Europe primarily, followed by the US, are slowly but surely destroying the confidence of markets in their ability to cope with the challenges that confront them. I would therefore expect a hard landing. When everybody realizes (too late) that the Euro cannot abide and that the economic structures which have led to these imbalances cannot be recessitated there will be a precipitous  drop in the market. I expect that the wheels will come off in the later part of 2012 or the early part of 2013.

 There is too much faith in the role of individuals, or changes in governments to solve the problems. Recently from Euro: 
 
“And make no mistake – that, in essence, is where the European crisis stands. The Germans -- and the ECB along with them -- believe (perhaps hope is the better word) that two new technocratic prime ministers, former EU commissioner Mario Monti in Italy and MIT-trained economist Lucas Papademos in Greece, will cast politics aside and force angry populations in both countries to take their medicine, whether they like it or not. Because it's for their own good, you understand. And besides, "we have them by the balls. They have to do what we say."

 This faith shows a fundamental lack of understanding about economic systems. More from CNN:

“ The Germans, he said, understood how beneficial to them membership in the euro zone has been. Without it, the gentleman said, the value of the Deutschemark would be 50% or 75% higher than it is under the euro.  "German industry would be wiped off the map."”

 Which is precisely why the Euro as presently constituted won’t work. Quoting myself:

“While it is true that the ECB could of been following a looser policy, the value of the Euro is basically based on Germany's
  productivity  which means that its equilibrium value, short of a massive inflationary policy by the ECB, will be too high for the competitiveness of the PIIGS. Only prolonged deflation, currently being prevented by the bailouts in the case of Greece, can bring these countries into international competitiveness. 
 
What's more, these countries have to  deal with the fact that the low wage manufacturing jobs that went to China and
other developing countries and are not coming back. Germany is positioned in the high value added  manufacturing sector and it will not be easy for these countries to carve out a  competitive niche without some sort of sustained program of economic development akin to that which Jeffrey Sachs is advocating for the United Sates. Given these realities, it will simply be easier
to dissolve the Eurozone, float your own currency, and impose trade sanctions to establish jobs for the lower skilled
workers.”

So stop thinking things are going to get better after we get past a rough spot. That rough “spot” can and probably will be a lot rougher than most are imagining and may last for the balance of the decade. The pressures are mounting.
 
Some are placing their faith in the ECB that through a massive devaluation, a beggar thy neighbour policy, the type of which as I pointed out in an earlier post reinforced the great depression. Good luck with that. It  doesn’t change the competitive balance within Europe that caused the problem in the first place. Furthermore, China and the US are not going to stand idly by and allow their terms of trade to deteriorate. China has already shown this by holding its currency fixed in the face of quantitative easing.
 
The latest "good news" announcement was that Portugal was downgraded. Genesis sums up my feelings in this post:

I must've dreamed a thousand dreams
Been haunted by a million screams
But I can hear the marching feet
They're moving into the street

Now did you read the news today
They say the danger's gone away
But I can see the fire's still alight
There burning into the night
 
There's too many men, too many people
Making too many problems
And not much love to go round
Can't you see this is a land of confusion?
 
Well this is the world we live in
And these are the hands we're given
Use them and let's start trying
To make it a place worth living in 

Ooh, Superman where are you now
When everything's gone wrong somehow?
The men of steel, the men of power
Are losing control by the hour
 
This is the time, this is the place
So we look for the future
But there's not much love to go round
Tell me why, this is a land of confusion


 

Speculation is often used to blame price increase in the oil markets, most recently in the historic increase – and then dramatic reversal in the Brent - WTI spread.  The balance between supply and demand in the oil market has been tight for years. For most of the past decade, global economic growth has been strong and oil demand growth in developing countries, particularly China, has been growing at nearly twice the rate of the developed world. Also, excess capacity in OPEC has been diminishing.  Despite rhetoric and promises to the contrary, Saudi Arabia has found it difficult to be the marginal supplier to the market.  In the short run, oil demand is relatively unresponsive, inelastic, to price changes and as a result, real oil price growth has reasonably tracked growth in global GDP.  Since 2007, the volatility of oil and the volatility of the S&P 500 have had a correlation of .87.

Currently, Saudi Arabia is scrambling to maintain production despite rig counts being near all time highs. So the demand story continues.   
 
 

There is going to be a shoot out, worthy of any classic western, in the global credit markets.

The major world economies are going through a debt crisis, the euro area is struggling to find a sustainable path, and political brinksmanship in the US congress contributed to a downgrade to the US credit rating. 
  
Despite some optimism about recent US economic numbers (I want to do a post on this topic, but I am currently focused on writing a PhD paper) the western economies seem headed for a recession and for some countries this will slip into a 
depression.
 
The basic formula for interest rates that we teach to undergraduates is nominal (money) interest rate = the real interest rate +
inflation. This can be rearranged so that real interest rate =nominal (money) interest rate – minus inflation. Real interest rates are often thought of as stable or relatively unchangeable over time, so most of economic analysis  is  often concerned with inflation
rates. Normally, real interest rates go up if a country experiences deflation. I have, of course, argued on these pages that prolonged deflation is necessary for countries in the euro zone to become competitive. 
 http://www.economicpresence.com/4/post/2011/09/i-guess-i-am-overdue-for-a-eurozone-post.html
 
However, I believe that deflation is not a necessary requirement for real interest rates to go up in this era of  sovereign debt crises and unstable political arrangements. It is hard to imagine that the sovereign risk of the world’s largest economies (including Germany) will not rise substantially over the next decade and with it will be a rise in real rates. With many countries defaulting or printing money to escape their real debts it is difficult to see how creditors will not demand a higher risk premium.
 
Adjustments of real rates are mainly a question of changing perceptions as we are now seeing with Italian bonds. Italian 10 year bonds have averaged 4.46%, since 2001, while inflation has averaged 2.2%, leaving a real interest rate of 2.26%. Last week, global investors woke up and (accurately, but two years late IMO) perceived Italy to be much riskier than before and the 10 year rate rose to 7.48%, forcing the resignation of Berlusconi. Italian inflation is currently around 3.07%. The real rate of interest being charged rose to 4.40% an increase of 95% above the average.

This, of course, creates a severe negative feedback loop which can turn into a viscous cycle as higher rates make it more difficult for a country to regain a sustainable economy path due to rising debt service costs necessitating more cuts and tax increases which in turn are negative for growth. 
 
It is unlikely Monti will be able to deal with Italy’s problems any better than his predecessor. Adjustments for Italy within the Euro area will either come through Germany or deflation. It matters little who is at the helm in Italy. After the resignation, the 10 year rate fell, but it is once again on the rise, up today 37 basis points, to 7.07%. To quote Tuco, from the Italian made (spaghetti) western, ‘The Good, Bad and the Ugly’:
 
“Who the hell is that? One bastard goes in, another one comes out.”
 
What is happening in Italy, will eventually happen for all western economies, until systematic and sustainable changes are made to restore internal and external balance to global economies. This will have a significant negative impact on global growth because so many borrowers, consumers and businesses, are on the short end of the yield curve. On the inevitability of such real interest rate increases, I quote Ben Wade, from a more recent western, ‘3:10 to Yuma’:
 
“Oh, they're coming, Dan. Sure as God's vengeance, they're  coming."  


Investors better get out of Dodge or grab a gun.

My father, Reinhold Pinno, was born the oldest of five on Mar. 23, 1911. He was born in Prussia, which would be modern day Ukraine, close to the Polish border. He related to us that during the First World War, the Austrian soldier’s commandeered their farm at night to use as a camp. As his father was fighting in the war, and his mother had an infant child, it fell to him, at the age of 6, to go and hitch the horses and drive the wagon. Reinhold drove all night with his mother and younger siblings. Shortly after dawn, they came to a meadow where a cavalry battle had taken place and their wagon was confiscated to take care of the wounded. My father watched them place a screaming soldier, begging for water, with an open stomach wound on their wagon; he  watched the man’s life ebb away. 

I was born when my father was fifty-five. Reinhold had lived through two world wars and the great depression. Like those of his generation, he was very afraid of debt, bought almost everything with cash and thought I was possessed by the devil when I got my first credit card at nineteen. He was deeply distrustful of banks, large corporations and governments. 

Between the First World War and the great depression, was a decade of decadence, the 1920’s.  The great depression in the US started in response to excessive borrowing and speculation which led to a bubble in the stock market and a crash in October 1929.  All over the globe, governments responded to economic distress by imposing “beggar thy neighbour” trade restrictions and austerity measures that brought on deflation. As a result the economic crisis deepened. There was a loss of confidence in capitalism, and a command economy, the Soviet Union, was held up as the model for economic growth. National Socialism grew in Germany, as it struggled under its war reparations debt and went through hyperinflation.

My father passed away in 1992. He never fought in any wars, but he had two brothers who fought for the Germans in the Second World War, one who died. Were he alive today, I think he would wonder if the world had learned any lessons from the past century.

We seem to be at a place in time where we have repeated, or are set to repeat, many of the same mistakes made a century ago. One way to honour those who gave their  life for our nation is to demand leadership that won’t repeat the mistakes of the past – to ensure sacrifices were not made in vain. Leadership that will inspire the country, and provide a notion of community and shared sacrifice as a nation strives for progress. 

“Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it.”
George Santayana

 Je me souviens, Papa.

Situation Comedies are often bellwethers on social issues. Three’s Company (1977-1984), was a comedy about a heterosexual male, Jack, pretending to be gay, so he could live with two heterosexual women. (The Landlord forbade unmarried members of the opposite sex from living together). The show made stars out of John Ritter who played Jack the clutzy cooking student, and the object of his attention Chrissy, played by Suzanne Somers(remember the posters), the daft buxom blonde roommate.

Homosexuality, even for a single man, was treated as something deviant and to be ashamed off and was the premise for much of the farcical plotlines of the show. The show turned the concept of “coming out” on its ear as Jack struggled to keep his sexual identity secret from his Landlord. The Landlord’s wife, who discovered the truth early on, can be viewed as a metaphor for acceptance of homosexual identity by one’s acquaintances.

Flash forward to today and the biggest comedy on television is “Modern Family”. This show pokes fun at the changing definition of family, be it suburban, intergenerational, cross cultural, homosexual and even interracial. Many members of Its ensemble cast were nominated for Emmy Awards. Last year, Eric Stonestreet, who plays my favourite character of the show, Cameron Tucker, won the Emmy for Outstanding Supporting Actor in a Comedy Series. Cameron is a gay man in a committed relationship with Mitchell Pritchett, with whom he co-parents his adopted Vietnamese child Lily. 

Eric Stonestreet, a heterosexual male in real life, paints a portrait of a warm, loving, over the top, gay house husband on television. I enjoy Cameron the most, because he is the character in the show that most accepts himself for who he is, foibles, flaming homosexuality, football fanatic, contradictions and all. More than any other character in the series, Cam is not embarrassed to be who he is - he relishes it.

Research has looked at issues of race, age and sex and attempted to test which preconceptions could be changed. Race was found to be the most malleable. 

“"Less than four minutes of exposure to an alternate social world  was enough to deflate the tendency to categorize by race." People seem to use race as a shorthand for "group," as if skin color were a different uniform, but drop it if the group cuts across
races.”

I also believe it is why public opinion on gay rights has changed so much in my lifetime. As gays have come out of the closet, people start to find out they have gay friends.

One gay friend - epecially one that you didn't know was gay - and you have tougher time being discriminatory. 

My guess, and that's all it is, is that gender and age are harder to change because they are linked to the reproduction cycle and it's very hard to overcome the biological imperative to perpetuate our genes. 

Two weeks ago, I wrote an article for this month’s Geopolitics of Energy. The article tied oil prices to oil demand and oil demand to global GDP growth. I suggested that the global economy would grow far less than most mainstream analysts were forecasting for the following reasons: the global economy will  take a decade to delever, the Eurozone is unstable and at least some countries will have to leave, there is an issue of structural unemployment in the US and European economies, and China is going to begin an extended period of slow growth around 2015.

These issues are not new to the readers of these pages. I identified them early on when I launched the blog.
http://www.economicpresence.com/4/post/2011/08/it-is-going-to-be-a-tough-decade-for-the-global-economy-and-the-brics-will-not-save-us.html

 Well it turns out that the Conference Board has released a report that essentially agrees with my points about slower global growth and China slowing down.

 Haven’t read the report but here is an excerpt from a review:

“The report, well covered in the Wall Street Journal, is a sober read.  Overall, world growth is expected to decline, with both China and India leading the decline.  The advanced countries are expected to recover from the current slump, but growth will remain anaemic for years to come.  In other parts of the developing world, growth could slow to a crawl, presumably reflecting poor demand for basic commodities in a slow growth world.”
 
That’s what I said. Here are my  words, verbatim,on China for GoE.

 "China
The market is severely overestimating future growth from China.
 The “Country Forecast China September 2011 Update” by the Economist Intelligence Unit forecasts Chinese growth at 8.2% in 2015. And yet China is primarily an export-driven and investment-fuelled economy. Consumption in 2010 was roughly 33% of GDP, nearly half the level seen in developed economies. Investment, on the other hand, represents an astonishing 45% of the Chinese total economy. If demand is set to be weak in Europe and the US over the next several years, who will buy Chinese exports?   Professor Michael Pettis predicts growth will slow down to between 3% (or  lower) by 2015.

When China slows down, there will be a disproportionate decline in investment. This decline in investment will invariably flow through as a  decline in demand for non-agricultural commodities, including oil.

By keeping its currency fixed to the US dollar, China has been importing inflation and, as a result, has to contend with a real estate bubble of its own. As a second order effect, one might question how efficiently these investments have been for future consumption in China, as much of the growth has come through capital-intensive, state-owned enterprises and there is evidence of  an overinvestment in real estate. 

Since running a trade deficit means a country is borrowing internationally, China will be forced to modify its economic model as the US and Europe seek to close their trade deficits. The sooner China begins this  process and the more gradually it implements change, the less likely it is to see social unrest."

You can contrast my thinking with McKinsey's, which this month, is warning business to prepare for a spike in oil demand.
Which risks are greater?

You be the judge.
https://www.mckinseyquarterly.com/Energy_Resources_Materials/Oil_Gas/Another_oil_shock_2873

Get Smart
The Cast
Chief:played by Germany
The always lovely and charming Agent 99:Played by France
Maxwell Smart:played by (varies like the Bond series) Portugal, Ireland,Italy,Greece and Spain.

Let's revisit some of the dialogue from our favorite epsiodes.
Agent 99: Did you hit your deficit target?
Max: Missed it by that much. (Hands held closely together)

Chief:How much are you going to pay us back?
Max:Would you believe 80%?
Chief: I find that hard to believe.
Max :Would you believe 50%?
Chief: I find that hard to believe.
Max :Would you believe we took a vote and decided not to pay?

Chief: Now listen carefully: [gives a series of complex instructions on how to solve the debt crisis] Did you get that?
Max: Not all of it.
Chief: Which part didn't you get?
Max: The part after 'Now listen carefully'

Chief: Max, you realize if you default and leave the Euro area - you'll be facing every kind of danger imaginable.
Max:  And loving it!

Seriously, those writers are hilarious. Where do they get their stuff?  

In September, ‘From The Sky Down’, a U2 documentary about the making of ‘Achtung Baby’, debuted at the Toronto International Film Festival (TIFF).   The film is directed by Davis Guggenheim, who directed the Oscar winning documentary ‘An Inconvenient Truth’, about climate change. Named the “Band of the Eighties”by Rolling Stone Magazine, U2 nearly broke up as the decade was coming to a close. Band members were burned out and going through the motions at their shows. Bono told the audience of a New Year’s Eve Party in Dublin, in 1989, that “they were going away to dream it all up again”. 
 
By the end of the 80s they had reached the pinnacle of success. In 1987, U2 released their fifth studio album ‘The Joshua Tree’ to commercial and critical success, and, as a result, became the most popular “underground” band in the world. Many bands struggle with their live performances to achieve the bar set by their producer in the studio. In contrast, U2’s signature ethereal neo-psychedelic sound and poetic, melancholy lyrics connected with audiences all over the world. To their fans, flocking to U2’s sold out stadium concerts represented a secular pilgrimage to receive musical communion at a modern day tent revival.  U2’s authenticity stood out for those of us coming of age in the cynical, foppish eighties; a buoy, floating in a sea of otherwise plastic entertainment consisting of new romantic and metal hair bands.

When asked why he made the documentary about ‘Achtung Baby’ the director responded:
“What I was drawn to was how they felt about that moment in their life. Each of them had a very different perspective, but it was definitely a tumultuous time for them. It was a time when they either had to reinvent themselves or perish. They reinvented themselves in an incredible way, but it was touch and go!”
,
The band’s need to renew itself, even at the risk of breaking up, is something we all pass through at various stages of our lives. They chose Berlin, right after the collapse of the former Soviet Union. The band recorded at Hansa Studios, known as “Hall by the Wall” because it is adjacent to the Berlin Wall. Other successful artists like David Bowie, Iggy Pop, and Depeche Mode had recorded music at Hansa. 

Bono was interested in dance music and the Edge had become interested in industrial music and both were determined to take the band in a different direction. Larry and Adam wanted a more traditional U2 record.

The choice of pushing themselves to either death or rebirth, the choice to radically change their style despite being at the top, to use a Berlin studio at the start of reunification were examples of Janusian thinking.

How much was U2 really risking? That is hard to define, but many of the most influential bands in Rock n Roll: The Beatles, The Eagles, Led Zeppelin, The Who, The Police, to name a few, couldn’t survive their success. 

Those people who take more, but not excessive risks have been shown to be the happiest. 

They fought. They yelled. They contemplated breaking up. Nothing was working out. The director describes the breakthrough moment:

 “And then this song (“Mysterious Ways”) happens. And I go,“Well, this is the moment. Let’s go after it.” We went into the archive and the original recordings from those sessions were there. They were playing “Mysterious Ways” and these chords arrived for “One,” and then the next moment when they pull those chords out to start another song, and wow! It’s like you’re an archaeologist and you’re digging through the dirt and the rubble and  you find this stone that holds the key to this mystery.”

From “Absolute Soul Destroying Failure” to “Mysterious Ways”to  “One”.

This, my friends, is the mystery of life. 
This, my friends, is grace. 
I have had it happen multiple times in my life.
May we all find it.
I am looking for it again, right now, in Sao Paulo, Brazil.
From The Sky Down
Namaste U2.