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December 2nd, 2010

Quote of the Week : “Having a zero interest rate is manipulation. Having quantitative easing is manipulation of what the market would otherwise do ... They are delaying the liquidation phase of a bear market.” (Eric Sprott, a contrarian, but quite successful, Toronto money manager - who says that, apart from shares in his own company, 90% of his money is invested in precious metals) – the only thing that ‘rolling a problem forward’ typically achieves is to only make its solution more costly. 

The temperature in the Middle East cauldron is rising. Following is a partial listing of recent events in the week before last. The Knesset passed the Referendum Bill. Israeli spy drones overflew Lebanese territory. Turkey’s Prime Minister vowed to react to any Israeli threat to Lebanon. Lebanon’s Prime Minister Saad Hariri accused Israeli Prime Minister Binyamin Netanyahu of “not believing in peace”. Israeli planes & ground forces attacked targets inside Gaza. Israel destroyed a mosque in the West Bank town of Tubas. And the 30-vehicle “Road to Hope” convoy arrived in Gaza via the Egyptian border crossing at Rafah after an eventful six-week journey from London. 

Signs waved in recent demonstrations in Athens saying “This is far enough, we can’t take any more “ & “No layoffs. Write off the debt” aren’t good news, especially since the Greek government is not meeting the conditions of May’s EU/IMF bailout package. 

One analyst recently observed “By not allowing their loosely regulated banks to fail, countries themselves are failing. So while Irish keep their banks’ doors open, schools and hospitals will soon close as the country tries to cope with a deficit one-third the size of its economy” - while this may, or may not, prove to have been an exaggeration, the point is nevertheless well taken.  

One columnist described the state of the hapless Alberta government as “a train wreck that won’t stop. The lead engine is lying in a smouldering heap, unmoving, but the cars keep slamming into the wreckage, victims of their own inertia. Just when you think it couldn’t get any worse, another car smashes into the pileup.” This is also a fair description of the Eurozone bailout debacle, except that in that case is not just cars, but whole trains, that pile into the wreckage as their engineers keep misreading the signals.   

University of Alberta Prof. John Parkin uses the term “corrosive trust” to describe the clubby atmosphere that often emerges over time between those representing the public interest & those with narrowly focused business interests whom they are supposed to supervise/regulate. This can lead to the former developing a “trust” in the latter that gets in the way of them exercising their fiduciary responsibility & of not asking the questions they should be asking - this was a (major) cause of the financial crisis; thus the SEC ignored  for a decade warnings Bernard Madoff’s operation was a gigantic Ponzi scheme 

After WW I the Treaty of Versailles required Germany to pay US$64BN in reparations for the damage the war had caused. After many renegotiations over the years Germany last month made its final payment, bringing the total amount it eventually paid to US$36BN. So it took almost 93 years to pay back a minute fraction, in inflation-adjusted terms, of a debt resulting from a  4 year, 3½ months’ war, the imposition of which is generally acknowledged was a major cause of WW II (that did far more damage than US$64BN). 

Some of you may know of someone who could benefit from the Khan Academy. This is a Gates Foundation-funded website that provides access, free of charge, to 1,800+ videos on a range of, mostly academic, subjects. This could be a boon for students & others in developing countries or isolated places, like Canada’s First Nations, but only if they have access to a computer & the Internet.        


No. 387 - December 2nd, 2010 


    · After the Irish situation pushed Portugal’s & Spain’s borrowing costs to record highs, Eurozone leaders sought to assure investors the Euro area won’t break up. Chancellor Angela Merkel said Europe was showing “more solidarity than a year ago”, after earlier having rattled  markets by saying on November 25th the Euro was in an “exceptionally serious situation”. The Chairman of the Euro Zone Finance Ministers, Luxemburg Prime Minister Jean- Claide Juncker, told the press he wasn’t  worried about the Euro’s survival, although he was concerned that “in Germany, the federal and local authorities are slowly losing sight of the common European good.” And Klaus Regling, Head of the European Financial Stability Facility, the financial safety net created after the Greek bailout in May, told the German newspaper Der Bild “There is zero danger. It is inconceivable that the euro fails ... No country will give up the euro of its own will : for weaker countries that would be economic suicide, likewise for the stronger countries. And politically, Europe would only have half the value without the euro.” 

None of this will have the desired effect. Investors have long since learnt that high level denials often are counter-indicators; ditto for Angela Merkel’s assurance that her idea of administering a “haircut” to bondholders wouldn’t take effect until after 2013. Resentment is building up among German voters about being made to pay for other countries’ follies & having a much later retirement age than those they are expected to bail out. While the next German election isn’t due until the fall of 2013, the German constitution provides for that date to be moved up under “exceptional” circumstances. Having shown such colossal poor judgment in the recent past, few leaders have much credibility left, while some of the language they are using in their public utterances is like that of the Oracle of Delphi in Ancient Greece’s heyday, duplicitous. Last, but not least, at some point some of the Eurozone’s weaker sisters may decide that quitting the Eurozone is the lesser of two evils, and less long-term damaging than trying to live with the conditions imposed on them for their continued membership in it.  


(G&M, David Parkinson) 

    · Ireland’s 85BN Euro rescue package will take a big bite out of the EFSF (European Financial Stability Facility) created last June. While on paper its has 440BN Euros in loan guarantees available from Eurozone member government for those in need, over one-third of those guarantees are those of the five PIIGS countries, the real value of which is zero. And EFSF would not be expected to bail out Ireland all by itself, if it were required to also help out out Spain, its cupboard would be pretty bare. 

The much-vaunted 750BN Euro bailout facility put in place last May consisted of 440BN Euros in loan guarantees from the EFSF, 250BN Euros in loans from the IMF & 60BN Euros from the European Financial Stability Mechanism (EFSM). More uncertainty has now been added to the mix by rumours about Belgium (that so far had stayed below the radar despite being one of only three Eurozone countries, the others being Greece & Italy, that had 100+% debt-to-GDP even before the onset of the financial crisis. 


    · Investors continue shunning Greek & Irish bonds, have been shedding those issued by Portugal & Spain, and now have started to dump Italian, Belgian, French & even German bonds. So continent-wide banks are now sitting on hundreds of billions of government bonds that are rapidly falling in value, many of them pledged as collateral for vital cash infusions from the ECB, and, to make matters worse, are now increasingly underwater on their loans to banks & borrowers in various troubled countries. According to Marco Papic, Senior European Analyst as Austin, Texas-based Stratfor “There is definitely a banking problem in core Europe, outside of the peripheral countries.” 

Somehow or other US banks somehow managed to stay clear from this mess 

TRICHET DEFENDS EUROZONE (EJ, Business Browser)       

    · As European leaders seek to contain a worsening souvereign debt crisis, ECB President Jean-Claude Trichet told law makers in Bruxelles on November 30th “I don’t believe that financial stability in the Eurozone could really be called at risk ... (Observers) are tending to underestimate the determination of governments.” 

All the determination in the world comes to naught if ill-directed. 


    · Its World Economic Situation and Prospects 2011 report said “The road to recovery from the Great Recession is proving to be long, winding and rocky”. It believes the US jobless rate could rise from its current 9.6% to 10+%, that it could take five years before employment returns to its pre-crisis levels, that the US, Japan & Europe may face a new (double dip) recession, & that the global economic recovery will be driven by China, India & Brazil, although they too face slower growth in 2011 (China from 10.1% to 8.9%, India from 8.4% to 7.1% & Brazil from 7.6% to 4.5%), before accelerating again in 2012. 

Its 2011 forecast for various countries doesn’t quite jive with its “double-dip” warning. For it foresees 2011 growth of 2.2% for the US, 1.1% for Japan & 1.3% for the Eurozone (which, while not impressive numbers, are a) positive & b) not that far out of line with their long-term trend rates.  


    · GM’s November sales were up 11.4% YoY, Ford’s 24.3% & Chrysler’s 17% (albeit from low year-earlier levels). But Japan’s slumped for the third month in a row, Italy’s were down 21.1% YoY, Spain’s 25.5% & France’s 10.8%. 

A US auto industry analyst recently told a Detroit audience he expects pent-up demand & population growth to drive US auto sales back to its record 17+MM annual rate by 2015 (which, if the US dollar declines enough in the meantime, could give the US economy a powerful shot in the arm, albeit possibly not soon enough to save President Obama’s bacon in 2012.    


(G&M, Kevin Carmichael) 

    · The MID (Mortgage Interest Deductability) was introduced in 1913. It inflates house prices, favours the rich, costs the government dearly & distorts resource allocation in the US economy. It has survived several attempts to end; for politicians view it as so key to the American Dream of home ownership as to be a “Third Rail” issue. Nevertheless, President Obama’s Deficit Commission is about to recommend a curtailing thereof (by limiting it to primary residences only & to only the first US$500,000 of mortgage principal). 

According to the Tax Policy Center, MID will cost the US Treasury US$130BN in 2012.    


    · President Obama on November 29th called for freezing the pay of 2MM federal employees saying “The hard truth is that getting this deficit under control is going to require some broad sacrifice, and that sacrifice must be shared by the employees of the federal government.” The two-year freeze wouldn’t apply to military personnel, and would save US$5BN over two years, US$28BN over five years & US$60MM over 10 years.  While it wouldn’t apply to Congress (which must approved any freeze), lawmakers last April voted to freeze their own pay by forgoing an automatic US$1,600 annual COL Increase.   

This is mostly optics, designed to mollify Jack & Jill American Taxpayer many of whom look upon federal public servants as a pampered, over-paid & over-benefited but underworked bunch of parasites who live high of the hog at their expense. For US$5BN barely makes even the tiniest of dints in a US$1.3TR deficit  

U.S. INDICATORS UP (EJ, Business Digest) 

    · Despite September’s faster-than-expected fall in single home prices, the Conference Board’s Index of Consumer Confidence Index rose to 54.1, the highest since June, up from an upwardly revised 49.9 in October & well above the analysts’ consensus forecast of 52.6.  

The devil is in the detail. The Current Conditions Sub-Index was up marginally from 23.5 to 24.0 while the Expectations Sub-Index (that measures consumers’ assessment of conditions six months out) soared from 67.5 to 74.2. The number of those who judged business conditions “bad” rose from 42.5 to 43.6 while that of those who thought them “good” slipped from 8.3 to 8.1, & although those who said jobs were “plentiful” rose from 3.5 to 4.0, those who said they’re “hard to get” rose from 46.3 to 46.5 


    · The Labor Department reported on December 3rd that just 39,000 new jobs were created in November & the unemployment rate rose to 9.8% (which some analysts now expect to soon surpass 10%). On the other hand, the 50,000 rise in private sector employment suggests the economy is still gaining momentum (although it will take 200,000 - 300,000 new jobs a month to make a sizeable dint in unemployment). 

Another bit of good news is that the number of new applications for unemployment benefits last month dropped to a two-year low. And to the extent the higher unemployment rate is due to more people looking for work, it actually is positive). 


(G&M, David Rosenberg) 

    · The political shift in the US from Left to Right & the growing bias towards budget cutting at both federal- & state levels signify voters want governments to practice the same of frugality as forced onto them. With economic life support from Washington ending, the negative fiscal shock from less government spending could trigger close to zero growth in the First Quarter & renewed talk of a double dip recession. The housing market cannot get out of its own way. Gasoline prices are high. The end of extended unemployment benefits will take a US$70BN bite out of potential consumer spending. And holiday shopping surveys show a marked fall-off in the spending plans of low-end households.  

Congress is moving slowly towards another (last-minute) extension of unemployment benefits, although this it may not have much of a pump-priming effect since the Republicans insist it must be spending-neutral.      


    · Canada’s Third Quarter performance was the slowest in a year, growing at a 1% annualized rate, vs. 2.3% in the Second-, & 5.6% in the First-, Quarters. Held back by weak demand from abroad & a drop in housing even as business investment surged & consumer spending held steady, exports to the US will be crucial in the months ahead.  

This is just about the dumbest, most myopic & traditionalist front page headline the paper has carried in a long time. For the US is economically not a paragon of rapid growth & politically becoming more protectionist. And all the growth these days, that Canada should try & tap into far more aggressivelllan than it has in the past, is concentrated in non-traditional markets in Asia, Latin America & Africa.


‘MORE POPULAR THAN BEER AND WINGS’ (Postmedia, Richard Foot)  

    · This is how one Newfoundland newspaper described the Province’s retiring Premier, Danny Williams, whose approval rating during his seven years in office seldom went below 80%. 

In Newfoundland terms greater praise is inconceivable. A former Rhodes scholar, he founded the Province’s first cable TV network (& later sold it for $232MM) as well as one of the province’s most successful law firms, and as Premier donated his stipend to charity. He took on the oil industry with considerable success, as he did Ottawa. On one occasion he became so incensed with the then Prime Minister that he ordered an end to the flying the Canadian flag from public buildings (which got attention). And following a run-in with Prime Minister Harper he launched a campaign in the last election to vote “ABC” - Anything But Conservative – (despite himself heading a Conservative government), that resulted in his fellow Newfoundlanders not electing a single Conservative MP, thereby robbing the Prime Minister of a majority in Parliament. And his parting shot was to negotiate a deal with Nova Scotia to become the Province’s partner in a project to move power generated in Labrador under water to Newfoundland & hence under water to Nova Scotia, so as to cut the Province of Quebec out of the loop (which for several decades has benefited more from the Labrador-produced power exported to the US via than Newfoundlanders think is fair & reasonable, & that has steadfastly refused to renegotiate the existing arrangement (that has several more decades to run).   


    · On November 25th former Israeli Prime Minister Ehud Olmert told foreign journalists Prime Minister Netanyahu should agree to the US demand to halt settlement construction in the West Bank so as to restart the Middle East peace talks. He said Netanyahu & Obama are wasting valuable time by focusing on such a “marginal” issue instead of tackling core issues (like the final borders, the ‘right of return & the status of Jerusalem). He also revealed that during his time as Prime Minister he had made the Palestinians an offer that would have given them control over 94% of the West Bank,  & be compensated for the remaining 6% through a ‘land swap’, and that would have turned the Arab neighbourhoods of Jerusalem over to Palestinian control, with the Old City governed jointly by Israel, the Palestinians, Jordan, Saudi Arabia & the US. 

That is close to what everyone involved knows an eventual peace agreement, if ever there is one, will look like (except for the “right of return”, that will likely be monetized, with Saudi Arabia funding most of the cost thereof). The timing of his comments, coming after him having lain low since being turfed out of office, suggests this may be a step in an evolving campaign to replace the current right wing coalition with a more dovish centrist one (rumour has it that Defence Minister Ehud Barak, who also heads the left-of-centre Labor party, a while ago put Netanyahu on notice that he would quit the coalition, in which he is the ‘odd man out’ anyway, absent serious progress in the peace negotiations by year-end).     


    · On November 26th China’s Foreign Ministry issued a statement warning against “any military acts in our exclusive economic zone without permission.” By Beijing’s definition that includes the waters to the West of the Korean peninsula in which major US/Korean naval exercises are about to take place & in which in the past US naval traffic has been quite common. And rather than Beijing using its influence over North Korea to rein it in, as Washington had hoped it would, the statement even failed to criticize North Korea for its November 23rd shelling of a South Korean island near their common border. 

While this intended, in part at least, as a way to further international acceptance of its unilateral definition of its ‘exclusive economic zone, it may backfire. For the naval exercises go ahead as planned. And then what can/will Beijing do? 


(G&M, Mark MacKinnon) 

    · October’s 10.1% jump in food prices drove its overall inflation rate to 4.4% YoY, the highest in 25 months & well above the government’s 3% target (although China Business News reported recently the government was considering raising this target for 2011 to 4%, which is, however, still well short of the 5½% economists at the Standard Chartered Bank are forecasting). Even the price of a Big Mac was recently raised by 8%. The rising cost of food is causing growing discontent among food shoppers many of whom must spend half their incomes on food, & growing concerns among Beijing decision makers who fear social unrest & are now talking about food subsidies for poor people, and price controls.

    · While part of the higher food prices are due to floods in some parts of China’s agricultural heartland & drought in others, concerns are growing it also may be a sign of the economy starting to overheat after two years of government stimulus which led to a 54% in the money supply & to much real estate speculation.    

China today & the rest of the world tomorrow? 

A TALE OF TWO EUROPES (G&M, Doug Saunders) 

    · Both the ECB & the EU Statistics Office this week released data showing the continent  is split into one group that is experiencing dramatic recoveries & shrinking unemployment (with GDP growth rates this year of 2.9% or more) & another group that is having the opposite experience (with negative growth rates as high as -4.2% in the case of Greece). Be that as it may, these two groups are joined at the hip; for the rising debt of the ‘have-nots’ is mostly owed to the banks of the ‘haves’, and the ‘haves’ economic growth has in the past been to a major extent been a function of their exports to the ‘have-nots’.  

The challenge for the ECB now will be to try & find a monetary policy that can accommodate a situation in which half its members’ economies may be at risk of overheating while those of the other half are ‘tanking’. 

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