May 15, 2012
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This essay is excerpted from a recent version of The Credit Strategist (formerly the HCM Market Letter). To obtain the complete issue, you must subscribe directly to this publication; Please go here. The Credit Strategist is on Twitter - @credstrategist
“This is what the guys at Bear Stearns and Lehman Brothers forgot. They forgot that they are a part of a continuum of history, and it’s not about the **** buck that you make today at whoever’s **** expense. If there’s not a sense of continuity, a sense of some sort of communal obligation and responsibility, a sense of a future involved in what you’re doing, and a sense of being beholden to the past, you end up being one shallow, greedy mother****, just trying to get all you can get.”
I recently had the honor of being asked to make a presentation at the Casey Research Summit in Weston, Florida. While Bruce Springsteen was not in attendance, many stars of the investment world were there– Doug Casey and David Galland, Lacy Hunt, John Mauldin, Gordon Chang, Harry Dent, James Rickards, Porter Stansberry, Rick Rule, Greg Weldon, John Williams, and last but certainly not least, David Stockman. I must admit that, at times, I wondered why they hadn’t handed out sedatives at the door since the general tenor of the conference was decidedly downbeat, but from an intellectual standpoint the sparks were flying.
The European economic catastrophe
One aspiring rock star who was not in attendance was Francois Hollande. He was busy campaigning for the presidency of France, an office he will likely attain. For a once great nation, M. Hollande’s ascension to the presidency will be a striking setback and an indication that the French people have lost their minds. The new president is a man of little accomplishment and, as far as we can tell, limited judgment since the proposals eructating from his lips demonstrate a shocking ignorance of history, economics and common sense.2 As someone who has spent much of his life admiring French culture and thought while abhorring French politics, this is another painful moment. How in the world can the French vote into office a socialist at this point in history? How can they fall into the trap of believing that socialism is the answer simply because the current model of crony capitalism in the West has failed? This, I suppose, is how the land of Flaubert and Proust has lapsed in the world of Houllebecq. Europe, whose economic condition is nothing less than terminal, is about to receive what physicians refer to as a “zetz” of morphine in the form of M. Hollande. A “zetz” is the final dose that doctors give to dying patients to hasten their passage to the afterlife. In Europe’s case, however, the medicine is not going to be painless, and its administration is not based on mercy but on resentment and stupidity. If the French are prepared to vote for Hollande and his patently idiotic agenda, one can only sit back and watch them get what they deserve and suffer the consequences. We can continue to enjoy their food and wine and watch the carnage from the sidelines. Even better, it will be easier to get a table at Chateau Boyer this summer!
As I told the audience at the Casey Research Conference, the European Union is a study in the misapplication of the lessons of history. After World War II, Europeans swore that they would never subject themselves to German hegemony again. More than fifty years later, they finally announced the formation of the EU with the goal of limiting German power. How did that work out for them? They ended up with a half-baked confederation that lacks political unity dominated by Germany to the extent that it is basically held hostage by Germany’s checkbook. Instead of lording over its neighbors by military means, Germany now does so by economic means. George Santayana famously warned that those who do not heed the lessons of history are doomed to repeat them. In the case of the Europeans, those who learned the wrong lessons of history are doomed to repeat them. The EU was flawed from inception and Europe and the rest of the world are now living with the consequences of this failed experiment.
The speakers at the Casey Research Summit were without exception negative on the outlook for Europe (including, obviously, your author). It is always prudent to ask whether any consensus is too obvious, but in this case you can dismiss the question. There is virtually no chance that Europe will experience a good outcome. Europe has accumulated a mountain of debt so large in both absolute and relative terms that it is impossible for it to manage its way out of it without significant damage. There may be a lot of worry about the debt situation of the United States, but global investors are still willing to finance our debts at ridiculously low rates. Europe enjoys no such exorbitant privilege, as former French President Valery Giscard-d’Estaing described it years ago. Lacy Hunt warmed up the Casey crowd with the fact that the United States currently has $55 trillion of total public and private debt and $15 trillion of GDP, a 3.67x debt-to-GDP ratio. That is a walk-in-the-park compared to the Eurozone, which bears a 4.85x debt-to-GDP ratio with $68 trillion of total public and private debt against $14 trillion of aggregate GDP. Moreover, Europe does not have nearly the flexibility that the United States potentially still possesses to reverse this condition of gross over-indebtedness. For the United States, a combination of tax reform, entitlement reform and budget discipline could shrink the debt-to-GDP ratio to a more manageable level. Theoretically one might be able to say the same thing with regard to Europe but would run smack dab into a brick wall of political and ideological division, inflexible labor regimes, grossly different cultural and economic models, a much higher debt load, and a much weaker productive engine to service it. To put it more simply, the U.S. may be behind the curve, but Europe is not even on the curve.
The economic data pouring out of Europe is simply alarming. Spain, the next domino to fall, is far larger than Greece or Ireland or Iceland and is rapidly sinking into what can only be called a depression. Spanish unemployment reached 24.44% in the first quarter, up from 22.85% in the fourth quarter of 2011. Youth unemployment is roughly 50%, which means that Spain is losing an entire generation to disillusion with political and business leadership. The next step is certain to be civil disobedience, higher crime rates, and social instability – none of which bode well for economic recovery. There is no way that Spain can (or should) conform with the Maastricht Treaty’s budget rules that “require” countries to limit their budget deficits to no more than 3% of GDP. While a respectable school of thought argues that the only way to cure a debt crisis is for a country to begin living within its means, it is perfectly reasonable to add that such a program can be phased in over several years through a combination of budget discipline and pro-growth spending designed to create the income necessary to service debt. Simple austerity without pro-growth policies is a sure recipe for disaster, and thus far European policy lacks the necessary growth component that would offer those disillusioned with austerity some hope that their sacrifice will eventually be rewarded. Hope may not be a policy, but hopelessness guarantees failure.
The champagne bottles that were broken out to celebrate the LTRO now merely lie broken as it becomes clear that trying to solve a debt crisis with more debt accomplished nothing and fooled nobody. The hope was that the LTRO would buy the banks and sovereigns at least a year; the reality is that it barely bought them a month. Spanish and Italian bond yields are well on their way back to 6 percent, the level considered unsustainable by most responsible observers. But honestly, who knows what level is sustainable in a world where the European Central Bank (ECB) creates fiat money out of the air, lends it to banks, and then watches those banks turn around and buy bonds issued by those banks’ sovereigns? One might think that what I just described was a satire if the potential consequences weren’t quite so serious. Then again, who else is going to buy this highly risk paper? Answer: Nobody who doesn’t have to. Since December, Spanish banks have purchased more than 100 percent of Spanish sovereign bond issuance according to Bridgewater Associates. And Spanish banks now own about €300 billion of Spanish sovereign debt while Italian banks own about €250 billion of Italy’s sovereign debt.3 Who knew that Charles Ponzi was writing a business plan for his patrimony?
1. In conversation with Jon Stewart, January 30, 2012 (Rolling Stone, March 29, 2012, “Bruce Springsteen’s State of the Union,” p. 45.
2. Having written that, I read it over and realize that virtually the same thing could be written about Barack Obama three years into his first (and hopefully final) term.
3. That is child’s play compared to the Ponzi-schemers in Japan, whose economic diagnosis would also have to be considered terminal if the country were not already economically dead. Japanese banks own $7.6 trillion of all outstanding Japanese Government Bonds (JGBs), or 66 percent of all outstanding JGBs. This data point renders the very concept of an independent central bank in Japan a joke (if that concept every applied in Japan’s managed economy).
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