Agcapita November Economy Briefing

Agcapita Macro Update November 2009 1

Summary By virtue of more than a decade of low and often negative real interest rates coupled with increasingly rapid monetary growth, the economies of the developed world have been increasingly skewed towards consumption rather than production. Unfortunately, consumption is the destruction of capital – by definition it represents the diversion of resources from productive purposes. Both the private and public sectors have been indulging in this protracted debt fuelled consumption spree. Savings rates have plunged and fiscal deficits have expanded. Each year it requires a larger and larger amount of additional debt to create each additional unit of GDP – on the order of $4 of incremental debt to $1 of incremental GDP. Why? Because on average, we are incurring debts that do not create offsetting cash generating assets. At some point governments in the increasingly indebted, consumption oriented and aging economies of the west are going to be faced with an unpalatable set of options: – Tax – Shrink Contents – Default 3 Monetary Authorities Ignoring – Inflate Asset Inflation Again? 3 Banks’ Duration Challenge Not surprisingly, the governments of the world seem intent on continuing to inflate as they desperately force feed the markets consumption-oriented 3 US Federal Duration Challenge programs in place of stagnant private sector demand. An interesting fact is 4 US Federal Outlays that for the last decade in the US, private sector job growth has been absent 4 Do Gold Prices Signal Inflation? and all net job growth has been in government or state dependent sectors. We are facing massive “political inflation” as well as monetary inflation. 6 30 Years of Western Consumption The problem arises that all state spending requires that capital is first taken 6 Money Supply Growth = out of the hands of the private sector via taxes, borrowing or inflation, then Inflation deployed in typically loss-making (capital destroying) activities. The net 6 Demographics are Destiny result is that the growing government spending and deficits are setting the stage for much greater problems in the future. Rather than allowing private 7 Just How Fast is the Global sector savings to replenish the pool of capital our governments are going Money Supply Growing? further into debt to finance policies that at best can only serve to pull future 8 Quick News consumption into the present. 1

To reiterate, what western economies need is more capital, not more consumption. There is no way to create capital other than through savings and hard work – a message to which our governments are reluctant to listen. Printing money seems alluringly easy at first, but it does not create capital, and worse, the inflation it creates ultimately causes long lasting harm to the production structure of the economy. I believe that in the current expansionary monetary environment there are several important themes investors should consider: 1) Reduced Returns on Investments Tied to Developed Market Growth: If current trends continue I believe the western economies could be entering a period of low real growth if not outright stagnation as debt levels are reduced and the capital base rebuilt. If this is the case, investments that depend on developed market growth will be exposed to a reduced demand profile and therefore reduced returns on the whole. 2) Inflation: Real yield will continue to be scarce as governments seek to suppress interest rates at the expense of exchange rates. Arguably in such an environment inflation hedging investments should generate superior returns. 3) Higher Returns on Investments Tied to Developing Market Growth: While the developed markets seem poised for sub-trend growth, this does not appears to be the case for the developing markets – China in particular. With high savings rates, large domestic pools of capital and favorable demographics these markets appear to be in a period of sustained expansion. Of course for the foreseeable future, direct emerging market investments will continue to be volatile and carry significant and difficult to quantify political risk. We believe, therefore, that the better way to invest in emerging market growth is to invest in the things that emerging markets require – particularly commodities – but where the investment premise is expressed in politically stable parts of the world. For example, energy and agriculture in western Canada. Regards Stephen Johnston – Partner 2

Global Macro Update Monetary authorities ignoring asset inflation again? The worlds monetary authorities are clearly ignoring “The average maturities of new debt issuance by the rapid reflation in risky liquid assets and focussing Moody’s-rated banks around the world fell from on CPI measures as their inflation yardsticks. The 7.2 years to 4.7 years over the last five years,” net result will be a growing disconnect between according to the Financial Times - “the shortest the speculative and real economies. This feels like average maturity on record. That means banks will a replay of the residential real estate bubble, where face maturing debt of $10,000bn between now ostensibly low consumer inflation measures allowed and the end of 2015, or $7,000bn by the end of central banks to ignore massive asset price inflation. 2012, according to Moody’s.” It was the mismatch Are we storing up another financial crisis as the between short-term financing and long-term loan real and speculative economies seem to be rapidly portfolios that caused the banking system to collapse diverging again? as underlying collateral values returned to historic norms. If the banking system cannot roll its financing Banks’ Duration Challenge requirements out to longer durations problems are sure to re-surface as commercial real estate comes The banking sector is facing a serious financing under pressure over the next 24 months. challenge ahead. They need to borrow larger amounts and at longer durations and they will be us feDeral Duration Challenge competing with the US government to do so (see US Federal Duration Challenge). The US government has an emerging duration problem in its borrowings states Bob English of the Precision Report, “A full 35% of the current Treasury Chart 1: average Maturity of MooDys debt portfolio ($2.5 trillion) matures by the end of rateD gloBal DeBt issuanCes FY2010 and must be rolled over, in addition to the 16.0 3,000,000 new debt that must be issued to cover the estimated 14.0 FY2010 deficit of $1.25 to $1.75 trillion.” Chris 2,500,000 Rupkey, economist at Bank of Tokyo-Mitsubishi Average Maturity (Years) Debt Issued (USD MIL) 12.0 2,000,000 10.0 states that “the budget deficit, while not expanding, 8.0 1,500,000 6.0 is still at levels unimaginable a few years ago,” … 1,000,000 4.0 “With receipts on the weak side, the Treasury will 2.0 500,000 have its work cut out for it when it comes to financing 0.0 0 the government’s flood of red ink” particularly at 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 longer durations. Avg Maturity Per Year Face Amount of Wholesale Funding Issued MTN share of Total Wholesale Funding System Average Source: Moodys 3

Global Macro Update (continued) us feDeral outlays This chart from the St Lois Federal Reserve provides with Governor Mullins of what would happen if the a glaring visualization of the magnitude of the Treasury sold a little gold in this market. There’s an unfolding US government spending spree and the interesting question here because if the gold price deficit it is fueling. The Federal deficit to GDP is at broke in that context, the thermometer would not levels not seen since WWII and in absolute terms be just a measuring tool. It would basically affect never seen before. the underlying psychology.” Greenspan was clearly advocating direct intervention in the gold market to reduce the traditional inflation signaling nature Chart 2: feDeral net outlays versus of gold. If gold prices are indeed managed (as far feDeral reCeiPts as possible) in a fashion akin to other exchange 3,600,000 rates, when gold is appreciating in a large number 3,200,000 of currencies is it time to pay attention? We believe 2,800,000 gold’s recent behavior is signalling an ongoing (Millions of Dollars) 2,400,000 attempt at simultaneous competitive devaluation 1,600,000 (or global “race to the bottom”) as gold increases 1,200,000 in relative value against most currencies - evidence 800,00 that most governments are actively debasing their 400,00 currencies. Gold recently moved to 8-month highs 0 against the Euro, Swiss Franc and Canadian Dollar, it -400,00 1895 1910 1925 1940 1955 1970 1985 2000 2015 also moved to news records versus the Indian Rupee FYON ET FYFR and Chinese Yuan. Source: St. Louis Federal Reserve (shaded areas indicate US recessions) Chart 3: gloBal golD inDex 300 Do golD PriCes signal inflation? 275 250 Gold in top 10 currencies (weighted by GDP) 200 Gold in US Dollars Think about this quote from Greenspan at the May 175 18, 1993 Fed meeting. The market price of gold 150 125 was increasing at the time and Greenspan, the then 100 Chairman of the Federal Reserve, said: “I have one 75 50 other issue I’d like to throw on the table. I hesitate 25 to do it, but let me tell you some of the issues that 0 -25 are involved here. If we are dealing with psychology, ‘00 ‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 then the thermometers one uses to measure it have Source: Bullion Vault an effect. I was raising the question on the side 4

Global Macro Update (continued) According to BullionVault.org, the price of gold Chart 5: golD inflation aDjusteD PriCe recently broke its previous high weighted against the world’s top 10 currencies by GDP and further that $2,000 an ounce gold has beaten all other asset classes so far this decade. Central banks have been net sellers of gold for many years but this is changing. 1,500 Are global central banks, particularly those of the emerging economies that run large US$ current 1,000 account surpluses beginning a move out of US$ reserves into gold? China, India and Russia all certainly have been increasing their holdings. 500 unadjusted ‘75 ‘80 ‘85 ‘90 ‘95 ‘00 ‘05 Chart 4: Central Bank golD reserves (thousanD tons) Source: Bloomberg, Bureau of Labor Statistics, World Gold Council 30 Through Sept. 2009 28 Chart 6: golD reserves (tons, seP 2009) 26 United States 8,966 24 Germany 3,757 Int’l Monetary Fund* 3,326 Italy 2,703 22 France 2,695 China 1,162 20 Switzerland 1,147 ‘00 ‘05 ‘09 Japan 843 * Adjusted to Source: Globe and Mail Netherlands 675 reflect recent Russia 627 sale of 220 India* 615 tones to India European Central Bank 553 by the I.M.F. Source: Bloomberg, Bureau of Labor Statistics, World Gold Council 5

Global Macro Update (continued) 30 years of Western ConsuMPtion Money suPPly groWth = inflation The consistent trend over the last three decades has Chart 8 shows US money of zero maturity (“MZM”). been decreasing bond yields. MZM technically equals M2 plus all money market funds, minus time deposits and in essence measures the supply of financial assets redeemable at par on Chart 7: us 30 year t-BonD yielD demand – a good reflection of overall US money (nov 2009) supply. Do you see any deflation in this chart? 145 140 135 130 125 120 115 Constantly Decreasing Interest Rates 110 105 Chart 8: MZM Money stoCk 100 95 90 85 10,000 80 75 9,000 70 8,000 (Billions of Dollars) 65 7,000 60 6,000 55 5,000 50 4,000 45 3,000 40 2,000 35 1,000 0 30 1950 1960 1970 1980 1990 2000 2010 25 Source: St. Louis Federal Reserve (shaded areas indicate 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 US recessions) Source: Stockcharts.com DeMograPhiCs are Destiny US interest rates have been decreasing by approximately 1.0% every 4 years and as the price The 19th century belonged to the UK, the 20th century of money or debt becomes less expensive more belonged to the US and it appears that the 21st is consumed. The steady interest rate decline is century will belong to China. A consistent theme in a product of a deliberate monetary policy that has the emergence of a new global power is a large and driven consumption and on a larger scale driven growing pool of domestic savings with a focus on asset prices as the financial sector intermediates investing in the capital base of the economy rather increasingly profitable but risky speculative activities. than increasing consumption and a population of What happens when this trend reverses? young workers. 6

Global Macro Update (continued) The world’s western economies find themselves The US government is now in the position of heavily in debt with deteriorating demographics. increasing its liabilities four times faster than its It has been said that “demographics are destiny’. tax receipts. At some point governments in the Unfortunately, our governments are attempting to fix increasingly indebted, consumption oriented and our problems by accelerating the very policies that aging economies of the west are going to be faced got us into this mess in the first place. with an unpalatable set of options: – Tax - higher taxes are politically impractical in the face of stagnant growth Chart 9: us governMent oBligations – Shrink – reducing the size of government is (trillions of us$) politically impractical in the face of large and influential state sectors Medicare – Default - possible but inflation, at least initially, Social Column is much less noticeable Trust Funds Total Valuation Security A Total Date Unfunded A, B, D Unfunded US Debt US Gov. – Inflate – printing money is almost invariably Unfunded Obligations the preferred option for cash strapped Obligations Obligations Obligations governments 2009 $15.1 $88.9 $104.0 $10.7 $114.7 2008 $13.6 $85.6 $99.2 $9.2 $108.4 The US Federal Reserve recently disclosed that it 2007 $13.6 $74.3 $87.9 $8.6 $96.5 purchased half of the newly issued US Treasuries in the second quarter of this 2009, and of course it 2006 $13.4 $70.5 $83.9 $8.1 $92.0 made these purchases with newly printed money - it 2005 $11.1 $68.1 $79.2 $7.6 $86.8 appears “inflate” is the path that has been chosen. 2004 $10.4 $61.6 $72 $7 $79.0 Source: Sprott Asset Management just hoW fast is the gloBal Money suPPly groWing? The US federal funding gap is growing at rapid rate. According to Mike Hewitt at Dollardaze.org the global Over the last 6 years: money supply (M0) continues to grow rapidly. M0 is referred to as the monetary base, or narrow money – Unfunded obligations increased by and is composed of notes and coins in circulation approximately 50% from US$79 trillion and in bank vaults. M0 is the most conservative to US$114.7 trillion; but measure of money supply growth. Interestingly – Receipts increased by only approximately the largest currencies are growing at some of the 12%. most rapid rates showing that this is truly a global phenomenon and not an artifact of just US actions. 7

billion in October from a year earlier, and corporate Chart 10: y-o-y inCrease in M0 (us$ tax receipts last month were a negative $4.5 billion equivalent as of august 2009) on the government’s books... Over the past week, the Treasury auctioned a record $81 billion in its quarterly sales of long-term debt. The Treasury’s us$ us$ Per debt-management director... told a meeting of bond Country % Billions Capita market participants last week to anticipate another US 10.50% $81 $268 year of government debt sales of $1.5 trillion to $2 trillion...” EU 13.40% $126 $252 Australia 11.20% $4 $182 November 13 - Bloomberg (Bob Willis): “The trade UK 8.40% $7 $111 deficit in the U.S. widened in September by the most in a decade, reflecting rising demand for imported Canada 6.80% $3 $96 oil and automobiles... The gap grew a larger-than- S Korea 15.60% $4 $74 anticipated 18% to $36.5 billion, the highest level since January... Imports climbed 5.8%, the most Mexico 14.90% $5 $43 since March 1993, to $168.4 billion. The figures China 11.50% $52 $39 reflected a $4.1 billion increase in imported oil as Brazil 11.10% $5 $24 the cost of a barrel of crude climbed to the highest level since October 2008 and volumes also rose... India 18.60% $23 $20 Exports rose 2.9% to $132 billion, the most this Source: Mike Hewitt Dollardaze.org, Agcapita estimates year, propelled by sales of civilian aircraft, industrial machines and petroleum products.” November 11 - Financial Times (Nicole Bullock): quiCk neWs “Some of the same financial troubles that have pushed California toward economic disaster are November 12 - Bloomberg (Vincent Del Giudice): wreaking havoc in nine other states and posing “The U.S. budget deficit widened in October from a threat to the nascent recovery, according to a year earlier, reaching a record for that month... research... ‘California’s fiscal problems are in a league The excess of spending over revenue widened to of their own,’ says Susan Urahn, managing director of $176.4 billion last month, compared with a deficit the Pew Center on the States... ‘but the Golden State of $155.5 billion in the same month a year earlier... is hardly alone.’ Arizona, Florida, Illinois, Michigan, Spending for October declined 2.7% from the same Nevada, New Jersey, Oregon, Rhode Island and month a year earlier to $331.7 billion, and revenue Wisconsin join California as the most troubled US and other income fell 17.9% to $135.3 billion... states... For residents, fiscal problems have meant Individual income tax collections fell 29% to $61.2 8

higher taxes, layoffs of state workers, longer waits for public services, more crowded classrooms and less support for the poor.” November 12 - Bloomberg (Darrell Preston): “U.S. states, which are closing $250 billion of budget deficits, will be forced to grapple with diminished revenue until at least 2012, a survey of fiscal officials found. The only thing that kept states from ‘draconian’ spending cuts has been $135 billion of funding under President Barack Obama’s economic stimulus package, according to a report from the National Governors Associations and the National Association of State Budget Officers. Revenue fell 7.5% in fiscal 2009, forcing states to close budget gaps of $72.7 billion. ‘These are the worst numbers we’ve ever seen,’ said Scott Pattison, executive director of the budget directors group... ‘States have been forced to lay off and furlough employees, raise taxes, drain rainy day funds and sharply cut state spending.’” 9

DisClaiMer: The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly. #400, 2424 4th street sW tel: +1.403.218.6506 www.agcapita.com Calgary, alberta t2s 2t4 fax: +1.403.266.1541 Canada

Agcapita November Economy Briefing

by Agcapita

Accessibility

Categories

Upload Details

Usage Rights

1 Embed 1

Statistics

Agcapita November Economy Briefing Document Transcript