Another Greek Panic Recedes Once More

Yet another Greek Crisis has been averted, another kicking of the proverbial can. Syriza has seemingly sold out its election pledges to keep the status quo intact. Should it be a surprise? What were the options?

Greece's largest creditors are members of the EU and the European Central Bank. Greece is broke. They have two options, to stick or to twist. Stick involves keeping on the side of their EU creditors. The twist option would be one of even more potential disaster. One only has to look at Venezuela for what happens when a country goes broke. Empty Shelves, rampant inflation, crime waves, brain drain emigration and no foreign investment. Greece could have decided to break from the EU but this would have involved the whole countries banking system becoming insolvent. Capital would be wiring instantly out of the country. A National currency would have been established to replace the Euro. Only the Government is broke. No foreign capital would come forth and with little genuine domestic capital would have resulted in the inevitable currency devaluation accompanied with crippling inflation. Syriza, now in power, realise this reality. They had to get a deal.

The real question how many crisis will we get? France, Belguim, Spain, Italy - you could name any of the EU countries, they all have terrible fundamentals. There will be other issues elsewhere, but all will be papered over, kick that can - thats what I can be sure will happen. How long can that "can" be kicked for? As I've said until the centralised central policy makers - IMF, Central Banks, Governments - can't fix the problem. In other words events go beyond their control. Currently they have the illusion of control. But in time they won't. We are in the midst of a super bubble, the bond bubble. I knew it would go bad but I didn't think it be this bad. 

It may sound like a doom rant but it was the same back in 2006 when I said similar (housing, Government Deficits etc). People not only didn't want to know, they think you to be some sort of loon. Then 2008/09 hit with everything going into a tailspin. Its going to be the same once more, only this time worse. I still believe we have some years to go. Interest Rates will go lower. Stocks will go higher. All this will fool everyone to believe all is well. But don't be fooled. The bond bubble will burst with catastrophic consequences. Currencies will be decimated. Chaos will ensue in financial markets once more, worse than in 2008/09. Governments and Central Banks will be helpless. It will be an economic event that we will all remember and tell our Children and Grandchildren about. 

Growth vs Austerity

The battle between Growth and Austerity continues as economies have become stagnant with no end in sight for the current crisis. In one camp the solution is to grow our way out of trouble by increasing public spending, therefore trying to shrink the debt as the economies size increases. The other school states, we need to reduce spending and remodel the economy away from the old borrow and spend mentality. It's hard to know who to believe. On the one hand economies got into this mess because they spent beyond their means, increasing their GDPs to artificial levels therefore one could conclude that the logical outcome is to reduce spending, to set right these imbalances. However many nations have adopted Austerity, growth has flatlinned, even gone into reverse, and created higher unemployment with incomes being continually squeezed. 

Do our main political parties really offer options? In the UK the pro growth Labour Party claims we need to increase spending, while the Conservatives, the pro austerity party, claim we need to cut spending. Despite all the rhetoric the difference between cuts actually implemented by the Government and the cuts that would have been proposed by the opposition under Alistair Darling results in only a £9B difference, small in comparison with an economy estimated to be in that value of £1.5T.

The problem with both camps is that neither really offer solutions to the problems at hand. Greece has attempted to implement austerity but has not really addressed the core issue. That core issue is the fact that the country is bankrupt, and when something is bankrupt it needs to default and restructure. Without a default and restructure the debate on growth or austerity is irrelevant, Greece will never be able to get out of its current mess. The same goes for many nations facing similar issues, primarily spiralling Government spending with income from taxation not keeping pace.

The schools of thought can be summarised as follows.

Austerity

In order to solve deficits austerity proponents state that spending has got out of control, therefore Government spending must be cut. A lot of the cuts are half measures, cuts made on the fringes of the welfare system that don't amount to much and don't affect the majority of the people. 

Interest rates are still held exceptionally low, printing money is still deemed as austere and emergency loans from the ECB/IMF are considered to be tackling the spending crisis.

With the above, austerity is not really being implemented instead many countries are just postponing spending into the future.

Growth

The followers of pro-growth believe the false Socialist Keynesian fallacy that we need to increase Government spending in order to haul our economies out of this mess. They believe that Growth can come from the Government and this will alleviate the debt crisis. Its a simple solution, although fatally flawed and over the long term would have the complete opposite effect. The level of bankruptcy within the country would intensify over time, with peoples living standards eroded further.

As spending increases, so do deficits. Governments over the long term can never create growth by arbitrary spending. Over time, taxes are raised to try and cover the gap caused by increased spending, undermining potential future growth further. Genuine capital for investment begins fleeing along with income from taxation as individuals stop paying taxes. The Government is put under further pressure and prints money to cover the shortfall. Inflation rises, living standards decrease, Entrepreneurship dwindles. In other words it becomes a vicious cycle where the Government finds themselves back at square one, however now in a more dire state of affairs. The Growth camp can only intensify the crisis further.

Default and Roll back of state

The other camp that remains out of the debate is one of default along with a roll back of what functions the state should perform. As Governments can not pay on the majority of their spending commitments they need to default on bond holders. If Greek debt stands at over 100% of GDP then the best way to reduce this is to default on much of it and liquidate capital, similar to private entities and companies. Billions of Dollars are liquidated all the time, either through share price falls or outright bankruptcy, yet the system is incredibly efficient and re-mobilises economic resources producing genuine long term future economic growth. 

The solution also involves rolling back the state and allowing free enterprise further reign in society to improve productivity and reduce costs. Healthcare, Schools, Government Pensions - the costs continue to rise while productivity falls. Private capital would solve many of these issues.

Default is politically unpopular and a banishment of the state is a banishment of politics. Many people still believe that state systems are "free" and that they benefit from them i.e. they take more from them then what they put into such systems, convincing many members of public that we need welfare. To default on loans is a political parties nightmare as this tarnishes the incumbent Government, despite helping to solve the spending problems by freeing up wasted lines of production. It is important to distinguish that a default will not solve the issue on its own, the Government has to take the correct action after the event, that's why a roll back of the state needs to occur with moves towards greater individual freedom and a smaller state.

In our current system only until market forces deem the situation so dire does bankruptcy come about. Currently the market is lenient as it realises debt can be monetised by Governments and inflation is historically low. It also realises that Governments control the rules and consequently can lend to itself or other Governments (as its been doing). Without the recent QE and low interest rates the market would have already started forcing bankruptcy upon many nations, fixing the ills we see. When Governments have such extraordinary control economic problems get out of hand, in comparison private companies go bust very quickly if they can't control expenditure versus income. Governments merely take or adjust the rules in play to avoid this scenario, thus continuing to put economic resources to bad use.

Default comes about when inflation gets out of control or Governments struggle to monetise the debts, then the markets deliver the killer blow  instigating a default. Britain went Bankrupt in 1976 because inflation was out of control meaning printing money would have been unacceptable to the public and markets refused to lend to a Government who couldn't control spending. The IMF bailed the UK out but it didn't fix anything, it just pushed the problems into the future. We should have just defaulted and rolled back the state. Of course the Government can still ignore these signals under a dictatorship and just print more money et al Robert Mugabe, leading to a world of misery. 

From a global point of view, the current fractional reserve system can deal with the odd small country defaulting, say Iceland, but when it comes to larger entities such as Italy, Spain, France, UK and so forth, then the true naked state of the system is shown. The interconnectedness of the current fractional reserve banking system comes down like a house of cards, calling into the question its very existence. People would then ask questions such as why do Governments have free reign on interest rates, money and permit fractional reserve banking? Why do we need Central Banks? Why do we need Governments? The ultimate solution is to remove all central powers, instead  empowering individuals with the freedom to run their own lives, free from third party interference.

Current state of affairs

So we find ourselves in the current predicament, no one really wants to do the right thing therefore the crisis is prolonged. Governments have great power through the monopoly they have in money so rather than accepting the situation they opt instead to push problems into the future. Bankruptcy and failure is nothing to fear or to avoid, it happens all the time in the free market and is an outcome of discovering prosperity. Until people are educated and aware in such matters then we will always have Government debt crisis throughout history on a regular basis. Austerity or Growth, both solutions do not fundamental solve the problems baked into the system. 

Central Banks are changing their Tune

This week the IMF began sales of their Gold reserves. I have mentioned previously that the IMF have been looking to do this, however how wrong was I regarding what may happen to Golds price! Two hundred tons came onto the market and rather than the price possibly dropping, the price instead soared. The Central Bank of India gobbled it all up in a single transaction. Many articles have already been published in relation to the event, and with good reason. The shiny stuff has risen in price for the past decade, despite european central banks selling huge quantities, the most infamous being my countries sale of half our reserves known appropriately as 'Browns Bottom'. The worlds central banks are suddenly looking at Gold from a different viewpoint. The move by India shocked everyone. The next sale could see multiple buyers apply, China, Russia, Brazil and other emerging nations will be feeling anxious - "How do we get out of our paper reserves"? One day there will be a rush for the exits, a dash for the ultimate form of cash. Meanwhile Geithner and Obama parade around the globe, reassuring foreigners of their strong dollar policy, their words contradicting their actions. A sound currency does not exist with zero percent interest rates, deficits as far as the eye can see along with printing more of the stuff. You don't need to be an 'A' grade economist to see the anomaly.

It's important to remember that you can't grow gold. Gold can't be produced in a factory, or planted as a tree. There has always been a finite supply throughout history and when there's no where for investors to turn, they head to safety, historically that has been precious metals. The limited supply can be seen with the recent "Sell your Gold" adverts, dealers buying the public's jewelry, melting it down, and selling it to institutional investors. While the recession continues to force the public to liquidate their hard assets for paper cash, the paper cash investors are diversifying into such assets. One only has to look at the events last autumn, bullion dealers ran out of stock which caused the adverts you now see. Hoarding along with limited ground supply has led the dealers to impell the public to sell.

One thing you have to understand is that China is sitting on 2 Trillion Dollars of paper promises. They currently have around 1,000 tonnes of gold. $2 Trillion could buy them an awful lot more, if they can find willing sellers. The recent IMF sale was $6.7 Billion for two hundred tonnes, I'm sure you can do the maths to see China's buying potential. Compared with nations in the West, many other emerging economies still have woefully imbalanced Gold reserves as the table details (original table taken from following article).



There are many countries who have plenty more cash to convert into Gold, histories ultimate form of payment. Germany, Italy and France hold approximately 70% of their nations reserves in Gold. Compared to China, India and Russia with 1.9%, 6.2% and 4.3% respectively, if I was a betting man I would say the latters percentages will inevitably increase.

For too long the West had a monopoly of talent and capital, corrupt regimes around the world ensured this. Battles between the far left and right in South America, Asia's experiment with Communism, Eastern Europe held back by the Iron Curtain, Middle Eastern states squandering the oil bonanza of the seventies and of course Africa's various despotic rulers. For too long during the 20th Century statism looked like the solution to peoples problems, when in fact it was the cause. Many talented individuals migrated to the West in search of a better life for their families. The collapse of Communism along with the revolution in telecommunications saw to it that many emerging nations began to realise their potential. Why emigrate to the West when they now have the same intellectually challenging jobs at home? Many Western countries still have one trump card - longevity in respect to human rights. No matter how bad my government messes up I always know I will be able to say what I want. I always know that the right path will eventually be trodden. I always know that Britain was the first nation to overthrow a monarchy on the continent during its Civil war, thus beginning the process towards the present inherently stable democratic system that has endured for centuries. The above may not seem much, but its amazing how we can all take this for granted. It won't stop the shift of power from West to East. Gold, it seems, is also moving in the same direction.

Thoughts on Oil, Gold and Bonds

The economic news has been quiet of late in comparison with the events we witnessed over the Autumn and Winter in 2008. However there are some interesting developments taking place in the markets. No one can know for certain what will happen in the short term, but I have some opinions of what I think will happen in three key assets, Oil, Gold and Bonds.

Oil

We have seen a recent rally in the price of oil for the past couple of months, with it hovering around the $70 mark. This has pushed up the price at the pump here in the UK to around a £1 a litre. Is this the beginning of a new rise to $100? I doubt it. It's just a rally to accompany the green shoot theories we are all been told or the reports stating that emerging markets are set to grow, but the world has serious issues and we are not going to get a new global boom any time soon. All these imbalances that were created over the past have to be addressed. Someone has to take the pain, but that has yet to happen. Investors such as Jim Rogers have stated they don't see anything worth buying, anywhere in the globe.

Over the long term I'm sure oil will hit new highs - in fact it has too. $200, $300, $400 dollars a barrel, I'm sure we will hit all these milestones in the coming decades. But as the globe enters what seems like a global depression demand just won't be strong enough. If people don't have jobs or incomes then people don't travel as much, and buy products that get transported as demand dries up. Over the long term we will get an oil drilling bonanza, as supply will not be able to keep up with the expanding industrialisation of the globe. When America peaked back in 1971, that decade brought about the biggest investment the US had ever spent on oil exploration and extraction, more money than its entire history. My father was one of the people who lived out there for a while as a young Chemical Engineer back during the oil shocks as the US scrambled to produce more oil (if he had stayed I would have been a Texan). We will have the same in the future only on a global scale. As the oil price climbs, green technology or alternatives will also have significant amounts of money poured into it, a possible future bubble, and if you know the sector there may be some good buys in the next couple of years, but not yet in my opinion.

There is only one reason that would cause the oil price to shoot up in the short term and that is war or civil chaos in the nations that produce oil. The west now relies on its energy from unstable regions of the world. There have been disruptions to a pipeline in Nigeria recently. The recent civil unrest in Iran is a further sign of rumblings in a nation that has potential to prosper, but has a regime intent on not allowing its large young population from obtaining wealth. Unemployment has been a hallmark there for years as the nation can not attract foreign expertise and capital to develop further. Iran has a lower per capita income by a third since 1978, which shows the declining living standards the people have had to put up with. Hostilities towards the west still exist, Persia in the past was a strategic location for oil for the UK which led to the downfall of the shah as resentment grew. With the wests support for Saddam in the Iran-Iraq war, diplomacy became even more strained.

Central Asia and Russia are other regions we obtain oil and gas from in order to diverse our supplies from the middle east, but that doesn't mean the region is anymore stable, its just a hedge between the two. Countries surrounding the Caspian sea such as Kazakhstan not only supply oil to Europe but have also made deals to Asia with China, South Korea and Japan picking up any slack that Europe doesn't use. All of Europe's domestic supplies are in decline. North sea oil and gas, be that from Norway, Holland or Britain are all past their peak. Algeria, which is another energy hub for Europe is also in decline. The EU is expanding beyond 'conventional' geographic Europe for this reason, trying to annex strategic nations such as Turkey or Azerbaijan.

Throughout history all great civilisations and societies have been built on increasing their energy inputs. From the Neolithic age where the domestication of animals increased food production, right the way through to the fossil fuel industrial revolution, society always requires energy to sustain and increase its living standards. Its no different to the age we now live in. Remarks about 'Black Gold' may have been made in the past, but for this century it really will be the case.

Over the long term I believe we will see price controls in energy. The media are already demonising the energy companies and oil companies for the price of such commodities. As long as we have prices set by market forces, supply and demand, then we have direction of how to live our lives and no shortages will occur. In a price based system you can never have shortages. It's always a common myth regarding markets, usually used to justify bubbles, that shortages will create rising prices forever. No matter how scarce a good is it will have a price. Only sentimental value can ignore price. For example there may have been a limited production of a certain type of car, but it will have a price, for example if you have to pay £10 million for it there will be a seller who will sell.

The problem is that price controls are always a popular policy, if the price of a common good has risen quickly in a short period of time. The is where the shortage begins. As the government sets a below market price, supply dries up - why bother selling a product for a loss? As the price is now cheaper then people can afford to buy more of it. With falling supply and rising demand you can see how much havoc this causes. During the 1970's oil shocks this happened when Nixon set price controls, and gas stations ran out of petrol. If prices float freely you can never get this situation as prices control supply and demand. If there is a high price it creates incentives to increase supply. It also creates incentives for people to demand less.

In the UK diesel prices were a lot higher than unleaded petrol a year ago, in fact I was paying around 20-25p more per litre, but I wasn't worried as prices existed. Now they are both the same due to the above concept - prices. Now what if the government had implemented price controls at the time to bring down the price of diesel to petrol? First of all there would have been no increase in production, there would be no incentive to build new processing capabilities. Demand would have kept increasing too as people could be careless in their use. Both would lead to shortages. I posted about price controls back in October last year and from what I've seen I think history will repeat at some time in the future. Again, just not yet.

Gold

Gold I feel is also overbought. Its done its job during the collapse in asset prices last year, it held firm in fact increased depending on what currency you base it on. But I now feel it is due for a downtrend. The IMF is trying to sell a lot of its gold, and has had recent approval from US congress. There has been record buying over the past six months and I think this is beginning to fizzle out. Again over the long term, like oil it will no doubt rise in price, but things correct in the short term and this correction may flush out a few investors and scare some people away. Like oil there is a wild card - are you confident with your domestic currency? As Iceland showed, its no good waiting for moves in the price of gold in say Dollars when your currency collapses. As a citizen of the UK this is the only thing that worries me, but in the short term I think the pound should be able to hold out. Over the long term, I'm very bearish on it. For the past Century in particular after the second world war my country has continually debased, lowering the pounds value, once the reserve currency of the world. It was oil and gas that saved its value in recent times, but this is not going to be the case going forward. The US looks to be repeating the same mistakes of history as we did.

There's a great quote by Hugh Hendry, a hedge fund manager, who is occasionally on the various business channels. It goes something like this as I can't find original version;

"I can't get gold coins right now, there is record demand for them. The current events we are going through is like a book, and everyone has jumped to the last chapter where currencies collapse and its the end of fiat money, but everyone has missed the story inbetween. During the seventies gold halved in price from the 1973 credit crunch until 2-3 years later. This is the part of the story we have yet to see and when this happens then you fill your boots with the stuff."

He also has some interesting views on government bonds which is my next asset I wish to discuss.

Government Bonds

So as Governments deficits were rising last year, with stocks and commodities rising in value until the great collapse of September and October what was Hugh Hendry buying? Government Bonds (specifically he recommended German Bonds). Of course it proved to be an excellent move. As the year went on rates dropped to reach a low round in January of this year or so, increasing the value of the ones he was holding (compared with the losses that the stock market and commodities would have provided). However since then we have seen dramatic moves on the upsides in places such as the US. Interest rates on the governments debts have been rising, which has since wiped out any gains. However I still see a fall to come over the next 6-12 months. We are not out the woods in this crisis and we will get another flight into cash again as events unfold. When this occurs then the so called "flight to safety" trade happens, into governments bonds.

There will be more QE to come, which will create the artificial demand needed for bonds, expanding the bubble further. This won't immediately result in inflation as like with any inflationary boom, the market begins to try and undo these credit excesses during the bust. Prior to WW2 this always resulted in falling prices and a healthy deflation. In recent times however it has been stagflation. Inflation or rising prices accompanied by a recession. Due to the excesses of the credit boom there is a lot more deleveraging to come, therefore the free market contracting money. However in the long term this will be countered by the governments printing money, which is why I believe inflation will happen.

There were comments from a reader in a past post regarding how will the government counter these market forces with such strong deflationary pressures. The answer is simple. The Central bank is an institution who can lend an infinite amount of money, and the Government can borrow as much money as it likes. With such an arrangement it becomes easy to combat these market forces. A loss of $500B, no worries wait while I type that number into the computer. It's that simple. They just call it QE and give it more structure.

Coming back to Hugh Hendry's bond comments, why specifically German Bonds? This is where I suspect Hugh was using history as a guide (It amazes me when people tell me how useless history is, when many individuals use it for investing purposes among many other uses). For the past half century Germany has been one of the hardest money countries around. It didn't experience high inflation during the seventies unlike the UK because it realises debasement never works. When there have been discussions regarding QE for the Euro, who has been staunchly opposed? The German Block, the old Bundesbank. Recent political bills have been passed in German Parliament to set limits on government debt over the coming years to balance the budget in a few years time. Angela Merkel has been critical of US policies and deficit spending, with many of the German political establishment demanding government spending restraint. It's this rhetoric that gains it the credit on the market that it will be the most likely nation to honour its debts, rather than default through inflation. We will have to see if history holds up for these extraordinary times we are going through.


Markets move in mysterious ways over the short term, but I am sure we will get bubbles in all of the three above at different points in time. I do not make investment recommendations in this blog however for the short term, I'm still in cash. I think there are still some more great buying opportunities to come.