The Curious Race to the Bottom

The continued uncertainty surrounding Greece and their out-of-control fiscal situation may be what the EU has been wishing for. My suspicion (it is only a suspicion) is that the the EU, lead by France and Germany, want this uncertainty to continue. If we look at the statements coming out of the EU, it becomes clear that something is up. For example Bloomberg's article Germany’s Bruederle Rules Out Bailout for Greece :

“I don’t think that a bailout is the right way because German and French taxpayers can’t pay for Greece,” Bruederle said in an English-language interview in Davos, Switzerland today. “Maybe they will give certain help, but first it’s for the Greeks to solve their problems.” When asked what kind of help he’d consider, he said “it’s too early to discuss.”
...

The comments came a day after EU Monetary Affairs Commissioner Joaquin Almunia said policy makers have no “plan B” to help Greece.

Usually, if you want to limit a crisis, you don't want to come out with vague statements. You want to reassure the public and investors that a comprehensive plan is being worked out.

From the same article:

Prime Minister George Papandreou said on Jan. 28 that Greece is being victimized by rumors in financial markets and he denied seeking to borrow from European partners.

Really, victimized, Greece is not part of the PIIGS countries because of their fiscal responsibility.

The reason they would want this uncertainty to continue, to devalue the Euro. In an economic recession where governments want to create employment, a weak currency means that your exports are cheap i.e. more potential exports, more jobs.

With unemployment at 10% in the Eurozone, any means to slow or reverse the trend becomes attractive. The crisis has proven quite effective in weakening the Euro.

Euro Value


With the American dollar strengthening and Obama's State of Union address focusing on jobs creation, the Americans are probably not happy with the current situation....

Book of the week

The current crisis has been given a myriad causes and reasons, many of them are just simply wrong. Most ideological explanations, when pressed against the reality of the situation shatter into no more than ideological voodoo.

Thomas Woods' book Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and the Government Bailout Will Make Things Worse is by far the most rational explanation of the current crisis. The Austrian Business Cycle, which Woods uses in this book has withstood the test of the historical application. From 14th century Venice to the current economic problems, Austrian Business Cycle (ABC) fits.

As most view the bust as the problem, it limits their analyse of the situation. ABC looks at not only the bust but what preceded it, the boom. The real problem resides in the boom as malinvestment increases because of manipulations of the interest rates under the market rate. The bust, is the market trying to recalibrate the economy and wash away the malinvestment.

Woods' book makes a logical and convincing case and uses historical event to further justify his explanation of the current crisis. It is without a doubt, a must read that will change your outlook on the business cycle forever.

GDP Growth in US 5,7%?????

The new GDP numbers are out in the US, 5.7 percent increase in gross domestic product at an annual rate. The Bloomberg article U.S. Economy: Growth Jumps 5.7%, Fastest Pace in Six Years states:
The U.S. economy expanded in the fourth quarter at the fastest pace in six years as factories cranked up assembly lines, indicating the recovery may be strong enough to be weaned from government support.
...
Consumer spending, which comprises about 70 percent of the economy, rose at a 2 percent pace following a 2.8 percent increase in the previous three months. Economists projected a 1.8 percent gain, according to the survey median. Efforts to rebuild depleted inventories contributed 3.4 percentage points to GDP, the most in two decades.

Unfortunately, growth may not be as robust as first report. It has become an interesting game of cat and mouse with the numbers. The numbers are often reassessed later, when they do not make headlines, on the downside. Also many private economist who do the number often disagree with some of the shake and bake accounting and have very different results when compiling the numbers. For example, Shadow Stats assessment of GDP:


Courtesy of ShadowStats.com

It is clear that the numbers from Shadow Stats reflect the disconnect between government number and what is probably really going on. The fact remains that the US consumer, that is responsible for 70% of GDP, is going through a deleveraging period and will be limited in his spending for a couple more years. On top on deleveraging, unemployment rates remain extremely high.


Courtesy of ShadowStats.com

The U6 measure of unemployment probably better reflect the state of the American worker. Without significant change in employment numbers and leverage, the American consumer may have a driven a little gain now (the stated 2%), but cannot drive any sustainable recovery. Exporting goods and service will have to become a more important part of the American economy if they wish to see significant growth return in any sustainable fashion.

Interview with Dr. Walter Block from November 2009

Here it is. Dr. Block is one of the leading economist of the Austrian school of Economics.

No, I'm not a Nascar driver.......

I will let everyone judge for themselves..... Happy to live in Canada after seeing this.

Found this on Mish's blog.

Will "PIIGS" fly or only the spreads

Today, most markets have been slaughtered and if your wondering why markets are down, you only have to look as far as the G in PIIGS (Portugal, Italy, Ireland, Greece and Spain). Today, for the third day in a row, spreads have been flying for the PIIGS and especially for Greece. It reached an astonishing 405 bps but lowered to 390 by the time I was writing this post. With the lowering spread a rally seems to be forming before the close in markets around the world (probably on bail-out news).

The Germans and the IMF seem to have a lot of pressure to bail-out poor Greece and in the end, probably will. But until then, the safety trade of US treasuries will be an attractive trade as credit concerns drive investors to safety. The 1-month t-bill even went negative.

Once a bail-out will come, markets will seems to resume "growth" only until the next crisis arrives. Japan, any of the PIIGS (maybe not Ireland yet), England, Dubai are only a few place where the next crisis could come...... will we see a sovereign default this year, it is possible, anything seems possible now.

Haiti and Domino's

On Monday January 25, 2010, Domino's Sherbrooke raised around 10 000$ to donate to the red cross for Haiti. I will be interviewing the owner of Domino's for Friday's show. I would like to congratulate him on the wonderful endeavour he accomplished and encourage more to follow in his footsteps.

Earthquakes are natural catastrophe that cannot be controlled and can affect anyone. Understanding the reason behind the massive devastation is primordial in preventing such a lost of life in the future.

Unfortunately, in the past weeks has many have had misguided conclusions about the causes of the massive devastation in Haiti. Northern California's 1989 Loma Prieta earthquake was more violent, measuring 7.1 on the Richter scale, resulting in 63 deaths and 3,757 injuries. The 1906 San Francisco earthquake measured 7.8 on the Richter scale, about eight times more violent than Haiti's, and cost 3,000 lives. The difference that many have pointed out in the MSM (main stream media) is that more stringent building codes would have saved many lives.

That in itself is missing the greater picture. I am not very aware of the building codes in San Francisco in 1906 but I would believe that they would be still quite rudimentary. The excessive poverty in Haiti has more to do with the devastation than the building code.

Haiti people do not have the economic liberty that is needed to build a prosperous society. For example, Haiti takes an average of 195 days to get a business licence, compared with the world average of 38 days. Haiti ranks 177th out of 179 countries in the 2007 Transparency International's Corruption Perceptions Index. Its reputation as one of the world's most corrupt countries is a major impediment to doing business.

So if stringent building codes are applied, most will not be able to afford the extra cost that the codes will impose, pushing more people to shacks and less than par living standards. The true solution for Haiti is economic freedom for their citizens, so they can afford the better and safer buildings and houses.

http://economics.gmu.edu/wew/articles/10/Haiti%27sAvoidableDeathToll.htm

Fear the Boom and Bust video

I love this video..... go Hayek

Turmoil Continued

Originally published October 8th, 2008 in The Campus Issue

The latest financial turmoil in the U.S. has seen many companies bailed-out by the American government. The trend has been criticized as an ever growing threat to so-called free-market policies. The $700bn bail-out could be the beginning of a long tumble down the rabbit hole.
When the housing bubble started to collapse, companies like Fannie Mae and Freddie Mac suffered greatly. They had backed money to “high risk” clients and many of these high risk loans went into foreclosure. Deemed too-big-to-fail, they were bailed out by the government, fearing their collapse could bring down the whole economy.
Fannie and Freddie were not the only institutions involved in this risky lending, many other institutions were involved. For example, Lehman Brothers closed the sub-prime lender, BNC Mortgage, in August 2007. But their involvement in the sub prime and lower rated mortgages lending continued. They were underwriting these mortgages with mortgage backed securities and collateralized debt obligations (CDOs.)
Mortgage backed securities and CDOs, in short, bundle the mortgages from the lenders into bonds. They are sold out on the bond market the same way government bonds are.
As more and more mortgages went into foreclosure, these underwritten assets started to loose value and Lehman Brothers could no longer sell them. Since Underwriting entails Lehman taking on the risk of distributing the assets, they suffered billions of dollars in losses. What followed was the failure of many deals to save Lehman Brothers and finally their bankruptcy.
The real danger of this crisis is not the housing bubble but credit default swaps (CDS), a kind of derivative. CDSs are insurance on financial instruments, in this case on CDOs and mortgage backed securities, that guarantees the debt.
When an insurance company insures cars, they calculate that only a few will have accidents and pay out a smaller amount than the money received from the insurance contracts.
The bond market is different. One big failure can scare off investors of all the other bonds preventing borrowers from finding capital to stay solvent. It creates a domino effect.
As these companies fail, so do their bonds and the CDS contracts have to be fulfilled. This is what happened to AIG Insurance when Lehman Brothers failed. They had to cover the failing bonds they had insured.
What is truly scary about CDSs is how complicated they are. Few people really understand them and it is unclear who has them and where they come from. The scariest figure is that the derivative market is estimated to be somewhere north of $500tn dollars. No one really knows what would happen if it collapsed and this is why Warren Buffet calls CDSs the “weapon of financial mass destruction.”
As the U.S. financial credit crisis plays out, many offer different views and opinions on how to rectify the issue. The traditional Keynesian response calls for government intervention, free-market advocates conversely support laissez-faire solutions but most have no idea what to do.
The plan that the house of representatives passed on Friday, was designed largely by the U.S. treasury secretary, Hank Paulson, and the Federal Reserve chairman, Ben Bernanke.
The plan, which is backed by the Bush administration, offers a $700bn dollar bail-out of the fragile financial system. The plan gives Paulson the power to buy risky assets from the financial institutions in an attempt to stabilize the system.
There are major problems with this plan. First, the government does not have $700bn available with which it can purchase those risky assets. The money will come fresh off the printing press of the Federal Reserve. Paulson will then buy the precarious asset with the new treasury bills. Bernanke and Paulson both argue that the purchase of these assets will allow the bank to begin loaning money at an increasing rate and help support housing prices.
By stabilizing the housing market, they will keep housing prices, already at record lows, from slipping further and minimize foreclosure. At the same time, keeping further situations like Lehman brothers and other government bail-outs to a minimum.
$700bn is a breath taking number, just to offer some comparisons: It is more the $2000 per person in the United States. It is approximately equal to was has been declared to have been spent on the Iraq War. It is more than the pentagon’s yearly budget.
The time frame surrounding the design, ratification and implementation of this legislation is even more impressive. This legislation was written and presented to Congress for a vote within two weeks of the initial realisation of the crisis. The breakneck pace of its design reaffirms the urgent call for action.
Throughout history, when governments have printed money, they have devalued their currency, decreasing how many goods money can buy. The Romans did it near the end of their empire, the Germans did it in the 1920’s and many other governments have done it in the past to finance their state endeavours at the expense of their populations.
A question that some in the financial sector are asking is: “should an increase in liquidity be the solution?”
Many argue that easy credit got us into this situation and that this solution would simply act as a band aid for a bullet wound, temporary gain and long term pain.
What will happen in the next couple weeks will probably seal the fate of the American economy and in turn, at least temporarily, the world economy. Unfortunately, the results of the bail-out will only become evident after the crisis has run it’s course.

Originally publisher in The Campus, student newspaper at Bishop's University
Available on-line at www.thebucampus.ca/

An Oil Game: The Future of American Resources

Originally published November 6th in The Campus

On July 11, 2008, the price of a barrel of oil reached a high of $147.27 U.S. Consumers were all feeling the pain of high prices at the pump, at the grocery store, and in almost every aspect of the daily life that depends upon oil.
Since July there has been more than a 50% correction in the price of a barrel to just under $70.00 U.S. Consumers have been rejoicing- they can now enjoy a few more dollars in their pockets- but the long term consequences could be dire.
Currently, the world produces 85 million barrels/day and the world itself consumes about the same amount produced. The U.S. consumes 20 million barrels a day and has to import 12 million of those, 2 million of which are from Canada, 4 million from various other countries and the majority comes from OPEC countries (6 million barrels/day)
Last week the Financial Times reported that the International Energy Agency (EIA) is going to report that, without an increase of investment in exploration and production, there will be a 9.1 percent decrease in world oil. This problem of depletion compounded with other factors could be devastating for the U.S.
One of biggest challenges for the U.S. is the control of the Iranian-Russian coalition over the flow of oil originating from Middle-Eastern OPEC countries. If one controls the flow of oil originating in the in the Middle-East, they have the ability to set the world price.
Iran has a strategic position when it comes to the flow of oil that is shipped out of the Persian Gulf. The narrow Strait of Hormuz, an area in the southern part of Iran and at mouth of the Persian gulf, allows Iran to heavily disrupt the shipping of oil leaving the region.
Russia itself exports 5 million barrels daily and can decide to limit exports to increase price. Another card that Russia has in her hands is the Baku- Tsilisi-Ceyhan pipeline.
One of the goals of the Russian invasion of Georgia would seem to be for the purpose of gaining control of this pipeline. The pipeline was one of the only routes leaving the Middle East towards the West free of Russian or Iranian obstruction.The control of the Baku pipeline gives Russia control of another million barrels a day that flow to the West. These factors seem to have made Russia a big player in world geopolitical system for the first time since the fall of the U.S.S.R.
Increased demand for oil in the emerging markets is another problem that cannot be overlooked. For the first time in 2008, Russia, China and the Middle East are expected to consume more oil collectively than the U.S. In the last year, demand in these countries has increased by about 4 percent collectively and is expected to continue and speed up in coming years.
The current financial crisis may dampen the levels of demand but the long-term demand for oil will probably continue strong with China leading the pack.
Back in America, President elect Barack Obama’s energy platform does not seem reassuring. Obama plans to place a windfall profit tax on oil companies. If the electoral promise is followed through it will cause a further reduction of oil exploration and production.
Oil companies will not be enticed to exploit a valuable resource at a minimal profit margin.
This will further cut domestic supply and increase dependence on foreign oil. A further challenge for oil companies is the limited amount of money available for development of these projects because of the current worldwide credit crisis.
Obama supports further research of green technologies, which are part of the solution but not a panacea. Most of the oil consumed in the United States is used for transportation, almost 70 percent. Even with a significant decrease in consumption, through increase public transit, more rail transport, locally farmed foods, we are years away from the technological developments with personal transportation vehicles, for now man cannot live on Sun and Wind alone.
Further more Obama does not support a lift on the ban of foreign ethanol. This is limiting a significant decrease in the price of ethanol. Many foreign countries like Brazil, produce ethanol at a much lower cost, because sugar cane is a cheaper and more efficient product to produce than corn based ethanol. Obama will be limiting the market’s natural movement to ethanol.
Many other sources should be looked at like nuclear, geothermal, tidal, coal. Increasingly diverse solutions significantly improve the outlook for U.S. economic sustainability. These solutions must be discussed and decided in the public discourse at record speeds. All of these solutions take years to develop and to build the infrastructture necessary.
We cannot just turn a switch and change entirely to alternative sources of energy. If concrete action is not taken immediately, once the credit crisis comes to an end and oil demand begins ramping up once again, the U.S. could find themselves in a situation were they are scrambling to deal with a new risis.
Low oil prices may put a short term smile on some consumers faces but the long-term may reveal expressions of frustration as drivers wait in line at gas stations with their oil ration coupons.

Originally publisher in The Campus, student newspaper at Bishop's University
Available on-line at www.thebucampus.ca/