I had meant to post this for a while but never got to it. Here is an important study by the Boston Consulting Group which concludes that manufacturing is about to return to America since China is rapidly losing its competitive advantage.
Within five years, rising Chinese wages, higher U.S. productivity, a weaker dollar, and other factors will virtually close the cost gap between the US and China for many goods consumed in North America.
Josh Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations. His blog is neatly called The Reformed Broker.
I’ve witnessed every single mistake an investor could make since I came into this game and I’ve made most of them myself. The mistakes where it’s very obvious that the odds are against you before you even begin are called the Money-Losers.
His 10 money losers with some of my comments. His complete post is here.
PAUL VOLCKER SPEECH AT THE WILLIAM TAYLOR MEMORIAL LECTURE
WASHINGTON, DC – SEPTEMBER 23, 2011
THREE YEARS LATER:UNFINISHED BUSINESS IN FINANCIAL REFORM
Telling it as it is, as it should be. Some excerpts:
Now, we know all the seeming mathematic precision brought to task, epitomized by calculations of Value at Risk, complicated new structured products, the explosion of derivatives, all intended to diffuse and minimize risk, did not bear out the hopes. Instead the vaunted efficiency helped justify exceedingly narrow credit spreads and exceedingly large compensation. By now it is pretty clear that it was faith in the techniques of modern finance, stoked in part by the apparent huge financial rewards, that enabled the extremes of leverage, the economic imbalances, and the pretenses of the credit rating agencies to persist so long. A relaxed approach of regulators and important legislative liberalization reflected the new financial Zeitgeist.
In the end, the build-up in leverage, the failure of credit discipline, and the opaqueness of securitization — all the complexity implicit in the growth of so-called “shadow banking” — helped facilitate accommodation to the underlying imbalances and to the eventual bubbles to a truly dangerous extent.
There are differences in national perceptions, reinforced by intense lobbying by affected institutions. The tendency may be to bend toward a least common denominator, weakening the standards, and to uneven application. Resistance to those pressures must be a priority for regulation.
More immediately important, and it seems to me more amenable to structural change, is the role of money market mutual funds in the United States. (…) Free of capital constraints, official reserve requirements, and deposit insurance charges, these MMMFs are truly hidden in the shadows of banking markets. The result is to divert what amounts to demand deposits from the regulated banking system. (…)The time has clearly come to harness money market funds in a manner that recognizes both their structural importance in diverting funds from regulated banks and their destabilizing potential.
(…) it is surely inappropriate that those activities (proprietary trading) be carried out by institutions benefiting from taxpayer support, current or potential.
Nouriel Roubini is not a favorite of mine. Yet, here’s a piece that is well worth reading:
So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.
The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.
The BIS published this interesting paper on the cancer that debt is. When is debt excessive?
At moderate levels, debt improves welfare and can enhance growth. But high levels can be damaging. When does the level of debt go from good to bad? We address this question using a new dataset that includes the level of government, non-financial corporate and household debt in 18 OECD countries from 1980 to 2010. Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the threshold is in the range of 80 to 100% of GDP.
Over the past 30 years, summing these three sectors together (household, corporate, and government), the ratio of debt to GDP in advanced economies has risen relentlessly from 165% in 1980 to 310% today, or by an average of more than 5 percentage points of GDP per year over the last three decades. Given current policies and demographics, it is difficult to see this trend reversing any time soon. Should we be worried? What are the real consequences of such rapid increase in debt levels? When does debt bite?
Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the number is in the range of 80 to 100% of GDP. For corporate debt, the threshold is closer to 90%. And for household debt, we report a threshold of around 85% of GDP, although the impact is very imprecisely estimated.
Entertaining, illuminating and frightening fifteen minutes (thanks David).
Kevin Slavin argues that we’re living in a world designed for — and increasingly controlled by — algorithms. In this riveting talk from TEDGlobal, he shows how these complex computer programs determine: espionage tactics, stock prices, movie scripts, and architecture. And he warns that we are writing code we can’t understand, with implications we can’t control.
An excellent book on quants and algos and how they impact the world is Scott Patterson’s The Quants. As David asked: “To when Skynet??”
With Greece and Ireland in economic shreds, while Portugal, Spain, and perhaps even Italy head south, only one nation can save Europe from financial Armageddon: a highly reluctant Germany. The ironies—like the fact that bankers from Düsseldorf were the ultimate patsies in Wall Street’s con game—pile up quickly as Michael Lewis investigates German attitudes toward money, excrement, and the country’s Nazi past, all of which help explain its peculiar new status.
We are not adjusting our cautious Recommended Asset Mixes. The global economy is slowing, and government is once again the problem and not the solution.
It seems that Congress, the President, and the Tea Partiers still think they have to answer only to America and not the world. A nation in debt to the world has no such independence.
Leading Public pension funds continue to use 8% as their assumed rates of return, and for discounting their liabilities; they will likely be the next class of investors to spawn disasters and taxpayer bailouts.
The euro has lost its status as an elegant, eternal theory of financial stability, and is becoming just another bad European dream. It will exist—for as long as it manages to exist—as the currency equivalent of the room in Hell in Jean-Paul Sartre’s famous existential play, No Exit. A man and two women enter the room singly and, upon realizing where they are, try to establish some basis for communication. The man falls
in love with one of the women, but she has a Lesbian attraction to the other woman—who rejects both her and the man. At that point, the door slams shut and they realize they will be each other’s torturers through eternity. It was Sartre’s sardonic view that Hell is eternal punishment in which we torture each other. In that sense, the existential risk to the euro from the acceptance of inevitable further bailouts of the defaulting three, and the likely future crises in Spain and Italy, are Sartresque: the euro is a locked room where countries are destined to torture each other in punishment of their sins.
The next economic crisis will originate in European banks stuffed with bad sovereign debts as more European economies weaken and the euro’s core contradictions can no longer be denied. It may well spread to the US.
This time, the backlash from an existential eurocrisis could become problematic for some big American money market funds that are heavily exposed to European bank paper. The Old World with the New Currency could—perhaps suddenly—become a new kind of challenge to the stability of the US financial system.
The most ominous recent development has been the run-up in yields on Italian bonds. Italy boasts (if that is the correct term) the third largest government debt market in the Western world. The sudden spat between Premier Berlusconi and his Finance Minister, Guido Tremonti, scared bond investors, and they ran to the exits. The successor to Jean-Claude Trichet as head of the ECB will be Mario Draghi, a respected Italian official. What is unclear is whether the ECB will be able to respond to an Italian crisis as easily as it has responded to squeals from other PIIGS if an Italian is the ECB’s numero uno. Investors should not assume that the eurocrew will be able to patch the leaks in their sinking ship indefinitely. The list of severe Sovereign risks will grow—not disappear.
The supposed risk-free asset class of government debt now has, collectively, significantly greater endogenous risk than high or medium-grade corporate debts.
The political class has—for decades—under-costed its vote-getting entitlement programs and, in recent years, over-estimated its revenues from taxes. The incentive system for politicians is skewed so as to punish candor about program costs and financial risks in favor of delivering goodies for voters. Already, 52% of voters pay no income tax and 70% of voters get more income from Washington than they pay in taxes. Any private business that had systematically misrepresented its financial affairs on similar scale would have gone bankrupt and its officers would have faced civil or even criminal prosecutions.
Already, the evidence of the terrible deterioration in Washington’s longer-term government liabilities has drawn response: one of the ratings services has indicated that a few leading corporate issuers—including Procter & Gamble—now have higher ratings than Treasurys.
As Peter Coy wrote in Bloomberg Businessweek, “An honest assessment of the country’s projected revenue and expenses over the next generation would show a reality different from the apocalyptic visions conjured by both Democrats and Republicans during the debt-ceiling debate. It would be much worse.”
The inexorable laws of compound interest alone will render it increasingly difficult if not impossible to rein in our debt. According to Mr. Coy, the Congressional Budget Office computed that it would require $15 trillion of cuts over the next decade just to keep the debt/GDP ratio where it is today in the year 2085 (a meaningless time frame but indicative of the scale of the problem). And even that ratio is artificially low because it excludes many off- balance sheet obligations such as Fannie Mae and Freddie Mac.
Current debates over the best way to address the budget crisis are based on the assumption that the problem can be solved through a fairly conventional combination of expense cuts and revenue increases. That is simply not the case anymore. These are linear solutions applied to a problem that is exponential in nature: the federal deficit and the cost of servicing it. The United States will have to adopt radical and creative solutions in order to avoid suffering the fate of other countries that have permitted their economic policies to be hijacked by selfish financial and political elites.
(…) any politician willing to place the public good above his reelection prospects could develop a meaningful budget reduction plan on the back of an envelope. Such a plan would include the following: Raising the eligibility age for Medicare and Social Security. Means testing all entitlements. Withdrawing from Afghanistan and Iraq and cutting defense spending commensurately. Raising taxes on the truly wealthy (income over $500,000/year). Plugging egregious tax loopholes like the carried interest tax on private equity. Broadening the tax base to include the half of the population not paying taxes. Making significant cuts in domestic spending and eliminating pork barrel spending. Such a plan would still fall short of solving the problem, but at least it would indicate that our leaders are approaching it seriously.
Reality dictates that the increase in the cost of servicing the debt will be exponential, not linear. President Obama’s 2010 budget (most of which nobody took seriously, with good reason) projected that interest payments on the national debt will be $900 billion in 2020, but that was based on a debt burden of $20 trillion in that year and doesn’t include the GSE’s (although it did assume higher interest rates). A sustained period of higher interest rates could render the U.S. fiscal position completely untenable.
The United States economy cannot grow at a sufficiently rapid rate to sustain these levels of debt, in large part because this debt itself suppresses growth.
The United States will likely reach its “Keynesian end-point” no later than 2020. That is the point at which total revenues are equal to the combined cost of entitlements and debt service. Japan is just now reaching that point, with repercussions yet to be felt by the global economy.
The tried and true method of solving this type of problem is a combination of inflation and currency devaluation. But matters are not that simple. As noted above, both of these phenomena will lead to higher interest rates that will further increase the cost of servicing a still-rising debt burden. Anything less than a comprehensive economic plan that addresses not only the budget deficit but the underlying industrial, education, energy, tax and regulatory policies that have contributed to this crisis will leave us chasing our tails.
The European Union is being held together by spit and rubber bands. Countries like Greece that cannot compete globally under the European currency regime must be released to reinstate their own currencies, devalue those currencies, and rebuild their economies. This is the path Iceland took and thus far it looks like it is working. Otherwise Greece, Portugal and Ireland will be joined by Spain, Italy and Belgium and drag the entire union into insolvency. Sooner or later the union will have to amputate its diseased limbs in order to survive.
Japan, as noted above, is reaching its “Keynesian end-point.” It remains to be seen whether the country will be able to finance its national debt and deficits through domestic sources or whether it will have to borrow from external sources, which would likely increase interest rates. Japan is also facing the world’s most dramatic example of an aging population and all of the attendant social and economic problems. Japan will not be in a position to contribute to global economic growth for a long time. Moreover, Japan will do everything in its power to cheapen its currency against the dollar and Euro in order to support its export-driven economy.
To quote David Rosenberg, “the entire recovery has been a soft patch.” Mr. Rosenberg also notes that records reaching back to the 1800s show that in balance sheet cycles like the one we are experiencing, recessions are separated by only 2-3 years compared to the 5-7 year gap common in garden variety inventory cycles. This year’s lack-of-growth increasingly appears to be following this pattern.
Things are so bad in Europe that shorting the Euro against the U.S. dollar also makes sense although both currencies are in a race to the bottom.