The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

David R. Kotok, Cumberland Advisors
May 16, 2010

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“… after less than a 12 year period, many observers are claiming the great European experiment is dead. Twelve years after thirteen colonies on the east coast of North America claimed independence from the most powerful empire at the time, they still did not have a constitution. It had a weak central government, without the power to tax and under the Articles of Confederation required unanimity in decision making. Yet to discount its future was a grave error.” -Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman, May 13, 2010

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My friend Bob Brusca publishes his research as Facts and Opinion Economics (FAO). We will follow his order in this email brief, which summarizes some research done this weekend in preparation for two discussions. At 10:30 am on Monday, CNBC plans a discussion about the Eurozone (they call it a debate) with Jeremy Siegel and me. That is a prelude to a one-hour conference call sponsored by WisdomTree on Tuesday, where Jeremy and I will get into more depth on the subject. WisdomTree arranged the Tuesday conversation (they, too, call it a debate). Their contact info is: http://my.wisdomtree.com/forms/Q210BullvsBearEuroDebate-nonprepop.

Fact set 1: Greece is an economy about the size of Connecticut and has been restating its economic statistics since it became the 12th member of the Eurozone. It is widely known for its profligate government spending patterns, indulgence of public-sector labor unions, corruption and tax evasion, an underground economy, a debt-default history … and its present difficulties. Markets and financial agents are highly skeptical about its promises to impose austerity, correct budget imbalances, and comply with Eurozone requirements. Runs have occurred on Greek banks. 75% of Greek government debt (bonds and bills) is held by non-Greek creditors, mostly European banks in countries like France and Germany. Greece is rated BB+ by S&P and its debt trades like a junk bond credit. It faces repeated public-sector-led strikes and protests, even though its parliament has enacted budget austerity measures. An immediate 110-billion-euro Greek bailout package is in place.

Fact set 2: Portugal is an economy about the size of Kentucky, and is considered to be the next weakest credit in the Eurozone. It is rated A- by S&P. It has announced a credible budget austerity plan that is projected to cut the deficit from 9.4% of GDP in 2009 to 7.3% in 2010 and to 4.6% in 2011. According to a Barclays Capital summary, steps to be taken include: a “5% pay cut for state-company managers, a 5% pay cut for political officeholders, a 1 to 1.5 point rise in personal income taxes, a 2.5 point rise in corporate tax, and a 1 pp increase in the VAT rate (to 21%).” The majority government and its opposition have agreed on the need for emergency action. It appears that the public-sector labor unions in Portugal support the austerity measures and understand their importance. 72% of Portugal’s debt is held by foreign creditors.

Fact set 3: Other countries in the Eurozone are rated as follows by S&P: Italy A+, Ireland and Spain AA, Belgium AA+, Netherlands, France, Germany, Austria, Finland AAA. Ratings notwithstanding, Ireland, Italy, and Spain are routinely identified as the other troubled Eurozone members.

Fact set 4: For the years 2010-2013 the gross government financing requirements of the following four countries are: Greece 158 billion euros, Portugal 70 billion, Ireland 69 billion, Spain 448 billion. Total gross financing needs are 745 billion euros. Note that the total announced European Stabilization Fund (ESF) package from the IMF, Eurozone, and EU authorities happens to be 750 billion. We will skip the composition of that 750 billion, since it has been widely reported in the press and detailed by our colleague Bill Witherell in a previous commentary. See www.cumber.com.

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OMG this is funny:

I submitted my new chapter for the paperback version of Bailout Nation (July 6, 2010). It contains a checklist to evaluate the upcoming — and as of yet, still ill defined — re-regulation of the financial sector.

I tried to keep it realistic, discussing issues such as derivatives regulation, capital requirements, and leverage.

However, I kept wistfully thinking about the real fixes that were needed — the things that I would do if I had unlimited power (trust me, that’s something you don’t want to see). I avoided (or only mentioned in passing) these politically impossible fixes.

But that doesn’t mean we can’t put them in a wish list . . .

1. Investment Houses Partnerships: Goldman, Morgan Stanley, Merrill Lynch — turn them back into partnerships. That means the partners all have unlimited joint and several — meaning personal — liability for any losses.

2. Public Track Records of Pundits: I was astonished to see the same terrible advice on the TV during the entire market collapse. The spokesperson for a trillion dollar firm recommended buying the dip — the whole way down! Buy Dow 14k, buy 13k, buy buy buy at 12, 11, 10. All the way down. But there was never any mention of the prior horrific calls.

My impossible solution? Mandate that all TV and radio stations reveal the most recent appearance forecast, stock picks, and commentary.

3. Return to the Specialist System: The Nasdaq-afication of the NYSE turned out to be a terrible mistake. We want human specialists matching orders, making a market, stepping in during a collapse.

4. Encourage More Short Selling:  Just about every major scandal of the past 2 decades has been uncovered by shorts. The Uptick rule is fine, but all of the other limitations on short selling are counter-productive.

5. Outlaw Bank/Investing Firm Lobbying: At the very least, the TARP money should have come with a 2 year moratorium. In the future, I would like to see extreme constraints on lobbying dollars –  (Hey, I told you it was a wish list).

6. Campaign Finance Reform: We used to call the purchase of politicians’ votes graft. Today, it is called campaign donations. The corrupting influence of money in politics has led America to a very sorry political state. The solution is a constitutional amendment for public financing of elections — to get the corrupting influnce of money out of DC.

7. Not-For-Profit Exchanges: The exchanges have foregone the individual investor. Instead, they are chasing fees from high frequency traders and hedge funds.

8. Decimalization: Give up the decimals, and return to fractions. This would allow investment houses trading desks to earn a decent profit. And that might reduce their need for reckless speculation.

9. Corporate Whistle Blowers Fund: A legitimate incentive to discover and blow the whistle on various companies. The IRS does this — a percentage of any fines and recovery get paid to the person who discovered the wrongdoing.

These are the effective things that a benevolent dictator/philosopher king could easily implement, but in our messy, corrupted democracy, they don’t stand a chance . . .

May 15, 2010
By John Mauldin

Europe Throws a Hail Mary Pass
It’s More Than Just Government Debt
The Grand Misallocation
New York, LA, and Italy

In a 1975 playoff game, the Dallas Cowboys were nearly out of time and facing elimination from the playoffs, down 14-10 against a very good Minnesota Vikings team. The Cowboys future Hall of Fame quarterback Roger Staubach had no very good options. He later said he dropped back to pass, closed his eyes and, as a good Catholic, said a Hail Mary and threw the ball as far as he could. Wide receiver Drew Pearson had to come back for the ball and, in a very controversial play, managed to catch the ball on his hip and stumble into the end zone. Angry Vikings fans threw trash onto the field, and one threw a whiskey bottle that knocked a referee out. After that play, all last-minute desperation passes became known as Hail Mary passes. (That was a very thrilling game to watch!)

And that is what Europe did last weekend. They threw a Hail Mary pass in an attempt to avoid the loss of the eurozone. Jean-Claude Trichet blinked. Merkel capitulated. Today we consider what the consequences of this new European-styled TARP will be for Europe and the world. We do live in interesting times.

(At the end of the letter I note that I will be speaking at the Agora Financial conference in Vancouver July 19-23. This is a wonderful conference and a lot of my good friends are speaking. They have extended their early-bird registration for one week for my readers. Join me!)

Also, I am finalizing the details on the next two Conversations with John Mauldin. The first will be on China, where I have two experts who disagree with each other. It will be fun and most enlightening. The next one will be on energy and oil. They will both be out in June.

We get a lot of positive responses to this service. Herb wrote about the last Conversation, “Wow. What a great discussion. What smart guests, how little BS. Congratulations. It’s the best of your Conversations that I’ve listened to.”

And ACK wrote: “Wow!! Just the most important discussion I have been treated to as an investor and fund manager this year or last. Your product is dreadfully underpriced, as it delivers more value and education than almost any other subscription that I have… Thanks so much… This particular conversation was just mind-blowing!”

Actually, we get that last comment almost every issue, as we somehow seem to connect the dots for different listeners. When we started, I promised to do 6-8 a year, and we have already posted 6 timely Conversations in the first 4 months of this year, including my special Biotech Series as well as the Geopolitical Series with George Friedman.

For new readers, Conversations with John Mauldin is my one subscription service. While this letter will always be free, we have created a way for you to “listen in” on my conversations (or read the transcripts) with some of my friends, many of whom you will recognize and some whom you will want to know after you hear our conversations. Basically, I call one or two friends each month and, just as we do over dinner or at meetings, we talk about the issues of the day, back and forth, with give and take and friendly debate. I think you will find it enlightening and thought-provoking and a real contribution to your education as an investor.

I can get some rather interesting people to come to the table. Current subscribers can renew for a deeply discounted $129, and we will extend that price to new subscribers as well. To learn more, go to http://www.johnmauldin.com/newsletters2.html. Click on the Subscribe button, and join me and my friends for some very interesting Conversations. (I know the price says $199 on the site, but for now you will only be charged for $129 – I promise.)

And we are starting a renewal cycle with the subscriptions and have found a small bug in the software we purchased to handle them. Renewals are therefore not instantaneous. It may take a day, and for that we apologize. We are fixing it. And now on to Europe.

Europe Throws a Hail Mary Pass

On Thursday of last week Jean-Claude Trichet, president of the European Central Bank, said three times “Non! Non! Non!” when asked in a press conference if the ECB would consider buying Greek bonds. His exclamation was accompanied by a forceful lecture on the need for eurozone countries to get their fiscal houses in order, some of which I quoted in last week’s letter. Trichet was remonstrating about the need for the ECB to remain independent, and was rather definite about it.

Then on Sunday he said, in effect, “Mais oui! Bring me your Greek bonds and we will buy them.” What happened in just three days?

Basically, the leaders of Europe marched to the edge of the abyss, looked over, decided it was a long way down, and did an about-face. It was no small move, as they shoved almost $1 trillion onto the table in an “all-in” bet.

Bailing out Greece is very unpopular in Germany. So why did Chancellor Merkel agree to do so? This is the story that has come out in the last few days.

“French President Nicolas Sarkozy threatened to pull out of the euro unless German Chancellor Angela Merkel agreed to back the European Union bailout plan at a summit last week in Brussels, El Pais newspaper said.

“According to El Pais, which didn’t say how it obtained the information, Spanish Prime Minister Jose Luis Rodriguez Zapatero said (in a private meeting of his Socialist politicians) that Sarkozy demanded ‘the commitment of everyone, that everyone should help Greece, everyone according to their means, or France would reconsider the situation of the euro.’

“Sarkozy banged his fist on the table and threatened to quit the euro, which forced Merkel to cave in, Zapatero told the Spanish politicians, according to the El Pais account.

” ‘If at this point, given how it’s falling, Europe isn’t capable of making a united response, then there is no point to the euro,’ the newspaper quoted the French President as saying.

“It wouldn’t be the first time Sarkozy linked the fate of the euro to a willingness to support Greece. On March 7, before meeting Greek Prime Minister George Papandreou in Paris, Sarkozy said: ‘If we created the euro, we cannot let a country in the eurozone fall. Otherwise there was no point in creating the euro. We must support Greece because they are making an effort.” (Bloomberg)

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Yet another case of anecdote trumping evidence: I am more than willing to entertain the possibility that squatters are a key component of this economic rebound, if only someone can show me some data that supports it.

However, charts like the following, that calculate liabilities owed, are only half the equation:

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7+ Million Homeowners in Default = $8-$12 Billion Per Month, or $100-$150 Billion Annually

Source: T2 Partners

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The above chart, from T2 Partners, shows the liability of defaulted homeowners. This is not a measure of cash, or savings, or spending — it only shows the total amounts owed.

Hence, this is a chart of liabilities, and not, as some authors have suggested, of savings and spending.

Would someone please demonstrate what the personal balance sheets of these 5-7 million delinquent people are, we can determine if squatters are driving retail sales. You need to show income earned, cash that is owed — but not paid — rather than the mere chart unfunded obligations.

How many of these squatters are amongst the 15 million unemployed ( ZERO Income) and the 6 million underemployed? My guess is most.

The squatting order that I deduce from the historical timeline and employment, income and default data is as follows:

Unemployment (or reduction of hours)
Reduction in Income
Late Payments
Missed Payments
Delinquency
Default

Squatting !

(eventually) Foreclosure

The Urban Legend — as of yet unsupported by data:

Unemployment (or reduction of hours)
Reduction in Income
Late Payments
Missed Payments
Delinquency/Default
Squatting

Non-Payment = Extra Income

Shopping!

If anyone thinks they can prove otherwise, by all means, please reveal your data . . .

Hey buddy, you’re an asshole, not a genius:

There is a longish article on the value (and misuse) of the GDP stats in the Sunday NYT magazine. The author lays out the case that the US will, over the next few years, supplement or perhaps even replace GDP as the ultimate measure of economic growth.

In its place? Several 100 metrics that measure all manner of other factors, both quantitative and qualitative.

This is intriguing, for numerous reasons. First, of all the official economic data points the government releases, GDP is the easiest to game — you simply under-report inflation, and GDP appears to be better than it is. And ever since the Boskin Commission’s misbehavior (I call it a cowardly theft from the elderly), we have been dramatically under-reporting inflation data. Hence, we have nearly two decades of bogus GDP data in the can.

Second, and perhaps more significantly, GDP simply measures how much stuff we produce, buy and sell, and the folks we hire to make that stuff. It ignores all manner of other elements that go into that process.

I am not suggesting that GDP is a valueless measure (at least, if it were somewhat more accurate). But it is woefully incomplete. And the impact of making policy towards GDP has had very specific, corporate benefits. If we were to incorporate other more human factors, the net result could be quite substantial.

I wonder if we might see some sort of a pushback on this, especially from the Randians and Chicago-ites.

Regardless, it is a worthwhile topic to think about, if you are at all interested in how the government deploys its substantial resources into the economy.

Here is an excerpt:

“Whatever you may think progress looks like — a rebounding stock market, a new house, a good raise — the governments of the world have long held the view that only one statistic, the measure of gross domestic product, can really show whether things seem to be getting better or getting worse. G.D.P. is an index of a country’s entire economic output — a tally of, among many other things, manufacturers’ shipments, farmers’ harvests, retail sales and construction spending. It’s a figure that compresses the immensity of a national economy into a single data point of surpassing density. The conventional feeling about G.D.P. is that the more it grows, the better a country and its citizens are doing. In the U.S., economic activity plummeted at the start of 2009 and only started moving up during the second half of the year. Apparently things are moving in that direction still. In the first quarter of this year, the economy again expanded, this time by an annual rate of about 3.2 percent.

All the same, it has been a difficult few years for G.D.P. For decades, academics and gadflies have been critical of the measure, suggesting that it is an inaccurate and misleading gauge of prosperity . . . In the U.S., one challenge to the G.D.P. is coming not from a single new index, or even a dozen new measures, but from several hundred new measures — accessible free online for anyone to see, all updated regularly. Such a system of national measurements, known as State of the USA, will go live online this summer. Its arrival comes at an opportune moment, but it has been a long time in the works. In 2003, a government official named Chris Hoenig was working at the U.S. Government Accountability Office, the investigative arm of Congress, and running a group that was researching ways to evaluate national progress. Since 2007, when the project became independent and took the name State of the USA, Hoenig has been guided by the advice of the National Academy of Sciences, an all-star board from the academic and business worlds and a number of former leaders of federal statistical agencies. Some of the country’s elite philanthropies — including the Hewlett, MacArthur and Rockefeller foundations — have provided grants to help get the project started. “

That’s your weekend homework assignment . . .

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Source:
The Rise and Fall of the G.D.P.
JON GERTNER
NYT Sunday Magazine May 10, 2010
http://www.nytimes.com/2010/05/16/magazine/16GDP-t.html

Okay, enough comment filtering for relevancy civility, and intellectual contribution: Its a weekend open thread, and just about anything goes.

Whats on your collective unconscious?

Want to discuss Markets? CNBC? 100% Cash? Sports? Politics? ANYTHING? Any good YouTube? Charts? Random linkage?

Anything goes, its an open thread !

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What Say Ye?

Andy Xie is a former Morgan Stanley analyst now living in China.

China Business, May 14, 2010:

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China needs to exit the stimulus policy as soon as possible. Otherwise, inflation may reach double digits in the near future. The right way would be to raise interest rates first and move the exchange rate, if needed, second.

A small increase in the value of the RMB won’t solve two pressing problems: inflationary pressure at home and political pressure from the US. A small appreciation will further attract hot money, adding to inflationary pressure. Consumption is too small a share of imports for CPI to be affected by a small currency appreciation.

Financial markets are on the RMB appreciation watch again. The inflation pressure at home and the political pressure from the US have inflamed the expectation. The intensity and persistence of the RMB appreciation expectation is probably the most important reason for China’s vast property bubble. By all measures (e.g., stock value to GDP ratio, inventory value to GDP ratio, new property sales to GDP ratio, price to income ratio, rental yield, and vacancy rate) China’s property market is one of the biggest bubbles in financial history, probably much bigger than the US’ property bubble relative to GDP.

The appreciation expectations have caused hot money to flow into China, which in turn has caused excessive liquidity and speculation, fueling the property bubble and causing inflation to pick up rapidly. This is how Southeast Asian countries got into a crisis situation: they kept real interest rates too low and fueled speculation that eventually destroyed their banking system.

If the monetary stimulus is withdrawn, the property bubble will cool and may burst. This is why so many are arguing against increasing interest rates and instead support using currency appreciation to cool inflation. The reason this policy option is so popular among many interest groups is that it will further fuel the hot money inflow, supporting and expanding the property bubble.

In a normal economy currency appreciation cools inflation by decreasing import prices. However, China’s imports are mainly raw materials, equipment, and components, so a small currency appreciation would do virtually nothing. The odds are that a small appreciation would only make the property bubble bigger and inflation worse.

A big appreciation or revaluation can cool inflation by removing further currency appreciation expectations. It would cause the hot money to leave China. The resulting liquidity crunch would almost certainly burst the property bubble, but I doubt that anyone would support such a policy move.

For China to see a soft landing from the current property bubble, if that is even possible, interest rates should be increased steadily, by two percentage points in 2010, another three percentage points in 2011, and more rate hikes in 2012. Such a trajectory wouldn’t bring a positive real interest rate anytime soon – so would not burst the bubble. But it would prevent the real interest rate from further declining in the environment of rising inflation. At some point the real interest rate will start to inch up, slowly reining in speculation. Stopping real interest rates from declining further prevents inflation expectations from accelerating, which could stop inflation.

That the RMB must go up is the most widely held belief on Wall Street today. However, Wall Street has a poor record of getting its big calls right. Indeed, in the past two decades the Street has got its three biggest calls wrong: the East Asian Miracle, the IT Revolution, and the Financial Innovation, i.e., the derivative revolution. All three mega trends had considerable substance. The financial markets just got the market implications wrong.

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I have no idea if this is true but: Surprise!:

“A big mystery seller of futures contracts during the market meltdown last week was not a hedge fund or a high frequency trader as many have suspected, but money manager Waddell & Reed Financial Inc, according to a document obtained by Reuters.

Waddell sold on May 6 a large order of e-mini contracts during a 20-minute span in which U.S. equity markets plunged, briefly wiping out nearly $1 trillion in market capital, the internal document from CME Group Inc said.

Regulators and exchange officials quickly focused on Waddell’s sale of 75,000 e-mini contracts, which the document said “superficially appeared to be anomalous activity.”

The CME document shows that during the sell-off and subsequent rally, other active traders in e-minis included Jump Trading, Goldman Sachs, Interactive Brokers, JPMorgan Chase and Citadel Group.

During the 20-minute period, 842,514 contracts in e-minis were traded while Waddell from 2 p.m. to 3 p.m. traded its contracts, CME said. The CME document did not provide a break-out of Waddell’s trading during the crucial 20 minutes.

Note that e-minis are amongst the most liquid futures contracts in the world . . .

Waddell & Reed’s response can be found here

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Source:
Exclusive: Waddell is mystery trader in market plunge
Herbert Lash and Jonathan Spicer
Reuters May 14, 2010 12:26pm EDT
http://www.reuters.com/article/idUSTRE64D42W20100514