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E.g., 05-12-2021
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    Gavekal Research

    The Long March of the Communist Economies

    As we look forward to the coming year, we can bet our bottom drachmas that French and Italian trade deficits are going to continue to crater. Industrial production in most European countries will continue falling (who will invest given the uncertainty and the constant changing rules?). Unemployment is going to go ballistic.

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    Gavekal Research

    Kicking a Can Full of Worms Down the Road

    An unfortunate fact of the Euro era is that a number of nations have become increasingly uncompetitive (see France is Getting the Italian Disease). The result has been a lower structural growth rate (e.g., Italy has had no growth for 10 years) and from there the double malediction of growing external deficits and widening budget deficits.

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    Gavekal Research

    Cutting Through the Noise in Europe

    Whatever the end-game of the ongoing EMU crisis, we can be sure of one thing: Europe will have to live according to its means and no longer according to how much it can borrow. Among other things, this implies:

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    Gavekal Research

    Where Do We Hide?

    As our regular readers know, we have been arguing that the US currency is now very undervalued, especially against the Euro and the commodity currencies of the world. In our view, the US current account will almost certainly continue narrowing for the next two years:

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    Gavekal Research

    Good and Bad Bubbles

    As we have often argued, there are two kinds of bubbles and two ways to finance them. The best kind of bubbles take place in productive assets (canals, railways & the internet) and are financed primarily by equity. When these bubbles burst it is of course very painful for the equity holders, but when it is all said and done, the world is still left with more productive assets and the banking system is still relatively intact.

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    Gavekal Research

    Daily - The Doomsday Machine Part Deux?

    In the midst of the Lehman crisis, we wrote about the The Doomsday Machine Unleashed in which banks, under mark-to-market rules, were forced to sell assets into a fire sale, thus perpetuating a cycle of doom. In other words, the incompetence of regulators gravely aggravated an already deadly situation. Most rational actors would think lessons had been learned here—yet amazingly, three years later, European policymakers may be setting in motion...

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    Gavekal Research

    Daily - The Bond Market vs the ECB

    One of the more important features of financial markets is that they are supposed to send messages about future economic conditions. But deciphering these messages has been particularly difficult in the past few months. In very short time spans, the stock markets were alternatively signalling that the world was coming to an end...or perhaps not. For a moment there it appeared that emerging markets would be the first fatality...but then not. One...

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    Gavekal Research

    Sowell's Four Steps to Hell

    Thomas Sowell is a great American economist and columnist, now in his 80’s serving at the Hoover Institute, with ideas similar to those defended by Gary Becker or Milton Friedman. Like Friedman and Becker, or Bastiat before them, he writes with extraordinary clarity on the complex economic and social problems of our days. One of his best pieces, in my humble opinion, is on what he calls the Four Steps (to Hell).

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    Gavekal Research

    France is Getting the Italian Disease

    I followed the events of the last week in Europe with considerable amazement. Clearly, much effort was made by all involved not to address the real issues. That in itself is to be expected, but it was disappointing to see that almost all the financial media swallowed the bait and talked endlessly about a bigger EFSF, bank recapitalizations, haircuts, etc.

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    Gavekal Research

    How Will Europe Pick the Rentiers' Pockets?

    In any given economy, the entrepreneurs, rather than the rentiers, are traditionally the risk-takers. The Euro, however, has led to an enormous transfer of wealth from Europe’s entrepreneurs to its rentiers (which includes the increasingly bloated public sector). There are now too many rentiers and not enough entrepreneurs and, in our view, the ongoing European crisis is the inevitable result of this wealth transfer.

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    Gavekal Research

    Our Velocity Indicator is Pointing to 'Risk On'

    In the annals of economic history, the velocity of money has gone by many different names: the Austrians called it “the preference for liquidity,” Lord Keynes referred to it as the “animal spirits,” Irving Fisher saw it as the variations in the desired level of cash balances…. Because it is so fraught with unpredictable and highly volatile psychological behavior, forecasting velocity is all but impossible. Our approach to this vexing problem has...

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    Gavekal Research

    The Euro Debate Continues: A Leveraged EFSF?

    Last week European markets enjoyed a short-lived rally amid talk that a leveraged EMU war chest would be used to shore up Europe’s ailing banking system. One reason such a solution is being considered is that the size of the EFSF, at €440bn, is likely not enough to make a big enough dent in Europe’s growing sovereign debt problem. After all, there is some €3.3 trillion in outstanding GIPSI debt alone, of which a substantial €1.5 trillion is in...

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    Gavekal Research

    Garbage In, Garbage Out

    Faced with another bad call in a 1981 match against Tom Gullikson, John McEnroe famously screamed: “You cannot be serious!” Being an avid tennis player in his now very distant youth, Charles often feels compelled to utter those same words as he reads the financial pages. Most recently, his frustration concerns the growing worries about the outlook for UK GDP growth.

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    Gavekal Research

    The Swiss Version of QE

    How far is the SNB willing to go to defend its new ceiling of 1.20 Francs per Euro, and for how long? The short answer is that, assuming the Euro remains, the SNB will likely defend the ceiling aggressively, so long as this is consistent with the SNB’s desired domestic monetary policy stance. Here is why...

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    Gavekal Research

    Free the Market

    Over the past decade or so, central bankers and public officials all over the world seem to have collectively decided that the markets needed some help to allocate capital properly and responsibly. After years of such intelligent interventions by global policymakers, the results of these policies have, unfortunately, been predictably dismal.

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    Gavekal Research

    The Road to Hell is Paved with Good Intentions

    With losses on GIPSI bonds at roughly €600bn (basically marking the losses to market before the recent ECB intervention drove Italian and Spanish yields back below 6%) and if most of Europe’s sovereign debt is held by European financials (banks, insurance companies…) then it is fairly obvious that Europe is in big trouble—given that the total market cap of the S&P EMU financials sector is today a paltry €400bn.

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    Gavekal Research

    On Basel 3 and Solvency 2

    In their seminal work, The Monetary History of the United States, Milton Friedman and Anna Schwartz showed that one of the main factors behind the Great Depression was the Fed’s error in allowing US money supply to collapse. On Friedman’s 90th birthday, back in 2002, Ben Bernanke acknowledged this in a speech: “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks...

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    Gavekal Research

    French Economic Activity and the Primary Deficit

    After the Merkozy summit this week, the big news was undoubtedly the disastrous revival of the financial transaction tax proposal (see Daily—The European Bait and Switch). However, somewhat lost in the shuffle, the French President and the German Chancellor also proposed another idea, which has far more merit: to introduce a constitutional rule in every Euroland country banning the very existence of budget deficits. This is an interesting...

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    Gavekal Research

    Daily - What Could Trigger a Rally in Equities?

    Two weeks ago, European policymakers supposedly delivered a solution to the crisis plaguing Southern Europe. Two days ago, US policymakers finally came to an agreement to prevent a technical debt default. But in spite of these apparent breakthroughs, risk assets are continuing to fare poorly: yesterday, the S&P 500 fell for the seventh straight day, its longest consecutive decline in three years, and the Dow marked its eight consecutive down...

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    Gavekal Research

    Daily - A New Turn in the Investment Environment?

    In our internal and external debates on the wisdom of excessively stimulative fiscal and monetary policies (see How the World Works or Chronicle of a Death Foretold), Charles has often quipped that “Keynes is dead, and we are in the long run.” Now beyond the Keynesian debate, the one thing any observer will acknowledge is that recent weeks have changed the world in which we live: from the US debt ceiling deal, the weak US GDP and ISM numbers, to...

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    Gavekal Research

    The Smoking Gun

    As our readers know, the US current account deficit, ex-oil and ex-China, is now in surplus, which means that basically the whole of the US CA deficit is due to energy imports and China. The problem here is that a crucial portion of the world’s global supply of US$ is going not to the free-trading private sector, but instead to the PBoC and local treasuries of the oil-exporting nations.

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    Gavekal Research

    The Tour de France & European Bond Divergence

    As good Frenchmen, once in a while we watch the biggest bicycle race in the world, the Tour de France. It is always full of action and drama—much like last week’s events at the EU Summit (except there's a clear winner with the Tour de France). The most spectacular moments always occur in the mountains when the best rider leads without looking behind him and once in a while, as the incline gets steeper, one of the riders suddenly cannot...

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    Gavekal Research

    The Unfolding Liquidity Crisis

    In The Threats To Our International Monetary System, we described the international monetary system as a road bound by two guardrails. One guardrail is a US Dollar Crisis: this typically follows a US-led boom, in which the US consumer parties hard, its Dollar rises and its current account deficit grows. This causes an excess of Dollars in the global system and generally leads to a US-led downturn (tech bust, the initial sub-prime bust...). The...

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    Gavekal Research

    The Euro's Design Flaw

    Since we are on the topic of Italy, let us look at the country’s structural growth rate (the seven-year average annual nominal GDP growth) against trends in its trade balance. First, here is a chart of the Italian coverage ratio (i.e., the ratio of exports to imports):

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    Gavekal Research

    The Euro's Design Flaw

    Since we are on the topic of Italy, let us look at the country’s structural growth rate (the seven-year average annual nominal GDP growth) against trends in its trade balance. First, here is a chart of the Italian coverage ratio (i.e., the ratio of exports to imports):

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    Gavekal Research

    On International Liquidity (Again)

    Our readers are well aware that in the past few months we have been focusing, with increasing concern, on global liquidity conditions. Our thesis is centered around the point that international liquidity is dependent on the US current account deficit. As the world’s reserve currency, the US is the only country that does not have a foreign trade constraint, and is able to buy more than it earns. So the biggest source of the US$ outside the US...

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    Gavekal Research

    Daily - Threats of a USD Squeeze

    It might seem strange to worry about a looming Dollar crunch at a time when the Federal Reserve has been printing feverishly. However, we have lately argued that such an event is nonetheless a distinct risk given some important recent developments. Specifically: i) the US current account deficit ex-China and ex-oil has moved to a significant surplus; ii) large global open positions in US$-based carry trades, and iii) an EMU event leading to...

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    Gavekal Research

    Trying to Understand, and Failing Miserably

    In the good old days, back when schools could be relied on to teach useful things (like latin or calculus), settling a trade deficit between two European countries, say Greece and Germany, was simple. When Greece ran a trade deficit with Germany, the Germans in surplus could either spend their Drachmas on holidays in Greece, re-invest the proceeds into Greek assets or—more often than not—sell the Drachmas for Deutsche Marks. When nobody was...

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    Gavekal Research

    The Typology of Government Debt - Charles Gave

    When buying a government bond, investors usually focus on two factors: the interest rate one is receiving and the time period in which one’s money is going to be repaid. These days, however, another question has become just as important: is there a risk that the principal will not be repaid in full? Indeed, for the first time in many cycles, the notion that some “serious countries” may not be able to meet their commitments is quickly spreading—i...

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    Gavekal Research

    An Update on the Euro Debate

    Investors currently have three major issues to confront: 1) The looming end of US quantitative easing, 2) Tightening in China and its potential impact on domestic growth and global risk assets and 3) The sustainability of Europe’s monetary union. Of these three issues, we have argued that the last one has the greatest scope for unleashing serious disruptions in global financial markets. This is why, on any given day, a good ten emails fly around...

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    Gavekal Research

    The Start of a Ten-Year Schumpeterian Cycle?

    Staying on the idea developed on the previous page, we would reflect on our 40 (long!) years of experience in the financial markets. For some reason, leadership in the markets seems to run in decennial patterns:

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    Gavekal Research

    On Chinese Cuisine and N*(N-1)/2

    I recently traveled though the Mainland, visiting Guangzhou, Foschan, Wuhan, Chongking and finally Shanghai. Among the many impressions I got, two things were especially striking:

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    Gavekal Research

    How Asset Allocation Adds Value

    Four years ago, Charles outlined his “Four Quadrants” asset allocation framework (see Mapping The Four Quadrants), which has guided his thinking since he started his investment career in the early 1970s. The framework is based on a simple concept: that the performance of various asset classes depends chiefly on changes in two variables – economic activity and inflation. If one could predict changes in these variables then it would be a huge...

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    Gavekal Research

    GaveKal Daily - Greece, the Ultimatum Game and a Modest Proposal

    Economists love to play games where the rationality of the players can be tested. One such game is called the ultimatum game, in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. If the second player rejects, neither player receives anything. If the second player accepts...

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    Gavekal Research

    The Outlook for US Structural Growth

    The US economy is at a crossroads. On the one hand, conditions are ripe for a new, capex-led leg-up to the recovery, thanks to strong corporate profitability and robust balance sheets. Yet uncertainties still cloud the outlook for entrepreneurs, particularly concerning government crowd-out and risky monetary policy.

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    Gavekal Research

    An Aging Dividend for Korean Stocks?

    Like many other Asian countries, South Korea faces the demographic challenge of a rising dependency ratio and the peaking of its working-aged population (see chart). The country’s so-called “1958 Year of The Dog Generation”— equivalent to Japan’s “Dankai Generation”, but about 10 years younger as Korean baby boomers were born after the Korean War—will gradually start retiring in the next 10 years. It seems reasonable to expect the Korean economy...

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    Gavekal Research

    GaveKal Daily - Can Capitalism Work Without a Cost of Capital?

    It is obvious that central banks operate with four policy gauges:

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    Gavekal Research

    The Keynesian Divisor

    If government spending goes up, and if this increase is financed by debt, it is reasonable to believe, as Ricardo did (or Milton Friedman with his constant income hypothesis) that the existing growth rate is borrowed from the future. In other words, it is an illusory growth since government debt is nothing but a deferred tax .

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    Gavekal Research

    Böhm Bawerk, Commodities and Monetary Policy

    Böhm Bawerk taught economics to both von Mises and Schumpeter, which should be enough for any reader to understand how great this man was. Among his many brilliant ideas, was his view that if one commodity price experienced a huge and abrupt rise, then other commodity prices would have to go down, since there is a limited amount of money which can be spent on commodities at any given point.

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    Gavekal Research

    False Prices, Unemployment & Asset Duration

    One of the most important prices in an economic system is the price of money. If the price of money is manipulated by a central bank, then money is no longer at a market price (see the works of Jacques Rueff). Furthermore, if we assume that any economic system typically has two kinds of assets, 1) those with zero duration (e.g., gold and silver), and 2) those with long durations (e.g., the S&P 500), then a non-market, or false price of...

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    Gavekal Research

    Oil as a Threat to Economic Activity, Part II

    As our readers know, we have, for some time, been pretty sanguine on the level of economic activity in the world. However, oil prices have rallied now close to +25% so far this year, throwing a serious wrench in the wheels of the global recovery. And while the turmoil in the Middle East seems to be abating somewhat, last Friday’s disaster in Japan is very likely to add upside pressures on energy prices (see The Latest, and Most Devastating...

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    Gavekal Research

    A European Tour d’Horizon

    Print Version:

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    Gavekal Research

    The High Cost Of Free Money

    Perhaps the most famous economic law is the one that there is no such thing as a free lunch. By keeping US short rates at abnormally low levels beyond the financial crisis and as growth bounces back beyond the dreams of the wildest optimists, the Fed increasingly seems to be trying to ‘feed the US economy for nothing’. This is worrying for as we have reviewed before, extended periods of cheap money typically come back with a hefty price tag,...

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    Gavekal Research

    Oil as a Threat to Economic Activity

    As our readers know, we have, for some time, been pretty sanguine on the level of economic activity in the world. However, some clouds are starting to be visible on the horizon, and they relate mostly to the price of oil.

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    Gavekal Research

    The Asset Allocation Quandary of 2011

    For almost every pension fund, the single most important decision is the relative weighting of equities versus fixed income. The next challenge concerns rebalancing decisions: should one automatically rebalance to keep weights (say 50/50) on an even keel or should one tactically redeploy capital based on the freshest macro and investment environment?

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    Gavekal Research

    Les Aristocrates a La Lanterne

    As the readers have probably realized by now, Marx has always been one of our heroes for a simple reason: there is no wrong idea about economic systems, political systems, human nature, or the future which he did not embrace with gusto. Finding someone else who has been so consistently wrong would be quite a challenge. But, like a broken clock, even Marx got to be right once when he wrote that “the economic infrastructure determines the...

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    Gavekal Research

    A Second New Year Wish

    The previous page discusses the Fed’s manipulation of the short-end of the yield curve. As we all know, the Fed did not stop here, but has also targeted the long end of the curve. It achieved this mostly by buying the benchmark 10-year bond, while talking the Dollar down at the same time. Why such a policy would make any American feel richer was never clear to us. After all, this policy encourages:

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    Gavekal Research

    Charles’ Wish for 2011 by Charles Gave

    It is customary at the beginning of the year to express some wishes. Mine will be very simple: I wish that the central planning in the US comes to an end. Since 2001, Fed directors have decided in their infinite wisdom that they knew better than the market. The prevailing idea seems to be that if interest rates are maintained at very low levels—even lower than the structural growth rate—then economic activity will improve. In fact, one could...

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    Gavekal Research

    Is EMU Rebalancing Possible?

    As 2010 unfolded, the viability of the European monetary union project became the main ‘x-factor’ for global financial markets. And as the new year starts, we see little reason why 2011 should prove any different. Indeed, the genie is now out of the bottle and the world realizes that the Euro is a political project with significant economic costs. Worse yet for European policymakers, these economic costs are now rapidly mutating into political...

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    Gavekal Research

    Five Corners (10 December 2010)

    This document is part of our old archive. You can download it by clicking the PDF button above.

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