China Has To Grow Up

China has become the world’s second largest economy based largely on the ability to churn out cheap consumer goods in vast numbers. It could do so because of a) very low wages, b) cheap land and c) nearly zero regulatory costs (i.e. pollution and labor safety regs).  Couple that with an artificially low foreign exchange peg, and it’s no wonder that  low and medium value-added industries moved there en masse.

However, China is now very keen to move up towards more sophisticated, tech heavy industries like autos, aerospace and high end electronics, heretofore the domain of Western companies and institutions that have created a huge pool of proprietary R&D and the mechanisms to transform it into high-end products.

The problem of safeguarding such Intellectual Property has been around since at least the early 1990s and has never been addressed properly.  As the US economy moves more and more towards Continue reading "China Has To Grow Up"

Trade War Over Steel? Gimme A Break…

So Trump throws up this firecracker about import duties on steel (25%) and aluminum (10%).  It’s a non-issue folks, despite hot air from Brussels about retaliation via Levi’s, Harleys and Jack Daniels. (Notice that the Chinese haven’t said a word - and rightly so).

Fact is, the US hardly imports any steel from the EU or China, as you can see from the graphic below.

Now, if Mr. Trump starts talking about consumer electronics, that would be an issue.  But in an economy completely dominated by the likes of Apple, Google, Microsoft and Amazon imposing duties on their products would be plain suicide and it won’t happen.

Steel Duties, Seriously?

Imposing import duties on steel and aluminum is akin to protecting the horse buggy business when Ford set up his car production line... completely useless and meaningless.

The US economy is long past it’s heavy, metal-basing industrial era.  Trump is just playing up to his lowest common denominator electoral base, that’s all.

For proof, just look at the makeup of the DowJones Industrial Average in 1980 (even 2000) and today.  Unlike the past, the US economy today is all about Google, Amazon, Apple, Microsoft and a couple pharma companies.

Move on...

Yes, Virginia, There IS Volatility

What happened with US stocks?  Why did they tank so suddenly after months of steady gains?

No, there was no irrational exuberance, no massive leveraging, no pernicious balance sheet shenanigans at banks, no NINJA loans, no CDS/CMO/CDO (plain, squared or cubed) baloney. Valuations weren’t even that high, given forward P/Es around 18-16x.

There was, however, a sort of  “complacency bubble”, aka very, very low volatility. This in turn spawned a variety of listed and OTC trades that shorted volatility for profit.  It worked like a charm - until it didn’t.

The following chart makes things quite clear.  It’s the price of an ETF (exchange traded fund) that shorts VIX futures.  Yes, Virginia, there IS volatility!

In my opinion that’s all there was to it - the snap unwinding of short vol trades.

USA Margin Debt

Given the stock market plunge of the last few days, the following chart is interesting.  It is current to year-end 2017 (latest available), the data comes from FINRA.

Given that total market cap at the time was approx. $32 trillion, margin debt of $650 billion doesn't seem all that excessive.  In other words, selling due to system wide over-leveraging isn't the likely culprit of the sell-off.

Greek PMI Near Record

Manufacturing in Greece is staging a strong and rapid comeback.  The Purchasing Manager's Index for manufacturing is now at the highest level since 2007.  Increasing new orders is the biggest contributor to the rise, with new employee hiring also boosting the index.

The PMI is a diffusion index, with levels over 50 indicating expansion and under 50 indicating contraction. The light blue area is annual GDP change, left scale.
Manufacturing accounts for only 12-15% of Greek GDP, but the correlation between PMI and GDP is pretty solid.  Interestingly, the last time PMI was at current levels the Greek economy was growing over 5% per year.

USA Debt: Is It A Threat?

US federal government debt is now at 106% of GDP, the highest in decades.  It got there because it was forced to bail out the financial sector during the 2007-10 Great Meltdown, essentially having the Federal Reserve "print" money with its Quantitative Easing (a.k.a. Ben's helicopter).

 This debt load certainly looks formidable and perhaps threatening to the economy's health.  Is it so?  Well, yes.  And, no...

Yes, because a highly leveraged economy has, by definition, a lower capacity to overcome recessionary downturns without painful asset liquidations and capital losses, perhaps even social unrest.  Just ask the Germans and how scared they (still) are of the Weimar hyperinflation period which paved the way for Hitler.

And no, because it matters very much to WHOM the debt is owed.  Just ask the Japanese today, who owe their huge debt (250% of GDP) mostly
Continue reading "USA Debt: Is It A Threat?"


Buffett, Bezos and Dimon announced they are going to massively disrupt US healthcare by designing and implementing an in-house system for their combined 1+ million employees on a not-for-profit basis, and potentially rolling it out to the rest of the country.

This is simply huge.

The US has arguably the world's most inefficient healthcare system, entangled in a mess of legal, insurance, pharmaceutical (need I mention Valeant?) and hospital concerns, all jockeying for legitimate and illegitimate profits.

The following chart says it all:  The US spends 17% of GDP on healthcare, far more than other countries. Even a 2% reduction means savings of almost $400 billion per year.

 If the trio manages to streamline the healthcare industry it will create a paradigm shift akin to Henry Ford's automobile assembly line.

There is another American "industry" that has also become very expensive when compared to the rest of the world:
Continue reading "Disruption"

A Funny Thing Happened On The Way To The Forum

The World Economic Forum at Davos is in the news these days, as it is every year at this time. The world’s leaders - political, business and financial - gather to rub shoulders and, very occasionally, achieve something more than self-congratulation.  Going back a quarter century, however, the WEF wasn't nearly as famous as it is today.  

And that's when yours truly comes into the story..

It was around 1992 when I saw an ad in The Economist for a position at the WEF.  They were looking for someone that combined knowledge in engineering/energy with finance. It fit my profile pretty nicely so I sent off a resume, mostly on a lark since I wasn't quite ready to move from the Big Apple to Geneva or some remote village in the Swiss Alps, no matter how glamorous. 

About a month later, however, I was surprised to
Continue reading "A Funny Thing Happened On The Way To The Forum"

Greece: Various Data

The situation in Greece continues to improve.  Latest data:
  • The 5-year CDS (credit default swap) dropped to 292.9, the lowest point since the crisis began.

    • S&P upgraded Greece one notch to B, with positive outlook.
    • The 2-year  government note now yields 1.25%, a multi-year low.
    • Building permits for  October 2017 were up 16.4% vs. Oct. 2016.  More importantly, the surface area represented in these permits was up 67% and the buildings' volume up 109%.  This means that large structures are involved, exactly in line with my predictions for major hotel building/renovation activity, right after the conclusion of the tourism season.
    • Electricity consumption for the whole year 2017 was up 3%, with the middle-power segment showing the largest increase at 5.84%.  That's demand coming from hotels, restaurants and other medium size businesses.

Greece, The IMF’s Sugar Daddy

Today, a look at the Greece-IMF relationship from the only perspective that really matters: money.

When Greece imploded back in 2010 it turned to the IMF for help.  The IMF agreed and as of Oct. 2017 Greece owes it 9.5 billion SDR (Special Drawing Rights, the IMF's in-house currency), equivalent to 11.3 billion euro.  The loan carries an interest rate around 3.5% per annum. 

So, Greece pays the IMF roughly 340 million SDR per year in interest (=396 million euro). 

So what, you ask?  Greece is the IMF's largest borrower by far and without the income generated from these loans the IMF would be hard pressed to make any profit at all.  

An excerpt from the IMF's quarterly statement ending Oct. 31, 2017 (I have annualized all amounts, in million SDR).

Operational Income:         1,658
Operational Expenses:    -1,344  (mostly Continue reading "Greece, The IMF’s Sugar Daddy"

Yadda, Yadda, Yadda And A Bottle Of Ouzo

Greece is highly indebted, bad loans swamp banks, the economy is in tatters... yadda, yadda, yadda.  Highly conventional wisdom, the one you get from the popular (and even specialist) media, is always last year's news and not only useless but potentially dangerous. 

Following up on my last post on the fast rise of Greek private sector debt during 1998-2008  (i.e. very much yesterday's news) and the resulting collapse, where does it stand now in comparison to other countries?

You may be surprised to know that the country's households and businesses are still very under-leveraged when compared to the rest of the world and the eurozone/EU in particular - just look at the chart below (Data: World Bank, 2016).

Furthermore, the same chart indicates that Greek banks' credit exposure to the private sector is likewise very modest.

 I'll let readers figure out what this means for the future Continue reading "Yadda, Yadda, Yadda And A Bottle Of Ouzo"

Leverage In Haste, Collapse At Leisure

"Sin in haste, repent at leisure" goes the well known sobriquet.  In the case of Greek businesses and households, they leveraged themselves so fast that the implosion was all but inevitable, particularly since state debt was also rising fast at the same time.  But, unlike other bubbles, the aftermath was not only painful but unnecessarily drawn out, too.

Going back to the beginning, we can see that private debt rose much faster than GDP between 1998-2008, going from 34% to 103% of GDP in just ten years. It was not so much a case of "too much" as "too fast", which created the real problem in Greek private sector debt and which left banks with a mass of non-performing loans. Unlike other western economies, Greeks were previously very under-leveraged and had no credit culture.  When the bubble economy collapsed many Greeks simply refused to pay their debts;
Continue reading "Leverage In Haste, Collapse At Leisure"

Greece: Creditless Expansion

The Greek economy is growing once again, and this time it is doing so without the benefit of credit expansion to drive consumption and investment.  For us schooled in chemical engineering, it is like running a reaction without the benefit of the necessary catalyst: if it proceeds at all, it does so at very low speeds and product yields.

For the first three quarters of 2017 (latest data available) nominal GDP has been rising, despite the credit contraction. Banks are scaling down their balance sheets, and the government is running very large primary budget balances, i.e. not borrowing at all.

In other words, monetary and fiscal policies are very restrictive in Greece.

 Nevertheless, the economy is growing - and what does this tell us?  Firstly, it says the economy is largely "importing" its growth via increased tourism and exports, instead of rising domestic consumer spending. Secondly, and Continue reading "Greece: Creditless Expansion"

Driving Ms. Hellas

Another alternative data set which better follows Greek economic conditions than headline GDP figures.

First-time vehicle registrations are up in 2017 for the fourth year in a row, now higher than 2011 levels.  More significantly, the rise comes from pricier automobiles (+22.1%) and trucks (+14.6%) rather than cheaper motorcycles, which were down 28.2%.

 While still very far from the unsustainable debt bubble days of 2000-08, the rise is indicative of core economic growth precisely because of the absence of auto loans.

Greek GDP And Credit Expansion – No Money, No Honey

Credit expansion, i.e. easy and cheap access to bank loans, is an essential ingredient of economic growth.  But as with all good things, too much of it can lead to trouble.

This was certainly the case with the economy of Greece during its debt bubble years.  The chart below shows how credit expansion grew much faster than GDP-  sometimes as much as 10 times faster. And this chart shows only bank credit, i.e. it does not include government borrowing which was also rising very fast.

The bubble burst in 2009 and the economy went south, staying in recession for eight straight years.

Can the economy now recover and grow without credit expansion? It is already doing so in 2017, even as banks shrink their balance sheets by selling or writing off bad loans (thus the large credit contraction in 2016-17).  Moreover, the government is not Continue reading "Greek GDP And Credit Expansion – No Money, No Honey"

Greek GDP – A Better Estimate

I have in previous posts expressed my doubts about official Greek GDP numbers as reported by the statistical authority (ELSTAT).  The major reason is the large "shadow" economy which operates under the table to avoid high value-added, income and social security taxes.   

A recent study by the Institute for Applied Economic Research at the University of Tübingen says Greece has the largest shadow economy in the world at 21.5% of GDP. 

It follows that calculating growth/recession rates becomes quite problematic since variations in the shadow economy cannot be counted. Thus, the need for a better yardstick, one that is not as affected by cheating on taxes.

My personal favorite is energy consumption (after all, every activity requires energy), and in this post I will try to provide a better estimate for real Greek GDP in 2017.

British Petroleum publishes an annual energy statistics study, widely
Continue reading "Greek GDP – A Better Estimate"

Greek Bonds Continue Massive Rally

Greek Government bonds continued their rally into the first week of the 2018.  The benchmark 10-year bond now yields 3.75%, the lowest since March 2006.  It was at 8% a year ago.
 The star of the market is unquestionably the short end, with the 2-year going from 10% to 1.45%, a massive 85% drop.  It now yields even less than the latest 6-month bill auctioned just four days ago at 1.65%!

I will note, once again, that this is far below the 3.5% interest rate charged by the IMF for its 11-12 billion euro loans to Greece, which have an average weighted maturity around 2.5 years. (From this perspective, Greece should arrange to immediately repay the IMF.)

Markets now discount a rapid return to normalcy for the country, driving credit default swap (CDS) premiums to 338 bp, down from nearly 1,000 a year ago.