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It's All About Jobs
Friday's employment numbers were decidedly soft, but the unemployment rate went down anyway, and that is about the best you can say. And this being a holiday weekend, it provides us an opportunity to look deep into the employment numbers, while we put off thinking about Spain for at least a week. And who knew that being an unmarried Asian-American in the US was a risk for unemployment? Plus a few other interesting items will make for an interesting letter.
All Spain All the Time
The events of the last 24 hours compel me to once again look "across the pond" at the problems that not only plague Europe but will be a drag on world growth as well, as Europe goes through its continued painful adjustment as a consequence of trying to adopt a single currency. Since Spain is going to be on the front page for some time, it will be useful to look at some of the problems it is facing, to put it all into context. And what I heard while in Europe in private meetings is troubling.
A Random Walk Through the Data Minefields
We are once again to a point in Europe where there are no good choices, only very bad ones. But this time it is with a country that actually makes a difference. (No slight intended to Greece, but you are just small.) Spain has no good way to cut its deficit without things getting worse. But Europe must be willing to then fund Spanish debt, even if "only" through more LTRO actions by the ECB.
There Will Be Contagion
The headlines are about Greece, but the real story is not Greece but who is next. European leaders were right to be worried only a short while ago about contagion effects of a Greek default to the entire Euro system, which of course they now say doesn't exist. This week we look at Europe, and sort through the ever more fascinating implications of the news in today's headlines.
Unintended Consequence
This week we wonder about the consequences of the European Central Bank (ECB) issuing over 1 trillion in short-term loans to try and postpone a banking credit crisis and lower sovereign debt costs for certain peripheral countries in Europe. What if, instead of holding the European Monetary Union (EMU or Eurozone) together, that actually makes a breakup more likely? That would certainly fall under the rubric of unintended consequences, and be worth our time to contemplate in this week's letter.
Tax That Other Guy
Last week's letter on taxes drew more response than any letter I have written in years. Questions that were raised simply beg for an answer, and some of the replies were very thoughtful, well-written suggestions for alternatives. This week I am going to do something I can't ever remember doing, and that is to use the entire letter to involve and respond to my readers.
The Cancer of Debt and Deficits
We will explore some options to actually resolve the deficit and debt crisis. Cutting spending or raising taxes have consequences, but not all cuts and not all taxes are the same. For those who have been wanting more specific solutions from me, I am going to address the issues surrounding taxation and offer my thoughts as to what we should do.
The Answer We Dont Want to Know
This election is ultimately about dealing (or not dealing) with the deficit, and putting the country on a path to a sustainable budget deficit, one that is less than the growth rate of the country. As I have argued elsewhere, and will argue in future letters, that is the paramount issue. Not dealing with the deficit runs the very real risk of the bond market treating us just as it is treating Italy and any other country that gets to the point where its debt is unsustainable.
Who Took My Easy Button?
There is no way enough money can be found to fund our entitlement programs, given the current system, even under the best of assumptions. Things must change. Either we will make the difficult choices or those changes will be forced by the market. The longer we put off the difficult choices, the more painful the consequences. This week we begin a series on the choices facing the US. We need to understand the consequences of the choices we make. Cut spending, say some. Tax the rich, say others. Cut out waste and corruption is always a popular choice. Do all of the above, intone others.
The Transparency Trap
We look at the shift in Fed policy, and at the balance sheets of central banks, US GDP, Portugal and the ECB, the LTRO policy, and yes, theres even a tidbit on Greece. Unemployment will be higher than we are comfortable with; it is just a product of the current environment and simple math. The US economy is in a Muddle Through range of around 2%. If not for a potential shock coming from a serious European crisis and real recession, the US should not slip into outright recession this year.
Staring into the Abyss
Europe's leaders are committed to keeping both the euro and the eurozone as it is. But for it to do so, everything must change, as the wonderful quote from the 1958 Italian novel suggests. This is no easy task, as no one wants a change that will impact them negatively; and there is no change that will allow things to stay the same that does not impact all severely, as we will see. In the third part of a continuing series, we look at the actual options that are available on the menu of choices, or as one group called it, the menu of pain.
The End of Europe?
The peripheral countries have no choices that allow them to grow and prosper without first suffering (for perhaps a long time) some very real economic pain. Leaving the eurozone has severe consequences; but the economic pain of leaving would go away sooner and allow for quicker adjustments, than if they stayed. However, the initial pain would be worse than the slow pain they'd suffer by staying in the euro. Their choice is, simply, which pain do they want or maybe, which pain do they think they want? Because whatever they choose, they are not going to like it.
2012: A Year of Choices
2012 will the year that the consequences of the choices made by the developed world will begin to manifest themselves in the economic realm. We are in the closing chapters of the current Debt Supercycle, with different countries strewn out along the path, and all headed for a destination that will force major decisions if politically painful actions are not taken. Some countries (e.g., Greece) have a choice between the dire and the disastrous. The option for merely difficult choices was long ago, and there is no going back to where you started without a different but equally painful outcome.
Collateral Damage
The economic travails of much of the West are reaching a decisive stage as the year ends. In 2008, we predicted sluggish recovery and a long period of low growth for the West in a two-speed world. This picture does not now properly reflect the downside risks. The policy of "kicking the can down the road" is failing, as the intensifying crisis in the euro zone and the failure of the G20 summit in late October clearly demonstrate. As to December's European summit, we describe its impact later in this paper.
Your Three Investing Opponents
Recently I have been having a running conversation with Barry Ritholtz on the psychology of investing (something we both enjoy discussing and writing about). Since I am busily researching my annual forecast issue (and taking the day off), I asked Barry to share a few of his thoughts on why we do the things we do. He gives us even more, exploring the three main opponents we face when we enter the arena of investing.
The Center Cannot Hold
We'll leave aside the politics of the payroll tax extension and look at the economic implications, and then go on to examine the deficit in the US. That will give rise to some thoughts about Europe and what would have to happen for a country to leave the euro. We'll finally close with some thoughts and graphs about the more controversial part of the tax cut extension, the Keystone XL Pipeline. Just how radical is it to build such a pipeline in the US? And what are the implications for the deficit?
A Player to Be Named Later
There are two main points to be taken away from this week's European summit. First, the Germans really took control. This has been coming for a long time, and it's not like we haven't discussed it in these letters. Second, Britain either opted out or was shown the door, depending on your point of view. That is the real game-changer, long-term, for more than the obvious reasons.
Time to Bring Out the Howitzers
It is now common to use the term bazooka when referring the actions of governments and central banks as they try to avert a credit crisis. And this week we saw a coordinated effort by central banks to use their bazookas to head off another 2008-style credit disaster. The market reacted as if the crisis is now over and we can get on to the next bull run. Yet, we will see that it wasn't enough. Something more along the lines of a howitzer is needed (keeping with our WW2-era military arsenal theme). And of course I need to briefly comment on today's employment numbers.
Changing the Rules in the Middle of the Game
Angela Merkel is leading the call for a rule change, a rewiring of the basic treaty that binds the EU. But is it both too much and too late? The market action suggests that time is indeed running out, and so well look at the likely consequences. Then I glance over the other way and take notice of news out of China that may be of import.
Print or Perish
I do not think the euro will survive with the current mix of countries, nor do I think that Germany thinks so either. Greece is likely to go, as is Portugal. Can Spain really get its deficit under control in time? Do we see a two-euro world, one in the northern states and one in the southern? And to which one does France go? Looking at the politics, one might think the answer is obvious, but if you just look at the numbers, it is clearly not. France is in many respects a Mediterranean country. So many choices and none of them good.
Where is the ECB Printing Press?
There is too much debt in many southern countries; France is not far from having its own crisis if they do not get back into balance. And if they lose their AAA rating, then any EFSF solution is just so much bad paper. The path of least resistance, and I use that term guardedly, is for the ECB to find its printing press. Perhaps they can borrow one from Bernanke.
Where Will the Jobs Come From?
What is the role of government in creating jobs? To answer that, let's look at the data that shows us where jobs come from. And we find that net new jobs for the last 15 years came from new business start-ups. Big business is a net drag on job creation, and small businesses are a wash. Governments have seen job growth, but where does the money come to pay government employees?
European Summit: A Plan with No Details
The market reacted like yesterdays announcement was the Second Coming of the Solution to End All Solutions. But if you look deeply there is more to the market "melt-up" than simple euphoria and relief. What you find is a very disturbing unintended consequence that will come back to haunt us. The finger points to derivatives and credit default swaps. This week, we look at gamma and delta and other odd entities that may be behind the real reason for the market response, as we march inexorably toward the final chapters of the Endgame.
Can 'It' Happen Here?
The beginning of the end of the Weimar Republic was some 89 years ago this week. There is a stream of opinion that the US is headed for the same type of end. How else can it be, given that we owe some $75-80 trillion dollars in the coming years, over 5 times current GDP and growing every year? Remember the good old days of about 5-6 years ago (if memory serves me correctly) when it was only $50 trillion? With a nod to Bernankes helicopter speech, where he detailed how the Fed could prevent deflation, I ask the opposite question, Can it (hyperinflation) really happen here?
An Irish Haircut
But here is the issue for Europe. The amount of money needed for Ireland is going to be a lot more than they now think, or at least are willing to admit. When Eurozone politicians worry about 'contagion,' or one country wanting the debt relief that another country gets, it is a very real worry. And rightfully so, as voters in Portugal or Spain or (gasp) Italy who are burdened by debt that is seemingly intractable will also want relief. It is not just an Irish condition, it is a human trait.
Tough Choices, Big Opportunities
There is a pattern, and the United States is no different than Greece or Ireland or Italy or Japan or any other country in history. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! confidence collapses, lenders disappear, and a crisis hits. There's a limit to how much the bond market is going to let us borrow. As we approach that limit and we're not there yet, we have time, thank God we can make choices about how we want to deal with the problem. But the problem is too much debt and too high a deficit.
Catastrophic Success
Rick Perry touched the third rail of Social Security and called it a Ponzi scheme, which of course immediately made him the leading candidate in the shoot the messenger category. Behind the rhetoric, I look at some actual numbers. Not the unfunded liabilities, thats too easy. Lets look at what a heartless, uncompassionate man President Roosevelt was when he started Social Security. And of course, we must start off with the results of the FOMC meeting, which has me feeling not at all amused. What are they thinking? Apparently, they are seeing the results from another, alternative universe.
Twist and Shout?
What in the wide, wild world of monetary policy is the Fed doing, giving essentially unlimited funds to European banks? What are they seeing that we do not? And is this a precursor to even more monetary easing at this next weeks extraordinary FOMC meeting, expanded to a two-day session by Bernanke? Can we say 'Operation Twist?' Or maybe 'Twist and Shout?'
Preparing for a Credit Crisis
This week we turn our eyes first to Europe and then the US, and ask about the possibility of a yet another credit crisis along the lines of late 2008. I then outline a few steps you might want to consider now rather than waiting until the middle of a crisis. It is possible we can avoid one but whether we do depends on the political leaders of the developed world making the difficult choices and doing what is necessary. And in either case, there are some areas of investing you clearly want to avoid. Finally, I turn to the weather and offer you a window into the coming seasons.
Its All About the Jobs and Gold
If somehow a Republican appeared in the White House tomorrow, there is no magic he (or she!) could bring with him/her to fix the unemployment problem. There are just some things the private sector will have to do for itself, and the sooner the government stops getting in the way, the sooner will get things fixed. But it will take a long time, no mater what. For the record, I think you should own about 5% of your net worth in gold, as insurance, not as an investment.
The End of the World, Part 1
It is only a matter of time until Europe has a true crisis, which will happen faster BANG! than any of us can now imagine. Think Lehman on steroids. The US gave Europe our subprime woes. Europe gets to repay the favor with an even more severe banking crisis that, given that the US is at best at stall speed, will tip us into a long and serious recession. Stay tuned.
The Recession of 2011?
If we are headed into recession, and I think we are, then the stock market has a long way to go to reach its next bottom, as do many risk assets. Income is going to be king, as well as cash. Well know several things. Recessions are by definition deflationary. Yields on bonds will go down, much further than the market thinks today. And while the Fed may decide to invoke QE3 to fight a deflation scare, the problem is not one of liquidity; it is a debt problem.
The Beginning of the Endgame
In short, there are no easy solutions. We have just about used up all our rabbits in the hat as far as fiscal and monetary policy are concerned. We now need to focus on what we can do to get out of the way of the private sector, so it can find ways to create new businesses and jobs. And that means figuring out how to get money to new businesses, because that is where net new jobs come from. But that takes time...
The Case for Going Global Is Stronger Than Ever
If we have learned anything from the current financial mess, its that building wealth is dependent on rational analysis, careful decision making, and risk management. Thats why sticking close to home at a time when our markets are more uncertain than ever is a recipe for disaster and absolutely the wrong thing to do. Not only will you miss out on the worlds fastest-growing markets, but the odds are exceptionally high that you will miss as much as 50% or more in potential returns over the next decade.
An Economy at Stall Speed
The economy is at stall speed, it is quite possible well see further downward revisions to the already anemic growth numbers, and Congress and the President are dithering over the debt ceiling. It will not take much to push us into an outright recession. We can go a few days, I think, with the latter problem, but not too long or the markets will throw up.
Kicking the Can Down the Road One More Time
I hope Europe pulls it off. I really do. They have done the US a huge favor by adopting this latest plan, as it keeps their banking system from imploding; because their banks are essentially insolvent with all the sovereign debt on their books. Such a banking crisis, which would be worse than 2008, in my opinion, would no doubt plunge a world already slowing down back into recession and pull our own slow-growth economy down into recession with them. How long can they kick the can down the road? My guess is that it will be longer than we suspect.
Back to the Basics
This week we are going to revisit some themes concerning the problems of the debt and the deficit. I am getting a number of questions, so while long-time readers may have read most of this in one letter or another, it is clearly time for a review, especially given the deficit/debt-ceiling debate. I will probably offend some cherished beliefs of most readers, but that is the nature of the times we live in. It is the time of the Endgame, where things are not as black and white as they have been in the past.
What Happened to the Jobs?
The economy will be slowing down. A recession in 2012 is a real possibility if there is any type of shock coming from Europe. Most European leaders are basing their thinking more on hope than on reality. When Greece defaults there will be a domino effect. And you could actually see a banking crisis before we get actual sovereign defaults. The market does not get it. Neither in Europe nor in the US. When someone says the market has already priced in a default, go back and ask them how well the market priced in a crisis in the spring of 2008. The market doesn?t know jack.
My View on the Last Half of the Year
The economy should be in Muddle Through range (around 2% growth), absent any shocks. For instance, today we had the June ISM number, which was stronger than most analysts expected, at 55.3. There was a lot of whispering that it could dip below 50. Some of the internal components were a little soft, though. New Orders were barely above 50. And Backlogs fell below 50. Exports fell to the lowest level in two years (more on that below). Of the 18 industries surveyed, only 12 reported growth. But Muddle Through is not going to allow us to really cut into the unemployment problem.
Could the Eurozone Break Up?
If the euro is not going to fall sharply, if reducing unit labor cost takes too long to restore competitiveness and growth and if deflation is unfeasible or (if achieved) self-defeating, there is only one other way to restore competitiveness and growth: Leave the monetary union, go back to national currencies and thus achieve a massive nominal and real depreciation. After all, in all emerging market financial crises where growth was restored, a move to flexible exchange rates was necessary and unavoidable on top of official liquidity, austerity and reform and debt restructuring and reduction.
Time to Get Outraged
This week we look at data from the Bank of International Settlements, by which (if someone does a lot of work) you can figure out how much US banks have written in credit default swaps to banks in Europe on Greek, Irish, and Portuguese debt. The details should not make you happy. I meditate on whether one should buy a house now, and then discuss ?the way out? of all this mess and why we will Muddle Through.
Economic Whiplash
The political winds in Europe are shifting. The crowd that runs the various member countries today will not long survive the changes. There will be new politicians with different mandates as it becomes clear that the costs of the bailout are going to fall on the backs of the solvent countries and that austerity is going to mean hellishly bad deflation, high and rising employment, and depression in the indebted countries. And with the US economy slowing down, it might not take much to push us over the edge.
A Random Walk Through the Minefield
In the last 48 hours, so much news has come out of Europe that has me frankly shaking my head. It is a strange game of brinksmanship they are playing, and it is one we should be paying attention to (as if the brinkmanship played by US politicians over the debt ceiling is not enough). This week we look at what seems to be European leaders taking random walks through the minefield at the very heart of the European Experiment. As Paul Simon wrote, ?A man sees what he wants to see and disregards the rest.?
All for One Euro and One Euro for All?
What Will the EU Do? Seriously, will Trichet really say ?non? when they once again peer down at the abyss? He blinked last time. But if the desire is to acknowledge in private what they cannot say in public - that Greece should leave the eurozone and go back to the drachma - there is no better way than to not take Greek debt onto the ECB?s books. It is not a matter of whether Greece defaults, but when. It may be easier in the long run to clean up the mess they have now than continue to create even more debt that cannot be paid.
Kicking the Can to the End of the Road
A crisis is brewing in the US and one is coming to a slow boil in Europe. We visit Greece and Ireland and ponder how this will end. It is all well and good to kick the can down the road, but what happens when you come to the end of the road? The European answer seems to be to haul in the heavy equipment and extend the road. In short, we are watching the biggest bubble of all time, the bubble of government debt, try to keep from popping. My bet is that it can?t. And while the ride will be bumpy, the world our kids get will be better off at the end of the process.
Muddle Through, or Crisis?
This week I finish the two-part letter on the Endgame and give you my thoughts on the economy over the next five years. This is the second part of a speech I gave last week at the Strategic Investment Conference in La Jolla. It is a rather bold forecast, and fraught with peril and likely errors, but that is my job here. I must offer one large caveat! If the facts change so will my forecast, but this is the view into my very cloudy crystal ball as I see it today. As always, remember that those of us in the forecasting world are often wrong but seldom in doubt. Read accordingly.
The Endgame Headwinds
By Endgame I mean the period of time in which many of the developed economies of the world will either willingly deleverage or be forced to do so. This age of deleveraging will produce a fundamentally different economic environment lasting anywhere from 4-6 years. Now, whether this deleveraging is orderly, as now appears to be the case in Britain, or more resembles what I have long predicted will be a violent default in Greece, it will create a profoundly different economic world from the one we have lived in for 60 years.
The 'Miracle' of Compound Inflation
Investors will face the ?zero bound? in interest rates for a while longer. They can sit on their cash and earn nothing. They can fret and wring their hands about a ramp-up in inflation, but the evidence so far does not support it. They can stay in the US dollar, in which case they can watch their dollars weaken relative to the rest of the world. Travelling in Sicily or Rome validates how strong the euro is relative to the dollar. All you have to do is buy a dinner or hotel room.
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