Rudely Interrupted Swagger

An article at Reuters on this year's Davos meeting is telling us that in spite of all the problems created by central bank policies, we shall prevail (presumably with the help of even more problems to be created by central bank policies).

Apparently there was a reasonably good mood, which the brewing EM currency crisis rudely interrupted, leading some of those present (the 'veterans' we are told) to warn of complacency:


“Just as they were getting their swagger back, the global elite stumbled last week on an emerging market sell-off that served as a reminder of the risks the global economy still faces.

Veterans of the annual World Economic Forum in Davos seized on the wobble as a warning that expectations for a smooth upswing were misplaced, and that recovery would likely be volatile and uneven.

The euro zone crisis is out of its acute phase and growth is returning across the developed world but a revival fueled largely by vast amounts of new central bank money is a capricious one.

The prospect of the U.S. Federal Reserve turning off its money taps this year, combined with political troubles in several emerging markets, drove last week's sell-off and exposed some of the unresolved problems in both developing and advanced economies.

"I hear way too much optimism now," Larry Fink, CEO of investment group BlackRock, told the forum. "I think the experience of the marketplace this week is going to be indicative of this entire year. We are going to be in a world of much greater volatility."

The return of growth in the United States, Japan and Europe masks festering problems from chronic youth unemployment to skills shortages and rising inequality that dampened any hubris in Davos. Tech executives were exuberant about breakthroughs that are revolutionising production, healthcare and communication but others warned those advances may kill jobs.

CEOs in Davos complained more vociferously than ever about a lack of talent for hire despite sky-high unemployment in rich and poor countries alike. In the West, too many young people are graduating from expensive colleges with high debts and the wrong skills, while in developing countries a big majority are not achieving their economic potential.”


(emphasis added)

This is quite a jumble of information, but let's look at the points highlighted above:

1. 'Stumbling elites'? Who cares? Most people care more about the economic mess the central planners among them have produced, even if they don't all necessarily grasp the cause-effect chain.

2. what the euro-zone is 'out of' could well turn out to be merely phase one of the crisis. The Fat Lady could break into song  again anytime

3.“…a revival fueled largely by vast amounts of new central bank money is a capricious one” – that is so far the understatement of the year. It is not merely 'capricious', it absolutely guarantees an even bigger crisis down the road.

4. Larry Fink will probably be proved right, quite possibly in spades. 

5. the idea that technological innovation 'kills jobs' is as old as the Industrial Revolution, and as misguided today as it was then. People continually seem to forget that the very object of economic activity is to achieve more with less, i.e., to increase economic productivity, and with it wealth, over time. Admittedly economic and technological progress leads to short term disruptions, but one must also keep in mind that there are jobs today no-one could even imagine 20 or 30 years ago, because the industries creating them didn't even exist yet. Innovation has brought them forth.

6. Nevertheless, the complaint voiced by CEOs is valid: there are at the moment notable mismatches in the skills demanded and supplied in the labor market. This is however not a result of technological innovation, it is a result of malinvestment. It is not only tangible capital that is subject to malinvestment, it also occurs in what is known as 'human capital'. We have a severely hampered market economy, in which the monetary authorities have become progressively more interventionist over time, fighting the consequences of their errors by committing the same errors over and over again, only on an ever greater scale. No-one should be surprised by the result.


Emerging Markets Victims of 'Tapering'?

There is still a strong belief that somehow, central banking 'works' in spite of all the evidence to the contrary, and that no lasting ill effects will be noticeable. Only a few 'ups and downs' are expected:


“The year ahead will witness a marked shift in the balance among the world's main growth engines, with the United States and other developed economies contributing more and emerging markets somewhat less than before.

Reduced Fed bond buying will reverse the liquidity that has flooded into higher-yielding emerging markets assets.

"We expected this year to be a volatile year for EM as the Fed tapers," Mexican Finance Minister Luis Videgaray said, adding that volatility "will happen throughout the year as tapering goes on".

Despite particular worries in countries like Argentina and Turkey, CEOs are still determined to tap into the growing middle classes of the new mega-cities of Asia, Latin America and Africa. But they are becoming more selective. The notion of lumping together diverse economies like Brazil, Russia, India and China has gone.

BlackRock's Fink said the Fed's tapering was just an excuse for turmoil in some emerging markets. The real cause was "bad policy" in the countries affected.

Renault-Nissan chief Carlos Ghosn, whose company has car plants in many emerging markets, said: "You have to be ready when you invest in emerging markets for ups and downs." In the short term, investors are braced for more downs.

"We are on the cusp of a slowdown in emerging markets," said Scott Gordon of Taconic Capital Advisors. "There is a higher proportion of developed market growth that will drive the global economy."


(emphasis added)

1. As long as the Fed continues to slow down money supply growth, there will indeed be a number of effects, but it would be naïve to expect them to remain confined to emerging markets. US money supply growth is more important to the US echo bubble economy (as an aside, Stephen Roach – who of course doesn't possess a crystal ball either – disagrees with the Davos consensus and thinks the US recovery is a 'false dawn').

2. “ tapering goes on” – from point one we can infer that 'tapering' will probably have a limited shelf life.

3. It is apparently the year of Larry Fink being right about everything.

4. The question is for how much 'down' investors are braced.

5. Developed market growth 'driving the global economy' is last year's story. No-one knows what will happen this year. Besides, there is no attempt at differentiating genuine growth from capital consumption masquerading as growth. It is easy to throw a party by printing trillions in new money every year, but chances are that it was a rather extensive (and ultimately costly) illusion, mostly generated by the spectacle of rising stock markets.


Euro-Land Disharmony

The one place where more central bank shenanigans are held to be 'advisable' is Europe, where several luminaries have apparently spied a developing 'threat' from falling prices which could actually end up relieving the budgets of consumers. We can't have that according to the prevailing orthodoxy (never mind that is hasn't yet happened anyway). Not everybody agrees:


“Yet advanced economies also have work to do to put their houses in order. "Complacency is both the positive and the negative of Davos this year," said John Studzinski, global head of Blackstone Advisory Partners. "On the one hand, we're not looking at the break-up of the euro zone anymore and people are more relaxed.


Even as headline growth numbers improve, few citizens are feeling the recovery. A survey by consulting group Alix Partners of 6,000 adults in six European countries conducted in mid-January showed 71 percent of those questioned saw the economy staying the same or getting worse over the next year.

Christine Lagarde, managing director of the International Monetary Fund, warned policymakers of "some of the old risks that have not yet been completely fixed", added to which is the threat of deflation in Europe.

A case in point is a European Union plan to curb banks' ability to take market bets with their own money, which Germany and France have attacked, warning in a paper seen by Reuters that it could jeopardise a delicate revival.

In some cases, European policymakers cannot even agree on the problems they should be tackling.

German Finance Minister Wolfgang Schaeuble publicly disagreed with EU Economic and Monetary Affairs Commissioner Olli Rehn's view that prolonged low inflation in the euro zone would make necessary economic rebalancing harder.

Schaeuble called that view "nonsense".

Both Rehn and French Finance Minister Pierre Moscovici said the European Parliament could still "improve" a complex system for winding up failed banks agreed by the EU last month. Schaeuble said there was little scope for change without breaching EU treaties.”


(emphasis added)

Let's look at the highlights again:

1. There is no call to get overly 'relaxed'. The problem is that Europe's sovereigns are today more indebted than at any time during the crisis period. This particular problem hasn't been solved, it has instead been papered over with the help of the ECB and the tottering commercial banks (a variation of the Three Card Monte has been played, and investors gladly allowed themselves to be duped).

2. It is no wonder citizens are “not feeling the recovery”. Rising stock markets do not represent a 'recovery', nor do constant assurances by officialdom that everything is fine again constitute a recovery. Incidentally, France just reported a new all time high in its unemployment rate.

3. We have discussed Ms. Lagarde's views before (see: “Ogre Spotting” for details). Not to get too technical about it, we think she's a deluded bureaucrat in what appears to be an advanced stage of decomposition. She is hardly alone of course (delusion-wise), and we don't want to pick on her in particular, but she does head an organization we believe to be just as surplus to requirements as central banks.

4. On the one hand it is true: if banks are no longer able to freely speculate on dodgy assets, the recovery illusion will likely falter more quickly. On the other hand, wasn't that one of the reasons why they got into so much trouble in the first place? The secret is in removing moral hazard – completely. That would imply free banking and a free market in money. Very likely, there would be no longer any meetings in Davos if we had all that, but smooth economic development would be far more likely than it is today.

5. Hallelujah. Olli Rehn is likewise a deluded bureaucrat (only in our opinion of course; others possibly think he's a great guru…naaah). Wolfgang Schäuble, although automatically suspect by dint of his profession (politician) is absolutely correct when he calls Rehn's deflation-phobia – or rather 'low inflation' phobia – nonsense.

At this point one must pause to take stock of euro-land's journey to date. On the one hand, the reform process has been deeply flawed. Way too much weight has been put on fixing budgets by raising taxes instead of cutting down on the burden of government spending. Reforms of labor markets and other important economic initiatives have been halfhearted and far from rigorous enough. On the other hand, although the ECB has frequently intervened to pull the chestnuts out of the fire for the euro zone's political class (see the above comment re. 'papering over' the debt problem), it has shown some restraint in terms of active money supply inflation (which is a refreshing contrast to the Fed). There has been an extended period of liquidation of malinvested capital as a result. It all could have gone far smoother of course, but it is conceivable that this will eventually produce a more balanced period of growth, provided it isn't buggered up again, which remains at all times a distinct possibility.



BELGIUM-EU-ECOFIN-FINANCESchäuble skeptically eyes a nonsense-purveying Rehn 

(Photo via AFP)



Has Japan Fallen Into the Sea?

We're wondering though: why was Japan not even mentioned in this Reuters article? One would think that the BoJ's desperate umpteenth iteration of 'QE' in even greater quantities than ever before and the still unfulfilled promise of 'Abenomics' would have been worth a comment or two at Davos. It's not as though Japan were unimportant.

However, Andy Xie recently published a few remarks on Japan that are worth repeating, mainly because we agree with him (he incidentally also asserts that 'Keynes is dead', meaning Keynesianism is dead, or at least should be, which earns him additional points):


“I’m surprised by how many investors are taken in by Abenomics. Most international funds that invest in Japan have been going all-out to market it to retail investors. This is the main reason that the Nikkei Average has stayed so lofty. I suspect that self-interest is the main driver. Such funds have been withering for a long time. They are latching on to Abenomics for a good time. Even if it doesn’t last, it is better than nothing. Most important, the people who sell Abenomics may not have their own money on the line.

Abenomics is just the same old construction stimulus that the ruling party has been doing for 20 years. The Bank of Japan’s QE isn’t new. It is just bigger than before. Its achievement is to get the yen down 20% against the dollar, which has happened before. Even the structural-reform talk isn’t new. It happened before and mostly remained talk. So far, structural reform in Abenomics is still talk. This glaring failure has not scared away the investor community. I guess they really don’t want to stop the party and are willing to ignore anything.

Japan has a low unemployment rate. Macro stimulus is the wrong recipe. Japan’s deflation just reflects the yen level. It is not causing a downward spiral. Curing deflation is just devaluing yen. It won’t cure growth weakness. The Abenomics bubble is likely to burst in 2014.”


(emphasis added)

There is really nothing to add to that – Xie clearly has Abe's number and is assessing the situation correctly.



Anyone who has not been completely asleep over the past two decades should have realized by now that most of the problems discussed at Davos are a direct result of the failure of interventionism. And yet, there is still no attempt to break this cycle, which is due to a mixture (we believe) of ignorance and vested interests defending their turf. These days one has to be glad if there is the occasional slight backtracking toward a less hampered economy, when so to speak circumstances force the political and bureaucratic classes to throw the free market a few breadcrumbs.




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One Response to “Davos 2014: Tempered Complacency?”

  • No6:

    Japan, Europe and the US all demonstrate how difficult it is to unhamper an economy even in the face of economic meltdown. Ancient Rome became ever more hampered even in the face of the Germanic hordes. Eventually Romans were fleeing Rome to join the hordes. The dark ages followed and lasted quite a while.

    I have a feeling that we will need to see multiple wars, a bout of the Black Death or its viral equivalent and a mini ice age (which is far more likely than global warming) before we clear out big government, all the Zombies and vested interests.

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