Where is the deflation?

"The Chinese government is expecting its economy to expand around 8% of gross domestic product in 2011, same as in recent years, but it has raised its inflation target to around 4%, indicating Beijing isn't willing to sacrifice growth even though fighting inflation is a top priority.

State television reported the new numbers Tuesday, citing Zhang Ping, the head of the National Development and Reform Commission. Next year's inflation target is a full percentage point higher than this year's target of 3%."

News that China will raise its Inflation target

If you were to believe the experts it is deflation we have to fear. Its just round the corner. Its a battle we must win. A depression must be avoided which apparently is caused by deflation. In the real world people are seeing costs rising all the time. Not just in the West but in emerging economies also. The Chinese authorities have raised their inflation targeting metrics in order to keep their bubble, sorry growth, moving up. A rule of life is governments always bend the rules. Its sets them. Free markets allow people as individuals to set the rules. Participants mutually trade with one another under an amicable agreement. The state takes at will and by force. Inflation is one such example, it benefits no one in society in the long run, only the government over the short term.

The fact that the target has been moved upwards should not be a surprise. This is what's going to happen everywhere, across the globe. Here in the UK our Inflation has risen yet again. Its now been above the target for over a year now and what are the "inflation fighters" (that is Mervyn King and his MPC comrades) doing about it, Nada. Zilch. They have already raised their inflation targets, they just haven't told the unsuspecting public. There's more price increases in the pipeline:

The increase in VAT from 17.5% to 20% that will come into effect next month will be used to "mask" more extensive price rises according to accountants at KPMG.

They claim almost two thirds of retailers and consumer product manufacturers plan to increase their prices by more than the planned VAT hike in January.

Martin Scott from KPMG told the BBC why he believed retailers would raise prices by more than just the VAT hike next month.

All this inflation is causing Government bond prices to stay high. Well I say high, but we haven't seen anything yet. They will go double digit over the course of this state induced disaster. Double Digit may seem high in today's environment buts that's what you would have thought when Interest Rates were single digit back in the seventies. In the US they eventually went above 20%. Ouch!

Well at least the banks are ok now. They were small fry. We have moved on to more impressive bailouts like, err, countries? Ireland, Portugal - what about when Italy and Spain need assistance? They in turn get bailed out by Germany or France or even the UK. Hang on, aren't we bust also? Yep. Fractional reserve banking, fiat state monopoly money, you have to admire it. The Governments legalised ponzi scheme. No one has the money for any of these bailouts. Deflation will never happen because Governments know this would be the end and a collapse of the system. Therefore they will print money. They will raise inflation targets. They won't even tell people they are doing this. Oil is at record high once more. Just like with any unwarranted inflation, peoples living standards are falling. Prices rise and real wages don't keep pace. 

Through all the bailouts and enlightened interventions, nothing has been solved. Its worse than before the crunch. Its the quiet before the storm, just like prior to the market collapse of 2008. Everything was fine until it happened. That's the problem with economic collapse caused by government mismanagement. You can't predict it, you just know it will come. And when it comes its always too late to act. We won't hit bottom until the market is allowed to cleanse itself, but that isn't going to occur. Until then, just know that inflation will always be there, always rising, even when it may seem its not. Deflation is just the Governments smoke screen.

The Euro, the Pseudo Gold Standard

The Euros showing signs of stress lately. The Dollar climbed to $1.43, its highest in three months as the fiat race to the bottom continues. Greece's sovereign debt was downgraded with the third generation of a Papandreou residing at the helm in what looks to be another Greek catastrophe. Spain somehow continues to mask the mess it finds itself in. At some point the poison will inevitably seep through. Meanwhile with regards to the other PIIGS (yes thats two i's, Ireland and Italy) we find Ireland have launched their second cost cutting budget in an attempt to appease the other 'sounder' Euro states. According to the governments figures they have come out of recession unlike here in the UK. Italy's leader Berlusconi took a beating, literally. Although the attack was appalling, its more disturbing to see such popular support for Massimo Tartaglia, the person who carried out the senseless assault. Austria's Government followed the new global trend by effectively nationalising the countries 6th largest bank, Carinthian Hypo Alpe Adria Bank AG, with the taxpayer now becoming it's largest shareholder. It's not the only bank in trouble with the countries 4th largest, Oesterreichische Volksbanken AG, also under the governments watch. Exposure in the Balkans and Eastern Europe, Austria's banking system is looking more insolvent as time goes on. Despite what Americans say about their banking losses at least their banks are declaring them. Europe's financial system is one monstrous black box, with everyone trying to call each others bluff. Even Germany seems to be throwing out the rule book announcing tax breaks despite a widening budget deficit, however compared with many other countries double digit percentage horror shows it won't sound an alarm with the bond vigilantes.

There's been many commentaries written in relation to the Euro the single currency that's used by 16 separate nations, usually critical toward the faceless bureaucrats who reside in Brussels. However its important to understand how the Euro came about. During Bretton Woods I, when the US was on it's quasi Gold Standard, they pegged the dollar to gold allowing only foreign central banks to redeem their dollars for gold. With increased deficits by Kennedy and then by Lyndon Johnson this spending had to be paid by someone, therefore the government does what it usually does, it printed money to pay the difference. When the Bretton Woods agreement was created the Keynesian's proclaimed that redeemability of the dollar for gold would cause no issues as institutions would never need to claim. Unfortunately for them they didn't count on Jacques Ruff advisor to former French president Charles De Gaulle. 'They run deficits without tears', thus Ruff advised De Gaulle to call the Americans bluff and trade in the paper promises for something that the American Administration couldn't create out of thin air. Others followed suit.

The rest as they say was history. Bretton Woods I was abandoned, in which we moved to the current global monetary system we still have now. The erratic fluctuations of the currency markets during the seventies accompanied with widespread financial turmoil prompted many European nations to look for solutions to stabilise trade, thus the chaos became one of the prime reasons for the single monetary currency created two decades later. There was an obvious issue from the start. Two distinct tribes existed within the union, the North dominated by Germans who had previously presided over the Mark, a currency as hard as any other in its day. The other faction, the Southern Mediterranean nations a historic bunch of pansies that would use their currency at the first instance of economic trouble to try and solve their problems. During its first 10 years all seemed well but when disorder came, the Mediterranean nations suddenly found themselves in a bind. They couldn't devalue or print as they had in the past, instead they were told by the Northern circle that they must cut their deficits along with reckless spending. Don't get me wrong, the ECB have dabbled in QE however in comparison to the Drachma, Lira, Escudo or Peseta if they still existed and were in the hands of the irresolute Southern Europeans, then things would be getting a whole lot worse for such countries as we tread into unknown waters.

The Euro is in effect a Pseudo Gold Standard for some. Similar to when the majority of nations had a fully convertible Gold Standard, there are checks on Government spending such that they can not rob the public through inflation, or sidestep genuine long term fixes with short term devaluations. This is not to say the rules can't be bent, the rules are always for bending when the government is solely in charge. For example the deficit limit for states that were to join the Euro was originally set at no more than 3% of GDP. Problem being that nations such as Portugal just moved some of their deficit from the official figures to assist in their entry into the Euro to meet the criteria. After the financial crisis fiscal restraint has been put on the back burner, another crisis will need to occur before anyone gets serious again.

Like a Gold Standard, the old bundesbanks dominance on the ECB acts as a check against others that are more willing to deploy looser monetary policy. It depends if you have the stomach for such medicine as to whether you believe it is beneficial.

Many commentators state that the Euro is the problem facing countries like Greece, the reasons given are usually the very same policies that got them in the hole in the first place, in this case excessive government involvement and monetary inflation. They are usually correct on one point, that it was the Euro that exacerbated the credit boom for many such nations. Generous subsidies to promote the Euro's launch created undeserved prosperity, accompanied with negative real interest rates in such countries, meant loose lending was endemic.

Ideas that increased inflation and spending can alleviate the problems we face are wrong. They instead increase the states control and crowd out private enterprise and initiative. Not only does it fail, but it becomes an immoral path as genuine savings are stolen from the people.

One of the questions people ask is what will become of the Euro? Will it survive? Will its members fragment? Will it gain in numbers and strengthen? I don't think we can arrive at a conclusive decision on any of the above as they are all legitimate possibilities.

Fragmentation could be possible. A number of nations could drown in their own debt but we have to realise governments always bend the rules. The ECB may show a tough hand for the moment but could ease if events got out of hand. If a nation did wish to exit then imagine the stigma attached to the politician in office at the time. It would take a brave politician to declare an exit from the Euro while others in the Balkan's, Baltic's and the East are clamouring for such prestige.

Would others join the Euro as a refuge? Possibly, however if the above were to occur we could see the emergence of a new strengthened Euro. Nations such as Norway or Switzerland could join, forming what would be one of the soundest currencies in the world. They didn't join in the beginning with the current members therefore , if the weakest were weeded out they could have a change of heart. This would be the only reason I could see them joining.

Survival? I'm bearish on all fiat money. Even the Euro. There are many problems contained in Europe. It could however emerge as a genuine contender to the Dollar if the harder money circles have their way.

So is the Euro a good or bad thing? Well I'd prefer the ECB administering my nations currency rather than the current set of inept individuals who are running riot with the UK's monetary policy. German jokes aside, you have to wonder how they do it. After a crippling war they arose as the dominant power of Europe once more, a dynamic economy that produced quality products, while other Western nations industries went into decline. It dealt with unification as Communism collapsed thus inheriting a nation with years of decay that required to be rectified. She then became one of the key participants to unify Europe under the single currency opting to bin their sound Mark. Subsidies were provided to Ireland and Spain to promote the Euro, subsidies paid for by the German taxpayer. She wasn't even resource rich, importing many commodities. There was however a culture of hard work, along with the abstinence of partaking in speculative activities such as Real Estate even as the 'Anglo-Saxon' economic models mocked the Germans for relative stagnant growth in comparison. Since the arrival of the crisis the jokes have stopped and once more the Germans hold the key to Europe, to the pseudo fiat Gold Standard known as the Euro. History leads me to the opinion that I'd prefer the Germans to manage my sovereign currency. Its the same story for many others who are current members of the Euro, it just depends if their culture can adapt to a different monetary way of thinking.

The Global Race to the Bottom

Since the financial carnage during late 2008, the real effects of the credit crunch have now started to be fully felt with members of the public now under no illusion of the severity of the situation the world finds itself in. No country has been isolated. The question is, how much worse can it get? Is the world heading towards a path of destruction?

Consumption based economies, resource rich nations, export driven countries - all have been hit hard by the turbulent events we find ourselves in. Since the collapse in commodity prices, after the huge de-leveraging that began in September last year, resource rich nations have come under intense pressure. The Rubble is in dire shape as Russia's Oil and Gas revenues have dried up. Run under a corrupt political system that is trying to keep together its fragmented collection of states by use of oppressive force which now seems unsustainable in the long run. Mexico, whose low cost manufacturing operations have been hollowed out in recent years by the lower Chinese labor costs, has been heavily reliant on it's Oil revenues, however production has been in decline for a good number of years. Along with the collapse in Oil's price, the nations stability has become questionable. The Peso has slid to record lows recently, with the Central Bank trying to stop the slide. Markets always have more money then Central Banks, however authorities always like to waste money to try and prop up their currency as though that changes fundamentals. It's remains to be seen if Venezuela can remain solvent with Oils new low price. Iran faces increasing fiscal pressures, along with other Middle Eastern states in an already unstable region of the world.

The Euro continues to mask the various problematic states that hide behind it. The Mediterranean nations and the Iberian Peninsula, Portugal, Spain, Greece and Italy all with a traditional weak work ethics and a short association with democracy, seem like they could once again fall under a Totalitarian dictatorship once more. Salazar, Franco, Mussolini or the "Junta" - we could well see a new generation of radical political movements. Germany's output has collapsed, as its export market has dried up. Eastern Europe's economic miracle after the break up of the Soviet empire is beginning to unravel. Latvia posted a 10.5% fall in GDP in the last quarter in 2008. After the IMF bailed out Hungary, the government are looking to cut government spending and balance the books further. Meanwhile in Ireland they have begun looking at cutting public pay, in order to keep the illusion of solvency for the time being.

After the surge in the Yen last year, as the unwinding of the Yen carry trade took its course, the BOJ will no doubt try and stem the rise by looking at measures to devalue, as its exports have fallen off a cliff. Many of the other Asian nations have not fared any better. China's exports have also collapsed, but so has their imports by a larger amount putting pressure on resource rich nations in the region such as Australia. China's creditor position, now as cash is king, is finally beginning to buy into the markets it will so desperately need when its rise as world superpower resumes. Layoffs in the urban cities continue to displace people back to the countryside, and its not just China where layoffs are occurring in Asia. Taiwan, South Korea, Vietnam all of these export based nations are suffering.

Back in the UK, Ed Balls, Gordon Browns trusted advisor and friend who recommended granting the BOE independence back when Labour came to power, stated recently that this was the worst financial crisis in 100 years. He also mentioned we could see a rise in extreme right wing politics as unemployment increases. Just like the 1930's another crisis in "Capitalism" has arrived, with worldwide contraction occurring once more. Once more the same mistakes are being committed. The Krona collapsed last year, however this won't be the last currency collapse of the crisis, or for years to come. There will be more that come under pressure. The Forint, Rubble, Dollar, Pound or Euro - no paper currency will be immune to what is happening. Continual debasement will occur and further currency crisis seem inevitable as a race to the bottom takes place.

The US are leading the world with further bailout packages. Obama's recent stimulus plan will soon be in the system. Who will pay for it? Who will pay for the $1Trillion and growing budget deficit? Domestic citizens? Foreigners? In the climate we find ourselves in? Recent losses have been announced at the recently formed giant UK banking group Lloyd's. More pain is yet to come, along with further nationalisation of the UK banking sector. In a post I wrote just before the globe came close to financial collapse, I said there will be a limit to how much Governments will prop up institutions and infuse money into the system. Well it looks like I was wrong on that point as most governments are more incompetent than I gave them credit for.

The 'Fear' Index

Since the Credit Crunch began around 18 months ago, we have seen great volatility in the stock markets and the currency markets. One measure that is used to measure volatility in the S&P 500 stock index is the VIX index, the volatility index, which the below chart illustrates.


The parabolic move, that can be seen in September/October of last year shows how distressed the financial markets became during this period. If we look at the blue line in the middle graph (the 50 day moving average of the index) we can see it has steadily been rising from a low of 0 in October 2007 (Just after the Credit Crunch began), to around 35 currently. Its been on a downtrend for the past couple of months, so does that mean the worst is behind us? Far from it. We are just starting the Bull market in market volatility as the graph illustrates, with further, and in my opinion greater shocks to come. A recent downtrend has emerged but for how long? The Western stock market will not be a place to be for at least the next decade in my opinion. The bailouts, money printing, increased government intervention, currency instability and record low interest rates will ruin the free markets price mechanism and further flatten the production structure. These destructive effects are yet to be felt.

So who will suffer the Worst and who will lead the upturn when it comes?

We are not going to see an upturn in 2009. That's for sure. The exporting giants, such as China, Germany and Japan will suffer a great deal, indeed China should fall into a serve depression if it allows markets to work their magic (I mentioned back in May that this should be expected). Germany and Japan should follow similar fates. In fact nations similar to this will experience as bad downturns if not worse than consumption based nations such as the UK and the US. But some of these nations should lead the world economy out of the downturn when the markets have cleared, along with resource rich nations such as Canada as people will always need materials. They already have the productive capacity or resources when the recovery arrives. The key thing is that they let their domestic markets clear. As Japan illustrated this is not always the case. China will no doubt experience shocks and inevitable set backs (just as the US did back at the turn of the Twentieth Century with the panic of 1907, or the UK did at the turn of the Nineteenth Century with the wars with France), but their leaders are about as Communist as Adam Smith, and have a long term outlook to supplant America as the economic superpower. They are not concerned with short termism, polls, or quarterly GDP figures. They are concerned about building a productive capacity, and becoming the economic engine of the globe. 600 years ago China was the largest economy in the world under the Ming Dynasty. There's no reason why it can't be again. The other Asian giant, India, may well suffer from their larger public sector debt than other countries in the region. For all India's progress, there are still great issues there, whether it is their poor infrastructure (bad roads, frequent power cuts) or the caste system, I still see great potential but it will be limited by these factors.

Nations similar to the UK and US, who have used up most of their natural resources, are running huge deficits, have lost all thrift and have lived on a mirage of debt and cheap goods will be the slowest to recover. Many Western Countries belong in this category. Countries like Italy and Greece, with greater life expectancy, will suffer even worse fates as their vast public sector debt will no doubt drown out any possible recovery. Nations such as Germany may well be hampered by nations such as these as they try to hold the Euro together.

After the fall of the Roman empire, European culture went backwards not forwards. It slipped into what is now known as the dark ages, as the Islamic nations along with the Orient, became the cultural centers of the world, producing goods that fascinated the outmoded Europeans. It wasn't until the fourteenth century that the Renaissance began in Europe, with cities such as Florence and Venice importing goods and ideas from the Orient and the Middle East. The conquests of the Islamic Moors on the Southern Iberian Peninsula further dispensed wisdom and knowledge that spread slowly throughout Europe. The Occident, or what we now refer to as the West, began a long transformation, increasing their material wealth and ideas. Once again, Eurasia finds itself in what seems like a similar junction. Ideas, knowledge and culture are flowing in the reverse, from West to East. In the past it took centuries. This process may well take decades, as technology has increased the ease and speed at which ideas can be spread. The race to the bottom has begun, but who will be the first to resume the race to the top when the recovery arrives?

To fight and conquer in all your battles is not supreme excellence; supreme excellence consists in breaking the enemy's resistance without fighting.
Sun Tzu, The Art of War

By nature, men are nearly alike; by practice, they get to be wide apart.
Confucius, The Confucian Analects

Britain is in Official Recession - No its much worse

“What I want to see is people who are mortgage holders having access to mortgages at prices they can afford. That's what tomorrow's programme is all about.”
Gordon Brown


Presenter: "You’ve said that over the long term, the US dollar is doomed. What are your thoughts on the British Pound?"
Rogers: "More doomed. It will disappear sooner. If it weren’t for the North Sea, the British Pound would have already disappeared. It’s more doomed. The UK has been exporting oil for 26 years; within the decade, the UK will be a net importer of oil again, and they have nothing else to sell to the world once the oil dries up."
Jim Rogers, CEO Rogers Holdings

It was another week packed full of financial news. Ireland looks on the verge of bankruptcy as they continue to guarantee all their banks, Spain lost its triple A rating, the prime minister of Iceland resigned for health reasons as its citizens begin to falsely blame the free market for their problems. David Cameron predicts Britain will soon require a bailout from the IMF just like the seventies, British banks were hammered with RBS shares down 60% at one point and its market capitalisation only worth £4.5B compared with £78B a year and half ago. “Reykjavik-on-Thames”, as London has become know to the world, is slowly collapsing, with defaults on British loans still to come. Bailouts and printing is the solution the Government proposes. Britain has even begun outdueling Ben Bernanke with the pound in free fall. Even with the pounds spectacular collapse now worse than the great depression, manufacturing still continues to shrink at a time when the UK economy is horribly balanced. As the off book liabilities are slowly included in the official debt readings, British debt now stands at its highest as a proportion of the economy since the dark days of 1978. To top off the financial Armageddon Northern Rock staff got a 10% bonus. This is what happens when you don't let business fail and distort free markets with all the imbalances becoming ever more clear.

The UK hasn't been the only nation is trouble. Ireland consistently blame the Euro, despite the fact that it is the euro that has sheltered them from early collapse just like Iceland. Just like Britain, Ireland continue to prop up the banks a policy that will lead to ruin. These banks have to fail - I can't emphasis this enough. There is a belief that they are too big to fail, however contrary to popular belief the bigger business, the quicker you have to let it fail. If we let these businesses go bust, it frees up scarce capital and labour that can be used more productively. Currently the UK government believes it can prop up the entire banking sector, a sign of incompetence or desperation. The fact that the government has not disclosed the full details of this second bailout attempt has spooked the market with the Government now believing it can beat the market. However, as history has shown, the market is much smarter than any individual or group of people - fundamentals always prevail.

It was also the week that a man from Alabama, who co-founded one of the most profitable investment funds during the seventies, told everyone to sell their Sterling. Jim Rogers has been telling people to sell the pound for years now, as he is one of the rare commentators on TV that talks sense (he also said the Federal Reserve should be abolished, which I also agree with, see my first post for a video of this). Then of course the pound fell, in which commentators began to point the finger at him that this was somehow intentional and he profited from it. I doubt it. Jim for a start is a buy and hold long term investor, in which he always comments he can never time markets, he's the "worlds worst trader" as he likes to be known. Jim has said sell the pound on numerous occasions without the pound flinching, its just this one got more publicity due to what was happening with all these disastrous policies our government is currently carrying out. Speculators placed bets as they assumed other speculators would bet on a fall so bet against Sterling. That's all that happened. It's the market pricing mechanism, not a conspiracy theory of 'fat cats' profiteering.

Demonisation of the Speculator

Of course people and in particular the left always like to portray the speculator as a breed of capitalists with no morals, always cutting a profit from the little man. Speculators, when they are doing their job properly are a crucial mechanism for the free markets pricing mechanism. Their job is to predict the future. In order for future demand to be met it is the job of the speculator to try and anticipate shortages of certain goods, therefore they place bets on goods and companies which they think are cheap, channeling capital to the required areas. There is great risk in it, as predicting the short term future is very hard but this increases the agility and responsiveness of the free market, in effecting keeping it one step ahead. Speculators don't gain as is commonly misperceived, they generally lose. It's like the lottery, there are big rewards for the few who bet correctly however there are far more loser's as greed gets the better. In the end they subsidise society. The recent spike in commodities we saw in 2008 was speculators anticipating the supply/demand imbalances, so directed capital towards these areas and pumped the price up. Of course the price of all these collapsed with great speed, wiping out gains that many had made and creating huge loses. To explain why the price collapsed and why commodities didn't gradually rise instead experienced violent up and down trends, means explaining how unsound money and fractional reserve banking has distorted free markets and their pricing mechanisms. I will leave that for a latter post.

The truth is Jim doesn't move markets, fundamentals move markets. Markets can stray, but they will always align themselves with the fundamentals and at the moment there are no fundamentals for the UK, as I explained in a previous post. Government spin about the 'green shoots of recovery' or the next imminent 'housing boom', will not change the markets sentiment. It seems that the UK is going towards the path of bankruptcy. Full Steam ahead, as Mervin King begins operation 'Money Print', magnifying the destruction. This could well destroy our currency over the coming years. The worrying thing is if the pound does collapse, there is little tools the MPC could deploy to stop the rot. We have very little foreign reserves of only around $60B, but our economy has trillions worth of external liabilities. By causing investors to loose confidence in the pound, this makes these external liabilities more expensive as the pound falls. To support the Pound the MPC could sell these foreign reserves and buy Sterling, but it wouldn't be nearly enough. The only thing they could do would be to raise interest rates through the roof, double digits, and this time it would be worse than the seventies. This is the end game, in all probability years away however if the worse happened, months. Like I've said, its only a matter of time before the UK loses its AAA rating, just like Spain has recently and who knows where it will stop.

Solutions to the issues above are simple:

• Stop inflating the currency. Stop interest rate cuts and printing money.
• Let the market take over. The Government needs to stop bailing everyone out and let them collapse.
• Cut government spending. Start reforming outdated institutions such as the NHS, whose costs are unsustainable over the course of coming decades.
• Let people loose their jobs and homes. We need to free up labour and capital and put it to more productive uses, quickly. Stopping this process will further ruin the economy.
• Gradually, over time, abolish the Central Bank. Free up banks to be part of the market, thus stopping the mass inflation that always occurs.
  

Most importantly do nothing. Let the market take over, in the short run it means substantial pain, but its better than causing irreversible damage, like we are seeing now. However the above won't happen. With the governments recent announcement that Northern Rock may start lending again it is further evidence of the desperation that is setting in. I joked with my dad a few months ago that by the time I look into buying a house I will have to go to the government for a mortgage. That joke seems to be quickly becoming reality. Gordon Brown likes to deflect the responsibility of this Depression onto 'Global forces' and 'sub-prime mortgages' but the UK is a mess from its own doings and it goes from bad to worse every week. A recent report on Channel 4 news that I saw while writing this article, posed the question if this was a normal recession, or something much worse with footage from the seventies shown. It was quite clearly not a question, but a statement, that this is clearly worse than a recession. As the months go on, and if these polices continue, I'm afraid the UK is in real trouble. My 'UK Bubble RIP' post, in which I thought we may have seen a high in the UK in our lifetimes may become true. Jim Rogers seems to agree.

"The idea that you can fix a period of excess borrowing and excess consumption by more borrowing and more consumption to me is just ludicrous ... I don’t think there is a sound UK bank now, at least, if there is one I don’t know about it ... The City of London is finished, the financial centre of the world is moving east ... All the money is in Asia. Why would it go back to the West? You don’t need London.”
Jim Rogers, CEO Rogers Holdings

Taxes and OPEC

"The hardest thing in the world to understand is the income tax."
Albert Einstein

"In this world nothing can be said to be certain, except death and taxes."
Benjamin Franklin

As the world descends into the synchronised Global recession, Keynesian fiscal policies are being used to try and counter market forces. Like pushing on a piece of string, our institutions and leaders will still not admit that we have been living in a bubble, and continue trying to spend money they don't have. Deficit spending has never worked and never will and government intervention has never worked either, but yet this is exactly what we are doing. Governments are increasing their debts, meaning more interest payments are being made to just cover the debt repayments. Money is being poured into overpriced assets such as finance and houses, rather than being spent on infrastructure, hospitals and schools. All this extra debt leads to one thing as time goes on - higher taxes. In my opinion this will happen. With the US presidential election taking place in a matter of days, both candidates are as clueless as each other of how to solve the current problems. Barack Obama is on a mission of change, one of redistributing wealth or to put it bluntly, he seems to be edging towards raising income taxes. In the UK, the pound is sinking and capital is fleeing, with the worst deficits since the Second World War, and coinciding with declining Oil and Gas revenues. The government should be cutting spending at times like these, however this is never a politically popular policy so they borrow. With further borrowing comes further taxation later.

One policy that made the Great Depression so Great, was when Hoover raised income taxes to try and fund the governments deficits. In my opinion we will see this again in the not too distant future. If we take the US for example, they have over $10 trillion of debt on the books, and around $50-$60 trillion of future liabilities, which will more likely increase as time goes on. You can't pay these vast numbers without tax increases, and this will put further strains on Western economies. Ireland and Spain boomed when they joined the EU as they benefited from the generous EU subsidies. Ireland in fact had their first housing boom in their history due to this extra income, but it was all a short term illusion. The Celtic tiger is due for a long decline, with emigration rather than immigration, occurring again. Spain too has issues, reliant on selling foreigners overpriced holiday homes. As air travel becomes more expensive over the years to come there will be further collapse. Italy has huge debts and is in complete denial. With a retirement age of 58, and a lethargic economy it is only being protected by its membership of the Euro. The UK after amounting huge debts, the biggest seen in the west proportionally per head, and with huge external liabilities seems to have run out of time. The plug could be pulled at any moment on any of these. IMF bailout talks have begun. Pakistan, Hungary and Iceland are a few, that have become unwound.

Increasing taxes are the worst thing a government can do during a downturn. This further compounds the problem, taking money out peoples pockets and thus the economy so the government can use it for their own inefficient consumption. If more taxes are implemented then expect very hard times indeed. I feel we have boxed ourselves into this position due to all the waste that has occurred over the previous years and we will have to pay more taxes, and I've been saying this for some time. They will either be taken from income or other indirect forms, or maybe a combination of the two. Governments will look to this to try and re-balance the books, rather than admitting the social system is too extended and cutting spending.

Income tax - Do we need it?

There are some people who feel that we shouldn't need to pay income tax at all. I always find this an interesting concept. Can you imagine getting all your salary with no tax deductions? We used to have no income tax in the UK a long time ago. It was in 1798 when William Pitt introduced income taxes in order to pay for the wars with France. This is essentially how it began. By Governments running up debts that they needed to fund, so turned to the working people to take some of their pay to subsidise their spending. So how could we survive without income taxes? Well we would use our newly untaxed income to pay for stuff ourselves, rather than the government spending our money for us. Schools and hospitals, for example, can function without the need for state systems. The best schools and hospitals are already private institutions. This system would in fact be incredibly efficient despite what people tell you that we need government. Income could be raised by taxing consumption, land etc. The working people who produce wealth for the economy, by expending energy should be the least taxed sector of the economy.

There is a problem with the above. It relies on people making the right decisions and being in control of their own lives. I and many others could manage our own affairs and ensure we had medical insurance and paid for schools etc. However a lot of people can't manage themselves, thus making the wrong decisions and taking the incorrect measures. A lot of people still need to be spoon fed and can not take responsibility for the actions.

OPEC and the Oil Barron's

OPEC have announced that they are going to cut supply and surprise, surprise, the uninformed governments and media have repeated the common mantra that the greedy cartel are responsible for high oil prices and they want the price to remain as high as possible. Nothing could be further from the truth. OPEC are simply trying to keep supply in line with demand and ensure a greater longevity in their oil fields. If they kept forcefully pumping their oil fields the way they have been, oil supplies would collapse within the next decade inducing worldwide collapse and a breakdown of society worse than anyone could imagine. Over pumping a field leads to a steeper decline, the best examples are the Russia's fields which during the eighties the Russians began overproducing them as it was the only way to get hard currency to support the collapsing Communist system. The curve of these fields is a very sharp increase in production, followed by an equally sharp decrease in decline as the field becomes depleted. Contrast that with the fields in Norway that have been well maintained and gradually extracted, the production gradually ramps up and peaks but the decline is gradual and thus the field yields more oil in the long run.

Saudi Arabia the worlds biggest oil producer have already damaged their oil fields, with various technical issues being reported by the Saudi Aramco engineers over time, as early as the sixties and seventies. During the oil spikes in the seventies Saudi Arabia ramped up production to cover the short term shortfall to ensure the west didn't enter a terrible depression, or try and find alternatives. Oil fuels Saudi Arabia's economy along with other OPEC members economies. The last thing they want to do is send the price sky high, thus destroying world economies with economic collapse and destroying their number one export industry. They are simply hinting to the world that this once abundant resource has ceased to be cheep and abundant. It is becoming increasingly hard to extract and more energy is required to get the remaining oil. High hydrocarbon prices are here to stay and countries need to adapt and accept this fact.

It's also amusing when the media mentions that the oil companies are making obscene profits, at the expense of the public. Again its all uninformed dribble, something that has become common in modern journalism (read any of John Pilgers work as he details the decline of journalism, I would personally recommend Heroes as a starting point). For a start oil companies are public listed companies. If they make huge profits profits, compared with other stocks then buy shares in them and reap the dividends. However there is nothing stellar in that aspect and they are like any other tradable company. Profits for big oil companies seem huge, but this is only because they work in huge volumes of the product they sell. Compared with other industries, oil companies actually work on lower margins. Oil company share prices are based more on their oil reserves rather than their profits, as a company without oil has a pretty weak business model, hence the fairly recent fiasco with Shell. The fact that oil is so volatile in price compounds their problem, which brings me onto the next issue of the recent oil price collapse.

This price collapse was to be expected. As with all markets, speculators got involved and drove the price of oil too high and subsequently as oil is bought in 6 month futures contracts these positions were unwound as the delivery date got closer. I predicted to my dad a few months ago that I thought they would fall to around $70-$80 a barrel, with them now around $67 so a tad below. I don't know how low they will fall or when they will begin to rise again, I'll leave that to the technical analysts amongst us. I like to focus on the fundamentals as short term markets behave irrationally, and $67 is cheap. While the public think this is great news, this is in fact setting up a future disaster in the next few years. Future oil projects are being cancelled as the price has collapsed, which means lower oil production for the future which will lead to a greater oil price spike. Projects that were producing, are now being shut down as the oil price has dropped below economic viability recently. It's not like setting up an Internet company. Getting oil projects set up along with the distribution network takes time, years in fact. That's why the looming crisis has the potential to be catastrophic. When it will hit I don't no. If the world collapses then never, but I think the world will go on and continue to grow. The above applies to all commodities. Similar projects are being cancelled as prices drop and projects become less commercially viable. The lack of credit compounds the problem too as money is not available to finance these projects.

I will end with a graph that I found regarding world oil production and projected demand. As can be seen, there's been no substantial increase for the past few years. If the predictions are to be followed as detailed on the graph have a look at how the population demand increases as supply keeps declining. It looks pretty scary 5-10 years from now, just when the next boom should begin. We may be looking at a complete disruption of the business cycle for years to come until we adapt the way we use energy.