Beginning of the “Keynesian Endpoint”

June 11, 2010

• The “Keynesian endpoint” where debt can no longer be cured with more debt
• Bipolar market exhibits more mood swings… Rob Parenteau on where we go from here
• Labor getting restive in China… Growing pains of a healthy economy or an ill omen?
• Oil slips below $75… Two factors to drive it higher from here
• The bitter fruits of our experience with the civil “justice” system

  “We need to slash debt,” declared our friend Nassim Taleb this week on CNBC. Government debt, that is. “Unfortunately, that’s the only solution.” And the most unlikely.

The Federal Reserve’s quarterly Flow of Funds report shows households trimmed their debt 2.4% during the first quarter. Business debt was flat. But local and state government debt grew 4.3%. And federal government debt ballooned another 18.5%.

And what do we have to show for it? “We had less debt cumulatively [two years ago],” Taleb says, “and more people employed. Today, we have more risk in the system, and a smaller tax base.

“Obama promised us 8% unemployment through stimulus,” he continues. “It hasn’t worked. It’s not that they [the administration] make mistakes, it’s that they almost get nothing right.”

The result of this — both here and abroad — is what one of Bill Gross’ top lieutenants at Pimco calls a “Keynesian endpoint.”

The notion of solving debt problems with more debt is increasingly “being seen as a magic elixir that has morphed into poison,” according to an e-mail note this week from Anthony Crescenzi.

“Time, devaluations and debt restructurings might be the only way out for many nations.”

  Perhaps the U.S. stock market senses this on some subconscious level, which is why it’s exhibiting the sort of financial bipolar disorder we’ve diagnosed the last couple of weeks. Yesterday brought us another manic episode, propelling the major indexes up nearly 3% and the Dow past 10,000 again, for no obvious reason.

Today? A depressive episode. Markets opened down nearly 1%. Before the open, the Commerce Department reported a 1.2% drop in retail sales from April to May… the first drop in eight months. This is another one of those “unexpected” numbers that are increasingly whacking traders upside the head. In this case the numbers were “much worse than expected,” according to MarketWatch.

So where from here? Well, consider this…

The folks at Westwood Capital put together these nifty charts with two commonalities — a bubble peak and a period of panic selling followed by a rapid rebound. You’ll also see what may turn out to be a third commonality — the rebound petering out in April 1930, and perhaps doing the same in April 2010.

Obviously, there are differences. In ’29, it took only three months to go from peak to trough. This time, it took nearly 18. As Mark Twain said, history doesn’t repeat, but it does tend to rhyme.

  And yet… we hear a nagging voice in our head, belonging to our resident economist Rob Parenteau. As we told you Monday, he sees the combination of suppressed wages and increasing productivity pointing to higher profits. And “we rarely see serious bear markets develop when profitability is so robustly on the mend,” he says.

Rob’s prescient insight into the Greek crisis has earned him a full-time media schedule of late. Earlier this week, the cranky English commentator Edward Chancellor highlighted Rob’s work in an Op-Ed in the Financial Times. And last night for the third time in as many weeks, Rob could be seen explaining how events in the sovereign debt crisis are likely to unfold to viewers of Canada’s largest business network, BNN.

Rob’s plays from the fall of the euro are up 9.1% and 9.5% thus far, with a lot more room to run. He sees the euro reaching parity with the dollar this summer. To act now on the trend, and be ready to act on his U.S. bullish recommendations, here’s where to go.  
 

Three days of fleeting euro gains have stalled as we write. The Esperanto currency sits at $1.207, ready to resume its run to parity.

Honda’s labor troubles in China haven’t subsided. As we reported on Monday, they settled a dispute at a parts supplier last week by raising wages 24%. Only to witness another walkout this week… once again settled by a 24% wage increase.

Now comes a third walkout at a parts supplier. So far, this one hasn’t shut down production at any of Honda’s four China assembly plants, but as this trend manifests itself, it’s only a matter of time.
 
None of these strikes has led to violence, but another one — not related to Honda — has.
Two thousand workers fought with police in Kunshan when they tried to take their protest from the factory grounds into the streets. Fifty people were hurt.

Last weekend, about 300 workers at a factory in Shenzen blocked highways to protest shift changes. That was quickly settled with a 10% wage increase. Likewise, Yum! Brands raised wages 30% at 68 KFCs and Pizza Huts in Shenyang.

Wage rates in China are going up.

“I am sure that China’s wages are going to go up a great deal over the next few years,” says Jim Rogers, whose China bullishness drove him to move to Asia in 2007. “Look at what happened in Japan, Japan used to be one of the lowest-wage countries in the whole world and their wage is now among the highest in the world, if not the highest, and they are still very efficient in competitive manufacture of many goods.

”That sort of thing, in my view, will happen in China.”

We forecast rising Chinese wages in the first edition of Financial Reckoning Day back in 2002. They’re the result of two trends worth watching: Growing pains of any industrializing country… and the demographic result of the state-directed “one-child” policy that had led to roughly 130 young men for every 100 young women.

That’s among the issues we’ll explore next Thursday after the market close during an exclusive conference call featuring myself, Chris Mayer, our potential partner in Beijing and a Western journalist-turned-investor who’s lived in China for years.

We’ll unpack the entire “China: Boom or Bubble” question, building on everything Chris and I gleaned from our visit there last month. We’ll develop strategies you can use to profit from China’s growth… and avoid losses in the sectors that have clearly gotten ahead of themselves.

Watch this video for a preview of the call.  It’s scheduled for next Thursday at 4 p.m. EDT. If you want to listen in, just let us know here.

  Gold has recovered as we write to about $1,225. Oil has lost some ground and has fallen below $75.

  Worldwide demand for oil during 2010 will clock in at 86.4 million barrels a day, says a report this morning from the International Energy Agency (IEA).

Rising demand could easily collide with falling supply from the Gulf of Mexico. The report says the Obama administration’s ban on new permits and exploration wells in the deep-water Gulf could pinch supply by up to 300,000 barrels a day by 2015.

Not exactly the 1.2 million barrel estimate we brought you courtesy of Morgan Stanley last week, but it’ll still put a dent in things. “We were just getting to the point where we could think about talking about drilling off parts of Florida, off the Atlantic coast,” our Byron King told Newsweek yesterday. “Within moments of the news hitting the wires, people were like … ‘Not off my coast.’”

  We’d be remiss not to mention this potential chokehold on oil supply either: The United Nations Security Council voted this week to tighten the economic embargo on Iran. Not as tight as your friends in Washington would like; concessions had to be made to get Russia and China on board.

Still, it was enough for Iran to make noises about curtailing its cooperation with U.N. weapons inspectors. Looking ahead, in the most extreme scenario, Iran might do what North Korea did a few years back — withdraw from the Non-Proliferation Treaty and kick the inspectors out. At that point, Iran would abandon any pretense of pursuing a nuclear program strictly to generate electricity.

Haven’t we seen this movie before? For variations on the theme, allow Mr. King to describe the “New War” scenario that could drive oil to $220 a barrel, right here. 

  “I want to give you a bit of anecdotal data supporting a recovery in the U.S. economy,” a reader writes.

“I work in high-performance computing (also known as supercomputing) as a software engineer. I specialize in making existing HPC programs run faster and in taking serial or single-threaded codes and making them use multiple processors effectively.

“I’ve been in the job market for some time. I said I’d provide some data supporting a recovery — a year ago, I was seeing very few positions listed for my type of work. Even work doing systems administration for supercomputing facilities was hard to find — about one listing per quarter. Since the start of the year, I’ve been finding 10 or more listings per month, and many are very close matches for what I do best. I’ve been getting about three phone screens per month since March, and multihour interviews monthly. So far no offers, but the increase in calls and interviews is definitely a sign of recovery.

“I also have stayed in regular contact with professional colleagues. They also are saying that hiring is picking up. A year ago, they were saying things are very tight; now they’re saying that jobs are available, but there’s more diligence involved before making an offer, due to the number of applicants.”

The 5: Thanks for the field report.

Anyone else? How does it look where you live? Let us know… we’d like to assemble a rebuttal to the Fed’s Beige Book next week.

  “I beg to differ,” a reader replies to our brief account of the jury duty we performed this week. “It’s a legal (with all that tawdry term implies) system, pure and simple.

“Any ‘justice’ is strictly coincidental, or accidental (and likely unavoidable!).”

The 5: No argument here. The very thing our jury should have been deliberating when we were handed the case… wasn’t allowed into evidence and therefore was prevented from being used to make the determination by law.

There were two defendants: The Baltimore Convention Center (owned by the city) and a private company contracted to stage conventions and trade shows. A woman stepped on a wobbly water port grate, twisted her ankle, fell and tore the rotator cuff and a tendon in her bicep as she tried to stop the fall.

Over 4,000 people walked over the grate the day in question… only one fell.

“All it takes is one,” the plaintiff’s attorney argued. “And unfortunately, that one was my client.” As you might expect, he focused on the pain, the surgeries she’d endured since and her inability to hold her newborn grandchild. The plaintiffs weren’t able to produce a single witness who had seen her fall or noticed the grate was instable.

We wanted to argue that since she was at the convention center on behalf of the municipality she worked for, she most assuredly had her medical costs and any lost wages covered by insurance, disability, workers’ comp or otherwise. Why wasn’t this trial being worked out in mediation between insurers?

From the deliberation room, we submitted a written question to that effect. We were in turn instructed by the judge that, as a matter of law, we were to disregard all potential payouts from insurance companies and any benefits she may be receiving from her employer.

In the end, we went along with the “negligence’ finding because every one of the witnesses produced by both the plaintiff and the defendants — union and city guys all of them — answered, “Hey, not my job” when asked if they had physically inspected the water grate they knew had been repaired… every one of them.

“Not my job.”

The only guy that should have been directly responsible, the building services foreman in charge of the grates in the floor, answered no to everything he was asked. He didn’t see anything, didn’t recognize anyone, didn’t remember anything… didn’t even show up on time. Ugh.

In the end, it was a pretty easy target for the trial attorney and the doctors performing the surgeries. In my view, the plaintiff was clearly coached and out of her league.

The defense attorneys for the BCC and the private decorator stepped into the elevator with us on the way down.

“Did you know the plaintiff,” the private company’s attorney asked me, “had been fully compensated already for her past and future medical bills and lost wages before the lawsuit had even been filed?”

“We suspected that was the case,” another juror and I replied, “but we were instructed by the court to disregard that question. Once the negligent verdict was unanimously agreed upon, the powers that be among the rest of the jurors took over and… well, you know the outcome.”

“Yeah,” the defendant responded. “That’s the law.”

“I’m just sick about it,” my fellow juror said later as we were standing line for our per diem stipend. During deliberation, she had argued most vociferously for the negligence finding.

There are no taxes paid on personal injury damages awarded in lawsuits.

Have a good weekend,

Addison Wiggin
The 5 Min. Forecast

P.S. Short program note: We’re told we had some technical difficulties yesterday when you tried to sign up for the eight China plays Chris Mayer has identified following our trip to Beijing last month. Apologies.

Our Web team has worked the bugs out, so you can still grab this special report — plus a ninth China play in the new issue of Mayer’s Special Situations coming out today — for just $1. Take advantage of this extraordinary value here.
 

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