Don’t Fight The Trend…

the trend

But don’t be off your guard either.

A lot of the time, stocks are priced at a value quite debased from their fundamentals. Thus they are either overvalued or undervalued. This is true since markets are, for the most part, driven by sentiment. In the most extreme circumstances, total greed or fear takes over.

I have been rather baffled by the stock market rally over the last few weeks after having witnessed some of the most spectacular series of crashes over the brief one month period from the end of February towards the end of March. This rally far from reflects the economic reality on the ground. Many people have lost their jobs and are struggling financially. Yes, there have been huge stimulus packages to soften the blow, but these are artificial and only increase an already substantial debt load.

Yet markets can behave irrationally for a very long period of time. Far longer than one can stay solvent, to quote the economist John Maynard Keynes. Instead of trying to be right, sometimes it can pay to just go with the trend. That often quoted adage, the trend is your friend, is very true. Rather than fighting it, it can be less painful to simply ride with it in whichever direction it may blow.

But don’t get carried away. Always be on your guard. As the tide can abruptly change without warning.

By Nicholas Peart

(c)All Rights Reserved 

 

Image: Peggy_Marco

It’s Only When The Tide Goes Out That You Discover Who’s Been Swimming Naked

low tide

This is probably one of the wisest bits of advice related to the current market turmoil. And it was said by none other than one of the most successful investors of all time, the Sage of Omaha himself, Mr Warren Buffett.

What this present crisis has exposed are those companies that are worst prepared to handle a downtown. A company should always have sufficient emergency cash reserves or at least some margin of safety to protect it in the event of a slump such as the one we are currently experiencing.

The most prudent companies always have this margin of safety. On the other hand, the most ill prepared companies overleverage themselves and take on large piles of debt during the good times. Then when the bad times arrive and the tide goes out, they are the ones who are most vulnerable.

Right now boring old cash is king. Some of the most indebted companies are currently facing a genuine liquidity crisis and the very real possibility of going bust as their cashflows have virtually dried up. However, those companies who have set aside enough cash, have no or at least manageable levels of debt, and don’t have unsustainable overheads (or a low cash burn rate) will survive this downturn period the best and will bounce back the strongest when the markets do eventually recover.

I think this is something we can all learn when we make investment decisions, especially when we buy shares in companies during a bull market. It is always important when doing your own due diligence on a company to figure out how well it would fare when the tide changes. When the tide goes out, will it be sufficiently covered?

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: TimHill

The Present Risks Of Holding Government Bonds

BankNotes photo

For a long time it has often been assumed that government bonds of developed countries are a safe investment. Whenever there has been a stock market correction, one always benefited by holding government bonds. Especially if they had a decent yield and it was above the rate of inflation. The difference now is that before the current market crash towards the end of February, interest rates in most developed countries were already at very low levels. Yet as the crash unfolded both the Bank of England (BoE) and the Federal Reserve (Fed) reduced interest rates even more to stimulate the economy. As I write this article, the current BoE rate is just 0.1% and the Fed rate is at 0%. Since 2016, the European Central Bank (ECB) interest rate has remained unchanged at 0% and so far there has been no plan to drop it down further towards negative territory, yet that could easily change in the coming weeks or months if the current crisis exacerbated by the Coronavirus pandemic shows no signs of improving.

The current yields on ten year government bonds in the following countries are just 0.8% in the USA, 0.39% in the UK, 0.02% in Japan, and in some countries such as France and Germany they are already negative at -0.03% and -0.37% respectively. For those bonds to increase in value these already pitifully low yields would have to fall even further. By investing in bonds with negative yields, you are essentially paying for the privilege of holding the bonds. And I have always wondered what would make one invest in bonds with negative yields?

In the case of Germany, if one had a lot of cash which they didn’t want to invest in other securities or deposit in a bank account, they would invest it in those negative -0.37% yielding government bonds. They may be too scared to deposit it all in a bank, which is financially not in great shape and may even be faced with the very real risk of going under Lehman Brothers style. The two main German banks, Deutsche Bank and Commerzbank, are both currently not in great shape financially and may need a bailout to save them. If a bank goes under, your money in a bank is safe up to a certain threshold and if you have savings deposits, which exceed the threshold amount, you will likely lose the entire excess amount if the bank goes bust. In contrast to other Eurozone (EZ) countries, Germany is in better shape than many other EZ countries. Furthermore, it’s national central bank, the Bundesbank, is running a massive surplus against the national central banks of most of the other EZ countries.

Unlike Germany, the yields on the ten year government bonds for Italy and Greece are positive at 1.21% and 1.43% respectively. Yet both countries have enormous and unsustainable levels of debt and are thus at a much higher risk of default. As I explained in some of my previous articles, I continue to remain of the view that it is becoming increasingly likely that the Eurozone will not last and that all Eurozone countries will revert to their own currencies. If this were to happen, it is highly probable that within the EZ area, there will be a huge flight of money to those countries such as Germany who will be least affected by any great devaluations of their new currencies. For example, the New Mark is likely to strengthen in value whereas the New Lira or New Drachma is likely to fall in value quite sharply against the new currencies of other stronger former EZ countries. Thus within the framework of the entire EZ, negative yielding German bonds are probably one of the safest securities to invest your Euros into despite the fact they come with a price. If the EZ falls apart and most EZ banks go under, those negative yielding German bonds will immediately be denominated into strongly valued New Marks. By contrast, those positively yielding Italian and Greek bonds will be converted into new weaker currencies.

In spite of all this, I think government bonds are overall very expensive where their risks vastly outnumber their rewards. Of course, their low yields reflect the low interest rates of their countries. However, if one were to look at the chart of the yields of ten year UK and US bonds over a 40 year period, it is clear they’ve been in a huge bubble for the duration of this time frame. In September 1981, the yield on 10 year US treasury bonds was over 15% and in that same year in October, the yield on 10 year UK gilts was over 16%. Yet since that time, the yields on both bonds has been in a downward trend and currently they both yield less than 1%. Some are predicting that the interest rates of both countries will fall into negative territory and therefore the yields of both bonds will also be negative suggesting that if one were to buy such bonds even with their extremely low yield, the yield may get even lower.

An unpopular opinion I hold, which many don’t share, is the real risk of dramatic and unexpected inflation. Many are predicting a long period of negative interest rates and deflation, but I am not so sure. What concerns me greatly is the huge amount of debt in many countries. Much of this debt is a result of an unusually long period of low interest rates. Since the middle of the last financial crisis in 2008, total levels of global debt have increased over 50%. And now with the current new crisis triggered by the coronavirus pandemic, this already staggering level of global debt is only going to get bigger as national governments plan huge rescue packages to prop up vulnerable businesses and households. In the USA, the Trump government is planning a $2tn stimulus package. In the past years since the 2008 financial crisis, large rounds of Quantitative Easing (QE) haven’t had too much of an affect on inflation. However this time it could well be different as the amounts of money printing rounds that national central banks will embark on could easily result in a great spike in inflation. This is very worrying as not only will this lead to central banks massively raising interest rates to tame this inflation, it will also make all outstanding government, corporate and household debt much more expensive to service. It is for those reasons that I think buying so called safe government bonds at current yields is a much more risky exercise than many realise.  Furthermore, as all those big accumulated existing debts become more expensive to service with rising interest rates, there will be lots more defaults which in turn will weaken the purchasing power of the currencies of major economies including the USA.

All these concerns naturally make me more attracted to precious metals like gold and silver, which, as tangible forms of insurance, will increase in value as the purchasing power of major currencies like the dollar and the euro declines. As precious metals are commodities, it is hard to predict their price movements. Yet if like me, you believe that they are a viable hedge against a world that is increasingly becoming smothered in debt, you will realise that there is quite a compelling case to owning some precious metals as a form of insurance against these economic vulnerabilities. Precious metals are the new safe havens rather than government bonds.

 

By Nicholas Peart

30th March 2019

(c)All Rights Reserved

 

Image: NikolayFrolochkin

 

MARKETS UPDATE: Thoughts On The Current Market Crash

comic-1296117_1280 (1)

The last two months have been an exceptionally volatile period for global stock markets. The current COVID-19 pandemic has taken many by surprise and its consequences have had a clear affect on the markets during this period. For a long time, I thought that markets were overvalued and due for an eventual correction. The roots of my worries were based on the increasing levels of global debt since the last financial crisis of 2008 that have been fuelled by an unusually long period of low interest rates. With low interest rates money is cheap and cheap money has been the cause of the high valuations of many stocks and other assets such as property. All this concerned me. I knew it wasn’t sustainable and that eventually something would have to give. Yet little did I know that the catalyst for this current market crash would be a virus, which is now affecting citizens and the economies of every country on the planet.

I wrote an article back in 2017 and another one last year stating my fear that markets were overheating. Throughout all of 2019, I almost became resigned to the fact that we were in a ten year plus long bull market that seemed to show now signs of slowing down. Save for a sharp but very brief correction in equity markets from October to December 2018, the markets duly recovered and subsequently continued to hit new highs. Earlier this year, the NASDAQ index hit over 9,000 points and by mid February it had hit a new record of over 9,700 points. Back then I decided to view a longer term chart of the NASDAQ index and had discovered that back in March 2009, in the wake of all the wreckage of the last financial crisis, the NASDAQ index had collapsed to just under 1,300 points. In almost 11 years, the index had increased over 7 times in value. In the UK, only the FTSE 250 index comes close to matching the NASDAQ’s performance, but even the FTSE 250 has been no match. During that same time frame, the index went from under 6,000 points in March 2009 to a record high of almost 22,000 points in January this year. That represents an almost four fold increase in value. Impressive but still falling short of the NASDAQ’s run.

The reason for the NASDAQ’s epic performance is quite simply the unbelievable success of many of the biggest technology companies in the world, which are all listed on it’s exchange. The following NASDAQ listed companies: Amazon, Apple, Facebook, Alphabet, Netflix and Microsoft: have all been quite simply ‘crushing it’ throughout the last decade.

In the UK, the two principle stock market indexes are the FTSE 100 and the FTSE 250. Even though the UK doesn’t have anywhere near the kinds of innovative and exponential tech companies that come out of the US, the UK has a lot of thriving successful growth businesses and lots of these are listed on the FTSE 250. The FTSE 100, on the other hand, is made up more of long established big businesses with multi billion pound market capitalizations. Examples of such companies include Royal Dutch Shell, BP, Rio Tinto, HSBC, Unilever, Vodafone and British American Tobacco. These are big behemoth companies, which may lack the growth prospects of the smaller businesses listed in the FTSE 250. Yet what they lack in growth potential, they make up for by paying quite large dividends to their shareholders as their businesses generate a lot of cash. The FTSE 100 overall has, by comparison, not been a great performer. Even though from March 2009 until the January 2020, it went from less than 3800 points to almost 7700 points. Even though the index more than doubled during this period, it’s also worth bearing in mind that just before the turn of the new millenium, on December 10th 1999, the index was over 6700 points.

What is noticeable about this particular market crash is just how dramatic it’s been. Before the very beginnings of this market crash, when the markets closed on Friday 21st February, the NASDAQ was trading at over 9500 points, the S&P 500 was over 3,300 points, the FTSE 100 was over 7,400 points and the FTSE 250 was just a few points short of 21,800 points. By the time the markets closed just a few days ago on Monday 23rd March, the NASDAQ was below 6,900 points, the S&P 500 was a little higher than 2,200 points, the FTSE 100 had gone below 5000 points, and the FTSE 250 was trading slightly north of 13,000 points. In fact, just a few days previously on March 19th, the FTSE 250 had hit almost 12,800 points.

In the space of little over a month, the NASDAQ had fallen around 27%, the S&P 500 had lost around 33%, the FTSE 100 had shed 32% and the FTSE 250 had lost over 40% of it’s value. Since these lows from last Monday, markets have made some gains owing to stimulus from central banks, yet at the close on Friday yesterday, a good chunk of these gains were erased.

Going forward

The question now is, how will markets behave over the coming weeks and months? Will the lows hit last Monday be retested? It is always hard to predict the future, but I think they will be. The difference between this crisis and others is that this virus has been very disruptive. Since there is still currently no cure for the virus, the only measures to contain the virus have been for governments to impose lockdowns and restrict the movement of people. The most affected industries include the airline and travel industries. The airline industry in particular has been greatly affected as the number of flights have been severely diminished. It is likely that even the most established airline companies will struggle going forward without some form of a government bailout. With their cash flows from operations dramatically reduced, they will be drawing on their precious cash reserves to keep the lights on. But the truth is, with the restriction of movement, most industries will be affected. If a lot of the most affected companies struggle to remain a going concern they will go bust and as a consequence many people will lose their jobs. As an increasing number of people lose their jobs, they will have no income and likely also little to no cash savings to keep them going. There will be a frantic need to create liquidity to free up emergency cash. And this is why there has been a sell off of almost everything, even the most defensive of assets such as gold. When people are desperate for cash they will sell anything. This notion that cash is trash is a myth. In a difficult crisis such as this one, hard cash is king.

So going back to my earlier question; will markets continue to fall? I think they will as I don’t see lockdown measures easing any time soon. I also see an increasing number of people continue to lose their jobs and as a result an increasing need for emergency cash as more incomes dry up. In this situation, markets will continue to sell off. Shares that may seem like a bargain now will get even cheaper. I think the situation is serious enough to say that it is likely that some of the lows of the 2008-9 financial crisis will be tested. Yet do I think there are currently bargain shares to buy? Of course. But at the same time one should ask themselves the following; how much free cash do they currently have to invest? Not essential cash to survive, but cash they can either afford to lose or not have any need to draw upon for at least five years. If the latter than I would recommend periodically drip-buying a select number of quality companies (that are not over leveraged, that generate a lot of cash and have sufficient liquidity to be able to ride out this crisis and thus recover once its over), investment trusts or tracker funds over the coming weeks and months.

Cheap money 

It is likely that as the current crisis continues to bite, they will be a lot of government intervention to help citizens and business. One solution that has been doing the rounds is the idea of creating ‘helicopter money’ whereby central banks print money which is then given directly to households to help them and keep them solvent. In the USA, the current Trump government is planning on putting together a $2tn rescue package to aid businesses and households most affected. With interest rates at close to zero, the idea of printing staggering sums of money is a tempting one. As mentioned at the beginning of the article, since the 2008 financial crisis we have had a long period of low interest rates. And since the first shocks of the current crisis began to appear, both the Fed and Back of England reduced interest rates even further. As of now, the current Fed interest rate stands at 0% and the Back of England interest rate is 0.1%. With such rock bottom rates, the temptation to just keep printing money to infinity is very strong. As previous rounds of Quantitative Easing (QE) since the 2008 financial crisis have barely had an impact on triggering inflation, the current conventional wisdom is that even bigger rounds of money printing will also barely stoke inflation. Even the former head of the European Central Bank (ECB) Mario Draghi who back in 2012 vowed to do ‘whatever it takes’ to save the Euro, recently commented that interest rates will remain low for a very long time. Others also share this belief. But what if, out of nowhere, in the midst of all this money printing, a tsunami of inflation catches everybody off guard forcing central banks to abruptly increase interest rates to control it?

In gold and silver we trust

If you have read some of my other articles you will see that I have always been a big fan of precious metals. And this is especially true now in our current economic climate where uber-low interest rates and cheap money have been reigning supreme. A consequence of more than a decade of low interest rates has been that total levels of government, corporate and household debts have increased dramatically. To exacerbate an already fragile economic situation, the current crisis has triggered central banks of major economies to drop interest rates to zero. On top of this, humongous rescue packages are being created to aid affected households and businesses. Although this may create short term relief, it will further accelerate already staggering levels of global debt, which have already been allowed to get out of control for too long. Taking on debt is fine when interest rates are low, but what happens if all of a sudden interest rates increase? I say this, because as I previously mentioned, not many people are taking into account the very real threat of inflation, which may finally be awakened out of its slumber in a big way as a consequence of larger than normal levels of money printing. When interest rates increase to control this inflation, suddenly all this cheap money floating around will seize to be cheap and all this gigantic debt will become more expensive to service.

I can’t help but think that all this will be nothing but beneficial towards the prices of gold and silver. Over the last several months, gold has been slowly increasing in value. It recently hit $1,700 an ounce and is currently hovering in the $1,600s. In my view, I think any dips in the gold price should be taken advantage of. It is unavoidable that there will be dips in the gold price as households scramble to free up cash, but over the coming months and years I think gold will do very well.

I am equally keen on silver. It is less scarce than gold and is more sensitive to industrial demand, but compared to gold it is currently extremely under-priced. For many years the silver to gold ratio (SGR) oscillated between around 20 and 100, and it was an incredibly rare moment if it ever went above 100. Over the last two weeks, this ratio broke the 100 ceiling and spiked to over 125 at one point. As I type, the ratio is 112. A consequence of this further distancing between the gold and silver price has caused some to say that silver is done and has lost its appeal as a store of value. Yet I disagree strongly. If anything, I think this is an incredibly good buying opportunity to have exposure to silver as I can foresee it playing catch up to gold in an epic way.

 

By Nicholas Peart

29th March 2020

(c)All Rights Reserved   

 

Image: OpenClipart-Vectors

 

Could Copper One Day Become A Precious Metal?

copper bullion

Copper is an important and much needed commodity. It is classified as an industrial metal. However, what if at some point in the future it became scarce enough to be reclassified as a precious metal?

Such a scenario seems inconceivable at this stage. After all copper is much more abundant than precious metals such as silver and gold. Most view it in the same light as other industrial heavy weight commodities such as iron ore or crude oil; fundamental resources in the movement, development and growth of the world.

Much of the world’s copper sources are also concentrated in just a few areas of the world most noticeably in Chile, which is the world’s largest copper producing country. Peru is the second biggest producer of copper followed by China and the USA. In 2018, the total global production of copper was 21 million tons. By comparison in that same year, the total global production of usable iron ore was 2.5 billion tons. For aluminium it was 60 million tons, for nickel it was 2.3 million tons, for lithium it was 85 thousand tons, for silver it was 27 thousand tons, and for gold it was 3.26 thousand tons.

A United States Geological Survey (USGS) global assessment of copper deposits around the world conducted in 2014 stated that there contained 2.1 billion tons of copper resources (note resources and not reserves) discovered under the ground while the number for ‘undiscovered resources’ of copper came at 3.5 billion tons. As of 2018, total global reserves of copper were 830 million tons. 

In 2018, total global reserves for the following commodities were as follows…

Iron Ore: 170 million tons of ‘crude’ ore reserves containing 84 million tons of iron reserves. *However it should be noted that the total amount of identified iron ore resources under the ground currently stands at 800 billion tons of crude ore resources containing 200 billion tons of iron resources. 

Aluminium: Global resources of bauxite (from which aluminium is extracted) are estimated to be between 55-75 billion tons.

Nickel: 89 million tons. *Total global resources of nickel are currently identified at 130 million tons 

Lithium: 14 million tons. *Total global resources of lithium are currently identified at 62 million tons

Silver: 560 thousand tons. *Silver is primarily extracted as a by-product mostly from lead-zinc mines, then from copper mines and then thirdly from gold mines 

Gold: 54 thousand tons.

So in light of all my findings, could copper one day become a precious metal? In my view, this is unlikely to happen anytime soon. Even if there is a growing demand for copper, the fact is, compared with silver and even other industrial metals like nickel and lithium, there is simply an abundance of copper. The current total global copper reserves are nearly ten times greater then the current total global nickel reserves and over a thousand times greater than the total global silver reserves, never mind gold.

Still, copper is aesthetically a very attractive metal and I rather like the novelty value of owning a few pieces of copper bullion. You can often buy a 1kg bar of copper via most bullion dealers for a very modest sum and the German bullion company Geiger Edelmetalle has a number of copper coins and bars you can buy from their online shop.

However, if you wanted exposure to copper in your portfolio, as with other industrial commodities such as iron ore, crude oil or aluminium, you are better off investing in blue chip mining stocks such as Rio Tinto or Antofagasta, which produce a lot of copper. What’s more, both companies also pay a dividend. Alternatively, you can invest in a copper ETF, where you have direct exposure to the copper price, but without the added stress of having to worry about factors such as company mismanagement or political issues when investing in copper related mining companies.

Both these options are far more practical than owning physical copper, which is just not feasible at current prices if one wanted to accumulate a large position. Even accumulating a growing stack of physical silver at its current prices can incur high storage costs if you wanted to store it with a reputable bullion dealer.

By Nicholas Peart

(c)All Rights Reserved

 

 

 

SOURCES/FURTHER READING

Main USGS link for commodity stats…

https://www.usgs.gov/centers/nmic/commodity-statistics-and-information

 

Copper production 2018 link…

Click to access mcs-2019-coppe.pdf

Iron Ore production 2018 link…

Click to access mcs-2019-feore.pdf

Aluminium production 2018 link…

Click to access mcs-2019-alumi.pdf

Nickel production 2018 link…

Click to access mcs-2019-nicke.pdf

Lithium production 2018 link…

Click to access mcs-2019-lithi.pdf

Silver production 2018 link…

Click to access mcs-2019-silve.pdf

Gold production 2018 link…

Click to access mcs-2019-gold.pdf

TARGET2: The Payment System That Keeps The Euro Going

euro-coins-and-banknotes

TARGET2 is the Eurozone national and cross-border payment system, which is used between Eurozone National Central Banks (NCBs) to settle transactions in Euros. It is little known to the general public but it is a very important component of the Eurozone financial system and in understanding the credit surpluses and deficits between the NCBs of each Eurozone country.

A simple and easy-to-understand way of explaining how this system works is featured in the following article here. Taking the example of two eurozone countries, Spain and the Netherlands, a Spanish tourist from Madrid travels to Amsterdam and has a 100 euro meal at a restaurant over there. Now if he had the 100 euro meal at a restaurant in Madrid, his bank in Spain would debit 100 euros from his account. Then the NCB of Spain would transfer the amount from the reserve account of the buyer’s bank to the bank of the restaurant in Madrid. The bank of the restaurant then credits their customer’s account. In this financial transaction, the money remains in the Spanish banking system enabled by Spain’s NCB.

However since the restaurant is in Amsterdam, the transaction is less simple. Since TARGET2 transactions involve the NCBs of Eurozone countries, both the NCBs of Spain and the Netherlands are involved in the transaction. The Spanish tourist’s bank has a reserve account at the NCB of Spain (Banco de Espana) and the bank of the restaurant in Amsterdam has a reserve account at the NBC of the Netherlands (De Nederlandsche Bank). The transaction is settled via the European Central Bank (ECB) between the two eurozone NCBs.

To summarize; 1) The Spanish tourist pays 100 euros to the Dutch restaurant. 2) The two transactions between the NCBs of both countries means an asset of 100 euros to the NCB of the Netherlands and a liability of 100 euros to the NCB of Spain.

Having given a basic example how the TARGET2 payment system works between Eurozone countries, one can better understand the current TARGET2 balances between the different countries in the Eurozone. This complete information of this can be found here from the official website of the ECB.

The figures from the latest TARGET2 balances report indicate that as of May 2019, Germany’s NCB, the Bundesbank, was running a surplus with other Eurozone countries of EUR 934.6bn whilst the NCBs of both Italy and Spain were each running a deficit with other Eurozone countries of – EUR 486.5bn and – EUR 405bn respectively. These figures indicate enormous TARGET2 imbalances between certain eurozone countries. In fact, according to the information provided on the website of the NCB of Germany, the Bundesbank, as of June 2019, the total amount of the Bundesbank’s TARGET2 claims are EUR 942.3 billion euros or to be exact EUR 942,319,065,584.45.

In 2012, less than three years after the start of the European Debt Crisis, the recently departed president of the ECB Mario Draghi stated that he would ‘do whatever it takes to preserve the euro’. From 2009-12, Germany’s NCB had a TARGET2 credit surplus which had increased from EUR 177.7bn to EUR 655.7bn between those years whilst Spain’s NCB was carrying a deficit, which had increased from EUR – 41.1bn to EUR -337.3bn during that same time frame.  In 2009, Italy’s NCB had a credit surplus of EUR 54.8bn yet by 2012 it was carrying a deficit of EUR -255.1bn. Today, Italy’s NBC’s deficit of – EUR 486.5bn is the largest TARGET2 deficit in the Eurozone.  Since Draghi’s pledge seven years ago, these imbalances have gotten even bigger. What is also interesting, is that since 2012, the TARGET2 deficit of the ECB itself has gone from just EUR -2.2bn to EUR -249.8bn (as of May 2019).

These TARGET2 imbalances today are important as their current levels are greater now than those during the height of the last financial crisis in the Eurozone. The question now is whether these current levels are a precursor to another financial crisis in the Eurozone or, more seriously, a potential breakup of the Euro? We are currently living in times of great global uncertainty. The rise of populism, especially in countries in Europe, is worrying. The emergence of Matteo Salvini in Italy and his fraught relationship with Brussels is unlikely to improve the already fragile economic situation in his country nor will it help to fortify the Eurozone in these difficult times. For a long time the ECB has been kicking the proverbial can down the road but as the former head of the Bank of England, Mervyn King, stated in his excellent book ‘The End of Alchemy’: ‘muddling through may continue for some while, but eventually the choice between a return to national monies and democratic control, or a clear and abrupt transfer of political sovereignty to a European government cannot be avoided’.

For countries such as Italy, Spain, Greece and Portugal, having a fixed currency like the Euro has handicapped their economic growth. Both Italy and Spain have large industries, yet not having the ability to devalue their own currencies or set their own interest rates has impacted their global competitiveness and thus their economic standing. Both countries suffer from high levels of unemployment with many young people from these countries searching for opportunities in other countries like Germany, UK, USA and Australia. The current substantial TARGET2 deficits of both Italy and Spain highlight the flaws and consequences of adopting a one-size-fits-all currency. While adopting the Euro has increased Germany’s competitiveness it has done the opposite for other large economies in the Eurozone like Italy and Spain. Hence why Germany’s NCB is running an enormous credit surplus with the NCBs of other eurozone countries.

It can be deduced, therefore, that the survival of the Euro is more important for Germany than it is for Italy and Spain. In the event, God forbid, that the Euro were to breakup and all the former Eurozone countries were to go back to their old currencies, Germany would lose its economic competitive advantage that it had as a Eurozone member since it would now be stuck with a new overvalued Deutschmark and this would thus likely effect its balance of trade. What’s more, in the event of such a Euro breakup, both the NCBs of Italy and Spain would likely default on their deficits with the NCBs of other former Eurozone countries in their new currencies meaning a huge potential financial loss for Germany’s NCB of the TARGET2 surplus monies it is owed. The upside though of any short term pain for Spain and Italy though would be that by finally having their own currencies back they would be free not only to devalue them and set their own interest rates, but they would have the chance to finally break out of their current economic stagnation, regain their competitiveness and return to higher levels of economic growth.

 

By Nicholas Peart

(c)All Rights Reserved

 

 

 

 

 

SOURCES & FURTHER READING…

 

PAPERS:

Blake, D. (2018) : Target2: The silent bailout system that keeps the Euro afloat

Lyddon, B. (2018) : The Euro’s Battle For Survival

 

BOOKS:

King, M. (2016) : The End Of Alchemy – Money, Banking and the Future of the Global Economy

 

ARTICLES:

https://www.moneyandbanking.com/commentary/2018/7/8/target2-balances-mask-reduced-financial-fragmentation-in-the-euro-area (Good article explaining how TARGET2 transactions work)

TARGET2 imbalances and the stagnating political economy of Europe

https://www.theguardian.com/business/nils-pratley-on-finance/2018/may/29/italys-eurozone-crisis-no-easy-fixes-for-the-european-central-bank

 

MISC:

http://www.csfi.org/2019-06-11-target-2-imbalances

 

 

BUNDESBANK TARGET2 Link:

https://www.bundesbank.de/en/tasks/payment-systems/target2/target2-balance/target2-balance-626782

 

ECB TARGET2 data link:

https://www.ecb.europa.eu/stats/policy_and_exchange_rates/target_balances/html/index.en.html

 

 

Image: flagpedia.net

What Makes A Country Poor Is Her Wealth

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‘What makes a country poor is her wealth’. Those are the words of a 16th century Spanish economist commenting on his homeland. One time many moons ago when I was having breakfast at a tourist café in southern Mexico, I overhead an American telling his friends, ‘Mexico is so rich in natural resources yet it is a poor country’. At the time I pondered over these words. Yet it was not until I reached Venezuela later on during my extensive trip of Latin America that those words began to have more weight with me.

Venezuela has one of the largest deposits of oil on the planet yet its history since it first gained independence from Spain has been rocky. As of today the country is in chaos with most of the population barely able to regularly access basic quotidian necessities. One story that famously did the rounds for some time was the one involving a shortage of toilet paper. Stories like these are inconceivable to outside spectators like myself. How could a country with such levels of natural wealth, fall so low? Venezuela is a breathtakingly beautiful country and I am fortunate to have some great and generous friends from this part of the world. In addition to its abundant natural resources, it has some of the most beautiful beaches on the continent (its entire coastline faces the Caribbean), rich and fertile land, pretty mountain towns and Spanish style colonial towns, a vast and diverse geographical topography etc – I could go on. But lets go back to those immortal words; ‘What makes a country poor is her wealth’. In 1973 and more than two decades before Hugo Chavez came to power, Venezuela experienced an unprecedented boom owing to a freak surge in the price of oil. The country’s oil revenues for that year alone were greater than all the previous years combined. Yet the former Venezuelan oil minister and co-founder of OPEC, Juan Pablo Perez Alfonso, refused to party denouncing oil as, ‘el excremento del diablo’ or ‘the devil’s excrement’. Furthermore he chillingly prophesized, ‘Ten years from now, twenty years from now oil will bring us ruin’.

With the exception of a small handful of nations, who had the foresight to diversify their economies away from natural resources, many natural resource rich nations are not as fortunate. Africa is loaded with natural resource rich nations that today still remain poor and underdeveloped. Angola and Nigeria’s vast oil and gas deposits have created more misery than prosperity for most of the population. Today Nigeria has one of the fasting growing economies in the world yet much of its future prosperity will depend less on oil and more on diversifying its economy and stamping out corruption. Norway and Qatar are two oil rich countries. Yet both countries also have a substantial sovereign wealth fund. This means that when the price of oil is depressed, they have a cushion to land on during the lean times.  Saudi Arabia, arguably the most oil rich country on the planet, for too long was overly reliant on its number one export yet in recent times it has followed in Norway and Qatar’s footsteps by establishing its own sovereign wealth fund to diversify away from the black stuff. Hopefully Venezuela, once it is finally able to free itself from the destructive Nicolas Maduro regime, will follow suit.

It is a blessing in disguise that the UK (barring the North sea offshore oil and gas deposits in Scotland) is not a natural resource rich country. This means that in order to maintain financial prosperity, it has to retain a dynamic and business friendly economy.

 

By Nicholas Peart

(c)All Rights Reserved

 

Sources/Reading material:

‘The Devil’s Excrement’ by Jerry Useem (2003)

 

Image: Aljazeera.com