Category Archives: Finance

Should we fear Chinese economic weakness?

The stock market mess started when China decided to devalue its currency by a paltry 3%. The panic that followed has apparently stopped them from doing more, if they ever had more in mind. Their stock market (if we can call it that) has fallen by 42% after rising spectacularly over the preceding year. That “market” is extremely illiquid and composed of odds and sods that hardly represent their macro-economy.

But even if it were the perfect cap-weighted index with every major company included, why should I care if it fell 42%? Do western banks lend to Chinese companies? No. Do western investors invest in their stocks? No.

If it’s indicative of a Chinese economic collapse, I still don’t care! China buys (virtually) nothing from the west so our companies would lose no orders. Sure Australia would sell them less iron ore but is that what we are so worried about? The question is, how does a decline in an irrelevant economy – spread to the west? What is the transmission mechanism?

Perhaps investors in Japan will get scared by a decline in that market and then we get scared by a decline in the Nikkei -etc etc but that sounds more like a limited decline. Oil prices will fall since China is a huge buyer and anyone with oil stocks or stocks of banks that lend to oil companies will get hurt. There is of course a benefit on the other side- we are all richer since we will save money at the pumps.

There are clear losers: Canada, Russia, Venezuela, Australia, Saudi Arabia etc. but can they cause fear to spread and explode. How much do we care about Toronto real estate or negative Venezuelan GDP? The answer is murky since transmission lines are often opaque so I don’t want to get too cavalier. Perhaps Chinese economic weakness is a symbol of weaker US import demand. China may just be the leech in the coal mine simply telling us that our own growth is flagging.

Wage growth has completely stalled as I predicted it would years ago. No wage growth -> no consumption growth -> no import growth. Competition from Chinese peasant labor has killed the glorious US consumer who they (the Chinese) depend on for work. The cycle is almost complete.

The parasite has sucked too much blood from the host.

Searching for A New Vein

Test Question: Can you name one Asian country that relies on domestic demand to fuel its growth?

I can’t.

China has failed for obvious reasons- poverty and corruption. You just can’t get enough spending from $4500/year laborers to generate new domestic production and tax revenue. Even the upper middle class has nothing left to spend after they save 30% (!) of their earnings. The script was written in Singapore and played over and over again in Taiwan, Tokyo, Hong Kong, Vietnam and South Korea. It created the economic miracle of China.

So when growth slows – what do you expect China to do? Devalue! The problem is that most first world production is already there and (therefore) first world workers’ earnings are utterly stagnant – which makes sense due to the commodification of labor from offshoring. It’s getting harder for the parasite to extract a quart of blood.

These circumstances explain why we shall never have inflation and we shall never see worker wages rise to any significant extent. The largest Chinese export is global economic stagnation. Every new devaluation exposes our policies as absurd and our policy makers as corrupt. Is Obama merely the President of cheap flat screen TV’s? A trade war is raging and all our politicians carry a white flag.

We can’t blame the Parasite – it has only one way to survive.

 

Death by China

What would Keynes do?

President Obama released a new budget plan last week that raises taxes on the wealthy to pay for infrastructure. It does nothing to reduce the current budget deficit In fact he predicted it would rise by 20% next year). The President continuously believes that one more magical fiscal push will get us over the hill. He also thinks that allowing in more poor immigrants, who would easily find work, would boost social security tax revenue enough to offset big increases in spending from entitlement programs. (Is he serious?)

The US budget deficit has shrunk from $1.4 trillion in 2009 to a mere $480 bn now so everyone is relieved. The fall in interest rates has reduced the cost of servicing the outstanding debt. I guess I should be happy but I have a problem…

The recession ended in 2009 so we have had six years of growth and the deficit is still about 3% of GDP. The entire logic of running active fiscal policy (Keynsianism) is that a country must run surpluses in good times to pay for stimulus in bad times. We have forgotten the first part. Politicians seem very sensitive to the flawed recovery since median incomes are not growing and the proper measure of unemployment (U6) still shows that good jobs are scarce. This rather unsatisfying bounce-back has kept them in spending/borrowing mode.

We have record levels of tax revenue and a steady 3% growth rate so politicians need to adjust government spending to suit our current state. Yes, wages are stagnant so  revenue will persistently fail to cover poverty programs caused by lingering un and under-employment: Medicaid, Foodstamps, UIC, and low taxable income. There is only one way to fix this huge (circular) mess (free the Yuan!) and neither Obama nor the Republicans have any intention of doing it. Yet they apparently can’t reconcile themselves to the economic climate that they have created. Every day they whistle on their way to work in a state of denial as though magic will intervene. Perhaps we will grow forever at a faster and faster rate in spite of the economic stagnation in the rest of the world.

If a Democrat is a believer in active fiscal policy he must buy into counter-cyclical budget adjustments, not perpetual stimulation and the buildup of debt. If he can’t then he must become a Republican and advocate a balanced budget – even during horrible recessions. Our anemic economy did not come from tax policy or (too) big government and it won’t be fixed by loose fiscal policy or smaller government.

Keynes had a reasonable idea and exchanging debt for Chinese-made clothes was not part of it.

 

Globalization’s Evil Stepchild

Everyone seems to ask repeatedly: How can the stock market set new records when there is all this global turmoil? Are investors not watching the mess in the Middle East, the bankruptcy of Russia, the instability in Brazil and Argentina, Euro-sclerosis, narco/government crime in Mexico, and Ebola?  Perhaps it’s all Fed created liquidity that just fuels an infinite rally. After all, the only alternative to stocks are bonds with no yield, so lets just go all in and roll the equity dice.

But maybe there is another logical explanation. It used to be that we would have bilateral trade – we would buy goods from specific countries where they had a geographic or technological superiority. Even more importantly, they would buy our stuff. Proximity was an advantage. Lower transportation costs and similar consumer tastes gave our neighbors significant advantages even if their labor costs were high. On the other hand i f they got hit by an earthquake or a revolution then we would have to find new buyers and suppliers. For now intra – European trade is still huge just like trade between the US and Canada.

Things are changing – fast.

We suddenly introduced an entity that can produce anything at a cheaper price. Egyptians now import twice as much stuff from China than from Turkey. China is the number one importer into Russia, Syria, and Brazil. It’s even passing Holland as the biggest importer into Germany! Virtually every country can now buy all its consumer goods from China at vastly lower prices than anything made regionally (or locally) – if they have sufficient US dollars… and therein lies the rub.

Since China buys nothing from anybody (except some raw materials from the Third World), Russia, the European Community and the UK have to borrow (US) dollars, endlessly to get all this fabulous stuff, that they used to make at home (or get regionally). The result is a crash in economic interdependence (and GDP growth) and a rise in borrowing to finance trade deficits.  No one cares if Russia dies because no one sells anything in Russia. Libya, Iraq, Syria, Brazil, Venezuela, Mexico, Turkey, Greece, Spain, and France can all implode – you can get everything you need from China so everyone else can go on permanent vacation; just don’t buy stock in a bank that lends money to these places.

It turns out that “globalization” was a fraud. Yes,we can now read tweets from Jordan and follow the Ebola crisis in West Africa thanks to new phone apps. But the economic connections that were flowering in the 90’s thanks to lower tariffs and floating exchange rates are dying. If everyone just buys everything from China then who needs their neighbor’s goods. For that matter, why do I care about the guy four states or four hundred miles away? As long as the economic implosion next door doesn’t cause people to invade then it’s all good. Japan has been in an economic quagmire for 20 years and it has hurt nobody other than Japan. If you had predicted that in 1988, people would have thought you were crazy. Now everyone is just like Japan.

In the end, it’s all about imports. As China takes up a greater share of every countries’ imports, other countries drop out of everyone else’s economy and out of their lives. They are seen and heard on the news but not in our portfolios (unless you are crazy enough to invest in them). Putin is a social media sideshow. We are economically invincible – feel free to ignore political or economic failure in South America, the Middle East, and southern Europe. Welcome back to the 1950’s when TV brought us news about far away places but everyone understood that none of it really mattered – unless we were stupid enough to send our army there. (or substitute “banks” for “army” to update this rule.)

All this freedom we now have, to ignore the world, comes at a huge price. We too, are part of the evil bargain. We have allowed Chinese imports to infect us as well so we wallow in debt and our wages stagnate. This is one huge trade-off: We have accepted a slow grinding economic death but are appeased by the lack of blow-back when other countries suffer more than us.

Unfortunately schadenfreude doesn’t pay the rent.

Has A Trade War Already Started?

OK – It’s true, actual trade wars aren’t allowed anymore because everyone has bought into the idea that tariffs and import quotas are bad for everyone. Even if your economy is getting destroyed by the global parasite you’re still supposed to sit still and accept your punishment – as though it’s good for you. “It will force you to be more efficient.” Japan’s economy is in ruins due to this situation so it fired the first salvo on the free trade paradigm last year when it began to intentionally devalue its currency. They have extended the policy by chopping another 10% of the Yen in the last 2 months.

The economies of Europe have been horrible for years, but the superior performance of Germany seemed to stop the European Central Bank from changing policy. Now that Germany’s economy is dying and pan-European inflation rates are crashing, the ECB has decided to go all in, with negative short rates and an apparent complete willingness to let the Euro slide.

So we have a race to the bottom. The best part is that no matter how much your currency falls inflation will never appear since wage growth is dead. Even oil prices are falling by more than these currencies, so importing oil is not getting more expensive (which is a normal negative consequence of devaluation).

The US government has no currency policy so it is just watching or maybe it doesn’t care. Maybe they feel like our (current) superior GDP growth rate renders us immune to such policy changes elsewhere. Have these people ever taken an economics class? Any country can choose not to accept the current undervaluation of the Yuan by devaluing against the dollar because it is pegged (manipulated). If they devalue enough, they’ll reprice Chinese imports and render themselves competitive. Chinese imports will actually decline. Along the way they’ll also elevate the prices of imports from America and their stuff will get cheaper here. Americans will switch to buying the ever cheaper Japanese and German cars and eventually our superior growth won’t look so superior.
Currencies are the things that make everything even out. If they don’t float then huge disparities in growth can develop as we see in the European Union and between the US and China. An intelligent economic policy always includes a currency strategy. China started this war and  every country other than the US has now engaged them.

Our indolence is stunning.

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Are we masochists or sycophants?

Last week Alibaba issued its first listed stock on the NYSE and investors went wild. The P/E came out at 40X earnings and the stock rallied 30% on the first day of trading. Do the buyers know that they actually own equity in a Cayman Islands shell company? The government of China makes it illegal for foreigners to own stock in any Chinese internet (services) corporation. In fact the legal details are so ugly that the Hong Kong Stock Exchange refused the IPO! Even the shell company may be illegal by Chinese law – to the extent there is such a  thing.

At almost exactly the same time, the government of China fined Glaxo nearly $500 million for bribery – a huge figure! Everyone assumes they are guilty because every company in China engages in bribery – right? Lately foreign companies are being targeted and shut out of the Chinese market (Microsoft, Google, IBM etc.).

The Chinese couldn’t be more transparent. Their anti-Western economic policies were on full display on the front page of every newspaper on the same day as their biggest eCommerce entity went public in New York! They can attack us with impunity knowing that we are too corrupt to withdraw or withstand their addictive offerings. We even accept casual beatings – our companies are publicly humiliated  for engaging in bribery, in a country where the President’s family is rolling in misbegotten cash. Does anyone really believe that Alibaba’s new “owners” will receive profits from Jack Ma – the way Wall St. investment banks have promised. (Yahoo had to sue Alibaba to get its proper share from the sale – it was a 23% owner).

Our short term desire for profits, market share, and cheap consumer goods have blinded us to long term nationalistic policies that China has every right to invoke and that we have every reason to reject. Isn’t this the time when the cooler heads of policy makers should be intervening to save us from the inevitable long term fallout.

To add insult to injury, we will now watch Alibaba go on a spending spree with our money – buying any and every Silicon Valley startup. No price will be too high since they are playing with money created in the Cayman Islands. New Alibaba stock (IPO) owners own no equity in the company at all, so even if every acquisition they make goes sour, there is no risk to the real owners of Alibaba.

Lenin quote
Xi Jinping, President of China

I wonder if there is a bar in Shanghai, where the likes of Glaxo, Ebay, Amazon, Microsoft and Google meet to make jokes about their growing market share in China.

The Business Cycle Breaks Down

Economics textbooks teach us that there is a sort of natural sine wave to the economy: A little growth->higher consumer confidence->more spending->lower inventories>production expansion->higher labor demand->higher wages->higher confidence and spending – and so we go round and round until inflation happens, and the Fed steps in to slow it all down because that’s what they do. The links between each step are normally quite solid and also hold up in reverse. A war or terrorist attack can reduce confidence which then reduces spending so we get layoffs and lower wages then we reduce spending even more… until eventually the Fed steps in to reduce interest rates.

Capacity utilization can’t even be measured anymore.

What happens if all our plants are in China so any increases in production take place over there? If the new iphone 6 is a hit it will lead to lots of new hiring at Foxconn in Shenzhen. Demand for US labor will not rise – in fact it might fall, especially if Americans redirect their spending away from US made goods or services. This is exactly what’s been happening for years. No matter how low the Fed sets interest rates and even if GDP growth exceeds that magical 3% target, wage growth simply never happens. The result is a non-cycle where growth in one quarter is not necessarily connected to the previous one. Weather and fluctuations in inventories now dominate our analyses and can tip the scales like never before. The animal spirits that beget inflation have been surgically removed. The inflation fighting Fed looks more like an anachronism. It’s purpose has been flipped upside down. This is a great story for the stock market: lots of liquidity (0% interest rates ad infinitum) plus a quiescent labor force that accepts/demands no wage increases – ever. broken unicycle

Two rules to invest by:

 1) Own stocks until you actually see the (typical) barely employed US  worker walk right past the Apple store loaded with all its new Chinese  made goodies.

  1.  2) Buy Bonds

 Beware of pundits waxing on about where we stand in the cycle.

Obama draws the line at “Tax Inversion”

The latest trend in reducing one’s corporate tax rate is to buy a foreign company so you can move a revenue stream to a foreign/lower tax location. Frankly it’s no more egregious than all the other clever tactics employed over the last 20 years (A few examples). All these efforts have succeeded so well that the effective corporate tax rate has plummeted:

US coprporate tax ratesGoogle currently pays a tax rate of 2.4%. Apple pays 8.2%. IBM- 5.8%  JP Morgan – 14% GE – 2%

Obama has decided that everything up to now has been OK but Tax Inversion is one step over the line. Why? Isn’t it worse to move work offshore than to manipulate the system to get a lower tax rate? If most of the shareholders are American there will be a benefit from these lower tax rates since the stock price will be higher or the stock buyback program will be larger. On the other hand, the loss of workers means far less government revenue from the taxes they would have paid and far higher expenditures on unemployment insurance, food-stamps and Medicare.

Mark Cuban has drawn the line, siding with Obama, -tweeting that he won’t buy stock in a company that engages in Tax Inversion. Someone needs to tell these guys that corporate taxes are of dubious value and even if this latest trick is shut down, there are still plenty of ways to get around the US tax code. There’s an industry full of highly paid experts solely devoted to finding loopholes. The US Congress will always lose against these guys.

My question for Cuban and Obama is: Why is it un-American to finagle your way into a lower tax rate and perfectly patriotic to hire only foreigners to make/import your products? In fact Congress voted to make any costs associated with transferring equipment to foreign locations for the purpose of “offshoring” tax deductible!

The problem isn’t tax inversion, it’s priority inversion.

 

traitors
An 1865 cartoon depicting the devil with his two favorites – Benedict Arnold and Jeffery Davis

 The devil would now also welcome members of the US Chamber of Commerce

Why is the Fed so concerned about the stock market?

OK, first I have to establish the premise: Is the Fed obsessed with the stock market? It seems to be a fairly well accepted position by Fed followers that the thing the Fed most fears is another stock market meltdown. Like any fallible human it is most afraid of the thing that just happened – a meaningful stock market decline might damage the slowly repairing bank balance sheets and the rather anemic housing market.  Yellen seems utterly devoted to making us calm which translates to lower volatility or higher equity prices – mission accomplished.

There is however another reason why this makes sense. (Perhaps the Fed knows this.) In a world that is awash in (virtually) free labor we have seen and will continue to see, pathetic growth in wages. Correspondingly we have seen a fabulous rise in return on capital so wealth distribution has gone feudal. If it were 1300 and King Edward II of England had a finance minister, what would he recommend if the goal was to stimulate growth? A lower tax on beer and wine might be received well by the peasants but they are so broke that any extra penny they save will be spent on a little more mutton or on another pint. Where does one get a real kick from new stimulus?  … the nobles!

If their taxes are lowered then either they have more disposable income to spend on new fine clothes or on more land on which they can build more castles thereby employing more serfs. Clearly Edward would and should favor the nobles. In fact during Feudalism tax policy was entirely about the nobles because that’s where the money was. Similarly, Janet Y. is praying for Ronald Reagan style trickle down economics since the common man is broke. It’s the only game to play.

If CEO’s use earnings to buy back stock thereby driving up its price then the Fed’s efforts would have only gone to further enriching capital owners. If none of the liquidity gets used to hire 1st world workers or build new 1st world plants then again, the policy will be a failure . It would be as if the 14th century feudal lords only hired nobly born workers to expand their castles, or if they took the tax savings to just buy other existing castles (creating a castle bubble). The problem is that the Fed can’t control how our aristocrats use all this liquidity. It will simply go where they believe it will get the highest return and currently high returns don’t come from expensive first world labor. Our plebs shouldn’t feel snubbed or insulted – nobles are just doing what they do.

There is an even worse solution: What if the Fed found some way to channel all the cash directly to our lower (used to be middle) class. They would simply spend it on imported goods at Walmart. The government might as well just put it all on a boat and sail it to China. Soon this will all be fixed: Our peasants will earn the same amount as Chinese peasants and then the rich will smile down upon them. There will be plenty of jobs washing limos and yachts, walking dogs, cleaning (mansion) bathrooms and even doing taxes (for plutocrats). American sweatshops may even reappear. More liquidity does create a trickle of GDP growth and it begets more and more inequality.

Janet just doesn’t have another option.

serf

Technology to the Rescue

Corruption is a constant problem that seems to derail certain components of our economy. It also fosters government distrust. Municipalities like Detroit and Newark seem to be stuck in neutral, unable to bounce back no matter what else is happening in nearby environs. The VA seems to have no idea how to go about its business efficiently. Foreign governments, even in the developed world (Italy, Quebec, Brazil, Russia) where all the latest Silicon Valley tools and toys thrive, can be crippled by fraud and malfeasance.

In a world with high speed internet, corruption should be as out of date as horses pulling buggies.

When you have a chance, go to Socrata – they have software which, quite simply, forces (facilitates) a government or supra-national to openly post its revenue and spending data – all of it. Skimming off the top or paying a mobster a % becomes very hard when there is transparency. Public contracts that go up for bid can all be done on line – in the open. Every salary, the price of every computer and every pencil will be there for the citizenry to peruse (Fifa could use this too).

The question we should be asking is: Why don’t you use Socrata Mr. Mayor? If a corporation is forced to pay a bribe or a hidden tax then the program will expose both the payment and the receipt records of the payer and the payee. They must match. Yes there will probably always be some petty bribery that will go unreported on both sides but alarms can be set if banking records show out sized deposits by public employees. If they don’t like the scrutiny they shouldn’t run for office.

We have the technology and a huge number of underutilized eyeballs. You can let your politicians choose from this list:

Why can’t we attack corruption like Uber is attacking the taxi industry?

 

 On a Separate Note

I Must Give Credit where it’s due… Paul Ryan made a speech Wednesday at the Center for a New American Security’s (CNAS) annual conference. He attacked China saying:

“But with its new power, China isn’t trying to bend the rules—it’s trying to rewrite them altogether. It’s stealing our intellectual property. It’s attacking our companies. It’s promoting crony capitalism. In a narrow-minded pursuit of its narrow self-interest, China isn’t trying to uphold market principles but to upend them,”

Well said Paul.