Wednesday Night #1552

The economy has become a national security issue

The Euro crisis has taken a turn for the worse. While not our baseline view, there is now a material chance of a disorderly breakup of the common currency. Investors should maintain a cautious stance in anticipation of more turbulence ahead.
The Special Report in this month’s Bank Credit Analyst discusses why income inequality has increased in the U.S. over the past three decades. We argue that while the share of income flowing to the top 1% has already peaked, the dispersion of income within the bottom 99% of the population is likely to continue to widen.

The evening opened with Beryl Wajsman’s account of a victim of the bloody mindedness of some members of the Quebec bureaucracy – a woman  died for the lack of the medicare card that she had been unable to replace after her wallet had been stolen. Something seemingly so simple and yet made impossible for her.  Beryl and Tracey Arial have taken up the cause and will express appropriate outrage in the pages of The Suburban, unfortunately too late to help the dead woman. This reminds us all that as we are fortunate to have a network of friends and colleagues who are able to advise and actually stimulate responses when we are confronted with seemingly insurmountable bureaucratic issues, we  also owe it to others less blessed to aid and abet their struggles.

Kimon gave a brief account of his visit to Moscow to discuss the possibility of a New School of Athens Dialogue on the Russian model  – that would be economic model – where he and Ion were “received like oligarchs”, with an impressive cultural program to complement their discussions. First impressions – Russia is a world unto itself and if the visitor doesn’t speak Russian s/he is at the mercy of a translator. There is considerable nostalgia for the old régime (“Before, people had bad food, bad clothes, bad lodgings and bad jobs, but they had all of these”).  Their host, an eminent professor and politician, is a nationalist, not that keen on globalization but as the Russian model was one of the dominant factors for at least half of the last century, there is good reason to hold such a conference.

The euro zone
The logic of the establishment of the euro zone is indisputable.  The principle of facilitating unhindered trade between neighboring relatively small countries is logical.  It is the differences in productivity between the Mediterranean and northern European members that appear to have constituted a major contributor to the present problems.
The outlook for the eurozone is grim. One proposal to salvage the situation suggests that :
1 –  the ECB flexes its muscles, announces that no country – with the possible exception of Greece – will be allowed to default, and  prints money to be invested in Euro bonds, essentially forcing a cap on yields, which should buy Europe 2-3 years. The ECB must become an effective lender of last resort. The objection to this is that inevitably the ECB would wind up holding the riskiest debt;
2-  inflation in Germany is allowed to increase, along with concurrent modest deflation in the southern part of the euro zone. A counter argument is that Germans generally have an aggravated fear of hyperinflation;
3- “smart austerity”– cutting spending and raising taxes is not the answer. Raise the age of retirement, which would encourage spending and increase tax revenues
What does the collapse of the euro mean? Does it imply simply a reevaluation to parity with the dollar, or that a decision is made that next week  or that in five years there will be no more euro? What are the implications? One scenario would be that Greece leaves and achieves a competitive edge over its neighbors, then logically,  Portugal and Spain might follow.  Would the core of Europe continue to use the euro – perhaps, and perhaps not. Natural rivalries might well emerge.
While on the surface, it would appear that Mediterranean members, specifically Greece, might be better off leaving the eurozone, this would result in some Greek citizens holding relatively worthless drachmas in conflict with others holding euros. The social unrest (revolution) ensuing is something the rest of Europe cannot afford. A two-tiered eurozone is conceivable, as long as Germany bites the bullet.

Canada and Kyoto
The  announcement of Canada’s withdrawal from the 1997 Kyoto Accord may send a message of  disregard for our stated commitment to establishing a cleaner environment, which raises the question of whether those who signed on at the outset understood the nature of the commitments. In the early days, delegates were largely scientists, today they are non-scientists – the same people who negotiate the WTO or other non-environmental agreements. One could argue that the scientists did not understand the political difficulties of implementation, while the political people did not understand the science.   Canada’s public withdrawal does not necessarily mean that we will do nothing. It does, however, mean that we are no longer at the table, thus without any influence over discussion. Other signatory nations are not meeting their commitments. Canada’s withdrawal  should provoke serious discussion, although the track record of this government with respect to environmental agreements is such that the international community may simply say ‘good riddance’.  It is to be hoped that the current federal government will reflect and act positively on the importance of environmental issues and refocus on other international organizations such as IRENA and other growing multilateral organizations that have disaggregated the issues.
Is there linkage between the economic crises and the environmental crises? Yes, but there is increasing dissonance between governance issues and the physical realities of environmental change.
At least one Wednesday Nighter believes that  global warming is a problem to be solved by engineers who see much cleaner solutions in solar, nuclear and other environmentally friendly energy sources, rather than by scientists.
The resident climate change skeptic, who argued that the IPCC falsified information, was reminded that a recently released study, funded by, among others, the Koch brothers, confirmed the results from earlier, independent studies by scientists at NASA and elsewhere that had come under fire during ‘climategate.’
Concern was, nonetheless, expressed that scientists are not looking at other causes of global warming such as methane coming from Arctic permafrost.
Canada is increasingly turning to biomass as an alternative energy supply. A topic for another evening.

Income inequality
The middle class is being slowly but steadily hollowed out
An important but relatively ignored problem, the result of the technological changes in the past half century, rendering manual labour much less important than previously, is an excessively increasing acquisition of wealth by the wealthy, at the expense of the economic middle class, bringing the latter closer to the lower class.  Technology, especially automation, has not only replaced relatively unskilled workers, but now white collar jobs are disappearing as computers become increasingly efficient (a computer can research case law as well as a law clerk).
It used to be that as technology expanded, so did the qualified work force, as people got more education. No longer true. Today, in the U.S. it is more likely that a 45-year old male will have more education than a 30-year old. Political polarization can be expected along with a shift leftwards; even Republicans will have to raise taxes to support the growing number of the elderly – who are, not incidentally, an important part of their political base. A class of the permanently unemployable may be created and to date we have no policy or structure to cope with the situation. In Québec a larger percentage of youths do not graduate high school and experience difficulty finding employment. Similar situations are showing up in pockets of the rest of the country. There will necessarily be an impact on Canadian immigration policy. Finally, there is the reality of longer life spans. In this, of course, Canada is not alone  but shares the problem with the rest of the world. As technology renders even the upper class unemployable, the solution may well lie in moving from an economy based on production to one based on distribution. Then we will need to envisage guaranteed incomes (as advocated by Hugh Segal).

Microcredit/finance
As often happens with good causes, it would appear that an attempt to hijack microfinance from a lifeline for poor women by charging excessive rates of interest has resulted in a new push to re-establish the original mission. There is a lot going on behind the scenes, and there is a movement to promote transparency in MFI lending practices, the development of social business (i.e. Grameen Danone) , including more academic centers focusing on various models. Sheila notes the number of inspiring Arab women who were preset at the Summit and says firmly that they will be the subject of her next book.
Redefinition of microfinance for developed nations is important, given the essential role small business plays in the economy. Credit unions (and caisses populaires) were early models for the MFIs and should again play the role in their communities that they used to.

The market
On October 4, the Stock Market hit a significant low, and a new high on October 29 which has since vaporized. Investors do not want to be in the market over the long U.S. Thanksgiving holiday; they came back to the market on Monday, which also accounts for the volatility this week. The now popular Black Friday sales (at greatly reduced mark up) have precipitated impressive sales. However, the effect, if any, on pre-Christmas profits remains to be seen. Will there be nothing left to buy on the 10th or 15th of December?  Following Tuesday’s drop, the current forecast is for the market to continue the leg up (The Santa Claus rally) until it reaches its mid-December peak, followed by an impressive drop. From that point until mid-2012, in one expert’s opinion, investors should curtail their stock exposure.

++++++++++++++++++

Prologue

There’s a treat in store this week, although we cannot guarantee a gigabyte of giggles.
Peter Berezin will present the conclusions of his latest Special Report for BCA, to be published on Wednesday. The Report deals with the cause and consequences of rising income inequality in the U.S, and what this means for investors. Knowing the thoroughness with which Peter prepares his reports, we can be assured of a truly in-depth view of the causes, which will take us well beyond the consequences for investors.
[UPDATE from Peter: The Euro crisis has taken a turn for the worse. While not our baseline view, there is now a material chance of a disorderly breakup of the common currency. Investors should maintain a cautious stance in anticipation of more turbulence ahead.
The Special Report in this month’s Bank Credit Analyst discusses why income inequality has increased in the U.S. over the past three decades. We argue that while the share of income flowing to the top 1% has already peaked, the dispersion of income within the bottom 99% of the population is likely to continue to widen.]
Will we touch on the Occupy (Wall Street, et al) movement? No doubt. In anticipation, do check out Paul Krugman: We Are the 99.9% who reminds us that “very few of them [the über rich] are Steve Jobs-type innovators. One recent analysis found that 43 percent of the super-elite are executives at nonfinancial companies, 18 percent are in finance and another 12 percent are lawyers or in real estate. And these are not, to put it mildly, professions in which there is a clear relationship between someone’s income and his economic contribution.”
Sheila Arnopoulos has recently returned from the Microcredit Summit in Valladolid, Spain. A report issued the week before the Summit announced that “137.5 million of the world’s poorest families received a microloan in 2010,. Assuming an average of five persons per family, these 137.5 million microloans affected more than 687 million family members.” The Summit organizers note “that astonishing accomplishment is reason enough to gather the leaders of the industry from across the globe to discuss how to further increase the impact that this powerful development tool has on the fight against global poverty.”
Already a year of Wednesdays since the wonderful celebration of #1500 at the University Club. While our personal life has progressed happily in new surroundings, sustained by loyal friends old and new, we cannot say the same for the world.
A year ago, Canada was in a minority government that was more or less satisfactory to most. Our main concern was the lack of civility in Parliament. The Liberals were the official opposition and the NDP was not considered a formidable rival. In fact, such an astute political observer as Conrad Black was writing The Liberals shall rise again (he meant before the last election). In contrast, there is a majority government, the NDP are the official opposition, and now we have Le Devoir’s irate piece Entre dicter et gouverner
In the U.S., President Obama hailed his meeting with GOP leaders as a sign of bipartisan cooperation: I think everybody understands that the American people want us to focus on their jobs, not ours. They want us to come together around strategies to accelerate the recovery and get Americans back to work. They want us to confront the long-term deficits that cloud our future. … and security and not allow matters of urgent importance to become locked up in the politics of Washington. We know what happened to that prognostication.
Despite the President’s positive tone, we were already worrying about the new Congress after the mid-term elections as evidenced by this 24 November 2010 post:
“Aside from the numerous political commentators (e.g. Nicholas Kristof: A Hedge Fund Republic? and the Economist: As America undergoes dramatic, uneven changes, it may become harder to govern) who regularly write on the topic, even … George Soros has recently been quoted as saying that at times China wields more power than the U.S.because of the political gridlock in Washington. (China has better functioning government than U.S.) Moreover, Paul Krugman, writing about The Hijacked Commission (the National Commission on Fiscal Responsibility and Reform) points out that “It seemed obvious, as soon as the commission’s membership was announced, that ‘bipartisanship’ would mean what it so often does in Washington: a compromise between the center-right and the hard-right” – not a recipe for democracy at work. Still more disturbing is Mr. Krugman’s There Will Be Blood: “One of our parties has made it clear that it has no interest in making America governable, unless it’s doing the governing.” And that has proven true.
Grover Norquist was not then viewed with quite the same dread as the Darth Vader of democracy. Mike Huckabee (remember him?) had just launched a book and was viewed as a GOP contender; Rick Perry was just another governor of Texas whose memory lapses went unnoticed.
A year ago (on November 28) international negotiators reach a deal with Ireland on a bailout worth about 85 billion euros; this year it’s Greece [Eurozone gives Greece $10.7 billion lifeline, stumble over plans to beef up rescue fund], Italy and Spain we worry about as we debate whether it is a good or bad thing that the former two are presided over by technocrats and even Spain’s PM-elect is accused of being ‘technocratic”, whatever that means. Debate about the responsibility for the Greek crisis, along with the future of the EU and eurozone, has accelerated with fingers pointed in all directions. Note the Telegraph reports that the UK Foreign Office is warning Britons to prepare for the euro collapse.
Nobody spoke of an “Arab Spring” on December 1, 2010. Mohamed Bouazizi was unknown outside his provincial town and had several more weeks to live. We – and their citizens – seemed to be stuck with Gaddafi and Mubarak. Today, the Guardian reports that in the first free ballot in 80 years, Egyptian voters have defied fears of violence with record turnout.
Avid followers of international finance knew who DSK was and judged that he was successfully piloting the IMF; amongst the chattering classes of France, there was considerable speculation that he would step down early to run for the presidency of France.
Although there were always naysayers, it was becoming easier to make the case for nuclear power as a viable alternative source of energy. Proponents pointed to the examples of France, Germany and Japan. That was before Fukushima became a household word in the wake of the terrible earthquake and tsunami. Fukushima sharpens focus on global stores of nuclear waste
Newscorp and the Murdochs were generally not among our favorite media topics, but there was no outstanding issue. Instead, the world was a-twitter with the latest dump of cables by WikiLeaks, and Interpol had issued a global arrest warrant for founder Julian Assange. How things change – or do they? Today, WikiLeaks, Julian Assange Win Major Australian Prize for “Outstanding Contribution to Journalism”; in a gracious response Julian Assange Blasts Press In New Wikileaks Documentary and is reported to have called British journalism a “credit-stealing, credit-whoring, backstabbing industry,” during an interview in the film.
Sadly, Some things do not change:
The 2010 G20 Summit in Toronto was mired in bad reviews and failed to do much about [its focus] recovery from the ongoing global recession and the European debt crisis. The November 2011 Summit was even less fruitful, although some might argue that the unintended consequence of Berlusconi’s departure constitutes a success.
2010 Climate Delegates Differ on Kyoto Extension, Compliance Monitoring (Cancun), and in 2011, Negotiators from around the world are gathering in Durban, South Africa, for climate negotiations with few observers expecting much progress on formulating a binding climate change battle plan amid accusations wealthy countries are bullying those in the developing world. Der Spiegel (Germany) (English online version) (11/25), The Guardian (London) (11/26)
We wish we could conclude on a happy or silly note, but none seems to come to mind, however, there is one item that could be of interest to many: What architectural wonder would you like to see as the next LEGO® Architecture model? Habitat 67 is seriously in the running, in fact seems to be leading. You can vote (three times). We did it with Monopoly so why not Lego?