December 26, 2012

Dancing Around the Fiscal Cliff


LONDON — Much has been made of the offers, counteroffers and feverish politicking swirling around the efforts by President Obama and speaker of the House, John Boehner, to reach a budget deal that would save the United States from tumbling over a “fiscal cliff.”
Let’s be honest: The importance of whether some compromise is adopted and what specific form it takes pales in comparison with the reality of the genuine fiscal abyss into which the people of the United States are staring. All of the politically realistic solutions, including those that feature cuts to Medicare, Social Security or increases in the income tax, are just Band-Aid measures compared with the problem of public debt, which is driven by a combination of enormous entitlement spending and a long-term slowdown both in the growth of economic output and population.
As a result, the United States, along with the rest of the industrialized West, has been on an unsustainable fiscal path for decades. Stephen Cecchetti, Madhusudan Mohanty and Fabrizio Zampolli, research economists at the Bank for International Settlements, predict that unless radical reforms are adopted, the public debt of the United States, France and Greece will reach over 400 percent of G.D.P. by 2040, with Germany rising above 300 percent by the same year. Similarly, unless policies change, in Japan the debt-to-G.D.P. ratio could be in the 600 percent range.
Such debt levels are wildly implausible, as creditors would likely stop lending to Western governments long before such levels are reached. Some politicians and economists may want to put a fig leaf on it, but the projections by Cecchetti and others mean that the West is effectively bankrupt.

The fiscal problem is not accidental: It is shared simultaneously by most Western countries.
Therefore, it does not make much sense to look for its parochialcauses” of in each country: President George W. Bush’s tax cuts did not get us here — and neither did President Obama’s stimulus, Greek tax avoidance, or wasteful spending under left-leaning governments in Western Europe. Instead, the depth of the current problem is a result of a deep ideological transformation of the West that dates back 60 years.
The Great Depression gave rise to Keynesian macroeconomics, which encouraged governments to borrow and spend during recessions in order to smooth the business cycle. However, over the years, deficit financing has become an operating principle of Western governments, in recessions as well as in good economic timessimply because it is a convenient way of financing electoral promises without having to raise additional tax revenue.
If our fiscal problem is a result of a deep ideological change, then it becomes clear that there are no quick technocratic fixes. Few people think that a deal between President Obama and Boehner would be the basis for a lasting solution. Likewise, the largely botchedausteritymeasures adopted by some European governments have done nothing to stabilize public finances over a horizon exceeding just a couple of years.
And suppose, for a moment, that because of the pressure from credit markets, a real long-term fiscal solution were agreed upon by the two parties in the United States, or by politicians in European countries. How credible and how lasting would it be?
As Mario Rizzo, a professor of economics at New York University, recently noted, “Contemporary federal governmentexecutive and legislatureexists for the purpose of giving favors to various groups in exchange for electoral support. Thus, even assuming the unlikely event that the long-term imbalance is resolved, how do we stay within the solution range? After all, we did not get where we are by accident.”
If the sources of West’s fiscal problems are running deep, then the solutions will have to be deep as well. Instead of tinkering with various parameters of our welfare states — such as tax rates or the retirement ageWestern democracies need to have a serious discussion about what goods and services the governments can and should be providing and how they can be restrained from overreaching.
Unlike the kabuki dances around the “fiscal cliff,” the discussion we need cannot be about technicalities: It will have to be about the social contract and the political philosophy underpinning our political institutions. It should worry us that, at the moment, no one is willing to have that debate.
Dalibor Rohac is an economist at the Legatum Institute in London.

Why Japan's "Lost Decades" Are Headed to America in 2016

December 26, 2012

By Keith Fitz-Gerald, Chief Investment Strategist, Money Morning

It's only been a little more than a week since Shinzo Abe won election as Japan's latest Prime Minister in a landslide-election victory and the pundits are already lining up telling investors to "buy Japan" because it's "dirt cheap."

The hope is that Abe's promises of fresh stimulus, unlimited spending and placing a priority on domestic infrastructure will be the elixir that restores Japan's global muscle.

As a veteran global trader who actually lives in Japan part time each year, and who has for the last 20+ years, let me make a counterpoint with particular force - don't fall for it.

I've heard this mantra eight times since Japan's market collapsed in 1990 - each time a new stimulus plan was launched - and six times since 2006 as each of the six former "newly elected" Prime Ministers came to power.
The bottom line: The Nikkei is still down 73.89% from its December 29, 1989 peak. That means it's going to have to rebound a staggering 283% just to break even.
Now here's the thing. What's happening in Japan is not "someone else's" problem. Nor is it something you should gloss over.

In fact, the pain Japan continues to suffer should scare the hell out of you.

And here's why ...

The so-called "Lost Decade" that's now more than 20 years long in Japan is a portrait of precisely what's to come for us here in the United States.

Perhaps not for a few years yet, but it will happen just as we have already followed in Japan's footsteps with a "lost decade" of our own.

The parallels are staggering.

Were it not for the names - Abe, Ishihara, Noda - the headlines being played out in Japan could well be our own especially when it comes to campaign promises of unlimited stimulus, more infrastructure development and a busted economy. All three were fundamental pillars in Shinzo Abe's reelection campaign just as they were in President Obama's.
The False Promise of Another Japanese Recovery
So now that Japan has its sixth Prime Minister in six years, will things change? Will Abe's efforts result in a Japanese recovery? Will this be "the" year Japan comes roaring back?

In fact, Japan has just fallen into another recession. The data show that Japan's GDP cratered -3.5% in the most recent quarter. Manufacturing is reeling and several
iconic Japanese brands are poised for what will be very expensive and nationally traumatizing bankruptcies.

The country is the most indebted of any nation in the world with the combined total of corporate, private and public debt over 500% of GDP, according to Goldman Sachs.

The demographics are working against the struggling island nation as well. This isn't a policy debate. It's not a partisan issue. It's a numbers game and right now the numbers are getting smaller.

There are a mere 2.8 workers supporting each retiree right now. That's especially problematic at a time when the birth rate is declining so fast it looks like a toboggan run.

Worse, as
I noted on Fox Business Network's Varney & Company recently, several surveys show that young Japanese simply aren't interested in sex, so a rebuilding of the domestic workforce is quite literally not going to happen.

You can attribute that to emancipated women, the cost of raising children, work pressures or other economics if you like, but that really doesn't tell the entire story nor get at the root of the problem - a lack of desire.

One survey from O-Net, one of Japan's largest online dating services, interviewed 800 young Japanese men and found that 83.7% didn't have a girlfriend. The survey also showed that 49.3% had never had a girlfriend. Another survey from the Ministry of Health, Labor and Welfare showed that 36.3% of young men had no interest in finding one.

The Wall Street Journal reported that 59% of Japanese females between the ages of 16-19 stated that they are totally uninterested in or completely averse to sex.

Married couples don't appear to be any different. Other data suggest that 40.8% of all couples are not only childless, but sexless as defined by not having had sexual intercourse for more than a month. So called "kamen-fu," or loveless marriages, are far more common than you would think.

It's no wonder the birth rate has dropped precipitously according to the National Institute of Population. Nor is it difficult to understand that "silvers," which is what the Japanese euphemistically call their senior citizens, will make up 40% of the population by 2060 despite the fact that the total Japanese population is expected to shrink by 1/3rd over the same time frame.

The implications of this demographic shift are tremendous. The newly elected Abe-san can print all the money he wants. He can build more bridges to nowhere and even double the Bank of Japan's inflation target to 2% if he likes. 

It won't make any difference on anything other than a short-term basis.

That's because Japan crossed the point of no return and became a "post mature" society in 1995, according to the National Intelligence Council. The term, in case you're not familiar with it, means that there is a disproportionately large number of older people in a given society versus the younger productive and reproductive population.

Put another way, the country's "window of opportunity" quite literally closed.
The Window of Opportunity is Closing Here In America, Too 
Many people are surprised to learn that the United States is in the same spot. But they are positively stunned to learn that our window of opportunity closes in 2015 -- only three years from now, when we, too, become a "post mature" country, and the median age climbs above 45 for the first time.

In vehement denial that we're heading down the same path, they explain away the mountains of debt, the failed stimulus, the out-of-control corporations and complete political disarray. But they cannot explain away the demographics here anymore than they can in Japan.

When Japan's markets fell in 1990, the numbers were already going in the wrong direction. The productive-age population had peaked and was in decline. Ours is, too. In fact, so is most of Europe's.

Twenty-two years later it's no surprise that there are fewer jobs and fewer Japanese workers. Nor should it come as a shock that the island nation is reevaluating its immigration policy, its military, and its role in the international community. There are huge, multi-year impacts that are directly related to fertility rates, not the least of which is the inability to kick-start its corporations.

Here in the United States, for example, we tend to think that immigration will be the miraculous do all, end all. Our fiscal survival, in fact, is predicated upon it.

In reality, it makes almost no difference whatsoever.

For instance, the Center for Immigration projects that immigration will increase the working age population to 58% of the total workforce by 2050. That's only 1% above the 57% projected rate with no immigration. If immigration falls, our population curve is indistinguishable from Japan's over the past 50 years.

As for the notion that immigrant children have more children (which is a key assumption in United States population-planning projections) -- that, too, is flawed.

Not only does the
data now show immigrant fertility rates are falling, but it also shows that fertility differences between American-born women of child-bearing age and immigrant women of the same age are not enough to increase the share of people falling into the productive working category.

In other words, immigration has only a minimal impact, if any, on slowing down the decrease in working-age population by 2050.

Put another way, there are presently 4.81 workers supporting every retiree over 65 in the United States. By 2050, this figure will shrink to 2.81 workers when you include immigration, and only 2.31
workers without. Remember, Japan's figure is 2.8 today and has dropped since the 1990s.

Many investors gloss over this relationship -- if they are aware of it at all. That's a huge mistake.

By hitching their wagons and their money to populations where the productive population is in decline, investors are dooming themselves to a massive value trap. Sure they can capture periodic market bursts based on stimulus or some other influence, but over time they'll be fighting powerful, self-defeating headwinds because the falling number of people in their productive years ultimately translates into earnings declines and changing purchasing patterns. The opportunity costs are simply daunting.

On the other hand, hitching your wagon to countries with growing productive-age populations, you can capture the "window of opportunity" while it is opening.

That speaks to concentrating your assets and your investments on those choices backed by windows of opportunity still opening --like
China's and Brazil's, which do not close until 2025 and 2030 respectively. And India's, which doesn't even open until 2015.

Obviously, all three of the markets I've just mentioned face their own challenges, so let's be clear: I am not saying you have to invest in them directly. Chinese shares are obviously prone to accounting "irregularities." Markets in India suffer from fragmentation. Brazil is struggling with inflation.

But I am saying invest because of them. That means making deliberate decisions to concentrate your assets and your investments in companies that will capitalize on places where the windows of opportunity remain open.

In some cases, that also means investing in those choices where the windows haven't yet opened but are expected to as suggested by population growth.

There's a big and profitable difference for investors who understand the contrast between the two.


December 26, 2012, 1:30 p.m. ET

BRICs Need to Change Their Tune



Brazil, Russia, India and China are the John, Paul, George and Ringo of the emerging markets—a neatly packaged group of disparate individuals that sometimes inspires hysteria.

This year, the BRICs turned 11 years old, so they have outlasted the Beatles, who notched up a decade. Like the band, the BRICs have enjoyed enormous success. In 2002, BRIC stock exchanges accounted for 3% of the total market value of members of the World Federation of Exchanges. By 2011, they represented one-fifth.

But 2012 for this foursome was hardly fab—apart from India, those markets trailed the S&P 500 significantly and economic strains appeared.

The calling card of the BRICs, high growth rates, remains valid but is curling at the edges. Between 2000 and 2008, they averaged annual gross-domestic-product expansion of 8%, almost six percentage points above the average for G-7 countries.

This year, the International Monetary Fund forecasts average BRIC growth of 4.5%, with the spread having shrunk to 3.1 percentage points. All the BRICs, even poster boy China, have seen a marked decline. Next year, growth is put at 5.5%- not bad, but a marked step down.

Up to 2008, emerging markets enjoyed average export growth of 20% to 30% a year. Europe and the U.S. enjoyed credit-funded consumption binges, sucking in imports from emerging markets which in turn fuelled investment in the latter.

Now, the euro zone is undergoing a drawn-out existential crisis and the U.S., while doing better, still suffers from high unemployment and wrangling over deficits. Exports from emerging markets are likely to shrink this year, according to UBS strategist Bhanu Baweja, and grow by between just 5% and 10% next year. This also is likely to curb investment as companies won't need to expand capacity so quickly.

This will hit all the BRICs, though Brazil and Russia look most exposed immediately because both are big commodity exporters.

Russia presents a conundrum. Its corruption problems and demographic decline are well known. But at about 6 times forecast earnings, Russian stocks look dirt cheap compared with 15 to 18 times for the other BRICs (or 14 for the S&P 500).

The problem is that two of the biggest influences on Russia's performance—the oil price and the euro-zone economy—present big risks in 2013. Bulls point to internal measures such as a recently launched anticorruption drive. But even if that proves successful—a Russia-size "if"—it could in the near term exacerbate capital flight, a persistent headwind in 2012.

Brazil looks better than Russia. But having been the hot story of recent years, its fall from grace in 2012 has been hard: Stocks are down 6%, the worst of the BRICs.

Third-quarter GDP growth of 0.6% was half what was expected. The big problem is low investment)—public and privaterunning at about 19% of GDP. This would need to rise to 22% for Brazil to get back to the 4.5% GDP growth rate it enjoyed for much of the past decade, according to Deutsche Bank .

The government has several grand projects planned, such as expanding Brazil's ports. But the state's heavy hand also is part of the problem. A complex tax code and web of regulation keep Brazil near the bottom of the World Bank's index for ease of doing business in Latin America. Energy subsidies in the form of price caps curb efficiency and constrain investment by the likes of oil major Petróleo Brasileiro .

India and China, meanwhile, ought to benefit from falling commodity prices. India, in particular, could use the help to tame inflation which still runs above 7%. Worryingly, inflation remains high even though GDP growth this year is expected to be just 4.9%, well below the average of 8% before the financial crisis.

Stubborn inflation reflects infrastructure bottlenecks arising from weak investment. High fiscal deficits, running between 5% and 6% of GDP since 2009, crowd out private-sector investment. And little of the government's spending represents genuine investment, which could improve productivity and curb inflation, providing room to loosen monetary policy.

Moreover, money that goes to subsidizing things like fuel to ease the burden of inflation takes away from investment in what is arguably India's greatest resource: its large, young population. Without policy changes, reaping India's demographic riches isn't a foregone conclusion, according to UBS's Mr. Baweja, who says India has "two choices: Employ these guys or subsidize these guys."

Unlike the other BRICs, China's problem isn't a legacy of low investment. Far from it: between 2003 and 2007, investment was about 42% of GDP. That is higher than the levels seen in Japan in the decade to 1974 and South Korea in the decade to 1997, at the height of their industrial development, according to Charles Dumas of Lombard Street Research. In response to the financial crisis, Beijing unleashed a stimulus effort that pushed the ratio to 48% in 2011.

The side-effects can be seen in trade friction, especially with the West, arising from overcapacity in manufactured goods ranging from steel to solar panels, as well as rising wage inflation and bad debts lurking in the financial system. Beijing's newly installed leaders appear to recognize the problem, with the latest five-year plan calling for domestic consumption to play a greater role in economic growth.

Such a plan is laudable, and problematic. First, shifting the burden of growth from investment and net exports51% of GDP—to consumer spending, which accounts for just over a third of the economy, necessarily entails slower growth overall. For a one-party government with a wary eye on the potential for social unrest, it will be tempting to fall back on the old model of lending money to state-owned enterprises to build stuff, return on capital be damned.

The flip-side is that, if Beijing stays committed, the transition is unlikely to be smooth and will certainly hit sectors tied to construction. The boom in prices of raw materials such as copper and iron ore, especially, looks numbered even allowing for the occasional relapse in Beijing's resolve.

Unlike previous crises, the BRICs aren't teetering, thanks to relatively clean balance sheets. But a decade in which they could do little wrong is well and truly over. Each must now grapple with the problems of reforming themselves for a changed world.

And increasingly, the political and economic differences between themobscured in the bull market—will become clearer, throwing the whole idea of the BRICs into question.

For fans of the band, there is no guarantee they will love them as solo artists in the years to come.