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Crisis and Calm

If you’re having trouble figuring out what’s going on in the world you’re in good company. The global economy has been undergoing rapid change for a number of years but global politics has been a bit slow to catch up to it.

A few items that Barataria has covered recently have entered new phases recently – unpredictable, rapidly changing phases that show that things are indeed coming to a head. We’ve consistently called 2017 as “The Year Everything Changes” for a number of reasons, but the lead-up to that year is proving to be especially chaotic. Here are updates to three stories we’ve been all over that should take surprising turns in the next year and a half. You read it here first!

It's interesting how the traditional view of a bank looks like the Parthenon.

It’s interesting how the traditional view of a bank looks like the Parthenon.

The Greek Crisis is hardly news anymore, having been spun out slowly over seven years now. It would come as no surprise to anyone that the latest chapter, the one which nearly destroyed the Greek economy, is not likely to be the last. But there was one critical twist that points the way to a very new discussion that is likely to change Europe one way or the other.

Perhaps it will even be the catalyst that gets Europe out of its terrible funk.

At the end of this round, Greece simply gave in and agreed to the harsh terms for new loans in order to re-open the banks and stop the bleeding that threatened to destroy them. It was a humiliating defeat for PM Tsipras and the nation. But in the middle of it all an unlikely ally for Greece stepped up – the largest bank in the world, the International Monetary Fund (IMF).

Their analysis starts with the simple fact that Greece’s debt is only going to rise under this plan and that a new crisis will come before 2017 as a result. More importantly, however, they became the first organization to say what everyone else knows – that Greece’s debt will simply have to be written down or written off before this is over.

The European Central Bank, all shiny and imposing.

The European Central Bank, all shiny and imposing.

As the New York Times has noted, there is no way this can happen without closer political and economic union in Europe. Germany and other rich nations will have to transfer wealth to the poorer ones whether they like it or not. That doesn’t happen today because there is no mechanism for doing it in the association of nations that has been cobbled together.

The solution? One big nation – or something much more like it.

This will come after the UK vote on membership in the European Union, so this could all go the other way as well. But a critical turning point for the EU is coming up by 2017, and it will require a lot of soul searching one way or the other. Europe will either get its act together or it will fly apart.

The second story that shows how much things are changing takes us to the Middle East, a place rarely mentioned without the word “turmoil” added at some point. A good part of that turmoil today involves the terribly low price of oil, the stuff running cheap enough to threaten the budget of every government in the region.

Demand for oil didn't rise as fast as expected, so supply got ahead of it.

Demand for oil didn’t rise as fast as expected, so supply got ahead of it.

As we speculated nine months ago when the price fell, this was all a plot by the Saudis to drive US oil production out of the picture. A Saudi oil official admitted as much when he claimed that the strategy was working. It is? US oil production has not fallen through this time so the claim that this was a good idea seems ridiculous on the face of it. But there’s more to the story.

The Saudi government is apparently facing a need for austerity itself, so short on cash that it’s going through a borrowing binge. In other words, forget about austerity – they’re going to borrow the money. At this rate they will be in serious trouble by 2018 as sources of credit start to dry up.

But this was all before the deal with Iran came out, promising to unleash the old Shia enemy of the Saudis and drive the price of oil even lower. When will the Saudis really hit the wall? Look for it to happen before 2017 at this rate if the price falls even further.

The Saudis have really screwed up on this one, no matter how they brag. If they run out of money the Middle East changes completely. If they face revolution as a result, all bets are off everywhere.

Today's bears are not irrational.

Today’s bears are not irrational.

Away from all this chaos is the US, a land slowly recovering from the Managed Depression that started in 2000. As we’ve discussed many times, the key statistic in everyone’s mind appears to be productivity. Output per worker is the basis for a sustainable recovery in the eyes of most economists, though many people are starting to worry that automation destroys more jobs than it creates.

It feels to many like there is a crisis already in the works.  What happened to productivity?  To earnings?

We can see where this may be going if we look at private investment since 2000. It fell off a cliff in 2008, like everything did, and is only now returning to its previous peak of $2.7T per year. Businesses are finally re-investing in themselves, which is one of the reasons earnings are down.

Private Investment since 2000, in constant 2009 Dollars.  From the St Louis Federal Reserve.

Private Investment since 2000, in constant 2009 Dollars. From the St Louis Federal Reserve.

The question remains, “Is this investment a sign of employment growth, or are companies only buying machines to replace people?” We can take a stab at this by looking at investment per employee, which is to say the amount of capital it takes to generate a single job. Since 1947 that has been growing consistently, showing the rise of automation generally as the key to productivity growth. But there is one very big inflection point around 1990 where the rate of growth in investment seemed to change – about the time the PC became a standard business tool.

Capital Investment per Employee in constant 2009 Dollars.  From the St Louis Federal Reserve.

Capital Investment per Employee in constant 2009 Dollars. From the St Louis Federal Reserve.

Investment runs very much with employment in this curve, falling off when employment does and rising back with the total number of jobs. The end result is that it takes about $20k worth of capital per employee, and that employee produces about $120k per year worth of stuff with that investment. It’s a good deal all around, but the increasing share of income going to capital is paying for the investment.

It’s been Barataria’s contention that earnings and productivity are not gaining rapidly in 2015 because there has been increased re-investment by corporations, something that will bear fruit in coming years. There is no evidence to change our minds on that.

But here’s the trick – if it costs $20k in capital every year to create a job, that means that to absorb 10M unemployed workers we need addition investment of about $200B. At the rate investment has been accelerating, that will be realized sometime by the end of 2016.

Will we see full employment in 2017? At this rate it seems to be in the cards. If this increased investment means increased growth it will indeed be the Year Everything Changes.

So what can we expect through the next 18 months? Europe is going to have a serious existential crisis, Saudi Arabia is going to have a nasty crisis, and the US may very quietly position itself for the next bull market after all. These are the children of stories we’ve been talking about for a while and we can expect them in the news in the near future. Look for them, but please remember you heard it here first!

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11 thoughts on “Crisis and Calm

  1. Europe is a joke. The sooner the Saudis get what’s coming to them the better. I hope you are right about productivity but with all this going on in the world I can’t see that the US doesn’t have a lot to worry about.

    • I have to admit that my prediction for Saudi Arabia is based in part on wishful thinking, but they really are screwing up. I see a nation that has always made a deal to gain control of things now more interested in bullying and forcing their way. That will not suit them, especially not in the Arab world. They must have a lot of people cheering for their downfall by now.

  2. Your pitch for good times in 2017 is getting old but I think we can all look forward to Saudi Arabia’s downfall unless there is a revolution and something like ISIS takes over.

    • I’ll try to be more moderate on 2017, but I am bullish and see all the signs of a turnaround! As for the Saudis, you have a point – be careful what we wish for!

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