Mish's Global Economic Trend Analysis

Lifesaving Injection of Debt
By 2015 Hard Commodity Prices Will Collapse; Australia's Mining Boom Dies (and the Official Denials Start)
Manufacturing ISM Contracts 3rd Month Led by Declining New Orders; Recession-Type Numbers? You Bet!
Central Bankers Fail to Understand Forces Holding Back the Economy; Ten Major Economic Headwinds

Posted: 04 Sep 2012 10:04 PM PDT

The bailout schemes get sillier and sillier. The Spanish bank Bankia has requested €19 billion in state aid, but in Bizarro World fashion will instead receive €4 billion in debt which it would then swap with the ECB for cash.

Please consider Madrid plans to inject Bankia with debt.

Madrid is planning to provide €4.5bn of stopgap rescue money to Bankia, the nationalised bank, by injecting it with Spanish government debt, in a move likely to reignite debate over how states can use the European Central Bank to recapitalise troubled lenders.

The Frob, Spain's state bank bailout fund, will issue BFA, Bankia's parent company, with €4.5bn of government bonds, said a spokeswoman for the economy ministry.

This gives the bank the possibility of depositing the bonds with the ECB as collateral in return for cash.

The bonds will later be returned by Bankia to the Frob after the arrival of €100bn in European aid for Spanish banks in late October or November.

The ECB declined to comment on Bankia or the Spanish government's plans. But any attempt to help Bankia create collateral in this way could well founder on rules designed to prevent so-called monetary financing.

The contortions the ECB goes through just so it can say it is not doing monetary financing are staggering.

Indeed, the entire Target2 scheme is nothing but backdoor monetary financing.

For details, please see Discussion of Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks "Can You Please Explain Target2?"

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

By 2015 Hard Commodity Prices Will Collapse; Australia's Mining Boom Dies (and the Official Denials Start)

Posted: 04 Sep 2012 01:38 PM PDT

I have been calling for a base metals bust for some time, fueled by a slowdown in China. Michael Pettis at China Financial Markets has been saying the same thing. Indeed, it is analysis from Pettis that influenced my views in the first place.

Pettis now believes commodity prices will collapse by as much as 50% over the next few years. His rationale is solid.

Here are a few snips from a recent Michael Pettis email in which he outlines the case.

By 2015 Hard Commodity Prices Will Collapse

For the past two years, as regular readers know, I have been bearish on hard commodities.　 Prices may have dropped substantially from their peaks during this time, but I don't think the bear market is over.　 I think we still have a very long way to go.

There are four reasons why I expect prices to drop a lot more.　 First, during the last decade commodity producers were caught by surprise by the surge in demand.　 Their belated response was to ramp up production dramatically, but since there is a long lead-time between intention and supply, for the next several years we will continue to experience rapid growth in supply.　 As an aside, in my many talks to different groups of investors and boards of directors it has been my impression that commodity producers have been the slowest at understanding the full implications of a Chinese rebalancing, and I would suggest that in many cases they still have not caught on.

Second, almost all the increase in demand in the past twenty years, which in practice occurred mostly in the past decade, can be explained as the consequence of the incredibly unbalanced growth process in China.　 But as even the most exuberant of China bulls now recognize, China's economic growth is slowing and I expect it to decline a lot more in the next few years.

Third, and more importantly, as China's economy rebalances towards a much more sustainable form of growth, this will automatically make Chinese growth much less commodity intensive.　 It doesn't matter whether you agree or disagree with my expectations of further economic slowing.　 Even if China is miraculously able to regain growth rates of 10-11% annually, a rebalancing economy will demand much less in the way of hard commodities.

And fourth, surging Chinese hard commodity purchases in the past few years supplied not just growing domestic needs but also rapidly growing inventory.　 The result is that inventory levels in China are much too high to support what growth in demand there will be over the next few years, and I expect Chinese in some cases to be net sellers, not net buyers, of a number of commodities.　

This combination of factors – rising supply, dropping demand, and lots of inventory to work off – all but guarantee that the prices of hard commodities will collapse.　 I expect that certain commodities, like copper, will drop by 50% or more in the next two to three years.

Based on my many trips in recent years to places like Australia, Peru and Brazil, I had plenty of anecdotal reasons to believe that commodity producers had significantly overestimated the sustainability of the Chinese growth model (or, perhaps more accurately, had not really thought about whether or not it was sustainable).　 I was worried that they were expanding production very quickly.　 Everywhere I went I heard stories of large-scale investments to expand production.

Many producers have acknowledged recent price declines, but they seem to believe that these are likely to be short-lived and that prices will soon rebound when Chinese demand returns. For example the Financial Times' Alphaville quotes Nev Power, chief executive of Fortescue Metals, discussing iron ore at a recent meeting:

Iron ore prices have slumped to $US104 a tonne in recent days, yet Mr Power said it could soon rebound as high as $US150. "As soon as restocking and production returns to normal we expect to see prices back in the $US120 to $US150 per tonne range," he said.

He will almost certainly be wrong. 　

Production capacity has grown

The surge in Chinese demand at the beginning of the last decade consequently caught everyone by surprise. Minack shows, for example, that in the past twenty years, global demand for steel grew by roughly 6% a year, with most of that coming in the past decade. If you exclude China, however, global demand for steel grew by only 2% a year in the past twenty years, implying that China accounted for almost all the increase in global demand in the last twenty years – and almost all of that occurred in the past decade.　 In the past ten years Chinese demand for iron ore has grown by 16% a year on average.

The initial surge in demand caught commodity producers off-guard.　 Because they were unable to ramp up production quickly enough, prices surged.　 After a few years of high prices, however, commodity producers responded to the huge new increase in demand by planning major expansions in production facilities.　

What about demand?

China currently is the leading consumer of a wide variety of commodities wholly disproportionate to its share of global GDP.　 The country represents roughly 11% of global GDP if you accept the stated numbers, and substantially less if you believe, as I do, that growth has been overstated because of the difference over many years between reported investment, i.e. its input value, and the actual economic value of output.　 China nonetheless accounts for between 30% and 40% of total global demand for commodities like copper and nearly 60% of total global demand for commodities like cement and iron ore.

The only reason China has provided such an extraordinarily disproportionate share of global demand for hard commodities has been the nature of China's growth model.　 While China may represent only 11% or less of the global economy, it represents a far, far greater share of the world's building of bridges, railroad lines, subway systems, skyscrapers, port facilities, dams, shipbuilding facilities, highways, and so on.　

Over the next decade, two things are going to change.　 The first is increasingly recognized, and that is that Chinese growth rates will drop sharply.　 The second is that China will rebalance its economic growth away from its appetite for commodities.

Which Way Can Prices Go?

For these reasons I am very pessimistic about hard commodity prices and expect them to drop substantially further in the next two to three years.　

Production capacity for hard commodities is rising much too quickly, in a belated response to the unexpected surge in demand just under a decade ago.

Expected economic growth rates in the country that has been biggest source of new demand – virtually the only source – have fallen sharply and commodity prices have fallen with them.　 Historical precedents and the arithmetic of rebalancing suggest, however, that the current consensus for medium-term Chinese growth is still too optimistic.　 Expected growth rates will almost certainly fall further in the next two years.

Beijing has finally become serious about rebalancing China's economy, and rebalancing means shifting Chinese growth away from being disproportionately commodity intensive.　 Instead of representing 30-60% of global demand for most hard commodities, Chinese demand will shift to a more "normal" level.　 Remember that even a very limited shift – from 50% of global demand, for example, to a still high 40% of global demand – represents a sharp drop in global demand.

There has been so much stockpiling of commodities and finished goods with implicit commodity content in China that the country could well become a net seller, and not net a buyer, of a wide variety of commodities in the next few years.

This is going to come as a shock to many people. 　In my discussions with senior officials in the commodity sectors in Brazil, Australia, Peru, Chile and even Indonesia, it seems to me that many analysts have been insufficiently skeptical about the Chinese growth model and are unaware of how dramatically the consensus has changed in the past two years.　

They have failed to understand how deep China's structural problems are and how worried Beijing has become (this worry may be best exemplified by the extraordinary growth in flight capital from China since early 2010).

Under these conditions I don't see how we can avoid a very nasty two or three years ahead for commodity producers.　 This isn't all bad news, of course.　 What will be a disaster for hard commodity producers will be great news for companies and countries that are commodity users or importers.　 One way or the other, however, we are going see a big change in the distribution of winners and losers.

Given that iron ore prices have already fallen by more than 50% perhaps iron does not see another 50% decline. Regardless, there is certainly room for many commodities to plunge that much, and copper is a prime example.

The price of copper at the beginning of 2005 was $1.50 and it fell below that price in late 2008 and early 2009.

Pray tell why can't (and shouldn't) copper see that price again if Pettis' view of Chinese growth is accurate (and I am quite confident in his view).

Official Denial from Australia Prime Minister

Please consider an official denial regarding Australia's mining sector : Boom Isn't Over Says Prime Minister

AUSTRALIA'S mining boom is not over and its 'death' has been exaggerated according to Prime Minister Julia Gillard.

Ms Gillard said she understood there was growing uncertainty due to economic problems in Europe and America, rising competition and a softening of China's growth.

"Let's be clear," she said, "reports of the mining boom's death are exaggerated."

Ms Gillard said the boom had three distinct phases - a prices boom, which was passing; an investment boom, yet to reach its peak, and a production boom "as all that effort comes to fruition in the years and decades ahead".

Her comments come as iron ore prices drop and Australia's third largest iron ore producer, Fortescue Metals Group, today added its name to the list of companies pulling back expansion plans.

Question? What Question?

"There is no question about whether we have a boom, the issue is whether we make it last" said Prime Minister Gillard.

Note the sheer foolishness of Gillard's statement. It is not up to Australia at all whether the boom is over or not. The boom is entirely dependent on what China does or doesn't do.

Moreover, there is no question the boom is over. The real question is "How big is the bust?"

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Manufacturing ISM Contracts 3rd Month Led by Declining New Orders; Recession-Type Numbers? You Bet!

Posted: 04 Sep 2012 09:35 AM PDT

Those looking for evidence the US is already in recession (and has been since June) need look no further than the August Manufacturing ISM Numbers released today.

Index	August	July	Change	Direction	Rate of Change	Trend in Months
PMI™	49.6	49.8	-0.2	Contracting	Faster	3
New Orders	47.1	48.0	-0.9	Contracting	Faster	3
Production	47.2	51.3	-4.1	Contracting	From Growing	1
Employment	51.6	52.0	-0.4	Growing	Slower	35
Supplier Deliveries	49.3	48.7	+0.6	Faster	Slower	7
Inventories	53.0	49.0	+4.0	Growing	From Contracting	1
Customers' Inventories	49.0	49.5	-0.5	Too Low	Faster	9
Prices	54.0	39.5	+14.5	Increasing	From Decreasing	1
Backlog of Orders	42.5	43.0	-0.5	Contracting	Faster	5
Exports	47.0	46.5	+0.5	Contracting	Slower	3
Imports	49.0	50.5	-1.5	Contracting	From Growing	1

Key Points

The PMI™ registered 49.6 percent, a decrease of 0.2 percentage point from July's reading of 49.8 percent, indicating contraction in the manufacturing sector for the third consecutive month. This is also the lowest reading for the PMI™ since July 2009.
The New Orders Index registered 47.1 percent, a decrease of 0.9 percentage point from July, indicating contraction in new orders for the third consecutive month.
The Production Index registered 47.2 percent, a decrease of 4.1 percentage points and indicating contraction in production for the first time since May 2009.
The Employment Index remained in growth territory at 51.6 percent, but registered its lowest reading since November 2009 when the Employment Index registered 51 percent.
The Prices Index increased 14.5 percentage points from its July reading to 54 percent.
Comments from the panel generally reflect a slowdown in orders and demand, with continuing concern over the uncertain state of global economies.

Recession-Type Numbers

Inventory added .6 to the PMI vs. a neutral reading of 50 or the PMI would have come in at 49.

The third month of declining new orders coupled with declining production strongly suggests that manufacturing employment will soon contract.

These are start-of recession type numbers.

Unless economic numbers quickly improve, the NBER is likely to backdate the start of the recession to June.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Central Bankers Fail to Understand Forces Holding Back the Economy; Ten Major Economic Headwinds

Posted: 04 Sep 2012 12:05 AM PDT

Central bankers Debating the Limits of Power in Jackson Hole are wondering what's holding back the economy.

"What is holding the economy back? Why is it that we've had such incredibly accommodative monetary policy for so long (but) we've had so little growth? I think it remains a puzzle," said Donald Kohn, who is now a senior fellow at the Brookings Institution think tank in Washington.

Adam Posen, who finished his final day as a member of the Bank of England's monetary policy on Friday and is a powerful advocate for more forceful central bank action, asked the same question as Kohn: "Why has all this lower short-term interest rates failed to make the economy go go go?" He argued that policymakers in Europe and the United States should waste no time in extending asset purchase programs to spur growth.

Alan Blinder, another former Fed vice chair who now teaches economics at Princeton, ticked off the two most blatant culprits for why the U.S. economy continued to struggle: government spending cuts and the drag from the depressed housing market.

Binder, Posen are Delusional

Adam Posen and Alan Blinder are clearly delusional.

Posen fails to understand the problems caused by going deeper in debt, even though Japan did just that for decades to no avail and has nothing to show for it but a mountain of debt.

As for Blinder, might I ask: precisely what spending cuts is he referring to?

Please note the Fiscal Year Budget for 2011 was $3.603 trillion. Also note the budget for 2012 was $3.796 trillion, and the 2013 budget is projected to be higher still, at $3.883 trillion.

Indeed, the projected budget rises every year through 2022. It is ludicrous to talk of spending cuts, when spending is projected to increase every year for a decade.

Failure to Understand the Obvious

Central bankers and economists are so wrapped up in warped mathematical formulas they fail to understand the obvious. The answer, which they refuse to accept, or even consider as a possibility, is that central bankers and the monetary system itself are the problem.

Belief that a bunch of central planners can sit in a room and divine interest rates and the proper amount of money in circulation is as ridiculous as belief that Russian central planners could properly set the price and quantity of steel or orange juice.

The boom-bust cycles of ever-increasing amplitude benefiting the 1% while hollowing out the middle class should be poof enough central bankers do not know what they are doing.

That they met in Jackson Hole wondering why their policies are not working is also sufficient proof they do not know what they are doing.

What's holding back the economy is three-fold.

Three Root Causes

Fractional Reserve Lending
No enforcement mechanism on governmental spending (i.e. lack of a gold standard)
Central bank and governmental meddling

For a discussion of point number 2 above, please see Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited

Since the end of the great depression until the year 2000 the Fed had tailwinds at its back and that made it appear Fed policy was successful.

Four Major Tailwinds

US productive capacity not destroyed in WWII
Baby boomer demographics
Women entering the workforce en masse
Internet revolution

Those major tailwinds, in order, are what made it appear Fed policy was working. It is easy to inflate when powerful forces are at your back.

Party-of-a-Lifetime

Following the 2001 recession, the Greenspan Fed held interest rates too low too long, allowing one last party. And it was the party-of-a-lifetime, culminating in the biggest housing and credit bubbles the world has ever seen.

In the wake of that party, all that is left is a big hangover and ten major headwinds.

Ten Major Headwinds

Boomers heading into retirement have insufficient savings
Student debt holds back home-buying, marriage, and family formation
Ability and willingness of individuals and businesses to take on more debt has shrunk dramatically. Attitudes towards lending, borrowing, and home ownership have changed.
Bank bailouts at taxpayer expense left banks intact but did nothing for households deep in debt
Tax policy encourages flight of jobs and capital
Technology now serves to destroy more jobs than it creates. Please see Robots to Rule the World? Taking All Jobs? Replace Women? for a discussion.
Untenable pension problems at the city, state, and federal level can no longer be put off.
Public unions and collective bargaining are structural problems at the heart of the pension mess as well as the heart of numerous city bankruptcies.
Artificially low interest rates weakens those on fixed income
Commercial real estate bust on top of housing bust limits further job expansion. How many more Walmart, Pizza Huts, McDonalds, nail salons, Kohl's stores, Office Depots, Home Depots do we need? Where?

Inflate to Grow Model Never Worked

It is disconcerting yet entirely predictable that central planners and government bureaucrats cannot see what the root problems are. After all, no one wants to blame themselves.

However, one might expect central bankers to at least understand headwinds and tailwinds. Sadly, you can forget about that as well.

The simple truth of the matter is the central planners model of "lowering interest rates to spur growth" never worked in the first place. Rather, four major tailwinds coupled with consumer attitudes (willingness to take on more debt) only made it appear so.

Central planners still fail to understand 10 obvious reasons why their policies are futile. And they are supposed to be guiding the economy!

Since central bankers cannot and will not admit the truth, they are left scratching their heads asking easily explainable questions like "What is holding the economy back?"

I would have loved to present my views in a speech at Jackson Hole, but even if I was allowed, the participants would not have taken too kindly to the obvious truth: Central bankers and planners are a huge part of the problem, and no part of the solution.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Tuesday, September 4, 2012

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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