Thursday, May 07, 2009

Is It Good To Be The King? - Growing Fissures In Germany And The European Union

I didn't post the chart of the Euro a few weeks ago by coincidence. Today the European Central Bank joins the world in the new phase of race to the bottom of the barrel by announcing the new purchase of debt instruments. It's apparent that we actually have to watch the world economy stimulate itself to death with money it doesn't have and quite possibly can't repay before we see fundamentals return. It's a little like watching a bad adult-entertainment movie and spending your life savings to do it. All while being unemployed. (Get it? Stimulate itself to death.........a little bad monetary policy humor.)

The continued rhetoric out of EU leadership is that they have the tools necessary to deal with any systemic shocks. Rhetoric, better known in America as Big Hat, No Cattle is a fine quality mastered by all bureaucrats and politicians. In other words, bureaucrats and politicians have little, if any, control over crises such as this. Don't worry though. You have a problem? A politician will have an answer for it. The only answer politicians have always involves other people's money. That might be acceptable when it has to do with social issues but that's not really what is going on now is it?

The end of this cycle perplexed most everyone with its voracity. Remember, those watching for traditional signs of a recession unexpectedly saw the world collapse around them while signs of an economic slowdown were generally very muted. Now, those same people are anticipating a recovery using senseless metrics such as housing and consumer spending. That includes many bears. This misunderstanding of how the world works is a major reason why so many prognosticators kept remarking that the global economy was fine as the bottom continued to fall out of global asset prices. Only realizing the size of the crisis when it was too late to react. The main reason for this? Typically a business cycle slow down causes a credit crunch. This cycle the credit crunch caused the cycle slow down. Something our models anticipated and we warned of before there were signs of trouble on the horizon.

In the last few months the world has just started to see a rise in the substantial economic consequences associated with a normal cycle slow down. Although this is a permanent economic shift rather than anything normal per se. As we have stated repeatedly, there is zero chance we will return to the economic environment of the last ten or twenty years. Absolutely zero. A very few are now starting to ponder a different outcome and its consequences. But global politicians and their economic ideologists are still attempting to serve last week's leftovers to the world's populace. That being gruel with a nice tall glass of ditch water. How's that working for you? (In other words, attempting to restart the economic policies of the last few decades.) This will only make the outcome that much more painful.

As we leave the initial financial shock wave and enter the economic shock wave of this cycle, we can start to gain an appreciation for the scope of this crisis by now looking at traditional measurements of economic activity. One such measurement is the demand for industrial investment. Germany is the largest exporter of industrial equipment in the world. It has been a key beneficiary of the global over-industrialization we have talked about for the last four calendar years.

As we look at Germany's foreign orders for industrial goods, we can see that its decline in output substantially lagged the initial shocks of this cycle. This would be anticipated in this type of environment as we highlighted above. In fact, global assets had already collapsed by the time measurements were signaling a substantial economic crisis had developed in Germany's foreign orders for industrial goods. Yet new orders have now literally collapsed. The last five months have seen orders decline at a -30 to -40% rate for the first three months then the last two being close to -50%. This was well after the collapse in the stock market confirming the credit crunch led the economic cycle slow down. Yet, this measurement now tells of a far more ominous future. A future not appreciated by rhetoraticians.

Don't let the politicians and bureaucrats fool you. We can expect the global economy's downturn to be lengthy and deep based on the collapse in demand for Germany's industrial goods - a major determinant of future wealth creation.

While Germany is a fundamentally sound economy, other than China, it is possibly the highest risk developed economy due to its extremely unbalanced domestic demand and an over-reliance on exports. A reliance that is triple the rate comparative to GDP of even the industrial exporting powerhouse, Japan. In other words, the Japanese economy is substantially more sustainable than Germany's. And, since China's propaganda machine is often good at passing along statistics they want the world to believe as opposed to reality, Germany's investment goods export statistics provide an unvarnished perspective of what is really going on around the globe.

Germany's reliance on industrial exports will cause substantially more economic pain than is being discussed today. Amongst many other reasons, Germany's relative position on the global supply chain guarantees it will experience very substantial impacts of the global crisis well after the initial credit effects are felt. Possibly semi-permanent effects. It will also experience greater negative consequences because of the Bullwhip Effect - a term coined in the last decade or so but an effect well understood by those in the supply-chain business for most of the twentieth century. Just not understood and appreciated by the money changers on Wall Street - one of many reason Wall Street has been completely caught off guard by the impacts of this cycle and remains in the dark about future prospects. It's also one reason why this liquidity-driven rally is not based in any form of economic reality. We have written of supply-chain shocks before but remember these effects applies not only to countries but to industrial companies, their equities & bonds and their suppliers. Two such suppliers that remains a Wall Street favorite are the energy business and the commodities bubble. Needless to say, I remain highly negative on both and expect a complete bust is very likely. Remember, many of these investments, including industrial commodities and energy, are being purchased and even propped up by excess liquidity in anticipation of a re-ignition of globalization. Most will have to witness the bust that will occur in order to believe it. All in due time.

Germany has the wherewithal to weather a substantial economic decline were that the only issue before it. But at some point in time the demands placed on the people of Germany by the European Union and German bureaucrats will cross paths with the substantial collapse in global demand for Germany's economic output, its substantial ongoing costs of reunification and its highly leveraged social safety nets. This has not yet developed. It will. And, that means any calls for EU bailouts to be backed primarily by the balance sheets of France and Germany will clash against the sovereign needs of domestic economies. Therein lies a serious risk and future tipping point in the making.

The EU and German bureaucrats pushing EU unification are elitists who wish to return the people's sovereignty to the Europe of old where cronyism - lords - determine the fate of a feudal society through knuckle-dragging policies of rhetoric and tyranny. Maybe not consciously so in today's environment. But by implementing policies crafted to benefit a very few rather than by or for the sovereign of Germany or any other EU country. Unfortunately, this inbred elitism has never been vanquished from European culture. Oddly enough, this elitism remains a primary driver for the success of America as it has for the past three hundred years. Though now we also see this same level of cronyism building to a systemic level in Washington over the last handful of decades. Regardless, I'm quite confident the American people are going to take care business. And, I'm actually becoming more confident many in Europe are finally going to do the same.

Throw in the political concerns of sovereign countries yielding to demands by France or Germany or the EU in exchange for possible financial aid and you have a healthy brewing cauldron of future volatility. One that the European Central Bank and European Union arrogantly believes it has under control. Of course, they also thought they had the situation well under control in, say, 1789. At that time it was also generally believed that it was good to be the king. As we enter the depths of a brave new world, is it once again good to be the king? Let's ask the EU leaders as this crisis gathers momentum. I suspect the answer is it "was" good to be the king.
posted by TimingLogic at 7:57 AM