Gleanings II ~ 492 ~ Compliments of Nick Rost van Tonningen Posted by John on January 5, 2013

Quote of the week : “Writing about the fiscal cliff is futile, especially now that we’ve gone over it. Who wants to spend time with a group of people who voluntarily set up a drop-dead event to force themselves to act and then decide that, actually, they’d rather drop dead … and take the country with them” – (Margaret Carlson, an award-winning journalist & one-time White House correspondent for Time, has since 2005 been a Bloomberg columnist – this was the opening sentence of her first 2013 column, which she devoted to another, more bread & butter, issue).

The odd part of the post-last minute deal to avoid going over the fiscal cliff was that it involved the House voting on a Senate proposal; for the Constitution says all fiscally-related legislation must originate in the House. Be that as it may, it was for all intents & purposes a non-event that Obama may come to rue before long. For it involved a cheap victory on the tax side, that could prove Pyrrhic in the overall scheme of things since it just rolled the real problem, unsustainable spending, a couple more months down the road. While he now had the Republicans by the short hairs, in two months time, when the debt ceiling issue will once roil the waters, his bargaining position will be nowhere near as strong. And as Sen. Dick Durbin (D.-Ill.) said recently “We can’t be so naive to believe that just taxing the rich will solve our fiscal problems.” (this from the second-ranking Democrat in the Senate, a veteran of 16 years there, & prior to that 14 years in the House, who is deemed “one of the most liberal members of Congress” (as attested to by the fact he has an F-rating from the NRA but 100% ratings from the AFL-CIO & an assortment of social safety net-oriented pressure groups).

A new term has entered the financial lexicon : “Inflationary deflation”, when there is inflation in the price of things in fiat money & deflation in their price in ‘hard’ money (i.e. gold & silver), the pattern of the past decade – thus relative to gold US house prices are down 80% since 2000 (& so is the price of just about everything else).

While on the subject of gold & silver :

• the global central bank complex held roughly 33,500 tonnes of gold in early 2000, ran it down to 30,000 tonnes over the next seven years (as the price doubled from US$300 to US$600), after which it stabilized for 18 months (as it went to US$1,000). Since then it has grown again to 31,500 tonnes (as developed country central banks quit selling & emerging country ones, with the People’s Bank of China in the van, started buying);
• Iraq’s central bank recently joined the ranks of gold accumulators when it bought 25 tonnes of the stuff, worth US$1.2BN, thereby quintupling its gold holdings;
• Eric Sprott recently had two interesting insights. The average daily turnover of ‘paper silver’ on the COMEX is 300MM ounces while daily newly-mined silver production averages just 2MM ounces (when the US$27BN University of Texas Investment Management Company (UTIMCO) in April 2011 decided to put 5% of its assets in gold, & bought US$1BN of the stuff, it insisted on taking physical delivery on the grounds that “if just 5% of Comex gold futures opted to take delivery, there wouldn’t be enough gold around to cover the demand and the Comex would have to default”). And the US Mint’s gold sales went from 34,000 ounces in 2008 to 1MM ounces in 2011, & those of silver from 87,000 ounces to 40MM ounces – although YTD they have eased off a bit to 750,000 & 34MM ounces respectively, it recently ran out of silver dollars & suspended their sale until January 7th, 2013;

Beijing’s latest ‘hard asset’ acquisition target is said to be foreign gold mines, likely driven by the fact that, while China is now the world’s largest gold producer (cum accumulator), its mines’ domestic gold reserve life is relatively short.

Reuters reported earlier this fall that a survey of 54 central banks found that 60% of them now deem equities “more attractive investments” than they had a year earlier (the Swiss National Bank has been on this, for central banks unconventional-, kick for some time & currently holds an estimated 12% of its rapidly-growing official FX reserves in equities).

The US stock market, as measured by the S&P 500, since 1945 has generated a compound annual return of 7.41% (11.31% with dividends reinvested). Within that 67 year period there were two bull-, & two bear-, markets. From 1942 to 1973 its compound annual return was 7.68% & 12.38% respectively, from 1973 to 1982 1.66% & 6.43%, from 1982 to 2000 (the tail end of which was the era of “irrational exuberance”) 13.70% & 17.20%, & from 2000 to the present day -0.05% & 1.77%. For those who are investors rather than traders, this suggests there are three, possibly four, reasons why the outlook for North American equities over the longer term is less gloomy than the bears would have us believe. By historical standards the current bear market is starting to look long in the tooth. Sophisticated investors are voting with their feet out of bonds & into stocks (& the two markets are so disparate size-wise that even a small move out of bonds could hugely impact on stock market valuations). As noted above, central banks, the quintessential buyers of bonds & the traditional buyers of last resort of government fixed income securities, are starting to sniff around the stock markets. And if the tsunami of liquidity that has emanated from central banks in recent years were to lead to a serious uptick in inflation, research done by, among others, Irving Fisher (1867-1947), whom some call the “the greatest economist the United States ever produced” (even though he made a disastrously bad call on the stock market in 1929), found that inflation benefits stock prices (because they represent residual claims, i.e. what’s left after creditors’ claims are met, on real assets that increase in value in an inflationary environment whereas creditors claims don’t).

According to Goldman Sachs, in 2012 the average US hedge fund had a rate of return of just 4.6%, less than half the S&P 500’s 11+%. And according to the Economist this was the ninth year in the past decade (2008 being the exception) that they underperformed the S&P 500 – hedge funds made out like bandits when there were just a few of them & their managers were hungry but, as they multiplied like rabbits (or rats?), competition for assets bid up their prices, lessening their arbitrage potential, &, as their managers became billionaires, less hungry & started to believe their own press releases, their average returns (before costs) started gravitating towards the mean.

While during the 1990’s the global cost of natural disasters averaged US$20BN/year, in the first decade of this century this rose to US$100BN/year (the damage caused by Hurricane Sandy alone earlier this year was an all-time single event record US$50BN). And with ocean levels rising, storms becoming more frequent & more violent, and many cities located, & hundreds of millions of people living, in flood plains, this is likely will create immense pressure on insurance premiums everywhere, even for those living in high & dry, far away places.

Many people may be reading too much in the US housing market recovery. While the stock of unsold new homes may has halved (to 4.7 months-worth of sales), David Rosenberg, until 2008 Merrill’s Chief Economist – North America, & now on the market’s buy side with Toronto-based money manager Gluskin Scheff, introduced a reality check when he pointed out that move-up buyers need someone to sell to & that, even with mortgage rates at record lows, first time home buyers are largely MIA due to their poor employment prospects & high student loan balances.

For years ETFs (Exchange-Traded Funds) of all kinds proliferated as financial intermediaries created “stories” to give themselves an edge in separating investors from their money. But the bloom may now be off this rose; for 2012 14 ETFs were wound up in Canada, & 95 in the US – investors are becoming more sensitized to the unknown ‘counterpart risk’ bugger factor.

The US Navy has 12 aircraft carriers, as many as, but bigger ones than, the rest of the world navies. But, according to the highly regarded, Austin, Texas-based global intelligence advisory firm Stratfor only one of them, the USS John C. Stennis, is now on active service, in the Persian Gulf. The other eleven are in port for various reasons (incl. routine maintenance & refuelling, and emergency repairs), six in Norfolk, Va. & nearby Newport Mews, four in various West Coast/Alaskan ports, & one in Japan. It is hard to accept such gross operational incompetence by the Pentagon. And having half of its carrier force in its Atlantic Fleet makes the much-vaunted US “pivot strategy” to the South Asia/Pacific region look like a “Paper Tiger”. This may be one reason why Beijing has picked this time to turn aggressive with Japan.

Canada-born David Frum, once Bush 43’s speech writer has a way with words (he coined the phrase “axis of evil”). And he proved that again when he commented recently on the wishy-washy decision by the Canadian Supreme Court as to whether a woman should be allowed to wear a face-covering niqab while testifying under oath in a Canadian court room. For he wrote in a recent column in the National Post “The reason to have a Supreme Court is to lay down rules of law that lower courts can follow. When the high court answers a yes-or-no question as ‘you go figure it out’, it abdicates its responsibility and wastes everybody’s time.”

An Angus Reid poll found Canadians are more confident about their economy than their US & UK counterparts. 62% said economic conditions were “very good/good” (vs. 23% of Americans & 11% of Britons), 56% that their personal financial situation was “very good/good” (vs. 43% & 38%), & only 16% expected economic conditions to worsen in the next six months, vs. 30% & 35%. The biggest concern for Canadians was the value & safety of their investments (35%) vs. the Americans’ 46%, while for 37% of Britons said it was unemployment (another, later poll by Nanos Research found them less sanguine with the percentage of those who thought Canada was moving in “the right direction” plunging to 48% from 64% a year ago) – contrarians may deem Canada due for a pratfall, as it may unless Alberta can find outlets, & get better prices, for its oil; for if it cannot, the oilsands boom will go pffft, & take much of the bloom of the Canadian economic rose.

According to Sam Peng, the Vancouver-based President of the non-profit Canada Chinese Investors and Entrepreneurs Association that seeks to match Chinese investors with Canadian financial advisers, it is not unusual for new immigrants from China to arrive with a couple of hundred thousand dollars in cash in their bags – & the anti-corruption drive gaining momentum in China may well result in more newcomers carrying larger amounts of cash.

The Israeli election has not worked out the way Netanyahu had expected. His Likud/Yisrael Beiteinu merger has cost, rather than gained, him seats : the latest polls suggest its support is continuing to slip & that, if the election were held today, it would get 34 seats in the next-, down one seat on the week & eight from the two parties’ combined standing in the last Knesset (& 12 from the 46 his US-based political adviser had told him he should expect), and that Lieberman isn’t even remotely a threat to him (it seems that the more likely it becomes he will remain Prime Minister, the more voter support he, & Likud, lose). The Likud ‘list’ of Knesset candidates is so far to the right it makes him look like a flaming moderate, & it contains several people (not incl. Lieberman) who would like nothing better than to see him bite the dust. And the pro-settler, but ‘moderate right”, Jewish Home Party looks set, despite internal squabbles & desertions, to triple, quadruple or even quintuple, its three seats in the last Knesset (as it attracts more & more support from disenchanted Likud voters who cannot see themselves voting for Bibi any more but who, being decidedly moderately right-of-centre in their thinking, cannot see themselves voting for either orthodox right-, or centre-left-, parties). This could make its leader a king maker in the post-election coalition-building process; for the extreme right wing nature of his party’s candidate list has robbed Netanyahu of the option of initiating what Italy’s Aldo Moro in the late 50’s called “apertura a sinistra” (Opening to the Left). The Jewish Home leader, Naftali Bennett, was Netanyahu’s Chief of Staff from 2006 to 2008 (although now Netanyahu, & more specifically his wife, are said to loathe him, a feeling Bennett says he doesn’t reciprocate). He has what it takes to attract voters looking for an alternative. Youth (40). A strong telegenic presence. An impeccable military record as a company commander in an elite unit during the Lebanon War. Unlike other Israeli politicians he is independently wealthy (while still in his twenties he started an anti-fraud software company that he sold six years later for US$145MM). And an expressed view, for which Netanyahu attacked him, that as a reserve soldier he would “rather go to jail” than follow an order to remove settlers from their homes. Haatetz calls him “the rising star of religious Zionism”. On the flip side, he believes the two-state idea is dead & that Israel should just annex the West Bank & get it over with, Amnon Abramovitch, a veteran political commentator for Israel’s Channel 2 TV, says “There is a huge gap between his appearance and his content … He looks very modern… (and) speaks very liberally, but his messages are extreme”, and, while officially pro-settler, he himself lives in the upscale, largely secular, 70,000 inhabitant city of Raanana, 20 kms. North of Tel Aviv in Central Israel, that has been called “the safest city in the Middle East”.

A survey by Haaretz found just 20% of Israelis interested in spending a ‘night out’ with the Netanyahus & only 9% willing to buy a used car from him. But he outpolled his rivals in believability (18%), economic management (37%) & sincerity (38%, vs. Bennet’s 9%, Tsipi Livni’s 8% & Shelley Yachimovich’s 4%), but came second to Shelley Yachimovich, 9% to 17% 17%, on “which politician do you think cares most about you & your problems?”

If the Second Iraq War was ever about US control over Iraq’s oil, it was a dismal failure. For few US companies garnered contracts to operate the various Iraqi oil fields, & the final nail will be driven into this particular coffin if PetroChina’s CNPC unit were to be successful in taking over the 50% interest in the West Qurna-1 field that ExxonMobil has decided to walk away from.

Two years ago all China’s foreign trade was done in US dollars while today 10%, with a range of partners that includes Australia, Brazil, Germany, Russia & Taiwan, is being done in Yuan – bad news for the US dollar; for this reduces their need to hold US dollar working capital balances.

On December 28th China’s national legislature amended its law on the elderly to allow them to sue their children for not visiting them “frequently”. There are regular reports in the media of elderly parents being neglected, or abused, by their adult children; for three decades of market reforms have led to a breakup of the traditional extended family (in which the elderly had a place), with few alternate arrangements having emerged to take care of the country’s rapidly aging population. And the problem is being aggravated by the long-term effect of the one-child policy, the increase in life expectancies from 41 to 73 since the 60’s, & by migrant workers leaving their children with their parents to look after while they go elsewhere for work.

Land prices are soaring again in China; thus in the Beijing suburb of Tongzhou a parcel of land recently sold for 5x its starting price.

Japan’s Prime Minister Shinzo Abe noted on December 20th that Japan’s defense spending has declined at a 1% annual rate for a decade & that the US is planning cuts in its defense spending, while China has been hiking its military spending at a 10+% annual clip. This he believes helps explain its aggressive stance in the East-, & South-, China Seas & justifies a bigger budget for, & a loosening of the MacArthur-imposed post-WW II restraints on the role of, its ‘Defense Force’ – the only practical problem is how he proposes to fund this.

In 2006,at age 36, Kyle Bass founded the Dallas-based hedge fund Hayman Capital Management & made a bundle betting the sub-prime mortgage business was about to implode (&, as a member of its Board, had a hand in the above-mentioned decision by UTIMCO to put 5% of its assets in gold and take physical delivery thereof). His latest prediction is that in the past two months Japan’s debt crisis has passed the point of no return because a) it cannot repay its existing debt, b) its interest expense is unsustainable, c) it can no longer fund its day-to-day operations, & d) its population crisis is upon it. And, perhaps most importantly, because the government hasn’t got a clue as to how to extract itself from the mess it’s in (there have been ten Finance Ministers in the past six years). He thinks Abe’s idea of having politicians dictate monetary policy is a recipe for disaster & expects him to orchestrate a massive Yen devaluation, and notes that Japan’s trade balance is going to hell in a hand basket. He expects all this to precipitate a financial crisis in the foreseeable future that will see a wholesale dumping by investors of JGB paper that will necessitate higher interest rates (which will worsen Japan’s fiscal predicament further since today, even with rock bottom interest rates, Tokyo’s debt service charges already eat up 25% of its tax revenues (one problem with Bass’ analysis is that it is of the “mote in thy brother’s eye & the beam in one’s own” variety; for if Japan’s debt-to-GDP ratio is in the stratosphere, that of the US is in a sub-stratospheric orbit, & climbing & its government unable to agree on how to achieve what everyone knows needs to be done).

One interesting observation by Bass on the effect of the aging of Japan’s now shrinking population is that in 2011, for the first time ever, more adult-, than baby-, diapers were sold there. Its population, & global average age, statistics are worth noting. Last year Japan’s population numbered 126.5MM, down 1MM YoY & back to the level of 2000 (it is expected to keep shrinking by an 1MM per year).

And its population’s average age (45.4 years) is second only to Germany’s 45.5. And average age statistics matter since there is an inverse correlation between a population’s average age & their economy’s GDP growth potential (generally speaking, the higher the average age, the lower the economy’s GDP growth potential). The global average age is 28.4 years. In European countries it’s typically in the low-, to mid-, 40% range (with Italy & Austria at the high end, with 43.8 & 43.4 years, and the UK & France the lowest with 40.2 & 40.4 years, respectively). In the US & Canada it is 37.1 & 41.2 years, in Central & South America in the mid-twenties to mid-thirties, in the Middle East & North Africa mostly in the 20’s (with Israel’s 29.5 years at the upper end of that region’s range), in China & India 35.9 & 26.5 years respectively, while in Sub-Sahara Africa they are mostly in the high teens. But there were interesting “outliers”. Poland’s 38.8 years, and Iceland’s & Ireland’s 35.9 & 35.1 years, South Africa’s 25.3 years, North & South Korea’s 33.0 & 39.0 years,. Russia’s unusually wide spread between the average age of men & women : 6.5 years between the 35.6 years for men & 42.1 years for women (due to the rampant alcoholism among Russian men?), and Australia’s & New Zealand’s 37.9 & 37.2 years. And the Ivory Coast is the only country where women’s average age is supposedly lower than men’s.

While the USDA is sticking to its 11MM ton forecast for the Argentinian wheat crop now being harvested, too much rain & heat at the wrong times, plant disease & fewer acres seeded to wheat are causing the locals to cut their forecast to below 10MM tons (& shade down its quality as well). If so, it will be down 15%, or more, YoY, little more than half the 18.6MM ton all-time record crop harvested in 2007, & one-third off the ten year average.

GLEANINGS II – 492
Thursday January 3rd, 2012

THE ELECTIONS THAT WILL DEFINE 2013 (G&M, Doug Saunders)

• The past 12 months have seen democratic changes in political leadership in Egypt, France, Georgia, Greece, Libya, Mexico, the Netherlands, South Korea & Senegal (although none in Russia, Venezuela & the US). Following is the roster for 2013 :
• Israel (January 22nd) – Netanyahu will remain Prime Minister, likely at the head of a more extreme right wing coalition than the last one, and one not fully reflective of many Israelis’ attitude towards peace & the settlements (& not in Israel’s long-term best interests?) – the polls consistently give the right-of-centre ‘bloc’ 68 seats in the Knesset & the left-of-centre one 52;
• Italy (February 24th & 25th) – Berlusconi stands a decent chance to become Prime Minister again by opposing the painful austerity measures introduced by the Monti government – this is nonsense : the clear leader, with 36% support, vs. 23% for Monti & 22% for Berlusconi, is the one-time communist Luigi Bersani now head of the left-of-centre Democratic Party of Italy (that was supportive of the Monti government’s policies). Berlusconi’s status with Italian voters has suffered less from his legal problems or his (now infamous) bunga-bunga parties than from a belated realization among growing numbers of Italians that the current mess is largely his doing as Prime Minister;
• Iran (June 14th) – The good news is that Ahmadinejad cannot run again & the bad news that voters may rebel against his flawed economic policies by voting in a more conservative Islamist candidate; and
• Germany (September/October) – She may have failed to lead Europe out of its crisis, but voter complacency & her hard line on Greece will see her re-elected. But her libertarian Free Democratic Party coalition partner may be wiped out; if so, she will have to choose between teaming up with the fiscally-sensible Green Party or the left-of-centre Social Democrats. Either way it will be a (minor?) shift to the centre.

The outcome of all of these has potentially major geopolitical implications.

ON A COLLISION COURSE WITH THE DEBT SUPERCYCLE (G&M, Larry MacDonald)

• The term “Debt Supercycle” was coined by Montreal-based BCA Research to describe a persistent increase over time in countries’ debt-to-GDP ratios as they live beyond their means (raising questions about the sustainability of their current levels of prosperity). The public debt in the developed countries has more than tripled from the 30% of GDP level of the mid-70’s – which doesn’t take into account their far greater unfunded liabilities under their safety net programs (& in the US total public & private debt went from < 140% of GDP in the early 50's to 380% today). While once the debt generally grew in line with GDP, a little faster during boom times & a little slower during busts, since the 70's central bankers have been quick to unleash stimulus to moderate downturns (& slow to withdraw it in recoveries), thereby preventing the corrective phase of the debt cycle from fully playing out. So each recovery was launched from a higher debt level than the previous one. And the policy makers have kicked this can down the road since human nature tends to ignore problems until they reach crisis proportions, at which point dealing with it becomes unnecessarily painful. Wasn’t it Ben Franklin who once observed “an ounce of prevention is worth a pound of cure”; but that advice fell on deaf ears in an era focused on Instant Gratification.. WORSE THAN GREECE? (Maclean’s, Tamsin McMahon) • A recent report by the Lisbon Council think tank & the Berenberg Bank says it’s Europe, not the US, that is on a path to long-term economic prosperity. For it says that since 2009 the Eurozone’s most troubled economies have made major gains in slashing their deficits, overhauling their civil service & fixing their trade balances. And, far from showing “moral hazard”, the countries bailed out by the EU & the IMF “are working hard to make sure ... they deserve such support.” And the report’s co-authors opine that, as “Many eurozone members are going through a wave of sweeping structural and fiscal reforms ... other even more heavily indebted major countries such as the US and Japan are not” & that America will need more belt tightening than Greece to reduce its debt-to-GDP ratio to 60% by 2030. • But the report also notes that much of the progress made is due to the dire economic situation of the countries involved. Thus sky-high unemployment has driven down labour costs & trade balances have improved, not because exports have grown, but because collapsing housing markets have sapped demand for imports. And countries’ debt loads have soared & an “overdose of austerity” could reverse these hard-won gains. • An earlier IMF report confirmed much of this when it noted that since 2009 Greece, Portugal, Ireland & Spain have slashed their budget deficits by the equivalent of 11% of their GDPs, Greece had raised its retirement age by two years & cut its deficit in half to 7.5%, Spain had introduced public sector wage cuts & a pension freeze, and eked out its first trade surplus since 1998, & Portugal had cut its deficit in half, and the Eurozone as a whole now expects to a budget deficit of 2.6% of its GDP for 2013 (vs. the US’ 7.3%). Everyone is entitled to his opinion. The alternate view was expressed by Ambrose Eavns-Pritchard in his January 1st column in The Telegraph which concluded “This is the year it will become clear that Europe is in far deeper trouble than supposed, that it risks tipping into irretrievable decline, that it is wasting its precious youth at the worst moment, as the aging crunch nears ... resorting to ever more coercive measures and autocratic methods, and all to save a currency that is the elemental cause of this disaster in the first place”. The report, entitled The 2012 Euro Plus Monitor - The Rocky Road to Balanced Growth & is available on the Internet. One of its co-authors is an IMF alum & a former Chief Economist, Europe for BankAmerica/Merrill Lynch while the CV of the other, the Berenbank’s Chief Economist, includes stints at the ECB & the Boston Consulting Group. It is one of an annual series ranking the 17 Eurozone countries (& this year three non-Eurozone countries, Poland, Sweden & the UK, as well) on their overall economic health & their responses to the challenges ensuing from the financial & economic crisis. With regard to the former it rates Estonia, Luxembourg, Germany, the Netherlands, Slovakia, Slovenia & Austria as doing better than average, and Greece, Ireland, Estonia, Spain, Portugal, Slovakia, Italy, Malta, Cyprus & Slovenia (& among the non-Eurozone countries Poland & the UK) with regard to the latter(note that it rates France’s performance as sub-par on both counts; this is the real risk to a Eurozone meltdown) - the Hamburg-based Berenbank is Germany’s largest private bank &, founded in 1590, the second oldest in the world (the oldest, the Tuscany-based Banca Monte dei Paschi di Siena, founded in 1472, a month ago was ignominiously downgraded by S&P to junk status) . THE WORST OF THE EURO CRISIS IS OVER (Reuters) • This is what German Finance Minister Walter Schaeuble told the daily Bild on December 27th; saying “I believe the worst is past ... The government in Athens knows it cannot financially overburden other eurozone countries. They are pushing forward with the reforms.” He is “optimistic” about France & its efforts to stop its debt burden, and “certain that France will fulfill its obligations.” This came three days after Wolfgang Franz, Head of the independent ZEW think tank & the panel of “wise men” advising the German government, told the Rheinische Post newspaper “Time will tell whether we have the worst behind us. There are … silver linings on the horizon. The current account deficits in Spain and Portugal are declining because they have become more competitive.” Schaeuble is dreaming in Technicolor (but may have little choice with an election looming). So many young Greeks want to leave that its economy may be “hollowed out” to the point where it becomes a country of mostly weak, elderly and/or infirm who need permanent charity. And his faith in Hollande & his crew to set things right in France is touching but likely misplaced; for they still operate on the premise, as did Mitterrand 30 years ago when he came to power until the real world set him straight, that for Socialists water will run uphill. And the French Constitutional Court has just declared unconstitutional his ‘crowning achievement’ to date, the 75% ‘super tax’ on incomes > 1MM Euros (that prompted the very public decampment of several high-profile French citizens to the more tax payer-friendly jurisdictions).

COMPANIES EXPLOIT DESPERATE BOND INVESTORS TO FUEL STOCK BUYBACKS (Business Insider, Ed Yardeni)

• Investors desperate to get yield North of zero on their fixed income investments channeled US$392BN net into bond funds in the year ended October 31st, 2012 (with US$267BN of it going into corporate & foreign bonds) while equity funds suffered net outflows of US$80BN. With corporations using some of this cheap money to buy back their shares, this is helping to keep the Fed-orchestrated bull market in equities going.

Historically retail investors have been counter indicators, i.e. wrong in their markets calls. And many institutional investors have no choice but to ‘reach for’ yield since their pension fund clients have unrealistic rate of return assumptions built into their pension plans by actuaries. PIMCO’s Bill Gross runs the ‘mother of all bond funds’ & his view on the bond market is that the Fed will keep the bond “balloon” in the air & won’t raise interest rates, and that this will lead to “big inflation” down the road. In his fund he is “underweight developed market assets.”

BAD NEWS BEAR GRANTHAM THE GRIM (Forbes)

• Jeremy Grantham is an old school money manager with a long & successful track record who sees & says things others prefer to ignore. His firm, Grantham, Mayo, Van Otterloo has AUM of > US$100BN, spots ‘irrational exuberance’ & has done well for its clients.
• Now we’d better pray he’s wrong. For his latest newsletter says “The US GDP growth rate … we have become accustomed to for over 100 years – in excess of 3% a year – is not just hiding behind temporary setbacks. It’s gone forever … Going forward GDP growth … is likely to be about 1.4% per year.” He believes that service sector productivity growth is poor, with manufacturing continuing to automate, a surfeit of service providers will drive down wages, & global warming will raise the cost of doing business.
• But in the 200+ years since Malthus first predicted gloom & doom, he & his followers have always been proven wrong. For by forecasting linearly they missed the role played by experimental technology & they didn’t give enough weight to the opportunities created for human creativity from better education, freedom, & greater access to bigger markets. So cheer up, things will turn out better than Grantham imagines.

The choice here is between siding with someone who daily puts his money where his mouth is or with a salaried scribe whose livelihood depends on feeding the ‘beast of public opinion’, that abhors bad news, in time for his next deadline (after which his writing ceases to be of concern to him). And while it is true that over the last hundred years US GDP growth has averaged 3%, during the first decade of this century it averaged 1.7% (& during the nearly century-and-a-half between 1860 & 2007, 1.9%). So Grantham & those like him may not be altogether out to lunch.

IRAN’S SLOWING OF ENRICHMENT EFFORTS MAY SHOW IT WANTS A DEAL
(NYT, David E. Sanger & James Risen)

• Some analysts take solace from the newly emerged fact that, starting last August, the Iranians began converting more of their medium-enriched uranium into forms suitable for use in a small research reactor used to produce medical isotopes (of US origin, dating back to the days of the Shah) but not for weapons production (if it hadn’t done so, by now it could have had enough weapons-grade material for one, if not two, nuclear bombs). But the White House is less sanguine about this, since its back-channel feeler to Tehran after the election seeking direct bilateral talks elicited no response.

The sanctions are biting. Domestic inflation has soared. Ahmadinejad just fired his gynecologist Minister of Health, the only female minister ever in Iran since 1979, for complaining about not being given the foreign exchange promised to pay for needed drug imports while others are given it to import “luxury cars”. And Tehran has problems finding a market for its oil; while shenanigans are afoot in the Gulf whereby Iranian oil is shuffled around from pillar to post to obscure its origin, this is believed to net Tehran only as little as US$38/bbl.

CONSIDERED STRATEGY NEEDED IN DIAOYU SPAT (Global Times)

• Japan’s new Prime Minister Shinzo Abe has deferred despatching law enforcement personnel to the islands, instead sending envoys to neighbouring countries to mend fences. But his hawkish instincts won’t change & neither will Japanese society’s right-wing tendencies. Many Chinese are wondering if a war will break out between the two. Some strategists believe so &, although neither wants a war, the Diaoyu dispute could trigger one. The Chinese public knows little Japan’s military strength & its contempt for it is soaring, and their deeply rooted resentment against Japan, once ignited, will have incredible power. If a Chinese aircraft were to be downed by Japan, the Chinese public will demand revenge in the form of a Japanese jet shot down in return.
• Japan’s provocation over the islands is a direct challenge to China’s reputation. If the government were to step back, it would become the world’s laughing stock. But if it goes forward, it may face a military confrontation with Japan. So, with going forward the only option, Beijing needs to think carefully on how best to strike at Japan’s arrogance while maintaining peace and stability in the Asia-Pacific region. It should enunciate principles that require Japan to pay a price to Japan & the US, and to the Chinese people so they will know about our determination to safeguard the sovereignty of the Diaoyu Islands. And there can be no compromising on these principles. They must stress with outsiders China’s firmness on this matter so as to have them stop harbouring illusions about China’s need to take military revenge on Japan. Of course Japan may retaliate against China, leading to a large scale war; if so, it will be a catastrophe orchestrated by the US.

One year ago Beijing took offense at the National Defense Authorization Act for Fiscal Year 2013 for, among others acknowledging Japan’s administration of the Senkaku/ Diaoyu Islands. It recently upped the ante by sending a second marine surveillance plane near the islands & when it put a second 052D class guided missile destroyer into service, it said that this should induce Prime Minister Abe to “lower his voice” when making claims about the islands. And Ni Teng, an expert in American Studies at the Chinese Academy of Social Sciences, told the Global Times “The situation has permanently changed since September 10th. Once we step in, we will not step back … Neither country will back off this time and a military confrontation is likely to occur at any time.” (the Global Times is part of the Communist Party-owned People’s Daily Group. While known for its populist-, & controversy-courting-, editorial policy, its language is extreme even by its standards. As to why Beijing has picked this time, when its blue water navy development is still in its nascent stage, to start painting itself in a corner on this issue, totalitarian regimes often create an external enemy at times of domestic unrest..

A CLOSE NEIGHBOUR IS BETTER THAN A DISTANT RELATIVE (GMA News)

• At a Beijing Foreign Affairs Forum (on China’s marine rights) over the December 28th weekend, attended by diplomats and representatives of international organizations, the business world & academe business people, Vice Foreign Minister Zhang Zhijun said China remains committed to “peaceful development and win-win cooperation” in a “chaotic” world. He maintained there was nothing contradictory in China upholding its sovereignty, security & development interests while simultaneously respecting the US’ legitimate interests & welcoming its “constructive role” in the Asia-Pacific region. But he made clear that on the South China Sea issue China’s position is clear (it’s an “inland lake”), & referred to the “sovereignty” of some islands & reefs in the Nansha/Spatly region & to the need for the “delineation of some waters in the South China Sea.”

Meanwhile, Maj.-Gen. Wu Guify, a former Deputy Chief of Research at the National University of Defense Technology told those present that the US has “continuously threatened China’s maritime rights for over 100 years’ & restricted China with military alliances”. And others noted that, while the US has no direct maritime territorial disputes with China, it is threatening its maritime rights over the South China Sea, the Diaoyu Islands & Taiwan. And it was reported that China’s new anti-ship missiles can target US carriers thousands of miles away (coming in from space at Mach 6, the US Navy has not yet found a way to protect its ships from them).

MACAU’S CASINOS END YEAR ON HIGH (FT, Josh Noble)

• A slowdown of, & tighter monetary conditions in, China’s economy made for a bad year for Macau’s casinos. The low point came in July when gaming revenues were up just 1.5% YoY. But 2012 ended with a bang when their December gambling revenues were up 19.6% YoY to a record US$3.6BN, bringing the year’s total to US$38BN, up 13.5% YoY, a decent number in absolute terms, but in relative terms only one-third of 2011’s 42%. And next year revenue growth is expected to slow down further, to 7% YoY, due to the introduction of a smoking ban & Beijing’s anti-corruption drive.

Macau is the world’s gambling Mecca, with revenues 3x those of Las Vegas. While it had been expected the anti-corruption drive would negatively affect revenue growth, there are two possible reasons for this unforeseen development. The most likely one is that China’s economy has improved more & faster than the numbers suggest & businessmen feel comfortable being extravagant. The other is that corrupt officials feel the Sword of Damocles hanging over their heads & have decided they may as well enjoy their ill-begotten gains while they still can.