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Reflections on world economy and more by Nick Rost van Tonningen of Canada

August, 4th, 2011

The best, or worst, one can say about the outcome of the debt ceiling issue is that this may have been a case in which having no deal may have been preferable to the deal Obama eventually settled for (‘the mountain laboured & brought forth a mouse’). Once again he proved himself long on vision but short on execution & willingness to fight for his vision, thereby confirming the Tea Partiers’ belief he is a wuss. He would have been better off following Bill Clinton’s advice to use in Article XIV (4) of the Constitution, that reads in part that “The validity of the debt of the United States ... shall not be questioned”, to unilaterally impose an increase in the debt ceiling & challenge his opponents to take it to the Supreme Court. While markets might not have liked that much, they wouldn’t have had much choice but to go along, & at the very least it would have put the Tea Partiers, & the world, on notice that there was a limit to his tolerance for abuse.  

While the politicians fought like spoiled brats over how to reduce public spending by a couple trillion dollars over the next decade (but not right away because the economy couldn’t take it  -there never is a good time to do unpleasant things), two percent higher interest rates/borrowing costs could cost the US Treasury as much as US$300BN per year more than likely budgeted for. 

While a default may have been avoided, a downgrade of the US credit has now moved from what once was a (long shot) possibility & then a probability to a near-certainty, and the interest rate impact thereof may well do a great deal more harm to the economy than if the the bull had been taken by the horns & the bullet bitten; for the proposed lengthy uncertainty as to what, if any, taxes may be, or may not be, cut will do little to restore confidence in an already seriously compromised US dollar, or to make US businesses shift from their growth-damaging policy of preserving cash & refraining from new hiring. Add to that the detrimental effect of near-zero, if not outright negative, growth in public sector employment at all three levels, & the prospects of creating enough jobs to keep up with the growth in the nation’s work force, never mind reducing unemployment,  are abysmal. 

Given all the bluster of Republican hardliners, it is worth remembering that when Bill Clinton turned the keys to the White House over to George W. Bush in January 2001, the Budget was balanced & federal spending accounted for 18.2% of US GDP, whereas when the latter vacated it to make room for the Obamas the deficit was in the US1.5TR range, federal spending accounted for 24.6% of an albeit slightly smaller GDP, and Washington’s spending was 40% funded by borrowing, all of this due to three reasons, two of which were 100% of Bush’s making, foreign wars & tax cuts, & only one of which was not due in its entirety to his flawed judgments. And while the Obama Administration’s spending in the past 1½ years may not have helped matters much, this was due, in part at least, to his perpetuating the flawed policies of Messrs. Bush & Paulson.             

One the most inane headlines in a very long time was one on the front page of the Toronto Globe & Mail of Wednesday August 3rd. It read “American turn the page on debt crisis.” Hell, they’ve barely gotten into the Introductory Section of the debt crisis book! 

While overall US consumer spending is at best anaemic (at last report it had actually declined marginally on a MoM basis), the ‘rich’ are spending like money is going out of style : sales of luxury items have now increased for 10 months in a row, in July by no less than 11.6% - so the overall consumer spending number understates the situation on Main Street. 

Recent polls showed, among others, that Americans’ disapproval rate of Congress is now at an all-time high 82%, and that they want job creation to take priority over spending cuts - as regards the latter see below in the third item in the body of Gleanings proper. 


No. 421 - August, 4th, 2011 


(Postmedia News, Ian Lee) 

  • The price of having the debt ceiling raised by US$2½BN, i.e. until after the November 2012 Presidential election, was agreement to cut  federal spending by a similar amount (60% of it to be determined later, by the onset of the 2012 election campaign, by a 12-person bilateral panel). But the bond rating agencies warned earlier that, unless federal spending was cut by US$4TR over 10 years, the US credit rating would be downgraded (& they cannot help but take a dim view of this a-bit-now-and-a-lot-later approach). And the deal ducks the problem of the cash-gobbling entitlement programs & makes no provisions for increasing revenues, no matter how carefully targeted those proposed by Obama may have been to affect only what the hoi polloi would consider “fat cats”.
  • Ten years ago already Pete Peterson in his book Grey Dawn postulated that the greatest crisis facing the US in the 21st century would be the aging of the entitlement generation. Last week the Washington Post’s Robert Samuelson said “it’s the elderly stupid”, pointing out that Medicare, Medicaid & Social Security  account for almost one-half of all federal spending & are bound to grow exponentially in the future. PIMCO’s Bill Gross in his recent article Skunked pointed out the unfunded liabilities of those three are US$22.8TR, US$35.8TR & US$8.0TR respectively. And Mary Meeker estimated that USA Inc., if analysed as if a corporation, would have a negative Net Worth of US$35-US$40TR. 

The deal, such as it is, creates uncertainty. And if there is anything business & markets abhor, it is uncertainty, and their resultant tendency to ‘play it safe’ is not conducive to economic growth. So it  was not surprising that on August 2nd, the day after the deal was announced, the price of gold jumped 40 dollars (2½%) after having risen ‘just’ 11% in all of July. And while a downgrade, won’t necessarily be the end of the world as we know it, it will be another nail in the coffin of the US post-WW II pre-eminent status therein. This it will fuel isolationist tendencies in the US (especially since the outcome of debt ceiling crisis suggests a shift of power from a  historically always more ‘internationalist’ White House to an always instinctively more isolationist Congress). And  while in the pre-WW II period this led to the Great Depression, now that the US accounts for less than half the share of global GDP it did then, it will have less of an effect on the rest of the global economy.  


(NYT, David E. Sanger) 

  • The bitterness, divisions & dysfunction that became evident as the US lurched towards default has suggested to the world that the US is approaching Japanese levels of political gridlock, and diminished America’s aura as the world’s economic haven & the one country capable of leading the world out of financial crisis & recession. And it has eroded the global status of President Obama who was once celebrated as someone who would end an era of American unilateralism (causing him to get the Nobel Peace Price before he even had been able to settle in comfortably in the White House).
  • The brush with default has added another dimension. It has left America’s creditors & allies wondering what had changed in American politics to make a significant part of its political establishment willing to jeopardize the nation’s reputation as the safest place in the world in which to invest, and raised doubts in the minds of decision makers everywhere whether America’s military & economic dominance is something the country is still willing (& able?) to pay for. According to Prof. Jeffrey Garten of the Yale School of Management the challenge for the US will not end with this crisis, even if the deal eventually arrived at were to pass muster with the rating agencies; for the US is seen to lack credible fiscal & growth strategies, and a clear pathway for making the debt sustainable & for dealing with a whole range of critical issues from infrastructure to education.
  • Warnings about an American decline are nothing new; they have been around ever since Vietnam. But with Europe consumed by its own economic crisis & Japan trying to recover from the earthquake & the tsunami, investors have few other places to go with their money. This helps to explain why there has been no real run on the US dollar.

The latter observation is another version of the belief “the US dollar is still the best-looking horse in the glue factory”; while a consoling thought in the short run, longer term the end is the same.



  • The term “The Great Recession” implies the economy is in a typical, albeit unusually severe,  recession and therefore amenable to conventional Keynesian ‘pump-priming’.  But what we have faced is a overleverage-driven financial crisis such as occurs once every 70 or 80 years, the only real solution to which is a major transfer of wealth from creditors to debtors through defaults, financial repression or inflation. And, as Prof. Carmen Reinhart & I demonstrated in our 2009 book This Time Is Different, it typically takes an economy at least four years to recover from it. With the No. 1 problem being too much debt, the best way of compressing the period of deleveraging & slow growth is a period of moderate (4%-6%) inflation, which, while  involving an unfair & arbitrary transfer from savers to debtors & regarded by some as heresy, is the most direct approach to a faster recovery.
  • The big rush to jump on the “Great Recession” bandwagon was a function of policy makers making decisions on the basis of assumptions that have been proven painfully wrong. Acknowledging this to have been the case is a prerequisite to finding a solution, and  dumping all references to the “Great Recession” a helpful first step in this process.

Meanwhile rumours have it the Fed is getting set to initiate another (vain?) attempt to invigorate the economy by traditional means (Einstein once defined insanity as “doing the same thing over & over again, and expecting different results). These rumours were given substance by a call by three former members of the FOMC for it to consider a QE3 bond buying program at its August 9th meeting (the term “financial repression” is used to describe government policies that seek to “crowd out”  other, often economically more deserving, borrowers from the market, & was coined forty years ago by two Stanford economists in the aftermath of President Johnson’s “Guns & Butter” fiscal policies & prior to the onset of the world’s financial system being flooded with surplus oil dollars (which led to the Latin American debt crisis & the double digit inflation of the early 1980's) - Rogoff is not your average ‘talking head’ : he teaches at Harvard, & at various times in his career worked at the Fed & was Director of Research at the IMF.  


  • Amidst rumours that the ECB was buying Irish & Portuguese government bonds, EC President Jose Manuel Barroso warned, in a letter to Eurozone governments dated August 3rd, that the souvereign debt crisis is spreading beyond the periphery of the Eurozone, and  called on them to give their “full backing” to the Euro & to support the proposed changes to the EFSF (European Financial Stability Fund) agreed to on July 21st to widen its scope & allow it to intervene in the the market. He also described the bond markets’ treatment of Italy & Spain as a “cause of deep concern.”

To the extent his letter was directed at Germany, he wasted his breath; for the official reaction of the German Finance Ministry was “it is not clear how reopening the debate only two weeks after the summit would contribute to the calming of markets.”   


  • The Institute for Supply Management reported on August 1st that its Index of National Factory Activity had slid from 55.3 in June to 50.9 in July (its lowest level in two years), vs a median forecast of 54.9. This followed reports the economy had slowed to a crawl in the First Half, growing by 0.4% in the First- & 1.3% in the Second-, Quarters.

This led Paul Dales of Capital Economics in Toronto to opine “The recent easing in economic growth is increasingly looking more like a sustainable slowdown than a short-lived soft patch.”        


  • On July 27th the Commerce Department announced durable goods orders had declined 2.1% in June (after increasing by 1.9% in May) as non-defence capital goods orders, a proxy for business spending, slipped 0.4% after rising by 1.7% in May.

Economists are concerned this drop in ‘core spending’ heralds a slowdown in business spending on equipment & software in the Third Quarter. 


  • They expanded in July at their slowest rate in 17 months, as the Institute of Supply Management’s Index of Non-Manufacturing Businesses (covering 90% of the economy) came in at 52.7, vs 53.3 in June & a median forecast of a marginal increase to 53.5. Economic data in the last two weeks have included weaker home sales & factory orders, waning consumer confidence & the first decline in household spending (down 0.2% in June) in two years (i.e. immediately following the official end of the recession).

None of this is helping the unemployment picture (the official number for which likely understates reality because of the growing number of people too disillusioned to look for work), while with the passage of each day more people run out of unemployment benefits of any kind & are forced to survive on ...?  


  • A shortage of suitable wood has led to a shortage of chopsticks in China. So Americus, Ga.-based Georgia Chopsticks, an eight months-old company, is now exporting 2MM sets of chopsticks a day to China, going flat-out to meet the demand & expecting to ramp up production five-fold by yearend so as to be able to export 10MM sets.

And in a deliciously ironic turn of events, each set carries a label saying “Made in USA”. Once upon a time “carrying coal to Newcastle” & “selling refrigerators to Eskimos” were part of the everyday lexicon; to that we can now add “selling chopsticks to China”. 


  • The Interior Minister (a member of the ultra-orthodox Shas party) has given final approval to the building of 930 more housing units in the East Jerusalem settlement of Har Homa, the largest (with 9,000 inhabitants) & most controversial Jewish settlement in East Jerusalem, previous expansions of which drew criticism from the US, UK & other countries. They will effectively cut the Palestinian town of Bethlehem off from East Jerusalem, and while the expansion was defended by the Minister as needed to help address the country’s housing shortage, his critics describe it as a “cynical exploitation” thereof.

With new household formation running at a 50,000 annual rate, it is not altogether surprising  that there is a housing shortage & that house prices are beyond reach of many young Israelis. But in the overall scheme of things, 930 units are all but irrelevant except as an “up-your-nose gesture” & a sop to the country’s radical right. And with the West pre-occupied with crisis management, the timing (for Netanyahu et. al) was just too good to pass up.    


  • The deadly crash involving two bullet trains near Wengzhou suggest Bejing’s approach to development not unlike Mao’s Great Leap Forward half a century ago. It too aimed at rapid industrialization, exhorting the Chinese people to do “more, better, faster and cheaper” so as to surpass other countries’ economies & become second only to that of the US. Thus a front page article in the People’s Daily of December 14th put Li Dongxiao on a pedestal for learning to drive a bullet train in just ten days, whereas his German instructor had said it would take two or three months, by sleeping only three hours a day & compressing three days’ learning into one, so as to enable him to train the first generation of China’s high speed train drivers before the onset of its 2008 ‘marquee project, the Summer Olympics.
  • And in the aftermath of the crash, Beijing’s  three priorities seem to have been to offer the families of those killed lots of ‘hush money’, to tightly control all media reports & to get the trains up & running again. The Great Leap Forward proved a useful learning experience & the lesson Bejing should take away from this accident should be to put people’s lives ahead of train schedules.

Beijing is caught between a rock & a hard place. On the one hand, it must ‘make hay while the sun shines’, i.e. max out its economic growth potential in the short-to-medium term before its demographic time bombs will make that more difficult, while on the other hand, it has few, if any, options but to proceed at breakneck speed to avoid the social unrest that might ensue if it were unable to meet the Chinese people’s skyrocketing expectations. 


  • Contrary to the common wisdom, they increased at a double digit rate in June, faster than in any month since January. Sales for the year as a whole are now expected to be in the 10.4MM range, up 10.6% YoY (in part due to a government incentive program giving rural owners US$2,800 for trading in older models) & to rise to 25MM by 2020. Most sales involved luxury models, over 25% of them European brands, prompting German automakers to plan to invest another US$15BN in China over the next few years.

Meanwhile, Sergio Marcionne, the Windsor, Ont.-born CEO of Fiat/Chrysler, earlier this week, at the Center for Automotive Research Annual Conference in Traverse City, Mich., an major annual industry event, warned that in a few years China’s auto industry will start wreaking havoc with the US & European auto industries, saying it was already starting to export cars on a significant scale, among others to Brazil, traditionally a key market for Fiat. And he took issue with critics of the proposed new long-term 54.5 mpg fuel efficiency target, saying it was eminently feasible.   


  • On August 2nd financial market pressure on Italy intensified, prompting emergency meetings in Rome & other European capitals. As Italian & Spanish bond yields hit 14-year  (i.e. pre-Euro) highs, five year Italian bond yields rose to match Spain’s, suggesting that Italy is overtaking Spain as the main focus of investors’ concerns about debt sustainability. While Alessandro Giansanti, ING’s Amsterdam-based strategist said “The fear of the market is that the world is going into recession again”, the EC said Madrid & Rome were taking the action needed to keep their economies on track & “we are confident in their abilities”, and OECD Secretary-General Angel Gurria told Reuters Italy had its public finances under control & was taking the right steps to reduce its deficit, and “doesn’t need foreign savings to finance its deficits and therefore it is OK.” But the fact remains that Italy’s debt to GDP ratio is 120%, second in the Eurozone only to Greece’s 160% & that the political instability in its centre-right government is of growing concern to the market with the Prime Minister on trial for alleged tax evasion & sexual relations with a minor & the Economy Minister under investigation for alleged corruption.

Italy is Europe’s second-largest debtor nation & the Eurozone’s third-largest economy. And while  Prime Minister Berlusconi proclaimed Italy to be “up to the task” of tackling the debt crisis & promised to speed up the process of eliminating the deficit, and told Parliament “If to our deficit, we add the savings of our families, we’d be second in the European Union in terms of solidity”, the problem is that his credibility is lower than a snake’s belly & that this is largely  irrelevant to any dealing with the national debt (& while his government may seem better positioned than others in the Eurozone’s ‘soft southern underbelly’, since much of its debt is held by Italians, rather than foreigners, to the extent it is held by Italian banks that could prove problematic. And while Winston Churchill once observed ‘the human spirit can endure an incredible amount of pain as long as people feel the burden is being shared fairly by all’, Italian politicians were careful not to infringe on any of their perks (which won’t help the bitter medicine go down with an Italian voter universe that, as in many other European countries, feels that it is entitled to its entitlements).    


(G&M, Tara Perkins) 

  • After other big private equity had looked, & turned their noses up, at the Bank of Ireland,  Toronto-based Fairfax Financial Corp. mobilized a small group of US investors to take a combined 35% stake in the bank that, along with some other funding initiatives by the bank, will reduce the Irish government’s stake in the bank from a potential 66+% percent  to 15%. Fairfax CEO & controlling shareholder Prem Watsa believes that Europe & the US still have a lot of pain ahead of them but is bullish on the longer term outlook for Ireland.   

It’s hard to argue with success; under Watsa Fairfax’s book value has grown at a 25% compound annual rate, & its shares at a 21% rate, since he took control over two decades ago (& he made a bundle after shorting the US real estate market before it collapsed).Media reactions in Ireland were mixed with some merely saying the government gave them too good a deal & others worrying that, when the bank is eventually sold to a bigger (foreign) bank, as they think is inevitable, Watsa & colleagues will make a bundle in a short time. And true enough, the bank’s shares are down about 97% from their pre-crisis high & it passed the latest stress tests.  


  • In July, storms dumped 5x the average annual amount of rain & snow on the world’s driest desert in Northern Chile, promising spectacular floral displays in the weeks to come.

In this case the “average annual amount” of precipitation is a fraction of an inch.

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