Despite our gloomy headline, today’s Markets and Money begins with some excellent news. The European Union won’t be in recession for another six months. Whoopeee!
Buy everything! Stocks, bonds, real estate and yes, even sovereign debt. [Editor’s note: please don’t do this.]
If you’re sceptical about this new-found optimism, here is our impeccable reasoning. First of all, a recession is defined as two consecutive negative quarterly GDP growth figures. Europe had its first in the last quarter of 2011. But the first quarter of 2012 has saved the entire region from economic chaos for sure, because the GDP growth figure wasn’t negative. So there’s no recession. And there can’t be for another six months, because it takes two negative quarters in a row before a recession is declared.
The funny thing is that while the GDP growth figure wasn’t negative, it wasn’t positive either. It was 0. Exactly nothing. But that’s good enough to prevent a recession for a whole half a year according to the rules of GDP. So party on and don’t question the sacred GDP figure. Don’t look closer at the massive divergence between the growing and shrinking economies of the Eurozone. Don’t suspect anything. As sergeant Schultz would say, ‘I see nothing’.
Eurozone GDP Growth
Yes, this is the bizarre world you and your investments live in. Not that the world you inhabited before 2008 was any less ridiculous. How about some inspirational stories from the good old days?
Before the financial crisis, many Greek public servants showed up at work. Once a month. To collect their pay. Others had their salary paid directly to their bank account, so nobody actually knows who they are. Their co-workers who did show up occasionally have never met them.
Not that their employer — the state — was any better. When Greece entered the euro it falsified its debt and deficit figures more than anyone in Europe suspected. And that’s saying something, given they suspected quite a bit. Without the fraud, the Greeks could never have entered the euro. More importantly, it could never have borrowed as much money for such a long time.
The Greek government practiced the basics of a ponzi scheme:
1. Falsify figures to draw in cash from investors.
2. Pay that money out to the stakeholders.
This is clearly a con game. But it’s a satisfying one, and makes perfect economic sense in its own way. A good con satisfies all parties at the beginning. Nobody pays taxes. Plenty of people get money for nothing. Politicians can spend.
It only takes some accounting gimmicks to make an unviable situation viable for quite some time. All governments use these accounting gimmicks. One good example is something called contingent liabilities. These are liabilities taken on but not yet incurred. Another gimmick is the cost of healthcare in coming years. That’s money you know you’ll have to spend, as a government. But with the right accounting, you don’t count the cost.
The main point of a good con game is to steal money. But accounting gimmicks serve another purpose: conceal the debt total as a percentage of GDP. For example, look what happens to US debt-to-GDP ratios when you use the two accounting gimmicks I mentioned above. By stripping out future health-care obligations and ‘contingent liabilities’ you reduce the total debt by half!
True Debt to GDP
Without the gimmicks, true debt to GDP figures are more than double their quoted levels. By the way, AUS isn’t Australia on this chart. It’s Austria, which is normally shown as AUT. We couldn’t find comparable Australian figures.
It’s a bad political joke, just like the reality facing Europe and investors.
The hubris and ignorance of the political establishment, to think that binding nations together would create peace, is beyond belief, especially in Europe. A quick tour of history will tell you it’s a bad idea. Anyone who tries, like the three individuals we mentioned, fails.
Just take a look at this video which follows the history of Europe’s borders for 1000 years. It’s like a kaleidoscope. The entire continent completely changed its borders in Napoleon’s lifetime, with whole States disappearing, emerging, and coming back again from the dead.
And then there’s the experience of Yugoslavia. There a small-scale experiment of combining different nations into one ended badly no less than three times in one century. By ‘badly’, we mean with mass graves as ethnic in-fighting tore the unnatural country apart. And who can forget the Soviet Empire? That unnatural agglomeration of different ethnic groups and nationalities resulted in whole scale liquidation of “undesirables”.
Our point? Europe has a history of creating its own problems. Those problems result in wealth destruction and debt at the least…or death and revolution at the worst. We’re somewhere on that continuum right now. The historical tendency to prevent war through greater political unification simply hasn’t worked. It’s always ended in a bloody disaster.
European Parliament politician Nigel Farage pointed all this out to his fellow members in another thrilling speech. He compared the current political unification of different countries to mixing their different cheeses together — a distasteful disaster.
This is probably not just a European problem. Maybe all overly-centralised unions in general are dangerous. That’s what we’ve been pondering all week…whether there is something inherently flawed in currency, fiscal and political unions. The Soviet Union came and went, along with Yugoslavia. Perhaps Europe is next, followed by none other than the United States of America. If they all have similar problems, why not expect similar outcomes?
Californian Governor Jerry Brown posted a YouTube video this week explaining the State’s dire financial position and his solutions. The speech could have been taken straight out of one of Europe’s troubled nations. In fact, many US states began austerity before it became fashionable in Europe.
There are other similar problems between the European, American and Soviet Unions. The NY Times criticises Europe for the same policies it supports at home and that failed in the USSR:
‘What is striking when you compare Europe’s policies on agriculture, monetary union and climate change is the way the Union keeps bolting on patches and extra wiring to try to fix problems created by its own solutions.The default response is always ‘more Europe,’ without insisting upon the most straightforward solution, which is often blocked by the threat of political vetoes.’
Here’s a quick example to tickle your tastebuds:
‘Take the Common Agricultural Policy. Conceived in the 1950s and early 1960s to feed postwar Europe at stable prices for producers and consumers, the system subsidized farmers to overproduce cereals, wine, meat and dairy products. By the early 1980s, it was swallowing 70 percent of the community budget.
‘Surpluses [of cereals, wine, meat and dairy products] grew so large they had to be taken off the market and stored for long periods in giant warehouses at taxpayers’ expense. Some were sold off at subsidized prices to the former Soviet Union and developing countries.
Then farmers were paid to dig up their vines, reduce their herds and leave land fallow. Eventually, the link between subsidies and production was cut, but farmers still receive E.U. payments for maintaining the countryside and producing high-quality food.’
Paying farmers to do nothing is just as stupid as the Greek public sector paying phantom employees. Financial market commentator Marc Faber reckons the Europeans are in a league of their own: ‘I do not have a high opinion of the U.S. government, but the bureaucrats in Brussels make the government in the U.S. look like an organization consisting of geniuses.’ We’re not so sure there’s much of a difference between the American, European and Soviet officials.
If you think it’s a bit of a stretch to say America’s problems are similar to Europe’s, take this comment from the same NY Times article: ‘The euro zone’s one-size-fits-all interest rate provided an irresistible temptation for countries like Spain and Ireland to build homes that people had never been able to afford before.’
How is that different from what happened in certain American states? It’s not.
So here’s our overarching theory. The welfare/warfare state inherently expands. Paying people to do nothing means you get more people doing nothing. Over time, governments run out of tax revenue, so they borrow. When they run out of room on their balance sheet, the only way to borrow more is to join together in a union.
The Americans needed a federal government and its ability to issue credible debt to finance the war of independence. The Europeans now need eurobonds to keep their welfare rort going for a little longer.
If the theory holds, it has an interesting implication. If the Europeans decide to create a fiscal union — to pyramid debt (eurobonds) on an international level like the Americans did on a national level — it might be America that busts first. A eurobond may kick the can down the road further than the American one can be kicked. Indeed, America’s true debt load — including the so called ‘contingent liabilities’ of healthcare and much more — is the worst of any nation relative to GDP.
Except of course Japan’s economy, which is a complete basket case.
On the other hand, Europe might come up with their version of the American civil war, where the south tried to break away from the north. Even the geographic references fit here, with the PIIGs nations being southern and the ‘fiscally stable’ nations tending to be northern. Would this mean an actual war?
We have no idea, although dismissing it is probably a mistake. Can you imagine the irony of a union meant to bring about peace, which ends in war? As we pointed out, it’s happened many times before. These situations often end in war. And here’s one big warning of growing aggression: more than half the Greek police force happened to vote for the holocaust-denying neo-Nazi party Golden Dawn in the recent elections.
On the bright side, the website Zerohedge points out that ‘68.8% of Americans are overweight or obese, [so it doesn’t] matter if America has $20 trillion or $1 googol in debt: everyone will be simply too fat to care.’
But here is the big implication you might want to worry about. All this could go on for a heck of a lot longer than you can reasonably expect it to. That’s an odd statement, so we’ll rephrase. What seems unsustainable doesn’t have to end any time soon. We might be looking at a Japanese situation for a Japanese length of time — the lost decade that has so far amounted to two decades.
That kind of scenario has implications for your investments. Sitting out two decades isn’t a viable wealth building strategy. Neither is the German model being implemented in Europe going to work for your portfolio. It’s called ‘Augen zu und durch’. Which means ‘eyes closed and through.’ The Australian version is ‘suck it up princess’ as your editor’s Energy Law professor once put it. No, you need something that works to grow your wealth. But what? We’re working on a range of ideas behind the scenes. Keep an eye on your inbox in coming months.
Until next week,
Markets and Money Weekend Edition
ALSO THIS WEEK in Markets and Money…
By Dan Denning
But here in the late stages of the race we have JP Morgan losing $2 billion in the hunt for yield. And why is JP Morgan hunting for yield and losing money? Because ultra-low interest rates (negative in real terms) force you to speculate and take bigger risks to earn a real return. It’s not just mums and dads. Its investment banks too. It’s everybody. We are all Jamie Dimon!
By Bill Bonner
One of the nice things about being a long-term investor is that you can wait a long time before you make your move. As Warren Buffett says, you don’t have to swing at every pitch. And there’s no penalty, except missed opportunities, for just waiting for the perfect ball to cross the plate.
That’s what’s so nice about cash. It’s a bat. It’s in your hands. And we wouldn’t be at all surprised to see Mr. Market toss us a powder puff pitch before too long.
By Dan Amoss
Dodd-Frank was a thin coat of paint over a cracked and broken banking system; since it failed to accurately diagnose the causes of the financial crisis, it was a dud and a nuisance from day one.
More legal complexity, more wasted money and red tape and more lack of regulator accountability is what we got, when in reality, a big part of the problem was regulators not policing activities at the Too Big to Fail banks. Here’s an idea – one that banking history expert Jim Grant has been pushing for years: It’s called “capitalism.”
By Eric Fry
Vibrant economies and civilized societies rely on law and order. And law and order relies on a foundation of fairness — a basic understanding that bad things are bad and good things are good. But when the powers of government begin to affirm that bad things are okay and good things are irrelevant, all hell breaks loose.
By Greg Canavan
China is in all sorts of trouble…and you’re seeing the effect of that now in the resource sector. Capital intensive sectors are always the first to feel the effects of an economic contraction. The question you should ask though, is how long China’s bust will take to impact Australia’s real economy and other areas of the stock market?