I can't believe the news today
Oh, I can't close my eyes
And make it go away
How long...
How long must we sing this song?
How long? How long...
'cause tonight...we can be as one
Tonight...
Oh, I can't close my eyes
And make it go away
How long...
How long must we sing this song?
How long? How long...
'cause tonight...we can be as one
Tonight...
Watching 52,000 students rioting in London this week over increased tuition made me think, "How long...how long must we sing this song?" Unfortunately, the answer is quite a long time. You see the riots in London weren't over a war, or racial inequality, the riots are happening because the government is trying to shrink. The size of the government relative to its economy can shrink in two ways; one, grow the economy faster than the government (not happening), or two, make broad based cuts to the government. In England's case, one of the cuts is to the college education entitlement. Prime Minister David Cameron's Conservative Party is trying to get their fiscal house in order and raising tuition (actually cutting subsidies) is one of many austerity moves. Cameron is proposing a tuition of $14,500 per year versus current tuition for a British student of about $5,300, prior to the 1990's it was free. The National Union of Students said it would try to recall legislators from the party who vote in favor of the hike. "We will not tolerate the previous generation passing on its debts to the next, nor will we pick up the bill to access a college and university education that was funded for them," said union president Aaron Porter.
Of course with the average US tuition at about $27,000 they get little sympathy from us. But this isn't about us versus them, this is about what happens when you take away entitlements.
Thursday the White House commission on deficit reduction laid out a plan to cut our deficit by $3.8 trillion by 2020. Here are some highlights:
-Cut $100 billion in defense spending.
-Raise Social Security age to 69.
-Raise gasoline tax by $0.15.
-Lower corporate tax rate to 26%.
-Repeal alternative minimum tax.
-Kill deductions on mortgages over $500,000.
-Cut federal work force by 10%.
-Cut farm subsidies by $3 billion.
Now we're a long way from any of these recommendations becoming law, but if we are really serious about getting our fiscal house in order, then there will have to be serious cuts that will affect us all. Hopefully there won't be violence in the streets, but I'm pretty sure some affected parties won't go along peacefully.
The other thing to think about is what do austerity measures mean to economic growth? The short answer is less growth near-term, and hopefully more growth in the future. For an example of this you needn't look any further than Ireland or Greece. Their economies are shrinking along with the size of their governments.
What do you think will happen to our GDP growth rate and unemployment rate, in the short-term, if we cut the federal work force by 10% and cut defense spending by $100 billion? Right, it's the opposite of going up.
An example of this on a micro level is this weeks earnings call by John Chambers of Cisco. Chambers put his company's second-quarter revenue growth at 3% to 5%, significantly below estimates of a 13% increase. During the call, he specifically pointed to a slowdown from the public sector, with weaker government spending from the U.S., Japan and Central Europe. The public sector represents nearly a quarter of Cisco's revenue. Cisco's stock is down 16%, one if it's worst one day declines ever.
Austerity = Slower Earnings/GDP growth and higher unemployment.
But austerity is needed when you are technically bankrupt. We all know this on a personal level. If you are deeply in debt, with minimal or no opportunity to grow your way out, then you simply must make hard cuts to your standard of living. This is what is happening all over the Western World, and will soon be happening here in the good ole US of A, we will all have a lower standard of living.
On that sour note I'll leave you with a priceless clip from Saturday Night Live. Enjoy!
More on QE2:
Last week I spent a lot of time going over the Fed's QE2 policy, and although I totally disagree with it, I also stated the importance of going along with any Fed induced bubbles so you can at least attempt to keep up with the coming inflation. Today I read this great quote by Billy Shakespeare, a man definitely ahead of his time. An astute businessman, he realized the importance of going with the tide:
"There is a tide in the affairs of men. Which, taken at the flood, leads on to fortune; Omitted, all the voyage of their life Is bound in shallows and in miseries. On such a full sea are we now afloat, And we must take the current when it serves, Or lose our ventures." –JULIUS CAESAR ACT 4, SCENE 3
Another good review of the "Bubble of all Bubbles" is this two-part video clip from Mark Fisher.
Key highlights: "QE2 can't end right. Worthless paper after endless paper.... What's good for the equity markets is not necessarily good for the economy. The equity markets are not going to create jobs. If you have a paper bag full of money are you going to go out and hire workers and take risk with healthcare and all these other regulatory restrictions? No, you are going to go ahead and buy high yield, you will buy equities, you will buy risk assets. The fallacy in the whole thing is that you are not going to go ahead and create jobs just by pushing up the market by 20%, 15%. In fact, to some degree by pushing up commodity prices to levels that are going to be obscene, which is what is going to happen, you are hurting everybody in mainstream America... If you have all this money coming into the system, and this money stays in the equity and commodity markets, when at some point you take this money out of the system, where is this money going to come out of? Parabolic moves have Parabolic corrections. This is going to end bad. It is not a matter of if, just a matter of when. This is going to be the ultimate bubble, this is going to make 2000 look like a cakewalk. This is going to be the bubble of all bubbles."
Shifting Wealth From The Developed World To The Developing World:
I'm old enough to remember when the world was divided into a first, second, and a third world. It has since become known as the "West" and the "Rest", and more recently the "Developed" versus the "Emerging". I'm not sure what we will call it in twenty short years when the world's former "poor" countries account for nearly 70% of global GDP. That's right, by 2030 the current undeveloped countries will see their share of the worlds economic pie grow from 50% to 68%. And I wouldn't be surprised if it happens much faster as the "developed" world undergoes forced austerity.
In a new report, the OECD Development Centre states that Developing countries have enjoyed strong economic performance over the past decade – often growing twice as fast as OECD economies. Updating Angus Maddison’s famous projections, it forecasts a world starkly different from today’s. The worlds’ poor countries will account for nearly 70% of global GDP in 2030. This remarkable turnaround is due to the dynamism of the developing world, in particular India and China. Combined with their large populations, this means that the economic centre of gravity of the global economy is changing rapidly, with all kinds of implications for economic policy in many spheres – macroeconomics, natural resource management, technology, agricultural, and development policy.
The scenarios depicted below (Table 1) include a revision of Maddison’s estimates for Asia, Latin America, and Africa. They also revise downwards the growth estimates for the rich countries in the aftermath of the financial crisis, motivated by recent studies that suggest that long-term growth in high-income countries may be dragged down by the high fiscal burdens resulting from the crisis (e.g. Reinhart and Rogoff 2010). It may also, of course, take a long time to sort out some of the other structural imbalances impacting growth performance in many industrial economies.
Table 1. Shifting wealth and the world in 2030 – New forecasts
Source: Author, based on Maddison (2007:Table 7.1) and updated from data available at the Groningen website (http://www.ggdc.net/maddison/).
This simple growth dynamic explains the need to have a fairly high allocation to emerging markets, both equities and debt. Go where capital is treated best.
What A Competitive Currency Devaluation (aka. Currency War) Looks Like:
Lastly a little humor on traders:
Be careful out there, and keep the lights on,
Chris Wiles, CFA
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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