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Herve van Caloen, a managing partner at Belpointe Asset Management, is an investor with more than 25 years of experience managing international equity portfolios for Scudder, Mitchell Hutchins, Provident Capital Management. He is currently a portfolio manager at Belpointe Asset Management in... More
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  • Keynes For Dummies

    "I found myself the only non-Keynesian there," remarked John Maynard Keynes following a meeting with economists in Washington in 1944.

    I wonder if the famous economist would feel the same way reading today's stimulus debate. Would he approve of trillion dollar deficits in the name of Keynesian policies? Would he agree with Paul Krugman that more government spending is needed? I suspect not. And here is why.

    According to Professors Backhouse and Bateman*, Keynes devised a system of economic policymaking that makes it possible to fine-tune the economy with careful adjustments of fiscal policy. "fine-tune" and "careful adjustments" are key words. It was his belief that sharp downturns in the economy could be mitigated with some governmental intervention.

    Today's Uber-Keynesians, however, have changed the government's role of fine-tuning the economic engine to becoming the engine itself. In the process, they turned central banks into ATM's.

    Four years into an anemic recovery, Europe is back in recession, the US is barely growing, Asia's export economies are sputtering and parts of Latin America are returning to their old isolationist demons. What went wrong? Why did all the stimulus programs not get the global economy roaring back? From Japan to the UK, from the US to China, trillions of dollars have now been borrowed from the next generation and yet there is very little to show for. Why? Well, Neo-Keynesian professors from Princeton to Paris have the answer: it was not enough.

    This we saw coming. We expected the narrative all along. Some readers may remember that we predicted that failure was going to be blamed on too little spending, no matter what the amount. Let's make another prediction: whenever countries start to tackle their gaping fiscal deficits, Krugman and Co. will claim it is too soon. Actually, they are already vilifying Europe (read Germany) for thinking that growth could come from structural reforms and not from spending fiat money.

    Not spending other people's money has now been labeled austerity. But is keeping France's governmental budget at 54% of GDP really austerity? How much more can the government overtake a so-called free economy?

    I doubt Keynes expected that some careful adjustments would have lead to public debts varying from 100% of GDP in Italy and the US to over 200% in Japan. The magnitude of today's interventions would most likely have made him uncomfortable.

    That is not all. Contrary to popular belief, Keynes was skeptical about the use of the budget to influence consumption. He was not a supporter of budget deficits if they took the form of borrowing to finance current expenditures. Even spending on public works, he believed, had to be considered carefully because it could frighten businessmen into reducing their own investments.

    In other words, not all debt is created equal. Like cholesterol, there is good debt and bad debt. Properly invested in capital goods that yield a revenue stream, debt can be very helpful. When, instead, debt is used to artificially maintain one's standard of living, the endgame is very different. That's the problem many governments are facing today. Fiscal deficits around the world are out of control while not yielding any returns. Therefore more borrowing is needed.

    Most rational people realize that this cannot go on. Something has to give. From borrowing to fine tune the economy, we have now created an economy addicted to government borrowing. We have even convinced ourselves economic growth is impossible without it.

    Central banks conquer. This chronic dependency could not have been created without their enabling profligacy. Market forces should have corrected politicians' behavior a long time ago. But, the manipulation of interest rates and the monetization of the deficits are keeping the free ride alive.

    Would Keynes have approved? Here again,it is doubtful. Why else did he warn us against debauching the currency? In his writings, he even calls Lenin to the rescue to make his point. It is said, indeed, that Lenin once declared that "the best way to destroy the capitalistic system was to debauch its currency", for changes in the value of money amounts to arbitrary confiscation of wealth. Keynes believed in the capitalistic system.
    Not that Bernanke, King or Draghi are intentionally debauching the global currencies. However, their enabling of excessive "Keynesian" policies could well result in such a destruction of the value of money. If not reduced with "austerity", how else will debt be dealt with? Inflation is the only alternative.

    The problem with Helicopter Bernanke is not that he is not a student of history. He knows Keynes' teachings better than anyone. Only, he tends to take them to new extremes. Keynes' emphasis on the psychology of expectations has thus brought us the wealth effect, first praised during the housing bubble.

    The paper profits in the stock market have similarly been pointed to lately by our dear chairman as a reason for optimism. The new wealth effect is supposed to lead to more consumption and, consequently, to more economic activity. It worked so well the first time.

    Another example of Bernanke's extreme interpretation of Keynesian philosophy is his treatment of fixed income earners. In this matter, Keynes was not exactly a moderate himself. Never a great fan of raw capitalism, he famously wished for the "euthanasia of the rentier". Could Bernanke be on a mission to fulfill this wish? It sure feels that way to many retirees…

    Turning back to Europe, we are told that today's debate is between Keynesian stimulus and fiscal rectitude. Keynes vs Hayek. Growth vs austerity.
    Now, who is against growth? Only monks are in favor of austerity. Obviously, these are not the real issues. Europe is dealing with a different debate all together. It is one between social democracy vs Club Med style socialism.

    Let me explain. All of Europe is socialist and wants to remain that way. Europeans reject what the French call "le capitalisme sauvage" as practiced in America. Their only division is on what kind of socialism. In essence, the difference comes from their opposing starting points. Social democrats study the economy as it is. Then, they try to implement as much social redistribution as the economy will tolerate. Their southern brethren start from what they would like the world to be. Then, they tell markets to adjust.

    Logically, when social democrats face an economic downturn, they reform. Not surprisingly, when the Club Med countries face a downturn, they fight even harder for their entitlements. After all it is for the markets to adapt to the newly proclaimed reality.

    Sweden reformed in the early 1990's in order to save their welfare system after a now too familiar construction boom-bust cycle.The German social democrat Gerhard Schroder reduced some entitlements and allowed some more labor flexibility at the outset of the century. Finland and Estonia are other examples and today Ireland may be the next country to have made the needed adjustments to…grow again.

    On the other side, we know what happened to Greece. Spain is facing the abyss and trying implement fundamental reforms. France, always different, is explaining to Germany how to grow an economy.

    Finally, Keynes' work drew heavily from an analysis on how to make ethical decisions. He was particularly taken by the moral consequences of unemployment.

    Now, it is difficult to see the ethical superiority of the southern European economies that are so heavily dependent on public spending.

    Unemployment is much higher. A ballooning debt will be passed on to the next generation. And, as if that is not bad enough, the Club Med countries are unashamedly shutting the young generation from the labor force! With no jobs and no income, how are they supposed to pay their parents' humongous debt? In countries like Spain and Greece, youth unemployment has already exceeded 50%. In France, it is "only" 25%.

    This is the real time bomb and only a full assault on labor rigidity can forestall disaster. Young people used to be known to be restless.
    German "austerity", in contrast, produces only single digit youth unemployment.

    Do not believe the false argument that Germany is trying to impose hardship on the rest of Europe. All they are saying is: "Grow up!"

    (*) Capitalist Revolutionary John Maynard Keynes by Roger E. Backhouse and Bradley W. Bateman

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: economy
    Mar 14 4:30 PM | Link | 2 Comments
  • China: The End Of The Deng Era.

    As I write, the Chinese political black box is preparing to spit out a new team of leaders. At their coming November Party Congress, the Chinese nomenklatura will designate the first generation of leaders not handpicked by the late Paramount Leader Deng Xiaoping.

    The Eighteenth Party Congress comes at a difficult time. The economy is in a relative slump. The country is trying to digest both a housing bubble and an excessive investment boom. Many government-favored industries are facing substantial overcapacity problems. Exports are under pressure and trade tensions are mounting. GDP growth is slowing. After three decades of breathtaking expansion, China has reached a new crossroad.

    The Chinese Economic Miracle.

    Chairman Mao left China in a shambles. The country had suffered massive famine during The Great Leap Forward. Then, Mao upped the ante with the Cultural Revolution, which added more hardship to an already devastated country.

    The Cultural Revolution was a purge like none other. Instead of targeting the incompetent leaders responsible for tens of millions of deaths, Mao Tsetung launched a vendetta against whoever questioned his judgment. Prominent among them was President Liu Shaoqi. His crime? Trying to reverse some of the catastrophic policies of the Great Leap Forward. Many others in Mao's entourage suffered the same fate. Anybody with a brain was considered a menace. Teachers and "intellectuals" were prime targets. Kids were forced to condemn their parents. Anybody that could perpetrate the idea of a calamity induced by Mao's absurd policies had to be silenced by death. Mao's Cultural Revolution was in fact the greatest exercise of forced amnesia in human history. Many in the West fell for it. That too was quickly forgotten.

    When Mao finally passed away in 1976, the Middle Kingdom was longing for stability and, above all, some sanity. Deng Xiaoping's steady hand would take them to a very different place.

    It took Deng a couple of years to push aside Hua Guofeng, Mao's designated heir. By then, Deng was already in his late 70's. He was in a hurry. He rapidly launched a number of reforms that eventually lead to the Chinese economic revival of the last 30 years.

    Deng first stabilized the country and then put it on a path to a free market economy. However, unlike his fellow reformist Gorbachev in Russia, the new Red Emperor believed in a carefully managed transformation. Too much freedom at once could lead to more chaos. More economic freedom did not have to go hand in hand with political freedom. The communist party's firm grasp on power was not to be challenged.

    Ever the pragmatic, Deng famously declared that the color of a cat does not matter, as long as he catches mice. Gone were Marx's teachings. It was all right to become rich again. But it was not alright to challenge the communist party's hold on power. That's where the old revolutionary drew the line. Gorbachev lost control of Perestroika. Deng was not inclined to make the same mistake.

    The Global Wind of Freedom Stopped in Tiananmen Square in 1989.

    Soon after returning to power, the aging Deng had put Hu Yaobang in charge of continuing China's economic transformation. Hu and his liberal policies were immensely popular. However, the Party took umbrage. Hu Yaobang's "bourgeois liberalization" was too much for the old guard to swallow so Deng pushed him aside. Still, Deng did not give up on economic reforms. He promoted another liberal, Zhao Ziyang, to the top job.

    Hu's death soon afterwards lead to the Tiananmen Square massacre. Young people gathered en masse to pay tribute after his funeral. The movement evolved rapidly from grief to demands for what Hu Yaobang had stood for: a more free society. Some in the communist party, including President Zhao, were sympathetic to the students' aspirations. Zhao even tried to negotiate with the students for several days. The world was mesmerized. Was communist China going to fall so soon after the Soviet Union?

    Eventually Deng lost patience. He was still pulling the strings and ordered Zhao to send the army to quell the movement. Zhao bravely refused, which led to his house arrest. Mao would have killed him.

    However, Deng Xiaoping did not give up. He was still intent on liberalizing the economy, if not the political system. He promoted Jiang Zemin to the presidency. Jiang, with the help of the very capable Prime Minister Zhu Rongji, continued the economic reforms during the 1990's. The Chinese economic miracle was born. However, it had a major flaw.

    Years later, Zhao Ziyang's illicit memoirs were smuggled out of the country. In them, Zhao warned of the incompatibility of a free economy with dictatorship, even one of the so-called proletariat. His contention is that entrepreneurship will be held back by monetary extortion from those with political power. An authoritarian regime leads to an unfair system that rewards the connected at the expense of the talented and/or hard working. Zhao writes that without political reforms, China will continue to suffer from "commercialization of power, rampant corruption and a society polarized between rich and poor."

    Hu Jintao and Wen Jiabao Proved Zhao Right.

    In 2002, power was peacefully transferred to the next generation in accordance with Deng's plans. Even though he had already passed away (in 1997), his orders to pass the torch to Hu and Wen were dutifully followed. This was a remarkable feat. How often do dictators give up power? Deng's instructions were still respected and implemented years after he had rejoined Mao and Karl Marx. In death, Deng had outdone Chairman Mao himself.

    Unfortunately, this time Deng may have overreached. He misjudged the next generation and overestimated their free market credentials. His chosen political grandchildren, Hu and Wen were no reformers.

    Using growing inequalities as an excuse, the new leadership reversed the policies put in place by their predecessors. Privatization was stopped and the public sector was again favored over the private sector. Today, for example, state-owned enterprises (SOEs) enjoy an effective tax rate two thirds less than the private sector's, as well as cheap capital from a state-controlled banking sector.

    Then, at the time of the global financial meltdown, Prime Minister Wen doubled down with a huge economic stimulus plan that favored mostly the SOEs. No longer a communist economy, China today has nonetheless moved back toward top-down decision making, focusing investments on "strategic industries". In the process, Wen and his family managed to accumulate an immense fortune. Many members of the nomenklatura are similarly wealthy today.

    For a decade, under President Hu, the Chinese people have watched bureaucrats distribute resources to state companies and their friends. Whereas the early reforms created explosive growth, new entrepreneurs and a trickle-down wealth effect, current neglect of free-market principles has led to corruption and profiteering by the well-connected. The stock market is a case in point. (In recent years it has been used mainly to list state owned companies at inflated prices, "raising money from outsiders (including foreigners) to redistribute to insiders", according to The Economist. Small investors did not fare as well. The Shanghai Composite Index, after peaking at 6,000 before the financial crisis, is now back to the 2,000 mark, about where it was twelve years ago.

    Wealth disparity, always a sensitive issue, becomes explosive when it is the result of a rigged system.

    A Middle-Income Trap.

    Without reforms, experts now fear China will slide into a "middle-income trap", i.e., rapid growth followed by stagnation. China is indeed at risk of duplicating what many Latin American economies have experienced. Corruption and a huge income gap will prevent the country from becoming the economic superpower many believe inevitable. Already capital is fleeing the country, a sure sign of how locals feel about the future. Real estate in Cyprus seems to be the fad among the wealthy Chinese.

    The irony is that China desperately needs to develop a "bourgeois class". Its growth depends on what is also known as a middle class.

    This is China's predicament on the eve of the 18th Congress of the Communist Party which is expected to elevate Xi Jinping to the top job. Li Keqiang will take Wen Jiabao's job. Astonishingly, no less than 70% of the aging leadership bodies-the Party, the army, and the government-- are also expected to be replaced.

    Can Xi get the country back on a free market track? Does he intend to? Will he have the authority to do it? Or is the old guard going to continue to pull the strings to keep the status quo? After all, if I were Mr. Wen I would worry about letting others decide if my accumulated wealth could stay in the family.

    Like Father Like Son?

    China's communist system is opaque and nobody seems to be able to assess where it is taking the country next. There is very little known about Xi's personality or his intentions. Neither have I read any story about how he got chosen to be the next head of the most populous state in the world. All we know is that he is a member of the new communist aristocracy, also known as princelings.

    Aristocrats, when they are not crashing their Ferraris, are usually inclined to paternalistic behavior. If so, is Xi going to implement a strong social agenda more in line with European socialist redistribution policies? Or does he feel he has to continue in the footsteps of his father, Vice Premier Xi Zhongxun, who was instrumental in setting up the first free economic zone of Shenzhen?

    Xi Senior was a true reformer and a bit of a trouble maker. Three times in his career he opposed the supreme leader. Mao sent him to internal exile in 1962. Deng brought him back. The elder Xi's rehabilitation under Deng, however, did not prevent him from speaking out publicly against the Tiananmen Square massacre.

    One can only hope Xi Liping is a more patient version of his father. But there is no way of knowing at this time.

    Time to Bottom Fish in China?

    Here is what investors need to see before committing money to the Chinese market. They should wait to see if President Xi will tackle fundamental problems currently impeding sustainable growth. In my opinion, investors should only re-enter the Chinese market if he goes that route. I do not agree with traders who want China to come up with yet another stimulus program. This would only aggravate long-term problems, including crony capitalism and further misallocation of capital and resources by the government.

    The reforms which should head Xi's agenda include: restarting privatizations; changing the one-child policy; abolition of the hukou system; and quickly addressing the looming nonperforming loan crisis.

    Xi should also phase out the remaining dominance in many key industries of state-owned enterprises. This would allow the private sector, the real driver of the economy, to boost growth.

    Unlike rapidly-aging Japan, China is getting old before it is getting rich. The one-child policy needs to be ended quickly if the Chinese do not want to be buried by the cost of an aging population.

    Using the hukou system to control migration is an anachronism. The rigid urban residency system was a logical part of a true communist system that controls every aspect of one's life. Today, in China's post-communist economy, it only creates more disruptions. Migrants have become the new underclass. When moving to where the jobs are, all migrant workers are denied health care, education and welfare benefits because of this outdated system. Being vulnerable, they have to settle for lower wages to boot.

    Finally, state-controlled have been told to lend money to SOEs without regard for profitability or viability. By consequence they are now sitting on an explosive number of non-performing loans. The sooner this is dealt with, the better for the overall economy. Pretending, as Japan did for years, that the problem is minimal will only prolong economic stagnation.

    And then there is the issue of escalating nationalism. Considering the many challenges the country is facing, one would think this is not a good time to look for trouble with neighboring countries. De-escalating the bellicose rhetoric would help. Nationalist anger directed at Japan, for example, is harmful in many ways, not least by severely discouraging foreign direct investment.

    Conclusion.

    More and more investment advisors seem to be attracted by the Chinese stock market. It has had a long correction and valuations may start to look attractive. However, China today is a good illustration of something most investors have forgotten about emerging markets: political risks justify lower valuations.

    Investors who are willing to put a toe in the water and wait for better times by buying an ETF or a dedicated mutual fund should do their homework. He or she should make sure the investment vehicle focuses on private companies and not poorly run state owned companies.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Nov 07 11:01 AM | Link | Comment!
  • The Collapse Of The Asian Economic Model
    The Collapse of the Asian Economic Model

    The Asian Economic Model

    For two years now, every second financial headline has been on Greece and the possible breakdown of the euro. When Greece pretends to behave, markets react euphorically. When markets realize Greece was just pretending, a sell-off ensues. This makes for great drama, but misses the real international challenge: the collapse of the Asian economic model.
    The Asian model originated in Japan after World War II when, in defeat, the country of the rising sun embarked on a deliberate policy of catching up to the West industrially and technologically. It was designed at the top and brilliantly orchestrated by MITI, the Ministry of International Trade and Industry. Simply put, Japan developed a fabulous export machine.
    Combining hard work, flexible labor with high education standards and a fast learning curve, Japan became the envy of the world. Good old protectionism and currency manipulation helped too. So did outrageous dumping policies and a great ability to copy Western products. But the success of this mercantile policy was made possible, first and foremost, by US laissez-faire. Without American consumers' insatiable appetite, the Japanese miracle would never have existed.
    Nevertheless, it worked miracles. It is hard to explain to today's new generation of portfolio managers but missing out on the Japanese boom was a costly proposition in the 1980's. Japan was the future. The Japanese stock market was soaring. Japanese industries from consumer electronics, to cars, to ship building were unrivaled worldwide. Trade surpluses ballooned to new highs every year. The country was raking in massive amounts of dollars which naturally flowed into the leading Japanese banks, eight of which ranked among the world's top ten by the end of the decade.
    Eventually, the accumulation of current account surpluses resulted in a spike in domestic asset prices. The yen appreciated and Japanese investors started to look for alternative opportunities abroad. Everything looked cheap from Van Gogh paintings to landmarks in New York and Los Angeles.
    That's when neighboring countries took notice. The way to prosperity had been laid out for them. South Korea, Taiwan and the other Asian Tigers followed in Japan's footsteps. In due course even Communist China jumped on the bandwagon. The Japanese model had now become the Asian model.
    Success attracts competition. Starting in the 1990's, while the Asian Tigers were roaring, Japanese hegemony receded. Hyundai challenged Honda in North America and Europe. The Samsung brand overtook Sony in consumer reviews. Acer and Lenovo laptops replaced NEC and Toshiba. Shipbuilding activity picked up in Changwon and on the Yangtze River at the expense of Kobe and Osaka.
    All this is resulting in too many Asian corporations chasing the same US consumer - and his European little brother. Not only have we reached some kind of saturation point, but it is happening as Western economies are in a slump. US consumers are deleveraging and Europeans have embarked in a German-inspired austerity.
    An overcrowded space and shrinking demand is not a good combination. Yet it is not the real problem. Japan ran out of steam in spite of ballooning global demand. What Japan did demonstrate is more fundamental. It is the limitation of an economy that systematically privileges production at the expense of the consumer.
    That model focused on the needs of large exporting corporations put Japan in the forefront of global manufacturing. It also took hundreds of millions of Asian people out of poverty and should thus not be dismissed. However, it is a bit reminiscent of the cartoon character chasing a rabbit. He quickly catches up and gets in reaching distance of his pray. Then, after they both run for a while at the same speed, just a few inches apart, the chaser always, somehow, manages to run off a cliff. He does not fall off the cliff, mind you. He just hangs in the air, not noticing the abyss. Then he looks down and realizes his predicament.
    One day Japan will stop refusing to look down.
    The core of the problem lies in a society that relies too heavily on top-down decisions. Maybe it is cultural. Asian societies are still quite hierarchal and power is concentrated in few hands. From the keiretsu in Japan to the chaebol in Korea, their economies are still very pyramidal. Not to mention communist China.
    Hierarchical societies are petrified of chaos. Consumer-driven economies are not orderly. Doesn't it make more sense to have the whole country pulling together in a synchronized way? Channeling everyone's efforts toward a common goal seems so much more efficient. It avoids waste. It prevents working at cross-purposes to the common good of the country. In a different place and era, Lenin famously predicted that capitalists would sell him the rope with which he would hang them.
    Indeed, Japan's orchestrated allocation of resources to export oriented industries proved very successful at first. So what if a Japanese consumer had to pay twice as much as his US counterpart for the same, Japanese-made Sony camera? If that was the price to pay for global supremacy, so be it. The country as a whole would benefit. It did.
    Until it didn't. While Sony was perfecting their cameras and laptops, Apple responded to consumer demand with new products, like the iPhone and the iPad. Facebook and Twitter also emerged from the chaotic American consumer-lead economy. Nobody at the top of MITI or of a keiretsu saw these changes coming.
    At the end of the day, in a hierarchical society, capital and energy are applied to preserve the status quo. Why would anyone give up a privileged position in society if not challenged?
    The Asian economic model's shortcomings are becoming more and more apparent. The world is flattening. Organizational structures are increasingly horizontal, a movement greatly magnified by the internet and social media.
    The consequences could be devastating for societies or companies that cannot adjust quickly. Take the music industry. It is used to sell CD's, a product rapidly becoming obsolete. Kids nowadays download their favorite songs from the internet. How does one react? Produce better CDs? Put internet users in jail?
    Left alone, the market will adapt. Bottom-up solutions will appear and new business models will emerge. Rigid, top-down systems will only tweak the existing world order.
    Recent history makes this abundantly clear. When confronted with a downturn, Japan's production-obsessed bureaucrats exacerbated the problem. All they could think of to do was double down and invest heavily in production capacity.
    An investment glut later, the same people in charge then decided to manufacture a top-down domestic demand recovery. Consecutive paternalistic Keynesian stimulus packages were introduced with a regularity that tended to coincide with election cycles. Public deficits shot up. Government debt exploded. The economy never got its footing back. Japan had entered its first lost decade.
    The parallels between China and Japan are striking. Neither country seems to understand that chaotic markets are the way to salvation. In China a shift toward a consumer-driven economy will at best take time. But the first steps have not yet been taken. Instead, China has initiated a Japan-like investment bubble. Keynesian policies are next.
    Marx may be in China's dustbin of history, but dirigisme is not. The Central Committee in Beijing will never laud the merits of 1,000 points of light. It wants to remain the unchallenged lighthouse.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: economy
    Mar 14 10:22 AM | Link | Comment!
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