| Lock Congress Up Until They Deal? Posted: 27 Dec 2012 03:51 PM PST Stocks staged a late day rally because the Senate is prepared to kick the can down the road, avoiding any chance of fiscal sanity this year or next. Whether or not the House will go along is another matter, but unfortunately Speaker Boehner calls House back to Washington on Sunday The House of Representatives will reconvene on Sunday evening, just less than 30 hours before the United States reaches the fiscal cliff.
House Speaker John Boehner, R-Ohio, notified lawmakers that the House would come to order at 6:30 p.m. ET on Sunday in hopes of averting the end-of-year combination of tax hikes and spending cuts that constitute the fiscal cliff.
The lawmaker on Thursday's call told NBC News that any Senate plan Boehner puts on the House floor (of which there is no guarantee) would only receive as few as 40 Republican votes, making Democratic help necessary.
"If the Senate will not approve these bills and send them to the president to be signed into law in their current form, they must be amended and returned to the House," Boehner told Republicans Thursday, according to a source on the call. "Once this has occurred, the House will then consider whether to accept the bills as amended, or to send them back to the Senate with additional amendments. The House will take this action on whatever the Senate can pass -- but the Senate must act." Flagpole Rally S&P 500 Futures  The moment I saw that second green candle and volume spike on the S&P 500 futures I knew a deal was in the works even though I could not find any news for a half hour. Magic Number is 60 MarketWatch reports Senate Republicans open to new cliff deal Senate Republican Leader Mitch McConnell said late Thursday that Senate Republicans are open to any White House proposal to avert the fiscal cliff.
Reid urged the House to pass a Senate bill extending Bush-era tax cuts for those earning $250,000 a year or less. The Nevada Democrat said the House is being operated under "a dictatorship of the speaker."
A spokesman for House Speaker John Boehner said in response: "Senator Reid should talk less and legislate more."
Even in the Democratic-controlled Senate, Obama's preferred bill faces an obstacle: Sixty senators are required to break a filibuster, and Democrats control 53 seats. Easy Escape for Senate Republicans The magic number may be 60, but I do not expect any filibusters in the Senate. The easy escape route is to pass the buck. In this case the Senate is likely to pass anything, hoping to avoid the blame, while placing a burden on the House to do something fiscally responsible. Let's hope the House rejects whatever watered-down proposal that comes out of the Senate. Lock Congress Up Until They Deal? MarketWatch Columnist Rex Nutting says On fiscal cliff: Don't negotiate, let's legislate. The United States doesn't have a fiscal problem. Or an economic problem. It has a political problem. The workings of the government are so gummed up that we're in danger of falling into a recession that's completely avoidable.
I think it's high time we locked the members of Congress in a room and told them that we'll let them out when they reach a deal. Economic Folly of Recession Avoidance The idea the US does not have a fiscal problem or an economic problem is of course total nonsense. That said, I am of course totally sympathetic towards the idea the US also has a political problem. Indeed, I am even willing to say the political problem is largely responsible for the economic and fiscal problems. Where Nutting crosses the line into economic folly is the idea Congress needs to avoid a recession. Quite frankly, that is a nut case proposal, and no solution at all. The US is in this mess because every step of the way, the Fed and Congress acted to avoid recessions. Greenspan in particular fueled a housing bubble holding interest rates too low too long to "help" the economy out of a dot-com bubble bust largely of the Fed's making. Now, Nutting wants to lock Congress in a room until they come up with a deal to avoid a recession. Instead, I propose fiscal sanity. I propose we lock Congress in a room until they come up with a proposal that will balance the budget within five years. Either Nutting is wrong or I am. And here's a hint, if I'm wrong about anything, it's that five years is too long. Nutting proposed nothing more than another can-kicking exercise that will never end. I suggest it's time for an honest economic discussion on what the country can or cannot afford. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Social Trap in Spain: Mortgage Nightmare; Why Spain (or Germany) is Guaranteed to Leave Euro Posted: 27 Dec 2012 11:39 AM PST Looking for a synopsis of the problems facing Spain? A summary of bullet points I gathered from the Spiegel article Evictions Become Focus of Spanish Crisis shows just how hopeless the situation is. - There were a record number of evictions in 2012, foreclosures are expected to increase in 2013.
- Some 400,000 eviction proceedings have been opened in Spain since 2007, with roughly half of the families involved having already lost residential properties due to foreclosures. That means Spain is only half-way through the crisis.
- There are now 1.7 million Spanish households in which not a single family member still earns a salary.
- 4 million people have lost their jobs since 2007
- 27 percent of the population lives below poverty level
- Evictions now affects pensioners, who have used their own homes as collateral to take out loans for their sons and daughters
- A joint study by UNICEF, Oxfam and Doctors Without Borders concluded that the country will need over 20 years to regain the standard of living it attained in the prosperous, pre-crisis years.
- In the Catalonia region, unemployment is 26 percent
- Youth unemployment is over 50%
Social Trap Spanish Prime Minister Mariano Rajoy has issued a moratorium on foreclosures for "extreme hardship" cases. The definition of "extreme hardship" is "families with two children and an annual income of less than €19,000, more than half of which has to be used for mortgage payments." Single parents with children under the age of three also qualify. Notice that the hardship rule still requires over half of income to go to mortgage payments. Meanwhile interest accrues indefinitely. There is no way for these families to ever pay back debts accumulated at or near the height of the bubble. If there are evictions people are thrown out on the street. If there are no evictions, then there is no way for banks to sell the properties to someone who is able to afford mortgage payments. Euro Trap In mid-December, Spain received nearly €40 billion ($53 billion) from the European Stability Mechanism (ESM) to restructure its ailing banks. Yet every day Spanish banks acquire more properties not marked-to-market. Moreover, moratoriums delay the process as interest accrues. The longer Spain tries to stay on the euro, the deeper Spain goes into debt to the rest of the EU. This is what happened to Greece, and the result was the rise of "Golden Dawn" a neo-Nazi group. Constitutional Crisis There are no sign of Nazism in Spain. However, Pro-Referendum Parties Won 87 of 135 Seats in Catalonia and a constitutional crisis is brewing as Catalans wish to secede from the rest of Spain. Every day, bad debts mount at Spanish banks. Catch 22 of Sorts On December 19, I reported Loan Default Rate Hits 11.23% in Spain, a New Record; Construction Defaults Hit 26.4%; Credit Plunges 5% Can anyone tell me how Spain can possibly exit their trap that does not involve Germany pouring vastly more money into Spain? The only way I can come up with is default with Spain leaving the Euro. Sooner Spain Leaves the Euro the Better for Everyone Note that the ECB, IMF, and the rest of Europe (including Spain), threw money at Greece, turning a relatively small problem into a much bigger one. As Greece has shown, the sooner a country leaves the Euro, the better off everyone will be. So when does Spain, or Germany come to its senses? Either one will do. In the meantime, politicians will kick the can for as long as they can, making the situation messier and messier along the way. Pick Your Poison The bottom line is Germany will pony up (and by pony up I mean "give" not lend) massive amounts of money to Spain, or Spain will have no choice but hard default. - Ultimately, a charismatic politician in Spain will blame Germany, blame the euro, and pledge to default. That politician will be elected.
- Alternatively, a charismatic politician in Germany will get tired of making handouts to the club-med states and promise to put Germany back on the Deutschmark. That politician will be elected.
This is a clear case of pick your poison, and Germany will take a hit one way or another. Timing is the only uncertainty Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Michael Pettis on China Reforms, Ponzi Schemes in Wealth Management Programs, Rebalancing Implications Posted: 26 Dec 2012 11:47 PM PST Here are portions of a email from Michael Pettis at China Financial Markets on the unsustainable nature of China's growth, Ponzi schemes in wealth management programs, and the implications of China's rebalancing efforts. By permission ... As analysts wrack their minds over specific debt problems in China and how they are to be resolved, I think we must remember to look not at specific debt issues but rather at the way the overall system operates.
I have argued many times in the past six years that the Chinese growth model has reached the point (perhaps well over a decade ago) where growth was almost necessarily driven by an unsustainable increase in debt. This meant, I suggested, that while it might be hard to predict where the next debt problem would crop up, it was very easy to predict that debt problems would continue to crop in one sector of the economy after another.
We need to remember this as we consider financial risks in China. One of the big stories this month of course was the failure of the Zhongding Wealth Investment Centre, the borrower against a Wealth Management Program (WMP) issued at a Shanghai branch of Huaxia Bank.
According to an article in the South China Morning Post, [Huaxia scandal spotlights China's Ponzi crisis] "dozens of depositors lost their multimillion-yuan investments in a "wealth management product" (WMP) sold at a Shanghai branch of Huaxia Bank. The sorry saga was a rude reminder that Ponzi schemes thrive on the mainland, where millions of residents still believe that banks are the safest havens for their lifelong savings."
The reason this particular story is important is not because the transaction is large enough to make much of a difference, but rather in what it tells us about risks in the financial system. The first point is that we have no idea what is really going on in this already large and rapidly growing part of the Chinese financial system, but whatever we can see looks pretty ugly.
In my October 29 newsletter I referred to a recent article that discussed this problem, an opinion piece by Xiao Gang, the Bank of China's CEO, in China Daily. In this piece he describes the shadow banking system and the role of wealth management products:
It is difficult to measure the precise amount and value of WMPs. Fitch Ratings says that WMPs account for roughly 16 percent of all commercial bank deposits, while KPMG reports that trust companies will soon overtake insurance to become the second-largest sector in the Chinese financial industry. According to a report by CN Benefit, a Chinese wealth-management consultancy, sales of WMPs soared 43 percent in the first half of 2012 to 12.14 trillion yuan ($1.9 trillion).
There are more than 20,000 WMPs in circulation, a dramatic increase from only a few hundred just five years ago. Given that the number is so big and hard to manage, China's shadow banking sector has become a potential source of systemic financial risk over the next few years.
Particularly worrisome is the quality and transparency of WMPs. Many assets underlying the products are dependent on some empty real estate property or long-term infrastructure, and are sometimes even linked to high-risk projects, which may find it impossible to generate sufficient cash flow to meet repayment obligations.
I went on to say in my newsletter:
There are three big questions with WMPs, as analysts are increasingly recognizing, each of which Xiao discusses, perhaps a little more politically than I do, in his piece. First, we don't know the size of the market. Second, we have no idea of whether or not the assets backing these products are money good – in fact the bankers themselves who sell WMPs are almost never able to explain what asset is behind the WMP. Third, we have no idea of the transmission mechanism between potential problems in WMPs and the banking system.
The key point we must remember is that whatever Beijing does about WMPs, this will not resolve the underlying debt problem. Growth in China is currently dependent on an unsustainable increase in debt. If one avenue for this growth in debt is cut off, we will simply see the debt rise somewhere else. Economic growth in China requires rapid growth in investment. This growth in investment is increasingly misallocated on projects that will not generate the increases in real productivity needed to cover the cost of capital. Since these investments are funded at least in part by debt, debt must rise in one part of the system or another as long as GDP growth rates exceed 4-5%.
In China, in other words, high growth is no longer compatible with a strengthening balance sheet. If China is growing at a rate that approaches or exceeds this level, it is probably a safe bet that debt is rising faster than debt servicing capacity.
The good news is that the current leadership seems very clear about the need to implement reforms, and also understands that this is going to be politically a difficult process.
As an article in the People's Daily put it: No easy path in sight for China's economic future
"Reform is exciting, but it is also full of difficulties and challenges. Xi said in Guangdong that China must squarely face difficulties and challenges, strive for the best results and firmly seize the initiative. This deserves consideration by the entire Party and society."
These expected, and exciting, "difficulties and challenges" are, I suspect, the things we should be most concerned about in our attempts to understand the pace of reform. The history of developing countries suggests that most countries fail in the reform and adjustment process precisely because the sectors of the economy that have benefitted from the distortions are powerful enough to block any attempt to eliminate those distortions.
Certainly not everyone in China is confident that Beijing will be able to force through the reforms that are widely accepted as necessary without a serious fight. There were two interesting and related articles in this week's South China Morning Post that may indicate the degree of worry.
The first article tells you much of what you need to know in the title ("China's rich and skilled leave in record numbers"). It goes on to say:
More than 150,000 Chinese became permanent citizens in major immigrant countries including the United States, Canada, Australia and New Zealand last year, topping the world's list of overseas migration in absolute numbers, a recent report revealed. The Centre for China and Globalisation (CCD) and Beijing Institute of Technology (BIT) School of Law jointly released their findings in the Chinese International Talents Annual Blue Book's International Migration Report (2012) on Monday, according to media reports.
…Another report by Hurun Research Institute and Bank of China in 2011 found that 14 per cent of China's high-net-worth individuals had either emigrated or were in the process of doing so. In addition, 46 per cent were considering permanently moving overseas through various immigrant investor programmes with real estate, foreign currency deposits and stocks being the primary areas of investment.
US Citizenship and Immigration Services (USCIS) declared that 41 per cent of total EB-5 Immigration Investor Programme applicants were Chinese while the Australian Department of Immigration and Citizenship reported that 61.5 per cent of applicants for the Business Skilled Migration Programme were Chinese.
We have known for a while that Chinese with the means to do so are increasingly opting to move abroad. There are many reason for this, of course, but China is still growing much faster than the rest of the world, even if some of us don't fully accept the official numbers, and so for people to look for opportunities abroad suggests at the very least that either some of these people seriously doubt the sustainability of China's current growth and expect it to come crashing down, or that they are worried about political uncertainty and the possibility of difficulty ahead. Or both.
The second article, China 'top source' of world's tainted money, also by the South China Morning Post, involves data from a completely different source and for completely different purposes, but it may broadly be telling the same story. The article is based on a very interesting study conducted by Global Financial Integrity on illicit capital flows around the world. The article summarizes their study as:
Some 150 developing countries, led by China, have been the source of flows of tainted money totalling US$5.9 trillion over 10 years through 2010, Global Financial Integrity, a research and advocacy group in Washington, DC, said.
Flows of illicit money from tax evasion, crime and corruption in the developing world have roared back to pre-financial crisis levels, topping nearly US$859 billion in 2010, near the all-time high of US$871 billion in 2008, it said. In 2009, following the global financial crisis, the figure dropped to US$776 billion.
China tops the list of developing countries sending illicit money abroad, either to offshore havens or to financial institutions in developed countries, GFI said in a study. In 2010, illicit money out of China totalled US$420 billion, the report said, and exceeded US$2.7 trillion for the decade ending in 2010 - nearly half that period's total for all developing countries
For comparison's sake, Malaysia came second, with over $64 billion in 2010 and $285 billion for the decade. Mexico was in 2010, with over $51 billion in illicit flows, and $476 billion for the decade. The study acknowledges that it does not include cash transactions, so actual illicit flows are probably higher, maybe even significantly higher.
The full ranking of 71 countries shows, among other things, that illicit capital flows from China are roughly equal to the sum of illicit capital flows from the next fifty countries. I haven't been able to adjust the numbers for GDP size (larger economies should on average have larger illicit outflows), but when you consider that the next fifty countries include Mexico, Malaysia, Russia, India, Indonesia, Poland, Brazil, Turkey, Argentina, Hungary and forty others, I think it is pretty safe to say that China's ranking as number 1 is not just a function of its being the largest developing economy in the world.
As a share of GDP, in other words, Chinese illicit outflows seem easily to exceed the average for all developing countries. Mexico's GDP, for example, is roughly one-seventh the size of China's, and yet for all its drug money, its illicit flows were only one-eight those of China. This means that the Chinese business and political elite export illicitly a larger share of the Chinese economy than the combination of the Mexican business and political elite and their drug cartels.
One of the most interesting paragraphs in the study, for me, concerned trade invoicing:
Trade misinvoicing is the preferred method of transferring illicit capital from all regions except the MENA region where it accounts for only 37 percent of total outflows for the decade ending 2010 (Chart 6). In declining order of dominance, the share of trade misinvoicing in total outflows by region is Asia (94.0 percent), Western Hemisphere (84.0 percent), Africa (65.0 percent), and developing Europe (53.0 percent). Large current account surpluses of countries in the MENA region driven by crude oil exports entail larger outflows through the balance of payments. In the case of Europe, the relatively large unrecorded outflows from the Russia's balance of payments dominate regional outflows.
This creates, for me, a real and very obvious problem with understanding China's trade figures. According to the study, illicit money out of China totaled US $420 billion in 2010. The study also claims that in Asia nearly all of the illicit money flows (94%) occur through mis-invoiced trade, which suggests, of course, that the trade numbers can be seriously distorted. If capital is being secretly taken out of the country through trade, exports are likely to be under-reported, imports are likely to be over-reported, and the real trade surplus is almost certainly larger than the reported trade surplus.
How much does this illicit capital flow impact China's real trade account? Here is a January 2011 Xinhua article on China's 2010 trade account:
China's foreign trade last year jumped 34.7percent year on year to more than 2.97 trillion U.S. dollars while its trade surplus fell 6.4 percent to 183.1 billion U.S. dollars, the General Administration of Customs (GAC) said Monday.
The country's exports grew 31.3 percent year on year last year to 1.58 trillion U.S. dollars while imports surged 38.7 percent to 1.39 trillion U.S. dollars, said the GAC. "China's foreign trade is, in general, heading towards a balanced structure," said the GAC in a statement on its website. The trade surplus accounted for 6.2 percent of all foreign trade last year, down from 8.9 percent in 2009 and 11.6 percent in 2008.
It is clear that these illicit capital flow numbers are pretty significant in relation to the trade numbers. China's trade surplus in 2010 was reported to be $183 billion, but GFI claims that Chinese illicit capital flows (I assume that most if not all represents outflows, or even net outflows) for the year were $420 billion, most of which may have been recorded as higher exports or lower imports.
Even if these numbers are way off, they still suggest that China's real trade surplus may have been substantially higher than reported, with much if not most of the money parked offshore for safekeeping. Among other things these numbers also suggest that the sluggish import growth of the past year, which smart people like Andy Xie insist are among the many numbers that are not compatible with the high official growth rates claimed by the government, may be even lower than reported.
Obviously I am not the first person to complain about the opacity of Chinese economic data and the difficulties we often have in reconciling one set of numbers with another, but I think it is important to note that while opacity may not be a terrible problem during the optimistic up-cycle (in fact hazy data give us more leeway to daydream pleasant things), it can suddenly become a huge problem during the pessimistic down-cycle, when they don't even constrain our nightmares. What is worse, an increase in opacity, which we are clearly seeing in the financial system, is usually a herald of bad tidings. When the economy starts to get bad, often the first impulse for many is to massage or hide the data.
I don't think this is the end of this story. The market hasn't yet priced in the amount of rebalancing China has yet to go through, and so it has also not priced in either the full reduction in hard commodity demand or the extent of rebalancing on China's export competitiveness. I expect a lot more of the same story in 2013 and 2014. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Michael Pettis is one of six speakers an an economic conference I am hosting on April 5, 2013, in Sonoma, California. I consider Pettis as one of the world's leading experts on China and on global trade issues. Click on the image below for conference details. "Wine Country" Economic Conference Hosted By Mish Click on Image to Learn More  |
