CautiousInvestor

Jim Rogers on the Next 10 Years

I am fairly confident China will become an economic super power, making me bullish on the long-term prospects for China. That said, it must be acknowledged that China faces challenges to growth, even with a population of over 1.3 billion people.

At the root of everything lies the question of whether the country's political structure is conducive to sustained growth. In the west, the classic pattern of development has been for economic change to stimulate demands for political reform and greater democracy. Fear of political change could hold China back; the top-down fiscal package exacerbated the fundamental weakness of the economy in expanding the role of state owned enterprises. The stimulus has rewarded many state owned enterprises and over the long run the role of SOE’s must be reduced while giving wider berth to small, privately held companies which will be more responsive to market changes and better incentivized to innovate.

The most immediate challenge is for China is to move from an export driven economy to a more balanced model in which domestic consumption plays a larger role that it does today. Relative lack of healthcare and the cost of a decent education mean that families save far more heavily than in the west, leaving them with less money left over at the end of the month to spend. China must extend upon its rudimentary social safety net and expand educations, pensions and health care

The very large demographic issue confronting China is interesting and unusual in that it is experiencing the problems of both a developing and developed country; high economic growth along with an aging population. Experts worry that China will become old before it becomes rich; Richard Jackson and Neil Howe wrote a report about demographic trends and they calculated that in 2004, the elderly—here defined as adults aged 60 and over—make up just 11 percent of the population. And by 2040, however, the United Nations projects that the share will rise to 28 percent, a larger elder share than it projects for the United States.

“In absolute numbers, the magnitude of China’s coming age wave is staggering. By 2040, assuming current demographic trends continue, there will be 397 million Chinese elderly people, which is more than the total current population of France, Germany, Italy, Japan, and the United Kingdom combined.” And Andy Xie is concerned that current demographic trends could worsen as a result of the property bubble with higher housing prices forcing many young couples to have fewer children. It is unclear how will address this issue but it is clear the government is worried about the cost of a western European-style welfare state.

Other challenges include the gap between living standards in the cities and in the countryside; the comparison between the wealth of the coastal strip and the poverty of the inland regions; the mismatch between the country's projected growth rate and its energy needs; and the need to improve the structure and regulation of its capital markets. In the longer term, Beijing has to decide how to use China's growing economic clout on the world stage and chart a course for developing its capital markets, including expanding the role of the Renminbi in global currency.

Why I'm a Nervous Bull

Another indicator is the Treasury market which is discounting low growth, possible deflation, rising unemployment and other indications of economic weakness. Historically, sharp divergences between the bond and equity markets do not last long..............and it will not be long before somebody will be proven wrong.

My money......literally..... that the bond boys better understand current macro-economic developments and when the economy fails to recovery after stabilizing the equity market could come under pressure. In past weeks Chinese markets have retraced 20% of their gains based upon growing concerns over liquidity leaks and overbuilding of capacity.

Little reported was a recent report on Japanese exports: Japan’s export slump deepened in July, indicating the boost in demand that helped pull the country out of its recession last quarter may be short-lived. Shipments abroad fell 36.5 percent from a year earlier, steeper than June’s 35.7 percent drop, the Finance Ministry said today in Tokyo.

The "stabilization" seen across the globe attest to the speed and strength of both monetary and fiscal responses to the global crisis and, nothwithstanding reports to the contrary, virtually all economic progress points towards governemnt intervention in contrast to increases in private demand.

Quantum Shift in Economic Baseline: A 'Black Hole' Recovery

As usual Steven you provide much interesting discussion and commentary.

The affect of demographics, baby boomers in particular, in this recession and pending recovery is indeed an interesting point of discussion. The civilian labor force totals around 155 million and I believe there around 78 million boomers; their aging and life cycle effects are certain to continue influencing economic events.

Consumers have lost around $14 trillion of wealth from the slide in equities and deterioration of home values but their indebtedness remains unchanged at $13.5 trillion..........and they are levered 3X what they were twenty years ago. With foreclosures up 18% YOY and credit card write-offs in the 10% range, consumers want to de-lever and lenders are forcing them to de-lever by reducing credit lines and extending fewer loans.

I think policy makers and government officials are guilty of both talking-up and propping-up the market to assist banks in raising funds and perhaps to restore part of the wealth our households have lost. More recently with the suggestion that a second round of stimulus may be required I believe the debate currently reflects a concern with deep rooted employment losses. I believe there is growing realization that propping up the market is not leading to expanded consumer spending and that the core issue of unemployment must be addressed.

This would suggest policy makers are aware of many of the issues you raise but are actually are afraid of the facts as they are politically dyspeptic and place policymakers in a feasibility trap. As Mohamed El-Erian said the “first best” policy solutions are elusive; and even in the world of second and third best, what is economically desirable is increasingly becoming politically infeasible; and what is politically feasible may well turn out to be economically undesirable.

As to the shape and nature of the recovery, I think there is a distinct possibility there will be an inventory restocking phase that will take place amid no change in final demand, leading to one or two quarters of growth and then a contraction much as we saw in the early 2000’s. We may also see the Fed increase interest rates to contain inflation resulting from QE, which could lead to another contraction. All in all, the recovery could be very uneven and fitful punctuated by alternating quarters of growth and contraction.

This will take place within the context of the new normal characterized by low economic growth, heavy regulation, higher taxes, higher rates of savings, reduced international trade and heavy government borrowing.

Deflation vs. Inflation: The Great Debate Rages On

I don't think they are mutualy exclusive.........with the timeframe being of paramount importance.

In the near term there are deflationary pressures as evidenced in US housing, Japan and the Eurozone. Along with high levels of unemployment, there is much excess capacity suppressing prices.

Longer-term expectations, though, are different and are being shaped by rapid increases in the money supply, the expanding Fed balance sheet and the avalanche of debt to be unloaded on world markets by the Treasury over the next years. And there is also concern that the Fed, if necessary, will help Treasury by monetizing debt through direct purchases of debt.

The US is faced with the choice of either paring back its budget deficits and monetary base as soon as the current risks of deflation dissipate, or setting the stage for a potential upsurge in inflation.

Quoting Alan Greenspan:

"The Federal Reserve, when it perceives that the unemployment rate is poised to decline, will presumably start to allow its short-term assets to run off, and either sell its newly acquired bonds, notes and asset-backed securities or, if that proves too disruptive to markets, issue (with congressional approval) Fed debt to sterilise, or counter, what is left of its huge expansion of the monetary base. Thus, interest rates would rise well before the restoration of full employment, a policy that, in the past, has not been viewed favourably by Congress. Moreover, unless US government spending commitments are stretched out or cut back, real interest rates will be likely to rise even more, owing to the need to finance the widening deficit."

Distilling the Economic Data: No Recovery News

Steve, thanks for investing the time and effort to properly frame the meme of green shoots and improving second derivatives.

Your data is self explananatory and suggests that both mainstream media and the markets are too far ahead of the curve..........and too far ahead of the actual recovery. Before addressing this last point, let me share some material from Dennis Gartman by way of John Mauldin.

Dennis also looked at rail shipments: "Since the start of this year this year, when the year-on year comparison was a relatively tepid -8%, the trend has been steadily 'from the upper left to the lower right' on the charts. By March, the year-on-year comparisons were averaging -15%. By April, -22%; by May -25%; and now, after a week or two of June, they are -26%. This is not a trend to be tampered with; this is a trend of some very real severity, and for now we fear that it is a trend rather firmly intact. Thankfully, it looks back, not forward; but if the past is prologue to the future, the future still looks rather bleak.

"Finally, there is a glimmering of hope on the rail horizon, and that is that the June figures, as they are compiled, are showing some signs of life. According to the AAR, 'freight traffic on US railroads during the week ended June 13 continued to show signs of gradual improvement ... [as] rail car loadings and intermodal were up from the previous week with carloads at their highest level in 10 weeks.'"

I am happy to cede that things are getting less worse but would point out that this deceleration in deterioration does not say we have hit bottom or says very little about the recovery. Getting to the bottom is one issue; recovering and moving away from the bottom is another.

This allows me return to the point that we .......the markets and mainstream media........are getting too far ahead of ourselves. We know the market is a forward looking discounting mechanism but I believe what the market presently "sees" is something robust and V shaped; what I believe the future will deliver will be less robust and almost anemic.........the new normal.

Many developments will contribute to the new normal but, in the main, it will resuslt from a macroeconomic reset in which the consumer increases savings from virtually zero to 9% to 10% and reduces consumption. This will put a brake on the economy as will reductions in capex spending by firms that serve the consumer who will see excess capacity until population growth offsets contactions in spending patterns.

I think unemployment will remain a problem until this correction has run its course; I am somewhat fearful of additional fiscal efforts to circumvent this necessary, painful adjustment.

Decline of the U.S. Dollar: Asian Initiative to Create Commodity Based Currency?

I can only agree with the excellent comments offered by User 353732 and SW.

By way of expanding upon point one made by SW, last month Beijing completed the last of a series of so-called currency swaps—providing yuan to other central banks for use in trade with China—with Argentina, Hong Kong, Indonesia, Malaysia, South Korea, and others.

These arrangements remove need for these trading partners to use the dollar as an intermediary currency in dealing with China. And, more recently, Beijing denominated a bilateral trade deal with Brazil in the two countries' currencies, rather than in dollars.

To achieve its long term goals, which could be as far off as 2020, the Yuan will need to be convertible and widely held in the form of bonds. I think the Chinese are feeling their way around the first challenge by exploring how they wish to value their own currency, whether through linkage to commodites, SDR's or other combinations.

With respect to laying a broader foundation for its bonds, China recently took the unprecedented step of allowing HSBC and a second private bank to underwrite and sell yuan denominated bonds inside of China. This is a big step towards expanding their credit markets and pursuing their long-term goals.

Thursday Outlook: Commodities, Global Markets

Boy yesterday was a trip...........and it was either programmed trading or the Boyz.

The cozy realtionship between the administration and the Boyz or Plummet Protection Force may become strained as Timmy wants to place hedge funds and private equity groups under federal supervision to better control financial risk and derivatives trading.

The administration’s framework would make it mandatory for large hedge funds, private-equity firms and venture-capital funds to register with the Securities and Exchange Commission, subjecting them to new disclosure requirements and inspections by the agency’s staff.

Wednesday Outlook: Commodities, Global Markets

Thanks David

The indicators I read are somewhat mixed with the exception of what you point out and slow stochastics, which is higher than this past January and signaling a change of direction.

Overall, other chartists and technicians expect a choppy consolidation with some saying there is room for several more days of gains.

I'm glad Treasury is targeting the root problem but worry about bank solvency and the scale of the effort compared to legacy asset levels. Not knowing what potholes we might hit, it would be easy to get ahead of ourselves.

Thursday Outlook: Commodities, Emerging Markets

The markets are eerily quiet and I think they are looking for a reason to go lower. The only possible catalyst I see today is new unemployment claims.