© Elliott R. Morss All Rights Reserved

Part 2 - China and the US

Introduction

Part 1 of this report highlighted the positions of the IMF and Europe on the austerity/growth trade-off as reflected in discussion on what to do about the problems of Greece, Italy, Portugal, and Spain. This second part examines austerity/growth perspectives in China and the U.S. As Table 1 makes clear, the economic situation in China and the U.S. are quite different from the euro countries covered in Part 1. China's growth, although slightly less than in earlier years, remains remarkably high. The U.S. does appear to be recovering from the global recession, albeit slowly. And even though China and the U.S. do not have the debt and unemployment problems of the euro countries, there is still an ongoing debate on austerity/growth in both countries.

Table 1. - Economic Projections: Eurozone Countries, China and

By Elliott R. Morss

Part 1 - Europe and the IMF

Introduction

Over the last two decades, the trade-offs between more rapid economic growth and the need for governments to keep their financial houses in order has been a topic of worldwide debate. Controversy over the issue has intensified recently with governments trying to counter the global recession. In this two part series, the issue is investigated by examining the changing perspectives of four of the most important global economic players: China, Europe, the US and the IMF. Part 1 focuses on Europe and the IMF.

Austerity/Growth Analytics

Most economists agree that at least in the short run, a reduction in taxes and/or an increase in government expenditures will stimulate spending, increase GDP growth, and reduce unemployment. . These actions will also increase the government deficit. The obverse is also believed to be true, i.e., a reduction in the deficit,

The Euro Mess Gets Messier

© Elliott R. Morss All Rights Reserved

March 2013

Introduction

I have not written about problems in the Eurozone and surrounding areas since last October since nothing had changed. The Eurozone is in the process of falling apart because what I called the "weak sisters" will never be able to compete with Germany, the Netherlands, and Austria. But Cyprus and the bank tax proposal is really special, so the entire subject is worth revisiting.

FocusEconomics

In past articles, I have relied primarily on data from the IMF and the World Bank. For this review and in the future, I will be using data from FocusEconomics. In my view, FocusEconomics is the best supplier of economic data on all regions of the world. In addition to collecting economic data from a wide range of sources, they provide projections (GDP growth, government deficits, etc.) from

© Elliott R. Morss

March 2013

Introduction

Every so often, people who buy stocks, hopefully via mutual funds and/or exchange traded funds (ETFs) should stand back from their home stock markets and look at how the rest of the world is doing. In the following, I look at what has happened to markets since U.S. banks collapsed in 2008 and the extent of the recovery since then. I conclude with thoughts on how well the underlying economies of the countries covered will do in future years.

Equities: Collapse and Recovery

1. Collapse

Table 1 goes back to the stock market peaks that occurred in either 2007 or early 2008. The "Peak/Trough Loss" is the percentage hit (peak to trough) the various markets took in the global collapse. And they are large: in an earlier piece, I concluded that globally, stock market losses were $36 trillion. Put that together with the

The bank crisis was serious - $52 trillion in capital losses leading to the largest global recession since 1929. We should work hard to insure it does not happen again. But there is a problem: there is little agreement on why it happened. The litany of reasons includes: banks got too big, government pushing too hard on homes for everyone, inadequate regulations, and rating agency failures.

My view: everything started downhill when the primary incentive structure of banks changed. Until recently, banks lived on the difference between what they had to pay for deposits and their income from loans they held to maturity. That spread was their life blood. And because of this, they were extremely careful about whom they lent money to. That meant that throughout the life of their loans they stayed in close touch with their borrowers to insure that interest and principal repayments occurred on

© 2013 Elliott R. Morss All Rights Reserved

February 2013

Introduction

It is well documented that picking individual stocks is not a good bet.(1) Market prices do a pretty good job at reflecting all available information, and when new information becomes available, you are not likely to be able to act on it before others. And having more than one stock in your portfolio reduces risk. That is why most people use investment vehicles that include a number of stocks, e.g., mutual funds or indices that reflect a group of stocks, e.g., ETFs.

The Stock Pickers' Club

But there remain a lot of stock pickers. I am one of them. I enjoy beating the market as I did in 2012 with Brookfield Asset Management (BAM +35%). I talk less about picks that don't do so well, e.g., my purchase of Allied Irish Banks before the Irish banking collapse in the

© Elliott R. Morss

In my recent article on manufacturing, I pointed out that the vast majority of job losses in the last 50 years were the result of technology gains rather than foreign competition. I also predicted that the prospects for US manufacturing were quite good because the labor share of manufacturing costs is falling and there is a growing demand for Western goods from emerging market countries. In this article, the prospects for employment in other US sectors are explored.

"Tradable" Goods

Michael Spence just wrote an article making an interesting distinction between "tradable" and "non-tradable" economic activities. He argued that most job losses in recent decades have occurred in the tradable sectors - agriculture, energy, manufacturing, and mining. He claims these losses are primarily the result of labor saving technologies but also stem from "disintermediation - the elimination of intermediaries in banking, online retail, and

Introduction

In earlier postings, I have examined global power from both "empire" and "fragmentation" perspectives. Empire implies concentrated power, usually for economic gain -- not just for the acquisition of power, per se. In my empire posting, I speculated that in the 21st Century, China would replace the U.S. as the global power. In 1989, the world had just witnessed an intense country-to-country confrontation -- during the Cold War, the question was whether the U.S. or the Soviet Union would destroy the world with hydrogen bombs. It was a definite "empire" focus.

But even as we watched the U.S.-USSR "empire" confrontation, things were happening to reduce the power of nation-states. Three new players had come on the scene:

• International organizations, most of which had been created by the U.S. at the end of WWII; but with the ending of U.S. dominance, these entities took on lives of their own;

The way the U.S. economic system is structured, employment is key: an unemployment rate higher than 6% is a problem. And there is great concern about job losses in manufacturing. How justified is this concern? To understand what is happening, a brief review of how overall employment in the U.S. has changed since the end of World War II is in order.

U.S. Employment - An Overview

In 1947, 87% of all non-farm jobs were in the private sector. Today, that share has fallen to 83%: while Federal employment has grown slowly, state and local government employment has grown rapidly. There has also been a dramatic change in the shares of people producing goods and providing services. Goods employment has barely changed since 1947, while service-sector employment has grown at a compound annual rate of 2.29%. That means the service share has grown to 86% of total non-farm jobs while

During the entire "Cliff" debate, I focused on one thing only: Will the politicians be foolish enough to imperil the slow and fragile recovery taking place in the U.S.? And on this issue, merely avoiding the Cliff was not enough; the government deficit stimulus had to be large enough to keep the recovery going.

Austerity Concerns

The Republicans remind me of the German political leaders: Oblivious to the dangers of "imposing austerity" too soon, the Germans have demanded that Greece, Portugal and Spain tighten their belts by reducing their government deficits. The result? Greece and Spain have unemployment rates of 26%, with Portugal not far behind at 16%. As I have written, these rates are politically unsustainable time bombs.

The U.S. Situation

The employment numbers appearing in the following table are all that matter: 3.8 million jobs lost in 2008 and another 5 million in 2009 - 8.8 million

In a recent piece, I described the evolution of investment opportunities in the U.S.: real estate, savings accounts, stocks/bonds/mutual funds, pensions, insurance, and on to ETFs, hedge and private equity funds. What will happen in China? Will investment opportunities follow the same pattern or in some other? And are there going to be special vehicles developed in China?

I put these questions to Gregory Wang. Gregory has worked as an investment banker in both the U.S. and China. After going to college in the U.S., he took assignments in both The Philippines and China. He then got an MBA from Columbia and returned to China as an investment banker. He is now the CEO of Newstar Investment, a family office representing Chinese investors that make investments in China and the U.S.

My questions/comments will be identified by EM and Gregory's by GW.

EM: You have seen

Introduction

Matthew Nimetz, an eminent scholar, lawyer, venture capital executive, and former senior U.S./UN diplomat, recently presented a thought-provoking paper at a joint meeting the National Committee on American Foreign Policy and the China Institute of Contemporary International Relations. Nimetz was asked to address the future of U.S./China relations from a U.S. perspective. The paper, which will be published by the National Committee on American Foreign Policy, concludes we should expect a somewhat rocky but hopefully manageable period in relations between China and the U.S. over the next few years. Admittedly, the conclusion is not headline material, but Nimetz raised some interesting points that I comment on below.

I have also asked Alexander Wilmerding to offer his thoughts. Alex has spent much of his professional career working in China. He is currently based in Hong Kong, where he is a principal at Pantheon, a firm that provides

By Elliott R. Morss

Introduction

To say there is a lot to worry about in the Middle East is an understatement: Consequences of the Arab Spring, including unsettled conditions in Egypt, Bahrain, Syria and Yemen, the Israeli/Palestine conflict, unstable Iraq, and aggressive Iran are just a few of the ongoing issues of concern. What will happen? This paper will help answer that question. Data and analysis of the social, economic and military power of these countries are presented below.

Military Power

It is an oversimplification to look at the balance of power in the Middle East as being determined strictly by whether the dominant sect is Shiite (Shia) or Sunni. Nevertheless, this distinction has relevance. It is also an oversimplification to think military power can be expressed by a country's military manpower. But again, such data are interesting. In Table 1, Middle East countries are categorized by sect along with

By Elliott R. Morss, Ph.D.

Introduction

Greece is involved in a series of austerity programs. And the U.S. is considering austerity measures to keep it from "falling off the fiscal cliff". The concern is even greater because nobody really knows what there is to fear. But it starts with the U.S. government going bankrupt and burdening children so we can consume today. Below, I examine the pros and cons of austerity and deficit policies in Greece and the U.S.

Austerity/Deficit Analytics

When a government spends more than it takes in, it is increasing a country's demand for goods and services - definitely good when a country is in a recession because it creates jobs. An austerity policy cuts back on that net aggregate demand stimulus and will cause jobs to be lost. The trick, coming out of a recession, is to phase in "austerity" (lower government deficits) when a

Introduction

If you are an American investor, you exchange US$ for EUR to buy EUR stocks - the opposite when you sell. That means a weaker dollar over your investment period would result in you getting back less currency on the exchange and vice versa.

When planning to make an international investment, are exchange rate fluctuations worth considering? Table 1 combines stock market and exchange rate changes from the depths of the recession until today. Consider first an EUR equity investment. Over this period, the EUR stock markets fell by 17%. That means if you bought an ETF indexed on the EUR stock markets, you would have had a 17% capital loss. The dollar increased by 10% relative to the EUR, so you only lost 6%. Not much change in England, but in Japan and China, your equity losses were compounded because the dollar weakened against both the yen and

TARP Revisited: Banks "Too Large to Fail"- A Red Herring

© Elliott R. Morss

October 2012

Introduction

Remember the Troubled Asset Relief Program (TARP)? Initiated in 2008 to bail out the US financial system, it is still around. In this, my fifth review of the program, I note that most of the money lent out has been paid back. And with the capital, interest, dividends, and warrants paid back, at least the bank-bailout part of TARP will do more than break even.

However, a number of problems remain. Of the 753 banks that originally borrowed from TARP, 319 have not yet paid the Treasury back. Why not? Remember that all banks are now paying 9% for TARP money. Banks in good shape can borrow at much lower rates. Draw your own conclusions. But it gets worse: 242 banks have missed scheduled dividend/interest payments to TARP. And there are 43

By Elliott R. Morss

Introduction

In earlier articles, I have talked of the "weak sisters" (Greece, Italy, Portugal and Spain) together, arguing they will never be able to compete with Germany and other more "efficient" eurozone countries. Of course, each weak sister is different. In this piece, I consider each separately and whether the German/IMF ongoing austerity pressures will lead to a major crisis.

Basic Analytics

For what follows, remember that without their own currencies, eurozone countries can "run out of money" in two ways:

• If governments cannot borrow, they cannot run deficits. This means their expenditures will be limited to the taxes and fees they can collect. This is significant inasmuch as the government deficits of the "weak sisters" are averaging more than 5% of GDP.
• If countries pay out more for imports than they take in and nobody will lend them money, they will exhaust their international

Introduction

Over the years, we have been treated to new investment vehicles every century/decade or two. Since cave man days, there has been real estate. Banks brought us savings accounts, followed shortly by brokers selling bonds and stocks. We then heard that placing large bets on individual stocks was too risky so we invested in mutual funds. And when we got the news that most mutual funds underperformed their closest index, we bought ETFs. At least that is what happened in the US and most of the developed world. But how about emerging market countries? Will they follow the same path?

A very interesting study was done on this subject several years back by McKinsey & Co., and much of the data that follows comes from the report. The question is relevant inasmuch McKinsey estimates that emerging market countries already own 21% of global financial assets and projects that

Introduction

I write about gambling because it ranks 6th behind drinking, drugs, sex, restaurants, and movies as a global entertainment industry. But I am hardly an expert on the subject. So having just visited Las Vegas and written a couple of pieces on coming casino problems in the northeast US, I decided to interview two people who are paid to know more than anyone about global gambling.

Bill Lerner is a principal in the Union Gaming Group, a portfolio of companies focused exclusively on the global gaming industry. The firms, with offices in Las Vegas and Macau, specialize in global equity research, investment banking, and gaming-related market and economic analytics. Their clients include public and private casino and integrated resort operators, gaming equipment manufacturers and real estate entities. They also work with various financial partners. Bill comes to this job after 16 years on

Open Letter to Chancellor Merkel

September 2012

Chancellor Merkel:

I have considerable sympathy for the position you are in. As a politician, you are trying to represent the view of the German people. And they have had it with bailouts for the banks and the "weak sisters" in the eurozone. Sadly, the need for new bailouts comes only a few years after the West Germans paid huge amounts to re-unite with and rehabilitate East Germany. On top of all this, your Bundesbank, still traumatized by hyperinflations that took place 90 years ago, is not cooperating.

And while the dream for a united Europe has soured somewhat, you persevere, believing that the arguments for holding it together are worth some extra effort.

Okay, so you want to represent your people's wishes and keep Europe united. These are both laudable objectives. But unfortunately, these aims have led you to support policies for