Do not forget the small print that governs most contracts often tells us rules can be changed causing many people and companies to become instantly insolvent.

The bottom-line remains, why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? We are abusing the large amount of wiggle room in our economic system and our ability to put off the day of reckoning only proving that we will until we can't! Modern society has become very good at kicking the can down the road and delaying the consequences of bad policy.  This means that at some point the return on loaning money is simply not worth the risk! Readers of my blog will be familiar with this argument and my strong warning that when the only lenders are those who print the money that nobody wants the only safe place to store wealth will be in "tangible assets."

Footnote; This post dovetails with many of my recent writings, for more I might suggest reading the article below. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged.