Mish's Global Economic Trend Analysis

Milestones in Bond Insanity: Negative 10-Year Yield on Swiss Bonds, Mexico Sell 100-Year Bonds Denominated in Euros; Are 1000-Year Bonds Next?
Rauner Seeks Insurance Program Changes for Illinois Retirees; Michigan Changes Upheld in 6-0 State Supreme Court Decision
Russia Forced to Do Right Thing? Buy Russia?
Readers Question Free Trade; Does Nonreciprocal Free Trade Cost Jobs? Paul Krugman "Was" Right!

Milestones in Bond Insanity: Negative 10-Year Yield on Swiss Bonds, Mexico Sell 100-Year Bonds Denominated in Euros; Are 1000-Year Bonds Next?

Posted: 09 Apr 2015 10:47 PM PDT

Milestones in Bond Insanity

Two events happened this week for the first time: negative yield on 10-year government bonds and 100-year bonds by Mexico denominated in euros.

Please consider Swiss, Mexican Bond Deals Represent Milestones for Debt.

Until Wednesday, no country had ever sold 10-year debt that gives investors a yield of below 0%. And no country had ever issued a 100-year bond denominated in euros.

But in the latest stark sign of how easy the era of easy money has become, Switzerland on Wednesday sold 10-year bonds that investors are actually paying to hold, while Mexico lined up a rare transaction to borrow euros it promised to repay a century from now—at a yield of 4.2%

The two extraordinary milestones reflect Europe's extraordinary environment.

Reserve prepares to raise interest rates, the European Central Bank is forcefully driving them down. The Swiss National Bank, eager to keep its currency from soaring too far above its eurozone neighbors', has itself shoved interest rates below zero.

The consequence is a strange collection of monetary phenomena: The ECB has begun charging commercial banks to keep money on deposit. Denmark's central bank has furiously printed kroner to mitigate a flood of capital into the country. Even Spain, which once looked on the cusp of fiscal collapse, is able to sell short-term Treasury bills that give investors back less principal than they started with.

In January, Switzerland's central bank, worried about the consequences of buying huge volumes of euros to keep the franc suppressed, scrapped its upper limit on the franc and cut deposit rates to minus 0.75%. Foreign-exchange markets were thrown into turmoil. Given that putting cash on deposit costs money, the very modestly negative yield of the new 10-year bond is marginally attractive. A similar story is playing out in the eurozone, where the ECB has set its deposit rate at minus 0.2% and aggressively bought bonds.

Mexico's interest in selling the bond at 100 years was partly to extend the maturity of its debt stock, but also to expand its presence in the euro bond market, said Alejandro Díaz de León, head of public credit at the Mexican Finance Ministry. "By placing debt at an exceptionally long maturity, it helps to consolidate Mexico as a widely accepted issuer," he said.

The sale wrapped up Mexico's foreign capital-market financing needs for 2015, and comes as the government moves to reduce spending this year and next because of lower oil prices and expectations of tougher financing conditions in the future—particularly when the Fed begins raising interest rates.

Jim Esposito, co-head of global financing at Goldman Sachs, who worked on the deal, said demand was "driven by European money managers" but also saw some U.S. buyers.

Huge Risks

Will the euro even be around in 100 years?

Even if the euro is around in 100 years, what countries will be in it? The value of the euro will vary widely if the answer is peripheral Europe vs. Germany, Austria, etc. Mexico is taking a gamble on this.

Of course, if the peso rises vs. euro, Mexico comes out ahead.

Euros vs. Mexican Pesos

Analyzing the Risk

In April of 2001 one euro bought 7.7 pesos. Today, one euro buys 16.1 pesos. That is a decline of 52%. Had Mexico done this transaction in 2001, it would be 52% in the hole on the currency move alone. And given that yields are lower now, no doubt it would be hugely underwater on interest as well.

Issuing debt or taking on debt in foreign countries is risky business. Just ask all those in Poland, Hungary, or the Czech Republic who took out mortgages in Swiss Francs. Many will lose their homes because debt payments have skyrocketed along with the soaring Swiss Franc.

As recently as 2009, one euro bought 20 Mexican pesos. Looking ahead, is it so hard to believe the Peso will not sink to that level or even a bit further, say to 25. A move to 25 pesos per euro would put Mexico 36% in the hole on currency fluctuations, and it would only collect 4.2% in interest.

I have no particular insight into which way the move will go, at least in a stated timeframe. I am simply highlighting the currency risk. There is interest rate risk as well, but at least that is defined.

Whether this deal works out well and for whom, depends on currency fluctuations.

The big risk in a eurozone breakup. If Germany exits the euro (which I think it should do, but probably won't), Mexico wins big as the euro would sink vs. the peso. If Greece, Spain, and Portugal leave the eurozone, the euro could easily strengthen by a lot, perhaps after a bit of volatility.

Are 1000-Year Bonds Next?

Given that countries are issuing bonds in foreign currencies for 100 years, why not 1000 years, or perpetual bonds?

After all, no country really ever intends to pay back this debt in the first place. Debt just grows, and grows, and grows.

A currency crisis is on deck, but few see it coming.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot

Rauner Seeks Insurance Program Changes for Illinois Retirees; Michigan Changes Upheld in 6-0 State Supreme Court Decision

Posted: 09 Apr 2015 02:21 PM PDT

Illinois state pension and retirement plans are in dire straits. The only way to fix the problems is with plan changes.

Michigan did that in 2012. And in a 6-0 decision yesterday, the Detroit Free Press reported the Michigan Supreme Court, rejected arguments from unions, and upheld the 2012 state law requiring teachers to put more of their pay toward their pension plans or face cuts to benefits.

The Michigan Supreme Court, rejecting arguments from unions, has upheld a 2012 state law requiring teachers and other school employees to put more of their pay toward their pension plans or face cuts to benefits such as post-retirement health care.

The law, backed by Gov. Rick Snyder and the Republican-controlled Legislature, was intended to cut an estimated $45-billion unfunded liability in the Michigan Public School Employees Retirement System by more than $15 billion.

The American Federation of Teachers and the Michigan Education Association unions argued the law impaired contracts and amounted to uncompensated takings of pension benefits.

But both the Michigan Supreme Court and the appeals court said the law doesn't violate a Michigan constitutional provision protecting earned pension benefits, because only future benefits are affected. Also, unlike an earlier law that mandated 3% contributions toward health care, the 2012 law provides an opt-out provision, the court said.

Good News For Illinois

What passes constitutional muster in Michigan may not do so in Illinois, but the unanimous ruling provides a model for what may work elsewhere. This is good news for all cash-strapped states.

In Illinois, Gov. Bruce Rauner Wants Changes to Insurance Programs for State Workers, Retirees.

Health insurance for active state workers and retirees is being targeted for big savings in Gov. Bruce Rauner's budget plan.

"By bringing health care benefits more in line with those received by the taxpayers who pay for them, we save an additional $700 million," Rauner said Wednesday in his budget speech.

His budget also calls for an end to state subsidies to the health insurance programs for retired downstate teachers and community college workers.

Right Path

Governor Rauner is on the right path. Benefits must be cut. For starters, Illinois needs to move all employees going forward into 410K type plans. Next, Illinois needs to address spiraling costs for those in defined benefit plans.

Michigan passed one law the Michigan Supreme Court rejected, and a second one in 2012 law that was upheld unanimously. Illinois would be wise to pursue changes that are likely to be upheld in court. We now have at least one model that works.

For more on problems in Illinois and what to do about them, please see ...

Illinois desperately needs to address the root of its fiscal problems: untenable pension benefits and promises.

Massive proposed tax hikes are not the answer. Tax hikes will do nothing but make already uncompetitive Illinois even more uncompetitive.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot

Russia Forced to Do Right Thing? Buy Russia?

Posted: 09 Apr 2015 12:55 PM PDT

Here's an interesting opinion article on MarketWatch: Sanctions, drop in oil price best things that ever happened to Russia.

A round of punitive sanctions designed to cripple the economy. A collapse in the price of its key commodity. A currency in freefall and a central bank hiking rates to emergency levels while a corrupt, authoritarian government embarks on foreign adventures at potentially huge expense. For the whole of 2014, the Russian economy was the most toxic in the world, with one calamity coming hard after another.

But here is something nobody expected. In the first quarter of this year, Russia was doing a bit better than anyone could have forecast. We learned last week that the economy managed to grow by 0.4% in the latest quarter, compared to the zero growth or the outright recession that most economists had penciled in. The ruble is the best-performing currency of the last three months. Even the Moscow stock index has started to recover.

In reality, sanctions and a fall in the oil price might have been the best thing to have happened to Russia since the invention of double-glazing. Why? Because the problem for a country rich in resources and well-educated, creative people has been an over-reliance on energy, and a tight-knit kleptocracy that distributes the wealth it generates. It has failed to create its own industrial economy.

The predictions of collapse have turned out to be wide of the mark.

Putin is still in power, and still in possession of Crimea. Nor is there much sign of anything more than short-term damage. A 0.4% quarterly growth rate is not fantastic, but it is better than France, and roughly the same as Germany or Japan.

True, the forecasts are for gross domestic product to fall for this year — the IMF suggest it will contract by more than 3% — but those may well turn out to wrong as well. What is certainly true is that the economy has not been devastated.

The interesting question, however, is whether it might actually be strengthened. That might sound odd. But the main problem for the Russian economy over the past decade was an over-reliance on oil revenues, and a state-led kleptocracy, which stifled the emergence of a productive domestic economy.

the big reason might well be what plenty of analysts over the years have described as "the curse of oil." The black stuff generates lots of easy money, and by filling the state coffers with cash, it makes it relatively easy for a corrupt, authoritarian regime to entrench itself in power. That has been seen in countries ranging from Saudi Arabia, to Saddam Hussein's Iraq, and Hugo Chavez's Venezuela. Putin's Russia was no different.

Without oil, Russia will have to develop its own industries. And with sanctions slowing down imports, there will be space for entrepreneurs to move into. The state will become less powerful, because it will have lower oil revenues, and so will the oligarchs. Russia will have the opportunity to gradually replace crony capitalism with competitive capitalism. In the medium term, that can only be for the better.

Of course, just because it might happen does not mean that it will.

Keep in mind as well that this is one of the cheapest markets in the world. The Moscow index trades on a price-to-earnings ratio of 6.7, less even than Greece. For an economy that is solvent, and growing at 0.4%, that is a bargain. Sanctions and a collapsing oil price were meant to torpedo Russia — but they may end up doing it a favor.

I sent the article to Pater Tenebrarum at Acting Man. He replied:

It seems Medvedev and his free-market economic advisors have convinced Putin to do just that. It was not reported in the Western press, but a few months ago Putin announced that all inspections of companies will be suspended for at least three years and that company start-ups will be free of taxation for their first two years. Add to that the 13% flat tax, and there could be quite an effect. According to Medvedev's advisors, Russian GDP could improve by $200 billion per year by curbing corruption alone. Since the inspections were the main avenue of corruption, their suspension is a very significant step. Admittedly, the jury is still out on the success of these measures, but they have been taken, and it was in reaction to the sanctions. Also, the author is correct: industry surveys in Russia show that companies see import substitution as a huge growth area over the coming year and have accordingly already increased investment and production.

I bought into Russia near the peak of the panic, but not enough. I have plans to add more.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot

Readers Question Free Trade; Does Nonreciprocal Free Trade Cost Jobs? Paul Krugman "Was" Right!

Posted: 09 Apr 2015 01:00 AM PDT

I received many questions and comments regarding Obama's Trans-Pacific Partnership Fiasco vs. Mish's Proposed Free Trade Alternative.

While most do see Obama's Trans-Pacific Partnership (TPP) as a fiasco, many question my alternative proposal:

An excellent free trade agreement would consist of precisely one line of text: All tariffs and all government subsidies on all goods and services will be eliminated effective June 1, 2015".

Even some "free trade" advocates disagree with my follow-up statement "I firmly believe the first country that fully embraces free trade would come out ahead, regardless of whether or not any other country reciprocates."

Worry Over Loss of Manufacturing Jobs

Reader Pina is worried over the loss of jobs. He writes ...

I realize that most economists advocate tariff free trade but how is this in the interests of workers who had careers in the rust belt who have watched their jobs migrate to China, India and other countries. Yes, American multinational corporations like the cheap labor and modest regulation in the third world but is this really best for the American worker?

Seen and Unseen

For starters, employment in manufacturing and some service industries is down everywhere due to hardware and software robotics. Tariffs or not, many manufacturing jobs have vanished and are never coming back.

Initially, those jobs left the US because of wage differentials, now they are simply gone.

Moreover, and more importantly, it is a mistake to look at manufacturing (or any trade) in a vacuum. We lost manufacturing jobs, but cheap goods from China provided millions of trucking and shipping jobs and allowed the expansion of massive numbers of retail jobs and construction jobs to build all the stores and malls everywhere.

Standards of living have soared. Even the poorest of families tend to have cell phones, internet services, and huge digital TVs.

Were the price of goods to double to save manufacturing jobs how many could afford to buy such things?

Productivity and Free Trade

The Library of Economics and Free Trade has an excellent article on the subject. It's title is simply Free Trade.

Here are a few snips, emphasis in italics is mine. I encourage you to read the entire article.

In running our personal affairs, virtually all of us exploit the advantages of free trade and comparative advantage without thinking twice. For example, many of us have our shirts laundered at professional cleaners rather than wash and iron them ourselves. Anyone who advised us to "protect" ourselves from the "unfair competition" of low-paid laundry workers by doing our own wash would be thought looney. Common sense tells us to make use of companies that specialize in such work, paying them with money we earn doing something we do better. We understand intuitively that cutting ourselves off from specialists can only lower our standard of living.

Adam Smith's insight was that precisely the same logic applies to nations. Here is how he put it in 1776: "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy.. . . If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage."

Spain, South Korea, and a variety of other countries manufacture shoes more cheaply than America can. They offer them for sale to us. Shall we buy them, as we buy the services of laundry workers, with money we earn doing things we do well—like writing computer software and growing wheat? Or shall we keep "cheap foreign shoes" out and purchase more expensive American shoes instead? It is pretty clear that the nation as a whole must be worse off if foreign shoes are kept out—even though the American shoe industry will be better off.

If cheap Chinese labor was stealing American jobs, why did the theft intensify as the wage gap fell? The answer, of course, is that Chinese productivity was growing at enormous rates. The remarkable upward march of Chinese productivity both raised Chinese wages relative to American wages and turned China into a world competitor. To think that we can forestall the inevitable by closing our borders is to participate in a cruel self-deception. Nor should there be any worry about failing to forestall the inevitable. The fact that another country becomes wealthier does not mean that Americans must become poorer.

A slogan occasionally seen on bumper stickers argues, "Buy American, save your job." This is grossly misleading for two main reasons. First, the costs of saving jobs in this particular way are enormous. Second, it is doubtful that any jobs are actually saved in the long run.

Many estimates have been made of the cost of "saving jobs" by protectionism. While the estimates differ widely across industries, they are almost always much larger than the wages of the protected workers. For example, one study in the early 1990s estimated that U.S. consumers paid $1,285,000 annually for each job in the luggage industry that was preserved by barriers to imports, a sum that greatly exceeded the average earnings of a luggage worker. That same study estimated that restricting foreign imports cost $199,000 annually for each textile worker's job that was saved, $1,044,000 for each softwood lumber job saved, and $1,376,000 for every job saved in the benzenoid chemical industry. Yes, $1,376,000 a year!

While Americans may be willing to pay a price to save jobs, spending such enormous sums is plainly irrational. If you doubt that, imagine making the following offer to any benzenoid chemical worker who lost his job to foreign competition: we will give you severance pay of $1,376,000—not annually, but just once—in return for a promise never to seek work in the industry again. Can you imagine any worker turning down the offer? Is that not sufficient evidence that our present method of saving jobs is mad?

But the situation is actually worse, for a little deeper thought leads us to question whether any jobs are really saved overall. It is more likely that protectionist policies save some jobs by jeopardizing others. Why? First, protecting one American industry from foreign competition imposes higher costs on others. For example, quotas on imports of semiconductors sent the prices of memory chips skyrocketing in the 1980s, thereby damaging the computer industry. Steel quotas force U.S. automakers to pay more for materials, making them less competitive.

On balance the conclusion seems clear and compelling: while protectionism is sold as job saving, it probably really amounts to job swapping. It protects jobs in some industries only by destroying jobs in others.

China Dumps Solar Panels

Let's investigate an amusing EU point of view in regards to "clean energy" tariffs. In May of 2013, Spiegel Online reported the European Commission approved tariffs on Chinese-made solar panels in response to complaints of price-dumping.

In my article Paul Krugman "Was" Right I commented on the solar panel boondoggle ....

Please note the irony in these tariffs. The EU is hell bent on promoting "clean energy" but does not want clean energy if the cost is too cheap. Obama's position is similar.

Supposedly China is dumping solar panels below cost? So what? If the EU and US were really interested in clean energy and reducing emissions, the only thing better than cheap solar panels would be free solar panels.

Step back for a second and think of the benefits of free panels. On one side of the equation, the EU and US would lose a few hundred solar panel making jobs. However, hundreds if not thousands of businesses and individuals would employ solar panels if they were free.

Think of all the trucking jobs, dock unloading jobs, and installation jobs, that would result from free solar panels. Whatever jobs were lost in manufacturing (if any), would come back 100 times over in other jobs.

Here is a second irony.

The first sentence in the Spiegel article reads "Back in 2008, the German solar manufacturing industry was riding the crest of a wave of growth fueled by generous subsidies and high demand."

Without generous subsidies, the European solar panel manufacturers were not profitable in the first place. Yet, the EU imposed tariffs to prevent Chinese "dumping".

Paul Krugman "Was" Right

In Paul Krugman "Was" Right, I also discussed a shockingly accurate revelation from Krugman.

In 1997 Krugman wrote a brilliant article "In Praise of Cheap Labor", stating "Bad jobs at bad wages are better than no jobs at all".

I wrote about Krugman's position in Fair Trade is Unfair; In Praise of Cheap Labor; Are Bad Jobs at Bad Wages Better than No Jobs at All?

Please check it out. Krugman "Was" Right. However, the definition of "was" requires one to go back to 1997 to see just that.

Why Does Free Trade Seemingly Not Work?

The above examples show free trade only fails to work from the self-serving point of view of the industry demanding protections.

Amusingly, auto manufacturers want to use cheaper steel, but the steel industry wants protection. And whether or not the auto manufacturers get steel imports at cheap prices, they want protection from alleged subsidies of Toyota.

It's hypocritical madness its finest.

Role of Nixon

There is another facet to the free trade debate and that is in regards to huge trade imbalances between the US and China.

I have written about this so many times it is disheartening to have to point out once again the root cause. Please read, and make an attempt to understand Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited.

Pettis: "The capital and current accounts for any country, and for the world as a whole, must balance to zero. In the old days of specie currency – gold and silver – this meant that specie would have flowed from Spain to Germany as the counterbalancing entry, and of course this flow created its own resolution."

Hugo: "The gold standard imposed order and harmony. If President Nixon had not 'closed the gold window' in 1971, the world would be radically different today. China sells vast quantities of goods to the rest of the world, without the rest of the world having any chance of selling similar quantities to China. China can do so, because today trade deficits are "paid" not in gold, but in dollars or euros or pounds sterling or yen, which will never be scarce: they are created at will by the USA, the European Central Bank, the Bank of England, or the Bank of Japan. It is no coincidence that some analysts have observed that in real terms, American workers have had no real increase in their income since 1970. The best and brightest of today's accredited economists attempt in vain to find a solution to a problem that cannot be solved except by the renewed use of gold as the international medium of commerce."

Enforcement Mechanism

Those are small snips from an article I wish everyone would read in entirety to fully understand where the problem is.

Pettis admits that a gold standard would address the issue, but that is not his preferred solution (which to the best of my knowledge he has never stated).

What both Michael Pettis and Hugo Salinas Price refer to is that ever since Nixon stopped paying for US trade deficits in gold, monetary expansion has been exponential. The result has been massive trade imbalances and extreme income inequality.

Problems in "Speece"

The lack of an enforcement policy also explains the problems of Greece and Spain vs. Germany. Collectively, I refer to (Spain, Greece, and peripheral Europe in General) as "Speece"

To properly understand the trade mess in Europe please read From ZIRP to NIRP: Virtues of Germany vs. the Vices of Greece; What About "Speece" and Gold?

Here is a key paragraph on "Speece", but to understand the ripple effect of no enforcement mechanism I suggest re-reading the entire article.

Still No Enforcement Mechanism, Anywhere

Because there were no trade imbalance enforcement mechanisms, Speece imbalances grew until they blew up. And until they blew up, the IMF had nothing but praise for Spain! And every step of the way, the IMF underestimated the problems Greece faced.

We are headed into the third Greek bailout, and the IMF remains clueless about Greece's ability to pay back "bailout" money.

Worse yet, there still is no "enforcement" mechanism anywhere in the world, and the structure of the euro is such that imbalances in Europe are even harder to fix than elsewhere.

Excellent Trade Agreement

Lack of a gold standard is a key reason "free trade" seems not to work. But the problem is not "free trade", the problem is elsewhere.

I repeat the assertion I made in Obama's Trans-Pacific Partnership Fiasco vs. Mish's Proposed Free Trade Alternative; How Will TPP Function in Practice?

An excellent free trade agreement would consist of precisely one line of text: "All tariffs and all government subsidies on all goods and services will be eliminated effective June 1, 2015."

Moreover, the first country that fully embraces free trade would come out ahead, regardless of whether or not any other country did so as well.

The logic behind those statements is impeccable.

Free Trade Never Causes Net Job Loss

Free trade is always beneficial. Lack of an enforcement mechanism, unsustainable union agreements, a loss of jobs to robotics, and incessant self-serving whining from industry groups demanding favors makes it hard for many to see the benefits.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot

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