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).