Demographics and Economic Crisis

The anti-population mainstream media has been doing some hand-wringing over the arrival of the 7th billion person on this planet, and warnings about environmental and food crisis have been flowing non-stop.  Not unexpectedly, intelligence service Stratfor has provided a piece on this matter via its Geopolitical Diary service. What was different was that Stratfor argues that we are on the verge of a population decline with the advanced countries leading the way via their aging populations.

One part of the article that resonated with me was the following:

Demography drove economies to this condition in the 1990s, when credit (and thus growth) increased. In the 2000s, mature workers produced a good deal of excess capital. The 2010s find the global economy correcting itself after 20 years of excess-capital-driven growth — at the same time as mature workers are retiring and leaving their capital-supplying role.

A darker period is likely to dawn by the 2020s. Most of those high-wage earners will have retired — they will no longer supply capital and instead will depend on the state to issue their pensions. The cost of capital will invert strongly. The generation born between 1964 and 1979 — characterized by its low numbers — will be responsible for supplying capital. They will not only have to fund the younger generations but will also have to support the pensions and geriatric-support programs created by their predecessors. Since the developing world’s aging process lags about 30 years behind that of the developed world, this same generation will act as the primary capital suppliers to the entire world. 

The developing world started to age too late. Its countries will lack enough mature workers to generate the capital needed to replace that which can no longer be imported from the developed world. The developing world will experience the financial challenges of the developed world, without having built up the infrastructure and industrial base the developed world has had for three generations. Such capital scarcity threatens to halt growth across the poorer parts of the planet. It will also make for strange bedfellows: the only hope the developed world’s ’64-’79 generation will have to meet their bills is to import more taxpayers. Perhaps the most unexpected outcome of population patterns is that the developed world will have a massive interest in attracting immigrants

The significance of the aforementioned for me is that while I disagree with the government's immigration policies as they now stand, one can see that if Stratfor's analysis is correct, Singapore is already quite ahead of the curve in terms of preparing for the darker future postulated.

As some commentators have noted, we could well be in the midst of a Kondratieff winter.  If that were the case, this dynamic of aging population in the developed world will have very serious repercussions for the global economy.  I suspect that those Singaporeans currently paying $100K COV for bigger HDB flats and $75K for a COE will not have too happy a future.

China Bailing Out the Eurozone

It's amazing what politicians will do to keep the status quo and their privileged positions.

The idea that China, a country of peasants who can barely afford to feed themselves, should put money into Eurozone bonds to bail out the fat cat bankers of Europe seems to defy common sense.  And yet, the financial markets rally on the news.  So much for the crap in finance textbooks known as the 'efficient market hypothesis'.

On China's part, it is merely trying to keep its mercantilist policies going, since it needs an export market for its excess industrial capacity.  Global debt deflation will immediately bring China into a Kondratieff winter that will make the Great Depression look mild.  Also, given the problems within China's financial system, one has to wonder where they are going to find the money to bail the Europeans out.  The US$ 3 trillion in reserves that the PRC supposedly has isn't actually enough to fix the internal financial black-holes there.

As for Europe, I think the 'peasants' who still can't accept the fact that their 60-year experiment with socialism has failed will eventually rise up and revolt against the political establishment in Brussels and their respective home countries.  Europeans will not likely take kindly to the prospects of their politicians selling the continent's 'crown jewels' to China.  This is something that the CCP leadership appears not to have understood so far.

Gold Breaks Above US$1650

Gold has finally achieved the price target of US$1650 set by the legendary Jim Sinclair many years ago.  Based on the movements in the US stock market overnight, it appears that market players are fleeing risk and that gold has finally become a safe haven play along with silver.  Unlike the last time round, the USD has not really been a safe haven play.

While many people were relieved by the debt-ceiling agreement in the US, the fact remains that nothing has been fundamentally fixed with regard to the untenable fiscal position of the US federal government.  I expect a full blown crisis soon, probably within the next 2-3 years.  I hope to be able to write more about this issue when I have time from my work.

Over in Europe, we have more rumblings as markets now attack Italian sovereign debt.

I think we are in for a rough ride in the markets over the short-term.

Market Outlook 20110717

Since my last Market Outlook more than a month ago, things have deteriorated in the Eurozone, with a debt downgrade for Portugal while Italy's problems have come to the fore.  Despite attempts by politicians to postpone the day of reckoning in Greece, things have not worked out as planned either. When these are taken together with the ongoing budget theatrics in the US, it is easy to see why many in the Western world are fleeing risk markets and moving into the ultimate safe haven asset - gold.

According to trader Dan Norcini, the gold chart patterns are suggesting to him that there is real fear amongst speculators that big troubles in the global financial system are heading our way.

When I look at things from a political perspective, a debt crisis in the developed world is a certainty - the only thing uncertain is the timing.  The reason for this is that the people in the developed world have, for the most part, not woken up to the terrible state of their countries' public finances.  Having lived for so long in a welfare-state system, they seem unable to mentally process the simple concept of 'We are broke'. In Greece for example, they have rioted, blamed the Germans by appealing to their 'past sins', and now even tries to demonise the Greek Orthodox Church for failing to pay its 'fair share' of taxes.  They simply have failed to realise that even if they tax the rich and Greek Church at 100%, there would still not be enough money to pay for welfare in a country of 11.5 million people that has fewer people working productively than Singapore.  Furthermore, as pointed out by the legendary James Dines:

Clear-eyed perusal of Greece seems that an inventory is required of what that nation has to sell to the world in exchange for its imports, for example: energy, medicines and oil. Greece has no prominent industrial manufacturing base, so it is reduced to selling its climatic beauty and relics; with copyrights on The Iliad and Odyssey having expired long ago, and fabled Greek drama supplanted by robocop-like movies, Greece is at a crossroads of something dramatic, possibly penury.

Thus, I think John Hathaway, a top portfolio manager in the gold mining sector, was right when he stated that 'welfare state democracy is incompatible with sound money', which to me means that politicians will continue to implement unsound Keynesian policies to try to hide reality from their electorates, and to try to deflect blame from their own corruption and collusion with greedy bankers.

Given the high degree of uncertainty in the current environment, I continue to think that only nimble speculators should involve themselves in the markets.  Long-term investors who want to implement a 'buy-and-hold' strategy will find the stock market challenging, and the only place that I can see such a strategy work is the gold market.

As an aside, I picked the quote from James Dines above to show that far more intelligent and successful investors than myself are of the view that a service-based economy is not capable of sustainable wealth creation and will lead to long-run fiscal problems.  As I have stated previously, I think Tan Jee Say has got it wrong in this regard.

A Good Summary of the Troubles in the US

I came across the follow passage from this month's edition of The Dines Letter, published by the legendary investor James Dines.  It provides summary of the challenges facing the US in the coming years, and is the basis for much of my investment think:

A richly-endowed America drained the bulk of its inherited reserves of
crude oil long ago, along with many of its other resources, well ahead of the
rest of the world. Now, with its work force priced uncompetitively higher than
hungrier labor in world markets, it is basically out of business and in
forebodingly deepening trouble. Why is that not more widely evident? By
historic accident the United States owns the world’s "reserve currency" such
that it can print as much money as it chooses, which we described clearly in
our Goldbug! book.

America can still use its great intellectual resources to create games and
social websites, much as a comparably hollowed-out England became the
world’s balladeers (exemplified by Beatle mania) after World War II. But
every action has consequences, and the racket of just printing money and
borrowing has never ended well. America scurries about to spend its wealth
on wars – justified or not – and nobody inquires as to where those dollars
wind up. Worse, to crown the spending, America additionally borrows over
$40 for every $100 it spends, a clearly unsustainable folly.

Unlike George Friedman's more optimistic analysis of the prospects for the country in the next decade, Mr. Dines is decidedly less enthusiastic about his country's future.

In the same article, he also predicts that we will soon see the end of free markets as nations scramble for the remaining resources of the world.  This line of thinking is similar to those of historian Harold James, who sees a general move towards state-directed capitalism, the type commonly practised in this part of the world.

Current Investment Strategy

Disclaimer: By law, I am not qualified to give investment advice, so the following does not pretend to be such. Read at your own risk.

Someone left a comment on one of the blog posts here and asked what my investment strategy would be, so here's an outline of my current investment thinking.

Long-term Fundamentals

The longer term issues that underpin my investment thinking are:

• Peak oil
• Resource scarcity
• Sovereign debt problems in US, EU, Japan
• Instability in the Middle East
• Possible instability in China
• Collapse of the USD-based global currency system
• Possible global depression

Because of these issues, I tend to think that the Warren Buffett style of investing will no longer work. Notice that his track record has been rather poor in the past decade: Wells Fargo needed a US Federal government bailout. Citibank's liabilities far exceed its assets if they were marked to market.

Where possible, I will put my money in things which will appreciate in value should any of the aforementioned issues come to the fore. Given a more expansive idea of what constitutes investments for me, even buying additional bags of rice for storage (during sales) can be an investment in an environment where food prices are going up steadily.

Short-term Challenges

The biggest short-term issue is US Federal Reserve policy, namely whether or not it will continue to 'print money' and debase the USD against everything else. Overnight US markets have been very quiet, reflecting a wait-and-see attitude. If there is any hint of tightening, I think a lot of markets will come off. Hopefully things become clearer once the Fed policy signals become known.

The forces of debt deflation continue to be met with global central bank efforts to re-inflate the system, thus causing a lot of cross-currents which make investing a challenge for many people.

Some Other Thoughts

These are some other things that colour my investment thinking:

• Real estate in Singapore is currently priced as if nothing bad will ever happen to the global economy or our own.
• Singaporeans are over-leveraged due to expensive housing.
• CPFIS policies need to be updated. They still reflect a pre-2000 view of the investment universe. Unless they are revised to reflect the new reality, there will be a retirement funding crisis down the road.
• Unless you have more than S$1 million to invest, you are very, very likely to get poor investment advice from the professionals. Most of the financial advisors who are in the 'retail market' serving poorer customers (I am such a customer) are, in my view, not equipped to handle the complexity that we are now experiencing. As such, I think expending effort to take control of your own investments is the way to go.

Current Portfolio

Some of the things I currently hold:

• Gold and silver
• Mining shares

I am looking to get into positions in energy once the uncertainty over US Fed policy has abated to some extent.

Finally, the most important 'asset class' for the future - trusted friends and family. This may be the most undervalued 'asset class' in Singapore right now.

Pardon the lack of fluency and organisation in this piece. :-)

James Kunstler's 2011 Forecasts

Well-known peak oil author James Kunstler has written a very long article on his blog detailing what he thinks could happen to the global situation in 2011. While I don't agree with some of the stuff he has written, his piece is nonetheless a very thought-provoking one.

In the article, the issue of the break-down of globalisation and even advanced industrial activities were considered, these being a corollary of the breakdown in both the global financial system and a short-fall in the output of oil. While such a prediction may not come to pass any time soon, I believe that the scenario is worth contemplating, especially with regard to how it would impact Singapore's economic survival. Personally, I find thinking about such a scenario allows one to appreciate the fragility of our country and to pierce through what I believe is a false sense of security arising from our national wealth.

Be that as it may, I also feel that the article provides some useful inputs as to the type of issues that we have to be prepared for in terms of dealing with unfavourable future outcomes.

Merkel Pledges Permanent EU Bailout Fund

The BBC has reported that German Chancellor Angela Merkel has vowed to implement a permanent bailout mechanism for the EU. As I have written earlier, the debt crisis will continue, and that's why the EU politicians deem that there is a need for a permanent bailout fund.

There was speculation earlier in the day as to the course that the Germans would take given that the continued bailouts have started to affect the country's credit ratings, as reflecting in the credit default swap market.

It seems to me that while the German people are unhappy with having to pay for the mistakes of other EU nations' banks (I believe that such bailouts benefit banks and shift the burden to taxpayers), their ruling elite has decided that the half-a-century political effort to build a united Europe and to prevent another war is worth the financial sacrifice. To make matters worse, several EU countries have started to take money from pension funds to support their fiscal shortfalls.

Given the protests that have taken place all over Europe, one has to wonder how much longer the political elite of the EU can continue to ignore the views of the people and pretend to be democratic.

In response to the Irish bailout, financial markets have sold off the Euro against the USD, and stock markets in Europe have ended Monday largely down.

Looking at the USD/SGD price chart, it would appear that the USD has reversed its downward course against our local currency. We could perhaps see the 1.40 level again if a big financial event occurs in the near future.

US Federal Reserve QE2 looks set to fail

Since the US Federal Reserve announced its US$900 billion 'QE2' programme of buying US Treasury debt and other mortgage-backed securities, stocks, bonds and commodities have moved violently in response. Looking at the intra-day actions on Wednesday and Thursday (US time), the market seems to be signalling failure of the new policy. Here's why.

Whatever the ostensible reasons for 'QE2', one important reason for the Fed's actions is to prop up the US stock market, using the 'reflation trade' to try to create enough wealth effect to stimulate household consumption, and thus get the US economy moving again. This is typical Keynesian thinking.

However, when we look at the market movements in the latter part of the week, we find that while US stocks have moved up, commodity prices have increased to an even greater degree. Since commodity prices influence cost-of-living, it means that the weak wealth effect has been more than negated by pipeline inflation. Thus, the market appears to me to be saying that the Fed's leveraging up of its balance sheet ultimately is a lot of 'noise' but no real impact is achieved. This is exactly what economists of the Austrian School have predicted together with some of the more savvy market participants.

For us here in Singapore, what this means is that we have to discount most of the 'good news' that the mainstream media is feeding us about the effectiveness of the Fed's latest policy move in helping the US economy to recover. The risk of a 'double dip' is still out there, probably in 2011.

Current Global Economic Conditions

Despite the strong performance of the Singapore economy so far this year, it is prudent to take note that the outlook for the global economy in the next 6-12 months is quite negative.

In the US, despite the NBER's proclamation that the recession was over in the middle of 2009, the reality appears to be that it is still in the midst of a severe economic contraction, to the extent that some US econ bloggers have called it a 'depression'. Consider the following statement put out by the folks at The Automatic Earth:

"77pc of Americans are now living paycheck to paycheck, in 2007 this figure was 43pc. That's 239 Million people one lost check away from ruin"

At present, there are about 43 million Americans who are on food stamps, and the level of desperation was aptly described by WalMart CEO Bill Simon, as reported by the Wall Street Journal:

"And you need not go further than one of our stores on midnight at the end of the month. And it’s real interesting to watch, about 11 p.m., customers start to come in and shop, fill their grocery basket with basic items, baby formula, milk, bread, eggs,and continue to shop and mill about the store until midnight, when electronic — government electronic benefits cards get activated and then the checkout starts and occurs. And our sales for those first few hours on the first of the month are substantially and significantly higher"

Over in Europe, Ireland is now acknowledged as the first country to officially go into a 'double dip', while the German economy has also slowed and the Greek situation is nowhere near resolved.

In Asia, the Japanese are upset with the Chinese buying their bonds, which they feel is a backdoor way of forcing the Bank of Japan to intervene in the FX market to weaken the Yen, so as to divert US Congressional attention away from the Chinese themselves, who are refusing to let the RMB rise. That said, China itself is not in any particularly strong state. In an effort to stave off protectionist measures by the US, Premier Wen Jiabao has stated on Bloomberg that a 20% RMB revaluation would cause social upheaval. Given the amount of excess manufacturing capacity in China and the razor-thin margins of the exporters there, I personally take Mr. Wen's statement as an appeal from a position of weakness rather than strength.

On top of all these, there appears to be a currency war going on globally, as the central banks of all the major economies are trying to avoid a strengthening of their own currencies against the USD, while the US Federal Reserve's intention to weaken the USD is being taken seriously by the markets, as evidenced by the strong performance of gold and silver.

Given the above, I believe it may be prudent to take steps to guard against the systematic currency devaluations that are taking place now. For my fellow Singaporeans, I have this to say: Go easy on the property speculation, there are risks just around the corner. I will write more regarding this in future.