Mish's Global Economic Trend Analysis

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• Syracuse New York Headed For Bankruptcy, 100% Certain
• Germany 6% Current Account Surplus a "Threat to the Continent" Says EU Commission; Solution is Gold Coupled With Eurozone Breakup
• France Beats Expectations With 0% Growth; Eurozone GDP Sank .2%

Syracuse New York Headed For Bankruptcy, 100% Certain Posted: 14 Aug 2012 07:28 PM PDT Without a doubt Syracuse, New York is headed for bankruptcy. Not only is there an "official denial" but the mayor of Syracuse is seeking legal guidance on municipal bankruptcy. Once again, public union wages and benefits, especially police and firefighters' pensions are smack in the midst of it. Please consider this news headline which I openly mock: Expert says bankruptcy for Syracuse is unlikely, but mayor should explore option While the financial situation in the city of Syracuse hasn't been described as desperate yet, Mayor Stephanie Miner has asked for some legal expertise on municipal bankruptcy. The signs of the city's financial problems have been evident for several years as city employees accept wage freezes and fire and police departments see staff reductions. The city will use an early payment from Albany to help keep the budget from dipping into dwindling reserves. Skyrocketing pension and healthcare costs continue to be a problem for the city budget. "Bankruptcy isn't the answer. It's not like we sort of restructure and become a different city," said Professor of Economics and Senior Associate Dean, Maxwell School at Syracuse University Michael Wasylenko. The mayor's office says it is also learning about what a municipal bankruptcy would mean, following places like Stockton, Calif. who made that move. The state has invoked a Financial Control Board before, currently in the city of Buffalo, twice previously in Yonkers, and once in New York City. Mish Translation Syracuse is doomed to bankruptcy Skyrocketing pension and healthcare costs have sealed the city's fate. Bankruptcy is the answer There is no other means to rid the city of onerous public union wages and benefits Professor of Economics and Senior Associate Dean, Maxwell School at Syracuse University Michael Wasylenko is so clueless that he deserved to be fired. Unfortunately, I strongly suspect that union contracts prohibit that option. In the union world, tenure rules. Gross incompetency is simply not grounds for dismissal, pay cuts, or pension benefit reductions. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Germany 6% Current Account Surplus a "Threat to the Continent" Says EU Commission; Solution is Gold Coupled With Eurozone Breakup Posted: 14 Aug 2012 11:34 AM PDT Germany's current account surplus has reached six percent, an amount that bureaucrats in Brussels have decided is a threat to the entire continent. The EU commission will likely issue a warning to Germany with threats of sanctions if Germany does nothing about it. I picked up this story from Eurointelligence which writes "FT Deutschland reports that Germany's current account surplus is likely to exceed 6% of GDP this year, the threshold which triggers a European Commission warning. The German government maintained its position that there was no problem with current account surpluses. On the contrary, the German economics ministry sees this a "very positive" development. The German government spokesman said yesterday that the problem of imbalances was a problem for a countries with large current account deficits." Mathematical Insanity Got that? Allegedly, large deficits are a problem but large surpluses are not. Given that surpluses and deficits must net to zero, the position that only deficits are a problem is ludicrous. Mathematically, both are problems or neither are problems, because you cannot have one without the other. Bear in mind it was not Eurointelligence that took a mathematically ludicrous position, but rather articles they referenced.   Germany's Surplus Could Trigger Collection Procedures Let's take a look at the Financial Times Deutschland article referenced above (translated from German and further modified by me for ease in reading) This year Germany recorded its highest trade surplus ever. This could crumble into the Federal Republic 2013 EU-collection procedures. The new macro-economic early warning system in Europe provides that a current account surplus over 6.0 percent of gross domestic product is a threat to the economic stability of the continent. The EU urges its members not to allow imports and exports fall apart too far. The early warning system developed Brussels to name mistakes and sanction if necessary. Since this year can be monitored in addition to the current account including private and public debt and the development of the real estate markets. As part of the EU early warning system Luxembourg and Sweden also have excessive surpluses. In Luxembourg, the current account surplus in 2011 was 6.4 percent of economic output - approximately $4 billion. For the same year, Germany had a surplus of over $200 billion. Only Deficits a Problem Says Frankfurter Allgemeine An article in German Daily paper Frankfurter Allgemeine, by business editor Philip Plickert says Only Trade Deficits a Problem. The very concept of "macroeconomic imbalances" is highly questionable. If countries have permanently high current account deficits and foreign debts pile up higher and higher, things may not go well. So the Euro periphery has slipped into crisis. Trade deficits were and are an expression of lack of competitiveness. Germany's surpluses are high contrast to the special strength and structure of the local economy. Germany produces high-quality (investment) goods that are used in emerging countries. This is no cause for concern. Euro as Gold Standard In one of the silliest articles ever written about European trade imbalances, Joe Weisenthal writes Actually, There Is A Gold Standard Today, And It's Causing An Economic Catastrophe. While it's easy to talk about the endless crises under the gold standard days of the 1800s, the truth is that we don't have to go back that far at all. Europe is a close analogue to a gold standard. Remember, each European country lacks the ability to print their own money. All the European countries have a fixed 1-to-1 exchange rate, with no ability to devalue their currencies to correct trade imbalances. The currency is designed to keep governments accountable, acting as a check on uncontrollable spending. Countries have to raise through taxation or the bond market a certain amount of Euros each year to spend. Bottom line, [the euro] is a hard money scheme in sheep's clothing. Notion the Euro Acts Like Gold Standard is Ridiculous Equating the euro to a gold standard is ridiculous. The ECB's (Emergency Liquidity Assistance) program acts exactly the opposite of a gold standard by allowing imbalances to accumulate to the point of crisis, a state the Euro is clearly in now. For further discussion, please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks "Can You Please Explain Target2?" "The Trade Imbalance Dilemma and Soaring Chinese Debt" Here are some comments from Michael Pettis that I wrote about in Hugo Salinas Price and Michael Pettis on the Trade Imbalance Dilemma; Gold's Honest Discipline Revisited The strength of the German economy in recent years has largely to do with its export success. But for Germany to run a large current account surplus – the consequence I would argue of domestic policies aimed at suppressing consumption and subsidizing production – Spain and the other peripheral countries of Europe had to run large current account deficits. Trade Imbalances Lead to Debt Imbalances The funding by German banks of peripheral European borrowing, in other words, was a necessary part of deal, arrived at willingly or unwillingly, leading both to Germany's export success and to the debt problems of the deficit countries. As long as Germany runs current account surpluses for many years and Spain the corresponding deficits, it is by definition true there must have been net capital flows from Germany to Spain as Germany bought Spanish assets (which includes debt obligations) to balance the current account imbalances. The capital and current accounts for any country, and for the world as a whole, must balance to zero. In the old days of specie currency – gold and silver – this meant that specie would have flowed from Spain to Germany as the counterbalancing entry, and of course this flow created its own resolution. Less gold and silver in Spain relative to the size of its economy was deflationary in Spain and more gold and silver in Germany was inflationary there – until the point where the real exchange rate between the two countries had adjusted sufficiently because of changes in domestic prices to reverse the trade imbalances. The Current Account Dilemma In today's world things are different. There is no adjustment mechanism – specie flow or imperialism – that permits or prevents persistent current account imbalances. This means that if Germany runs persistent trade surpluses with Spain, there are only three possible outcomes. First, Spain can borrow forever to finance the deficit (of which the ability to sell off national assets is a subset). [Given the size of Spain], this clearly is not a possible outcome. Second, Spain can take steps to erode the value of those claims in real terms. It can do this by devaluing its currency, by inflating away the value of its external debt, by defaulting on its debt and repaying only a fraction of its original value, by expropriating German assets, or by a combination of these steps. [Third] Germany must accept a reversal of the current account imbalances or it must accept an erosion in the value of the Spanish assets it owns as a consequence of the current account imbalances. This is the important point. Once you have excluded infinite borrowing capacity there are arithmetically no other options. Given the limits, especially debt limits, it is irrational for anyone to expect that Germany can continue to run large current account surpluses while Spain does nothing to erode the value of Spanish assets held by Germans. I suspect that Germany is hoping and arguing that Spain can somehow reverse its current account deficit without the need for Germany to undermine current account surplus. But this won't work. Problem in Europe is Arithmetic, Not Confidence I wrote about European math again, just a few days ago, also referencing Michael Pettis. In case you missed it, please consider Problem in Europe is Arithmetic, Not Confidence; Why the Eurozone Cannot Possibly Survive Intact The current problem most certainly is math, and mathematically "Germany must accept a reversal of the current account imbalances or it must accept an erosion in the value of the Spanish assets it owns as a consequence of the current account imbalances." Everyone is looking for magic bullets but there are none. One way or another, much pain is coming to Europe, including Germany. Mathematically it must be so. Root Cause of the Debt Crisis and Trade Imbalances The root cause of this mess (including the USA's huge trade imbalance with the rest of the world) is twofold. Fractional Reserve Lending Lack of a Gold Standard (Or Other Enforcement Mechanism) No Better Enforcement Mechanism than Gold Rather than blaming this mess on the gold standard, one of the reasons for large trade imbalances is precisely because there is not a gold standard. Most of the problems people assign to the gold standard are not problems with the standard at all, but rather problems associated with fractional reserve lending that allowed more gold to be lent out than there was actual gold. Bear in mind that Pettis does not support a return to the gold standard. However, Pettis does believe an enforcement mechanism is needed. For further discussion, please see Michael Pettis Warns of "Virulent Political Turn Against Euro", Adds Clarification to "Gold's Honest Discipline" Certainly, lack of an enforcement mechanism regarding trade is an enormous problem. Debts pile up forever, with no way to pay them back. From my point of view, history suggests there is no better enforcement mechanism than gold. Unfortunately, Mitt Romney believes the solution to the US trade imbalance with China is labeling China a currency manipulator, to which he has promised massive tariffs. Should Romney do that, a collapse in global trade is likely, just as happened during the Great Depression following passage of the Smoot-Hawley Tariff Act. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

France Beats Expectations With 0% Growth; Eurozone GDP Sank .2% Posted: 14 Aug 2012 08:35 AM PDT Eurozone GDP sunk .2% in the second quarter and is clearly back in recession as a whole. For that matter, the eurozone has been in recession all year if not starting in the final quarter of 2011. Thus I am amused by headlines such as this one from the Financial Times: Eurozone edges back towards recession The eurozone edged closer towards its second recession in three years after a resilient economic performance from Germany and France failed to prevent the single currency bloc from contracting in the second quarter. Gross domestic product in the euro area shrank 0.2 per cent in the three months to June, compared with the previous three months when there was no growth, as the economies of Greece, Italy, Spain and Finland contracted sharply. Robust investment and domestic consumption helped the German economy expand 0.3 per cent in the second quarter, beating expectations of just 0.1 per cent growth, while French GDP remained unchanged avoiding a highly anticipated contraction. The Netherlands also outperformed forecasts, growing 0.2 per cent. But a 1 per cent fall in economic output in Finland, a close ally of Germany in the battle for greater austerity in Europe, illustrated how the sovereign debt crisis that has been troubling southern Europe is spreading to the bloc's economically stronger core northern states. The FT suggested the outperformance of Germany will not last, something I strongly agree with. Italy, the third largest eurozone economy contracted at .7% quarter-on-quarter and Greece shrank at 6.2% annualized. Even by a strict definition of two consecutive quarters of negative GDP, does this look like a recession or not? That chart is going to look a lot worse when Germany and France both decline in a meaningful way next quarter. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

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