And while all around there was Armageddon, Mr and Mrs UK Press had a picnic.
Okay, that’s a little harsh and maybe a touch over the top. But the truth is, this week’s budget should have been no more than a sideshow while some serious stuff was taking off in other parts of the world.
Germany is in the spotlight. Three of the most highly respected men in the economic world have lined up to take pot-shots at the country. Also aiming his sights at the land of Beckenbauer, Becker and Schumacher, is none other than Barack Obama himself. But Germany’s iron lady said words to the effect, ‘you turn if you want to, the lady is not for turning’. In short, Germany is not bowing to international pressure, and the implications are far reaching indeed. It “could undermine democracy”, said one member of our trio. The second warned of a domino effect, with depression the end result. By contrast, our third musketeer was quite reserved and merely warned of a greater than 50 per cent chance of a double dip recession.
Mind you, the analogy with dominoes doesn’t work. The whole point about dominoes is that one falls and knocks down the one next to it, and so on until there are no more dominoes left standing. The analogy is breaking down because we are seeing signs of a circle. You will recall that the whole economic crisis began in the US with falling house prices. Well, US house prices, relative to income, are quite cheap now. So you would imagine the crash has run its course. Don’t you believe it. In Japan, after house prices fell so that the ratio of price to income was below the historical average, they just kept on falling. Now there are signs this is happening in the US.
First musketeer warns of end to democracy
In the novels by Alexandre Dumas there were actually three plus one musketeers.
First there was Athos. This is what our modern-day member of the quartet, and we shall call him George Soros, said: “German policy is becoming a danger that could destroy the European Project. A collapse of the euro cannot be excluded.” He continued: “At the moment Germany is pushing its neighbours into deflation: this threatens a long phase of stagnation, leading to nationalism, social unrest, and xenophobia. It endangers democracy.” Soros reckons that if Germany is unwilling to change, then she should do the rest of her partners in the single currency a favour and withdraw from the euro. He said: “Unfortunately, Germany doesn’t realise what it’s doing.”
To be honest, George Soros may have a track record as an investor that demonstrates he is quite brilliant, but some of his ideas have been a bit quirky. He is a fan of the philosopher Karl Popper. Now, Popper was something of a high priest of what is called ‘falsification’. (Bear with us, we are going somewhere with this argument.) Popper argued that a theory could not be said to be scientific unless one could envisage certain circumstances that would disprove it. So the theory that all swans are white is a scientific theory because it could be disproved if we found a black swan, which indeed we did – eventually. The big problem with economics is that the theories are so obtuse that it is nigh on impossible to find any kind of evidence to either support or contradict them. Therefore, economics is not a science. Soros has written a number of extremely hard-to-follow books exploring this idea. Nassim Taleb, the author of The Black Swan, has suggested that Soros is trying to use his standing as an investor to force other ideas, which he is not necessarily qualified to make, down our throats. In his book, Fooled by Randomness, Taleb said: “Soros wanted to be taken seriously as a Middle European professor who happened to have gotten rich owing to the validity of his ideas (it was only by failing to gain alpha acceptance by other intellectuals that he would try to gain alpha acceptance through his money, sort of like a seducer resorting to an appendage of a red Ferrari to seduce the girl).”
The point of all that is this. Just because Soros has made a lot of money it does not mean he is an expert on the economy, and it does not mean he is right in everything he says.
On the other hand, Soros was ahead of the field in predicting the financial crisis. Quite early on, and way before forecasters had woken up to the danger of recession, he was talking about a crisis in capitalism.
George Soros, by the way, was initially quoted by the German publication ‘Die Zeit’.
Second musketeer warns of falling dominos
The second musketeer was Porthos, and the second member of our quartet is the Nobel Laureate Paul Krugman. He has been in Germany recently, and told the German press: “I don’t have a problem with trying to balance the budget in five or 10 years. The question is whether one should start when the economy is at 7 or 8 per cent below its normal capacity and interest rates are at zero. Now is not the time to be worried about deficits.” He was speaking vociferously against the idea that Axel Weber, who is a bit like the Mervyn King of Germany, should take over at the ECB, and said if this happened, there would be a domino effect reaching Spain and Italy. Frankly, his prediction is odd. Krugman seems to be behind the times with his thinking. The danger of this domino effect has been staring us in the face for months. Krugman is not saying anything we didn’t already know.
One of Mr Krugman’s favourite stories relates to a babysitting circle. In his story, which is supposed to be true by the way, a number of parents got together and agreed to babysit each other’s kids. Every time they babysat, they got a voucher. Then, when they wanted to go out, someone else in the circle babysat for them, and our first couple paid for this service by handing their voucher over. It was a nice idea, but then one day for some reason (the reason does not matter – it could have been down to the forces of randomness), more people wanted to collect babysitting vouchers then spend them. And because there were more babysitters than babies needing sitting, the frugal parents panicked. They had fewer vouchers than they wanted, so they went out even less, and the shortage of babies requiring a sitter got even bigger. In short there was a savings glut, followed rapidly by a babysitting recession.
The babysitting circle, however, and who knows, maybe they turned to Krugman for advice, came up with a clever wheeze. They printed more vouchers, and gave them out to all members of the syndicate. And lo and behold, the recession ended.
The economic cycle can be like that, says Krugman. And that is why there are occasions when it makes sense for the central bank to go out and print money. And that is why the views of Krugman and Axel Weber seem to be diametrically opposed.
Third musketeer warns of double dip
The Aramis, or the third musketeer of our story, is Nouriel Roubini. Now, Professor Roubini probably did a better job than any other economist in the world in predicting the financial crisis. In that sense he is quite the opposite of BP, as his stock is high – very high.
The professor of economics at New York University was interviewed on CNBC and said: “I would say that the risk of a double dip recession is the highest right now in the Eurozone. I think that the sovereign problems, the debt problems are severe, the shock in the markets is going to be an economic downturn and that is very likely… I wouldn’t say 80 per cent. I would say there is more than a 50 per cent probability, the Eurozone growth was expected by the IMF to be only 0.8 per cent this year or they may surprise with 0. So if it is not technically a double dip, it is effectively like one.”
His interviewer then questioned Roubini on the Soros comments, asking was Soros talking about global issues or the US. The economics professor replied: “He was generic about it. In my view, in the US, we are going to avoid a double dip recession. But in the second half of the year, the growth is going to be below 2 per cent. So, with growth at below 2 per cent, the unemployment rate goes higher, the housing market keeps on falling in terms of prices, the budget deficit becomes larger, the losses that financial institutions get on loans, securities are higher. So we don’t need a double dip recession for having a negative economic outlook. If he is right then I believe he is 100% right on the new normal, in US new normal needs 2 per cent growth or below 3 per cent potential… that is a very bad economic outlook, it makes everything worse… that means downside risk to financial markets.”
Barack ‘D’Artagnan’ Obama joins the melee
The fourth musketeer, the D’Artagnan of the quartet, is Barack Obama. In a letter to G20 leaders he called for “unity of purpose to provide the policy support necessary to keep economic growth strong”. He said public finance should only be restored to health in the medium term. He also talked about “heavy reliance on exports by some countries”.
If you know your Dumas, you may well know who the villains in his novels were. But on this occasion, the musketeers seem to be up against Germany’s finance men and women.
Angela Merkel said: “If we don’t get onto a path of sustainable economic growth but have rather a growth bubble, then if the next crisis comes we won’t be able to pay for it.” She added that export strength was the right thing for Germany.
The truth is, however, that the German economic model, if applied by all, would not be sustainable. We seem to be heading towards a German way of doing things. But it is just impossible for all countries to export more and import less simultaneously alongside Germany doing the same.
Soros has said: “The truth is that what we have in Europe is not a currency or sovereign debt crisis as many people think, but a banking crisis.”
Debt, banking or saving crisis?
We would half agree with him. We would also say we don’t have a debt crisis. Not really, not when you drill down. But we do have more than a banking crisis. What we really have, across the globe, is a savings crisis, and banks face problems because they are the custodians of savings. The housing bubble was a symptom of this savings crisis.
Did you know, right now, across the globe, the broad money supply is contracting at an unprecedented rate. We have covered the fall in the US money supply on many occasions. Well, it is not just the US, the big contraction is global and expect this to be one of the hot topics later this year.
But the problems are not just in Europe.
According to data out from the US this week, sales of new homes for families have fallen to the lowest level ever recorded. Sales were down 32.7 per cent in May from the previous month alone, or so says data from the US Census Bureau. Sales of new homes fell 18.3 per cent, to a level which is 78 per cent off the peak. Inventory of stock of new homes has risen through the roof, up from 5.8 to 8 months’ worth of supply. The historical average is 6.2.
The tax credit for first-time buyers came to an end on the last day of April. Now there is a very real chance of US house prices seeing a second crash.
We are seeing a crisis unfold before our eyes. You don’t need to read Dumas or any of the classics for your entertainment, for right now, economic truth is much stranger than fiction.
© Investment & Business News 2013