Dr. Hans Black
Interinvest Review & Outlook
Our dear clients and long term friends will forgive us for using a title now employed in popular culture. The current movie "Hurt Locker" uses a military term to describe an extremely difficult situation, i.e. being in a locker, a tough spot, or a hurt locker, a really tough spot. I could not help but think of the fiscal situation of so many developed nations, be it Japan, North America or Europe, as all of them appear to us to be in a difficult "hurt locker." Since this economic crisis began in 2007 with the collapse of the sub-prime debt market, we have had to withstand wave after wave of difficulties as the world collectively wakes up to the sequelli that years of capital markets abuse have inflicted on so many nations. While it is difficult to tell which chapter in this rather long book we are currently on, we unfortunately believe that we are nowhere near the middle of this tome, but probably getting close. Gone for the moment are the fears of a financial system Armageddon which, of course, existed in the late fall of 2008. The current chapters, however, reveal the awakening of widespread sovereign risk far greater than many had suspected even fifteen months ago.
Late last fall the world was taken aback by the sudden quasi default of Dubai debt, which had previously been considered beyond reproach. As 2010 began, the focus has been on Greece and, of course, some of the other problem areas in Europe, namely Portugal, Ireland, Spain, Italy, and now, quite conceivably, the United Kingdom. As this is being written, it would appear that Greece, by using extremely difficult belt tightening techniques, will be able to pass by the near term crisis, at least for the moment. The Greeks, of course, have learned a difficult lesson as they have discovered the obvious; they can no longer print money. Only the European Central Bank can perform this miracle, at least for now. Other governments, notably the Untied States and the United Kingdom, are both able to essentially create liquidity out of thin air in a wonderful process that politicians and central bankers have dubbed "quantitative easing". Indeed, as quite a number of observers have pointed out, the Greek budget deficit which is just under 13% of GDP is hardly so different from the U.S. budget deficit for the current fiscal year which approaches 11%. It is remarkable, in our opinion, that while the Greek government has given speech after speech announcing a wide variety of austerity measures, the U.S. government continues to spend and indeed continues to propose expensive new spending plans.'
It will remain to be seen whether Congress moves ahead and passes a comprehensive universal health bill, but one cannot but be troubled by the complacency in many quarters in Washington regarding what certainly appears to us to be out of control spending. In recent weeks, we have taken the time to carefully study the finances of a number of key states, namely California, New York and New Jersey, as their difficulties are indeed monumental. What caught our attention at first was an interview given by the new governor of New Jersey, Chris Christie, when he expressed chagrin that the previous governor Jon Corzine was busy wiring monies to various municipalities just two hours before the new governor was inaugurated. In fact, the morning of the inauguration, the departing governor managed to send out over $350 million to a wide variety of municipalities in order to give them some breathing space. We have all, of course, heard similar anecdotes about the situation in California and will undoubtedly hear many more, notably now that the political situation in New York State has become so difficult. None of these states or municipalities, of course, can print money and are, therefore, beholden to Washington to print some more and send it to them. This would appear to be where a lot of the stimulus money has gone in recent months, that's right, merely to plug up holes.
Needless to say, the situation in Japan continues to worsen and despite their very best attempts to manage their disastrous fiscal and debt situation, nobody seems to have an answer. It is worth noting that the national debt of Japan, which is over 200% of their GDP, is now virtually equal to the entire reservoir of household wealth for that once proud country.
Despite all this cheerful news, perhaps the biggest problems is that there appear to be very few in power that truly recognize what is going on or are prepared to face the voters with extremely tough measures. Inevitably these will come, although the real danger appears to be that, for the moment, too many people are patting themselves on the back with the view that things are just fine once again. In time, we believe that we will see at the very least the adoption of a national sales tax in the United States. Such a measure, which as been debated oftentimes, might be introduced as early as 2011 as a way to combat the growing deficit. Indeed, the United states, as we have commented before, is now the only G10 nation without such a form of taxation. It is also possible that one way to deal with the traditional arguments against the tax would be to institute a graduated level of sales tax for higher priced items. It is important to remember that still 65% of the $14 trillion American economy is consumption and, therefore, even a modest sales tax of 3.5%-4% can begin to make a real difference.
Time will, of course, tell but unfortunately we are not too optimistic for any near term surprises from politicians in the developed world. For the most part, they are still busy cleaning up the mess of 2007 and 2008 and have hardly begun to even focus on the longer term consequences of the very real next crisis, i.e. that of potential sovereign or state insolvencies.
Editor's Note: Dr. Hans Black is editor of Interinvest Review & Outlook, P.O. Box 51462, Boston, MA 02205, 1 year, 12 issues, $125. Interinvest Corporation Inc. is a global money management firm with affiliated offices in Boston, Montreal and Zurich. www.interinvest.com.
