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    Gavekal Research

    Implied Assumptions

    Financial markets operate on a number of implied assumptions about growth, policy direction and other factors. Experience tells us that these assumptions often turn out to be erroneous. The goal of this paper is simply to test the rationality of the current set of assumptions.

    9
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    Gavekal Research

    The Social Purpose Of Tax Havens

    The Cahuzac affair in France has conveniently emerged just as the search for possible scapegoats to Europe’s quandary was intensifying. Thanks to the former French budget minister’s secret Swiss bank account, Europe can now move from its war against finance (Hollande declaring that finance was his enemy, the financial transaction tax, capping of bonuses, etc) to an outright war against tax havens (letting Cyprus sink, arm-twisting Luxembourg...

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    Gavekal Research

    A First Non-Euro Currency Debate

    Last Thursday the Bank of Japan stunned investors with a muscular monetary response that aims to break a deflationary cycle that had seemed to condemn Japan to permanent economic decline. In this piece we debate what the new policy settings mean for investors and crucially, seek to answer the trillion-yen question of where the Japanese currency is headed.

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    Gavekal Research

    France On The Brink Of A Secondary Depression

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    Gavekal Research

    A Recantation

    Over the years a number of economists and political scientists have seen the error of their ways and come clean with a reasoned recantation. The mid-19th century British thinker John Stuart Mill famously changed his mind on the divisive question of industrial wages. My contribution to political economy hardly matches Mill’s, but I have spent my adult life pondering the linkages between economics and markets. However, in recent times I have come...

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    Gavekal Research

    Return Of The Great Euro Debate

    Overview — by Arthur Kroeber

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    Gavekal Research

    Quarterly Strategy Chart Book - Beyond Currency Wars: A New Investment Landscape

    Since the end of 2011, the world MSCI has gained more than 20%, while the safe-haven bond markets of the world are basically flat. Given this strong rally in equities, it is important that we get confirmation of global growth – a theme we explored in our last Quarterly. Fortunately, the news on this front remains fairly encouraging, and we don’t see any reason to change our optimistic outlook on growth. What has changed quite significantly is...

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    Gavekal Research

    Down With Reform

    Italian electors’ rejection of Brussels-imposed economic diktat is an extraordinarily important moment in the history of modern Europe—perhaps the best political news since the fall of the Berlin Wall. Given the power of unelected technocrats, it is easy to forget that sovereignty in Europe still resides with the nation state as expressed through elections. The problem for those unelected officials who conspired to capture the political system—...

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    Gavekal Research

    The Last Great Potemkin Village

    On the surface, it would seem that the euro crisis has calmed. Markets have rallied since the summer and, to borrow a phrase from Herbert Hoover, “prosperity is just around the corner.” But outward appearances in Europe are like a Potemkin village. Behind the well-scrubbed facades, Southern Europe is collapsing. Anyone convinced that the European monetary union has come through the crisis stronger is a victim of the slickest PR campaign in...

    21
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    Gavekal Research

    Towards Government Sponsored Bubbles

    Usually in periods of asset inflation driven by excess liquidity, investors know that the central bank will eventually step in and restore order. Indeed, the normal complaint is that this happens too soon. As William McChesney Martin, the longest-serving Fed chairman once put it, the job of central banks is to "take away the punch bowl just when the party gets going."

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    Gavekal Research

    Carried Away On Corporate Bonds

    At GaveKal we see three main ways to make money from trading: return-to-the-mean, momentum and carry trades. Of these, the carry trade can be both the simplest to conceptualize, but the most dangerous to manage. It is easy to become fooled that the circumstances supporting a particular carry trade is a permanent market feature—until, of course, it reverses. Since the acute phase of the 2008-09 financial crisis the relentless tightening of...

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    Gavekal Research

    A Wicksellian Analysis Of Four Fed Chairmen

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    Gavekal Research

    US Seminars: Charles & Anatole Debate, Plus Francois, Will, Nate and Tom

    We sent a big gang to Boston and New York for our pre-Christmas seminars this year. Charles and Anatole debated on Keynesianism and the true scope of government participation in OECD economies. Francois explained his nearly singular view within GaveKal that European growth is set for take-off (at least in some parts). Will Denyer examined the shifting drivers of the US economy. Nate looked at why shale gas has not taken off in China, and Tom...

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    Gavekal Research

    The Control Engineers And The Notion Of Risk

    There is a great movie scene where Harpo and Groucho Marx meet in the “socialist restaurant.” Groucho says, “this food is disgusting and inedible!” To which Harpo replies, “and on top of that, the portions are far too small!” So by the late 1930s and the golden era of the Marx Brothers, it was already obvious that socialism was bad fare in high demand. Yet it took another half century for “scientific socialism” to be finally discredited in...

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    Gavekal Research

    By All Means, DO Fight The Fed

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    Gavekal Research

    GDP As A Concept: Misleading If Not Outright Criminal

    If I receive a research piece by an economist who starts by giving me his “forecast” of the GDP for the next year or two, or who writes that the government should spend more money to "avoid a decline" in the GDP, or even worse, tells me that if the government starts cutting, GDP will collapse and that it would be a disaster, I stop reading immediately. Not worth my time.

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    Gavekal Research

    The End Of Japan As A Global Shock Absorber

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    Gavekal Research

    And Meanwhile In Iceland

    The negotiations over the latest “extend and pretend” deal in Greece is, as usual, focusing on to what degree the economy should be strangled as retribution for past financial sins. According to the logic of the geniuses who created the euro, the population of Greece — as well as Spain, Ireland, France, Italy, Portugal, etc — has to suffer because there is "no other solution.”

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    Gavekal Research

    The Benefits Of A Receding Hairline

    One of the few benefits of getting old is that one gets to say: “I’ve seen this all before.” Take the current over-indebtedness of most Western democracies today. This is a situation that anyone with hair growing where one does not want it and not growing where one would like it to, has seen before. And not that long ago. Indeed:

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    Gavekal Research

    European Seminar Presentations - With Anatole, Charles, Francois And Andrew

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    Gavekal Research

    Four More Years

    The American electorate may share the same national bed, but they have vastly different dreams. Our take on the election’s significance is similarly bifurcated—a cathartic political cleansing allowing for a deal on the fiscal cliff (Anatole) to disaster (Charles). Arthur asks whether the Republican Party can win nationally without reconciling itself to America’s changed demographics and the realities of the new knowledge-intense economy. Will...

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    Gavekal Research

    A Simple World

    Many of our readers seem to believe that the world is getting ever more complex. I disagree. In fact, I have never seen a world whose key drivers were so simple to grasp. Almost everybody, save a few politicians in France, realize that government is the problem. Even the 50% or more of US citizens who receive "bribes" with money borrowed from their grandchildren concede the spending has to slow. As the anti-Obama adverts on TV put it...

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    Gavekal Research

    A Measure Of Keynesianism

    Economics is, ultimately, a science of measurement. But not everything is directly measurable. For instance, the powers that be have decided the private economy is broken, and needs government fixing. That means we have to measure the competence or incompetence of those at the helm, something that cannot be done with any reliable precision. One rule of thumb is that the shorter the time that the elected officials have spent in the private...

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    Gavekal Research

    If I Were A German

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    Gavekal Research

    GaveKal Five Corners

    One of the main themes of our research since last summer has been the possibility of a sharp improvement in the US economy—and the likelihood that US economic conditions, whether good or bad, would set the tone for financial markets in 2012, even while investors and policymakers remained obsessed with the chaos in Europe. In other words, the US economy would produce the “signal” for markets, while Europe would create a lot of random noise. This...

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    Gavekal Research

    Of QE3 And Black Swans

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    Gavekal Research

    The Fed's Money Tree

    QE3 has set off a debate not just over whether this is good or bad (most here agree it is bad) but on what are the short– vs long-term effects on economies as well as markets. Louis and Charles make the contrarian argument that open-ended and more aggressive quantitative easing will ultimately take away, rather than add, to global liquidity, and warn that investors should prepare for a dollar crisis further down the line. Anatole and Francois...

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    Gavekal Research

    Frugal Italy And The French Carry Trade

    From time to time financial markets throw up pricing anomalies which are not backed by underlying economic reality. At the height of the global financial crisis in 2009, for example, yields on investment grade US corporate bonds were as much as triple the level for comparable local government bonds. At such a point, the rational investor has to admit that something has fundamentally changed, or, instead, recognize that markets have a bad dose of...

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    Gavekal Research

    False Optimism

    There are days when I feel very discouraged. A supposed upside to the economic misery in Europe is that, thanks to deflation and a weaker euro, the EMU’s real effective exchange rate has fallen considerably since 2008. But it is preposterous to tout the external trade benefits of a collectively weaker REER—when the trend in real intra-EMU exchange rates is what put us in this boat in the first place.

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    Gavekal Research

    Is Germany Entering A Recession?

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    Gavekal Research

    Shadoks & Stock Markets

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    Gavekal Research

    The Coming French Depression

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    Gavekal Research

    The Euro Debate Returns

    The markets reacted very positively to the announcements that followed the 20th ‘save-the-euro’ summit. So, like 20th marriages, is this the triumph of hope over experience? Or perhaps a cynical “mark-up” exercise of risk assets in the last hours of trading before the quarter’s end? Or did we see the beginning of a solution to the crisis finally emerge? The general media was quick to portray the summit as a victory of a “united South” against a...

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    Gavekal Research

    Charles' Presentation At Our June 26, 2012 NY Seminar

    At our recent New York seminar, Charles discussed the unintended consequences of excessively loose monetary policy. Attached is his presentation; this is mostly slides, with little text.

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    Gavekal Research

    Obsessed By Negative Real Rates

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    Gavekal Research

    Armistice Or Capitulation

    Why did the euro first come about? Some will explain that it was to favor pan-European trade, tourism and a more efficient allocation of capital; even if in the times of Visa/Mastercard/Amex cards, and of easy currency-risk hedges through forwards, options and the like, such an explanation appears naïve at best. Others will explain that the euro was created as a “political project” to ensure the political integration that Europe’s people did not...

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    Gavekal Research

    Federalism, Debt Traps And Competition

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    Gavekal Research

    Euro Choices Are Getting Starker

    As has become painfully obvious, we have now moved to the next chapter of the euro crisis. Southern Europe’s vulnerable bond markets are again under pressure (Spanish 10y yields have risen to 6.2%, and the Italian counterparts are at 5.9%), European equity markets have sold off brutally and EMU bank stocks have now fallen to the lowest level since late 1987.

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    Gavekal Research

    Euroland's Secondary Depression

    The US economy continues to throw off seemingly contradictory signals. Since the start of the year bond yields have fallen sharply even while equities have rallied convincingly and economic data points to a clear, if patchy, recovery. So why are US Treasuries priced for a lost economic decade? Earlier this week, Warwick argued that the market was irrational in its pricing of Treasuries (see The Sun Still Rises, We’re Still Bond Bears). But of...

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    Gavekal Research

    How To Deal With Bad Bubbles

    As our regular readers know, there are good bubbles and there are bad ones. By our definition, a “good bubble” occurs in productive assets, such as railways or internet lines, and is financed by equity. A “bad bubble” takes place in unproductive assets (tulips, land, government bonds…) and is financed by bank credit.

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    Gavekal Research

    CHF Peg And The Bund Rally

    Over the past month German bunds have rallied significantly with yields on the ten-year dropping by –42bps since March 16th. Partly fuelled by fears of deterioration in Spain’s fiscal and financial situation (see Europe Is Still The Ugliest Sister), they hit an all-time low yesterday of 1.63%. These movements have an obvious proximate cause, but arguably a less visible effect may be stirring the move to safety.

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    Gavekal Research

    Debt Traps: A Refresher

    What economists refer to as the “debt trap” was first defined by Lord Keynes and the logic is very simple: when a country’s cost of capital exceeds its economic growth for a protracted period, trouble soon follows.

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    Gavekal Research

    French Election: A Friedmanian Take

    The US primary marathon may be nearing a resolution, but another not insignificant electoral process kicks off on April 22 with the race to choose an occupant for the Elysee Palace. Readers may be aware that Gavekal has certain French roots, which we hope are discernible from the mélange of elegance, moderation and occasional insight provided by our writings. For this reason, some clients have asked for a view on the forthcoming presidential...

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    Gavekal Research

    An Alternative View On The UK

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    Gavekal Research

    When A Bond Hedge Stops Working

    A diversified portfolio of 60% equities and 40% bonds has outperformed the equities market since at least 2000, which marked the beginning of the first real non-inflationary bear equity market since the thirties.

    5
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    Gavekal Research

    On US Inflation

    One of the big concerns last year was the fear of a US double-dip. Now, however, as US economic data keeps surprising on the upside, it seems increasingly likely that this year’s more pressing issue will be the risk of an inflation backlash. Will the slack in the economy, coupled with the continued deleveraging of government and the financial sector be enough to stave away any price pressures? Or will the unprecedented central bank liquidity...

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    Gavekal Research

    Blind Men Looking At Money

    Over the past year, we have published a number of debates on the euro, which generated vigorous client feedback, from the logical “isn’t it obvious that, if the euro continues as presently constructed, then it won’t”, to the somewhat tasteless “I was at Disney World this weekend and saw the Euro wearing a Make-A-Wish T-Shirt”. But at the heart of every one of these debates was a simple question—namely, what is money?

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    Gavekal Research

    Bernanke's Comeuppance?

    Milton Friedman’s contention “that inflation is always and everywhere a monetary phenomenon” is a famous entry in the economic lexicon. However, Professor Friedman also explained that lags between money supply (monetary policy) and prices can be huge and variable. This is because the velocity of money reacts very strongly to conditions in the banking system.

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    Gavekal Research

    The Non-Event Of French Elections

    There is a famous story about the last days of Constantinople. While the Turks were at the gates of the city, heated discussions were taking place inside the walls about whether angels were male or female. This is exactly how Paris feels these days, with candidates in the upcoming presidential elections debating the gender of angels, while ignoring the biggest dangers.

    0
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    Gavekal Research

    The Non-Starting Keynesian Identity

    Everybody knows the Keynesian identity, which postulates that GDP = government + investment + net exports + consumption, summarized as the famous equation of GDP= G + I +(X-M) + C. And using that formula, Keynes argued very influentially that when private-sector C + I collapses, then the government must increase its weight in the economy. Otherwise a recession or even a depression is unavoidable (e.g., see any article by Paul Krugman). The...

    5
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    Gavekal Research

    Returning to the Golden Rule

    The “golden rule” as expressed by Maurice Allais or Knut Wicksell specifies that, over the medium term, long rates and the nominal growth rate of the economy tend to converge. Thus, if the reader accepts our basic premise that an increase in government spending leads to a decline in the structural growth rate of the economy, then it stands to reason that an increase in government spending leads to lower interest rates, since the interest rates...

    0
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    Gavekal Research

    The US and the UK are on Right Track

    Recently there has been a lot of talk about the supposed stark differences between the US and UK budget policies. Many argue that the UK policy path of aggressively cutting government expenditure is going to lead to a new recession; in contrast, the sure-to-be-reelected President Obama is said to be wisely staving off a double-dip by maintaining government spending at a high level. There is a slight problem with this view, however. It is not at...

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    Gavekal Research

    Draghi in Control, But for How Long?

    [INDENT=2]

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    Gavekal Research

    The Triumph of Southern Italy over Northern Italy

    In Have Southern Europeans Bought Too Many BMWs?, my colleague argues that Italy’s balance of payments problem is not caused by the Euro, but instead by the China factor and rising commodities prices. Besides the fact that Italy would have better adjusted to the pressures of a rising China and higher commodities prices were it not for its artificially high foreign exchange rate under the Euro, this theory fails to explain Italy’s disappearing...

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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:

    0
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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.

    0
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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...

    0
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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...

    0
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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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 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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    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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    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 Daily - Can Capitalism Work Without a Cost of Capital?

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

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    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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    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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    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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    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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    A European Tour d’Horizon

    Print Version:

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    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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    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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    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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    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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