Monday, November 14, 2011
This Would Be Funny If It Weren't So Dire
Let's see. All is well so far on the home front. As far as family goes, that is.
Italy flogged five year bonds, but had to pay over 6%. This does not compute if it continues. ECB is buying bonds, but it is not enough so far. I guess ECB will keep cutting rates. A five year rate at 5% would be very dicey over the next couple of years, given Italy's weak economic trajectory. ECB can thus either buy nearly all Italy's roll over the next six months, which would allow the ECB to set rates for market risk, or Italy will be in trouble by next August. Draghi has said that the ECB won't do this, but we'll just see. The adoption of the Euro provided a one-time bump for Italy which deferred its problems, but demographics and politics forbid a repeat. This has implications for seemingly remote nations!
Given what was reported about the Monti measures, it does seem as if the attempt is to raise enough revenue to cover an additional annual financing cost between 10-12 billion Euros. The problem is that each year Italy will roll more debt over at higher costs - they can't keep jacking up taxes by even 8 billion Euros each year for four years straight. This is why traders seem to be risk focused on the next few years. The alternative is a wealth levy, but that can only be a one-off, and it will produce capital flight unless it is done in circumstances such that property holders believe it won't be a reiterated measure.
Italy's economy is currently over 70% services, and you can expect higher taxes to inflict a pretty sharp drop in employment and service activity, which is already occurring, with the inevitable consequences for employment. Services cuts usually inflict a two to three year downturn/low growth cycle on a modern Western economy, so it appears impossible for Italy to balance its budget by 2014. It's almost 2012!
Nor can Italy expect any oomph assistance from external economic growth, because France tumbled down the hill in October to join Jack (Italy) and Jill (Spain) at the bottom. This is pretty impressive, as far as declines go. The French and German economies are tightly intertwined, so don't expect Germany to sustain epic growth without France at least remaining stable. In October, Eurozone composite PMI fell into the highly recessionary range.
Raising taxes at the beginning of a recession, which is what Italy is doing, is the best way to increase employment losses and a consumption fall. This has a particularly serious impact on service-weighted economies (which is why service-weighted economies tend to build up public debts over time), and I cannot see any factor that would prevent Italy's GDP from contracting 2% or so. Thus, I expect the Italian debacle to reach its inevitable end in 2013. Either the EU finds a way to pool excess Euro sovereign debt and write it down, or Italy exits. If Italy exits, it will still have trouble deflating its way out, so I do expect some outright defaults as the 70% probability.
India's inflation is still over 9%, and in fact closer to 10%. This despite a truly impressive series of tightening measures by their central bank, aka RBI. Last month RBI said it was about at the end of that cycle, and bets were building that it might have to ease, because higher rates are really curbing demand. In the absence of CB easing, the government is seeking other ways to stimulate growth. I think fuel costs and lower profits are going to exert an inexorable drag. India's government has a fiscal problem which is not yet severe but which dictates caution, and now you can expect increased investor wariness.
Spain - the next ECB buying opportunity. This gets deep fast now. Realistically, the ECB is limited as to its total purchases under its current line. Draghi has warned of this. Things will change. Ireland and the UK are currently holding their own, but it probably will be difficult to sustain this through the middle of next year.
Because Italy is such a large economy in global weighting, the investor psychology change involved will change the world economy. For the US, it brings forward our confrontation with Mr. Market backed by Mr. Reality. For China, it limits the ability of banks to accumulate bad debt as a stimulus measure. For countries like India, it forces tighter management of budgets and fiscal balances.
Right now the US seems to be passing through a native skipping recession, a la Japan. There are two reasons for the skipping effect. The first is that the US has a large group of consumers with plenty of cash on hand - the fiscal conservatives - and many of those consumers have been conservative for so long that they should be forced to spend some money. The second is that next year spending on housing (mostly maintenance) should pick up. The third is that the USD is hardly strong and that US manufacturing should continue a slow mild climb (with fluctuations).
However US real per capita incomes are still on a downward trend so growth cannot be strong, and it is likely that we will see a continued pressure on the services side of the economy. The best possible trajectory is for the third trough to end up (on a real basis) no lower than the first (that we have just been through). The likeliest is that we edge down a bit in a Japanish way over the course of this adjustment period.
Now a great deal depends on Mr. Market's patience - if we are forced to correct the US budget deficit very quickly, things will be much tighter and we could see a 1% fall over the course of the trough/peak skipping recession cycle.
When I look at fuel prices I think world events have overtaken us, and that 2012 will blow up our native cycle and throw us into an outright recession. It's clear that refineries can't produce product and sell it profitably right now from production/supply data, so it seems that the jig is up and that there will be no market-based adjustment, which means that the real economy just skids down a hill into a ditch.
Whatever happens to us is likely to happen to China.
A property boom is hitting in Germany - people there are not in the mood to throw money into Bunds. I have to believe that this is significant. The money that does not go into sovereigns has to go somewhere.
To hedge my bets, I'm currently putting the household through a maintenance cycle. Fix the roof, fix the car, fix the teeth, fix the cat. If it's old, either refurbish it or replace it. Especially if it's a big chunk of steel. Not entirely sure my dollars would pay for this by the end of 2012.
If you look at current street prices for gas and the crude inventory report, it looks like it already busted out and the debris starts falling on our heads any day now.
I don't think confidence in the longer term US outlook will be restored until we amend our wicked ways.
US deposits stopped growing in October.
That's why I'm mostly repairing things, rather than replacing. I know some excellent contractors and mechanics that are very happy to get fill-in work. New old stock on appliance and vehicle parts is still fairly cheap, although good used vehicles have gotten expensive.
I hope you're right about oil. If the precious metals take off it's all fun and games, at least for a while. Even steel and copper wouldn't be that bad if it's for a limited time. But expensive energy would be a disaster.
This Would Be Funny If It Weren't So Dire
I should have felt my facial expression move from happy to sad as I read your title. Fortunately, that was not the case.
I should probably mention that I had dental work done today so I could not actually feel my face do much of anything. No joke, lol. Sigh.
This too would be funny if it weren't so dire.
That's just over $1,000 in "mostly repairing things" found within my mouth today. No insurance. There was a 5% discount for cash though.
I laugh just the same though. Embrace the gallows humor! :)
Than hard assets, including in some areas, housing.
So...as you have time, assuming you do, as the bulldog and the Chief permit: What's the result if Larry Lang is correct, and China is going down hard? A lot of folks, Tom Friedman aside, are saying China's poised to see the bubble pop. Europe has no buyers for its bonds? Caterpillar has no buyers for heavy equipment? Australia has no buyer for its coal? Villagers rise up and kill the asshat overlords?
LA Area Port Traffic Is Rolling Over
Stick a fork in it.
Food Stamps Heat Map
Check out Oregon. Or should I say Portlandia?
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