Wednesday, 22 June 2011

Deficits, schmeficits.

This morning, the deficit reality came in worse than projected:
...the fall in borrowing could not fully offset the impact of the disappointing April, leaving the deficit for the financial year to date at £27.4bn, a record for the period as the Government borrowed £1.5bn more than a year ago.
One of the key reasons behind devaluing ones currency, is to become more internationally competitive, favouring local producers over foreign. This should in turn mean higher exports and fewer imports, which over time will reduce the deficit. So, when this in fact doesn't quite turn out as expected, what could possibly be the solution? should not be assumed that the £200bn quantitative easing (QE) programme is over just because inflation is more than double the target level at 4.5pc.
When all you have is a hammer, everything looks like a nail. That's right, the BoE is starting to bang the drums, hence preparing the proles for another round of Quantitative Easing.

No doubt, it is partially this realization which has driven gold to an all-time high when denominated in Pound Sterling this morning. £957.63/oz as we speak. But if the madmen at BoE actually go through with this, no doubt we'll see £1,000/oz hit in no time - unfortunately, this will almost certainly be with the companionship of further price increases at the supermarkets, and the petrol stations.

And it's worth recalling that it was inflation which brought out the masses in the Middle East.

Monday, 20 June 2011

On the Greeks leaving the Euro.
In an emergency debate, senior MPs from all parties demanded that Britain stand aside from a new rescue package for Greece and push for the country to leave the euro.
Although I most certainly don't support this pointless waste of money bailing out bankrupt nations truly is, there are substantial dangers in not only allowing these to default, but to have them leave the Euro as well.

First off are the well known direct implications with regards to the owners of Greek government bonds. Whoever hold these - banks, retirement funds, hedge funds - will eventually need to accept a significant haircut (writedown on the value of the bonds). Already, yields are reaching astronomical figures, a direct result of no-one wishing to buy Greek government debt, thereby effectively reflecting an expectation of an upcoming default.

But a far greater problem it could be to allow the Greeks to leave the Euro. In the event this were to happen, the Greeks wouldn't actually need to formally declare bankruptcy - they could instead forcibly convert their bonds to Drachma denominated, only then to let the currency crash. It should be rather obvious this really is no different to actually declaring bankruptcy, as for the bondholders the net result is the same - a significant haircut.

But the implications of letting the Greeks perform this covert bankruptcy stretches beyond the Aegean Sea. It would in an instant leave the bond market for other borderline bankrupt nations completely frozen - if the Greeks can leave the Euro, stuffing the bondholders in the process, why wouldn't Portugal and Ireland follow in their tracks? This would case yields on not only currently troubled nations such as Ireland and Portugal to go parabolic, but also - from a point of view of scale of the respective bond markets - far larger nations such as Spain and Italy.

And if yields for Spain and Italy were to skyrocket, it could become an almost overnight self-fulfilling prophecy - these nations could be forced into bankruptcy, as the bondmarket no longer would have any faith in these nations staying in the Euro, the very thing the European Central Bank and the IMF have been attempting to avoid.

Monday, 11 April 2011

Mervyn King says the rise in inflation is temporary.

Do you worry about the increasing expectations of inflation? Well, worry not, the Bank of England governor, Mervyn King, asserts it is nothing to worry about:

April 18, 2007
The Governor said that inflation had become more volatile, in line with the Bank’s forecast, and he repeated its view that inflation was likely to fall back “within a matter of months”.
21 June 2007
Our central view remains that inflation will fall back this year as the rises in domestic gas and electricity prices last year drop out of the annual comparison, and the recent cuts in prices feed through to household bills. But it is important to look through those temporary effects to the outlook further ahead.
Oct 12, 2007
The inflation report describes a benign central view of steady growth with inflation remaining close to the target,” said governor Mervyn King.
However, he anticipated that the rise in inflation would be temporary and would be due to increases in imported energy and food prices that were unlikely to recur.

12:30PM BST 17 Jun 2008
The Bank Governor indicates that the recent rise in inflation is both largely beyond his control, having been generated by international factors, and will be temporary.
16 September 2008
"Inflation has risen sharply this year, from 2.1% in December, to 4.7% in August. Inflation is ultimately determined by the pressure of money spending on capacity, which is controlled by monetary policy. But, other factors both here and in the rest of the world can have temporary implications for inflation.
16 Dec 2008
The MPC considers the direct price level effects associated with the changes in VAT to be an example of such a temporary disturbance.
British consumer price inflation rose unexpectedly to 3.2 percent in February, data showed on Tuesday, and Bank of England Governor Mervyn King said it was probably a temporary move due to sterling weakness.
it is likely that overall CPI inflation will return to target in the first half of 2009 and then move materially below it later in the year.
13 Oct 2009
"In August, Governor King forecast inflation falling 'quickly' with the chances of it dropping below 1pc as 'more likely than not," said Philip Shaw, an economist at Investec.
December 16, 2009
As the Monetary Policy Committee [MPC] learnt last year, a temporary rise in inflation, by itself, is not a good reason to raise interest rates.
6:00AM GMT 17 Feb 2010

In the letter, the Governor said the Bank's Monetary Policy Committee (MPC) expected the rise to be "a temporary deviation of inflation from the target" because of short-term factors including VAT, the volatility of oil prices, and the fall in sterling in 2007 and 2008 which is still feeding through.

May 19, 2010 - 02:19 AM
The MPC judges that together these factors more than account for the deviation of CPI inflation from target and that the temporary effects of these factors are masking the downward pressure on inflation from the substantial margin of spare capacity in the economy.

10:54PM BST 14 Aug 2010
However, Mr King has repeatedly argued that high inflation will be the temporary result of one-off shocks – including higher fuel prices and, from January 2011, the rise in VAT to 20pc from 17.5pc – while a sustained UK economic recovery is not yet guaranteed
15 November 2010
As I described in my August letter, the MPC's assessment is that the current elevated rate of inflation largely reflects a number of temporary influences
6:00AM GMT 16 Feb 2011
Mr King believes inflation should ease as "temporary" factors such as the VAT rise, the low value of the pound and rising energy prices fall away.

So, worry not. The current inflationary trend is "temporary", and will - as has been repeatedly assured for months, even years now - fall back to within its 2.0% target any day now.

Tuesday, 5 April 2011

John Law lives.

Fed's Dudley says NY Fed, money managers and banks will create swap plan

Well, excuse me for being a cynic, but I think this will work like this:

1. QE2 will be shut down, as the inflation expectations it bring with it are spiralling out of control.
2.The primary dealers will keep buying treasuries, but will repo these back to the Fed in exchange for cash.

One of the drivers of John Law's Mississippi Company bubble, was the French National Bank allowing MC equity being accepted as collateral for new debt - which would then be promptly reinvested in MC equity (repeat ad infinitum).

But, this time, instead of Mississippi Company equity eventually crashing, it will be US Treasuries.

But, of course, that's just my opinion as a cynic.

On peak oil, UK imports, and the economics behind it all.

UK oil production peaked in 1999, at a time where the oil price ran in the $10-20/barrel range. At that time, total production of 3m barrels per day (bpd) meant 1m were destined for export. At a $15 average price point, for the UK this meant total income of:

1mbpd * $15/barrel * 365 days = $5.5bn in income contribution to the British economy.

However, this doesn't factor in production cost, which is generally said to be running in the $9/barrel, when you factor in exploration, extraction, and general production costs (for the record, these have in the meantime increased to around $22/barrel for North Sea oil):

1mbpd * $(15-9)/barrel * 365 days = $2.2bn in post-production cost income contribution to the British economy. The bottom line is that the British economy via the public and private sector have overall had income emanating from the oil sector.

However, as the UK is now well past peak, imports will necessarily rise, and just at a time when oil price is spiking due to a rising demand/supply imbalance.

Last summer, BP released the current status on localized demand and supply, and it shows the demand of the United Kingdom to be gradually reduced 3-5% on an annual basis, no doubt the direct result of higher prices, which puts a limit on marginal demand. However, this fails to keep up with the decline of supply, which runs in the 6-10% bracket (General North Sea decline is around 9% annually, with some estimates all the way up to 17%!).

In 2009, the demand and supply figures for the UK were 1.611mbpd and 1.448mbpd respectively, which essentially means the need for imports is the differential (1.611-1.448=) 163kbpd. In monetary terms, this means with a current Brent price of $120/barrel, the amount of money leaving the British economy on an annual basis amounts to:

163,000 * 365 * $120 = $7.1bn.

This is not an issue at present time, but if we consider demand/supply decline rates of 4 and 8% respectively, this is the equation to consider (The equations are admittedly simplified, but the errors introduced will not be statistically significant):

fnc(year,avg_price) = ((1.611*((1-0.04)^year)) - (1.448*((1-0.08)^year))) * avg_price * 365

Assuming the price stays static at $120/barrel (which is highly unlikely), these are the figures we get (annual, and cumulative):

2010 - $9.3bn, $16.5bn
2012 - $13.0bn, $40.9bn
2014 - $15.7bn, $71.2bn
2016 - $17.6bn, $105.6bn
2018 - $18.9bn, $142.8bn

However, with a 10% annual oil price growth, this is the equation to consider:

fnc(year,avg_price,avg_price_growth) = ((1.611*((1-0.04)^year)) - (1.448*((1-0.08)^year))) * (avg_price*((1+avg_price_growth)^year)) * 365

And here are the net results:

2010 - $10.3bn, $17.5bn
2012 - $17.4bn, $48.6bn
2014 - $25.3bn, $95.1bn
2016 - $34.4bn, $
2018 - $44.6bn, $243.2bn

The bottom line is that what used to amount to a gentle financial aid to the British economy, is rapidly turning into a huge drain, which will leave the British economy struggling, increase the pressure on the welfare state and hence increase the deficit. And this is not considering gas imports, which are rapidly growing as well.

Saturday, 2 April 2011

On financing the UK budget deficit.

No-one questions a small elite sit on a disproportionate amount of the wealth in the UK:

Top 1%£688,22821% of total UK wealth
But in this post, I intend to focus on income taxation, not wealth confiscation, regardless of which arguments may exist to further this issue, if for no other reason it's a complicated topic as wealth confiscation ultimately lead to capital flight, and hence a gradually reduced gain. Introduced capital flight regulation of course would be possible, but this would with almost certainty guarantee plummeting foreign investment in the UK, and furthermore a London finance sector on board the next available flight to Zurich.

An assumption with regards to my calculations is that higher taxation will not lead to reduced motivation and brain drain, both of which lead a high income taxpayer reduction, and hence less income gained for the inland revenue, and thereby a rising deficit once again. It also assumes small business owners will not simply decide to just shut down, which would lead to a higher number of individuals on transfer incomes, yet again which would result in a rising deficit.

I finally also ignore potential effects with regards to inflation, currency valuation, and interest rates, as these would increase the length of this post significantly.

Some of the numbers are not in complete sync in terms of year - the budget is from 2011/2012, and the household figures are 2008/2009. However, since the start of the financial crisis, income figures have been largely stagnant, so the introduced error should not be significant.

A final note, as I most certainly will be accused of "protecting the bankers" and other such nonsense - no, I don't. I am simply going through the numbers as they stand, and in this regard it is important to note the the current deficit is not the result of support for the banking sector other than through added gilt interest, which amounts to no more than the statistical inaccuracies attributable to the expected 2011/2012 deficit of £122bn (keep in mind that bond interest rates are practically at all-time lows, and have been for the past few years, so any gilts sold over this period would have a low coupon rate, and also a significant amount of bonds have been bought by the Bank of England, which transfers interest paid back to the treasury).

Anyway, disclaimer out of the way - although I won't be using these as basis for my calculations, I add them here to put a perspective on numbers - here are the numbers of high income earners in the UK:
£50,000 to £70,000859,000
£70,000 to £100,000410,000
£100,000 to £200,000300,000
£200,000 to £500,00089,000
£500,000 to £1 million16,000
Over £1 million6,000

I found the following stats on households, rather than individuals, which would seem more appropriate, as often the rights of children in poverty is brought up as a main argument for a more equal wealth distribution:

The number of households in England is projected to grow to 27.5 million in 2033, an increase of 5.8 million (27 per cent) over 2008, or 232,000 households per year.
So, for 2008, the number of households in the UK is (27.5-5.8=) 21.7 million.

In 2008/09, income before taxes and benefits of the top fifth of households in the UK was £73,800 per year on average compared with £5,000 for the bottom fifth, a ratio of 15 to one. After taking account of taxes and benefits, the gap between the top and the bottom fifth was reduced with average income of £53,900 per year and £13,600, respectively, a ratio of four to one
Average income for the top 20% percentile is £73,800, or £53,900 after income taxes.

This means the top 20% of the population gains approximately:
(0.2*21.7m) * (73,800) = 4.34m * £73,800 = £320.292bn.

But this is a pre-tax figure; post-tax figure is given by:
4.34m * £53,900 = £233.926bn of potentially taxable income.

The 2011/2012 current budget deficit runs at (an optimistic estimate of) £122bn:

So for the deficit to be covered by the top 20%, 122/233 = 52% of currently post-tax incomes must be taken by the Inland Revenue. For the average top 20% household, this results in total income taxes of:

(73,800-53,900) + (53,900*0.52) = £47,928 annual tax bill
(73,800-47,928) = £25,872 total post-tax pay

Yielding an effective tax rate of (47,928/73,800) = 65%.
The current effective tax rate is (73,800-53,900) / 73,800 = 27%.

So, the actual numbers say that for the current budget deficit to be entirely solved by "taxing the rich", the effective tax rate for the top 20% income bracket must more than double, and for this to even work, it is assumed that no-one from this bracket will become unmotivated or take their business elsewhere, which is frankly a little more than a stretch.

It also completely ignores what would happen to the housing market, in the event post-tax income were to collapse for the top 20% as calculated. And if the housing market were to collapse as such, it would not only inevitably take down a lot of home owners, but also lead to lower income taxes received through stamp duties, ie a yet again rising deficit.

In other words, believing this budget crisis can exclusively be solved through "taxing the rich", with absolutely no cuts in public sector spending, is nothing short of fantasy.

Saturday, 26 March 2011

On Japanese treasury holdings.

two weeks after the earthquake, uncertainty still reigns over whether Japan will reduce its purchases of Treasury debt and other foreign assets — a decision that could force the U.S. to pay higher rates on its securities to attract buyers and possibly drive up U.S. interest rates.
Another significant hint at exactly in how precarious a state US finances truly are. If the Japanese can't realistically sell their treasury holdings during an emergency, then what good as an investment are they really?

So far, Japan's financial response to the disaster has been monetary easing:

The BoJ doubled the cash it sets aside for buying assets such as government bonds on Monday to 10 trillion yen ($124.1 billion) in an emergency move to shore up confidence in crisis-stricken Japan.
Total rebuilding efforts are rumoured to be in the $180-300bn range. If we were to take $250bn as the final bill, financed through the sale of treasuries, this would amount to (250/885=) 28% of Japanese holdings of US Treasuries.

In the event they were to sell, who would turn up as a buyer of size? China would be the obvious candidate. They currently sit on $1,154 billion of US Treasuries. But except for China, the only other obvious bidder would be the Federal Reserve, by yet again expanding their Quantitative Easing program.

And that's really the crux of the issue. Either the US needs to increase the pace of their QE program, or the Japanese do. Either way, we'll have more paper currency chasing a fixed amount of goods, which will ultimately translate into higher prices for the consumer.

On the protests in London

So, today we're supposed to see upwards of 300,000 people march the streets of London, protesting public sector cuts.

The truth is that public sector spending as part of GDP has increased from 35% of GDP to 53% today, and the balance sheet of the UK as a result has turned from a surplus into a significant deficit.

I did a little digging, because I would have expected the only Western countries to have comparable public sector spending would be Scandinavian, with their generous welfare models, and this is what I found:

Sweden at 56.6% of GDP, Denmark at 51.7%, and Finland at 48.6% reflects very high public spending, compared to 46.9% in Germany, 39.3% in Canada, and 33.5% in Ireland.[2
First thing which strikes me is that Danish public sector spending is below that of the UK, which genuinely surprised me. But the thing about both Denmark as well as Sweden, is that both have tax rates significantly above those of the UK, which essentially means for the UK to be able to support the current system, either taxes need to increase to Scandinavian levels, or cuts will be required. There has historically been a third option - growth - but considering the economic climate of today, I think it's safe to say we can leave this option out, also for the simple reason that the only time where a comparable debt situation has been resolved through growth, was in England, at the onset of the industrial revolution.

Anyway, the 2011-2012 budget at a glance:

The gap is (rough figures) £710bn spending, unmatched by £590bn of intakes.

The protesters in London will obviously want tax increases "on the wealthy". The thing is that the deficit - £122bn - is 75% of the amount of tax intakes. In other words, income taxes would need to increase by 75% to cancel out the deficit. There simply is no chance of anyone actually staying behind in the UK if that were to pass. Alternatively, every type of tax would need a (710/590)=20% increase. This would mean the 20% VAT would increase to 24%, council taxes on average increase from (estimate) £1,200 to £1,440, and naturally income taxes would rise equivalently as well - not to forget the additional fuel duties, which I'm sure the protesters would be understanding of.

I'm sure you by now have realized just how unrealistic it is to expect the problem to be solved entirely by raising taxes, and hence public sector spending remaining where it is. Cuts are required.

The vast amount of spending goes on 3 items; welfare (£200bn), NHS (£126bn), and education (£89bn). Since calls for these to be ring fenced are voluminous in scale, if these were to be wholly preserved, we would need to almost completely eliminate defense, public order, social services, and housing & environment in order to balance the budget.

And all of this against a backdrop of deteriorating demographics, which ensures a continuously growing outlay on pensions and health services for a growing retiree population, and less people in the workforce to provide the tax base for this to happen.

On silver and gold.

People question whether gold and silver are still worthwhile investments. I think they're still among the best investments you can make at this point in time.

The primary buyer of US government debt is the Federal Reserve. The Fed creates the money out of thin air through the means of "quantitative easing", a fancy way of saying "printing money".

Although in somewhat better fiscal shape, the United Kingdom employs her own QE scheme. One major advantage the UK has relative to the US is the average maturity of government debt. The average US maturity is around 4-5 years; the equivalent figure in the UK is 12-13.

The European Central Bank (ECB) has recently found it necessary to bail out Greece, Ireland, and Portugal are in the works. This money was raised primarily through printing, but additionally also through coercive measures, hurting pension funds of citizens of the countries in question.

Japan has recently been hit hard by the tsunami and the Fukushima Daiitchi nuclear disaster. To stabilize the economy, the Bank of Japan announced various fiscal measures which essentially consisted of further monetary easing, aka printing money.

Not even China are in the clear. As the American economy ground to a halt in 2008, China announced significant stimulus programs - in fact, the vast majority of the alleged 2009 Chinese growth was down to government stimulus programs. In addition, China struggle with substantial amounts of bad debts, which are covered up primarily through printing. A quick peek at the Chinese monetary base confirms this.

So, in essence, every major central bank on the planet is printing away. And lots of outlier countries, from Brazil to Peru, have announced measures to artificially depress the value of their own currencies, in the name of protecting the competitiveness of local industry. What this amounts to is essentially printing lots of local currency, and selling this in the open market in exchange for US Dollars, thereby propping up the Dollar and depressing the local.

All this printed cash will eventually find its way into the pockets of consumers, and signs of mounting inflation are readily available throughout the world - China, India, and of course the rebelling Middle Eastern countries, the trigger here often quoted to be rising food prices. But we also start to see creeping inflation in the UK, with recent CPI going from 4.0 to 4.4% in one month alone.

So given that all central banks print as if it's going out of style, given these additional currency units - according to standard supply/demand - will chase a fixed amount of goods, this will necessarily dictate that prices should go higher. Be this gold, silver, oil, copper, rice, wheat... even equities.

Now, the key question here is the speed at which the newly created currency enters circulation. Some completely question whether it will enter at all, claiming all price rises are down to one reason or another. I don't question whether there are additional factors, there always are from year to year. But we see inflation throughout ALL commodities, not just the ones where the supply is in question. And this underlying trend can most easily be explained through the monetary expansion, aka "printing money".

So, in short, all this money printing will lead to a rise in inflation, and historically, precious metals have been among the best hedges. So I'm still a buyer at these levels.

Friday, 25 March 2011

On peak oil in general.

I find it rather surprising, when otherwise informed people think peak oil will hit in possibly 20 or 30 years, or "hopefully not in my lifetime".

The International Energy Agency (IEA) says production of conventional crude oil peaked in 2006
From here on out, we rely on an ever-increasing amount of ultradeep and unconventional oil to come online. Ultradeep has been a political hot potato ever since the Gulf of Mexico Macondo tragedy in 2010, and would be politically difficult to get through in any significant quantity, plus given the time to explore and get online, will not address the problem in time.

This leaves unconventional sources, such as the enormously polluting tar sands (Canadian Athabasca, and upcoming Venezuelan Orinoco), and other sources such as the much fabled Bakken shale field (much nonsense is published about this, but we'll ignore that for now), NGL-to-liquids, and the extremely polluting coal-to-liquid processes favoured by the Nazis during WW2.

But, being the lions share, the important part to focus on here is conventional. The IEA have formerly (2010) announced decline rates in the region of 5.1-6.7%, with whistleblower estimates all the way up to 9.1%. This effectively means we need to find a new Saudi Arabia (8.5mbpd) every two years through unconventional sources, something a lot easier said than done.

And most of the unconventional processes carry heavy penalties. Any conversion process is by definition a net energy loser, and the polluting processes don't scale at anywhere near the required rates.

And all of this is happening in an environment with ever-increasing competition from primarily China and India for supplies. One wonders what a Chinese consumer will think, having just bought his/her first car, now sees fuel prices rocket before having had a genuine chance to enjoy this newly found mobile freedom.

Western hypocrisy & the war in Libya.

Gerald Celente points out the blatant Western hypocrisy behind claiming the invasion of Libya is on humanitarian grounds, yet ignoring atrocities in Yemen and Syria.

The Libya invasion is about oil. Period. 1.5m barrels/day of easily refined light sweet crude - less than 2% of global daily output (total of which is around 85mbpd).

And this is what makes me worry about the upcoming peak oil crisis. Iraq sit on 10% of the world's oil deposits, with a relatively primitive oil infrastructure, so the effective yield of this invasion was significant, the idea being additional investment could take the 2mbpd figure upwards (though 7 years on, and we've only seen about 0.5mbpd go online). But Libya's (declining) 1.5mbpd, and 3.5% of world reserves doesn't have the potential of an increase in daily output anywhere near that of Iraq, so for the US Military to get involved to the extent it has... well, we must really be approaching the cliff event faster than anyone care to mention.

More tax hikes.

In the midst of the "Great Recession", California - following Illinois - is next in line to raise taxes.

Unfortunately, it's not much of a long term solution. With LA pension benefit expenditures to reach 20% of tax intakes by 2015, this is soon to be either followed by more increases, or outright default.

Rising pension and retiree healthcare costs for public safety workers are expected to consume 19% of the city budget within five years (up from 8.7% this year).