sustainability of government deficits (Capital Economic)

The colourful table above from Capital Economics shows how sustainable the government deficits are in the Eurozone.
Nobody has a completely green score card. Even Greece has something green (total debts versus GDP, something that is pretty normal for a country where the rich almost dont pay taxes; but it is not in line with the criteria of Capital Economics: it is above 170%).

Germany leads in Green Revolution

Germany is the farsth in the Green Revolution. The chart above from Der Spiegel ((http://cdn2.spiegel.de/images/image-354621-galleryV9-entn.jpg) shows this.
This is an expensive hobby. Until 2020 this wiill cost about € 154B , around 2030 € 335B.

The US follows at a big distance (https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgEwX9f1Dg2oVjgiz1tIWj965XZVk1bKBw4EMAMwPa6iyRCxmokMWhsGXoN9eeAKRk2sqqd-xVVyS5tilpgu6DoD5j-dmmzN0E0hKUhrpVEDCAlHmBq8_qiYgokubpdjAcnpwsxeicGXTA/s500/energy.jpg
But they have enormous amounts of natural gas (with fracking etc.)

Is austerity bad? Why no push for infrastructure investments in the West?

It is hard to call economics a science. You cannot give an emprirical and theoretical answer that is not contested on the almost most important question of the moment: is fiscal austerity good or bad?

The opinions about this topic vary immensely. There is some consensus that 1% more austerity by governments leads to 0.5% lower expected economic growth. That is what according to Brian Reading of Lombard Street Research for example the OECD is doing for its forecasts of 2013.

Some economists like Richard Barro see almost no negative influence of fiscal austerity. Other economists like Krugman and Summers see the end of the world (at least a rehearsal of 1937-1942) when there is much austerity.

They think (and write) that the current economic conditions are causing a way bigger negatieve influence of austerity: maybe 1% austerity leads to -1.5% less growth. This is happening now in several countries because the output gap is big combined with a credit crunch. According to some simulations with numbers of the IMF you can get these results, so warns also Reading. So austerity will not cause a multiplier effect but a divider.

This clearly seems the case now for Greece and Spain.

Macky of JP Morgan had a scenario analysis for Spain. When you have a divider of 1.5, then growth collapses: -21% per year in the next decade (every year). A divider of >  1 makes the situation unstable: total collapse is possible in that situation.

Keynes was not insane with his tehrapy for governments in the great depression:  more austerity was a disaster, we are still mocking Herbert Hoover and his stupid policies, and more fiscal stimulus will help when nobody else spends money.

There is uninamous agreement under economists that the multiplier of investements is the biggest, bigger than that of consumption. There is also a majority that thinks that it is wise to do more fiscal  austerity when the output gap is about zero or better. Stimulus will only lead to more inflation in that situation. So for countries with  a low unemployment rate like Germany and the Netherlands fiscal austerity will not be bad (for the Netehrlands it also helps it is a small country). But it definitely will help when you push investments / R&D, / education and then accept a bigger government deficit.

In Europe and the US they only talk about how to reduce spending/ how much the deficit has to go down, but not how to do that. How do we get to the extra growth that

Hollande rightly sees as necessary?

It is clear that governments have to invest more in infrastructure. That must be made possible with European bonds only for infrastructure (from EIB for example). That would help. You must isolate deficits because of infrastructure spending from other deficits. We need a return of the old fashioned golden rule: government deficit has to be zero ex government investments.

 

China: economic growth lower for longer: because of middle income trap or passing of Lewis Point

The growth in China disappoints. The Chinese Citigroup Economic Surprise Index is lower than in Europe. The last data are bad.

More people are starting to believe that the growth is not all recovering to 7.5%+ but going down to about 6-7% to stay there for longer. Ex big help from the government it can stay there for years. Government will step in because they see also the low growth but much less than in 2009 and with much more caution and less soon.

The explanation for the disappointing growth is the slower investment growth, export growth while retail sales are now also disappointing.

That slowing of the investment growth is seen and forecast by the Chinese government in their five year plans.They rightly put more emphasis on consumption growth.

Chart of investment growth in China (no numbers for the months in which the Chinese New Year can fall)

The consensus thinks this decline of investment growth will be temporary and is to be seen as a payback of the bubble in 2009. When the soft landing is over, you will see numbers like the green line.

More and more it is becoming clear that the slowing will go further, to about 10-15% or even lower. Credit growth will not recover to the old growth and lower reserve requirement ratios and lower interest rates will not help much.

There are two reasons for this:

1. China is falling in the middle income trap, just like many moons ago happened with Japan and Korea (the good examples) and Latin America (some of the bad examples). Even in the good examples economic growth slowed considerably. Investment growth slows and consumption growth accelerates but the multiplier of investments is higher than that of consumption so growth slows and productivity growth also.

China is passing the Lewis Point, where the growth of the number of labourers in manufacturing will go to zero, while in previous decades that grew with 20-30 million of farmers became workers in manufacturing wit hits much higher prooductivity and added value. The wages go up considerably after the Lewis Point, but this doesn’t compensate enough for the stop of the growth of the labour population. Capex is going down because of the higher wages and the loss of emergency to create work for new labourers.

2. China invests way too much, as much as the US and Western Europe together. Investments/ GDP are much higher than was the case in Japan and Korea when they passed the Lewis Point. There is much overinvestment now in China as is to be seen in real estate and inventories of commodities. Investments/ GDP have to come down a lot.

The growth in China will not collapse, even with lower investment growth and lower exports to Europe, because consumption is doing well (forget the last numbers) and lower inflation will help. Wages are rising fast, inflation is declining, oil prices going down.

There are still many good infrastructure investments to do in China and this will help growth more than it did in Japan in the 90s.

So I think we will see about 6.5-7% growth in China this year, with infrastructure investments etc next year 7.5-8.5% and then on average 6-7%.

!0 year Germany going to 0.5-1% (Buckley)

This morning George Buckley from deutsche bank sold his moderately optimistic gospel for the short term and the pessimistic gospel for the long term.
It is becoming abundantly clear that Europe is in a Japan scenario. The 10 year yields of Germany are following the script precisely. So yields will go to 1% and then stay there for ten years at levels of 0.5-1%.

Real yields are so low for a good reason: growth will be slow in the next century. The UK will see lower growth than the average since 1830.

It is also ridicilous that economists don't believe the Bank of England and that inflatie will be only 2%, not the 2.5% of the consensus.

Yes they were wrong after 2008, but they were pretty close to target from 1997-2007.

Chinese electricity production disappoints: soft landing goes down further

The stories about economic growth in China are not getting better. After decent numbers in March that did give hope of a soon end of the soft landing, April numbers disappointed severely. Credit growth deteriorated. Also worrying is the sudden decline of the electricity production in April. Because that is one of the more reliable numbers in the Chinese statistics it is even more worrying.
Several brokers say you must not get overpessimistic, this kind of growth of electricity production points to 6% growth and electricity production will grow faster soon.
(chart from FT)

The Netherlands after 1600: boom, stagnation, boom or new period of stagnation

In my presentation Wednesday for the Dutch association of investment analysts (VBA) about “The Kondrtieff wave and longer”  I showed the two very long charts below (and many other charts).

The first chart source
 http://www.hoofbosch.nl/Aandelenvanaf1602/tabid/69/language/en-US/Default.aspx ) is the Dutch equity market since 1602 (VOC only of course in the first years).

You don’t see Kondratieff waves in the price pattern. What you do see is a tremendous boom from 1602 to about 1730 and then there is a stagnation that lasts until about World War II. From 1950 you get a tremendous boom that just until 1960 produced an all time high , above the one of 1735. This boom ended in 2000.

I think the Dutch equity market will join the other markets in the world (=high correlation with the S&P500) and that will be on average favourable: profit margin will stay high, exports will remain good because of Emerging markets compensating for the disaster in Southern Europe and because of tremendous technological progress (=lots of innovation profits).

Most important the times will be better than most people think now and that will mean higher valuation. Conclusion: better times for equities ahead.

Jaap van Duijn (former CIO Robeco and Kondratieff wave adept) concluded from the chart and his chart of the equity market in the UK since 1800 that stagnation is normal and this normal situation has returned and will remain the base scenario for the coming decades in the West. We just have to get used again that you invest in equities because of the dividend yield, not because of elusive profit growth in the future, just like the old investors in Robeco thought form 1929 to 1982.

The second chart is about the house prices on one of the main canals in Amsterdam, the Herengracht. Piet Eichholtz has collected a lot of data about house prices of the Herengracht since 1600 and produced this chart for a standard average house (all land plots had the same length at the canal, only in the corner you had smaller parcels with half the length and depth like my little house).


Again you see a big rise of property prices until 1730, a big decline until 1800 (bankruptcy of VOC did hurt) and only after WWII prices started to rise to set a new all time high in real prices in 2006.

The chart makes of course no correction for the fat that Amsterdam Herengracht was the most prime location in the world until 1730 and after 1730 it became less prime (but still it is an excellent location). Also there is no correction for restorations.

This is in line with the price development of my little house on the Keizersgracht. The land was sold for 300 guilder in 1672 (the disaster year in Dutch history when England, Germany etc. attacked the Netherlands), the first speculator bankrupted and only in 1680 the house was built and sold for 2000 guilder. It reached its highest price of 6400 guilder in 1730 and then it lasted until about 1960 before the price became higher. It is completely renovated in 1975 and sold for 450,000 guilder in 1978 and I bought it in 1982 for 200,000 guilder (and some other things), after 1982 prices exploded again (to about € 600,000 or more) and now the prices are in decline again (a fall of 25-30% from top should be normal). So here the stagnation seems to last longer, there is no help from Emerging markets.

US houses too cheap (mortgages rates versus rents)

Felix Salmon showed with the chart above that houses are now really cheap in the US for the people that can get a mortgage. These happy fellows then no longer have to worry about faster rises of the rents.

Jaap van Duijn and the daughter of Kondratieff

Yesterday we had the Kondratieff seminar of the Dutch association of investment analysts ( Vereniging van BeleggingsAnalisten) with Jaap van Duijn and me as speachers.


Jaap van Duijn started his story with his encounter of the daughter Kondratieff as a result of somebody that had met her at an equestrian event where she also was in the jury. She was very interested in Jaap who had written so obviously with great respect about her father.

Jaap did get so the only picture of Kondratieff that was known (the picture above of course). Jaap gave a copy to Gerard ter Veer and that picture we used thankfully in our scripts about the Kondratieff wave.

In that time there was no glasnost yet and she had to be very careful. She managed to debunk some fantasy stories about Kondratieff. Nicolai is not at all exiled to Siberia but was imprisoned just outside Moscow. He was not so much a danger because he made his theory about a long wave of good and bad times but just he was an intellectual.

Kondratieff was a quite modest person despite his famous theories and the start of a Russian planning agency. He was not saying the prices followed a Kondratieff wave, it was Schumpeter that named the long wave after Nicolai. Kondratieff just suggested that there might be a long wave of prices. The Dutch de Wolf and van Gelderen had already earlier suggested an existence of a long wave (one of the reasons why the Dutch still have an above average interest in the Kondratieff wave).

He was quite young when he became under minister of agriculture and that is why he was so interested in agricultural prices on the long run.

Kondratieff was as scientist fors ome time at US universities, but he went back to Russia. That was not such a good idea because he first was sentenced to seven year jail and after those year the sentence was repeated and at long last they killed him in 1938.

Jaap was in 1992 in St Petersburg for the celebration of the 100th birthday of Kondratieff, but what stroke him most was how poor the university was. He got some manuscripts of the daughter of Kondratieff he had written in prison.

Further there was laughter when Jaap told how he started his research after the Kondratieff wave in 1974. He lent a book of a French scientist that was not lent out after 1959. That encouraged him to go further: the Kondratieff wave was definitely not over researched.

The exponential decline of the price of solar energy

Diamandis and Kotler had in their book Abundance : The Future is better than you think (the best book of 2012 according to the Club of Optimists) a chapter about energy.

The chart above shows the price of solar energy halved about every teen year. In China the last years this decline has been way faster. Recent technology breakthroughs will make more faster progress possible. That halving in ten years seems to be a prudent estimation of the trend.



That is wonderful, very good news because it will make solar energy in some time dirt cheap. The fans of singularity like Kurzweil will be true believers in solar energy. It is almost unlimited available, in principle enough to provide in the total electricity production of the world. That is not happening yet, because solar energy is still too expensive for the time being.



A square kilometre Sahara receives as much solar energy each year as 1.5 million barrels of oil or 300,000 ton coal. The Sahara alone could produce 40 times the total electricity production of the world when you should make the Sahara one big solar panel.



Diamandis and Kotler give as an example of cost reduction the achievements of 1366 Technologies, that will get down the costs of silicon wafers, the most expensive part of solar panels, down with a factor ten. The forecast that solar energy will be cost efficient within five years in California for a household.

Will China be bigger than the US in 2016 as Ferguson forecasts? Or never?

John Mauldin had the chart above from Niall Ferguson (http://www.businessinsider.com/mauldin-a-graphic-presentation-on-the-sorry-state-of-the-global-economy-2012-5)  about shares in the world GDP of the most important countries. and his forecast until 2016. So it is definitely not a certainty.

China is approaching the US GDP very fast. The real growth is I think about 6% faster, inflation is a 2 tot 3% higher and the yuan was appreciating with about 3 tot 5% a year. Together that is a lot and nominal GDP of China could surpass the US nominal GDP around 2020. Ferguson thinks it will go even faster (he is more negative about the US).

But is that going to happen? The yuan is no longer appreciating. Worse, China is now fighting the middle income trap , and 85% of the countries did not manage to win that battle. China must undergo a transition from an export and investment driven economy tot a consumer driven economy. For the time being the signs are favourable. The wages rise rapidly and people want to consume more, the middle class is buying everything.

China is overinvesting in a terrible way, not seen before in the world (China invests as much as the US and Western Europe together) and this will go all right only for a few years. The Chinese government tries to stop the overinvestement, but this is a nearly impossible thing to manage. Around 2018-2020 it will go wrong in a terrible way. Just like in Japan after 1990 investments/ GDP will have to decline substantially for a long period. The demographics are already bad at the moment (after decades of tremendous growth of industrial labourers and fast rising population after 2015 we will see a decline in the labour population and no inflow from ex farmers). When those overinvestments become bad investments that will cause a real recession in China (not lower than 6% growth, but lower than 0%). This will cause a recession in the entire world, the first China driven world recession.
China is not flexible enough to invents its way out so it wil last long.

The growth of the US in US $ will be quite often be higher than that of China in that scenario. Population growth in the US is high, the US is much more innovative, profitability is beter and more solid. When the bad times in China will last too long it is even thinkable that the US GDP in $ in 2100 is higher than in China. The population of China will decline from 1300 million to maybe 950 million and the population of the US will grow from 320 million to about 500- 550 million in 2100. It is definitely not unthinkable that GDP per head in the US will still be double that of China in 2100.

China: credit growth accelerates and decline of house prices is stabilising

The credit growth decelerated in a year time from 9.7% to 8.1% and that is reason enough to forecast lower growth in China at the moment.

The numbers of April show fortunately a big revival and that is a powerful indication China is in a soft landing that will be over in H2.

The prices of houses in China are declining, but the decline is stable and low. The trend is not yet bent up again. 8700 yuan or about € 900 per m2 is a lot for a developing country (too many times the average wage), but for a house in a big city with far above average wages it doesn’t seem too ridiculous. As long as the downtrend continues the recovery from the soft landing will not be that great. Residential investment, construction has grown way too fast for a number of years in China and even after the soft landing this growth ought not to come back to the old 30% growth.  

Chinese equities were a disappointment compared to the high GDP growth. Will they do better now!

In the Financial Times (http://www.ft.com/intl/cms/s/0/4c38bfc4-92b3-11e1-b6e2-00144feab49a.html#axzz1u0KENQdr China stocks battle the growth paradox) , was again an article that demonstrated good economic growth is not always a good equity market. The most grateful example for this is the Chinese market where since 2001 the equity market rose only 46% while the value of the output as up almost five times.

In general I agree with the thesis that the relation between the growth of the GDP and the stockmarket often is not that good or not there at all, but one should not too automatically take that as a certainty based on numerous scientific studies. Who could forecast well the economic growth in the next two quarters in the US could have earned lots of money with that in the previous few decades (more precisely: one should have avoided big losses: when you see a recession arriving you have to get rid of your equities).

The Chinese equity market is a difficult one with it’s a and B shares where you as foreigner are a B investor. Insiders that know what the government will do have a big advantage.

Wit IPO’s the prices are often way exaggerated obeying to the wishes of government that places again and again more shares of state companies. That continued dumping is also very bad for prices. So Joe Sixpack is very disappointed about equities and prefers to make money with art, porcelain, stamps etc. .

Government has dumped bad state companies at the markets. Especially banks had to finance these loss making state companies with lots of loans and so the banks were saddled with mountains of bad debt.

Because of the high GDP growth a lot has improved for the banks. The state companies are more efficient now and there are now more normal private companies at the market. So the quality of the Chinese equity market is a lot better than before say 2000.

 Until 2006 the Chinese equity market was doing horribly because of all those garbage, but in 2006 one started to realise that the quality of the companies had improved tremendously. Suddenly everybody started to buy and the Chinese started to gamble with stocks, believing the fairy tale that earnings would grow with at least the high nominal GDP growth. Then the credit crisis arrived and gone where the profits.

At the end of  2008 the Chinese government started to make investing in equities more attractive again with lower transaction taxes etc., not only with high infrastructure investments. As investor one can better believe the government (even more tha in the US don’t fight the FED) and so you had to buy.

The chart in the FT (http://im.media.ft.com/content/images/13065c62-92f3-11e1-b6e2-00144feab49a.imgc) suggests that the Chinese government thinks share prices are too low and that they want action, less insider trading etc. and the Peoples Bank of China will of course follow suit. Especially when you believe China has a soft landing you should maybe obey again to the Chinese government and buy Chinese equities!

Map of PMI's in world: deterioration and improvement in May

From  Business Insider two charts(Platt) of the PMi's in the world.
Above was the situation in April, green (=>50) in the Americas, India, Russia and reddish (=<50) in Europe and Australia

In May the situation had deteriorated in Europe and Australia, but also in Brazil.
There was improvement in the US and China and Russia, so you can't say there was a deterioration in the world of the PMI's. Also important is that the PMI of China is the longest leading PMI and then follows the US, while Europe PMI always was lagging on the US

Lombard Street Research (Dario Perkins) the three big problems for the world economy: Europe, US fiscal cliff and the problems of China

Dario Perkins was in our office today to sell the gospel of LSR, Lombard Street Research. LSR is a little more optimistic than normal by only seeing three big problems (Europe, the fiscal cliff of the US and structural plus cyclical downturn in China).

All in all they still believe in the US in the long run and there is optimism about Japan that will grow because of reconstruction spending.

Why so optimistic about the US?

 The US is so flexible, innovative and business has done the deleveraging that was needed, households have to do only a bit more and government is not that much of a problem on the long run. The financial sector is not that big that it will create problems (unlike the UK, Spain, Italy etc.). The US $ is now competitive, even versus China.

The short term is more of a problem in the US: the fiscal cliff will come into force in January and take 4% of growth. He thinks half of it will be repaired but with big risks: maybe the lifting of the debt ceiling will not be managed in time (because of elections there is only about one month left to arrange things, that is way too short as we saw in 2011) and with big disputes.

China: LSR is the most negative on China in a decade: there are structural problems (the mid income trap that caused a growth pause in 85% of the countries that got from poverty to that middle income level), the transition from investment/ exports to consumption will be difficult. They cannot increase market share in exports with the old products now wages have become too high.

Short term cyclical problems: stop and go problems cause way too little growth of M3 now. Credit growth too low for high growth, government stimulus a problem. GDP growth is clearly lower than official statistics indicate, only about 6%.

Europe: the frog will be slowly boiled

Europe is repeating the errors of the US in the 1930s/ Japan in the 1990s. Bigger austerity is working out counterproductive.
Further decline of house prices in Spain, Italy etc will increase the problems of banks while the banking sector is too big in several economies.

He sees underestimation of the probability of bank runs (Greek banks already have 50% less saving deposits)

Politics Greece: right wants lower taxes, normal parties at best 45% of votes, extreme parties 55%: so  a big majority will be for no more fiscal austerity = quarterly help for Greece will get less support in the rest of Europe, the core will throw Greece out of the euro.

Biggest problem of Europe: Europe has no growth policy, no credible policy how to get out of the problems. No ECB that helps enough, that prevents deflation/ depression thinking

ECB: no targets yet for bond yields Spain Italy at say 6% because of opposition from core Europe: sustainability will force this over some time.

FED: Bernanke has done a very good job with avoiding deflation expectations to get hold, he needed unconventional policies that had no majority in any central bank. He got it and radicalized against the will of the hawks. Because of diminishing return of QE etc the US needed more and more radical things and that happened. He still is limited because he doesn’t want to enter the history books that blew the monetary policies with unconventional measures.

 Fiscal policies: Europe will start taxing profits of business that are hoarding too much. That will not happen in the US and the UK.

All in all are big parts of Europe sinking away. What happens with France will be critical. The help to the PIGS is unsustainable (5 to 8% of GDP of the Eurozone every year). Their wages have to become competitive with Germany. The euro will remain too strong because the market expects that the weaklings will leave the euro and the strong countries will remain in the euro. So European governments will not get rid of their high debt/GDP ratio with more austerity, banks will go down the drain because of very bad real estate markets especially in countries with too big banks, bad real estate markets and a lot of government debt.

ISM almost 55 like model

The ISM surprised to the upside after the disappointing reports from the Phillyfed and other states, the lower orders for durable goods. Orders etc were good, so now people are starting to believe the ISM can rise further (unless the pain of Spain becomes too big and contaminates US (exports, financials etc)).

Still it was no surprise at all according to the little model I use since some time to get an impression where the ISM is headed. It is based on the lagged output gap measured with the capacity utilisation numbers (a big output gap normally causes the ISM to go up), the lagged decline of intial claims for unemployment (a decline is good, it signals more income and final demand ahead) and the lagged rise of the retail sales (this helps the ISM, especially when people buy things).
The model points to an ISM that will remain close to the level of past month. Further away the ISM could go a bit down because the intial claims are rising.