Spanish PM Rodríguez Zapatero Calls Early Election

Articles:

Wall Street Journal, Spanish Leader Calls Early Election, Jonathan House

El País (Spain), Final de Ciclo, Editorial 7/17/2011

El País (Spain), Rubalcaba: “Tuvimos ocho años para pinchar la burbuja y no lo hicimos”

Rubalcaba and Zapatero
from Iberosphere.com

The Spanish Prime Minister, José Luís Rodríguez Zapatero, called for early elections on November 20, ahead of scheduled elections in March, 2012.   Spain is suffering from an unemployment rate of over 20%, the highest in the developed world.  Zapatero's socialist PSOE party was handed losses in key regional elections is May.  Left-leaning newspaper, El Pais, has been called for elections "as soon as possible", and said that the leader has not given any reasonable hope for relief to the five million unemployed, and the 300 thousand who have lost their homes in the last 3 years.  They have gone so far as to say that the November date was too late, and that sooner would be better.

Rodriguez Zapatero was elected in March, 2004, just after the terrorist bombing in Madrid commuter trains, which killed 191 people and caused over 2000 injuries, on March 11, 2004.  Zapatero's predecessor, José Maria Áznar, of the conservative Partido Popular (PP) had positioned himself as a leading supporter of George W. Bush, and had sent Spanish troops to Iraq, despite large public opposition in Spain.   When it became clear that the bombs had been set off by al Qaeda (despite early attempts by Áznar to blame Basque separatists), many Spaniards reacted by giving a surprise victory to Zapatero, who had pledged to pull Spanish troops out of Iraq.  Shortly after being elected, Zapatero made good on his pledge.  He was re-elected in early 2008, before the real estate sector, and then the economy, crashed.

It is interesting to see that in today´s El País, it is reported that socialist candidate Alfredo Pérez Rubalcaba said: "We had eight years to pop the bubble, and we didn't do it."  It looks like Spain will have a conservative government by the end of the year.

Debt Ceiling: the Story that Won't Go Away

New York Times: The Centrist Cop-Out, Paul Krugman
Wall Street Journal: House Postpones Vote on Boehner Debt Plan, Naftali Bendavid and Carol E. Lee
Wall Street Journal: Lending Markets Feeling the Strain, Liz Rappaport and Matt Phillips

The ongoing "crisis" over increasing --or not-- the Federal debt ceiling has become unavoidable.  It is all over the news; one plan after another has crashed and burned as unable to pass the Congress (House Postpones Vote on Boehner Debt Plan); the stock market is down for its 5th consecutive day; Wall Street's industry association, SIFMA, has been holding conference calls to hammer out the operational nitty-gritty of how to handle a debt default that really should not be happening (Lending Markets Feeling the Strain).

This morning I watched CNBC as Becky Quick hammered Maryland Democratic Representative Steny Hoyer for blaming the other side, and not doing enough to avert the crisis.  But in his op-ed today, Nobel laureate Paul Krugman argued that the news media, in its attempt to be even-handed, has neglected to squarely place the blame for the deadlock where it belongs: on the "extremism" of Congressional Republicans.  I agree with him.  Though all agree that long term deficits and debt--caused largely by health-care and retirement costs and wars-- are out of hand and must be addressed, there is absolutely no reason to link action on this to the short-term operational decision to lift the debt ceiling.  Other developed countries do not even have a debt ceiling.  It was the decision of Congressional Republicans to use the debt ceiling as a weapon to dismantle social programs which the majority of Americans want and expect.   The absolute refusal to allow the expiration of the "temporary" Bush tax breaks on the wealthiest Americans is deeply irresponsible.  America already has the greatest gap between rich and poor of any developed country on earth and it has been steadily widening--is this good for our nation?   All compromises, including the latest one worked out by Republican House Speaker Boehner, have foundered on the insistence by some to maintain the tax burden on the wealthiest at its lowest level since the 1920's.

I hope this will be resolved.  I hope the debt ceiling will be lifted.  I hope that both sides will be steadfast in building consensus for an aggressive plan to put the fiscal house in order, with a sensible mix of spending cuts and fair revenue enhancements, which economists agree is the proper course of action.  But if the Republican intransigence continues, I have a guess about what will happen.  There will be a temporary government shutdown which will be resolved in a matter of days or weeks; we will not default on our debt, but there will be a delay in cutting checks and providing services.  Lots of money will be wasted digging out from the mess that the temporary shut-down will cause.  And in 2012, tea-party affiliated Congressmen who came in in 2010 with a "mandate" will be swept out just as quickly.  Remember Newt Gingrich in the 1990s?  It could happen again.

Natural Gas: Fracking in Europe

Article: Wall Street Journal, Fracking Pioneers Pierce Europe, Guy Chazan

 El Mundo (Spain), The United States' Dirty Energy Revolution, Pablo Pardo

Chesapeake Energy natural gas well in Bradford County, PA
from www.csmonitor.com

One of the biggest stories of the last few years is the growth of unconventional sources of energy.  In the U.S., this mainly means petroleum from the oil sands of Alberta and natural gas from shale, the latter being retrieved via a process known as “hydraulic fracturing”, or “fracking” for short.

The following article from Spain’s El Mundo: The United States’ Dirty Energy Revolution --translated into English on the website WatchingAmerica.com-- gives a good overview of how unconventional energy is transforming the “energy panorama” in the U.S, mainly by making the country much less dependent on world energy markets, and poses the question of whether this “revolution” will spread to Europe.

The WSJ article talks about an early effort to explore fracking in Southern England.  At this time the drilling has been halted, as the result of a minor earthquake, which some say was caused by the drilling.

I have recently become very interested in where the world gets its energy.   This topic is vitally important economically, politically, environmentally, and most importantly, for my investment portfolio.

As far as natural gas and fracking go, I have learned the following:

• Natural gas burns very clean (think of a gas stove), though it does produce carbon dioxide (CO2), the main greenhouse gas.
• It is estimated that the U.S. has at least 100 years supply of unconventional shale-based natural gas.
•  Fracking is a highly controversial practice, as there is evidence that it can lead to polluted aquifers.
• Fracking has been temporarily banned in New York State, but continues in Pennsylvania, Texas, Oklahoma and other areas.
• In Europe, fracking has been banned in France, but is being attempted in Poland, Northern Germany, the UK, and according to the El Mundo article, in Cantabria, Spain.
• One think tank estimates that Europe has at least 60 years of energy reserves in extractable natural gas, though I understand this to be a very preliminary estimate.
• Natural gas can be used to fuel vehicles, but in the U.S. very little infrastructure to provide it (i.e., gas stations) exists at this time.  When I lived in Spain ten years ago I saw buses and taxis that ran on natural gas.
• Natural gas is generally transported via pipelines.  In the absence of such an infrastructure it can be converted into liquid natural gas (LNG), and transported in ships, but the process is currently expensive and difficult.  

Arctic Princess Natural Gas Carrier
Courtesy of  www.ships-info.info

Because of its abundance, cheapness, and the fact that it does not have to be imported, many see natural gas as the solution to the United State's  energy problems, at least in the short-to-medium term.  To the extent that we are concerned about global warming and CO2 emissions, other green energy sources (wind, solar, etc.) may be preferable, but these technologies are not yet economically viable.  Assuming the dangers of fracking can be addressed or mitigated, the use of natural gas to replace sources of energy such as coal and petroleum –and possibly nuclear power—seems highly probable.

Profits Are Up, What About Jobs?

This WSJ article by David Wessel gives an interesting analysis of why we have not seen job growth commensurate with the recent growth in corporate profits.

Courtesy of Wall Street Journal

Yes, unemployment is a complex and multi-layered issue, with a mixture of  long-term structural factors and short-term economic factors.  As labor productivity goes up, businesses can use fewer staff to generate a profit; labor is less mobile than it used to be because many people are stuck in homes with underwater mortgages and cannot move; the housing market (and therefore construction) is stuck in a medium-long term rut; our educational system does not produce workers with the high-tech skills that many businesses need (also in today's WSJ: U.S. Business Leaders Press Senate Panel for More Work Visas); executives are uncertain about the effects of Obama-care, Dodd-Frank,  etc, etc.

However, I wonder how much this might have to do with incentives that are out of wack.  Corporations focus on setting up a proper compensation system so that senior executives' incentives are aligned with shareholder's incentives --basically CEOs and other fat cats are paid very little in wages and receive most of their compensation in stock or options.  Executives make more when profits go up.  But regular employees simply receive a wage, and executives have every incentive to reduce costs (i.e., other people's salaries) as much as possible.

My first question which has nagged at me as I studied corporate governance: why the big difference between senior executives and other employees?  In the end, aren't they all supposed to make an important contribution?  As a customer, if I go into a Starbucks, the performance of the guy making the coffee is much more important to me than the performance of the CFO--why does the corporate governance structure make a qualitative distinction between the two?  Why are a few people given the privilege of having their compensation "aligned with the shareholders' interests" --which means they may have earnings measured in the millions-- while others have earnings measured in the tens of thousands, and can get canned at the drop of a hat, by some brilliant new cost-cutting executive?

Executives have a big incentive to cut costs and get rich in the process.  But isn't there some benefit to having long-term stable, loyal employees, to treating employees as valued partners, not to mention the "Corporate Social Responsibility" that many corporations preach in their annual reports?  Perhaps so, but my sense is that these are factors that will generate benefits over the long term--years and decades-- and require patience and skill to capitalize on.  Cutting heads, if it can be done without driving customers away in the short term, generates a quick jump in the bottom line.  Traditionally, another big disincentive to laying  people off wholesale were the unions, which have all but disappeared in the private sector.  No, I do not advocate a system like Spain's, where unions made it nearly impossible to fire under-performing employees, thus leading to an 10% structural unemployment rate (now around 20% due to the bursting of their real estate bubble).  But look at the growing discrepancy in pay between executives and line employees in the US, look at the gap between rich and poor, look at corporate profits, and look at the unemployment rate.  And then maybe take a look at the tax structure.

Executives who get paid mostly in stock or options make most of their income from capital gains, which are taxed at 15%.  Other employees get salaries, which are taxed based on a sliding scale, with a maximum rate of 35% (25% for incomes between $34,500 and $83,600).  This is the U.S. government doing its part to make employee wages even more expensive for corporations, relative to what they pay executives, therefore increasing the incentive to use salaried employees as little as possible.   Is this really what we want to be doing?

Why can't we have a fair, simple tax structure which values work as well as deal-making?  And why can't we have an informed, well-educated work force?  Is this too much to ask?

Astonishing Household Wealth Gap Between Whites and Blacks, Hispanics Increases

Wall Street Journal: White Minority Wealth Gulf Widens

Washington Post: Wealth gap widens between whites, minorities, report says

This was an eye-opener.  The story was that while the recession destroyed household wealth across the board, it had a worse effect on Blacks and Hispanics than on Whites.

Courtesy of Wall Street Journal

But what strikes me is the following: while the median White household has some modestly significant wealth, the median Black and Hispanic household has virtually nothing.  Yes, the gap widened, but qualitatively it was the same story after the recession as before.

Meanwhile, Congressional Republicans fight tooth and nail so that the marginal tax rates on those making over $250K per year cannot possible go up-- rates which Warren Buffet pointed out are often close to 15%, much lower than the rate on middle-income earners.

I am all in favor of fair, simple taxes, and of the U.S. being a meritocracy.  Naive redistribution of wealth is not the answer.  But it is in everyone's best interest for us to have a level playing field.  It must start with education.  You should not have to be from a rich family to get a good public education.  If we could effectively address the educational slide in our country relative to the rest of the world, I think it would mark the beginning of the reversal of such disheartening statistics.

What About Japan?

Article: The Economist, Japan's Debt: The Domino that Never Falls

Courtesy Japan National Tourist Organization

One of the reasons that I love The Economist is that it does not ignore the world's third largest economy.  There is always one article, and often two or three on Japan each week, even when the country is not being devastated by earthquakes and tsunamis.  Last year, China passed Japan as the second largest economy in the world, but China has a population that is ten times Japan's, and all manner of natural resources.

From a 2007 BBC News Article

Japan, despite myriad problems --natural disasters, the largest government debt in the world (225% of GDP, compared with Greece's 144% and USA's 100%), few natural resources, a shrinking, aging population, a hidebound government-- is still a prosperous country where a large majority of the population is middle-class and well-educated.   And as pointed out in this week's article in the Economist, it is the place where bond investors run when there is uncertainty in other developed countries.  Because of debt problems in the US and Europe, the Japanese yen is now stronger than ever, at around 78 yen to the US dollar.  This is bad news for Japanese exporters, as well as tourists who visit Japan from overseas.  When I visited in 2007 I remember I got 140 yen for each dollar.  Economically, at least, I'm not looking forward to my next visit.

I'm not sure why Japan is still a safe haven for investors.  I think it has something to do with how their debt is funded.  The article points out that households alone have assets of nearly twice the national debt.  The Japanese are great savers, and tend to put their money in savings accounts, traditionally in the postal banking system.  The banks invest the deposits in Japanese Government Debt (JGBs).  Most JGBs are owned domestically, not by foreigners--in contrast to the US, where close to half the debt is owned by foreigners, who, at least in theory, are free to divest at any time.  In Japan, perhaps, there is more political and social pressure to keep the deposits in JGB's.  Not to mention that it would be difficult to find safe and liquid investments in which to place such a huge volume of deposits ($16 trillion in household assets).  They would probably have to move overseas, and be subject to all manner of exchange rate and political risk.

According to the Economist, referring to the JGB market, "...the risks of a confidence crisis, though not necessarily imminent, cannot be ruled out."  Who can tell what would happen in such a case?    Would the crisis of the PIGS (Portugal, Ireland, Greece and Spain) look small in comparison?

from www.uprofish.com

I think we can learn about the importance of education from Japan.  They became the world's second (now third) economy not because of a huge land mass, oil or minerals, or military and political dominance.  It was largely due to their talented, disciplined, educated population.   When we think about what is going on in the USA, I hope we don't forget an important long-term priority:  not deficits, jobs, healthcare or energy, but education.  In my opinion education is the most important item in the list, because even if we botch the other priorities, educated future generations will be able to make additional progress.

US Default: Neon Swans

Last year, as a hedge against inflation I bought a moderate position of 10-year US Treasury Inflation Protected Securities (TIPS). I have watched the value of these securities go up by more than 10% -- not because of 10% inflation, but because of falling interest rates. I feel tempted to sell them to cash in on the unrealized gain. Perhaps gold would be better as an inflation hedge anyway (though I have read there is no clear correlation), and I can be fairly certain that at some point in the next ten years interest rates will creep up again from their absurdly low present levels, and I will lose my 10% gain if I hold the TIPS to maturity as I originally intended.

Now, with the various branches of the government flailing about in so-far fruitless attempts to raise the debt ceiling and avoid default by August 2, I wonder if it might be a good time to sell. On the other hand, no one else seems to be selling -- yields on US Treasuries do not seem to be rising and falling based on political news about the debt ceiling--the market is sanguine, and it almost seems unpatriotic to sell at this point

Jason Zweig's column in today's Wall Street Journal refers to the possibility of a default or downgrade of US Treasury debt as a neon swan: "an event that is unthinkably rare, immensely important and blindingly obvious", riffing on Nassim Taleb's "Black Swan". He remarks that "many investors seem to be coping with what seems like an obvious risk by simply closing their eyes."

This puts me in mind of the temporary Newt Gingrich-led government shut-down of 1995. I was working in the client administration area of a large international financial institution, which was custodian for a good chunk of US Government Debt held by Japanese institutional investors--billions of dollars worth of T/Notes and T/Bonds. At that time, we used to receive a pile of faxes every day from our customers in Tokyo: inquiries on everything from fee bills to 1 penny rounding differences on multi-million dollar settlements. There was virtually nothing on the looming government shut down which was all over the press, and how it would effect them.

I wish I had kept a journal back then.  As I recall, a day finally did come that we did not get paid interest on some Treasury issues (the operations staff had to manually reverse automatic postings that the system had made) I approached the head Japanese relationship manager, and asked him how we would explain this to the customers. He asked me to draft something. I made a brief write-up, explaining that processing of the payments had been delayed because of the government shut-down, which they had probably read about in the newspaper. The fax went out, the payments were made a couple of days late, and we never heard anything more about it.

There are about $14 trillion of US Treasuries outstanding, and foreign countries hold over $4 trillion, of which China and Japan each hold about $1 trillion (see http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt) . Maybe the market is sanguine because there is so much money involved --the vested interests are so powerful-- that no amount of political in-fighting can change the basic facts. I also suspect that any S&P, Moody's or Fitch downgrade will also be a non-event. Those who hold debt balances in the hundreds of billions will do their own analysis, and make their own decisions, regardless of what a few analysts in an office in Manhattan decide.

Let's hope I'm right.

$157 Billion Greek Bailout

This morning's Wall Street Journal speaks of a new $157 Billion Greek bailout: Greece Gets New Bailout as U.S. Nears Brink

An admission of defeat by all involved: ECB President Trichet was unable to avoid a "technical default"; German Chancellor Merkel was unable to avoid spending more of her frugal citizens' money.

The Dow went up over 1% yesterday, partly on this news, which at least showed some leadership by Europe, and brought some certainty.

On the other hand, there are a lot of questions:

What about Greece's primary deficit? The country is spending more than it takes in, even before it services its debt. On this basis, they will run through any and all bailout money that they receive (around 100 billion in 2010, over 150 billion in 2011 --quite a bit for a country with a GDP of around $310 billion). I wonder if major political reforms/purges will be needed in order to accomplish the necessary economic restructuring.

Suggestion number 1: stop worrying about Turkey. I understand that a part of the problem has been huge unnecessary military expenditures over the years, which I can only assume have been accepted by the population because of anti-Turkish paranoia. Maybe leadership in some sort of Eastern Mediterranean free trade zone would help Greece's economy.

Suggestion number 2: Sweep out the Greek political class, and put people who are not implicated in the current mess in charge. Dominique Strauss-Kahn should be available soon :)

Will the technical default cause CDS contracts to pay out? WSJ's Steven Fidler says "probably not", because the deal for private sector contributions is voluntary, then follows up by asking "What use is default insurance if there's a default and no payouts?" (see A Guide to the New Deal in Athens: How a 'Selective Default' Works)

If you ask me, Credit Default Swaps (CDS) should not be allowed. I cannot buy insurance against your house burning down, because I have no "insurable interest", and doing so would give me an incentive to set your house ablaze. The word "swap" in the CDS acronym is a fig leaf, just put there to allow lawmakers to pretend that they are not insurance, and can be used by financial institutions in an unregulated fashion. New regs are trying to change this, but the CDS market is still murky and opaque -- its been 8 years since Warren Buffet called these and other derivatives "financial weapons of mass destruction". A large part of what makes a Greek default so scary is that it is impossible to tell what exposures are out there, and what dominos will fall if Greece stops paying off.