Blue Marble Sustainable Investing

Bernanke to Fight Deflation - Market Rallys - For Now Anyway.

Ben Bernanke, the FED Chairman in the US gave a speech today that had every economic and market commentator absolutely hanging off of every nuanced word. Listening to the passages would likely put most people to sleep.

And from time to time the phrases that command the most attention change and their focus either diminishes or grows in import. Today the phrase "is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” referring to the Federal Open Market Committee's desire to fight deflation.

So that begs the question: "If Ben Bernanke and the FOMC are stating that they are prepared to fight deflation then is deflation a serious threat?" Now I am not the sharpest tool in the shed but if Ben Bernanke mentions deflation that makes me listen.

Now it was also the revised projected GDP increase of 1.6% annualized in the second half of 2010 as compared to the highest estimate of 1.4% annualized that was also cause for a market rally of considerable strength. My concern is that this weekend all the traders are going to go home and think "Hey...is deflation a real threat? And if it is what room do we have as a nation to fight it?"

Well I believe it is and the US only has a few options left. Basically it amounts to reducing rates paid on reserve balances, securities purchases, or just plain money production. And they are fighting a bit of an uphill battle.

They hold $ 1.1 Trillion in Mortgage Backed Securities (MBS). When rates fall (in order to stimulate the economy) people refinance their mortgages. When this happens MBS get prepaid and money that the FED put out to buy the MBS comes back into their pockets which is monetary tightening. Not the result they were hoping for.

And the US Consumer, that component of GDP that the US is relying on to bring about the hoped for robust recovery is saving instead of spending. The US savings rate is now 6% from its low of just over 1.00% in 2005. That takes money out of the economy and only comes out in new investment or spending. Bored yet?

Simply put the FED has little room to manage, has structural issues that will impede their work, and is doing so hoping that US Consumers will return to their spendthrift ways. How Ben Bernanke does all this without going crazy is impressive. I wish him luck but we are still not equity buyers at this time.

If it Looks like a Duck - Chinese Real Estate

Its not like we have not had our share of bubbles in North America. And we are not unfamiliar with the results. But what happens when a bubble on the other side of the world collapses and its effects ripple like a tsunami the world over? This is what is happening in China right now. And like the real estate collapse in North America and Europe it is following the same pattern.

Chinese real estate is perhaps the most expensive on the planet. At an average of $ 1,160 USF per square meter against an average annual family income of about $ 7,500 USF per year it is almost 5 times more expensive than New York at $ 2,059 and $ 72,000 respectively.

China has been putting the brakes on real estate lending and has implemented some measures designed to let the market cool but at this stage, very similar to the 2008 real estate markets in the United States and Europe, speculation is rather rampant.

The debt loads behind the real estate market in China are lower than the US and Europe but at the current price levels real estate has a long way to fall even if it were to fall in line with Tokyo or New York. However it may just be that there are enough wealthy speculators to keep the market going for a long time but the end result will be a crash. Signs of collapse are already starting to show in prices and everyone, including the Prime Minister are stating that China has a real estate bubble.

So if European and North American debt levels were not enough to give investors serious pause for concern, the potential for a Chinese real estate crash should be. Where do you think they get all the commodities and durable goods to produce all the materials required for putting up massive real estate developments? That's right, a lot of it comes from North America and Europe as well as Asia.

European and North American consumers helped create the debacle that is China and it will be European and North American consumers and businesses that pay the price when it has its first major collapse.

Far From Safe

I am sure by now that you all know I think debt levels the world over are way too high and they pose a latent threat to recovery and to the economic futures of many countries the world over.

So in this post I just wanted to make people aware of a couple of items. The first is a book I am currently reading and the second is a news article I read a couple of weeks ago that has been haunting me ever since.

The book I am reading is called "This Time it's Different - Eight Centuries of Financial Folly" and while the title seems a somewhat whimsical, I have been completely surprised by the content and the quality of the information within.

The authors, Carmen Reinhart and Kenneth Rogoff have complied debt and debt default statistics for countries spanning 8 centuries. And they have provided some very interesting and compelling research surrounding this very important topic. While I am not done the material yet, I can say that when you look at the current debt situation the world over it becomes very apparent that we have seen this movie before and the ending was not a "happily ever after" one.

Next, and very much in line with the discussion on the book I am reading, is an article that appeared on the Bloomberg website on July 12, 2010. A small article for this publisher but its import is staggering. Essentially the US Federal Government, through its co-Chairman of the National Commission on Fiscal Responsibility and Reform, Erskine Bowles, has told States that they cannot rely on the Federal Government for budget bailouts.

States in the US have seen tax revenues plummet during the recession and they have not come back despite some recovery. This has led many States to look to the Federal Government to make up budget shortfalls. Apparently this is no longer possible.

The question that arises from this situation is what will the Federal Government do if a State looks as though it is going to default on its debt?

F35 for Canada - Costly Error in Judgment

OK so this blog entry may be a little off topic but I just had to comment as it is a topic near and dear to my heart. The Canadian Air Force has some of the best pilots in the world. We consistently rank in the top when it comes to NATO exercises, TOP GUN training, or just about any combat aircraft competition held anywhere on the planet.

To get there you have to have top notch equipment and more importantly you have to use it to its limits. This comes from training and operational use. And lots of it. Canada currently uses the F-18, one of the best fighter aircraft ever made.

For Canadian pilots, who fly in some of the most population scarce parts of the planet, having  fighter aircraft with two engines is vitally important. It allows pilots to get back to base if one engine fails. And from time to time they do exactly that. I worked in Base Flight Safety when I was an Officer Cadet in the Forces in the mid-eighties. Other than learning what happens to aircraft in every type of incident possible (birds at 500km/hr in-flight collision speeds are the worst), I also came away with an appreciation of why the Canadian Air Force has, since the single engined F-86 Sabre was retired, required their fighters to have two engines.

Besides safety, it comes down to economics. When an aircraft with two engines has one of those engines fail it can usually get back to base on one. It is a mechanical failure but usually not an emergency. When an aircraft with one engine has an engine failure you have an emergency. If it cannot be re-started in the air, and depending on the altitude of the failure you do not have much time as fighter aircraft sink like rocks with no power. Therefore if the pilot has to eject you not only have to spend time and money to recover him/her, you have just lost a $135 million aircraft in the case of the F-35.

Current F-18 E/F versions will set you back about $ 90 million each. Canada already has most of the infrastructure in place to service them. And when one engine fails it does not cost you $ 135 million in a lost aircraft. It is incomprehensible to me why we would chose the F-35.

2012: Forget the Mayan Prediction - Think Debt

According to the ancient Mayan calendar the December 21, 2012 solstice marks the end of a 5,125 year Great Cycle. After that a new one begins and what is in store for humanity remains a mystery. Likely it will pass with the same underwhelming result as the Y2K threat. However, 2012 promises to be the end of another cycle that may have more impact on the planet than the Mayan prophecy.

In that year Banks the world over will have to roll over $5 trillion (yes 5 with 12 zeros behind it) in bonds. Of that about $ 1.3 trillion is in the US and $ 2.6 trillion in Europe. The rest is scattered about the globe and of less consequence. 

Why is this important? Very simply put the European banks will be in competition with European Governments to raise new financing. The very same governments that provided the European banks with short term loan guarantees during the crisis so that they could issue debt to recapitalize and get stronger. Unfortunately, the guarantees were fairly short term so the banks issued short term debt that will be coming due, largely, in 2012.

This competition for financing will lead to a glut in the market and likely cause rates to increase. In addition the weaker banks will have to pay a higher interest rate on their debt making them less competitive. From there it follows there will likely be more bank mergers in Europe as the weaker banks get taken out by those able to borrow at much lower costs.

Should banks be unable to fund out their total requirements it means that credit for businesses and consumers alike will see lending slow down and those that are able to get financing will be doing so at a higher overall rate.

But who knows? Maybe the results of the stress tests that are to be released on July 23 will show that the largest 91 banks in Europe have no issues and that they are strong and that there really are no reasons to worry. But what about the hundreds of other smaller banks? And what if, as widely expected, the stress tests show some weakness?

Debt is insidious and so are its effects. At the current levels of debt the world over in the developed countries, a sovereign default, whether overt or covert (printing money) has a high probability of happening. It is this mountain of debt that has to be dealt with and the reality is that one way or another it will be. The results will vary depending on response, but either way it will end in tears.

G8G20: Austerity and Hypocrisy

The G8/G20 meetings in Toronto and Muskoka have come and gone. But their legacy will be around for many years. As will the memory of the shameful vandalism and thuggery performed by the Black Block who are simply petty criminals disguised as agents of change. There are two legacies that will fall out of the meetings. One to Canada and one to the world. 

For Canada, its legacy will be one of hypocrisy. It was President Obama who wanted the group of countries to continue stimulating their economies although at the cost of ever increasing debt burdens or in the absence of borrowing to simply turn on the printing presses and keep the cash flowing. However, as much as President Obama wanted this to happen it was not to be. Prime Minister Harper and the rest of the fiscal conservatives won and austerity and deficit and debt reduction became the mantra.

That the meeting cost over $ 1 billion for security alone with the final and complete cost likely to never be known to Canadians is hypocrisy at its greatest. Prime Minister Harper fought for and won debt and deficit reduction at meetings Canada had to borrow to pay for. If ever there was a dreadfully clearer example of hypocrisy this was certainly it.

For the world the legacy is far more troubling. Having the wealthiest countries on the planet commit to debt and deficit reduction raises the potential for a deflationary cycle in the presence of a tepid recovery, large debt to GDP loads and very high deficit to GDP budget shortfalls. The parallels to the 1929 crash are becoming eerily similar. The initial fiscal stimulus simply delayed what was to come. While the time period is different, people have not changed and the austerity measures that eventually led to the Great Depression seem to have reappeared. Remember, it was not the initial fall of the stock market that caused the Great Depression, it was the actions of the next three years that did so.

So with the close of the meetings Canadians and citizens the world over will eventually feel the effects of a meeting that cost too much, accomplished far too little, and has simply become a prelude of things to come.

G8/G20 in Canada - Good Thing its Not Their Money.

By now you have no doubt heard of the estimated cost of security for the G8/G20 series of meetings to be held in Canada. At CDN $ 1 Billion it literally boggles the mind. And it is likely the best indication that government no longer cares about how they use taxpayer funds.

The last time this meeting occurred in Canada was 1988 and it only cost CDN $ 6 million for security. On an inflation adjusted basis it should cost about CDN $ 10 million to day. So why is it 100 times more? Is the world really that much more dangerous now compared to 1988?. I think not. The IRA wanted Thatcher's head, Ronald Reagan was the target of an assassination attempt and plenty of threats, and there were plenty of terrorist organizations around the world. These are the risks most heads of state have to deal with. Al Qaeda is just a different flavour of the same danger shake.

So we are spending 100 times what we should be for security in a world that is just as dangerous as it always has been. But what is truly disturbing about this set of meetings is that this sum is being spent in a period where most of the G8/G20 countries are running astronomical budget deficits and are accumulating debt levels of disturbing proportions. Lets take a quick look.

The G8/G20 countries are (G8 are the first 8 countries listed): France(-8.4%), United States(-8.8%), United Kingdom(-12.0%), Germany(-5.5%), Japan(-7.8%), Italy(-5.2%), Canada(-4.3%), Russia(-3.9%), Argentina(-2.8%), Australia(-2.9%), Brazil(-1.9%), China(-3.1%), India(-5.5%), Indonesia(-2.1%), Mexico(-1.0%), Saudi Arabia(+4.3%), South Africa(-6.8%), South Korea(-2.1%), Turkey(-4.5%), and European Union(-7.0%). The numbers in brackets represent each country's budget deficit as a percentage of their GDP for 2010.

Looking at the list above it is interesting to note that NOT ONE of the G8 countries is running a budget surplus. What is even more shocking is that with the exception of Canada, the members of the G8 have been accumulating debt at unheard of rates over the past 3 years. Looking at the G20 there is only ONE country running a budget surplus and that is Saudi Arabia. That should not come as a surprise.

So why is it in this time of austerity measures in Europe and financial difficulty in almost every major country that will be attending these meetings that this money is being spent? If I remember correctly the UN Headquarters in New York is specifically set up to deal with meetings like these and has the security and meeting space to do so.

Why is Canada spending over a billion dollars to do the same thing? And because we too are running a budget deficit it means that we are BORROWING the money to put on this show. Each Canadian will be going an extra $31.25 in debt for little or no enduring benefit other than the show our politicians get to put on while at the same time insulating the top politicians from other countries from anything that may be real.

If ever there was a singular indication that politicians have lost their ability to link the money they spend to the people who pay for it this would be it. It does not matter the colour of the stripe on the politician, they have all forgotten it is the hard work of the citizens of their countries that provide the funds they squander without regard to value or future consequence. Venality and arrogance are lethal. Certainly for taxpayers the world over.

PACE Bonds - Here they come.

It should not come as a surprise that some new financial innovation developed in the USA will be adopted by Canadians and other countries. However, what will come as a surprise is that this time the new innovation is unlikely to create catastrophic financial failure.

The innovation is PACE Bonds. PACE stands for "Property Assessed Clean Energy". The process is very simple. Owners of homes, commercial properties and industrial properties looking to install new energy efficient heating, ventilation, lighting systems or other capital intensive energy saving modifications are able to access long term loans to do so. Often with little or no cash outlay of their own. The principal and interest is amortized over the expected life of the upgrade, typically 20 years, and the payments are simply added to the owner's tax bill.

So why is this go great? Well there are many reasons. First, the owner has little capital outlay and therefore upgrades that can cost a significant amount get done instead of deferred. Second, because the payments are simply added to the annual property tax bill it is efficient and means that loans get paid because they are secured by a tax lien on the property. Third, the investment is an incredibly secure one for insurance companies, pension funds, or other long term investors because it is secured by property tax liens and if you look at the Canadian property default history (very good) you will understand how safe they are. Lastly, the owner obtains very high ratio loans that are paid off with the extras saving from energy efficiency gains from lower power bills.

Now those benefits are direct but there are indirect benefits as well. Like the strengthening of the local economy, renewal of the energy efficiency of the national housing stock which is a MAJOR greenhouse gas emitter, and the ability for civic pension funds to invest in secure bonds locally with better returns than traditional bonds.

So finally a financial innovation coming from the USA that just might be worthwhile and not end up blowing up world financial markets. And the multiple benefits that derive from the structure just make it that much more appealing. All this from the land of the LTCM, Internet Bubble, Sub-Prime, and soon to be High Frequency Trading fiascos. Who would have thought?

Japan - Turn on The Yen Press For Crying Out Loud

There has been no shortage of concern regarding the massive amount of public debt that Japan is accumulating. But should there be? In my humble opinion the answer is no.

For the past 15 years at least Japan has been stuck in a debilitating cycle of deflation, continuous stimulus attempts and debt accumulation as a result. What is perplexing to me is why one of the few countries that could benefit from printing money does not do so.

The country has massive foreign reserves (over 1 trillion USF), runs a current account and trade surplus, has spare industrial capacity, some of the lowest interest rates on the planet, and most of its government debt is held in Japan. Oh, and it is running a large budge deficit and has been in a deflationary cycle for years now.

Of all the countries I can think of, Japan is best suited to start printing Yen. In this case a little inflation would go a long way to solving some of its problems.

First, it would reduce the the amount of government debt outstanding. For a country that spends almost 40% of its annual budget on interest payments, even at the low interest rates it obtains in the market, it would seem to me to be a good way to reduce that bill.

Second, it would devalue the currency and either force Japanese interest rates up or in the absence of that it would increase exports. Maybe both would happen. If Japan was smart and it paid down the short term debt first the increase in interest rates might not hurt it so bad. And the additional foreign reserves from increased exports could be used to buy back Yen lending a base to the currency. 

Third, maybe putting some cash into domestic bondholders' hands might force them to start looking to invest that money in projects that increase their rate of return and start growing their economy.

Finally, by printing Yen Japan could start to solve its foreign reserve problem which is a problem of riches. As the Yen appreciates the value of its USF foreign reserves falls. So why not depreciate your home currency by printing Yen and then sell your USF foreign reserves in the open market for a better rate and buy your home currency? There are too many people sitting on USF foreign reserves and one day when everyone figures out what a basket case financially that country is there may be a rush to the exits.

I am sure there is much more to all of this. Some complications that would preclude using basic economics to help solve the ridiculous cycle that Japan has been stuck in for many many years. Maybe it is time to try something different to get a different result.

The Cost of one Man's Venality and Arrogance

No doubt by now you may have heard of the results of the Oliphant Commission report. It is refreshing as it is depressing. As Canadians however, I believe it is important that each and everyone of us read it, or at the very least the 75 page Executive Summary.

The Mulroney Schrieber affair has been at times bizarre, gross spectacle, intriguing, sad, and ultimately instructive. But more importantly it has been an example of the cost one man's arrogance and venality can have for a country's citizens.

That Mulroney took $225,000 to $ 300,000 in cash stuffed envelopes on three separate occasions has been well documented. That Mulroney and Schrieber each are not to be trusted has also been well established. And while Canadians have watched this ridiculous affair unfold, the truth and magnitude of which will never truly be known, we have also paid for it dearly.

Had Mulroney declared the funds immediately and recorded the transaction on his tax return in the year(s) of receipt of the cash the Canadian Government would have simply collected $ 100,000 to $135,000 in taxes and that would have been the end of it. But no. Instead, due to the venality and arrogance of Mulroney, Canadians had to suffer a circus act more bizarre and expensive than anything one could dream of.

In the first installment of this sordid soap opera Mulroney launched a defamation suit against the Canadian government and was awarded $ 2.1million in damages and legal costs. For his sad performance at the Oliphant Inquiry he received about $ 2.0 million to pay for his legal costs. And now we find that the total cost of the Oliphant Inquiry was in the area of $ 14.1 million. $ 18.2 million total.

So for the venality and arrogance of one man we have paid $ 18.2 million to determine that taking cash stuffed envelopes and not declaring the income is "Inappropriate". Frankly, I could have told you that for much less. As a Canadian taxpayer this should make you very upset.

Frankly, I think Mr. Mulroney owes Canadians about $18.2 million.