Monday, July 06, 2015

Ragin' Contagion: When Debtors Go Broke, So Do Mercantilist Exporters

Papering over the structural imbalances in the Eurozone with bailouts or bail-ins will not resolve the fundamental asymmetries in trade.
Beneath the endless twists and turns of Greece's debt crisis lie fundamental asymmetries that doom the euro, the joint currency that has been the centerpiece of European unity since its introduction in 1999.
The key imbalance is between export powerhouse Germany and its trading partners, which run large structural trade and budget deficits, particularly Portugal, Italy, Ireland, Greece and Spain.
Those outside of Europe may be surprised to learn that Germany's exports ($1.5 trillion) are roughly equal to the exports of the U.S. (1.6 trillion), and compare favorably with China's $2.3 trillion in exports, given that Germany's population of 81 million is a mere 6% of China's 1.3 billion and 25% of America's population of 317 million.
German GDP in 2014: $3.82 trillion
Chinese GDP in 2014: $10.36 trillion
U.S. GDP in 2014: $17.42 trillion
Germany's dependence on exports places it in the mercantilist camp, countries that depend heavily on exports for their growth and profits. Other (non-oil-exporting) nations that routinely generate large trade surpluses include China, Taiwan and the Netherlands.
While Germany's exports rose an astonishing 65% from 2000 to 2008, its domestic demand flatlined near zero. Without strong export growth, Germany's economy would have been at a standstill. The Netherlands is also a big exporter (trade surplus of $33 billion) even though its population is relatively tiny, at only 16 million. The "consumer" countries, on the other hand, run large current-account (trade) deficits and large government deficits. Italy, for instance, runs a structural trade deficit and its total public debt is a whopping 137% of GDP.
Here's the problem when debtor/importer eurozone members such as Greece go broke and default: Who is left standing to buy all the mercantilist exporters' goods? Ultimately, much of those goods were purchased with debt, and when debtor nations default, the credit spigot is turned off: no more borrowing, no more money to buy Dutch, German and Chinese exports.
This chart illustrates the dynamic between mercantilist and consumer nations:
Although the euro was supposed to create efficiencies by removing the costs of multiple currencies, it has had a subtly pernicious disregard for the underlying efficiencies of each eurozone economy.
Though German wages are generous, the German government, industry and labor unions have kept a lid on production costs even as exports leaped. As a result, the cost of labor per unit of output -- the wages required to produce a widget -- rose a mere 5.8% in Germany in the 2000-09 period, while equivalent labor costs in Ireland, Greece, Spain and Italy rose by roughly 30%.
The consequences of these asymmetries in productivity, debt and trade deficits within the eurozone are subtle. In effect, the euro gave mercantilist Germany a structural competitive advantage by locking the importing nations into a currency that makes German goods cheaper than the importers' domestically produced goods.
Put another way: By holding down production costs and becoming more efficient than its eurozone neighbors, Germany engineered a de facto "devaluation" within the eurozone by lowering the labor-per-unit costs of its goods.
The euro has another deceptively harmful consequence: The currency's overall strength enables debtor nations to rapidly expand their borrowing at low rates of interest. In effect, the euro masks the internal weaknesses of debtor nations running unsustainable deficits and those whose economies had become precariously dependent on the housing bubble (Ireland and Spain) for growth and taxes.
Prior to the euro, whenever overconsumption and overborrowing began hindering an importer-consumer economy, the imbalance was corrected by an adjustment in the value of the importer's currency. This currency devaluation would restore the supply-demand and credit-debt balances between mercantilist and consumer nations.
Absent the euro today, the Greek drachma would fall in value versus the German mark, effectively raising the cost of German goods to Greeks, who would then buy fewer German products. Greece's trade deficit would shrink, and lenders would demand higher rates for Greek government bonds, effectively forcing the government to reduce its borrowing and deficit spending.
But now, with all 16 nations locked into a single currency, devaluing currencies to enable a new equilibrium is impossible. And it leaves Germany facing with the unenviable task of bailing out its "customer nations" -- the same ones that exploited the euro's strength to overborrow and overconsume.
On the other side, residents of Greece, Italy, Spain, Portugal and Ireland now face the painful (and ultimately unworkable) effects of government benefit cuts aimed at realigning budgets with the productivity of the underlying national economy.
Either Germany and its export-surplus neighbors continue bailing out the eurozone's importer/debtor consumer nations, or eventually the weaker nations will default or slide into insolvency. Greece is merely the first domino to fall.
Now an inescapable double-bind has emerged for Germany: If Germany lets its weaker neighbors default on their debts, the euro will be harmed, and German exports within Europe will slide. But if Germany becomes the "lender of last resort," then its taxpayers end up footing the bill.
If public and private debt in the troubled nations keeps rising at current rates, it's possible that even mighty Germany may be unable (or unwilling) to fund an essentially endless bailout. That would create pressure within both Germany and the debtor nations to jettison the single currency as a good idea in theory, but ultimately unworkable in a 16-nation bloc as diverse as the eurozone.
Despite endless assurances that the Greek debt crisis is contained, the reality is that the ragin' contagion of debt crises will spread not just to other deeply indebted nations but to the mercantilist economies that depend on selling goods to borrowers. Strip out the borrowing, and you strip out most of the customers for German, Dutch and Chinese goods.

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Greece's New Money: Many, Not One?

What we may be witnessing is the first phase of a new era of widespread non-state currencies.
It was easy to predict the eventual collapse of the one-currency-fits-all euro:indeed, many analysts explained why it was doomed before it was adopted as an integral part of the European Project, which broadly speaking calls for complete integration of the European economies.
I covered the many structural deficiencies in the euro five years ago:
The hard part is guessing what's next. It seems one dynamic of "what's next" is multiple currencies being used in Greece rather than one single currency: many, not one. As the U.K.'s Telegraph reports, companies are issuing private currencies to fill the void.
Despite assurances, the crisis is likely to escalate fast if there is no resolution early next week. Businesses in Thessaloniki and other parts of the country are already creating parallel private currencies to keep trade alive and alleviate an acute shortage of liquidity. Vasilis Papadopoulos, owner of the Maxi paper mill in Katerini, said the situation was becoming desperate for his industry. "I have enough raw materials to last until July 14. If I don't get any more pulp, I will have to close the factory. It is a simple as that. I have 183 employees and I will have to start laying them off," he said.
His firm has reached an accord with regional supermarkets to accept coupons or private scrip money in lieu of payment as soon as next week. His workers will then be able to use this paper as a parallel currency at the supermarket to buy goods.
The idea that scrips, IOUs, letters of credit or indeed, notched sticks, can act as perfectly legitimate money is not surprising to anyone who has read David Graber's marvelous history of credit and money, Debt: The First 5,000 Years or Fernand Braudel's three-volume history of modern Capitalism:
The Structures of Everyday Life (Volume 1)
The Wheels of Commerce (Volume 2)
The Perspective of the World (Volume 3)
When exchange-money is in short supply, i.e. a liquidity crisis, various forms of currency arise to fill the need to grease commerce. Money has two basic purposes: to grease trade/commerce, and as a store of value. the two functions appear to be seamless when one form of money fills both needs, but quite often there is no one form of money available in sufficient quantity to fill both needs.
Accounts of people in Greece buying crypto-currencies such as bitcoin strongly suggest that multiple currencies will serve as exchange-money. In its cash form, the euro will of course still be money, but there may not be enough of it in physical form to enable trade.
As I have often pointed out, the U.S. dollar acts as money virtually everywhere--especially when the local currency is depreciating or there is a liquidity crunch.
Gold and silver, traditional stores of value, can also act as exchange-money, though the principle that bad money drives out good money (Gresham's law) holds that people will hoard gold and silver and use scrip, paper currencies etc. for exchange purposes.
What we may be witnessing is the first phase of a new era of widespread non-state currencies, that is, currencies issued by private parties rather than nation-states or central banks. These could be crytpo-digital currencies, gold-backed currencies or any number of other variations.
Nation-states and central banks are anxious to maintain their monopoly on money issuance, of course, because the power to issue money is (along with forced conscription and making war) the ultimate foundation of state power.
As correspondent Mark G. observes, the evolution of multiple forms of money speeds up in times of rapid transition:
Companies issuing private label currencies is probably not as one-off exceptional as people will tend to assume. I personally have been anticipating that further evolution towards a more "Hanseatic" style economy will include the emergence of multiple exchange systems operating concurrently in parallel. These exchange systems will naturally develop faster during times of turmoil than when everything is quiet.
We can look to evolutionary biology's theory of punctuated equilibrium for a potential model of this process of experimentation and rapid evolution: the stasis of central-bank issued currencies gives way to a period of experimentation driven by pressing need that leads to a new equilibrium.
Breaking the grip of central-state/bank issued money will be a major evolutionary step forward for the global economy. Breaking free of the state's power to depreciate our money at will is a major advance in human liberty and economic security.

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Thursday, July 02, 2015

What Choice Do We Have?

As systemic solutions fall short, we must grasp the nettle of making our own arrangements in a time characterized by burgeoning demands and diminishing resources, capital and security.
The idea that our large-scale problems could be fixed with systemic reforms is enticing: replace the thousands of pages of tax code with a simple flat tax without deductions, for example, or the replacement of too big to jail/fail banks with community-owned banks that served the public, not shareholders.
But the attraction of reforms is a siren song, because our system is run by vested interests for vested interests, period. Any real reform is Dead On Arrival (DOA) because any real reform threatens the swag and security of vested interests.
One person's livelihood is another person's vested interest.
Toss in The Enchanting Charms of Cheap, Easy Credit and Our Spoiled-Brat Economyand we have a toxic resistance to systemic reforms that require any degrowth, direct democracy, writedowns of debt, devolution of centalized power, i.e. any real reforms of the unsustainable status quo.
So where does that leave us? With no choice but to submit? No, it leaves us with private solutions, by which I mean arrangements made on the individual and household level that do not assume the unsustainable status quo will magically continue to issue us our "we wuz promised" share of the swag.
Private solutions subdivide into practicalities (securing multiple income streams, choosing where to live, arranging access to healthcare, food and energy, proximity to friends and family, like-minded colleagues, etc.) and what we might term self-fulfillment: aligning our internal goals, priorities, personality traits, values and skills with the practical externalities of daily life.
Longtime correspondent Bart D. recently responded to an email in which I expressed the all-too common sense of being overwhelmed--by work, duties, responsibilities.His response gives us a starting place for choosing our priorities and goals:
"At the suggestion of a 93-year old relative, I spent a bit of time thinking of myself as being on my death-bed and considering what I’d wished I’d spent more time doing in my life. Then I went out and did it (and still am). That way, hopefully, when I eventually get there, I won’t have any need to ask myself that question because I’ve already resolved it. (It’s a minor form of ‘time travel’ in my way of thinking.)
After that, I stopped worrying about lots of mundane life things and focused on the next really excellent thing I wanted to do. For me, that meant doing a great holiday with the kids, taking them (and myself) to an interesting and inspiring place, getting out into the wild. As a result of that first inspiration we travelled 3200km across the continent and spent days swimming and soaking in a thermal river in the top end of the Northern Territory. I ended up talking to heaps of people from all over the world as they drifted past ‘our spot’. Each had a little piece of wisdom to pass on.
During that time I completely forgot to think about any of my mundane life troubles and I remained changed after returning home.
Holidays are now my stepping stones through mundane existence. It’s the great luxury I wanted but never had as a child.
Where once I was an ardent ‘saver’ I’m now a moderate spender on things that provide a good life experience. I’ve also cut back on my sense of ‘duty’ to achieve certain things for others. My outlook now is that I’m a part of a greater social machine and there are others in that machine that can (or should) take a turn in bearing the load. I will now let others fail if they don’t want to share the load. We can’t keep everyone happy all of the time. Just some people happy some of the time. And that includes our own selves."
This reassessment of duty and what is possible is especially critical in times of decline/decay, as the process of decline is essentially one of burgeoning demands and diminishing resources: there simply won't be enough to meet everyone's demands.
This means we have to pick our priorities wisely, so we 1) don't get dragged into the abyss by over-committing our limited time and resources in a vain effort to meet the demands of everyone around us, and 2) by keeping our expectations realistic, i.e. within the boundaries of what is possible without extraordinary effort, wealth and luck.
This process of reassessment implicitly holds the promise of a fulfilling life even in times of turmoil, instability and diminishing resources. As author Michael Grant noted in his history (referenced in Part 2 of my Collapse series last weekThe Fall of the Roman Empire, many people opted-out of the decaying Imperial system by joining monasteries that were by design self-reliant and self-supporting. It was not an easy life, as the religious organizations operating the monasteries demanded piety and plenty of hard work. But the order provided security and purpose--precisely the qualities lost as the Empire frayed at the edges.
Some families of great wealth exited Rome and set up self-sustaining private fiefdoms in the countryside--manor houses supported by farms. Tradespeople and merchants impoverished by rising taxes found refuge as laborers on these sprawling estates. Once again, it was not the ideal setting, but it offered security, protection and purpose.
In our era, the questions that present themselves are: where shall we devote our limited resources of time, capital and effort? What is the payoff of our choices, and what are the opportunity costs, that is, what other choices must be abandoned to pursue this path? What trade-offs are we making, explicitly and implicitly? What must we forego to pursue our primary objectives? What is the balance between practicality, duty, risk, security and fulfillment?
Modern life in advanced economies implicitly promises order and security stretching on into the future. That order and security might fray is troubling, for it upsets the foundation of our decision-making and prioritizing.
I place Bart's family vacations in this category. We cannot assume limitless growth, security, wealth, resources, etc. Rather, we should align life today with what we have concluded (after much consideration) to be our life's work, purpose, priorities, goals, limits and yes, pleasures, for the essential characteristic of fulfillment is a sense of doing what is most meaningful, what Ralph Waldo Emerson referenced in his famous phrase, “Trust thyself: every heart vibrates to that iron string."
Yes, we must make a living, or have the means of a living. Yes, we must care for others as well as for ourselves. But as systemic solutions fall short, we must grasp the nettle of making our own arrangements in a time characterized by burgeoning demands and diminishing resources, capital and security. Fulfillment is not precluded by decline; rather, it gains in importance with each passing day.
The Mobile Creative credo: trust your network, not the corporation or the state.
This essay was drawn from Musings Report 26. The Musings are sent weekly to subscribers and major financial contributors (those who contribute $50 or more annually).

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Wednesday, July 01, 2015

The Coming Era of Pension Poverty

Assuming "growth" will fund all promised pensions and entitlements is magical thinking.
The core problem with pension plans is that the promises were issued without regard for the revenues needed to pay the promises. Lulled by 60 years of global growth since 1945, those in charge of entitlements and publicly funded pensions assumed that "growth"--of GDP, tax revenues, employment and everything else--would always rise faster than the costs of the promised pensions and entitlements.
But due to demographics and a structurally stagnant economy, entitlements and pension costs are rising at a much faster rate than the revenues needed to pay the promised benefits. Two charts (courtesy of Market Daily Briefing) tell the demographic story:
As the 60+ million baby Boom began qualifying for Social Security and Medicare entitlements, the percentage of beneficiaries rose quickly from a decades-long level of about 16% of the total population to 18.5%. This might seem like much, but what's troubling is the steep rise in the number of beneficiaries while the number of full-time workers who pay the vast majority of the income taxes has remained stagnant:
Federal social spending (entitlements) has almost tripled from 5% of GDP to 14% while federal tax revenues/spending have remained range-bound as a percentage of GDP. In other words, social spending is soaring as a percentage of the economy (GDP) while revenues to support that spending are limited by the slow-growing economy and the correlation between high tax rates and recessions.
The other structural headwind is low investment returns in a zero-interest rate global economy. The only way to increase yields is to take on more risk, a strategy that has potentially catastrophic consequences: Pension Funds Are "Compromising Their Solvency" OECD Warns.
Any criticism of rapidly rising public pension costs quickly draws accusations ofunion-bashing, a favored propaganda technique to divert investigation of blatant abuse of the system. Since I have cousins who have retired from California police and firefighter jobs, I know all the insider games and tricks that many public employees can use to boost their pensions and benefits.
The issue isn't unions, it's the systemic abuse of public trust and public funds.
Buying political influence with campaign contributions doesn't mean promised public-employee pensions and benefits will align with tax revenues and yields on pension funds. The global economy is due for a recession and an extended period of slow growth/stagnation as the Great Deleveraging of credit/asset bubbles strips away phantom collateral and pops all the bubbles. This global deleveraging will occur whether we like it or not, and refusing to consider massive losses in pension-fund owned assets and declining tax revenues will only lead to greater fiscal imbalances/crises down the road.
The usual excuse for insider abuse is "everybody does it." What this means is "everybody on the public payroll who can get away with it does it." The private sector doesn't offer tricks like doubling your overtime in your last year of service to plump up your pension, or getting cashed out of your sick leave and unused vacation time to the tune of hundreds of thousands of dollars:
In the real world, these benefits vanish if you don't use them within the allotted time.
Promises made in flush times cannot be kept in lean times. Common sense suggests that public employee pension benefits should be tied to the revenues required to pay them and the rate of low-risk returns on pension funds. If common-sense is "union bashing," then we not only have a pension-funding problem, we have a propaganda problem.
Regardless of what was promised, what can't be paid won't be paid. The federal government can print money, but state and local governments cannot print money to pay soaring pension and healthcare costs. Push taxes and junk fees up enough and you will spark a taxpayer rebellion. If you doubt this, check out the origins of Prop 13 limits on property taxes in California.
I have suggested that the federal government eliminate the Social Security payroll tax and just print the money for Social Security pensions: How About Ending Social Security and Paying Retirees with Cash? (November 15, 2013)
The reason why this is practical is the Social Security system is not open-ended like Medicare; costs can be fairly accurately predicted, and SSA pensions are limited. In a deflationary $17 trillion economy, printing $1 trillion and distributing it to tens of millions of beneficiaries, most of whom paid SSA payroll taxes for decades, would not be enough to spark systemic inflation. (The Federal Reserve, so desperate to generate inflation, should jump on the prospect of goosing some mild inflation via broad-based spending by tens of millions of households.)
Assuming "growth" will fund all promised pensions and entitlements is magical thinking. We're going to have to do better than indulge our Spoiled Brat Economy mindset because "we wuz promised." What we were promised based on faulty assumptions, faulty projections and wishful thinking no longer matters.
Gordon T. Long and I discuss these systemic issues in a video program:

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Tuesday, June 30, 2015

Our Spoiled-Brat Economy

By insuring spoiled brats/vested interests never face the consequences of their actions and choices, we guarantee failure of the entire system.
Spoiled brats do not take kindly to being called out as spoiled brats. Since economies are aggregates of individuals, we can anticipate howls of outraged denial at our economy being identified as spoiled rotten.
The two essential characteristics of spoiled brats are 1) a complete disregard for the burdens of those paying the bills and 2) a childishly self-absorbed sense of overweening entitlement. Spoiled brats have no sense of fiscal discipline. Indeed, it is their defining characteristic. They want what they want, and they want it now, regardless of the cost to others or the system as a whole.
In America's Spoiled Brat Economy, no vested interest is ever allowed to fail. Lost billions gambling with borrowed money? Just throw a K Street temper tantrum and threaten to close all the ATMs when you go broke, and voila, Mommy and Daddy (the federal government and Federal Reserve) come rushing with trillions of dollars to make all the bad things like well-deserved bankruptcy go away.
That tens of millions of savers must be robbed of hundreds of billions of dollars in lost interest to rebuild your banks' profits and balance sheets--the sacrifices of others are of no concern to spoiled brats.
What does not allowed to fail bring to mind? How about coddled children who are crippled by helicopter parents who do their homework for them and schools that give everybody passing grades and gold stars?
A system that doesn't allow individuals and enterprises to fail is a system that is simply taking another path to failure. Students who are given gold stars and 9th place ribbons (Meet the Fockers) cannot possibly establish a real sense of accomplishment or learn how to make a realistic assessment of their deficiencies or strengths. They are crippled by all the "help" enablers press on them.
The same is true of spoiled-brat economies. Enterprises that are never allowed to fail (for example, too big to fail banks, bankrupt cities, counties and states, defense contractors who produce failed weapons systems, healthcare organizations that cheat the government and patients, etc. etc. etc.) become deadwood that saps the vitality of the economy, dragging down the few productive sectors.
The "help" lavished on vested interests include sweetheart contracts, direct subsidies, tax credits, lines of credit, zero interest rates and a vast range of other subsidies. The entire point of the vast lobbying machine that funnels federal and Federal Reserve largesse to vested interests is about staving off the very failure that keeps economies from imploding (creative destruction).
By insuring spoiled brats/vested interests never face the consequences of their actions, choices and self-absorbed greed, we guarantee failure of the entire system. So by all means, keep passing out subsidies to too big to fail banks and 9th-place ribbons, and give the brats whatever they want as soon as they start wailing, regardless of the cost to the system itself.

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