It was a big question: would European debt woes bring down the global financial system and economy the way the US debacle did in late 2008?
I say “was”. Because, ever since the EMU created a trillion dollar backstop for member countries and banks, the notion of insolvency has been taken off the table. Does that leave a weaker future for the euro and the EMU countries generally? Maybe. But consider:
- OECD Lifts Growth Outlook as Emerging Nations Rebound
- Durables Orders in U.S. Increased More Than Forecast
- U.S. Stocks Gain on Strong Economic Data, Continuing Rebound
These are just a selection of today’s headlines. The global economy is going to keep chugging along. That means it’s only a matter of time before economic fundamentals retake primacy and the bull market resumes its climb. Another way to say that: it’s overwhelmingly likely this is a correction and not a new prolonged bear.
Maybe this correction is about over, maybe it’s not. It’s felt like forever, but it’s only been a few weeks—this could drag out at least another few. Like 1998, it wouldn’t surprise in the least if we get near or touch the -20% mark for global stocks from their most recent peak—volatility has been so high, and the market swings have been so big (up and down), 20% relative to what we’ve been through right now isn’t so unfathomable. Maybe you’re one of those who calls 1998 a bear. I’m not, simply because it was so fleeting. That year, stocks recovered just as quickly as they fell, and it turned out to be a terrific year for stocks.
It’s fine to be fearful—the breakup of the euro is a big thing to contemplate, and most folks are gun shy from the last few years. But we’re quickly running out of fundamental reasons to remain fearful, and the bullish economic case hasn’t much budged from its position of strength since this episode began. This is looking like one of those many times in market history where discipline and sticking with the market will pay off before the summer’s end.
There’s been much made of Kenneth Rogoff and Carmen M. Reinhart’s recent book This Time Is Different: Eight Centuries of Financial Folly. Bears and Armageddon-mongers alike are using it as an intellectual bludgeon to “prove” we are all still doomed. Essentially, the book is an exhaustive study of sovereign debt busts through the ages, and many view its findings as a warning for what we’re going through right now in Europe . I’ve weighed in on this issue (and the book) here. But for those still wooed by Rogoff and co., this article is worth a look—a devastating (though somewhat technical) critique of the book and the ideas therein.
By Marshall Auerback
1. Get this: The US economy might well return to its pre-crisis peak as early as next quarter. That would mean a new all-time high in GDP. If that isn’t stunning—and bullish—relative to today’s dour sentiment…well, I don’t know what is.
2. Why it is the Greek government was allowed to cut its budget deficit 42% after it got bailout funds, I’ll never understand. The world would’ve been saved a lot of heartache had they had that discipline pushed upon them by the EMU in the first place. This is the very point of market-determined yields on sovereign debt!
Sometimes we laugh at things that aren’t funny. For instance, I get a kick out of the notion that Portugal and other European nations in potential debt trouble are creating “austerity” measures – mostly by raising taxes with a dusting of actual spending cuts. But it’s really nothing to laugh at – fiscal reform is serious business for the euro’s future. To meet spending cuts agreements made during the creation of the bailout, Portugal has announced the following measures:
- Increasing their value added tax (VAT) by 1% to 21%
- Increase income taxes up to 1.5%
- Increase corporate taxes 2.5%
- And, lastly, almost like an afterthought, cut public sector salaries cut by an average of 5%
The Keynesian notion of increasing taxation in order to get fiscal budgets in order is ludicrous. The answer is and always has been growing the tax base. That is, growing the economy to pay down deficits. More taxes won’t do it in the long run. At least Spain seems to take this seriously, announcing the biggest budget cuts in 30 years.
The question of the euro’s long-term viability hinges on whether troubled member countries get serious about fiscal reform. Or, as Paul Volcker said earlier this week, “You have the great problem of a potential disintegration of the euro. The essential element of discipline in economic policy and in fiscal policy that was hoped for… has so far not been rewarded in some countries.”
Volcker’s words are probably a bit overwrought, but it is semi-concerning in the sense that the euro’s demise is being seriously contemplated. Hence, the resumption of very high volatility in markets. Right now, uncertainty seems to be winning the day – the European government is in many ways being as erratic as the US government was two years ago. But in this case, the EMU was quicker, and already brought out the big bazooka of a near trillion-dollar backstop if solvency becomes an issue. With that in place, it’s likely sooner than later that overwhelmingly positive global economic data regains primacy, and stocks resume their climb.
Mr. Friedman is more journalist than economist, which makes for entertaining reading, but the book is way too long. (I’ve long wondered whatever happened to editors over the last few decades—nonfiction titles are growing ever longer and more tedious.) Now the book has three editions, and Mr. Friedman has been goaded into stuffing it full of more stuff. It’s chock full of anecdotes and provocative but ultimately useless interview questions like, “What was the moment you realized the world was flat?” (Who cares?)
There’s a free market capitalist lurking in Friedman, and it’s great when he lets it run: He extols Ricardian trade (which says trade is ultimately a win/win), roots for globalization and competition, reminds us capitalism isn’t about how the economic pie is shared but about increasing the size of the pie (i.e., wealth creation), and cheers the entrepreneurial spirit.
He is right in all this, and those who fear outsourcing should visit the book’s first third. A chart of US unemployment over time shows it’s never—ever—been driven by how many jobs are going overseas, but rather by recession and expansion. The business cycle creates wealth by increasing productivity—allocating jobs and resources to the most efficient places (even if they’re in another country) actually adds to wealth creation. The US has reinvented itself—of its own volition—many times, and will do so again. Note that throughout much of the last decade (as the world was “flattening”), unemployment was quite low (under 5%). It wasn’t until a global recession that unemployment spiked. Short-term dislocation effects of unemployment are a legitimate concern, and certainly fuel populist support for protectionism. But since when has moving between industries been a bad thing for the US or global economy? Or would we still prefer to be an agrarian economy as we were 150 years ago to “save” jobs?
For all this, Friedman can’t help but often take a pessimistic tone about the US. A vast chunk of this book warns US citizens they must change to compete in the flat world. This is off track and more than a little offensive in parts. A true free marketer would never dictate what society must “learn”; instead, folks should be free to pursue their own self interest. But Friedman’s convinced the only real future job growth will be in software engineering, math, science, and such. Therefore, we need programs to create more scientists, engineers, and PhDs generally. He mixes this with an abundance of vague dictums like “we must be more versatile than ever before,” but we must also cultivate “greater depth” in our citizens.
Why is it that, suddenly, here on education, Friedman abandons his free market views for mercantilism? I don’t know. To dictate what a society must “learn” requires an omniscience and flexibility no single human can have. Which is one of countless reasons dynamic free market capitalism is so effective—it adapts without a central planner. It’s been precisely the freedom to choose that’s created such vast economic strength over time. I wish Friedman had the courage to go there. Instead, we get didactic gobbledygook about what we need to do as a society, which weakens his argument for free trade. Keep things free and fluid and opportunity should flourish. That will be, as it always has been, a stronger force for wealth creation than any command from on high.
Folks often don’t think in this way, but jobs and skills today considered ironclad may not always be. Decades ago we used to say learning certain skills or trades would provide a great career forever. But through time skills can become “commoditized”, that is, many workers become able do the work, and perhaps technology can largely replace those skills—like robotic assembly lines for cars. Today, we tend to believe trades like software engineering and the sciences will always provide job safety. Probably wrong. My guess is, as the world continues to develop, many parts of engineering and the sciences will become commoditized too. For instance, mechanical engineers are facing tremendous competition from software programs that can design products faster and better than ever before. Because of this effect, it’s imperative to allow the workforce to remain fluid rather than direct folks into this or that field of study.
The reason all this is offensive is it’s predicated on the myth the US is a nation of ignorant, indolent, lethargic, stupid folks more occupied with Britney Spears than Noam Chomsky. We’re Yankees. Yet, paradoxically, we’re also known as the most “Type A” workaholic nation ever. We take less vacation than anyone, have more stress, and more families working two jobs. We’re the biggest economy in the world and it’s in better shape than most after a nasty global recession. How can we be those things and simultaneously fat and lazy? They can’t both be right. If the education gap were truly so dire, then how can we explain that in the US grads are heading to college in record numbers?
This book attempts to be all-encompassing, and Friedman won’t stay away from politics. Our politicians must be “inspiring” and able to “explain” the situation, he says, to direct folks to get the needed skills to become competitive. We need an army of John Kennedys, according to Friedman, to lead all this new centrally planned competition. Wrong. Ronald Reagan (love him or hate him) is the best example of fostering competitiveness in a flattening world. Reagan indeed inspired the populace with his “Morning in America” concept. But instead of some bizarre and misguided centrally planned education expedition, he let Americans achieve their greatness by choosing their own paths.
Ultimately though, despite these weaknesses, Friedman delivers a book that asks us to embrace globalization, see the tremendous opportunities it can generate, and invites us to participate—a worthy message in an age of anxiety.
Running low on Shekels? Wish you could afford that nice goatskin your wife’s been asking for? Are you covetous of the new model mule—the one with 0.5 horsepower? Do you desire your cup to runneth over with libations? What about that designer robe of fine cloths that caught your eye in the bazaar last week? Tired of the same old salted meats and dry grains when you could be enjoying the rare spices of the world? Then have I got a book for you!
One of the longest running and bestselling investing books of all-time, The Richest Man in Babylon is attributed to George S. Clason, but there were probably many authors. The book first popped up in the mid 1920s as a series of short anecdotes widely circulated by financial institutions, and was eventually compiled and released as a book. It’s a series of allegories set in ancient Babylon meant to convey the “timeless” wisdom of finance.
Timeless, maybe, but in some ways it feels dated—stuff like IRAs, 401Ks, savings accounts, and the general notion of investment as a venue for retirement is hugely popular today…probably at least a little because of this book’s longevity and popularity. All this is certainly in the public consciousness by now (of course, whether folks heed the advice or not is another matter entirely).
What I like is the spirit it conveys—equating financial prudence with wisdom and teaching that achieving wealth is often a matter of personal responsibility. In today’s world, where populist anger equates wealth almost exclusively with greed, we could use a reminder that riches for most folks are the result of a lifetime of work ethic, discipline, and prudence. As such, it’s a great book for budding graduates and other young adults who need such lessons.
But it’s hammy. The characters speak like a cross between Hamlet and Yoda, and often descend into aphorism, banal platitudes, and a sort of prophetic righteousness that will elicit more than a few chuckles. In its own way, this feature contributes to the fun of the book more than it detracts. For instance, the “Seven Cures for a Lean Purse” feature great one-liners like, “Start thy purse to fattening,” “Make of thy dwelling a profitable investment,” and “Guard thy treasure from loss.” Even a perpetual sourpuss has to smile a little at these.
For some reason, ever since the King James Bible folks seem to think all cultures before about 1800 AD spoke the King’s English (A favorite quote: “Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field”). I guess the lofty language gives the sheen of wisdom. There’s always been the fantasy that “ancient” means wise. But none of these folks spoke this way in ancient Babylonia. Barely anyone could read or write. Yes, languages of antiquity were fairly well developed, but on balance were rough and far less sophisticated than much of what we have today. (Language is a technology too, and differing dialects have differing usefulness, particularly in fields requiring exactitude like the sciences and finance. But I digress.)
As allegories go, Babylon is fairly entertaining and drives its points home. But generally allegory is used to nuance and juxtapose lessons so as to broaden and deepen the teaching. I’m not sure there’s a lot of nuance in this book: save, be frugal but enjoy your life, and invest in things that generate income—we hear these dictums over and again.
Importantly, the story and its ancient setting actually obfuscate some of the finer points of today’s investing landscape. For instance, I doubt your average Babylonian citizen particularly had a long enough time horizon to see the benefit of compounding interest. Sure, some lived long and grew fat with years, but when you’re looking at an average lifespan of well below 50, and the occasional plague or famine, well, that starts to alter your long-term plans. Also, what’s magic about 10% as an appropriate savings rate? Why not 15% or 5%? There’s no discussion of such things, or of other basics like diversification (probably because diversification as a formal finance theory was still decades away in the 1920s). But not putting all your shekels in one clay wine jar is really important for novice investors to know.
Another example is gold. “The Five Laws of Gold,” which comprises a large chunk of the book, is sometimes misleading. I think what’s really meant here is “the five laws of money”, or capital. This seems like quibbling, but it’s an important distinction because much of this book is about how to generate future income. Well, gold is not a productive asset—it’s just a thing, a commodity. You have to do stuff with it to get income, that is, to create value. That’s different than owning a stock, for instance, which is ownership in a share of an enterprise that exists to create value.
You can have a lot of fun with Babylon. Where Warren Buffett would say something boring like, “I only invest in businesses I understand”, here you’ll get, “Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those who are skilled in its keep.” But I’d advise sticking with a modern dialect when discussing your investments with your advisor, lest you end up with a portfolio denominated in goatskins.
With all the chaos in markets this week (evermore European debt concerns and trading flubs), a virtual truckload of positive global economic news went almost totally ignored. It was a terrible week for stocks, but all this is bullish looking ahead. Markets are likely to work through today’s fears (we’ve been talking about debt problems in Greece for months now), and as they do, what we’ll be left with is a global economy recovering and surging past expectations. That bodes well for stocks looking toward the rest of this year.
One can appreciate investor concerns with Europe , but my view is that we’re probably entering a somewhat overdue period of re-pricing risk among nations. That costs of capital are rising in countries with sluggish economies and high debt levels is not a catastrophic thing—and probably ultimately good. And keep in mind even with recent spikes in LIBOR, etc., costs remain very low on an absolute basis versus history. I’m not sure who can reasonably argue Greece’s debt costs should be as low as they have been—this is a country that’s traditionally spent a good chunk of its existence in default of some kind or another. A similar logic applies for any of the PIIGs— Portugal , Italy , Ireland , Spain …their debt costs should be higher.
Entering this weekend, I’d imagine many investors are feeling shaky and thinking this is late summer 2008 all over again. A re-pricing of risk for European countries may be somewhat disorderly, but isn’t likely to derail the global bull market in progress.