Monday, December 29, 2014

Dont celebrate the low oil prices yet

When the Organization of Petroleum Exporting Countries failed to cut production quotas last month, the initial investor reaction was: Hallelujah! Lots more savings for energy buyers! Blowout Christmas spending by consumers!

The celebrations may have been premature. True, the $1 decline in U.S. gasoline prices since April is the equivalent of a 1 percent rise in consumer spending power. Of course, some of that may be saved and not spent, at least initially. And in countries with fixed fuel taxes, including China, the economic effect will be greater. At the same time, U.S. auto makers may benefit from increased sales of low-mileage SUVs and light trucks, which are highly profitable.

Net energy importers, including Japan, South Korea and other East Asian countries, also benefit from lower energy prices. China imports 60 percent of the 9.6 million barrels of oil it uses each day.

Other energy importers helped by lower prices include India, Turkey and Western Europe. Pakistan, Egypt, India and other countries that subsidize energy costs will be able to reduce those expenses. Some of the benefit, though, is offset because the euro and other currencies are weak and oil is priced in more expensive U.S. dollars.

But the list of oil losers may overpower the winners. Almost immediately, energy companies started to cut capital spending, which equaled 0.9 percent of U.S. gross domestic product in 2013, the largest share since the early 1980s. An index of oil-field service companies is down about 40 percent from its peak.

Also harmed are oil-sands producers in Canada, where a lack of transportation had pushed prices to $48 a barrel by late November, well below all-in production costs of about $85. Canadian Oil Sands, the largest owner of the giant Syncrude oil sands joint venture, plans to cut its dividend by almost half.

Also vulnerable are highly leveraged North American oil and gas producers. The 10 worst-performing energy companies in the Russell 3000 index have debt that is four times their market value. By comparison, the energy sector's average is 1.2 times.

Energy companies issued junk debt with abandon in recent years. Strained financial conditions may force weak energy producers and service companies to divest properties or sell themselves, yet buyers are likely to be scarce until energy prices stabilize. Many low-quality master limited partnerships in the energy area could be in trouble.

The weakness in junk bonds is spreading beyond energy-related issues as scared investors retreat. Since June, they have pulled $22 billion from junk-bond funds as they begin to realize they were further out on the risk curve than they wanted.

Also, post-financial crisis regulations are limiting banks' involvement in junk-security markets, removing their cushioning effect as providers of liquidity. Ditto for leveraged loans that banks often make to finance private-equity deals (and the subject of considerable worry at the Federal Reserve).

Overseas, grossly mismanaged oil producers, including Venezuela and Nigeria, are obviously in trouble. They need prices well above $100 a barrel to meet budget needs.

Russia, of course, is the poster boy for troubled oil exporters. Even before Russia's central bank raised interest rates to 17 percent from 10.5 percent on Dec. 16, it said the economy could contract by as much as 4.7 percent next year if oil remained near $60.
Russia's Putin with Obama
I've been looking for an economic shock to end the disconnect between soaring equity prices (fueled by central bank largesse) and limping economies. Since the 2008 financial crisis, central bank money has encouraged individuals, businesses and countries to borrow at low rates. The nosedive in oil and other commodity prices makes it hard to pay back those loans as deflation spreads worldwide and almost every currency declines against the U.S. dollar.

The U.S. stock market, while pointing up now, may yet have a negative response to declining energy costs, suggesting that the financial risks from falling oil prices may outweigh the benefits to consumers.

If a full-blown global financial crisis unfolds, along with an accompanying worldwide recession, investment strategy will no doubt shift from the current "risk on" stance to "risk off." In that scenario, you would expect to see a rush into the safety of Treasury bonds and the U.S. dollar and a stampede out of commodities and stocks globally.

Interestingly, most of this is already in tow. Treasuries are rallying as Americans and foreigners pour in; yields recently hit 2014 lows. The dollar has been robust against the deliberately devalued yen and euro, as well as the currencies of commodity exporters Australia, New Zealand, Canada and Russia. And commodity prices, from oil to copper to sugar, are falling.

Only stocks remain to turn down decisively, and even that could change if oil prices keep sinking.

Monday, December 22, 2014

Oil prices could go lower than expected

When the U.S. Federal Reserve ended its quantitative-easing program in October, it also ended the primary driver of U.S. stocks during the past six years. So long as the central bank kept flooding the markets with money, investors had little reason to worry about a broader economy limping along at 2 percent real growth. 

Now investors face more volatile markets and securities that no longer move in lock-step. At the same time, investors must cope with slower growth in China, minuscule growth in the euro area and negative growth in Japan. 

Such widespread sluggish demand -- along with ample supplies of oil and most everything else -- is the reason commodity prices are falling. They have been since early 2011, but many people failed to notice until recently, when crude oil prices nosedived. 

Normally, less demand and a supply glut would lead the Organization of Petroleum Exporting Countries, beginning with Saudi Arabia, to cut production. As the de facto cartel leader, the Saudis would often reduce output to prevent supply increases from driving down prices. 

Of course, this also cost the Saudis market share and encouraged cheating by OPEC members. Saudi leaders must grind their teeth over the last decade's unchanged demand for OPEC oil, while all the global growth has been among non-OPEC suppliers, principally in North America. 

That may explain why, while Americans were enjoying their Thanksgiving turkeys, OPEC surprised the world. Pressed by the Saudis and other rich Persian Gulf producers, it refused to cut output despite a 38 percent drop in the price of Brent crude, the global benchmark, since June.  

OPEC, in effect, is challenging other producers to a game of chicken. Sure, the wealthier producers need almost $100 a barrel to finance bloated budgets. But they also have huge cash reserves, which they figure will outlast the cheaters and the U.S. shale-oil producers when prices are low. 

The Saudis also seized the opportunity to damage their opponents, especially Iran and what they see as Iran-dominated Iraq, in the Syria conflict. They also want to help allies Egypt and Pakistan reduce expensive energy subsidies as prices fall. 

Then there’s Russia, another Saudi opponent in Syria, with its dependence on oil exports to finance imports and 42 percent of government outlays. With the ruble collapsing, the Russian central bank let the currency float in November after blowing through $75 billion to support it. Then the central bank tried to stop the free fall by raising interest rates by 6.5 percentage points to 17 percent on Dec. 15.  

Still, the Russian currency is floundering, along with the economy. Consumer prices in Russia rose 9.1 percent in November from a year earlier. The economy will be in recession next year, the website of the Russian economy ministry acknowledged for a few hours on Dec. 2, before the posting was deleted. 

Venezuela is also suffering. The government needs $125-a-barrel oil to cover its spending, of which 65 percent depends on oil exports. Its crude production is down a third since 2000. With inflation raging, the bolivar officially sells for 6.29 a dollar, but for 180 on the black market. 

In Nigeria, where oil and natural gas account for 80 percent of government revenue and almost all its exports, the Naira has fallen 11 percent versus the greenback so far this year. 

How low can oil prices go? In the current price war, the global market price needed to support government budgets isn't really the main issue. Nor are the total costs for exploration, drilling and transportation.  

What matters are marginal costs -- the expense of retrieving oil once the holes have been drilled and pipelines laid. That number is more like $10 to $20 a barrel in the Persian Gulf, and about the same for U.S. shale-oil producers. The estimated $50 to $69 a barrel break-even point for most new U.S. shale-oil production is less relevant.  

Developing countries that depend on commodity exports for hard currencies to service foreign debt will produce and export even at prices below their marginal cost. Until some major producer chickens out and cuts production, oil prices should remain low. 

They could decline a lot more than the 50 percent drop so far. 

Monday, December 8, 2014

Gary Shilling explains why currency differences dont make much difference to consumers

You might expect a strengthening dollar to depress U.S. economic growth by encouraging cheaper imports and reducing more expensive exports, but the actual effects are small, as are the resulting deflationary pressures. When a currency strengthens, exporters don’t pass on the cost to buyers but shave their profit margins to avoid losing sales.  

Conversely, importers don’t pass all of the currency's rise onto customers, and instead fatten their profit margins. These actions explain why import-price volatility is only about a third the volatility of a currency. 

Instead, the principal force affecting imports and exports is economic growth. When an economy is growing, consumers and businesses buy more of everything, especially imported products. The correlation between U.S. imports and the dollar is weak, but the relationship between imports and GDP is strong. My firm’s statistical models show that imports rise 2.8 percent for each 1 percent rise in GDP, but fall only 0.1 percent for each 1 percent rise in the dollar.  

Wednesday, December 3, 2014

King Dollar is here to stay

China wants the yuan to be a global currency but not at the expense of tight government control. 

Earlier suggestions that the euro might rival the dollar have been replaced by worries over whether the Teutonic North and the Club Med South can remain under one currency. There is no common fiscal policy in the euro zone and none is likely, considering the region's vast cultural and economic differences. 

The Japanese government is taking small steps toward globalizing the yen, but fundamentally doesn't want the yen to be an international currency. 

The dollar has been the primary trading and reserve currency since World War II and is likely to remain so for decades. Rapid growth in the economy and per-capita output weigh in the dollar’s favor. American financial markets are broad, deep and transparent, as is the economy. Despite the dollar's decline since 1985, its credibility is substantial.  And there is no real substitute for the dollar as a global currency. 

Monday, December 1, 2014

US Dollar looking good both short and long term

The forces pushing up the dollar are likely to persist in the short run. Among them are deliberate devaluations of the euro and yen, weakness in commodity-driven currencies, slower growth in China, the carry trade, the dollar’s safe-haven appeal and developing-economy woes.  

The greenback is also likely to remain strong in the long run. To put it into perspective, the dollar reached a peak against major currencies in 1985, then slid 52 percentage points over the next 25 years. It's been rising since August 2011, yet has recovered only 8 percentage points of that 52-point slide. 

Of course, there’s no assurance that the dollar will regain its 1985 peak, yet there are concrete reasons to expect it to remain strong over the long haul.  

Monday, November 24, 2014

Still a bull market although one should be bit cautious

I think we are still in a Risk-On environment. That doesn't mean its a very stable one. I mean the profits growth has really come from cost cutting, margin 
improvements hasn't been solidly based from revenue growth, top line growth, pricing power, its also been a big PE play. Last year two-thirds of S&P was from PE expansion. 

Its not the kind of stock market you'd say you wanna buy and forget about it. In portfolios we manage we take a very defensive position on stocks, in other words we look at things like Utilities, Consumer Staples, Healthcare, things that people are going to buy regardless and also have above average dividend yields. 

Monday, November 17, 2014

Gary Shilling on Oil Prices and OPEC

We have a chart we use in our monthly newsletter Insight that shows OPEC and Non-OPEC production [of Oil]. In the last ten years OPEC production has been flat and all the growth has been Non-OPEC,.. a lot of it coming from North America with Fracking and Horizontal drilling, etc etc.

But this has left the Saudi's in a tough position because historically they have been the swing producers, they have been the country that's willing to cut back to avoid over-supply at given prices; in other words to keep prices from declining. 

They gotten to a point where they are saying "Hey we are not willing to put up with that. We are going for market share" 

Now at what price are they going to say enough is enough, its probably a lot lower price than other OPEC producers and a probably a lot lower price than the Oil Sands at Alberta would be profitable, its probably a price where there would be a lot of pain before the Saudi's throw in the towel. But you can never really tell, this is a Kingdom, this is not a democracy. But I think they are trying to run it rationally in their own long term sense.

Gary Shilling criticizes big government and Obama

His [President Barrack Obama] got two years to go. You would think he would want to go out having accomplished something and being willing to work with congress. That's what Clinton did. But his an ideologue, he apparently prefers confrontation. 

But one thing important to realize is, if you look at the Constitution, Congress passes the law, and the President enforces them, that's the way. Its come a long way from there and the Federal Government has gotten so big that the President has immense power of his own quite apart from the Congress.

So what you have is a huge bureaucracy, and a huge administration all the agencies and Departments and so on. And the President ,just by being President has huge powers even if can have firm opposition in Congress. I think it tells you about the size and scope of the federal government.

VIA Bloomberg

Monday, October 13, 2014

Warnings in todays stock market

At the beginning of this year, investors hoped that the stock market rally, which pushed up the Standard & Poor's 500 Index 30 percent in 2013 and 173 percent from its March 2009 low, would continue apace. So they seized on any optimistic data and forecasts to justify their hopes.

A number of warning flags are flying today. Among them:

1. High price-to-earnings ratios. These ratios aren't at record levels, but they certainly are elevated. Yale professor Robert Shiller’s CAPE (cyclically adjusted P/E ratio), based on the last 10 years of inflation-adjusted earnings to iron out cyclical variations, was 26.5 in mid-September, 61 percent above the long-term average of 16.5. Stocks would need to drop by more than half to reach the long-run average (and remember that declines usually undershoot the average, just as rallies do).

Also, because this ratio has been above average for most of the last two decades, it will probably spend many future years below 16.5 -- if the long-term average is still valid. It is now in the top 10 percent of its range, and when this occurred in the past, the real S&P 500 fell 1.4 percent a year over the next decade. The Shiller P/E isn't a precise forecasting tool, but its elevated level for so many years is a warning sign.

2. Slow economic and corporate revenue growth. Real gross domestic product growth since the mid-2009 expansion began has been the slowest in the post-World War II era. I expect tepid growth to persist at about 2 percent annually until financial deleveraging is completed in four more years or so. 

Growth in corporate sales will probably continue to be minimal and pricing power almost nonexistent, resulting in further minimal rises in S&P 500 sales per share. Both consumers and businesses are forcing corporations to slash prices, and many households are again switching from national brand products to cheaper house brands.

3. Earnings depend on profit margins in the absence of meaningful sales volume and price increases. Profit margins are at an all-time high and have been on a plateau for a few years, as measured for the total economy by profits’ share of national income. Margin improvement, which is based on unsustainable cost-cutting and lower borrowing costs, isn't as solid a foundation for profit growth as sales volume increases and pricing power are.

Costs can always be cut further, but the low-hanging fruit has been picked, as seen by the slower productivity growth since the burst in 2009 when U.S. businesses took a meat ax to costs. Furthermore, corporate interest payments can’t decline indefinitely. They have fallen along with interest rates, even though the amount of corporate debt has risen in recent years.

Wall Street analysts expect even higher profit margins this year, a sign of over-optimism.

4. Fed tapering. The Fed hasn't started to reduce the huge $2.7 trillion in excess reserves that member banks have on deposit with the central bank, and it will need to do so before rapid economic growth can resume once financial deleveraging is completed. Otherwise, reserves above the required level will get lent, turn into money in circulation and risk driving the economy through full employment and into serious inflation.

Nevertheless, the Fed has been reducing the additions to these reserves as it cuts its monthly purchases of securities from $85 billion last year to zero next month. So the Fed has been adding less and less fuel to the fire that was the principal driver of stocks since August 2008.

VIA Bloomberg

Wednesday, October 1, 2014

Gary Shilling remains long defensive stocks

I think this market really isn't based on fundamentals. Profits aren't growing because of pricing power and unit volume growth. It's not a sustainable kind of thing.

VIA Yahoo News

Monday, September 29, 2014

Still a "Risk On" environment

We believe that a 'risk on' investment climate still prevails, despite the many warning signs related to economic growth and financial markets here and abroad. So we continue our defensive stance towards equities and suggest Treasuries as a safe haven and beneficiary of possible deflation, especially in the Euro-zone, as well as the strengthening dollar.

Tuesday, September 9, 2014

De-leveraging is cause for slow world growth

We continue to believe that slow worldwide growth is the result of the global financial de-leveraging that followed the massive expansion of debt in the 1980's and 1990's and the 2008 financial crisis that inevitably followed, as detailed in our 2010 book, The Age of De-leveraging: Investment strategies for a decade of slow growth and deflation. We forecast back then that the result in the U.S. would be persistent 2% real GDP growth until the normal decade of deleveraging is completed. Since the process is now six years old, history suggests another four years or so to go.

We’ve also persistently noted that this deleveraging is so powerful that it has largely offset massive fiscal stimuli in the form of tax cuts and rebates as well as huge increases in federal spending that resulted in earlier trillion-dollar deficits. It has also swamped the cuts in major central bank interest rates to essentially zero that were followed by gigantic central bank security purchases and loans that skyrocketed their balance sheets.  

Without this de-leveraging, all the financial and monetary stimuli would surely have pushed real GDP growth well above the robust 1982–2000 3.7% average instead of leaving it at a meager 2.2% since the recovery began in mid-2009.

Tuesday, August 19, 2014

Low pay jobs being created in this economic recovery

Part-time jobs paid less than full-time jobs. And, also, most of the jobs that have been created in this recovery so far have been in things like leisure and hospitality, and retailing, which pay a lot less than manufacturing and utilities.

Tuesday, August 5, 2014

Gary Shilling: Economy to continue to grow after deleveraging completes

Once private-sector de-leveraging is completed, real GDP growth will probably return to its long-run trend of about 3.5 percent, and perhaps more. Productivity improvements and labor-force growth will likely resume. And the slow-growth-forever crowd will need to find a new theory.

Thursday, July 31, 2014

Economic strength the solution to Federal debt problems

I disagree with the economic pessimists who believe that persistently slow growth will be the norm for years to come.

Yes, huge federal government deficits and debt are a major drag. It’s also true that budget surpluses aren't likely to materialize to shrink the $17 trillion-plus national debt, even if growth resumes.

Nevertheless, there is a strong possibility that government debt relative to gross domestic product will fall appreciably, as it did after World War II. Back then, deficits were relatively small, so GDP outran gross federal debt. The debt-to-GDP ratio dropped from 122 percent in 1946 to 43 percent 20 years later.

The ratio fell even further in the late 1960s and 1970s as inflation, caused by rapidly rising federal spending on Vietnam and Great Society programs, pushed taxpayers into higher tax brackets and filled government coffers. Higher corporate-tax revenues also resulted from under-depreciation and inventory profits.

A more recent example of a reduction of the federal debt-to-GDP ratio came in the 1990s under President Bill Clinton. Robust nominal growth of 5.5 percent a year caused deficits to shrink so much that small surpluses existed in fiscal years 1998 to 2001. Federal tax receipts rose 7 percent on average, faster than nominal GDP, and outlays grew slower, at 3.6 percent. The dot-com bubble lifted individual income-tax receipts at an 8 percent annual rate and corporate taxes by 8.3 percent a year.

On the outlays side, national defense spending fell 0.2 percent a year as the Cold War ended. Medicare spending jumped 7.2 percent annually but was only 7.8 percent of outlays in the 1990s. Social Security spending climbed 5.1 percent a year, less than social-insurance receipts.

In contrast, in the 2000-2012 years, nominal GDP growth slowed to 3.9 percent while anti-recessionary tax cuts and rebates shrank federal receipts’ annual growth to 1.6 percent. Outlays climbed at an average 5.8 percent rate, driven by Iraq and Afghanistan spending and by Medicare outlays. Not surprisingly, the resulting huge deficits drove gross federal debt-to-GDP to 103 percent in fiscal 2012.

The message is clear: Rapid economic growth pushes down the federal debt-to-GDP ratio directly as the denominator rises. Rapid growth indirectly affects government debt, too, as taxpayers get pushed into higher tax brackets, corporate profits grow faster than the economy, and tax cuts and government spending on social-welfare programs are curtailed.

Conversely, slow economic growth, as in the 2000-2012 period, pushes up the ratio directly. It climbs even more as the weak economy spawns tax cuts and counter-cyclical outlays.

So the resumption of rapid economic growth is the answer to the federal debt problem. Of course, the 800-pound gorilla in the room is the need for greater Social Security and Medicare outlays for retiring post-war babies. So far, Congress and the Barack Obama administration prefer gridlock to solving the looming entitlement-spending explosion. The more time passes, the more disruptive the solution must be. I believe, however, that Washington will do the necessary thing when there is no other choice.

As for the Reinhart-Rogoff argument -- that high government debt depresses GDP -- my view is that government debt doesn't depress economic growth, as they contend, but the other way around. Slow growth depresses tax revenue and raises government social spending, causing deficits and debt levels to rise.


Wednesday, July 30, 2014

Shilling believes in technology

I believe much of today’s new technology -- the Internet, biotechnology, semiconductors, wireless devices, robotics and 3-D printers -- is in its infancy. Collectively, they have the potential to rival the rapid growth and productivity-generating effect of the American industrial revolution and railroads in the late 1800s. Mass-produced autos and the electrification of factories and homes, which led to electric appliances and radio in the 1920s, offer yet more examples. Today, only a third of the world’s population is connected to the Internet but 90 percent live within range of a cellular network.

Sure, productivity (output per hour worked) grew by only 1.5 percent from 2009 to 2012, but that’s normal after a severe recession. I expect it to return to a 2.5 percent annual growth rate -- or more -- after deleveraging is completed in another four years or so. Even in the 1930s, productivity averaged 2.4 percent a year, higher than in the Roaring '20s. In the 1930s, much of the new technology from the 1920s -- electrification and mass production -- was adopted despite the Great Depression.

Rapid productivity growth offsets slower labor force advances. The decline in the labor-force participation rate is likely to slow in coming years once normal economic growth resumes. The rate has fallen as baby boomers retire and discouraged workers drop out of the labor market or stay in college.

Tuesday, July 29, 2014

Gary Shilling on American College crisis

Solutions to the crisis in higher education may also promote productivity. The poor job market for debt-laden college graduates is forcing Americans to realize that smart people go to college, yet college doesn’t make them smart. They now know that just any college degree won't guarantee a well-paid job.

In this environment, top institutions will continue to attract the best and brightest. Many of their students will go on to graduate and professional schools, often in other fields. These schools will continue to be well-financed.

Middle-tier schools, however, will need to be more focused on providing students with careers. They must emphasize science, technology, engineering and math -- the most in-demand majors. And they’ll need to convince applicants that their education is a profitable investment.

Community colleges with ties to apprenticeship programs that prepare students to be skilled mechanics or operators of sophisticated equipment will also be in demand. Middle-tier colleges and community colleges that understand their markets may prove to be significant in advancing productivity.

Monday, July 28, 2014

Housing market recovery led by Rentals

It’s really been a rental-driven housing recovery because it's really new home-builders that buy starter houses and sellers can then buy next higher-price houses so it hasn't been a very solidly-based recovery and it’s really stalled out.

Wednesday, June 25, 2014

Gary Shilling has a good track record of spotting bubbles

"Spotting bubbles is one of the things I specialize in—something that very few people can do well. I look for situations that are clearly out of line, ride up with the bubble, and then get out of the way before it breaks. In fact, you could say I've made a career out of seeing things that no one else sees before they happen. And this goes way back."

Thursday, June 19, 2014

Gary Shilling: Could China real estate cause huge losses to investors

Real estate has been an investment darling since 2009, when China countered the global recession with massive bank lending. Thrifty Chinese households save almost 30 percent of their incomes and have few other investment opportunities. Stocks continue to slide with the Shanghai Composite Index off 67 percent from its October 2007 peak. Government regulation prevents the widespread movement of investment funds abroad. Government-controlled bank deposit rates pay a trivial 0.35 percent, well below the 2.4 percent inflation rate.

So beyond the shadow banks, real estate has been the star -- much to the displeasure of Chinese leaders, who hate the related speculation. Government attempts to curb the earlier leap in real estate prices by limiting multiple apartment ownership and restricting financial leverage may finally be working.

Prices for new real estate in major cities such as Beijing, Shanghai, Shenzhen and Guangdong leaped 45 percent between February 2012 and this February, but then fell 7 percent through April. 

Given the ghost cities and other measures of extreme overbuilding, the recent slide in real estate values could evolve into a rout, with considerable loss of Chinese wealth and financial institutional failures.

Tuesday, June 17, 2014

Chinese Yuan drop maybe a dangerous sign

Chinese leaders have an easier time controlling their currency than their corruption. The government has alternated between pegging the yuan to the dollar and allowing it to move up or down in tightly controlled bands. Some say the huge devaluation of January 1994, in which the yuan moved from 5.8 to the dollar to 8.7, laid the groundwork for the collapse of other Asian currencies five years later.

The yuan was repegged in May 1995 at 8.32 to the dollar. But under immense pressure from Washington, which claimed China was purposely undervaluing its currency to increase exports, the yuan was allowed to reach 6.83 to the dollar in July 2008. The recession brought another peg that lasted until June 2010. From that time until early this year, the yuan has appreciated an average of 2.5 percent annually, with low volatility.

That, of course, has attracted a huge number of speculators who see the yuan's appreciation as a safe, one-way bet to leverage to the hilt. Such strong demand has kept the yuan trading close to the 1 percent limit above the rate that the central bank sets daily.

The profit opportunity has even encouraged speculators to smuggle money into China. Some Chinese exporters, for example, inflate their invoices. That allows more dollars to be remitted to China than the goods are worth. Similarly, some Chinese companies borrow yuan to finance exports. Then they send the exported goods back to China, where the imports are paid for in dollars. They repeat the process to generate even more dollars.

Moving goods in and out of the Shenzhen special trade zone also provides a means to ship dollars into China to speculate on anticipated yuan appreciation. Investment products sold to Chinese exporters to hedge against the dollar are also used for yuan speculation.

Chinese foreign currency reserves leaped $510 billion last year to $3.8 trillion, suggesting money came in through illegitimate channels. About $150 billion of $244 billion in capital inflows was hot money. In January, $73 billion flooded in -- the biggest monthly inflow in a year.

Chinese leaders are clearly unhappy with the one-way bet they are providing to speculators as they also seek to curtail excess liquidity. So in late February, the People’s Bank of China, the nonindependent central bank, engineered an unexpected drop in the yuan by buying dollars and selling yuan. Sure, this fits in with China’s long-run plans to free the yuan and make it an international currency. And China did increase the trading band from 0.5 percent to 1 percent. A weaker yuan, furthermore, helps Chinese exports. But the timing implies this policy reversal was a blatant attempt to punish speculators.

The effects were swift and significant. Global trading in the yuan dropped 8.5 percent in February from January, pushing it from the seventh to the eighth most-used currency.

The Chinese government, which doesn’t want to push the currency into free-fall, is playing a dangerous game. A weaker yuan revives criticism from the U.S. and others that China is a currency manipulator. And further weakness could cause foreign capital to flee China in anticipation of even more declines. Besides, dollar-buying only adds to China's embarrassing horde of foreign currency.

Nevertheless, as we know from repeated historical examples, runs on currencies are difficult to stop. Chinese leaders, in their zeal to punish speculators and assert control, may have erred. 

Monday, June 16, 2014

Gary Shilling on why he thinks China could be in for trouble

China could successfully increase economic growth, transition smoothly to a domestic-driven economy, control its rising militarism, reduce corruption without major disruptions, cease manipulating the yuan, lower the risks in shadow banks without clumsy bailouts, slowly let the air out of the real-estate bubble and deregulate interest rates. 

Given the history of other countries with similar problems, I wouldn’t bet on it.

Thursday, June 12, 2014

Aussie Dollar and Canadian Dollars at risk from China

The currencies of weak emerging economies that depend on commodity exports for growth will suffer if China has major financial and economic woes. 

Developed countries' currencies, such as the Australian and Canadian dollars, are also vulnerable to declining commodity demand, which could result if China has financial troubles.

Wednesday, June 11, 2014

Argentina, Brazil, Indonesia, South Africa, Turkey to be affected by China

China’s reduced thirst for commodities would depress commodity exporters, especially the poorly managed emerging economies of Argentina, Brazil, Indonesia, South Africa and Turkey.

All five depend on continuing foreign-investment inflows and lack the cushioning effect of current-account surpluses to accommodate hot-money outflows, as happened earlier this year. Consequently, they were forced to raise already-climbing interest rates to attract new money and protect their weak currencies. Their falling stock markets over the last decade also reflect economic and financial weaknesses.

Tuesday, June 10, 2014

Gary Shilling: Short Chinese stocks, sell commodities

Short Chinese stocks

The Shanghai Composite Index is down 67 percent from its October 2007 peak. Even though Chinese stocks may seem inexpensive -- the price-to-earnings ratio for the Shanghai index over the last 12 months is 9.8, compared with 17.3 for the far more costly S&P 500 -- there is no obvious floor. If China has a financial crisis, the risk to Chinese equities is considerable. Bank stocks may be especially vulnerable. Investors who lack direct access to mainland Chinese stocks can use Hong Kong-listed equities and exchange-traded funds.

Sell commodities 

Industrial and agricultural commodity prices took off in 2002, right after China joined the World Trade Organization. As manufacturers in Europe and North America shifted production to China, its thirst for commodities kept growing. Many producers of industrial materials, including base metals, iron ore and coal, also increased capacity as prices leaped.

Along came the global recession, which drove down materials prices in response to weak demand. Prices soon recovered, only to fall again in 2011, possibly in anticipation of slowing growth in China, which is embarking on a difficult transition from an export-led economy to one driven more by domestic spending. A financial crisis in China would no doubt further depress commodity consumption and prices.


Monday, June 9, 2014

What could trigger China financial crisis

China's growing list of problems, including a slowing economy, rising militarism, messy corruption crackdown and increasingly troubled shadow banking sector, could provoke a major financial crisis. 

Thursday, June 5, 2014

Gary Shilling worries of rising potential for conflict in Asia

China believes that, as a world economic power, it must have a major military presence. The government’s budget calls for a 12.2 percent increase in spending in 2014, much greater than the 7.5 percent GDP growth target, yet in line with past increases. Defense spending — $132 billion for 2014 — is more than double the 2007 level (although some experts believe China vastly understates its defense spending).

China’s military outlays are only 22 percent of the US’s $608 billion, but China’s costs are much lower. And while China’s spending grows rapidly, President Barack Obama is calling for a $400 million cut in defense outlays in fiscal 2015. China’s official military budget also excludes big-ticket items such as arms imports and military components of its space program.

One danger sign of a more muscular military sector is the ongoing spat with Japan over disputed islands in the East China Sea, which may have oil under them. China is also in a dispute with Vietnam over China’s deployment of an oil rig into South China Sea waters that both countries claim.

Then there is the problem of a nuclear-armed and unpredictable North Korea. China probably worries a lot about North Korea and its volatile dictator, Kim Jong-un. But China no doubt likes to have the Hermit Kingdom as a buffer against a militarily strong South Korea.

I’m not predicting major conflicts in Asia any time soon. Still, rising nationalism in China and Japan, to say nothing of Russia, is a concern.

Wednesday, June 4, 2014

Rapid growth to resume after deleveraging completes

We’re in what I call the Age of Deleveraging. My book from 2010, The Age of Deleveraging is about this.

This global deleveraging, or working off of excess debt, normally takes about 10 years, that's the historical average. We’re six years into this, so another four years of slow growth could be expected. As a matter of fact, at the rate the deleveraging is taking place now, it will probably take longer than that.

And if that’s another three of four years, we'll probably have the Fed and other central banks maintain essentially zero short-term interest rates for that period. All the attempts thus far to revive rapid growth with fiscal and monetary ease have not worked, and that shows the power of this deleveraging. But beyond that, I think we’re going to see the resumption of rapid growth. That’s what I talked about at this year’s Strategic Investment Conference (SIC).

I call this “theory follows fact.” When fact continues for long enough, the theories come out of the woodwork as to why it's going to last forever. Of course, it’s very easy to sell “slow growth forever” when investors see it happening before their very eyes. People will say "Hey, right on brother, I see that right in front of me."

But I think we are going to see resumption of rapid economic growth. We're going have a return to rapid productivity growth. We have a lot of new technologies: biotech, robotics, additive manufacturing etc. that more in their infancy than they are fully developed. And they're going to drive productivity, and we’re probably going to have a lot of people come back into the labor force, a lot of people have dropped out because they couldn’t find jobs. I think we're going to reform our education system to orient more toward where the jobs are and less toward people taking a soft major in college and just assuming that because they got a college degree from Podunk University they deserve a job.

I think there’s going to be a lot of very favorable developments.


Monday, June 2, 2014

China slowdown will affect world economies

China is the world’s second-largest economy, even if it remains an economic pygmy, with $6,091 in per-person gross domestic product in 2012, compared with the US’s $51,749. Its global importance was magnified when North America and Europe shifted their manufacturing to the Middle Kingdom. That shift made China the primary importer of raw materials and exporter of manufactured goods.

China’s size and impact on the global economy mean that China’s problems are now the world’s problems. No single issue is likely to cause a major crisis, yet in combination they certainly could.

The first and biggest problem is slowing economic growth. Until 2008, China had accelerating double-digit real GDP growth. Then the recession and retrenchment of US and European buyers knocked growth down to 6 percent — a recessionary rate for China.

The coming economic transition the government is planning is the second big challenge. After the recession, Chinese leaders realized their earlier growth model — with an emphasis on exports and the infrastructure that supported it — wasn’t working. Most of its exports were bought by Americans and Europeans. But as those economies continue to deleverage and grow slowly, the game has changed.

Now, Chinese leaders want to shift from export-driven to domestic-led growth.

But in promoting a consumer-led economy, China is way behind the goal post. The latest data from 2012 show that consumer spending only accounted for about 36 percent of GDP, far behind the developed countries. Even emerging economies are faring better: Russia’s consumers make up 48 percent of GDP; India’s are 60 percent and Brazil’s 62 percent.

The government knows that to increase consumer spending it must increase incomes and reduce savings. Chinese households don’t have much of a safety net to fall back on, so they save almost 30 percent of their income to cover health care, retirement and education.

Slow growth in US, Europe affects Emerging economies

These countries, whether they're in Asia or Latin America or Eastern Europe, they depend on exports for growth. And where do those exports go? They go to Western Europe and North America. If you’ve got slow growth in both those areas, growth in demand for everything is weaker. And that's why the Chinese, for example, are trying to convert from an export economy to more of a domestic-driven economy.

But then within the developing countries, you have specific differentiations between them. And some of these countries are very well-managed, like South Korea or Malaysia. They tend to have a current account surplus. This means that the internal savings by business, consumers, and government all combined exceeds domestic investment. Now, if saving exceeds investment, what do you do to with the excess? You export it.

If a country’s exporting capital and then the hot money that’s rushing in and out of these countries leaves, it means the current account surplus is going to be less, but they’re still going to be exporting capital. They’re not going to be in a troubled condition. And those well-managed countries that tend to have current account surpluses also tend to have stable currencies, low inflation rates, and stock markets that have been stable in the last decade and low interest rates.


Thursday, May 29, 2014

Competitive currency devaluations a threat no one can win

If we have a stronger currency, then American companies have currency-translation losses. Their earnings in euro terms, through exports or operations within the eurozone, translate into fewer U.S. dollars.

The second effect is more subtle, and it really has to do with a string of competitive devaluations. When domestic economies are weak, the urge is to increase exports. You don’t have domestic demand, so let’s let foreigners fill the gap by demanding more of our exports. Well, how do you do that? How do you make exports cheaper? Because everybody wants to export, nobody wants to import.

There are various ways, though. For example in Greece they've had what’s called internal devaluation. Their labor costs are about a third what they were before the crisis started, they’ve simply fallen because their economy’s so weak. Because they’re a member of the eurozone, there's no Greek Drachma that they can depreciate anymore, so they've got to do it internally.

Another example is France. France put on a scheme, which the Germans invented, where they simply cut corporate taxes. The idea was to lower costs and therefore lower their export prices to get more exports. And, at the same time, they offset that with a higher value-added tax. Now with the value-added tax, you can add on to import costs, which raises the price of imports making them less attractive, and subtract it from exports, making them cheaper for foreigners. So they get a triple-whammy there.

Then there’s explicit currency devaluations, that's what we seen in Japan where the government of Prime Minister Abe is deliberately trashing the yen. We may see that in the ECB, now, we see that in South Korea. The Chinese, of course, are manipulating their currency. They’re trying to drive out speculators, but they're making it weaker in the process.

The risk is that if you get into this pattern of competitive devaluations, which means nobody really wins because it offsets. I think that most countries end up devaluing their currency against the dollar. But how can the dollar devalue? The greenback is the reserve currency, there’s nothing to devalue against.

This works to the disadvantage of U.S.-based companies in terms of the currency translation losses, but also with these competitive devaluations. They tend to offset, and the net effect is lower economic growth all the way around. It actually ends up reducing everybody's exports, because exports go down when your trading partners’ economies suffer. They don’t demand as much of everything, including your exports.

So I think that's the risk. It’s a little more subtle and down the road. But the translation losses are fairly direct.

- See more at:

Wednesday, May 28, 2014

What ECB can do to avoid crisis.

One is they can further reduce their overnight reference rate, which is now 25 basis points. They could knock that down to zero.

The second thing is that they can charge member banks for leaving money at the European Central Bank (ECB). Right now, they pay zero, but they can reduce that to negative territory. In other words, they can say to banks “you have to pay 50 basis points to leave the money here,” which encourages banks to lend the money.

They can also get involved in so-called quantitative easing (QE), go out and simply buy various forms of securities, but it’s not as easy for them as it is for the Fed because there’s 18 member countries in the ECB. They don’t just go out and buy Treasuries, they have to think of 18 different issues of government papers.

They say they’re going to do something in early June unless things change dramatically, but they are clearly concerned about deflation.


Tuesday, May 27, 2014

ECB afraid of deflation

Mario Draghi, the head of The European Central Bank, came out and said what I was predicting, that they are going to trash the euro because they see it as a promoter of deflation, of which they are scared stiff. 


Wednesday, May 21, 2014

Gary Shilling: Deleveraging has another 4 years

Once private sector de-leveraging is completed in another four years or so, real GDP growth will probably return to its long-run trend of about 3.5 percent, and may be higher on a catch-up basis – a big jump from the 2.3 percent growth in the recovery so far.

The headwinds of de-leveraging will have calmed and more rapid productivity and labor force growth will likely return. And the slow-growth-forever crowd will need to find new theories to promote!

Monday, May 19, 2014

Gary Shilling on tech's future

To say that the Internet is fully exploited is like yelling ‘Get a horse!’ in the early 1900s at a Model T Ford driver whose car had broken down. 


Friday, May 16, 2014

Gary Shilling praises Draghi

Draghi gets a lot of credit for his July 2012 “whatever it takes” statement, but it was foreshadowed by the earlier lending program. 

In the last year-and-a-half, most of those ECB loans have been repaid. The ECB could probably reactivate this form of QE by “encouraging” its member banks to renew their borrowing. In any event, it will take much more than words to reduce the euro’s value significantly and head off deflation.

Wednesday, May 14, 2014

Gary Shilling says Time to short Euro

The European Central Bank is gearing up to depress the euro, which it blames for much of the deflation threat in the euro area, or at least the portion it can influence.

The ECB reduced its overnight reference interest rate from 0.5 percent to 0.25 percent in November. If it cut the rate again, the ECB would join the Federal Reserve and the Bank of Japan with rates of essentially zero. 

With all the central-bank-created liquidity sloshing around the world, these rates are largely symbolic. Yet another ECB reduction could make foreign investment in the euro area less attractive, to the detriment of the euro.

Currently, ECB member banks are paid nothing on their deposits. A negative rate -- charging banks to leave their money at the central bank -- would encourage them to lend and invest elsewhere. That would push down returns in the euro area and discourage foreign investors, also to the detriment of the euro. 

Looming deflation is pushing the ECB rapidly toward measures aimed at depressing the euro as well as stimulating euro-area economies. The time to be short the euro against the dollar may finally have arrived.

Article via

Wednesday, April 30, 2014

Gary Shilling: Deflation fears in Europe

The days of euro strength may be numbered, however, because of mushrooming fears of deflation in Europe. Average house prices in the euro area have dropped 5 percent since the second quarter of 2011. More important, inflation increased a mere 0.5 percent in March from a year earlier. Since January 2013, inflation has been below the ECB’s target of “just under 2.0 percent.” In the 28-country European Union, inflation was just 0.6 percent in March versus a year earlier.

Bankers and policy makers worldwide are deeply worried about trivial inflation in the euro area turning into chronic deflation. Christine Lagarde, the chairman of the International Monetary Fund, said in a January speech: “We see rising risks of deflation, which could prove disastrous for the recovery. If inflation is the genie, then deflation is the ogre that must be fought decisively.”

This month, Olivier Blanchard, the IMF chief economist, said deflation “would make the adjustment both at the euro level, and even more so for the countries in the periphery, very difficult. We think that everything should be done to try to avoid it.”


Tuesday, April 29, 2014

Euro currency not a safe haven

The euro has been defying gravity for years. Europe's Teutonic North and Club Med South were joined under one monetary policy. But the 18-member euro area has no common fiscal policy and probably never will, given its vast cultural and economic differences. This hardly makes the euro a safe-haven currency.

Tuesday, April 22, 2014

Part 2: Sheep economies vs Goat

The Goats [Brazil, India, Indonesia, South Africa,Turkey, Argentina] are in deep trouble, but they are better off today than they were in the late 1990's, when many had fixed exchange rates and borrowed in dollars and other hard currencies. Back then they didn’t want to devalue because it would have increased the local currency cost of their foreign debts. But when Thailand ran out of foreign currency reserves in 1997, the Goats fell like dominoes. That triggered the 1997-98 Asian crisis, which ultimately sank Russia, Brazil and Argentina.

The Goats also have country-specific problems. Brazil is promoting consumer spending to the detriment of investment in industry and infrastructure. It’s also dependent on raw materials and agricultural exports. Turkey is in the midst of a sprawling corruption probe and a political power struggle. South Africa suffers from labor unrest. Energy-dependent Russia is subject to sanctions.

The securities of most emerging markets may get beaten down to the point where they look attractive. I’ll still favor the Sheep [South Korea, Malaysia, Taiwan and the Philippines]. Their economies are well enough managed to make it in a world with limited demand for their crucial exports. The Goats may not collapse and default, but until they get their houses in order, my answer is naaah.

Story via

Wednesday, April 2, 2014

US recession effects on economy and consumers

A U.S. recession would halt the housing recovery, which is already on shaky ground, as pending sales, housing starts and mortgage applications for refinancing decline. And a housing slump would spread to many other sectors, including home furnishings and autos.

The retrenchment by consumers -- which is already evident in the weak retail sales data of recent months and the lackluster holiday shopping season -- would accelerate, hurting appliance and automakers, the airline industry and other consumer discretionary spending products. Consumer lenders also would be hit as borrowers withdrew or repaid debts and delinquencies increased.

Tuesday, April 1, 2014

Sheep vs Goat countries part 1

As I noted earlier, since the Federal Reserve began its taper talk last spring, investors have been forced to separate the sheep -- the well-managed emerging economies -- from the goats with their poorly run economies. 

The sheep -- South Korea, Malaysia, Taiwan and the Philippines -- have surpluses in their current accounts (the excess of domestic saving over domestic investment) from 4 percent of GDP to almost 12 percent as of late 2013. They are exporting that difference, which allows them to fund outflows of hot money. The same surpluses mean the sheep haven’t had to raise interest rates to retain investors' funds.

The sheep also have stable currencies against the U.S. dollar, with exchange rates relatively unchanged since 2009. Moderate inflation of less than 4 percent has been the norm in the sheep countries for several years. The stock markets of the sheep economies have also been fairly flat over the last decade, unlike the less-well-run goats, whose equity markets have sunk. In part 2 of this article, I will explain more fully what makes a goat a goat.

Monday, March 31, 2014

US corporations exposure in developing countries

U.S. corporations, however, have considerable exposure to developing economies. In 2011, 34 percent of sales by U.S. multinationals’ majority-owned foreign affiliates were in emerging markets, up from 25 percent in 2000. 

Emerging markets figure even more prominently in U.S. companies' overseas expansion plans. In 2011, developing countries accounted for 42 percent of capital spending by those affiliates, compared with 30 percent in 2000.

Friday, March 28, 2014

Emerging economies have to fix their own problems

The agonizing reappraisal of emerging economies by investors started with the Federal Reserve’s taper talk last May and June. Emerging-market officials never thanked the Fed for creating all those inflows of easy money, but now they blame the U.S. central bank for outflows. To be sure, the human tendency is to blame outsiders for self-inflicted woes.

The Fed, however, shows no intention of bailing these countries out. In 2011, Chairman Ben S. Bernanke said, “It’s really up to emerging markets to find appropriate tools to balance their own growth.” And in response to the current emerging-market crisis, Fed Chair Janet Yellen told Congress in February that those problems didn’t currently pose a threat to the U.S. recovery, signaling no change in the Fed’s tapering policy.

Thursday, March 27, 2014

Weak Import demand remains a problem

Falling currencies increase the cost of servicing foreign debt and trigger inflation as import prices leap. Weaker currencies should also aid exports by making them cheaper, but the question remains: Export to whom?

European and North American imports are subdued, while slowing growth in manufacturing-driven China makes that market tough for competitors and materials suppliers. Troubles in emerging economies, which account for 50 percent of worldwide GDP, may prove contagious.

Wednesday, March 26, 2014

People are forgetting what happened

You have Fed tapering and problems with the emerging markets—we’re really in a world where people are either forgetting reality or they are correctly anticipating that these problems really don’t matter and that the economy is, for the first time in years, actually going to grow more rapidly.

Tuesday, March 25, 2014

Play it defensively

You’ve got stocks that are really not supported by fundamentals and...with the uncertainty over Obamacare, with concern about minimum wage and income polarization. I play it defensively.

Monday, March 24, 2014

Emerging economies depend on Developed countries

Since the start of 2014, investors have fretted over emerging markets. And they should. Early in this economic recovery, investors repelled by low returns in the developed world leaped for the stocks and bonds of emerging markets, whose markets promised faster growth.

In 2009 and 2010, emerging economies grew much faster than the U.S. did; stock prices rose 46 percent annually, more than twice the gains of U.S. equities. Hot money flowed in, but so did foreign direct investment, which is harder to extract. Last year, foreign direct investment in the developing world grew 6 percent, to a record $759 billion, or 52 percent of the global total.

In their indiscriminate rush into emerging markets, though, investors forgot two important points: First, without exception, these economies depend primarily on exports for growth, which means the developed economies, especially the U.S., must be capable of buying their goods. And second, not all emerging markets are alike.

Friday, March 21, 2014

Protectionism and competitive devaluations are a worry

The increase in protectionism, perhaps in the form of competitive devaluations, also is a worry. Japan has already embarked on this course and, as discussed previously, South Korea could retaliate as the two nations compete to sell autos, consumer electronics and other products amid sluggish global demand.

Thursday, March 20, 2014

Risk off investments

A major shock would increase the appeal of familiar “risk-off” investments. Investors would rush to Treasury bonds, high-quality corporate debt and the dollar as havens while dumping stocks and commodities. Some niche investments -- such as small luxury goods and medical office buildings -- also would look good.

There is a long list of unattractive investment areas in a “risk-off” environment that includes developed- as well as emerging-market stocks and bonds. 

Wednesday, March 19, 2014

Gary Shilling: US vs China bailouts similarities

A cautionary tale emerges from the recently released transcripts of Federal Reserve policy meetings at the height of the 2008 financial crisis. They show that, like China today, the Fed had all the money it needed to bail out any financial institution, yet central bankers admitted they were “behind the curve” and failed to move swiftly before runs on banks, notably Bear Stearns Cos. LLC and Lehman Brothers Holdings Inc. 

Could China be facing a similar situation -- plenty of bailout ammunition, ample willingness to use it, but tardy in its decision to step in? A financial crisis in the world’s second-largest economy would have global consequences.

Tuesday, March 18, 2014

What market risks to watch for currently

Investors also should keep a close watch on emerging markets, where the threat of contagion is real, as was demonstrated in January with a worldwide flight from risk because of financial, currency and political uncertainty in Ukraine, Turkey, South Africa, India and Argentina.

A financial crisis in China could be another reason for the market to change direction. Even after the recent surge in local government debt, China's total government debt is a modest 53 percent of gross domestic product. Still, the central bank’s efforts to contain the explosive growth of the shadow-banking system may not work. The leap in short-term rates to 30 percent in June could be a warning sign.

Monday, March 17, 2014

US stocks heading to a blow off top

U.S. stocks may be headed for a blow-off as individual investors pile into the market after last year's meteoric increase. Peaks often are reached when everyone has been sucked in. Then, a major shock could force investors to focus on the slow global economy. 

With U.S. growth of only about 2 percent, it won’t take much of a jolt to precipitate another recession, which is long overdue by historical standards.

The investment climate would then shift from “risk on” to “risk off.”

Sunday, March 16, 2014

Chinese government likes to be in control

Chinese leaders are control freaks. Every January they tend to have negative exports because of the Lunar New Year, but this was more so than usual.

Thursday, March 6, 2014

More Government regulation leads to inflation

In reaction to the financial collapse, Wall Street’s misdeeds and the worst recession since the 1930's, substantial increases in government regulation and involvement in the economy are certain -- and therefore, so is more inflation by fiat.


Monday, March 3, 2014

Inflation and Deflation cycles

The long bull market that began in the 1980's was followed by two bouts of financial deflation, in 2000-2002 and 2007-2009, as stocks declined by more than 40 percent for only the fourth and fifth times since 1900. 

A financial inflation/deflation cycle has also occurred among financial institutions that greatly leveraged their balance sheets over the past three decades and are now being forced to raise capital, while reducing risk and leverage.

Monday, February 24, 2014

The real umemployment rate is

Watch the interview to listen to Mr Gary Shilling's full commentary on Bloomberg

Tuesday, February 18, 2014

Volatility can be a friend of a strong market

Watch Gary Shilling talk on Bloomberg USA news. Click on the above play button.

Wednesday, February 5, 2014

Is South Korea developing or developed economy

South Korean economy fits between the rich countries of Europe, the U.S. and Japan and the developing countries. Still, because of its heavy dependence on exports (56 percent of GDP), it resembles emerging markets in a world where export-led growth is no longer a winning game. The economy’s dominance by the chaebol conglomerates (82 percent of GDP) is also more typical of developing than mature economies.

Monday, February 3, 2014

Gary Shilling likes South Korean investments

Chronic government surpluses and low debt are advantages for South Korea, however. So, too, are huge foreign exchange reserves built up from years of current-account surpluses. It ranks 34th out of 177 countries for economic freedom. Other pluses include the highly educated workforce, a robust work ethic and solid banks.

That is why South Korea should be near the top of the list for investors interested in developing/semi-developed country markets.

Friday, January 31, 2014

Korea to devalue yen to compete with Japan

Japan’s deliberate efforts to devalue the yen will probably induce retaliation by other nations. South Korea, which competes with Japan in many export markets and has a history of currency manipulation, may be the next to competitively devalue, given the recent strength of the won.

Tuesday, January 28, 2014

Gary Shilling on Korea work and education

South Korea also doesn’t have a lot of unemployed people who can be put to work to increase output. The unemployment rate remains low, and the labor force participation rate has been rising recently despite the aging of the population, as is the case with many advanced countries except the U.S. and Canada. As with other highly industrialized lands, South Korea’s population growth has slowed to almost zero.

Meanwhile, the South Koreans’ legendary work ethic and zeal to get ahead continue to be apparent in the emphasis on education. The goal is to get into prestigious universities that lead to jobs in chaebol. Parents incur huge debts to pay for cram courses for their children’s entrance exams. These efforts seem to pay off. With the exception of China, South Korea ranks highest in reading and math, and is behind only Finland and Japan in science.

Nevertheless, with seven of every 10 high school graduates attending a university, there is a surplus of educated people. Estimates show that there are 50,000 more college graduates each year than the labor market needs, but there is a shortfall of 30,000 people for jobs requiring just a high school degree. Estimates are that 40 percent of college graduates are redundant.

South Korean youths pursuing an education are delaying raising families, contributing to the low fertility rate of 1.2 per woman and to low population growth. This compares with 1.4 in Japan and Germany, 1.6 in Canada and 2.1 in the U.S. Excluding immigration, a 2.1 fertility rate is needed merely to replace the population.

Also, because they are delaying their entry into the labor force while attending a university, young people’s contribution to GDP has been negative since 2009. They added about 2 percent a year from 1970 to 1990.

Monday, January 27, 2014

South Korea has a huge income disparity between rich and poor

South Korea is essentially divided between members of the upper class who are involved with the chaebol and are politically well-connected, and the rest who earn relatively low incomes and operate small businesses, largely in the service sector.

A larger problem is the huge income disparity in South Korea.

 According to the Organization for Economic Cooperation and Development, 45 percent of old people live in poverty, three times the average of wealthy nations, and the social safety net is one of the weakest. The chaebol are widely blamed for doing very little for the underclass.

Friday, January 24, 2014

South Korea still dependent on Chaebol's

The family-run conglomerates known as chaebol are very powerful, with annual revenue equivalent to the nation’s GDP. They were central to the efforts of Park Chung Hee, the military ruler from 1962 until his assassination in 1979, to propel the nation from war to prosperity in one generation. The chaebol were granted tremendous economic power and near-monopoly control in autos, electronics and other industries.

Ironically, Park’s daughter, who is now president herself, was elected in part on her pledge to restrain and clean up the chaebol. So far, she has little to show for her efforts: Last year, sales of the largest 30 conglomerates accounted for 82 percent of GDP, up from 53 percent in 2002.

Thursday, January 23, 2014

Gary Shilling praises South Korea

South Korea is one of the few emerging markets to weather the recent storms. This stability is the legacy of 60 years of forced industrialization imposed by authoritarian governments and tightly controlled monetary and fiscal policies.

South Korea’s growth has been fueled by exports, which accounted for 58.7 percent of nominal gross domestic product in 2012.

Wednesday, January 22, 2014

Why China supports North Korea

One reason China supports North Korea is probably the desire to keep a buffer between China and South Korea and to force the South to maintain an expensive military establishment to counter the belligerent North.

Monday, January 20, 2014

South Koreans yearn for North Korea's collapse

Consider what would happen if the totalitarian regime in North Korea collapsed and that vastly underdeveloped country of 25 million was absorbed by South Korea, with its 50 million highly motivated and industrious citizens. Despite the huge initial costs, South Koreans yearn for this opportunity.

Gary Shilling via

Thursday, January 16, 2014

Japanese yen devaluation is a danger to South Korea, no winners in devaluations

The competitive devaluation of the yen is a considerable threat to South Korea’s export machine because it competes with Japan in many export industries, including automobiles. Competition is also fierce in electronics, especially parts and components and machine tools.

Adding to the pressure of recent cost increases and the strong won is the lack of innovation in South Korean manufacturing. Samsung Electronics Co.’s smartphones accounted for 29 percent of world demand in 2012, but the mobile phone industry is reaching saturation, with new demand centered on low-priced models in developing countries.

Japan’s competitive devaluation comes at a critical time for South Korea. Despite huge monetary and fiscal stimulus, most economies around the world are experiencing slow growth. The obvious alternative to domestic-led economic growth is export expansion, but the question is, to whom? For decades, the U.S. has absorbed the world’s excess goods and services. Slower growth in real wages and incomes means Americans are no longer able to occupy that role. Indeed, U.S. trade and current account deficits are shrinking. These trends will probably persist as the rising consumer saving rate continues to damp demand.

So promoting exports requires making them cheaper to gain market share from other exporting countries. Yet when countries resort to tit-for-tat competitive devaluations, no one wins.

Wednesday, January 15, 2014

China middle class not as big as US middle class

China’s economy could shift to being domestically driven if its middle class were big enough and inclined to spend freely. But Chinese consumers save a third of their income to cover old age, health and other costs no longer provided for by the government. The stock market bubble there attests to huge savings with few investment alternatives.

And although there are an estimated 110 million people in China’s middle and upper classes, that represents only 8 percent of the 1.4 billion population, and these elites control just 25 percent of GDP. In contrast, the U.S. middle and upper classes make up about 80 percent of our 300 million people, with incomes that equal 80 percent of GDP.


Tuesday, January 14, 2014

South Korea dependent on exports

South Korea rebounded from the most recent recession as exports leaped. Growth has subsided, however, and will probably be held back by the slow recovery in Europe, the slowdown of growth in China, the competitive devaluation of the Japanese yen and a tepid U.S. economy. Industrial production is barely rising. Business conditions continue to be subdued, and the consumer sentiment index has been little changed in the past year.

Dependence on exports, however, has left South Korea vulnerable to global volatility, as was evident from the nose dives in real GDP caused by the 1997-1998 Asian crisis and the 2008-2009 global crisis and its aftermath. The relatively low level of consumer spending, 53.5 percent of GDP in 2012, was inadequate to offset the collapse in exports.

Monday, January 13, 2014

Shilling on what 2014 could bring to stocks

Will the negative effects of the government shutdown and debt ceiling standoff, coupled with the confusion caused by the rollout of Obamacare, be a sufficient shock? The initial Christmas retail selling season may tell the tale, and the risks are on the down side. Besides the consumer, we're focused on corporate profits, which may not hold up in the face of persistently slow sales growth, no pricing power and increasing difficulty in raising profit margins.

Nevertheless, we are not forecasting a recession for now, but rather more of the same, dull, slack 2% real GDP growth as in the four-plus years of recovery to date.


Sunday, January 12, 2014

Emerging markets not ready to decouple from US, Euro Zone, Japan and UK

After the global recession of 2007-2009, growth has been sluggish in the U.S., the euro area, the U.K., Japan and other developed lands. Meanwhile, the economies of China, South Korea and many other developing countries revived and grew much more rapidly.

This convinced many equity investors that the real action was in emerging markets, where equities rose much more than in developed countries from March 2009 until mid-2011. Once again, investors forgot that those economies are all driven by exports that are bought by developed countries, principally the U.S. and Europe. So if mature economies are growing slowly, rapid expansions in developing countries are unsustainable.