Thursday, May 13, 2010

The Coming Protests in Europe (and the US?) - Alpha

Protests in San Francisco
As I walked to get a late take-out Korean lunch in downtown SF today, I saw another protest on the halcyon streets. About 40 people were marching with bullhorns around the Grand Hyatt Hotel in downtown SF, in protest about wages and benefits in union bargaining. They were angry and aggressive (I almost felt sorry for the Hyatt's guests). But such protests are becoming more common. Over the last year, I have seen about 8-10 protests (slightly less than one a month) in downtown SF, in the financial district, within a block of my office. Most are around hotels, but a few concern insurance companies and banks (I'm not close to the municipal/state govt. buildings, which I know have their own protests). For example, walking out of my gym at the Embarcadero Center a month ago, I was stunned to see a protest had actually come into the building into the mezzanine floor (private property) and that 6 security guards were scuffling with about 20 protestors trying to get into the elevator bank and go upstairs. The SF police finally came and broke it up, arresting and ejecting the protestors out of the building. Will matters get worse?

Protests in the Western World

Yes. My thesis is that protests in Greece, with violent street fighting, fires, and flares, are just the beginning. As unsustainable debt loads and the eventual financial crises force governments and economies to deal with the real problems, much of Europe will have to deal with protests. Taxes will have to go up as government services, esp. welfare services, are cut. I see Spain, Portugal, and the UK as the highest risk, but Portugal and France aren't far off (it doesn't take much to get the workers of France to strike). Odds are still high that one or more PIIGS will leave the euro (the currency, but probably not the Euro-zone). The US and Japan have 1-3 years more breathing room (maybe less if financial contagion spreads), but politicians in both countries still want to maximize very short term political gains over dealing with the long-term problem (including President Obama - if a ship is moving toward an iceberg of debt defaults, you don't speed up the ship's engine with more health care obligations). Much of the fiscal data is here in the McKinsey and IMF reports: &

THE FINANCIAL BEZZLE OF THE WEST: The data jumps from the table (click on it to enlarge it):

The Financial Bezzle of the Western World is Lifting

What Europe hasn't realized is that large parts of it are closer to being Argentina of 1999 versus a solvent "developed world" country (Singapore of 2010). Argentina is sobering because bad choices by the elites made the country, once the 5th richest in the world (1914), into a third-world country (1980). An unsustainable debt boom from 1994-2000 ended in the largest sovereign default so far, 5 presidential administrations in a year, tears, and a national poverty rate above 45%. What the Western financial system has done the last 10-30 years is create a "bezzle," where financial innovations made it look like people were getting richer, but they weren't - the "inventory of hidden embezzlement" was growing as unrealistic and unsustainable debt loads grew. Real (after-inflation) incomes in the US have stayed constant from 1975 to 2010, but employment is much higher (wages for men have fell while those for women have increased, so the gender pay gap has narrowed in an uncomfortable way). See Galbraith describing the aftermaths of the 1920s debt bubble and bezzle, ending in the 1929-31 crash:

“In many ways the effect of the [1929] crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. there is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should be called the bezzle. It also varies in size with the business cycle.”

The Great Crash: 1929″, John Kenneth Galbraith, First Published 1955, Page 152 to 153.

What should we make of the bezzle that is slowly lifting? The asset reflation/boom of the past 12 months has very much been part of it, temporarily covering the core economic problems. Most politicians still have not communicated the bankruptcy or near-bankruptcy of Western countries. The UK will be the first realistic test (the Irish are struggling under their painful reforms).

Capital and Labor

What this means is that capital and labor both need to get realistic.

The shrewdest businessmen/investors I observe (smart capital), with $100mn plus portfolios, are realistically expecting NO GAIN on their capital over 10 years. Basically, they expect a 3-4% real return for consumption/donations, and 2-3% for inflation. So their capital base won't grow at all, and they are realistically worried they will have to spend down capital. So businessmen expect 5-7% nominal returns (real returns plus inflation), but like monkeys covering their eyes, they are afraid to think about inflation above 3%, let alone 5% to 10%. Contrast this with most large pension funds, endowments, and foundations (dumb capital), which still think they can get 8.5% returns (the 1950-2000 average for a 60/40 portfolio). How much does the 8.5 - 5 = 3.5% differential matter? A lot, as in 20 years it means these funds, providing for workers and charities, will have half as much capital as they project (so pension/ foundation underfunding will be massive). Also, inflation will return in a big way. Countries with long maturity, fixed rate nominal debt (in their own currency), with many external debt holders (but that is a detail), will inflate away the real value of these debts. Count on it. The UK is the highest rich country on my list for this, but the EU and US aren't far behind.

As for labor, I roughly see two groups: educated workers with a 4-7% unemployment rate, and the un-educated underclass with 10% to 30% unemployment rate. Group 1 tends to ignore Group 2. It should be a national priority to transform the second group into the first. Politicians have spouted lots of cute rhetoric in the US, but little to no real action has occurred. What protestors don't understand is that the pie is small, and that they can win higher wages and benefits in a further bezzle (look at UAW union workers at auto plants and their generous concessions), but they will still be bust unless they improve their skills. And they need help to do that (national student loan programs aimed toward jobs in demand, education programs tracked toward hard job skills and not 19th century liberal arts categories). As for national saving, clueless economists have applauded GDP growth fueled by debt and more consum er spending, when what the US needs is more saving (by capital and labor) and real investment (in job training) for its people.

Maybe Shakespeare was wrong, and "The first thing we do, let's kill all the economists." Would that pacify the protestors?

NOTE: One reader told me I'm an idiot (usually true), because he doesn't see protests yet in Philly or NYC, and that SF is just a protester city of whiners. Maybe. We shall see. Tourism is the biggest industry here, so hotel employees are the largest labor group. Detroit saw protests as the auto industry collapsed. North Carolina saw protests as the textile industry died. I have yet to see construction workers get out the pickets, but...

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