Beruflich Dokumente
Kultur Dokumente
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Horizon Scanning
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Contents
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Status Report
11 Cyprus Debacle - Going off the cliff with offshore-banking - The story of banks 12 The story of the banks 13 The unraveling 14 The bigger picture 15 Does the Mass Media drive perceptions ? 16
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16 Japan & the UK at a cross-road? - Japan - The story of the ageing samurai reaching for the elusive fountain of youth 17 The story of the ageing samurai reaching for the elusive fountain of youth 18 Exporting false dawns 18 New Sheriff in town - meet Abenomics 19 New Sheriff in town - meet Abenomics 20 Graphs 21 Graphs 22 Graphs 23 Japan & the UK at a cross-road? - UK - Empire no more 24 Still looking for a recovery 25 Running out of gas 25 From longest period of expansion to triple dip recession 26 From longest period of expansion to triple dip recession 27 Lost in the maze? 27 The not so great GBP 27 Two archipelagos set for change? 28
continued continued continued
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Contents
29 The fading growth benefits from stimulus, but for how long? 30 Weakness across all industries 30 Lack of global activity in key transport segments 31 The U.S. - The best house on a bad block? 32 The best house on a bad block? continued 33 U.S long term trends - wall of worry? 34 U.S long term trends - wall of worry? continued 35 Private deleveraging the ugly way 35 Trickle down economy? 35 Lower wages & higher cost of living 36 Past mal-investment An opportunity? 36 The least unattractive house on a bad block? 36 Still consuming Auto sales: U-turns & Down-turns 37 The EU - Sum of its parts? 38 Lost in that 19th Century feeling? 39 The road to shared prosperity? 39 The long-term trend Core nations 40 The long-term trend Core nations 41 The long-term trend Core nations 42 Germany - Introduction 43 Is Merkels economic machine beginning to show signs of neglect? 43 Germanys Choice 44 France - Introduction 45 Introduction
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45 Le retour a lancien regime 46 A civil service affair 46 Le Nationalism 47 Military might in Timbuktu? 48 Italy - Old, heavily indebted, structurally impaired and without leadership 49 Old, heavily indebted, structurally impaired and without leadership
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50 Reasons for protest? Italys long-run economic decline keeps getting worse 50 Italys debt/GDP: Highest since unification, other than wartime
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51 Spain - Introduction 52 A visual guide to the pain in Spain 53 A visual guide to the pain in Spain
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54 2013 unlucky for some 54 Construction & Real Estate sectors still in dire straits 54 Bad Bank(ia) 55 Captive bond buyers at the extremes 55 The second set of books - Al Capone style 56 Netherlands - Introduction 57 Dutch Decline? 57 Not looking so core 58 The Rest - Introduction 59 The scariest commodity during periods of plenty is the memory of past cycles 60 Investment
Implications
60 Custodial & Country Risk - Cypriot Take Away? - Introduction 61 A Powerpoint presentation too far 62 The source of much confusion and potentially lots and lots of lawsuits 63 Currency Risk - Introduction 63 Historical risks when mankind plays with the concept of money 64 The great U.S. equity markets disconnect? 65 Is the broad corporate reality a future of lower profits? 66 Is the broad corporate reality a future of lower profits? 67 Our
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67 Precious Metals - Physical Gold Ownership - What is the value of permanence 67 Value of permanence vs. the value of the ownership of a paper derivative 68 Central Banks continue to buy gold 68 Chinas ingrained understanding of the value of gold 69 Gold & Deflation 70 Are gold miners finally getting it right? 71 Agriculture & Fresh water - A look at Farmland vs RE/CRE 72 The water story 73 The water story
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74 An interlinked world 74 The porcelain project 75 The porcelain project 75 Solutions required - all hands on deck 76 Energy - The U.S. - Leader in the great energy transformation? 77 The clear benefits so far 78 Energy - Driving towards a future of natural gas? 79 Changes in the global energy mix are under way 80 Changes in the global energy mix are under way 81 Energy - The LNG story 82 The future is floating 83 Shell Game - Forward thinking or boys with toys? 84 Our
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Summary
85 About 86 Disclaimer
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Introduction
The Librarium Associates Quarterly Review Series is a publication created by our team highlighting core global trends and projecting future paths on a geopolitical and macro economic level. We are constantly engaged in active horizon scanning while adhering to our belief that students of the lessons of history and permanent features such as geographic realities can provide superior insights. From these broad scenarios we work to identify investable trends and specific opportunities. We find that such a broad approach provides an early alarm system for risk management and an indicator of attractive price/value situations across asset classes. The intention of our research and the basic premise of this publication is to present rational perspectives based upon a diligent analysis of historical data. Through organizing the data logically, information is created. Through understanding and developing perspectives on the information, knowledge is generated. With knowledge, one can then start to make informed decisions. The most practical way to imagine the future is to question the expected, this is best done making use of what we call critical thinking - Critical thinking is the careful, deliberate determination of whether one should accept, reject or suspend judgment about a claim and the degree of confidence with which one accepts or rejects it. Critical thinking employs not only logic but a broad intellectual criteria such as the one outlined above. Critical thinking requires extensive experience in identifying the extent of ones own ignorance in a wide variety of subjects which is often captured in the following sentence; I thought I knew, but I merely believed. As J.F. Kennedy put it; Belief in myths allows the comfort of opinion without the discomfort of thought. Our aim is always to avoid this trap of the mind, when one attempts to look into the future one is better of exhibiting a more intellectually humble approach and challenge ones beliefs and opinions by asking the question; What if we took the opposite view? This leads to a more balanced set of insights in our view. The insights and opinions offered in this document are meant as a summary of events and our views not a conclusive or exhaustive overview or for that matter a specific investment recommendation. We hope it will offer some food for thought and that it can form the basis of conversations between our clients, interested parties and ourselves. Sincerely Yours, Mr. S.H. Sorensen Senior Associate Librarium Associates Ltd.
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Status Report
Source: The Economist *Estimates based on 52 countries representing 90% of world GDP. Weighted by GDP at purchasing-power parity.
Even the normally pro-growth biased IMF has had to revise their outlook for the coming years, numbers which will no doubt have to be revised downward further as realities around the world set in. The illustration below shows the most challenged geographical segments with Europe on red alert.
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Source: IMF
Slowing economic growth combined with increasing debt loads is not a recipe for success. Yet this is the exact situation we find ourselves in currently. As a person, a company or a government you are faced with challenges when dealing with a heavy debt burden that is not supported by a productive asset. If you can not increase the value and the income you are faced with only poor choices, default or if you are a government who has its own central bank you can use inflation as a subtler means of creating a wealth transfer from savers to debtors. The debt overhang is still there and its increasing every second.
Illustration 3 - Global Debt 2012
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Source: JPM
Milton Friedman once quipped that; There is nothing as permanent as a temporary government program. This would appear true when looking through the government budgets of most OECD nations during the last 30 years and we believe when you take a look at central bank special measures instigated during the last 5 years you may be faced with the same reality. In the run-up to a debt crisis, bad debt tends to move to the highest level and may ultimately accumulate on the central banks balance sheets, provided the economy in question has its own currency. Excessive debt incurred by consumers, homeowners and businesses first moves to the banking system and corrupts its balance sheet. If, rightly or wrongly, the banking system isnt allowed to fail, bad debt is then transferred to the government via bailouts or implicit/explicit guarantees. When exacerbated by the burden of unfavourable demographics and several decades of proliferating welfare spending, it may overwhelm the governments debtcarrying capacity. Should financial markets become unwilling to refinance the government debt at rates acceptable to the government, central banks step in. They monetize government debt in the name of propping up the economy, creating jobs or weakening the currency to keep borrowing rates low and exports more competitive. The process whereby government or quasi-government debt is taken over by the central bank is called quantitative and qualitative easing. Many observers assume that, once bad debt is purchased by the central bank, the debt crisis is solved for good. The implicit assumption is that central banks have unlimited wealth at their disposal or can print unlimited wealth into existence. However, central banks can only create liquidity, not wealth. If printing money were equivalent to creating wealth, then mankind would not have to get up early on Monday mornings. Q.E. just transfers losses from the previous holders of the assets purchased by the central bank to the central bank itself. Up to a certain amount, the central bank absorbs these losses by sacrificing its equity and accumulated profits. But what happens once the central bank breaches this point? Inflation and high inflation would appear the logical answer. Historically, restructuring, inflation and financial repression has been part of the package as they all are measures that reduce your existing stock of debt but austerity must be a part as well as it stops you from adding further to the debt. There is no either-or. You need a combination of both to bring down the debt to a sustainable level.
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Status Report
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Source: WSJ
On February 10th the FT referenced a confidential EU memo in an article, which pretty much foretold the events ahead with absolute precision. The article stated;
A radical new option for the financial rescue of Cyprus would force losses on uninsured depositors in Cypriot banks, as well as investors in the countrys sovereign bonds, according to a confidential memorandum prepared ahead of Mondays meeting of euro-zone finance ministers. The proposal for a bail-in of investors and depositors, and drastic shrinking of the Cypriot banking sector, is one of three options put forward as alternatives to a full-scale bailout. () By bailing-in uninsured bank depositors, it would also involve more foreign investors, especially from Russia, some of whom have used Cyprus as a tax haven in recent years. That would answer criticism from Berlin in particular, where politicians are calling for more drastic action to stop the island being used for money laundering and tax evasion. Labelled strictly confidential and distributed to euro-zone officials last week, the memo says the radical version of the plan including a haircut of 50% on sovereign bonds would shrink the Cypriot financial sector, now nearly eight timers larger than the islands economy, by about a third by 2015. Senior EU officials who have seen the document cautioned that imposing losses on bank depositors and a sovereign debt restructuring remain unlikely. Underlining the dissuasive language in the memo, they said that bailing in depositors was never considered in previous eurozone bailouts because of concern that it could lead to bank runs in other financially fragile countries.
Watching the subsequent chaotic process which followed - where all past judgments and common sense went out the window as the aptly named Mr. Panicos, head of the Cypriot Central Bank, and the newly elected government desperately tried to salvage the situation through backroom dealings with the EU and Russia one can not help but recognize that the process was extremely poorly handled by all involved. The 50% haircut on Cypriot sovereign debt, mentioned in the article, has not yet come to pass but as with Greece, give it time and considering the perilous economic and political situation on the island it will surely follow as the missing piece in the sustainability puzzle.
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Source: Bloomberg
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Japan The story of the ageing samurai reaching for the elusive fountain of youth
A journey through Japans recent history From Meiji to Hiroshima to Pebble Beach to Deflation Ville to Fukushima and beyond. A rich nation, a strong army (Fukoku Kyohei) was the mantra of the reformers who in 1868 transformed Japan from an essentially agricultural country into a great industrial and military power. A new Japan, open to the world and keen to equal the West, was born on 3 January 1868, the day when imperial power was restored in the person of the Meiji emperor. The Meiji restoration initiated a radical process, motivated by a fierce desire for national independence and economic expansion to Western levels, founded on a strong industrial base, both civilian and military. Manufacturing output increased by a factor of thirty between 1878 and 1939. In 1968, exactly one century after the Meiji restoration, Japan overtook Germany and became the worlds third-largest economy after the U.S. and the Soviet Union. In the mean time, it had won wars resulting in the annexation of Taiwan, Korea and de facto, Manchuria. This in turn led to the invasion of China but culminated in Japans first ever defeat, in the Pacific War, and surrender in August 1945 to the U.S. Imperial Japans ambitions for hegemony in Asia had come to naught, the country lay in ruins and its economy was in tatters, with agricultural and industrial output running at barely a third of their pre-war level. The U.S. strategy was to turn its former enemy into an ally against the communist threat in the region. Just ten years after its defeat, the newly democratized country embarked on what has been called the Japanese miracle. The miracle refers to the high growth period (1955-73), when an average annual growth rate of 9.7% was sustained over eighteen years. Japanese GDP grew fivefold between 1955 and 1973 and doubled between 1974 and 1990.
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Japan The story of the ageing samurai reaching for the elusive fountain of youth
In 1974, a double whammy sent the economy into a savage recessionary spiral. The 1973 oil shock quadrupled oil prices and hit Japan at its most vulnerable point, energy dependence, while exports were undermined by the appreciation of the yen, which rose by over 30% in two years. Annual inflation rose to 25% in 1974 and a period of adjustment became necessary. Household savings financed budget stimulus packages, while the quest for energy efficiency brought about profound changes in production methods. Growth resumed at an annual rate of 4% until the end of the 1970s, by which time Japan was the worlds third-largest economy and exporter with 6.4% of the global market in 1980, compared with 2.1% in 1955. Japan was ready for the next phase of its expansion. Japans rise as a financial and technological power was almost symmetrical with the U.S.s decline, during the period from 1980 to 1989. Japan, the worlds largest creditor nation, was accumulating substantial foreign assets and running both a balance of payments and a budget surplus, while its financial institutions were expanding internationally. The U.S., now the worlds biggest debtor nation, was seeing its foreign debt rise sharply and running both a balance of payments and a budget deficit, while its financial institutions were retrenching. Tokyo overtook New York as the worlds biggest stock market in 1987, the worlds ten biggest banks in 1989 were all Japanese and they were responsible for 30% of all international lending. The 1980s were golden years, and by 1989 it looked as though nothing could halt Japans stellar ascension as an industrial, technological and financial power. The Plaza Accord of September 1985 enforced by the U.S. lead to the near doubling of the value of the yen against the USD between 1985 and 1987. This started the process of unravelling the last decades unsustainable practices. The bubble finally burst in 1990 and the ensuing collapse of the stock market and real estate prices, which had tripled since 1985, triggered a financial meltdown. The government used the twin levers of budget and monetary policy to deal with the problem. Ten stimulus plans followed in rapid succession over the ten-year period, at a total cost of USD 1 trillion, but they had such little effect that interest rates were cut to almost zero. Despite this shock treatment the recovery never came.
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Japan Graphs
Illustration 9 Japan growth abyss 1991-2011
Nominal GDP growth
Lost Decades
Source: JPM
Illustration 10 - Japans trade balance June 28, 1985 through December 31 2012
Source: Bloomberg
Demographic headwinds
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Japan Graphs
Illustration 12 - Japan government debt to GDP
Source: BOJ
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Japan Graphs
Illustration 15 - Japanese Index vs. S&P 500 Growth of $1 December 29, 1989 through February 28, 2013
Source: Bloomberg Note: Nikkei 225 Index Total Return = An index showing the average closing prices of 225 stocks on the Tokyo Stock Exchange. S&P 500 Index is a capitalization = weighted index of 500 stocks.
Source: Nomura, Based on BOJ, FRB, ECB, BOE data Note: The estimate is based on the assumption that required reserves will increase by 3% a year and bank reserves constitute 88.8% of financial institutions current deposit holdings with the BOJ. The BOE has suspended reserve requirement in March 2009. The post-March figures are based the assumption that the original reserve requirement is applicable.
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UK Empire no more
During its heyday as the British Empire, the UK was the largest and most influential economy in the world. As the birthplace of the first Industrial Revolution during the 18th century, the UK ushered in what economic historians agree to be the most significant event in mankinds history. The UK was also able to be at the forefront of technological advances during this time, giving it a strong economic advantage over any country in the world which was furthermore expressed by the GBP acting as the worlds reserve currency. However as other countries began to catch up technologically wise, the UKs economy was also greatly affected by the two World Wars which subsequently led to the breaking up of its territorial empire. Though Britain and the empire emerged victorious from WWII, the effects of the conflict were profound, both at home and abroad. Much of Europe, a continent that had dominated the world for several centuries, was in ruins, and host to the armies of the U.S. and the Soviet Union, who now held the balance of global power. Britain was left essentially bankrupt, with insolvency only averted in 1946 after the negotiation of a loan from the U.S. This financial reality and the general wind of change ultimately meant that the British Empires days were numbered, and on the whole, Britain adopted a policy of relative peaceful disengagement from its colonies once stable, non-Communist governments were available to transfer power to. Between 1945 and 1965, the number of people under British rule outside the UK itself fell from 700 million to five million, three million of whom were in Hong Kong which has since been handed over to China. The UK spend the following years having to come to terms with its new reality economic and geopolitical. In 1976 the UK faced another severe financial crisis. The government was forced to apply to the IMF for a loan of $4 billion. The IMF insisted on deep cuts in public expenditure, greatly affecting economic and social policy.
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The UK, a leading trading power and financial center, is the third largest economy in Europe after Germany and France. Over the past two decades, the government has greatly reduced public ownership and contained the growth of social welfare programs comparatively to its peers within the EU. Agriculture is intensive, highly mechanized and efficient by European standards, producing about 60% of food needs with less than 2% of the labour force.
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The fading growth benefits from stimulus, but for how long?
Illustration 19 - Global Manufacturing PMI Index
Source: JPM
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Source: JPM
Source: JPM
Source: Bloomberg
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Source: usgovernmentspending.com
Source: JPM
Source: Datastream
The public has two hopes, and government makes two promises - many benefits and no taxes. Hopes and promises, which being contradictory, can never be realized.
-Bastiat 1848
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Source: Datastream
Illustration 27 - Overall US debt still remains elevated and the financial sector is still bloated
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Rising inequality
Source: NY FED
Source: dshort.com
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Source: BCG Note: Net domestic fixed investments are fixed investments, purchases of residential and nonresidential structures and of equipment and software by private business, nonprofit institutions and governments minus consumption of fixed capital the decline in the value of the stock of fixed assets due to wear and tear, accidental damage and aging.
Source: GMO Note: Estimates are subject to numerous assumptions, risks and uncertainties which change over time and as such the forecasted segments are a provided as a guide only.
Decline is relative
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France
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France/Prussian war and impact of tarif reductions on French industry Great depression, worsened by delayed move by France to drop gold standard
Italy
Cumulative impact of 10-year Franco-Italian tarif war which resulted in a 60% decline in billetral trade
Spain
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Overflow and exile of Queen Isabella II, collapse of railway boom and financial sector Currency, banking sector and stock market crisis, impact of New World grain invasion Pan-European banking crisis. Baring Brothers failure after Argentine govt default. Philomena epidemic arrives in Spain
Source: JPM
It happens slowly at first... then all at once. Everything feels normal then suddenly it is not.
Source: JPM
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Source: JPM
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Source: Lighthouse
Source: Lighthouse
Source: Lighthouse
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Source: Lighthouse
Illustration 43 - The Austerity never really gets started until the Troika arrives
Can we afford the cradle to grave government systems which we have promised ourselves?
Source: Lighthouse
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Germany Introduction
The German economy the fifth largest economy in the world in PPP terms and Europes largest is a leading exporter of machinery, vehicles, chemicals and household equipment and benefits from a highly skilled labour force. Like its Western European neighbours, Germany faces significant demographic challenges to sustained long-term growth. Low fertility rates and declining net immigration are increasing pressure on the countrys social welfare system and necessitate structural reforms. Reforms launched by the government of Chancellor Gerhard Schroeder (1998-2005), deemed necessary to address chronically high unemployment and low average growth, contributed to strong growth in 2006 and 2007 and falling unemployment. These advances, as well as government subsidized reduced working schemes, help explain the relatively modest increase in unemployment during the 2008-09 recession the deepest since WWII and its decrease to 6.5% in 2012. GDP contracted 5.1% in 2009 but grew by 3.7% in 2010, and 3.0% in 2011, before dipping to 0.9% in 2012 a reflection of the worsening euro-zone financial crisis and the financial burden it places on Germany as well as falling demand for German exports. Stimulus and stabilization efforts initiated in 2008 and 2009 and tax cuts introduced in Chancellor Angela Merkels second term increased Germanys budget deficit to 3.3% in 2010, but it ran a balanced budget in 2012. A constitutional amendment approved in 2009 limits the federal government to structural deficits of no more than 0.35% of GDP per annum as of 2016. Following the March 2011 Fukushima nuclear disaster, Chancellor Merkel announced in May 2011 that eight of the countrys 17 nuclear power plants would be replaced with renewable energy. Before the shutdown of the eight reactors, Germany relied on nuclear power for 23% of its electricity generating capacity and 46% of its base-load electricity production.
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Germanys Choice
The European crisis will enter a new phase this year that will expose Germanys limitations in managing the situation and intensify an ultimately irresolvable debate over who within the euro-zone the core or the periphery should bear the political, economic and social burden of the crisis. With parliamentary elections coming up this year, the German government is facing growing pressure to show German taxpayers that Berlin will manage the European crisis with a firm hand. At the same time, Germany must make concessions to deflect rising criticism from heavily indebted peripheral states that are now questioning the security of their bank deposits and are looking to France to champion their cause. France, facing rising unemployment at home, will identify with these states demands but will also have to choose its battles with Berlin wisely to avoid breaking the alliance that holds the European Union together.
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France Introduction
The French economy is diversified across all sectors. The government has partially or fully privatized many large companies, including Air France, France Telecom, Renault and Thales. However the government maintains a strong presence in some sectors, particularly power, public transport and defense industries. With at least 79 million foreign tourists per year, France is the most visited country in the world and maintains the third-largest income in the world from tourism. Frances leaders remain committed to a capitalism in which they maintain social equity by means of laws, tax policies and social spending that reduce some income disparity and the impact of free markets on public health and welfare. Frances real GDP contracted 2.6% in 2009, but recovered somewhat in 2010 and 2011, before stagnating in 2012. The unemployment rate increased from 7.4% in 2008 and has remained above 9% per year since then. Lower-than-expected growth and increased unemployment have strained Frances public finances. The budget deficit rose sharply from 3.4% of GDP in 2008 to 7.5% of GDP in 2009 before improving to 4.5% of GDP in 2012, while Frances public debt rose from 68% of GDP to 89% over the same period. Under President Sarkozy, Paris implemented some austerity measures to bring the budget deficit under the 3% euro-zone ceiling by 2013 and to highlight Frances commitment to fiscal discipline at a time of intense financial market scrutiny of euro-zone debt. Socialist Party Candidate Francois Hollande won the May 2012 presidential election, after advocating pro-growth economic policies, the separation of banks traditional deposit taking and lending activities from more speculative businesses, increasing the top corporate and personal tax rates, and hiring an additional 60,000 teachers during his five-year-term.
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France Introduction
France ratified the EU fiscal stability treaty in October 2012 and Hollandes government had maintained Frances commitment to meeting the budget deficit target of 3% of GDP during 2013 even amid signs that economic growth will be lower than the governments forecast of 0.8%. However, during quarter one Hollandes government admitted that it would be unable to meet this target in 2013. Despite stagnant growth and fiscal challenges, Frances borrowing costs declined during the second half of 2012 to euro-era lows. The growth challenge for France is something we will have to watch, its not as bad as Italy, but as shown below, other than during wartime, this has been a very bad stretch for French growth. A period of no growth over 7 years in France is something seen more frequently during the 19th century. It was also seen during the 1930s when France struck to the gold standard longer than other countries did and paid a price. The same parallels between the gold standard in Europe in the 1930s and the binding constraint of todays currency union can be observed.
Source: Lighthouse
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France Le Nationalism
Nationalism is a strong force in French politics, and the ongoing European crisis may be nurturing its growth. The National Front, which represents French nationalism politically, fared better in the most recent presidential election than previous ones. Central to the partys platform is the notion that immigration is a threat to national identity and that the European Union has weakened the French economy. With high rates of immigration and with the European Union integrating further, the ideals espoused by the National Front may appear even more valid in the eyes of French voters. Already mainstream political parties are adopting some aspects of the National Fronts platform to reflect the partys growing popularity.
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Italy Reasons for protest? Italys long-run economic decline keeps getting worse
Illustration 45 - Change in 7-year real Italian GDP, percent, since 1861 (Unification)
Source: JPM
Source: JPM
Source: JPM
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Spain Introduction
After almost 15 years of above average GDP growth, the Spanish economy began to slow in late 2007 and entered into a recession in the second quarter of 2008. GDP contracted by 3.7% in 2009, ending a 16-year growth trend, and by another 0.3% in 2010, before expanding moderately in 2011, making Spain the last major economy to emerge from the global recession. The economy, however has once again fallen into recession as deleveraging in the private sector, fiscal consolidation, and continued high unemployment weigh on domestic demand and investment. The unemployment rate rose from a low of about 8% in 2007 to roughly 25% in 2012. The economic downturn has also hurt Spains public finances. The government budget deficit peaked at 11.2% of GDP in 2010 and the process to reduce this imbalance has been slow despite Madrids efforts to raise new tax revenue and cut spending. Spain reduced its budget deficit to 9.4% of GDP in 2011 and roughly 6.7%* of GDP in 2012, both above the 6.3% target agreed between Spain and the EU. Spains large budget deficit and poor economic growth prospects remain a source of concern for foreign investors, the governments ongoing efforts to cut spending and introduce flexibility into the labour markets are intended to assuage these concerns. The government is also taking steps to shore up the banking system. Their main step has been to manoeuvre for an EU bailout for its banks to the tune of $130 billion in order to recapitalize struggling banks exposed to the collapsed domestic construction and real estate sectors.
*Note: Even this number was later challenged as it does not include the costs associated with recapitalizing Spains banks. The European commissions estimate was much higher, at 10.2% of GDP because it included them.
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Source: JPM
Source: SG
Illustration 50 - Spains debt to GDP at levels not seen in over 100 years
Source: El Pais
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Source: El Pais
Source: SG
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Bad Bank(ia)
The Cypriot debacle kept the spotlight away from Spains own hair-cutting session. The Spanish government announced that it will impose heavy losses on investors at nationalized banks. The restructuring terms announced will impose losses of up to 61% at Spains largest nationalized banks. At Bankia, the largest of the institutions and the only one that is publicly traded, shareholders will be nearly wiped out and junior bondholders will lose around 30% of their original investment.
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Netherlands Introduction
The Dutch economy is the fifth-largest economy in the euro-zone and is noted for its stable industrial relations, moderate unemployment and inflation, a sizable trade surplus, and an important role as an European transportation hub. Industrial activity is predominantly in food processing, chemicals, petroleum refining, and electrical machinery. A highly mechanized agricultural sector employs 2% of the labour force but provides large surpluses for the food-processing industry and for exports. The Netherlands, along with 11 of its EU partners, began circulating the euro currency on 1 January 2002. After 26 years of uninterrupted economic growth, the Dutch economy highly dependent on an international financial sector and international trade contracted by 3.5% in 2009 as a result of the U.S. mortgage crisis. In 2008, the government nationalized two banks and injected billions of dollars of capital into other financial institutions, to prevent further deterioration of a crucial sector. The government also sought to boost the domestic economy by accelerating infrastructure programs, offering corporate tax breaks for employers to retain workers, and expanding export credit facilities. The stimulus programs and bank bail-outs, however resulted in a government budget deficit of 5.3% of GDP in 2010 that contrasted sharply with a surplus of 0.7% in 2008. The government of Prime Minister Mark Rutte began implementing fiscal consolidation measures in early 2011, mainly reductions in expenditures, which resulted in an improved budget deficit of 3.8& of GDP. In 2012 tax revenues dropped nearly 9% and GDP contracted. Although jobless claims continued to grow, the unemployment rate remained relatively low at 6.8%.
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Source: CBS Statistics Netherlands Note: 2012 to 2014 Dutch Central Bank forecasts
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The Rest The scarcest commodity during periods of plenty is the memory of past cycles
Russia went through the so-called Ruble Crisis which on the 13th of August 1998 led to a collapse of the Russian stock, bond and currency markets. Annual yields on the ruble denominated bonds were more than 200%. The stock market had to be closed for 35 minutes as prices plummeted. When this happened, it was down 65% and from January to August 1998 the stock market lost 75% of its value. On the 17th of August 1998, the Russian government devalued the ruble, defaulted on domestic debt and declared a moratorium on payment to foreign creditors. Since Chinas era of reform and opening up began, the country has experienced three instances of large-scale public-finance problems. In the late 1970s, the country faced a debilitating fiscal deficit. In the 1990s its corporate sector was plagued by triangular debts (when a manufacturer that has not been paid for its product is unable to pay its suppliers, which in turn struggle to pay their suppliers). Later that decade, financial institutions were burdened by bad debts generated by state-owned enterprises. Chinas corporate and local government sectors are again looking fragile in our opinion, while the sovereign should be able to step into the breach and mop up the mess, it will still result in potentially dysfunctional financial markets and an official increase in the sovereigns debt burden. India is the most likely to default on its debts currently according to CDS rates and it has severe current problems. This is nothing new to India and veteran investors into this nation. In 1985, India started having balance of payments problems, by the end of 1990 it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had been reduced to such a point that India could barely finance three weeks worth of imports. India had to airlift its gold reserves to pledge it with the IMF for a loan. Brazil has a varied economic history as we highlighted in our last report. It is worth noting that when Brazil had its first post-military-regime in March 1990 it was faced with imminent hyperinflation and a virtually bankrupt public sector. Furthermore in 1998 Brazil received a $41.5 billion IMF-led international support program. In January 1999, the Brazilian Central Bank announced it could no longer peg its currency to the USD and a serious devaluation followed. It is important to remember that only a couple of economic cycles ago these so called titans of growth were very poor developing nations with significant problems. A few skyscrapers and a financial center does not necessarily mean that there is a sustainable economy nor a liquid and transparent financial system with consideration for the protection of investors interests in place.
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Investment Implications
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Custodial & Country risk - Cypriot take away? A Powerpoint presentation too far
Illustration 54 - Bank of Cyprus Group Presentation
Bank of Cyprus marketing materials The band on the Titanic played on.
Source: Bank of Cyprus Q3 2012
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Custodial & Country risk - Cypriot take away? The source of much confusion and potentially lots and lots of lawsuits
Illustration 55 - Mixed messages all around
Source: Zerohedge
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Source: GoldMoney, Bordo and Landon Lane, Rutgers University, Temin, MIT, Simmons, Harvard University, Goldman Sachs Global ECS Research
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Source: Bloomberg
Hope is a poor strategy but there appears to be a high level of hope involved in the predicted future earnings for the U.S. Around the world analysts are comfortable marking down expectations for U.K., European, Asian and Emerging Market nations but not so far in the U.S. It would appear to us that the U.S. will struggle to realize these hopeful expectations if the rest of the world is heading into negative territory.
Illustration 58 - High expectations for the US Stock Market A decoupling from reality?
Source: Reuters, CS
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The great U.S. equity markets disconnect? Is the broad corporate reality a future of lower profits?
In our opinion it is not uncertainty, as many observers claim, that is holding back corporate capital investment and employment - it is certainty that the future will not be like the last 20 or 30 years of relative balmy times. Tax revenues will have to rise in the future and the corporate sector has come under severe scrutiny as many of our largest companies pay little tax comparative with their real earnings. With increasingly desperate governments looking for income and reassessing their past arrangements with the global corporate sector it maybe a time where the double Irish and the Dutch sandwich gets taken off the menu. Furthermore corporations, such as Toyota and BP and the global financial industry, have been forced to deal with an increasing amount of penalties and settlements surely this is a trend that will not go away as it is a politically agreeable route. More of the future pension burden is also likely to be pushed onto the employer as governments tackle their gigantic un-funded liabilities. Most savings and efficiencies have been squeezed out during the last couple of years and businesses are now faced with the reality on the ground. It is a reality of slower global economic activity. From a value investors perspective, forecasting future earnings is a perilous task at the best of times, but broadly speaking it would appear that the trend is negative.
Illustration 59 - Considering the US fiscal situation how long can these balmy times go on? As of Feb. 2013
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The great U.S. equity markets disconnect? Is the broad corporate reality a future of lower profits?
As discussed in our last report central banking special measures are not reflected in the real economy a disconnect is increasingly taking hold with the real economic activity broadly negative but with financial assets and equities especially behaving like we are in the midst of a period of strong sustainable global growth. Now we do not claim to know the future and even understanding current events in their totality can be a challenge but we do not see any real indication that we are in the midst of a strong sustainable scenario of global growth. The fundamentals underpinning the S&P500 would appear to be increasingly coming from one source and it is a source who makes decisions based on political priorities. The FEDs actions have inadvertently affected the broader financial markets and as the graph below indicates the S&P500 has been a strong beneficiary of the dovish actions.
Illustration 60 - FED magic?
Illustration 61 - How long can the share buy backs, special dividends etc. go on at these levels?
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Source: Roy Jastram, The golden constant & Silver, the restless metal, Erste Group
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In our last report we concluded that farm and forestry land offers a compelling proposition as a store of value, a cash-yielding asset and with a potential for capital gains. The illustration above from Savills highlights its relative performance vs. Commercial and Residential Real Estate (CRE & RRE). Farmland has clearly outperformed both. The level of farmland returns has been substantial in most geographical locations it has furthermore held up comparatively well in the U.S. who saw a well-documented collapse in RRE & CRE valuations during the covered period. We make the comparison between farmland and CRE/RRE with some reservation. Though farmland is often included in the real estate asset class, it is in our opinion more truly a hybrid of the real estate and commodity asset classes. Farmland values to a large degree are a derivative of agricultural commodity prices unlike RRE & CRE. This linkage in part, is the appeal of farmland investments as agricultural commodity demand fundamentals are robust and land prices remain relatively low. U.S. pension fund manager, TIAA-CREF, who have around $2.5 billion invested in farmland expects a continued return of 8 to 12% per year as global food demand increases.
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Source: USGS, globe illustration by J. Cook, Woods Hole Oceanographic Institution, A. Nieman
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However these are simply bandage solutions that can only forestall the inevitable without other advances to address the problems. Hopefully human innovation will again come up trumps after all it was wells and aqueducts that let civilization move inland from the riverbank, and irrigation that made communal farming scale, and sewers and pipes that turned villages into cities. Such innovation naturally represents a host of attractive investment opportunities. Given how much water we use today, there is little doubt that conservations sibling recycling is going to play a big role.
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Source: Bloomberg, SG
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Source: Bloomberg, SG
According to a study by Citigroup Inc. oil may reach a plateau worldwide by the end of the decade as cars, trucks, railroad engines and power plants increasingly use natural gas instead. As the illustration above highlights, U.S. prices for the fuels provide an economic incentive to make the switch. Crude oil is about four times more expensive than gas for a similar amount of energy, measured in British thermal units. The U.S. is already leading the way with others set to follow as gas becomes more plentiful and anti-pollution efforts intensify. China already has more than 40,000 trucks that run on liquefied gas and plans to put up thousands of service stations for these vehicles and passenger cars. In the U.S. a growing number of corporate and public-transport fleets use LNG or other forms of compressed natural gas. Canada, Russia and India are testing locomotives fueled by LNG. So is BNSF Railway Co., a unit of Warren Buffets Berkshire Hathaway, which said it would operate six LNG engines in 2013. Natural Gas may supplant oil as a fuel for generating electricity in the Middle East, India and Latin America. The shift may also be seen within international shipping and petrochemical companies. According to the report, greater fuel economy may combine with shifts towards gas to cause global demand to level off at about 91 million barrels a day. ExxonMobiles recent long term outlook also identified a trend towards natural gas, nuclear and the renewable segments as the illustrations below shows.
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Driving towards a future of natural gas? Changes in the global energy mix are under way
Illustration 69 - Significant changes underway
Source: ExxonMobile
Source: ExxonMobile Note: *Wind and solar exclude costs for backup capacity & additional transmission
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Driving towards a future of natural gas? Changes in the global energy mix are under way
According to the same report, natural gas will be the fastest growing major fuel between now and 2040. The International Energy Agency (IEA) estimates that there is about 28,000 trillion cubic feet (TCF) of remainging natural gas resources across the globe. Experts believe this is enough natural gas to meet current demand levels for more than 200 years. Globally, unconventional gas makes up about 40% of the estimated remaining resources. In North America, unconventional production gas has a higher share accounting for about two-thirds as the illustration below highlights.
Illustration 71 - Abundant natural gas
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The LNG story Shell Game - Forward thinking or boys with toys?
Shells most prized LNG project is its Prelude Floating Liquefied Natural Gas (FLNG) Project in Australia, which is moored some 200 kilometers out to sea and will produce gas from offshore fields and liquefy it onboard. The LNG, LPG and condensate produced will be stored in tanks in the hull of the facility. LNG and LPG carriers will moor alongside to offload the products. This vessel (See image below) will be six times bigger than the biggest aircraft carrier and will cost between $10.8 and $12.6 billion to build but it also means that Shell wont have to pay rising prices at Australias onshore LNG plants. The facility will produce about 3.6 million metric tons of LNG and 1.3 million tons of gas condensate a year. Shell furthermore holds an advantage as it has its own fleet of LNG tanker vessels so it does not incur the same processing and shipping costs. The cost of an LNG tanker more than doubled from 2010 to 2011. Shell is also gearing up for LNG exports from its North American terminal in Kitimat (British Columbia). Shell is also developing ideas for an LNG terminal in India, which would be the countrys first, and would handle LNG Imports from their Australian operations. Beyond Shell one can also look to some of the smaller independent owners and operators of LNG carriers. The field is driven by innovation and as such innovative companies who target this segment and can develop and scale their solutions represents an appealing proposition.
Illustration 73 - Mobile turn-key solution in LNG Shells flagship project
Source: Shell
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Our Summary
Continuing from our core observations from 2012, we have explored the challenges facing the two archipelagos on either side of Mr. Halford Mackinders EuroAsian heartland Japan and the UK. Plus we have added up the sum of the five key cogs of the euro-zone along with a broad overview of the U.S. and The Rest and the conclusions have to be that we are no where near a situation were the pieces of the sustainability puzzle are matching up. The worlds central banks have again been doing their outmost to extend some short-term protection to the global economy and its financial conduits but elected and unelected officials around the world appear unable to produce real solutions that are based on long-term sustainable foundations. The Q.E. medicine can only cover the realities for so long as it is not a cure but simply a local anesthetic which can dull the pain for a while. With Kuroda in place in the Abenomics team and Carney the Canadian not quite Conan the Barbarian - but the first foreigner to take charge of the Old lady of Threadneedle Street - the next couple of years should be interesting to observe unless you are sitting long these currencies. Will the German choice be to let Super Mario go to the next level or will he be stuck in the mud? Several of the emerging markets are still candidates for a hard landing and geopolitical stresses are increasing around the globe with resulting unpredictability and potential for dramatic paradigm changes. We recommend that you prepare for a storm, as to the old Chinese proverb; When the wind of change blows, some seek shelter others build windmills. We suggest that you do both.
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