Tuesday, August 25, 2009

The Effects of Epic Stimulus

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Gary’s Note: Stimulus distorts. So you have to be very wary when looking at what are supposedly market signals, lest you make a misstep. Chris Mayer is on hand to help out.

Whiskey & Gunpowder
By Chris Mayer

August 25, 2009
Gaithersburg, Maryland, U.S.A.

The Effects of Epic Stimulus

What makes investing particularly difficult now is that the distortion in prices, as if reflected in a funhouse mirror. Normally market prices should reflect underlying demand and supply. As in a vegetable stand, the prices come from the buying and selling of people in the market.

But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?


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It’s hard to say, but let me give you a couple examples of distortions…

CNN’s bailout tracker reports that US government stimulus has totaled $2.8 trillion so far this year, with another $8.2 trillion in commitments. Most of this money has gone to the financial sector. Some of it has gone to infrastructure projects and to consumers (cash for clunkers, for example).

That is a lot of money. It is hard to say how all of this spending has artificially boosted economic activity in some sectors of the economy. It is obvious that such spending cannot continue indefinitely.

This has also been a worldwide phenomenon. There isn’t an economy of size that does not have some stimulus-spending program in place. Governments are spending money they don’t have. The result is widening budget deficits and higher debt levels.

First up, take a look this graph, from the Economist, which shows the industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. That chart shows the “decoupling” that became such a hot topic of discussion last year. The idea was that the emerging markets would not necessarily follow lockstep with the Western countries.

But this graph only tells a part of the story. China is one of the countries in “Emerging Asia.” China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009… The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009…an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?”

Let me remind you that GDP is a clumsy way to get at an economy’s size. It is a figure that includes government spending. So, put another way, stimulus money this year is about 64% of the recorded economic activity in the first half of last year for China.

Where the Money is Going — Commodities

In some ways, the Chinese government spent well — investing in the commodities it craves. It’s locked down oil and gas assets, iron ore contracts, interests in rare earths and more. It’s put up power plants and laid down roads and pipelines. It’s made long-term investments in Africa and Brazil. Some of that will pay dividends down the road, if not already.

For instance, in the first six months of this year China became Brazil’s single largest export market. That’s the first time that’s ever happened. The Chinese and Brazilians are doing deals. For instance, China will lend $10 billion to Petrobras in return for 200,000 barrels of oil per day. China, in fact, has been active throughout South America, investing billions in mines, refineries, ports, and railroads.

These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen.

It’s clear that China will have enormous needs for commodities over time. In the short-term, we are surely seeing distortions from the stimulus money. But the long-term demand is there nonetheless and the Chinese have a lot of money to spend.


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Global Infrastructure is Still Getting Older Everywhere

In fact, infrastructure needs — especially in the areas of water and energy — are becoming more of a headline issue than ever. Not a week goes by where I don’t pick up a handful of stories of infrastructure falling apart somewhere. This, too, is a global story.

This week, for instance, there was a terrible accident in a Russian hydropower plant. Eleven people were killed and 65 were missing after water burst into a turbine room. It also destroyed the turbine. Besides the irremediable loss of life, it will take hundreds of millions of dollars and years to repair the demand.

As the FT reported, the accident “was a powerful reminder of Russia’s dire need for hundreds of billions of roubles in investment in its crumbling Soviet-era infrastructure.”

Putin’s government put aside $200 billion for infrastructure in two oil windfall funds, but that money is already being tapped for social spending programs and to help make up budget deficits. As in many places, including in the U.S., money set aside for infrastructure has been essentially hijacked by the political process and diverted to other uses.

Another story this week comes from Britain. Britain faces huge deficits in energy and the risk of widespread blackouts. Its energy complex is old and strained. The Economist reports: “The nuclear stations are simply too old to carry on: most are over a quarter of a century old. Around half have already been shutdown and are being decommissioned.”

About half of its electricity comes from natural gas, a legacy of its North Sea riches. But the North Sea peaked in 1999 and has been in steep decline ever since. Britain’s coal plants struggle under new pollution control rules and the effects of age. It’s an ugly situation that will cost a lot of money to fix.

The positive for investors is that there are several firms that are right in the sweet spot of this global infrastructure crisis. We own a few.

Chris Mayer

A Parting Shot
“I am so sick of these death threats,” I complained out loud.

The Whiskey Bar recently relocated to a quiet corner of the Agora Financial building. Here the Bar has only two very quiet neighbors. One of them is Bruce Robertson. Bruce coordinates the yearly Agora Financial Symposium, among other things.

“Death threats?” he asked.

“Well not exactly. I mean they’re not saying it…for legal reasons, I’m sure…but you can tell that’s what they mean.”

The nasty e-mails calling me a big meanie were still pouring in. I’d had just about enough of Whiskey readers (of all people!) explaining to me that universal health care existed in some pocket hyper dimension where the laws of supply and demand didn’t apply.

Bruce and I were among the few remaining souls in the building after 6:00pm. I had to complain to somebody and he made an easy target.

Bruce’s father is a Scottish citizen while his mother is Canadian. So by his own admission there’s a lot of socialist blood running in his veins. I took care not to offend him.

I needn’t have worried, however. If you work for Agora Financial, you have a keen sense that there ain’t nothin’ free…and that offers from the government ought to be turned down gently.

“Catastrophic insurance is a good idea, of course.”

I hadn’t thought too much about that. I’d read that New Zealand covers everyone that way. I wasn’t sure I like the idea of government paying for it. At the same time, it would be awful to be hit by a car and then be left dying in the street because that month’s premiums hadn’t been paid.

“You don’t want people using insurance to tie up doctors’ (expensive) time with things that will clear up on their own…but in the event of emergency, it’s nice to know you’d be taken care of.”

“Indeed,” I agreed. “But who pays for the insurance?”

Do we all pitch in a little bit in our taxes to cover each other? Seems like a slippery slope to me. Most of you would call me dogmatic. Why not allow the state to handle something that seems like such a good thing at so small a cost, something so downright…communitarian!

But the state has ever proved that it’s not very good at handling much outside of taking people’s stuff via taxes and war.

Now before you get busy abusing your keyboards to point out how well the state is handling health care everywhere else in the First World, let me point out that the state is already intricately involved in health care in this country. Licensing, proscriptions, outright bans…all these things effectively create a monopoly which limits choices and drives up costs (sound familiar?).

No one is willing to address this sort of problem at its root: the state already interferes with the market when it comes to medicine. They claim that otherwise quackery and snake oilism would bloom like mushrooms after the rain.

I don’t have the space to debate that here. Nor the inclination after three days of abusive e-mails.

I’ll just fall back on my persistent wish: that states were much, much smaller…and that they had to compete in the market with other states as well as the private sector for customers.

I wish I could choose my level of government simply by moving to a different town or city. If I wanted to sign a social contract and pitch in via taxes for a bevy of services, I could live in a socialist pile up like New York. If I wanted minimal taxes and more self-reliance, I could move to someplace smaller and saner. And maybe there’d be a place in a jungle for me to get away from all of it.

Alas, that’s the thing with the nation-state. No matter where you go, there you are.

States in the industrial era enjoyed the same economies of scale as factories. Never before were governments able to marshal so many resources (tax) and project so much force (make war). Communism tends to remove incentive from its slaves, but democratic capitalism keeps the carrot before its citizen laborers so that there is more income to appropriate.

In the real world the only level of taxation I can change by moving is the tithe I pay for owning land. Wherever I go, there the state will be, taking its pound of flesh in exchange for its protection. Sort of like a gangster keeping the victims of his extortion safe from other groups of thugs…

Well, enough of that. Soon enough we’ll all be able to get all sorts of expensive medical treatments at no visible cost! I can have that new knee I’d been saving up for.

You can direct your outrages to gary@whiskeyandgunpowder.com …but I won’t be reading them. I promised you and myself that I’d take a little break for a few days. You’ll continue to get Whiskey, but the Parting Shot will have departed until next week. And we’ll find something else to holler about.

Gary Gibson
Managing Editor,
Whiskey & Gunpowder

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