Thursday, 17 December 2009

Blue pill or Red Pill?

Morpheus: This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how deep the rabbit-hole goes.

The Matrix movie - 1999

There we are year end coming fast and everyone is expecting the recovery in 2010, following the surge in the many green shots seen in the economy.

Too many people have taken the blue pill.

The facts unfortunately doesn't support the idea of a strong recovery.

In my last post Greece Sovereign CDS was trading around 230 bps for 5year. Another downgrade from S&P came along and there we are with Credit-default swaps linked to Greek debt rising another 30 basis points to 260, according to CMA DataVision, the highest since March.

Everyone is expecting Greece to do the right thing, cutting on spending and reducing their abyssmal budget deficit before it is too late. Will a Greek socialist government be as aggressive as the Irish in tackling their issues?
The answer is definitely no.

Standard Bank has definitely turned negative on both Ireland and Greece:

As per my previous post, there is a probability that Greece could at some point exit the Euro.

Prime Minister George Papandreou announced he was taxing greek bankers at the rate of90% of their bonus and a the same time he announced that civil servants making less than 2,000 euros a month would get pay rises above inflation.

How does the Prime Minister of Greece expect to fund the salary of his public servants? By issuing bonds that no one will want?

Get ready for another bumpy ride in 2010...

Also in the news, one of Austria's largest bank (ranked 6th) had to be rescued by the Austrian Government:

Hypo Group Alpe Adria hit the wall. Another one bites the dust.

"Under the terms of the deal, Austria will take over 100 per cent of HGAA and the shareholders surrender their stakes and inject about €1bn ($1.5bn) in capital."

"Meanwhile, Austrian banks could face another €10bn in writedowns over the next two years, Austria’s central bank warned on Monday. Austrian banks have about €200bn of exposure to central and eastern Europe and have written down €15bn since the start of the crisis."

Problems have not been resolved by the governements and the deleveraging is still an ongoing process globally.

Defaults are still rising and unemployment levels are still going up.

(Bloomberg) -- Homeowners with mortgages of more than $1 million are defaulting at almost twice the U.S. rate and some are turning to so-called short sales to unload properties as stock-market losses and pay cuts squeeze wealthy borrowers.

It started with subprime mortgages going sour, then the ALT-As and ARMS, now the prime and jumbo loans are getting hit hard as well.

What we can expect is that the FED will maintain the interest rates low for a long period. We cannot expect them to raise rates in 2010. By maintaining them artificially low, they are trying to ensure banks can offset somehow the tidal wave of defaults and provisions they are facing, ensuring they make some very good profits on the spread banks are borrowing at and lending at.

The recession will really be over when small businesses which are the motor of an economy will start to hire as they did last time we had a valid recovery.

Here is the Red Pill for all of you who want to see how deep is the rabbit-hole we are:

From David Goldman's excellent blog (the link is indicated in this blog as well)

"Structurally, a very large percentage of job losses during recessions reflect creative destruction: big companies who lay off workers in recessions downsize permanently. The jobs are not replaced at the same companies; the old jobs go away forever, and new jobs are created at the grass roots of the economy.

That’s why we have to look to small business for continued job growth, and why the prospects are grimmer than the market seems to believe."

No matter how much liquidity the US administration injects, no matter how Obama would like bank to increase lending (for some who have the capacity to do so...), the recovery is not around the corner but at least a couple of years down the line.

This is the awful truth.

The governments are preventing creative destruction to take place by trying to prop up some dying parts of their economies: GM, some banks, etc.
I mean by creative destruction the emergence of a new economy based on new technology or new industries.

As Joseph Schumpeter mentioned creative destruction hurts a lot in the short term and this goes again governments and short term views for short term political gains.

Volcker, arguably the best president the FED ever had, killed stagflation in the US in the late 70s. Soon we will be entering a new phase of Stagflation and you can expect inflation to start creeping up at some point and commodities prices to reach new highs.

As per a Wikipedia article around Creative Destruction:
"Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. Though a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term, and in the long term for those who cannot acquire the skills and work experience."

Joseph Schumpeter was a visionnary, and probably on of the first takers of the "red pill".

For those of view who would like to extend on Schumpeter's economic views which are very accurate, I recommend reading his book: Capitalism, Socialism and Democracy.

Here is a link to Wikipedia's review on this major book.,_Socialism_and_Democracy

So which countries to look for to invest? Follow where innovation is taking place at a fast pace, where education levels are strong and where there are plenty of skilled workers: Asia. India and China will continue to grow strong in 2010, they have the skills and the ressources to navigate these treacherous waters much better than most developped countries.
Canada as well will do well thanks to their natural ressources and their solid financial sector which was not damaged by the financial crisis.

I will conclude this post by a quote from Joseph Schumpeter:

"Capitalism’s Greatest Enemy: The Intellectual
The proper role of a healthily functioning economy is to destroy jobs and put labor to better use elsewhere. Despite this simple truth, layoffs and firings will still always sting, as if the invisible hand of free enterprise has slapped workers in the face. Unsettling by nature, capitalism’s churn gives rise to a labor movement designed to protect workers from job loss. That movement is fed emotionally by displaced workers and others who blame the capitalist system for their troubles, but it is led psychologically by a whole other type of person—the intellectual. Intellectuals—with little to do owing to the success of the capitalist economic system but with an intense desire to be seen as caretakers of society’s general well-being—anoint themselves as leaders of the labor movement. They object to capitalism on moralistic grounds and seek its destruction and replacement by another system—socialism—which places them center stage."

You could replace "intellectuals" in the quote in today's economy by politicians and you would not be far from what is currently happening in many countries today.

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