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quarta-feira, setembro 02, 2009

UBS Thursday Macro Sales Ideas/Sales thoughts - A Bridge to Nowhere???

UBS Equity Derivatives Macro Sales Ideas / Sales Thoughts – (By Andrew Lees 44 207 568 4350). Thursday 13th April 2009

Please note these ideas may differ from UBS Research / UBS house view

A Bridge To Nowhere?

A lot of us criticise China for not having end consumption. We also criticise them for unsustainable investment, and for excess capacity etc. We say that Japan invested during the 1990’s in roads to nowhere and bridges that weren’t needed. In the US we worry about the cash for clunkers programme. Others are concerned about propping the banks up to reflate the same old bubble. A very common phrase at the moment is “artificial demand”. What is artificial demand however, and what distinguishes end consumption?

Some people – (in fact most people) - call me a dinosaur because I refuse to have a mobile phone. As far as I am concerned they are a scourge on humanity. Its not the fear of microwaves or the affect that the mono-syllabic conversations are supposed to have on dumbing us down- (“no wot i min”) - , nor the fact that they seem to generally be a massive negative to people’s efficiency, or that they destroy social skills and manners etc, but rather the fact that conversations people have on them are not personal; they are loud and they are intrusive and stop me falling to sleep on the train. In my opinion spending money on mobile phones is a complete waste. And it is a huge waste at that; remember the scale of the money wiped out on the mobile phone bust in 2000/2001. I am the minority however. To me it is a waste of money, but to the majority of people, they are something that they can’t do without.

At the end of the 1980’s Japan was extremely wealthy. I remember seeing reports that it had about 3 cars per household, a much higher concentration than anywhere else. For one reason or another, the household decided enough was enough. Had things been left like that, unemployment would have soared. Perhaps that wouldn’t have been a bad thing, lying around in the sun all day. Clearly the public still wanted to work so the government had to decide what could occupy these people. It decided to build some roads. Whether the reason was because of the large number of cars per capita meant that Japan needed more roads or not I have no idea, but the fact is that building roads was an easy way of employing large numbers of people. This enabled these workers to finance some of their debts etc whilst the rest was defaulted on. It was not as well paid as exporting goods to the rest of the world, but the rest of the world had decided that it wanted to buy cheaper goods from South Korea and Taiwan etc, but it kept the Japanese occupied. Where the roads a waste or not? That depends on your perspective.

In the book The China Dream, Joe Studwell described a lot of the Chinese boom in the 1990’s as “a monument to a pharaoh”. But if it kept the public happy and contented, then so what? If China wants to cozy up to the US by buying its friendship with loads of cheap goods, then what is wrong with that? We all know that the US can’t afford the debt, but is it better for China to keep supplying goods to the States knowing that or risk stopping production and seeing its own unemployment soar? If the US can’t afford this debt, then can China take a lower and lower rate of return on their investment? Is there a limit to this? Realistically there is no limit. If you think at the extreme, social security or dole payments are just loans with zero interest and zero capital repaid. We accept making these loans, so if it keeps China happy, then why not them as well? Given that it is an external transfer payment, does that make a difference? Again the answer is no, not really; the central country of an empire taxes their member states. Eventually China may decide it is not in its best interests to continue supporting US consumption, but it has been very clear that is not in the short term. In the mean time it is willing to be subservient to the States. As you know, my personal belief is not that China will break the relationship of its own accord as the cost to it – (a loss in value of its FX reserves and probably social unrest etc) – will be too high, but that it will be forced upon it by an outside force which I believe to be resource shortages. The dollar crisis that we are all fearful of is actually essential to sort out the problem.

When people talk about Japan building bridges to nowhere, what determines that it is nowhere? Should we look ex-ante (before the event) or ex post (retrospectively). I have described the Fed’s balance sheet expansion as a massive bypass. Initially it is a bypass through the middle of nowhere but gradually out-of town shopping centres etc start to build up around it and eventually a town. With hindsight it is not a bridge to nowhere but in fact a route to a new town or in this case to a new banking and finance system, etc. As a client said, the best example of a bridge to nowhere must be Columbus. That bridge over the Atlantic Ocean that discovered America turned out to be the most profitable bridge ever.

If the question therefore is not whether this consumption is “real” or “artificial” etc, what should the question be? The answer must be 2-fold; whether we are maximising the output from the limited resources that are available and who should actually have the right to chose what goods we want? The answer to both of those comes back to productivity, and that becomes a circular question, balancing out productivity of particular goods against our choice of which goods we want to consume. Paper money is supposed to be the medium that keeps a count of how these two equations are moving against each other.

We do not have artificial consumption. You and I may disagree with the particular consumption mix as I disagree with mobile phones, but the fact is that is what we have collectively chosen through our respective governments – (shame on us). Likewise we may know that Toyota can build cars more efficiently than GM, but we have chosen to allocate production to GM. In my opinion, neither the production or the consumption are what I would chose, but that doesn’t mean that they are artificial or unsustainable. They are simply a choice – (in this case political choice) that we have made.

My own choice for governments spending would be to squeeze end consumption of goods and instead invest in nuclear fusion, hopefully opening up the door to a new global growth phase bigger than the industrial revolution 200 years earlier and slamming the door shut on the resource constraints and inevitable slowdown that otherwise we are looking at; ie my preference is to slow our production of mobile phones and re-allocate resources to developing nuclear fusion, but I am in the minority. Only ex-post can we possibly answer the question whether my choice was the right choice or not, ie whether we can actually create the technology to make fusion, but clearly certain things can point to that choice being right ex-ante in just the same way that Columbus had worked out that he was not going to sail off the edge of the world and that there were great riches at the end of his bridge to nowhere.

Why have I written all of this? The point is that when everyone is saying that government spending etc is unsustainable because it is creating artificial demand, this is nonsense. The only things that can determine whether it is sustainable or not is the resources – (land, labour, and energy and capital) - but even here, financial capital is not a real resource but rather just a choice of how we collectively chose to allocate the other resources. The credit crunch is simply the process of changing our collective decision of how we allocate those resources, premised by the fact that we had insufficient energy to support our previous consumption choices. As I highlighted earlier in the week in my piece on Big Government, there appears to be a growing resentment on just how we are allocating our resources etc, and I think watching how this develops will be more of a key to long term resource and spending allocations.

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