Aug 10, 2010

Worldwide Cognitive Dissonance

Wilfred HahnBy Wilfred J. Hahn
Eternal Value Review

The times continue to be marked by the unconventional and the unprecedented. Conditions have been turned upside down in many respects. For example, given the perceived shortage of “safe assets” in the world today, the government bonds of emerging and less advanced nations are considered safer than those of the advanced nations such as Britain, Spain, France and the US. Or, the securities of large multi-national corporations are held to be more creditworthy than government bonds in general.

It is indeed a strange world. Few developments are outside the realm of possibility. As such, there is no cause to be complacent about anything.

Enormous shifts are taking place globally and many trends have suddenly emerged from apparent obscurity into the bright limelight. For instance, in a very short space of time, Germany has today become the “de facto” leader of Europe. France will increasingly come to the recognition that it no longer is a co-leader in Europe. Germany’s relatively balanced economic policies over the past several decades have allowed it to weather the financial crisis better than most other countries. It was one of the few nations that did not have a real estate bubble.

Neither are German consumers as over-extended as those of America, Britain and other nations. And now, partly due to Germany’s stringent “austerity” approach to the budgetary excesses of other European nations, the future configuration of Europe and its currency is anyone’s guess. Whatever the case, a period of rapid change is likely in the near future. Stay tuned.

As readers of EVR will already know, we are of the view that the world is now in a post-globalism, post-multi-lateralism environment. As such, a new period of global geopolitical instability has arrived. That last-day world seen in Prophet Zechariah’s two visions mentioned in Zechariah 5, where a world marked by “lying and stealing” — swearing falsely and thievery (verses 3 to 5) — would be cursed, is steadily unveiling.

Given the extreme global imbalances, it is unlikely that any common consensus will be found by global multilateral groups such as the G-20 and others, as the interests of their members are contradictory and incompatible.

Quoting Tom Bernes (of the Centre for International Governance Innovation):

“The G-20 is fragmented as it transitions out of its role as a crisis-fighting committee […]. While G-20 leaders agree on the need for stronger financial regulation, actual details continue to be vague and lacking a solid deadline .... there is a huge unfinished agenda.”
Though these groups seek to bring stability back to the world, there is yet no agreement as to what caused the Global Financial Crisis in the first place. Incidentally, an insightful article on the mired state of global multilateralism and its likely solution was written some time ago by Moses NaĆ­m, the former chief editor to Foreign Affairs. (See the article in the July/August 2009 edition of Foreign Affairs entitled, “Minilateralism: The magic number to get real international action” and our article posted on our website entitled Ten: The Magic Number of Post-Globalism.1)

Fresh from the G-20 meetings of early June this year, Mr. Dominique Strauss-Kahn offered his post-game assessment as head of the International Monetary Fund. Listen closely and see if you can pick up the significance of his comments carried in an official IMF release.
“As the world edges toward recovery, IMF Managing Director Dominique Strauss-Kahn briefed economists, analysts, and reporters at the Peterson Institute for International Economics, a Washington think-tank, on the main outcomes of the weekend meeting of the leaders of the Group of Twenty (G-20) in Toronto—and looked ahead to a new round of reforms at the IMF to enable it to be even more effective for its member countries.

He said that the Toronto Summit of leading industrialized and emerging market economies showed that the “spirit of international collaboration is still alive.” In the run-up to the meeting, he noted that there had been reports of disagreement within the G-20 over whether the priority facing the world now was for fiscal consolidation or growth. In fact, he said that while it was agreed at the summit that policy responses should be tailored to individual country circumstances, it was also agreed that what the global economy needed is “fiscal consolidation and growth.”2
There you have it. According to him, there were no schisms at the G-20 meeting table. Why? Because delegates could agree to incompatibly opposite positions. G-20 members will both suck and blow at the same time … have both hot and cold water coming out of the same tap … by endorsing a policy of “fiscal consolidation and growth.”

Capturing the “you can have your cake and eat it too” sentiment, reported Reuters:
“The G-20 rich and developing economies tried to balance their contrasting priorities by pledging to halve budget deficits by 2013 without stunting growth, and to clamp down on risky bank behavior without choking off lending.”3
This is double-speak (lying), confirming that there really is no G-20 consensus at all. Fiscal consolidation (i.e. austerity measures, the cost of which mostly fall disproportionately upon the economically disadvantaged) cannot really co-exist together with growth initiatives. For the most part, on a net-net basis, they will cancel each other out. The recognition here is that every nation will end up doing individually what they need to do. This is the post-multilateralism
environment that we worry about.

What these statements should further alert us to, is the political slights-of-hand to be expected with austerity measures. While the one hand may visibly play up the “political correct” austerity card to appease sovereign bond markets, at the same time the other hand will want to engineer ways of boosting growth unseen. These tactics could include everything from depreciating currencies, to money printing and unending “quantitative easing.”

Given the double-spin, mutually incompatible vested interests, and treacherous global conditions, anything is possible … though not necessarily probable. These are dangerous and desperate times, in which governments and individual households alike are facing intractably difficult conditions.

Governments around the world now realize that deficit spending is near the end of its Keynesian rope. Bond markets are not willing to finance any more increases in government deficits. As such, for some countries, austerity is the new policy (Germany and even Britain) and for others, such as Greece, Ireland, Portugal and others, it is being forced upon them.

We quote some research from Steve Keen that supports the view that economic growth will at best be slow for some time. Effectively, he points out that finding that narrow path between “greater-than-stall-speed” growth and deflationary austerity will be more challenging for the U.S. today than it was in the 1930s.
“Firstly, the contribution to demand from rising private debt was far greater during the recent boom than during the Roaring Twenties — accounting for over 22% of aggregate demand versus a mere 8.7% in 1928. Secondly, the fall-off in debt-financed demand since the date of Peak Debt has been far sharper now than in the 1930s: in the 2 1/2 years since it began, we have gone from a positive 22% contribution to negative 20%; the comparable figure in 1931 (the equivalent date back then) was minus 12%. Thirdly, the rate of decline in debt-financed demand shows no signs of abating: deleveraging appears unlikely to stabilize any time soon.

Finally, the addition of government debt to the picture emphasizes the crucial role that fiscal policy has played in attenuating the decline in private sector demand (reducing the net impact of changing debt to minus 8%), and the speed with which the Government reacted to this crisis, compared to the 1930s. But even with the Government’s contribution, we are still on a similar trajectory to the Great Depression.”4
However, while all of these factors appear to be unconstructive and negative, that does not necessarily mean that stock and bonds markets must fall … at least not right away. As mentioned, at the outset, it is an upside down world, full of treachery (lying and stealing). What the masses may expect to happen, likely will not. Consider that money reserves are piling up in the trillions in some areas, even as other sectors are shrinking. Crucially, all of these developments we list here are taking place in non-bank sectors.
  • U.S. Corporations now have accumulated an astonishing $1.8 trillion in cash on their balance sheets. This is unprecedented. Cash generation remains high as capital spending has collapsed.
  • Corporate Share Buybacks: (To date, 343 new authorizations for $178 billion in buybacks have been announced in 2010 (according to Merrill Lynch.)
  • Some sovereign wealth funds (SWFs) continue to accumulate surpluses. For example, with oil at levels still above $70, enormous funds flow to the energy producers, their investments and currency reserves piling up. (Abu Dhabi recently was contemplating buying BP.)
  • International reserve assets were up $1.617 trillion year-over-year … or 23.7%, to a record $8.434 trillion. Really, this is incredible. An increase of nearly one-quarter can only be considered gargantuan, underlining the need for huge capital recirculation into “safe” assets.
  • The hedge fund sector to date (privateering money which can be mobilized quickly) has high cash levels. As a financial sector, they account for over 20% of U.S. equity trading volume in the U.S. Most are in a capital preservation mode at present. This industry manages $1.67 trillion.
  • The Private Equity industry in the U.S. is flush with cash … with nowhere to put it to earn their fees. Uninvested cash levels are estimated at $500 billion in the U.S.
  • The savings rate of the world’s advanced countries has risen to an equivalent of 7% of GDP or $3 trillion.
Expect the unexpected … or at least, do not complacently ignore the wide range of possibilities.

4. Steven Keen, quoted from Naked Capitalism, July 5, 2010