The rising risk of a global trade war

Michael Pettis, whom some of you may remember as head of Bear Stearns Asset Management emerging market debt product and who is now a professor of finance in Peking, warned in today’s FT of the growing risk of a trade war. He fears that if the big exporters like China, Germany and Japan don’t increase imports and consumption, then the trade deficit countries like the US, Spain, Italy and Greece will react with import controls. “Other economies must absorb a large share of the European shock – or the US will be forced into tariffs and import quotas.”

This reminded me of the conversation I had with the CIO of a Boston-based institutional money manager on Friday. He talked about the rising force of “localization,” by which people look after their interests on the local level rather than on a broader one. Also, at a recent talk in Cambridge, MA, Nassim Nicholas Taleb, who focuses on fragility, noted that the most efficient system is not necessarily the most robust. For example, because the power grid in New England is very reliable, no one has emergency generators, so a power cutoff would be far more disruptive here than one in Baghdad, where people and businesses have localized their power supplies.

This increasing local focus makes trade restrictions more attractive because they lead to more robust if less efficient societies.

WikiDicki

On August 23, 2010 the Financial Times reported that Julian Assange of WikiLeaks had been charged with two counts of molestation and rape based on complaints by two Swedish women during the Australian’s visit to Sweden last week. The charges were withdrawn a few hours later, probably because the women reversed their claims, which I take it to mean that they groped him, which is plausible.

The end of majorities?

The recent Australian election resulted in a parliament with no majority party for the first time in sixty years. Iraq has no majority party or coalition. Italy’s ruling coalition appears to have broken up. The UK likewise has no majority party, and it looks like President Obama’s party will lose its majority in at least one of the two houses in November. Fragmentation reduces governments’ ability to make bold policy moves.

Pork belly shortage

Last week we received a package of farm produce, jams, and salsa from my brother’s place in Iowa. The tomatoes were wrapped in an August 15 edition of the Des Moines Register. The headline of the business section read “Pork belly shortage adds $1 to price of bacon.” Des Moines Cold Storage normally has 10 to 20 million pounds in inventory but now is down to 300,000. Exports are up 27% yoy. Iowa is the nation’s biggest hog producer, with an annual slaughter of 30 million head. Iowa also is the nation’s biggest consumer of bib overalls. Maybe this shortage is one reason so many workers are having trouble bringing home the bacon.

“US proves call centre match for India over hire costs” FT August 18, 2010

Indian call center provider Genpact says it will triple its US employee count from 1,500 today over the next two years. Wipro says half of its 110,000 strong workforce will be non-Indian in two years, from the present 39%.

US workers and executives are now cheap on a global basis in some areas.

Annals of the Great Recession, The Pine Street Inn, Boston

Debbie and I had an interesting experience yesterday. Our church is one of the supporters of the Pine Street Inn in Boston, a private philanthropy that serves about 1000 homeless people in Boston daily through its various programs and facilities. The main building is quite imposing; it is the former headquarters of the Boston Fire Department and was built in 1892 modeled on an Italian Renaissance palace in Siena.

Once each month, our church prepares the evening meal. It is cooked in the church kitchen by a team of volunteers. Debbie and I picked up the meal, as well as another volunteer Jim, in our leafy suburb and drove into Boston. (I have never done this before but one of the church ladies broke her wrist and I was pressed into service at the last minute.)

The Pine Street Inn has two sections, one for men and one for women. The “guests” arrive in the evening for dinner, then go upstairs for showers, and then spend the night. In the morning they leave, mostly to return in the evening. We served the women dinner yesterday. I might add that the facility was immaculately clean.

I had been expecting to encounter people who were somehow impaired, either physically or mentally, and some were. But mostly I encountered people whom the English used to quaintly call “distressed gentlefolk,” that is to say, people superficially like us. Some women looked as if they had come directly from the affluent suburbs. They were clean, properly dressed, polite and well-spoken. When we left, we received many “thank you’s.”

Troubling. The Great Recession is reducing some people not unlike us to indigence. This is an offense to the natural order.

"The gathering storm"

Yesterday, George Will wrote a column “In Netanyahu, Israel has its own Churchill.” (IBD, Aug. 12, 2010, p. A11) He pointed out that Netanyahu has two pictures in this office, one of Theodor Herzl and one of Winston Churchill. “Netanyahu,” Will writes, “his focus firmly on Iran, honors Churchill because he did not flinch from facts about gathering storms.”

About a year ago, I wrote an essay for Euromoney entitled “The hedgehog and the fox,” harkening back to Sir Isaiah Berlin’s theory that there are two types of personalities, that of the fox, who knows many things, and that of the hedgehog, who knows one big thing. Netanyahu and Ahmadinejad are hedgehogs and Obama is a fox. The one big thing Netanyahu knows is that Iran must be stopped before it has effective nuclear weapons and Ahmadinejad knows he has to have them. Assume, therefore, a 50/50 chance that Israel will attack Iran within the next year and that the US will intervene to reopen the Straits of Hormuz after Iran closes them. How should this possibility affect one’s investment policy?

“Badges? We don’t need no stinkin’ badges.”

Since Congress has not passed Cap and Trade, the Administration is planning to implement it by fiat. Last December, Environmental Protection Agency administrator Lisa Jackson classified carbon dioxide as a dangerous pollutant and asserted her authority over it under the Clean Air Act. In April, the EPA issued rules limiting greenhouse gases in automobile emissions and is preparing to do the same for power plants. Ultimately, however, the Supreme Court, which is loathe to allow any of three branches of government to impinge upon the powers of another, except for themselves of course, will stop the IPA’s coup d’état.

In the meantime: “Badges? We don’t need no stinkin’ badges.”

(Background info from Investor’s Business Daily, August 12, 2010, p. A1)

The problem with polygamy

An advisor to the prime minister of Turkey has published a book in which he admits to a polygamous relationship with three women. His father-in-law, or at least one of them, Suat Kilic is a leading member of the Justice and Development Party who introduced a bill legalizing polygamy which was defeated. It is not known how he feels about his son-in-law’s espousal of his principles.

The problem with polygamy is that Nature has so ordered human life that there is an approximately the same number of men and women in every population. To make polygamy work, a man should eliminate another man of marriageable age for each additional wife he takes. This could be done by stirring up wars, of course.

http://www.nytimes.com/2010/08/11/world/europe/11briefs-TURKEY.html

Americans buy more treasuries

“NEW YORK — For the first time since the start of the financial crisis in August 2007, US investors own more Treasuries than foreign holders.
Mutual funds, households, and banks had boosted the domestic share of the $8.18 trillion in tradable US debt to 50.2 percent as of May, according to the most recent Treasury Department data.” http://www.boston.com/business/markets/articles/2010/08/10/us_investors_buy_up_treasuries

This reflects higher domestic savings.

Singapore economic miracle accelerates

Second quarter GDP was 18.8% yoy. Government now expects 13%-15% growth this year. Unit labor costs were down 8.8% yoy.

Portugal: 45% of electricity from renewables; national electric car recharging grid

And they said it couldn't be done. 60% of electricity from renewables by 2020. Article in NYT: http://r.smartbrief.com/resp/xFBkqGpHkHbNkryAahdnvMalUyNl?format=standard

Greek government bonds

The Wall Street Journal says the following today:

"What does Greece have to do to get a little credit from investors? Greek bonds, while off their lows, showed virtually no reaction to recent praise dished out by the International Monetary Fund. A combination of illiquidity, technical factors and binary valuation arguments are stifling the market.

"This is despite seemingly juicy returns on offer. The 30-year Greek bond hit a low on June 23 at 47% of face value, according to Tradeweb, offering a chunky 10.4% yield. The small rise since then, to 56% of face value, translates to an 18.5% capital gain. Even bonds maturing in three or four years yield 10% to 11%.

"There are good reasons, though, for the lack of action. First, for many investors, Greece is off-limits: Ratings downgrades have removed it from key European bond indexes, but it doesn't qualify to join emerging-markets indexes.

"Second, the market is illiquid. Trading volume on Greece's HDAT electronic platform was just €1.6 billion ($2.13 billion) in June, down from €27.8 billion a year earlier, according to the Bank of Greece. Buyers may fear pent-up selling pressure from banks still holding Greek debt.

"And third, shorter-dated bonds trading at prices of 70% to 80% of face value mightn't be attractive enough if an investor fears a debt restructuring. While there are good arguments that a restructuring wouldn't make sense and Greek officials rule it out, investors are concerned by the scale of potential write-offs if a default occurred, given the debt-to-GDP ratio of 130% or more.

"Niche funds with strong risk appetite may be able to take advantage. But the big money will stay away for some time yet."

Comment: I am reminded of the saying of Hecataeus of Miletus, ca. 500 BC: “What I write here is an account that I believe to be true. For the stories told by the Greeks are many and in my opinion ridiculous.”

McMansions In The Sky

McMansions In The Sky

Currency debasement and inflation have ultimately been bad news for men of modest means. Lincoln Rathnam learns lessons from the history of Emperor Diocletian on why our present penchant for McMansions may point to an Appalachian future

According to Gavin Menzies interesting book 1434 when a Chinese fleet sailed up the Adriatic in that year, they passed by the Dalmatian coastal retirement palace of the Roman Emperor Diocletian, who reigned from 284 AD to 305 AD. I was surprised to learn that the palace had lasted for 1000 years and even more surprised to know that it is standing today. Diocletian’s palace is a largish building, about the size of Versailles. Both palaces are real, long-lasting monuments to their designers, not the fragile, pre-packaged McMansions we have recently been building.

Diocletian was a cruel but effective emperor who ended the Crisis of the Third Century, fended off barbarian hordes, and, after proclaiming himself related to the god Jupiter, launched the tenth and most brutal persecution of the Christians by the Romans. To finance these achievements he produced hyperinflation in the empire by regularly buying up coins, melting them down, and producing many more new coins with reduced precious metal content, eventually reducing the silver content of the “silver” antoninianus to 2%.

Diocletian expanded the army from 300,000 to 500,000 men and increased the size of the bureaucracy, but he protected the state and its favoured few from the negative effects of inflation by effectively tying revenues to real commodities and making annual tax reassessments. The population grew more impoverished, and many free men were reduced to serfdom as they agreed to be tied on a hereditary basis to the great estates in order to survive.

Inflation increases income inequality. Wage earners and salarymen are always playing catch-up until inflation begins to decline, when they have a chance to move ahead again. This is not a conspiracy; it is simply how the world works. Still, Diocletian’s policies allowed the empire in the West to stumble on for a couple hundred more years and in the East for another one thousand. Not bad.

So what have the life and good times of Diocletian taught us? First, I think, that inflation impoverishes everyday people or, as the chairman of BP PLC so charmingly calls them, “the small people.” (Of course, the chairman is a Swede, a very tall race, so the sobriquet may well apply from his perspective.) If we are to have big government and inflation, then it’s a good thing to be an emperor or one of the few others with pricing power, but it is in the long run worse for everyone else.

Some people might buy McMansions, but they won’t last as long as Diocletian’s, and they might find them hard to keep up. After all, we have just learned that one-in-twelve mortgages in the USA is non-performing while the delinquency rate for mortgages over $1 million is one-in-five.

Despite recent hard times, US CPI is up 27% in the past ten years using the Clinton era calculation and twice that using the pre-Clinton calculation. In this period, US GDP increased 17% in real terms while median household income was basically flat. Price rises have been persistent and insidious. Eventually, however, people become aware. This is why President Lula of Brazil has been so popular with the small people there; he has dramatically reduced inflation so they could catch up and afford to have chicken twice a week. Lula put prices and real income more in sync.

“Tarnation” is an old New England and Appalachian slang term meaning “eternal damnation.” A recent neologism has come across my desk: “intarnation”. This is when a middle class person dies and comes back as a hillbilly. It is, I believe, clearly established in history that inflation results in intarnation for the 99% of the population that does not have pricing power. It is worrisome that governments around the world engage in monetary debasement on a scale that would have impressed even Diocletian. With monetary inflation, 99% of the population is faced with “intarnation.”

Economists such as Irving Fischer and Keynes have written about the “money illusion,” which comes when people mistake changes in nominal income or costs for real changes. For example, if inflation rises 5% and wages rise in 3%, wage earners think that they are 3% richer even though they are 2% poorer, and they expand their consumption accordingly. Inflation is like the drug “soma” in Aldous Huxley’s Brave New World: it creates a false feeling of euphoria. The soma of inflation makes people feel richer and able to buy McMansions they cannot afford.

Today various experts, such as Paul Krugman, are urging further debasement of the currency through Diocletian-like monetary expansion while others, mainly in Europe, are worried about the debacle that such expansion will inevitably produce. If the former prevail, we may be in the last days of our Roman Empire. Either way, of course, life will go on, even if only through our intarnation in the next generation. Tarnation for us…too bad for them.