Flashman Letters

Spain Misses 2013 Budget Deficit Target in Spite of Massive Tax Increases; So Much Pain for Virtually No Reward

Spain's budget deficit fell from 6.84% of GDP in 2012 to 6.62% of GDP last year.

The budget goal was far less ambitious than previous, but still did not met the commitment to Brussels. The Government has published today the first official public deficit figure for the end of 2013, there will be new reviews in the coming months and a year, but Spain has deviated from the intended target.

Specifically, the government recorded a hole of 6.62% of GDP in 2013 (67.755 billion euros), one tenth of a percentage point above the limit of 6.5% agreed with the European Commission, according to Finance Minister Cristobal Montoro, in a press conference after the Council of Ministers. However, the announced figure does not include the cost of financial aid reported last year (0.46%), so that the actual deficit stood at 7.08% of GDP.

So Much Pain for Virtually No Reward

Via translation from Guru's blog, paraphrasing a bit because of a difficult translation, please consider So Much Pain for Virtually No Reward, Fire the CEO.

Happy and content as a lark, Montoro proudly announcing that Spain "almost" met the deficit target.

The Spanish public deficit closed at 6.62% of GDP in 2013, slightly more than a tenth above the target of 6.5% agreed with the European Commission (well the first we agreed if I remember correctly was 4.5%)

Are you telling me that this is all we get for so much pain? Well, boys and girls, something has gone badly wrong.

via globaleconomicanalysis.blogspot.com.es

Austrian business cycle theory refuses to die - click for link to paper

This paper examines financial instability associated with bank credit expansion in a set of 23 developed countries over the years 1920-2012. We find that credit expansion, measured by the three-year change in bank credit to GDP ratio, predicts a significantly increased crash risk in the returns of the bank equity index and equity market index in the subsequent one to eight quarters. Despite the increased crash risk, credit expansion predicts both lower mean and median returns of these indices in the subsequent quarters, even after controlling for a host of variables known to predict the equity premium. Furthermore, conditional on credit expansion of a country exceeding a modest threshold of 1.5 standard deviations, the predicted excess return for the bank equity index in the subsequent four quarters is significantly negative, with a magnitude of nearly -20%, while the positive predicted excess return subsequent to a credit contraction of the same size is substantially more modest. These findings present a challenge to the views that credit expansions are simply caused by either banks acting against the will of shareholders or by elevated risk appetite of shareholders, and instead suggest a role for optimism of bankers and stock investors.

via marginalrevolution.com

Wow... That is stealing big.... China seizes $US14.5bn assets linked to ex-spy chief Zhou Yongkang

Chinese authorities have seized assets worth at least 90bn yuan ($US14.5bn) from family members and associates of retired domestic security chief Zhou Yongkang, who is at the centre of China's biggest corruption scandal in more than six decades, two sources said.

More than 300 of Zhou's relatives, political allies, proteges and staff have also been taken into custody or questioned in the past four months, the sources told Reuters.

Prosecutors and the party's anti-corruption watchdog had frozen bank accounts with deposits totalling 37bn yuan and seized domestic and overseas bonds with a combined value of 51bn yuan after raiding homes in Beijing, Shanghai and five provinces.

via www.theguardian.com

China’s Bills Come Due

China’s credit problem is rooted in its very rapid growth over the last six years in the shadow-banking sector, shorthand for a mélange of lightly regulated special-purpose financing vehicles, wealth management products and trusts. These products have given local governments and small companies that lack access to institutional credit a way to borrow substantial sums of money. And they have done so: Credit Suisse’s Head of Non Japan Asia Research Dong Tao noted in a report this month entitled “Embracing Higher Risks” that “shadow banking counts for more than 40 percent of total lending and is the key credit channel for marginal lending.” Last year, Tao estimated the size of non-bank debt financing in China to be 22.8 trillion yuan ($3.7 trillion) – equivalent to 44 percent of China’s GDP.

The Financialist

After years of pretty much zero defaults, problems are emerging. A 3 billion yuan ($480 million) loan originated by the China Credit Trust Co. for a coal mining company narrowly escaped default in January when an unknown third party took over the debt. Investors recouped their principal, but had to forfeit the final interest payment. In late February, Shanghai Chaori Solar Energy Science & Technology Co. became the first Chinese company to default on corporate bonds onshore. And they are unlikely be the last: Credit Suisse’s Tao told investors on a conference call earlier this month that markets could be seeing a dozen defaults a week come summer.

Credit Suisse does not believe these anticipated failures pose a systemic threat to either the Chinese or global financial systems. But the bank’s fixed-income strategists cautioned in a note this month called “To Blink Or Not To Blink” that liquidity could decline significantly if private investors begin to shun the wealth management products that provide the lion’s share of funding for the corporate bonds and trusts that accounted for 21 percent of new credit issued in 2013. And that, in turn, would pose a significant threat to economic growth.

As with many things China-related, it is not exactly clear what the country’s leaders intend to do about the debt problem, if anything. The People’s Bank of China clearly wants the economy to deleverage, Tao says, having twice issued repurchase agreements this year to drain liquidity from financial markets. The Chinese authorities have also been trying to shift the economy from near-total dependence on exporting goods and building infrastructure – a model that requires gobs of credit – to a heavier reliance on domestic demand.

Officials set on deleveraging are not likely to be particularly keen to step in if local governments that used shadow banking products to raise money for infrastructure projects—many of which were not economically viable in the first place—are unable to pay their bills. Local government debt now stands at 10.9 trillion yuan ($1.76 trillion), 3.5 trillion yuan ($560 billion) of which is maturing in the second half of 2014. Credit Suisse’s Tao sees higher-than-usual risks in a particular 2.3 trillion yuan ($370 billion) batch of trusts created in 2012 that is maturing in the second half, and he noted on the investor call that “the prevailing sentiment in the central government is that local governments need to be taught a lesson.”

via www.businessinsider.com

Credit Crunch getting worse - From Wolgang Munchau

We cannot recall ever seeing such a strong dichotomy between the reality of a deeply wounded economy and policymaker’s euphoria. here are the latest depressing ECB data on monetary developments and banking lending. M3 remains at levels that are not consistent with an expansion of nominal GPD growth. Bank lending is now down -2.3% on last year. As the breakdown of the data below shows, the crunch is in the business loan segment, and there is no improvement there.

annual change in %	Jan	Feb
M3	1.2	1.3
Total Credit	-1.8	-1.8
Loans to the private sector	-2.2	-2.3
Loans to the general government	0.2	0
Loans to non-financial corporations	-2.9	--3
Loans to households	-0.2	-0.1

And unlike in the period 1999-2007, one cannot simply dismiss a deviation of M3 growth on the basis of some technical factors. Here is a table the links the credit crunch to non-performing loans:

There will be no economic recovery until these numbers turn around.

Struggling eurozone risks losing its good looks

Forget China’s surplus. The eurozone’s will be roughly as big (as a share of GDP) for at least a few years, according to International Monetary Fund projections.

A lesson of the past seven years is that current account and fiscal balances are important as indicators of financial stability, including within a monetary union. Before 2008, large deficits run by southern European economies were ignored – with catastrophic consequences. Now, investors rank the vulnerability of emerging markets according to the size of their current account deficits.

The eurozone is running a surplus partly because its economies have fared so disastrously. Imports were slashed as domestic demand collapsed. Surpluses have also been flattered by money repatriated by emigrants who have fled in search of work elsewhere – a particularly significant factor for Portugal.

Germany’s large surplus, meanwhile, attracts global criticism on the grounds that its conservative economic policies are stifling neighbours – although that view is hotly contested in Berlin and Frankfurt.

But the shift by peripheral eurozone countries from large deficits to surpluses has boosted global investor confidence in their stability. “This has been massively important for countries such as Spain – it shows they are no longer reliant on being financed by the rest of the world,” says Gilles Moec, European economist at Deutsche Bank.

Surpluses are also signs that reforms are working – Spain, Ireland and Portugal have seen significant structural, or long-term, moves towards current account surpluses; Italy less so, according to Deutsche Bank research.

via www.ft.com

Fed-Induced Speculation Does Not Create Wealth - At least not for me

Based on valuation methods that have maintained a near-90% correlation with actual subsequent market returns not only historically but also in recent decades, we presently estimate 10-year nominal total returns for the S&P 500 Index averaging just 2.3% annually. It is worth remembering that these same methods indicated the likelihood of 10-year S&P 500 total returns averaging 10-12% annually in late-2008 and early-2009 (our 2009 insistence on stress-testing against Depression-era data was not based on valuation concerns). Moreover, our current estimates of prospective S&P 500 total returns are negative on every horizon shorter than about 7 years. Meanwhile, corporate bond yields and spreads are near record lows, Treasury bill yields are near zero, and the 10-year Treasury bond yield is just over 2.7%. Our friend James Montier at GMO correctly calls this a “hideous opportunity set.”

via www.hussmanfunds.com

Albert Edwards Destroys The "Solid Earnings Growth" Myth

Most of the market tends to focus on profits on a pro-forma basis. We have never been big fans of this. These are the earnings numbers companies like to publish that steer attention away from the ?bad stuff?. My former colleague James Montier used to be highly scathing, describing them as “undefined, unregulated and untrue”. But because of their ready availability most in the market tend to quote pro-forma earnings numbers from the likes of Bloomberg and I/B/E/S and many base their equity valuations on this dodgy earnings metric. Yet even on this artificially inflated measure, trailing EPS grew only a paltry 5½% yoy in 2013, and 3% on a non-financial basis.

 

 

Andrew states that ?when looking at profit growth, a better profit series comes from MSCI. This definition of earnings is not as harsh as the S&P earnings definition incorporated into the likes of Robert Shiller?s cyclically adjusted PE (CAPE), but neither is it as overly generous as the pro-forma numbers supplied by I/B/E/S. To give you an example of the difference, during the 2009 profit slump S&P core earnings fell peak-to-trough by 92%, MSCI defined earnings fell by 55%, and I/B/E/S pro-forma earnings fell by 36%.

 

As we show above, not only are MSCI reported profits no longer growing, but the gap in thegrowth rate between these numbers and the pro-forma numbers is widening, with the proforma number considerably more ?optimistic?. ?This is a phenomenon that often precedes a more significant profit slump. It is also an indication that the quality of earnings is deteriorating."

via www.zerohedge.com

Economic consequences of income inequality - Michael Pettis - Intersting throughout

Just as clearly countries like China and Germany must take steps to force up the household income share of GDP (in fact polices aimed at doing this are at the heart of the Third Plenum reform proposals in China). Because it will be almost impossible to do these quickly, as a stopgap countries with productive investment opportunities must seize the initiative in a global New Deal to keep demand high as the structural distortions that force up the global savings rate are worked out.

But redistributing income downwards is easier said than done in a globalized world, especially one in which countries are competing to drive down wages. The first major economy to attempt to redistribute income will certainly see a surge in consumption, but this surge in consumption will not necessarily result in a commensurate surge in employment and growth. Much of this increased consumption will simply bleed abroad, and with it the increase in employment.

Less global trade, in other words, will create both the domestic traction and the domestic incentives to redistribute income. In a globalized world, it is much safer to “beggar down” the global economy than to raise domestic demand, and so I expect that there will continue to be downward pressure on international trade.

Until we understand this do not expect the global crisis to end anytime soon, except perhaps temporarily with a new surge in credit-fueled consumption in the US (which will cause the trade deficit to worsen) and more wasted investment in China (which, because it is financed with cheap debt, which comes at the expense of the household sector, may simply increase investment at the expense of consumption). These will only make the underlying imbalances worse. To do better we must revive the old underconsumption debate and learn again how policy distortions can force up the savings rate to dangerous levels, and we may have temporarily to reverse the course of globalization.

via blog.mpettis.com

Robert J. Shiller attributes Japan's incipient recovery - and weak growth elsewhere - to prevailing economic narratives.

http://www.project-syndicate.org/commentary/robert-j--shiller-attributes-japan-s-incipient-recovery---and-weak-growth-elsewhere---to-prevailing-economic-narratives

TOKYO – Fluctuations in the world’s economies are largely due to the stories we hear and tell about them. These popular, emotionally relevant narratives sometimes inspire us to go out and spend, start businesses, build new factories and office buildings, and hire employees; at other times, they put fear in our hearts and impel us to sit tight, save our resources, curtail spending, and reduce risk. They either stimulate our “animal spirits” or muffle them.