Where to start on a day like today...
AUGUST 08, 2011
More thoughts on the S&P downgrade
The media is full of commentary discussing the impact of S&P's downgrading of US sovereign debt to AA+ from the coveted AAA rating, largely blaming the stock market drubbing on this event. The media doesn't get it.
After briefly falling, both the US dollar and US treasuries found sustained bids throughout the day. Treasury yields fell across the entire spectrum with the exception of the very short end, while the US dollar is now within spitting distance of breaking through parity with the Loonie.
As I said yesterday, the downgrade needs to be put in perspective. Moody's and Fitch, the other two big rating agencies, recently affirmed their AAA rating on US debt. Yet S&P considers the US to be at greater risk of defaulting on its debt than Microsoft, and on par with with the riskiness of Lichtenstein. Does anyone seriously believe this?
While fiscal discipline is needed in the US, the loss of their AAA rating while France and the UK maintained theirs seems laughable to me.
Regardless, let's remember the world we now live in. Everything is relative. And as I said yesterday, does anyone seriously believe the US will see the crap hit the fan before PIIGS woes cripples the Eurozone and threaten the survival of its common currency? In a world where all things are relative, expect capital to flee the weaker areas for the relative safety and liquidity offered by the US treasury market.
The reality is that the European Monetary Union is in a race to implement a credible solution to the debt woes in its peripheral countries before the bond market forces some form of debt restructuring. The ultimate lasting solution would be a debt consolidation and the issuance of Euro bonds....but good luck floating that past the people of the more financially stable countries like Germany. Who can blame them. Who can blame them for not wanting to assume the debt of the Greek people who have experienced years of excess spending, rampant tax fraud and, unsustainable growth in their public sector.
Yet without a credible solution, restructuring is inevitable. And with it come major losses at the big European banks, credit market tensions, and the heightened specter of a renewed credit crunch.
THIS, coupled with the significant slowing in the US and global economies, is what is driving the exodus out of risk assets and into safe havens like treasuries and precious metals.
About that global weakness...
On that topic, the Conference Board of Canada released their leading economic indicators. One word: Slowdown.
Every region surveyed was identified by the Board as either being in a 'slowdown' or as peaking.
So what comes next?
Likely a recession for the US. Fiscal policy is now firmly handcuffed while consumers are retrenching and house prices are double dipping. And us here in Canada? Well, all of a sudden that 1.5% GDP forecast I made last year doesn't seem so laughable. And with consumer confidence now firmly retrenching, as also reported by the Conference Board:
"The Index of Consumer Confidence dropped for a third straight month in July, this time falling 1.8 points to 81.3 (2002 = 100). Consumers continue to express uncertainty about future job prospects, despite strong job creation numbers so far this year. As well, the balance of opinion on the major purchases question has trended increasingly negative over the past year."
People who don't feel too rosy about their future prospects tend not to spend frivolously. In fact, they largely delay major purchases. And yet consumer spending represents 65% of our GDP. It's not shocking then that demand for consumer credit is at its weakest level in nearly two decades.
All of this is happening at a time when house prices are stable, though showing increasing signs of topping. If you want to see consumers really retrench, just throw in falling house prices which effectively cuts off wealth effect spending....as well as access to lines of credit, which I believe have masked what would otherwise be a higher default rate. No one defaults when they have access to additional credit. Pay Peter by robbing Paul. Rinse, repeat.
Yet the acceleration of mortgage debt relative to GDP (which has a very strong correlation to real house price growth) has been exceptionally weak over the past two quarters.
If I were a betting man, I would say that this looks as close to a peak in debt demand as I have seen. And with the increasing economic turmoil and falling confidence threatening to become the new drivers of mass psychology, the risk of retrenching sales and cooling credit demand over the next few quarters (all but assuring falling house prices) is very real.
Here's the message to take away: The world won't fall apart. If you've been investing for your future with an eye for the long-term, are holding an appropriate weighting of risk and safety assets in your portfolio, and are not following the crowds, the sun will rise again. If you're not sure how to build that model portfolio, read this.
The stock market is throwing many babies out with the bath water. For those patiently holding cash, there are some darlings out there well worth considering. We'll talk about them tomorrow. In the meantime, grab a Valium and chill out. Unless you're leveraged into the Vancouver or Victoria market or have partaken in the T.O. condo craze....Then it's time to panic.
Cheers,
Ben
Posted in:
32 Comments
Don't panic everyone. Bernanke will press Ctrl-Print a la Weimar Germany style tomorrow.
I am less pleased with Flaherty's recent comments about deficit reduction in countries operating below full capacity. Just throwing it out there... maybe stock markets are rebuking austerity plans.
So Ben, while people like you sit back endlessly predicting a housing crash, the stock market falls to the basement. Where are all of the geniuses who predicted that one?
Still no matter what, the housing bubble diatribe drones on with the same old tired graphs and well-rehearsed arguments. Yet the real estate market keeps on 'keepin on, making a mockery of such increasingly lame predictions.
Good chance 5-year mortgage rates are headed considerably lower - great news for all of those thousands of proud homeowners renewing their mortgages, the majority of whom will be renewing at a lower rate than 5 years ago.
Imagine that, most people making more money than they were 5 years ago, yet having lower mortgage payments. Talk about freeing up cash flow. What were you saying about wealth-effect?
Not to mention all those variable mortgage holders (like me) paying prime minus .85. Money is practically free. I'm loving it - my rental properties will likely be paid off before the stock market recovers.
Oh well, I'm sure one day you'll get your housing crash Ben, just don't hold your breath.
Whatever you smokes, I wants.
You should be crapping your pants at this sentence:
"Money is practically free. I'm loving it - my rental properties will likely be paid off before the stock market recovers."
Why would you cheer on free money?
Sure, you may have a personal bias, but from a macro perspective, it is quite clear what happens when governments create free fiat currency (perhaps in the form of credit, giveaways to banks, etc).
The US housing bubble was a consequence of free money in the US, directed towards non-productive ends. In economic terms, it was a misallocation of capital.
Interest rates have at least three components: (1) compensation for time value of money (deferred consumption, or opportunity cost; (2) a risk factor; (3) a hedge against inflation.
A negligible interest rate means that all of these are devalued. Hence, the government is declaring that it cares little about opportunity cost, risk or inflation. As do the banks that get their hands on this cash, using it to lend long while borrowing short. (carry trade, etc).
Add the moral hazard of property insurance mechanisms like CMHC to this, and you have a recipe for lending institutions to make highly risky investments that do not serve any productive purpose.
If we had a boom in scientific research or engineering, at least some good might have come out of it on a macro level. A boom in housing is stupidity incarnate. Cheering on price inflation for homes is something that an economic ignoramus does.
"Cheering on price inflation for homes is something that an economic ignoramus does."
Unless of course, you're not a renter.
@Appraiser
Wow....just.....wow!
Jim - very well said!
Trolls. Do not feed them.
"the loss of their AAA rating while France and the UK maintained theirs seems laughable to me."
Well, if this laughable to you, it is just because you don't understand why S&P degraded US bonds, or have not read their press release. Let me copy it for you:
"– The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.
– More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011.
– Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government’s debt dynamics any time soon."
Reading between the lines, S&P is not saying that the US can't pay back its debt, it is simply saying that their political system is so messed up that they might default not because they can't pay (probability of 0% according to Greenspan today, since the US can print as much money as they want), but because a minority of douchebags can take the country hostage if the majority doesn't abide by their rules, and therefore provoke a default on their debt. What's been lost in the US is the ability to find reasonable compromises to address the economic situation of the coutry. Politics in the US is now all about filibuster, blackmail and populism. Markets hate extremism, and that's what S&P is telling the US.
On the other hand, France and the UK have political systems have allowed them to start tackling their issues seriously. With a projected Federal Deficit at 11% and a debt above 100% GDP, the US is in no better shape than UK and definitely worse shape than France (7.5% and 85%). US is actually comparable to Portugal in terms of economical performance...
"(...)before PIIGS woes cripples the Eurozone and threaten the survival of its common currency?" (...) "Who can blame them for not wanting to assume the debt of the Greek people who have experienced years of excess spending, rampant tax fraud and, unsustainable growth in their public sector.".
This is the absolute crap read in anglo-saxon newspaper to make everybody believe that the eurozone is threatened in its own survival. You take Greece as an example, without mentioning that it is only a tiny 2% of the eurozone GDP. Greece is a non-problem economically speaking. They are not angels by any stretch and have definitely messed up with their finances, which is pissing off everybody in Europe, not just the Germans, but again, this is a tiny problem. Ireland and Spain were outstandingly well run countries (budget surplus, low debt) before the financial collapse of 2008. They are in a messy situation because, like the US, their real estate bubble burst and they had to bailout banks, which cost them a fortune and put them in the financial situation they are in now. Both of these countries can still be rescued by the Eurozone (even though Spain is a "big fish").
The real problem is Italy, which would be "too big to save", but then again, this is a false problem as Italy is a very rich country with a solid industrial base. The economic situation in Italy is not, by far, as bad as the US. They could easily implement a tax on the richer Italians (who are on average, 25% richer than their European peers) to fix a good chunk of their budget and deficit problems.
By reading this post, I’m assuming that you don’t read French or German newspapers. You would have a much different view on what’s really going right now in Europe. What we’re witnessing right now is a massive currency war with the Euro as the target of Wall Street and the City. The ultimate goal is of course to weaken the Euro and avoid it being a concurrent reserve currency to the dollar. If that were to happen (which it will eventually), the US would lost an outrageously unfair competitive advantage (printout as much money as it wants without creating inflation!).
To dig a bit deeper, I would suggest you to read the excellent analysis made by the “Global Europe Anticipation Bulletin” in their Summer 2011 issue. These guys (real economists...) have predicted accurately pretty much all the events that happened since 2008. Here is an abstract:
“
The detonating mechanism of European government debt
The Anglo-Saxon financial operators have played sorcerer's apprentice for the last year and a half and the first headlines in the Financial Times in December 2009 on the Greek crisis quickly became a so-called "Euro crisis". We will not dwell on the vicissitudes of this enormous chicanery with a news item orchestrated from the City of London and Wall Street, as we have already devoted many pages to it in a number of GEAB issues throughout this period. Suffice it to say that eighteen months later the Euro is doing well while the dollar continues its downward spiral against major world currencies; and that all those who bet on the collapse of the Eurozone have lost a lot of money. As we anticipated the crisis favors the emergence of a new sovereign, Euroland, which now allows the Eurozone to be much better prepared than Japan, the United States or the United Kingdom for the Autumn 2011 shock ... even if it ends up, quite reluctantly, playing the role of detonator. The "bombardment" (since we must call things by their proper name), interspersed with breaks of several weeks, to which Euroland has been subjected during all this time, in fact had three consecutive major effects, two of them far from the results expected by Wall Street and the City:
1. at first (December 2009 - May 2010), it removed the European currency’s sense of invulnerability formed in 2007/2008, introducing doubts about its durability and more precisely putting the idea that the Euro was the natural alternative to the US dollar (or even its successor) into perspective
2. then (June 2010 - March 2011), it conducted Euroland leaders to start work at "top speed" on all measures to safeguard, protect and strengthen the single currency (measures which should have been taken many years ago). In so doing it has revitalized European integration and reinstated the founding core at the head of the European project, thus marginalizing the United Kingdom in particular. At the same time it has boosted increasing support for the European currency from the BRICS, headed by China, which after a moment of hesitation became aware of two fundamental points: first Europeans were acting seriously to face up to the problem and secondly, given the Anglo-Saxon determination, the Euro was obviously an essential tool for any attempt to exit the "dollar world".
3. Finally, (April 2011 - September 2011), it is currently compelling the Eurozone to start reaching for the sacrosanct private investors to make them contribute to solving the Greek problem especially via “voluntary” repayment rescheduling (or any other form of cuts in expected profits).
As one can imagine, if the first blow really was one of the objectives pursued by Wall Street and the City (besides the fact of turning attention away from the United Kingdom and United States’ massive problems), on the other hand the other two had effects totally opposite to the desired outcome: to weaken the Euro and reduce its attractiveness worldwide.
Especially since a fourth series is gearing itself up which will see, by early 2012, the launch of a Eurobond mechanism, enabling the sharing of a part of Euroland countries’ debt issuance, and the inevitable growing political pressure to increase the share of the private contribution in this broad process of restructuring the debt of the Eurozone’s peripheral countries.
And with this fourth series one enters the heart of the contagion process that will trigger the US federal debt bomb. Because, first, in creating a global media and financial environment ultra-sensitive to the issues of government indebtedness, Wall Street and the City have revealed the unsustainable size of US, British and Japanese government deficits (20). This has even forced the rating agencies, faithful watchdogs of the two financial centres, to engage in a mad race to downgrade countries’ ratings. It is for this reason that the United States now finds itself under the threat of a downgrade, as we had anticipated, even though it seemed unthinkable to most experts only a few months ago. At the same time, the United Kingdom, France, Japan... also find themselves in the rating agencies’ crosshairs.
Remember that these agencies have never forecast anything of importance (neither subprime, nor the global crisis, nor the Greek crisis, nor the Arab Spring, ...). If they downgrade willy nilly today it’s because they have been caught at their own game. It’s no longer possible to downgrade A without affecting B’s rating if B is no better off. The "assumptions" on the fact that it’s impossible for any particular state to default on its debt have not withstood three years of crisis: this is where Wall Street and the City have fallen into the trap which threatens all aspiring sorcerers’ apprentices. They have not seen it would be impossible for them to control the hysteria kept up over Greek debt. So today it’s the US Congress, with the bitter debate on the debt ceiling and massive budget cuts, that the consequences of the misleading articles in recent months about Greece and the Eurozone enlarge. Once again, our team can only stress that if history has any sense, it’s certainly a sense of irony.”
Here is the link to the article: http://www.leap2020.eu/GEAB-N-56-Special-Summer-2011-is-available-Global...
Another thing that you seemed to ignore about how the Eurozone work. In this zone, Germany and France are the co-leaders, which Germany playing the bad cop and France playing the good cop. It has always been this way, and at the end, they always find a compromise that satisfies everybody. At the end of the day, it’s in everybody's best interest that the Eurois kept afloat. The Euro is not threatened by anything now, it's actually doing pretty well...
And I have a news for you: the next target (after Italy) of Wall Street and the City is Belgium. Watch out the news in the coming weeks...
Makaya
Excellent analysis Makaya. Thanks. And thanks to Ben for always writing and facilitating a reasonable discussion.
Do you think the new Iranian oil bourse is also adding to pressure to the USD?
I agree that US dollar global imperialism is not healthy.
Well it turns out S&P was a joke, not least because yields FELL when, if the ratings downgrade were in any way credible, yields would go up due to increased default risk. Ben is spot-on: the S&P ratings downgrade is simply a hoocoodanode catalyst for underlying economic, not political, weakness. S&P can have its opinion but, from what I've seen, it has nothing to do with an impending default of US sovs.
Eurozone debtor countries are in trouble because their obsession with austerity is contractionary when unemployment is elevated. The markets are sending that message loud and clear. To think that Ireland and Spain are some fiscal darlings is suspect. They chose a different path -- housing market bubbles -- that are blighting their economies, their youth exiting en masse to find decent employment in other countries, leaving their future tax base hamstrung.
There is no grandiose conspiracy against the Euro -- why would the US want to inflate its currency, exactly? It has been doing all it can to do the opposite, same as everyone else.
Agree about Belgium and how Italy can solve its problems. But right now the market thinks Italy won't be able to figure out how to solve it and frankly its track record to pull it off given its rancorous political climate is far from stellar.
"Well it turns out S&P was a joke, not least because yields FELL when, if the ratings downgrade were in any way credible, yields would go up due to increased default risk. Ben is spot-on: the S&P ratings downgrade is simply a hoocoodanode catalyst for underlying economic, not political, weakness. S&P can have its opinion but, from what I've seen, it has nothing to do with an impending default of US sovs."
Nobody question the fact that the US will be able to service their debt, as I pointed out in my previous message, which is why the yields fell. And nobody question also the fact that the US are in a pretty bad economical shape too. If you read S&P statement, it is pretty clear to me that the major reason for this downgrade was more political than economical. If not, why didn't they downgrade the UK at the same time?
If the US had come up with a reasonable deal (mix of tax increase and spending cuts) without all the political drama we have witnessed, S&P would probably not have degraded the US. What they are saying is that their is a political risk now in Washington.
"Eurozone debtor countries are in trouble because their obsession with austerity is contractionary when unemployment is elevated. The markets are sending that message loud and clear. "
Are you part of these people that believe that you can solve the current debt problem with more debt? It didn't work in the US so far, why would it work in Eurozone debtor countries? The only way to get out of this mess is for governments to reduce their budget deficit, which is what the ECB and Germany is telling the Eurozone debtors before being "rescuing" them. Let me point you out what Peter Schiff was saying about that, back in 2006 (1min into that video: http://www.youtube.com/watch?v=2I0QN-FYkpw). The remedee Peter Schiff was recommending is exactly what's being applied in Europe...
"To think that Ireland and Spain are some fiscal darlings is suspect." You probably misunderstood what I said. Ben was rightly criticizing the Greek for their reckless spending since they joined the Euro, I was objecting that not all countries that are in financial mess today were behaving like the Greek. I took the example of Spain and Ireland pre-recession.
Let me point you to the facts:
Spain: BBC: "Spanish in strong budget surplus" (http://news.bbc.co.uk/2/hi/business/7257999.stm)
Here is a graph showing their budget deficit/surplus and you'll see how affected they have been since the financial crises in 2008: http://www.tradingeconomics.com/spain/government-budget
Ireland: Irish Time: "Large surplus expected" (http://www.irishtimes.com/focus/budget2007/news/news43.htm)
Here is the graph of the evolution of their budget deficit/surplus: http://www.tradingeconomics.com/ireland/government-budget
Ireland, before the crisis, has been consistently in budget surplus and were reducing their debt quite drastically. In 2008, the Irish Public debt was only 21.1% (77.9% in 2010!)
"There is no grandiose conspiracy against the Euro -- why would the US want to inflate its currency, exactly?"
QE1 and QE2 and probably QE3 was nothing more than monetizing debt, which basically means printing money and creating inflation. That has weakened the dollar and gave a competitive advantage to US exporters vs. their european competitors...
There is indeed a massive currency war going on, with China, the US and Europe being the main actors. Ask the Brasilians what they think about it: http://www.ft.com/intl/cms/s/0/36ee3298-a731-11e0-b6d4-00144feabdc0.html...
Regarding Italy, they might not have a stellar track record of keeping their promise, but they are not a third world country either. As I said, they have a very solid industrial base, it's a rich country and they have not been affected as much as others by the financial crisis in 2008. They have committed to put their finances in order and are under huge pressure of the ECB to do so. They have basically no choice. Here is an article from a french newspaper talking about it (with google translate):http://translate.google.com/translate?js=n&prev=_t&hl=fr&ie=UTF-8&layout=2&eotf=1&sl=fr&tl=en&u=http%3A%2F%2Fwww.lefigaro.fr%2Fconjoncture%2F2011%2F08%2F08%2F04016-20110808ARTFIG00475-la-bce-met-de-facto-l-italie-sous-tutelle.php
My overall point is: the so called "euro crisis" is completely overdone. Europe as a whole is actually in a much better financial shape than the US. The Eurozone is not an homogeneous zone. The bigest countries (France and Germany) are still financially sound and strong.
The Euro has been the target of Wall Street and the City for years now. Denying it is being a bit naive... The currency war is all over the newspaper in Europe. Here are a couple of examples after 2 minutes of google search:
http://translate.google.com/translate?js=n&prev=_t&hl=fr&ie=UTF-8&layout...
This one from a former french president:
http://translate.google.com/translate?js=n&prev=_t&hl=fr&ie=UTF-8&layout...
To further the point I made last night about the downgrade of the US treasury bonds, here is today's editorial written by Krugman. He's more eloquently saying exactly the same thing I did last night:
"No, what makes America look unreliable isn’t budget math, it’s politics. And please, let’s not have the usual declarations that both sides are at fault. Our problems are almost entirely one-sided — specifically, they’re caused by the rise of an extremist right that is prepared to create repeated crises rather than give an inch on its demands.
The truth is that as far as the straight economics goes, America’s long-run fiscal problems shouldn’t be all that hard to fix. It’s true that an aging population and rising health care costs will, under current policies, push spending up faster than tax receipts. But the United States has far higher health costs than any other advanced country, and very low taxes by international standards. If we could move even part way toward international norms on both these fronts, our budget problems would be solved.
So why can’t we do that? Because we have a powerful political movement in this country that screamed “death panels” in the face of modest efforts to use Medicare funds more effectively, and preferred to risk financial catastrophe rather than agree to even a penny in additional revenues.
The real question facing America, even in purely fiscal terms, isn’t whether we’ll trim a trillion here or a trillion there from deficits. It is whether the extremists now blocking any kind of responsible policy can be defeated and marginalized."
http://www.nytimes.com/2011/08/08/opinion/credibility-chutzpah-and-debt....
Makaya, if you're quoting Krugman then I suggest you start reading his blog posts as well, where he makes no bones that fiscal restraint and austerity like measures being taken in the Eurozone, and in North America too, are exactly the wrong thing to do. The previous stimulus conceived in 2008 was too small and too short-lived to be effective -- it should have been sustained until unemployment drops to near full-capacity and IS/LM pull away from the lower bound. There is a large private debt overhang that needs to be paid down and people not working won't help with that because they either aren't working or their wages aren't going up. Falling bond yields and chronic high unemployment will do little to relieve these nominal debts. To this end, Krugman is advocating a higher inflation target.
Again, looking at budget surpluses as evidence of a government's success is not the correct answer here. Spain and Ireland as public/private entities still carry massive debt loads and their populace are going to be paying for it for decades to come with punishing high real rates.
Re S&P downgrade, it is disingenuous of S&P to start wading into political waters when it also rates fiscal instruments. If they want to start playing politics, produce a separate scale for political credit ratings but keep the fiscal stuff fiscal. Now they have a situation where their credit rating is obviously at odds with the reality, that the US is in no danger of defaulting any time soon, but we're supposed to read between the lines and understand that, oh no no that AA credit rating isn't about fiscal distress, it's that their political climate is a Gong Show, but you can treat this particular AA rating as AAA from a fiscal point of view.
Then they have the gall to start downgrading GSEs as well. The bond desks must use S&P press releases as comic material the same way we pass around Dilberts at work.
"Makaya, if you're quoting Krugman then I suggest you start reading his blog posts as well, where he makes no bones that fiscal restraint and austerity like measures being taken in the Eurozone, and in North America too, are exactly the wrong thing to do."
I do read his blog, and I disagree with his idea. I quoted him only because he interpreted the S&P downgrade the same was as I did (not that my opinion matters!). No matter how you look at the problem, you cannot solve a problem of excessive debt with more debt, the same way you can't drink yourself sober. One only need to look at Japan to see how this has worked out for them. To quote JC Trichet (translated from french), "the problem with inflation is that it is like toothpaste, once it gets out of the tube, it's very difficult to put it back".
I agree with you though that, in the short term, lack of public spending means higher unemployment, losy economy, etc. But this is temporary. As Peter Schiff pointed out, sometimes medecine test bad, you have to swallow it if you want to cure your sickness.
"Again, looking at budget surpluses as evidence of a government's success is not the correct answer here. Spain and Ireland as public/private entities still carry massive debt loads and their populace are going to be paying for it for decades to come with punishing high real rates."
When their economy was booming, these countries were very well managed, with budget surplus and reduced debt. That's a fact you can't deny. Look at the budget situation in the US during the economic boom... The problem was that their economic boom was driven by a massive real estate bubble (sounds familiar with BC?). When that bubble popped, banks had to be bailed out, which is the reason why these countries have so much debt today. And their citizens have seen their wealth vanished and debt reamined. It definitely sucks to be Spanish or Irish these days, we probably agree on that one...
"Re S&P downgrade, it is disingenuous of S&P to start wading into political waters when it also rates fiscal instruments. If they want to start playing politics, produce a separate scale for political credit ratings but keep the fiscal stuff fiscal. Now they have a situation where their credit rating is obviously at odds with the reality, that the US is in no danger of defaulting any time soon, but we're supposed to read between the lines and understand that, oh no no that AA credit rating isn't about fiscal distress, it's that their political climate is a Gong Show, but you can treat this particular AA rating as AAA from a fiscal point of view."
I agree with you. If you look at the abstract of the article I copied in my previous message, it explains somehow how these credit rating agencies are getting caught at their own game. The attack on Greece was completely overdone. The downgrades were mostly motivated by political considerations, not by economic ones. With the ECB behind them, the risk of default from Greece was as minimal as a default from the US...
To finish this message, if you want to know a good example of how to get out of this mess, you would need to look at Sweden. They had a massive RE bubble that popped in the 90s, failing banks etc. Very similar to what the rest of the western world has experienced in 2008. They have taken tough measures back them, but it's now paying off. This year, their growth is expected to be 4.2%... I know it's a small country, etc. But the principles they applied should be followed if we are serious about getting out of this mess. That's what Europe is doing now and it will pay off in the future, while painful in the short term.
Here are a couple of articles:
"Sweden hikes interest rate as economy booms" July 5, 2011
http://www.swedishwire.com/component/content/article/26-economy/10480-sw...
"Sweden's crash and recovery"
http://www.nytimes.com/2008/09/28/opinion/28iht-edbildt.1.16532793.html
This article only talks about the financial sector. Sweden had also massively restructured its public sector, which was really inefficient and is now working great...
"the same way you can't drink yourself sober. One only need to look at Japan to see how this has worked out for them."
But the US does have an example on how to pull itself out of a depression because it's been through one before. Money is not akin to alcohol. The point I'd make here is that there are tens of millions of Americans (and millions of Canadians) either sitting at home doing nothing or doing jobs that produce nothing of benefit. Slashing spending is good if what the person is doing has zero value (or worse) but there are many opportunities to produce things of value through government spending if the private sector is unwilling to. This is the old Keynesian infrastructure argument geared to achieving full employment, best done at a time when the government can raise money at virtually no cost.
"When their economy was booming, these countries were very well managed, with budget surplus and reduced debt. "
OK so they had booming economies but much of the economic activity was illusory. Neither economies are poster children for how to run governments in the long run -- their housing policies failed miserably and the proof is in the pudding: large debt with high real debt servicing costs for its citizens. If they could turn back the clock and do it differently, given their de facto currency pegs, I am almost sure they would.
On Sweden, it took 7 years of elevated unemployment before its economy rebounded again, and they were buoyed by a fully-firing world economy in the late-90s as well. Canada too has a similar case in point to the US around the same time period as Sweden's woes, where cutting spending and increasing taxes brought budget deficits in line again. I agree with you the US has some great examples on how to get it done but neither Sweden's nor Canada's previous crises faced a liquidity trap situation that the US does today. That is another wrinkle, where demand is simply not present to allow debts to be reduced. Interestingly Sweden was fighting deflation for 7 years and its economy was one of the more dynamic ones in Europe even pre-1993. For the US... even with successfully-implemented Scandanavian-inspired austerity and reforms, it's going to be a long process.
Thanks for the well-thought-out responses.
"The point I'd make here is that there are tens of millions of Americans (and millions of Canadians) either sitting at home doing nothing or doing jobs that produce nothing of benefit. "
You're spot on on the root cause of the troubles all western countries are facing. I'm going to be extremely politically incorrect here by simply saying that the free trade agreement and especially China joining the WTO (without respecting "the rules" i.e. currency manipulation) is the root cause of most of the financial disaster we are currently living.
Thinking that we could stop producing and base our economy solely on consumption was absolutely stupid. It worked great for a while until it didn't. We have "off-shored" our industrial base with all the high paid job and replaced them by low-paid service jobs. It's now obvious that it couldn't end well, but at the time of the GATT negotiations, a few tried to warn of the dangers of opening the borders to countries that do not share the same standart of living. We obviously couldn't compete with workers paid $50 per month. To make the matter worse, we have also transferred our most advanced technologies, to see later Chinese companies competing against ours at unbeatable prices.
If you have a bit of time, I would strongly encourage you to watch the excellent interview of Sir James Goldsmith made in 1994 (the guy passed away in 1997) regarding the potential consequences of the Free Trade Agreement (1994). It's a long interview (8 parts), but absolutely worth watching. Everything he said exactly happened how he predicted them. On part two of the interview, he had an exchanged with one of Bill Clinton's economic advisors. What she said reflect the common religion (as it is still today) that free trade, low taxes, etc. is the only way to go for prosperity. She's been proven wrong by the facts, but we're still not "fixing" the problem, which is protecting our industries and jobs from countries we can't compete with (because they manipulate their currency or because they don't respect the rules i.e. copyrights, etc.)...
http://www.youtube.com/watch?v=4PQrz8F0dBI
The (rightly or wrongly) anger directing at China for its currency manipulation is now starting to hit the news big time. Here is an article about it posted in the most influential newspaper in France, Le Monde:
http://translate.google.com/translate?js=n&prev=_t&hl=fr&ie=UTF-8&layout...
"Thinking that we could stop producing and base our economy solely on consumption was absolutely stupid."
The terms the Chinese have provided for consumers were so favourable it would have been difficult not to take advantage. The past few years of outsourcing should be seen more of an opportunity squandered: someone is willing to do mundane tasks for a fraction of the cost so we can innovate and increase goodwill (IP, education levels, etc.) and infrastructure. Unfortunately that didn't happen as much as it should have but the opportunity was there.
I'll be politically incorrect, as you, and state that China has a long ways to go to be on equal footing to what most of the developed world has produced over many centuries. They'll get there quickly thanks to catch-up logic (terms of trade) but I think people underestimate the subtleties of building a modern society that, from what I've seen, China is lacking. The rule of law and property rights is one of the big ones and their education system and philosophy needs work too. Both are slowly improving but it will be a while.
Interesting and thought-provoking analysis, Makaya. I may repost this, as well as Jesse's comment as a stand alone post later today.
Two things regarding Europe:
1. Derivatives
2. The end game is always political
Interesting post, but I have to take issue with some of the racism that you are spewing:
"This is the absolute crap read in anglo-saxon newspaper"
Find me a SINGLE newspaper owned by a person of anglo-saxon descent. Most of them are owned by Jewish people, as are a good percentage of the banks. Last I checked, Ben "Shalom" Bernanke, Tim Geithner, Alan Greenspan (and the rest of the Treasury, IMF, Bank of England, etc) were not exactly Anglo-Saxons.
If you are going to be racist, at least get the race right.
@Jim
My comment had nothing to do with any form of racism, sorry to disappoint you...
The term anglo saxon was maybe mis-used, I probably should have said "anglo-american".
Get a life Jew-baiter. Most British and American and Canadian and Australian newspapers are not owned by Jews as a moment's thinking will make clear, nor are most banks owned by anyone in particular. The Aspers went broke, remember? Meanwhile, certain Jewish papers, like the New York Times, are reflexively Judeophobic in their writing.
However, there is no denying many Jews do well in the modern world; one might think their cultural skills are something to emulate not resent but then you would have to turn to more Jewish thinking to truly understand why some people get trapped in a resentful identity and cannot but see the free marketplace as being guided by an "invisible hand" that is not really so invisible if only you are in the know.
I love the commentary about how 5y yields are going to bend and how the incomes had increased...
1. there is no guarantee that the yields will bend (or that bond vigilantes will not put Canada under their sight next). Esp. now that Aus. is tanking (and to external investors it is a prototypical instance of Can.) I see no reason why we would suddenly become 'safe heaven'.
2. stats Canada shows that incomes had actually dropped across the board and fuel/food (non discretionary prices) had actually increased.
3. it is now widely aknowledged that we have misplaced our capital into unproductive assets through rampant speculation. Guess so much for us being competitive on the global markets in the things that actually matter.
4. stock markets downfall actually will force those that planed to use their equities for retirement to
liquidate their RE holdings... how nice (the law of unintended consequences).
In any case Japan had ZIRP going on for the past 2 decades and nothing to show for in the housing market...
However, we still have delirious optimists spewing badly thought through nonsense...
Banking crises precede sovereign crises. Not the other way round. The banks lobbied hard to get rid of decades-old banking regulations, promising not to abuse their new-found freedom, but being the greedy bastards that they are, they went crazy. The banks lent to sovereign governments and households, many who were bad risks, and they lent too much at ridiculously low rates. They weren't forced to lend; they just did. Lax lending and low rates caused excessive asset speculation, excessive banking leverage, and voila - housing bubbles were born from Iceland to China, from Australia to Canada, and almost every country in between.
Of course, we know the rest of the story: the banks are in huge trouble. But instead of allowing the banks to go under (for making bad loans), the governments and politicians (who are really owned by the bankers) were given their orders - that the banks will be bailed out and that all debts should be heaped on the taxpayers of each respective country. Of course, in order to now pay for the debts, austerity is being implemented and social programs are being axed.
What about those rating agencies? Throughout the whole fraudulent mortgage-backed securities mess, did we see them step up? The last decade saw rampant fraud, but did the ratings agencies step forward just once? They even overlooked what Bernie Madoff was doing (along with the SEC). Why is it that one has stepped forward now, and against the U.S., to boot?
The rating agencies are part of the power structure in the States. They do as they are told. I believe S&P downgraded the States because they were told to, because the politicians want to desperately feed the country austerity, strip their Social Security, Medicare, Medicaid, but there is a real backlash to doing this. Having S&P downgrade the country takes the painful message away from the politicians and puts it on someone else.
There is absolutely no way S&P would have downgraded the States without being told to - no way! They would not have dared.
Just watched this documentary film, "inside job" few days ago. highly recommended.
From the Telegraph:
"The causes of recession set out by J K Galbraith in his book, The Great Crash 1929, were as follows: bad income distribution, a business sector engaged in “corporate larceny”, a weak banking structure and an import/export imbalance."
Mix in a lack of real leadership from the top, cheap credit that countries get drunk on, and you have the same outcome.
Ben, you said: "In a world where all things are relative, expect capital to flee the weaker areas for the relative safety and liquidity offered by the US treasury market."
And maybe that was the objective.
""What you cannot get – not at a meeting sponsored by the International Monetary Fund, not from the participants at the Institute for New Economic Thinking – is any serious discussion of contract law and fraud. I’ve tried, repeatedly. No one will deny, in response to the question, the role that fraud played in the financial debacle. How could they? But they won’t discuss it either. And it seems to me, this reflects a logic which bears pursuing.
Why not? Why is this one of the great taboo topics of our modern economic history? Well, personal complicity, frankly, plays a role among present and former government officials, regulators, consultants and the academics who advised them and those who either played the markets or took fees from those who did.
I highly recommend to you, if you haven’t done so, that you read the Financial Crisis Inquiry Commission Report just published in the United States, or the even more recent report of the Senate Permanent Committee on Investigations, the many reports of the Congressional Oversight Panel and the report of the Special Inspector General for the Troubled Asset Relief Fund, SIGTARP. These are, by the way, very, very good documents prepared by serious public servants and it’s plain as day.
Fraud was not a bug in the system, it was a feature. The word itself, along with abusive, egregious, reckless and even criminogenic suffuses these accounts of what went on."
http://www.nakedcapitalism.com/2011/08/james-galbraith-on-fraud-and-how-...
I wager the people who 'manage' the system profit from the fraud.
The most obvious culprit is the Federal Reserve itself. A cartel of private bankers (mostly European, by the way), given power to regulate the money supply.
The link on the above should be:
http://www.nakedcapitalism.com/2011/08/james-galbraith-on-fraud-and-how-...