Nick Rost van Tonningen ~ Gleanings II ~ 514 Posted by John on June 12, 2013

Quote of the week : “In this age of social networks, populist revolts and superempowered individuals, international public opinion matters more, not less.” – Yaron Ezrahi (which is relevant given what you will read a few items further down about the low esteem in which much of global public opinion holds Israel). Ezrahi is a professor emeritus in Political Theory at Jerusalem’s Hebrew University who, while still a doctoral student at Harvard served as a science adviser at the OECD in 1969, & at the White House in 1970. His book last fall, Imagined Democracies – Necessary Political Fictions, was synopsied by Cambridge University Press as follows : “Exposure to electronic media has made contemporary democratic publics more aware that (seemingly?) credible popular fictions have a greater impact in shaping political realities than do rational choices or moral arguments.” – I found this quote in a recent NYT column by Thomas Friedman entitled Israel lives the Joseph Story, that one of you kindly ‘bird dogged’ for me & that is one of his more insightful, visionary  pieces that everyone of you may want to take the time to read. 

For some time there has been a great deal of hype that the US is on the threshold of energy independence, even though the growth in natural gas production has started to show the effect of the precipitous drop in the number of rigs drilling for gas. But a key efficiency factor for the industry is what it calls “oil intensity”, i.e. the number of barrels of oil produced for every barrel of oil consumed producing it. According to Stephen Leeb, Founder, Chairman & CIO of the New-York-based, ‘big cap growth’ money manager carrying his name, the North American oil industry’s oil intensity has dropped from 15 to 3 in the past two decades (and is lower still for oilsands oil & by some accounts even < 1 for corn-based ethanol).

Presidents Obama & XI are have been meeting in California. One “hot” topic was expected to  be China’s hacking-facilitated theft of US intellectual property, especially of critical (weapons) technology. Recently I reread Dan Morgan’s rather informative 1979 book entitled Merchants of Grain in which he at one point tells the story how Pillsbury in the late 1870’s got a jump on the competition by having advanced rolling technology stolen to order from Hungarian mills – industrial espionage has been around forever as the less technologically advanced seek to pull themselves up by the bootstraps ‘on the cheap’ at the expense of the more technologically advanced; only today the methodology for doing so has become more sophisticated & the physical danger to those  doing so eliminated. Meanwhile the Chinese have started accusing the Americans of hacking into their systems as well, as they likely have been doing (albeit possibly into different areas); if so, the only question really is who is better at it. Meanwhile the White House made a major ‘faux pas’ when Michelle Obama didn’t accompany her husband; while one cannot help but symphasize with her reason, her youngest daughter’s 12^th birthday, the fact remains that this left Peng Liyuan, Xi’s popular folk singing wife, who also holds the rank of major-general in the PLA & who accompanies him on his travels, way out on a limb; presumably a more “diplomatic solution could have been found (e.g. by having the Obama girls accompany their parents so that the four ladies could do some touristy things together?).     

The CW (Common Wisdom) is that gold is yesterday’s story & that Asian demand is moribund. The former remains to be seen but the latter is simply wrong. India is the world’s biggest market for physical gold (it is estimated to be the repository of one-eighth of all gold ever mined – which would mean that Indians collectively would hold twice as much gold as there is supposed to be in Fort Knox, Ky.). In 2011 it imported 1000 tonnes of it, over one-third of total global newly-mined output, the equivalent of 10+% of its GDP & close to half of its trade deficit. Last year its gold imports were down 20%, in part due to the fact that the weak rupee had driven the local price up and in part because the government, concerned about the impact of gold imports on its deteriorating trade balance, had pro-actively moved to discourage retail gold buying. This caused the head of India’s largest gold exchange to predict last November that demand this year could be down another 30+% (to 532 tonnes). But boy, was he ever wrong; for First Quarter Indian gold imports were up 200% YoY, & in May alone were 162 tonnes, more than in the entire Second Quarter of last year. This prompted the government to announce this week that “effective immediately, any import of gold on a consignment basis (i.e. without payment upfront) shall now only be permitted to meet the needs of exporters of gold jewellery.” (this may prove meaningless since much of India’s gold demand comes from Pops, & especially Moms, who not only must pay cash on the barrelhead but have been so anxious to own more gold as to be willing to pay up to a US$50 premium for immediate delivery). The story in China is similar, albeit it not necessarily the same in detail, with imports breaking records with great regularity (the World Gold Council, which, while having a vested interest in gold, is nevertheless a good  source of facts about global gold market conditions, estimates that this year China may import 880 tonnes – if so, that would only be a 5% YOY increase, a pittance compared to last year’s 100%; but it would nevertheless mean that, for the second year running, between domestic production & imports, gold ‘disappearance’ in China will account for half the total global newly-mined gold production). Elsewhere the Turkish central bank in the three months to May 31^st is believed to have boosted its gold holdings by one-third to the 450-500 tonne range. And it is by no means the only central bank to be buying gold, real gold that is, not the paper stuff; believe it or not, according to IMF even Greece’s central bank has been doing buying gold (and it is worth keeping in mind that both central banks and Indian & Chinese retail investors are long-term keepers of the real McCoy, not short-term speculators in the bogus stuff).        

 In the face of all this, Prof. Nouriel Roubini who teaches at NYU’s Stern School of Business and who, after correctly predicting the 2008 US financial meltdown has sought to monetize this by launching the strategy research firm named after him, maintains in the Project Syndicate, deemed by some “the world’s smartest op-ed page”, that gold’s glory days are over because :

$               it’s not always a winner during economic crises & not impervious to margin calls – like so many others, he fails to distinguish between speculators’ demand for paper gold & long-term holders’ demand for the real thing;

$               it performs best when inflation is high – while many people are sanguine about the inflation outlook, they will likely be proven disastrously wrong (thus every time I go grocery shopping – and I think of myself as an unusually beedy-eyed grocery shopper, the evidence that the official food price inflation number, for instance, vastly understates the real world food inflation food situation stares me in the face from every shelf;

$               it generates no income – due to the central banks’ zero interest rates policies this has not been an issue for some time;

$               interest rates are set to rise – while this is likely, if not inevitable, it may actually boost the demand for gold, if it were to be seen as evidence the system is in trouble;

$               indebted governments are likely to sell their gold holdings – they may or may not, depending on its medium term price outlook; in addition, there are questions about how much double counting of their gold has taken place; so they may be an inclined not to open up that can of worms, and let that particular sleeping doggie lie.

$               the argument the US government will expropriate private wealth cannot be sustained – events in the US during the Thirties invalidate this line of argument.

Over the weekend I watched a video of a talk two months ago at the Philadelphia Fed by Columbia University’s Prof. Jeffrey Sachs (who in his spare time doubles as an adviser to UN Secretary-General Ban Ki-moon & to Second & Third World governments). He conveyed the anger felt by many emerging economy governments (because of its impact on their economies) about the mess the developed countries have made of the global economic & financial system, and about their audacity at nevertheless expecting their opinions & advice on global economic & financial matters to have any credibility. And at a personal level he railed against the “mountain of illegal and criminal behaviour” that now hallmarks,  & is being tolerated if not condoned by, the developed countries’ authorities in, a banking system proven to be a “moral-, regulatory- & legal failure”. As proof of the latter he used the case of SAC Capital that then had just been fined US$642MM by the SEC for improper activities, without having to admit or deny guilt (only weeks after its top trader had been arrested in handcuffs) while its CEO, Stephen A. Cohen in 2012, a year in which his fund underperformed the market, had taken home US$1.4BN in compensation (of which he had wisely spent/invested US$217,000 in political campaign contributions). In other words, Cohen underperformed, but still took home a pay cheque more than twice the size of the fine he stuck his investors with – it’s hard not to share his indignation at a system so seemingly out of political & regulatory control, and out of legal bounds, although one also has to wonder what’s wrong with the corporate directors & (institutional) shareholders who let such behaviour go unchallenged (the outcome of the recent vote at the JPMorgan Annual Meeting to deprive Jamie Dimon from one of his rather incestuous dual roles as Chairman and CEO suggests they don’t give a fig, provided the share price keeps going up).

The US market seems  to have started ‘pricing in’ a ‘tapering’ decision (i.e. to anticipate the Fed easing its foot off the QE3 gas pedal) at the September 18^th FOMC meeting, seemingly blithely disregarding that earlier that month will be the ‘drop dead date’ for a debt ceiling decision. But this may have overhasty given the market’s response to events this week, when the ECB stood pat, thereby dumping the responsibility for stimulating growth into the laps of over-indebted governments that so far have been unable to rise to the occasion, any occasion, while Japans Prime Minister Abe’s in underpromising on reforms (at least until after this summer’s Senate elections?), did the reverse.

Back in 1998 Monsanto started developing a GM Roundup Ready–resistant wheat but stopped in May 2004 when the Canadian Wheat Board, then the world’s largest grain seller, said it would be unacceptable to its biggest ten customers, incl. Japan, the UK & Malaysia (but in 2009 resumed it). But recently some was found in a shipment of US wheat to Japan, prompting the it to cancel a 22,612 tonne order for US wheat & to suspend all imports thereof, and the EU to recommend that its member governments test all US wheat shipments, despite assurances by the USDA’s Animal Animal & Plant Inspection branch it would pose no threat to human health & Monsanto’s that this was an isolated case involving one Oregon farmer, and that “There are no food, feed, or environmental safety concerns associated with the presence of the Roundup Ready gene if … found … in wheat.” – alas the Canadian Wheat Board no longer occupies the exalted place it once did in the world’s grain markets since Prime Minister Harper ended its monopoly over Western Canadian farmers’ wheat & barley sales. The official USDA/Monsanto ‘line’ is that the farmer years ago had sprayed his corn to get rid of ‘volunteer’ wheat, found that some of latter had survived & then propagated the seeds from those survivors to create his very own Roundup Ready-resistant strain of wheat).

GlobeScan/PIPA earlier this year conducted its annual worldwide poll for the BBC among 26,299 people in 16 countries as to their attitudes towards the other 15; more specifically it asked them whether they thought the various countries played a positive or negative role in world affairs. Canada tied with Britain for second place overall with a 56% positive rating, second only to Germany with 59%, with a majority of people in every country, except Pakistan, seeing it in a positive light. Canada fared best in the US (84%), France (82%), Britain (80%), Australia (79%) & South Korea (77%). Rather interestingly, while Canadians continue to see Germany (with 69%) in a very positive light, Germans’ perception of Canada cratered in the past year from 75% to 51%. Another anomaly is that, while Americans give Canada an 84% positive rating, Canadians are split evenly at 45% (down from 48-42 a year ago) on the US (this is nothing new; Canadians have historically had a love-hate view of the US). Also interesting is the anomaly between the Harper government’s & Canada’s hoi polloi’s perception of Israel : while the former’s support for Israel is strong & unwavering, Israel’s stature among Canadians (at 25-57, only two points better than North Korea’s) is roughly in line with the survey’s 21-52 average reading (the US is the only one of the 16 countries with a positive view of Israel, albeit only with a 51-32 split). Canadians, at 29-59, are also more negative than the 42-39 average on China.         

Mention has been made here before of it being “Amateur Hour” in Canada’s foreign policy-making process. Ottawa has for some time been negotiating a free trade deal with the EU purportedly to make Canada less dependent on trade with the “slow growth” US (by making it more dependent on the even slower growth EU?), & right now Prime Minister Harper is in such deep doodoo politically at home about the way some of his appointments to the Senate have fiddled their expense-, & per diem-, claims (presumably because he is known to be such a ‘control freak’, one poll found that only one in eight Canadians will take him at his word when he says he knew nothing about these things – which must be a record low for any politician anywhere) that the negotiation team currently in Brussels has supposedly been to told to get a deal, any deal, before the G-8 clambake in Lough Erne, Northern Ireland on the 17^th & 18^th of this month so he’ll have something to crow about & deflect the heat he’s now feeling domestically (which now looks to be more & more unlikely, whatever his instuctions). Meanwhile the post of Canadian Ambassador to Germany, the dominant power in Europe, has been vacant for over six months! And as a cost-saving measure, the life of Canadian passports will be extended from five to ten years and its format reduced from 48 to 36 pages while for the many Canadians who travel frequently for business-, work- or pleasure, the existing 48 page format in use for decades was already insufficient to handle all their border crossing stamps for the full five years (the US uses a 52-page model, the life of which can be extended with an insert, as is the case in most western countries except Canada) – in other words, the government is going to save a bit of money on paper only to incur potentially huge increases in labour costs from the need to issue new passports to frequent travelers more frequently. Meanwhile, Canada’s diplomatic representation abroad is continuing to be cut back, particularly in Africa, many parts of which had GDP growth rates during the Great Recession that developed countries, incl. Canada, could only envy & which in the coming decades will  account for a hugely disproportionate share of global population growth.

The Japanese bubble burst in the late 80’s, at which point the Japanese government’s annual new debt issuance was 4TR Yen &, with interest rates in the high single digits, its annual debt service  costs were in the 55TR Yen range. By 2004 after several years of fruitless deficit financing in a vain attempt to reflate the economy, annual new debt issuance had waxed 10x to over 45TR Yen but, due to a massive slide in interest rates, annual debt service costs had declined to less than 8TR Yen. Four years later, largely due to some bold initiatives by Prime Minister Koizumi (he with the wild hairdo) annual new debt issuance had been cut back to 4TR Yen & annual debt service obligations stabilized at 8TR Yen. This year it is estimated new debt issuance could go as high as 55TR Yen (i.e. roughly half a trillion dollars in an economy about  one-third the size of that of the US, with debt service obligations up 25% to 10TR Yen.

In recent years unusually heavy rains have caused calamitous floods all over the world, this week in Central Europe. This supports what head-in-the-sand climate change deniers refuse to accept, namely that global warming is a reality. For it is an uncontestable fact in physics that warm air can hold more water than cool air; so when air moves across the world’s oceans & absorbs the water evaporating from it, as it has done since time immemorial, it becomes ‘supercharged’ with the stuff. And then, when overland a warm air mass collides with a colder one, another immutable fact of physics comes into play, namely that ‘what goes up, must come down’; and so does the water in the air, as it always has, only in larger than the usual quantities. 

In Spain unemployment is still in the stratosphere & the public mood sour; but unlike others that blame the Germans for their ills & their unwillingness to share their bounty – a la the grasshopper & the ant of Aesop’s Fables’ fame – many Spanish people understand their troubles are of their own-, not someone else’s-, making. The government is unpopular (but so is the opposition), as it has pushed through some meaningful restructuring & reforms (although much is left to be done on that score), & is likely to serve a full term (i.e until late 2015), thus providing a modicum of political stability & predictability. While on the surface the numbers remain grim (the First Quarter was its seventh consecutive negative growth quarter, the deficit is still 7% of GDP, small firms are experiencing a severe credit crunch & corporate bankruptcies are running at 10x the pre-crisis rate), there are “green shoots”. It has a government than can, & will, do things, unlike France’s that is going back on its earlier promises for change & Italy’s that cannot even agree on a program.  It has taken down less than half the 100BN Euros earmarked by the European bailout fund for its banks & its financial system has been rationalized, with many of its worst assets hived off into a ‘bad bank’. The public payroll has been shrunk by 375,000, close to 1% of its total population, & its unit labour costs have declined 6% to 114% of their 2003 level while Germany’s have risen 6% to 106, France’s 5% to 120 & Italy’s 4% to 121. Its current account has gone from a deficit of 10% of GDP in 2008 & 5% in 2009 to breakeven in 2012. But, according to the Economist it still faces three key challenges : get lenders to start focusing more on extending credit where it will promote growth rather than using it to fund ‘hold-the-line’ operators, overcome the hoi polloi’s ‘reform fatique & boost local demand since exports can do only so much (especially since in the past most of its exports went to other EU countries). In a not dissimilar fashion there are green shoots in, of all places, Greece : hedge funds are snapping up its bonds, bailout money from the EU & IMF is flowing as reform milestones are met, this summer the place is expected to be overrun by tourists taking advantage of cheap prices, a small “primary surplus (i.e. before debt servicing charges) is now expected as  privatization has started, there have been deep cuts in health & welfare spending and job losses for public servants are now starting to occur, the Chinese are proposing to buy the Piraeus container port where its major container line, Cosco, already has terminal, this fall work is expected to resume on 6BN Euro-worth of EU funded highway work that is expected to create 30,000 jobs. So a bit of GDP growth is now expected for next year, followed by a return to more normal 2% growth in 2015 – while the big albatross about both their necks remains their unsustainable debt loads, if their economies nevertheless will start showing signs of life again, the pressure for some debt restructuring cum forgiveness will seriously escalate.

Obesity, diabetes & hypertension now are major health problems in North America. But a 2010 study published in the American Journal of Preventive Medicine found that people who switched from commuting by car to doing so by public transit were 81% less likely to become obese, while an earlier study by the City University of New York had found that those who did so on average walked 8.3 minutes more each day than non-transit users. And a 2006 study by Toronto’s Mount Sinai Hospital found that those who lived in an area with at least one supermarket were 12% less likely to suffer from hypertension & 24% less likely to be obese than those living in areas without one, while in 2012 researchers at Toronto’s St. Michael’s Hospital found that immigrants living in ‘less walkable’ areas were 50% more likely to develop diabetes than those living in areas more conducive to walking. And many studies have found that kids living within one km. of their school were more likely to use ‘active’ modes of transportation, incl. walking, biking or skateboarding, while the majority of those living 2 kms away were more likely to take the bus, or be driven (while a much earlier study in Britain had found that kids who were not driven to school, on average tended to perform somewhat better academically – which was attributed to the fact that the physical exercise involved had taken a bit of the edge of their youthful energy, thereby making them more amenable to receiving instruction).  And modern suburban development hasn’t helped; for, whereas in 1961 in the Ontario city of London, for instance, 75% of the people lived within one kilometre of a supermarket, a decade ago that had declined to < 20%.

GLEANINGS II – 514

Thursday June 6^th, 201

POTENTIAL RIPPLE EFFECTS AS US MOVES CLOSER TO EXIT FROM ACCOMMODATIVE  MONETARY POLICY (Institute of International Finance, Press Release)

$               Following its meeting in Rome on June 4^th, its Market Monetary Group issues a statement pointing out among others that :

$                                 as Japan & Europe intensify their efforts to use monetary policy to stimulate growth, signs of the underpricing of risk persist (because of the resultant excess of liquidity in the system). Slower growth in key emerging economies also pose a risk to export markets, especially for commodities. And if a lack of growth and/or inflationary pressure were to continue, the underpricing of risk – and the potential for disorderly reversals – will combine to accumulate;

$                                 as US policy makers debate a strategy of tapering off bond purchases, US long-term bond yields remain 225-250 basis points below their average level in 2009,  a return to which could have significant ripple effects, incl. raising the cost of servicing high budget deficits in mature market economies, risks for recovery in Europe & losses for bond holders, incl. central banks;

$                                 a need for reconsidering the zero-risk weighting of domestic government bonds for members of the currency union (i.e. the Eurozone) because it has encouraged the unhealthy accumulation of private sector holdings thereof that will create a major risk to the system if public debt sustainability in the weaker member countries were once again be called into question; and

$                                 potential vulnerabilities also exist in a number of Eurozone countries where corporate debt-to-GDP ratios are high as corporate profitability has suffered from prolonged recessionary conditions.

The Institute is the Washington-based lobby group cum idea clearinghouse for several hundred of the world’s leading private sector financial institutions. This press release seems to suggest that in its view the system is in the quiet ‘eye’ of a world class financial tornado, rather than through it. What is new is its reference to the risks in European corporate bond markets, its call for reconsidering the zero risk-weighting of some government bonds (which is akin in military terms to a unit on the front lines calling for artillery fire on its own position as a desperation measure as it faces being overwhelmed by a vastly superior force), and its seeming implication the world (desperately?) needs more inflation.               

CENTRAL BANKERS GONE WILD (Thoughts from the Front Line, John Mauldin)

$               It’s important to understand the challenges facing Prime Minister Abe; for he appears bound & determined to share them with the world. His country this year has a fiscal deficit of nearly 10% of GDP & his government will fund nearly half its budget from net new borrowing when its debt-to-GDP ratio is already 245%. Tax revenues have shrunk for decades & now are back to their 1985 level at the same time its budgetary spending rose by 50%. In the last month JGB ten-year yields more than tripled from 0.30% to over 1% although they have since been driven back down to 0.85% by massive BoJ intervention ( albeit either way they are still well  below the 1.30% of two years ago). The government now spends 24% of its revenues on debt servicing, & estimates are this could go to 80%

if interest rates were to rise to 2.2%. After years of running trade surpluses Japan now has a trade deficit at a time it needs a trade surplus more than ever. For 20 years nominal GDP has been static (due to deflation) but it now it needs it to start growing again; while there are two possible ways to achieve this, get real growth or inflate, the only realistic option in dealing with fiscal problems is the former. But Japan’s overriding problem is that its rapidly aging population is turning from saving to cashing in its savings to sustain themselves in retirement (which tends to be deflationary).  The only way around that is to import inflation by debasing the currency through QE (justifying that to other governments & central banks by saying the objective is only to bring Japan’s inflation rate target in line with theirs). But the problem with that is that negative real interest rates will cause rational investors to quit buying bonds while raising interest enough to keep them positive will worsen the government’s deficit (& debt serviving costs) to potentially fatal levels. The long & short of it is that, that to achieve Prime Minister Abe’s 2% inflation target, the Yen must depreciate by 15% per annum (which cannot help but prompt serious responses from other governments & lead to the most significant currency war since the 1930’s – South Korea whose global competitive position has already been affected by the cheaper Yen, & will continue to do so the more the Yen is devalued, already has given notice that it expects this month’s G-8 Summit to address the issue of the cheaper Yen).

This scenario suggests the next global financial crisis could start in Japan, the world’s third largest economy & then possibly/likely infect the US, the world’s largest (just as little Greece infected bigger EU ones), at which point there would be anyone to bail out the system.

DECADES-LONG BOND RALLY MAY STILL HAVE LEGS (G&M, Martin Mittelstaedt)

$               Two uncanny US market watchers, Gary Shilling & Van Hoisington, think the recent plunge in bond prices is only a temporary pause in the bond market’‘s long upward move. The former says “Many people have periodically, and now is no exception, said ‘it’s over’ … but I think you’ve got to see a change in economic conditions for that to happen” (& he is doubtful the Fed will change gears anytime soon, in part because there is ‘virtually no inflation’), & the latter that bonds have fallen “for a time every year’, only to resume their advance; he has (correctly) been bullish for two decades & says markets shouldn’t fear an end to QE because when the Fed buys bonds their prices fall as investors dump their holdings to move into other assets, since they fear it may stoke inflation, but start buying again when the Fed stops doing so because these worries subside.

Shilling decades ago had a stellar forecasting record but recently has been less ‘on the mark’. As to Hoisington, the founder of the Austin, Texas-based, fixed income money manager carrying his name, he is ‘talking his own book’. Both will be proven disastrously wrong, although they may be proven right over the very, very short term. For bull market in bonds are driven by declining interest rates & right now, with interest rates at historically record low levels, there is far more upside risk in them than downside potential. For inflation the same is true, more upside risk than downside potential. Those who took first year economics also learned that the value of a good in endless supply will gradually gravitate to zero &, while bonds may not be in endless supply, the fact some central banks are now their main buyer by far suggests a fundamental supply/demand  imbalance in bond markets that will prompt higher interest rates & lower bond prices).  

ECONOMIC STORM CLOUDS AHEAD (The Stock Report.com, Robert Reich)

$               The most recent data give cause for worry. All the momentum in the economy is coming from the consumer. While First Quarter consumer spending was up 3.4%, the personal savings rate dropped from 5.3% to 2.3% QoQ, a post-Great Recession low as the Fed’s low interest rate regime continues to enable home owners to get cheap home equity loans with which to sustain consumption. Home prices are rising all right, but at an unhealthy, unsustainable rate, faster than the historical average. The higher stock prices mostly benefit the wealthy & have been driven by corporate profit growth of corporations keeping their labour costs down thereby stifling the potential for consumption growth, that softened in the First Quarter. Exports are being affected by the lousy shape Europe remains in & the slowdown in Asia. And the full effect of sequestration is yet to be felt. So don’t be swayed by all the sunny talk; it ain’t going to be smooth sailing.

Reich was Clinton’s Secretary of Labor & likely the most left-of-centre member of his Cabinet. He now teaches at the University of California (Berkeley). While he sees everything through a ‘common man is being screwed’ looking glass, his observations are not without foundation.

THE WAR AGAINST SUPERBUGS (NYT, Barry Meier)