Why Sooner or Later in Europe Someone Will Have to Pay
Let the recriminations begin! And then the show trials!
This whole idea of moving money from the public to the insiders - and maintaining the public's enthusiasm for getting ripped off - is in trouble. It's not just Facebook, either. China has apparently had enough of Europe's family squabble about who will pay the bill for a decade of spending decadence. Today's Daily Reckoning will look at the complex picture and explain why it must end in catastrophe.
But first the comedy. Sort of. Lawyers are queuing up to ask Morgan Stanley what it knew and when it knew it. Specifically, media reports suggest that Morgan Stanley, one of the underwriters of the disastrous Facebook IPO, may have shared negative earnings forecasts for Facebook with investors just hours before the IPO.
Not just any investors, though. Certainly not mums and dads or the folks who'd be buying. The folks who may have been tipped off about the negative analyst report were institutional investors, the most likely sellers. This may explain why Facebook's shares fell nearly 9% again on Tuesday to close at $31. The shares are now down over 26% from the IPO price. That's a 'pop' alright, but more like a punch in the mouth than the typical easy money made in the aftermarket of an IPO.
There WAS easy money made in the IPO. But it was by the underwriters and the insiders, not the public. We're not telling you anything you don't already know. But it's probably a good reminder for Aussie investors: for some companies, there's more money to be made mining shareholders than there is digging and drilling for actual resources.
Not all resource companies are like this, mind you. Our mate Alex Cowie came into the office this morning with good news about one of his recent recommendations. Diggers and Drillers readers probably already know what we're talking about.
What's going on in Europe is not dissimilar to the Facebook IPO. One group of people - the EU elites - is trying to take money from another group of people (investors, voters, China) without letting them know it's probably a giant rip off. But the European shell games and brinksmanship have finally taken their toll on Chinese patience.
'The debt crisis is actually much less devastating than the handling of the debt crisis,' said Jin Liqun. He's the chairman of the China Investment Corporation (CIC). CIC is China's sovereign wealth fund. It controls $409.5 billion in funds. Europe's bankers and politicians want some of that money to recapitalise its banking sector and fund government deficits. They probably want all of it.
Jin is having none of it. He said that, 'Too much time has been wasted on endless bargaining on terms and conditions for piecemeal bailouts... Since the debt crisis broke out, there has never been a master plan for a resolution. There were only Plan As, never a Plan B.' And then he called down the thunder in terms the Europeans could understand. 'Frailty, thy name is leadership.'
Hamlet was angry with his mother for never meeting a King she didn't want to sleep with. In Europe, everyone is...sleeping...with everyone else. This precedes the complexity catastrophe we'll discuss shortly. Everyone is screwing around in Europe, and Jin is worried that the Chinese will get screwed too.
It's not exactly subtle language. But here we are. It's a reality check for the Welfare State and crony financial capitalism. Jin says Europe needs to get on with needed reforms and stop thinking about 'illusions of massive relief funds from outside the region,' or relying on 'the magic of street demonstrations'.
That's a Chinese capitalist telling European socialists that there's no such thing as a free lunch. It's also a Chinese pragmatist, having made an allusion to a 'masterplan' criticising fiscal-policy-by-street demonstration. Someone (else) had to say it. Modern Welfare State democracy - 'What do we want? Everything! When do we want it? Now! Who do we want to pay for it? You!' - is not compatible with balanced budgets and sound money.
That would seem to leave only two alternatives; less democracy or a return to sound money. Which one do you reckon we'll get? Sigh. We agree.
One thing you don't have to guess about is that this ongoing debt/identity crisis is bad for Aussie stocks. They are down again today by about one percent. This decline may have more to do with China than Europe, though. Some Chinese companies are defaulting on contracts for thermal coal and iron ore, according to the Financial Times. Others have asked traders to defer delivery.
Why would that happen? Maybe because there's heaps of iron ore lying around already, according to this Reuters video. ANZ Economist Nichoals Zhu is trying to separate official Chinese statistics from reality. What he finds are empty warehouses, stockpiles of iron ore being moved from one pile to another, and idle steel mills.
Granted, this is just one picture from a very large economy. But if you were a shareholder in BHP or Rio Tinto (and who isn't, really?) it would have to worry you a little bit. Rather than worrying, though, we're keeping our eye on the Aussie dollar chart. Have a look below.
Aussie Dollar Clinging On For Dear Life
Source: StockCharts
The Aussie dollar is already down over 13% from its all-time high against the USD. You'll know we're in full-blown 2008 crisis mode if the dollar breaks through last October's level and heads to 80. Of course it went much lower than that in 2008. But we're assured this time around that Australia is a 'safe haven' and a destination for capital in flight from Europe.
We'll see about that. We've gone on record in Australian Wealth Gameplan with our view on the dollar. What it means for investors is that things can get a lot worse a lot faster than the 'experts' imagine. We hope that doesn't happen. But hope is not a strategy.
There is one chart that tells you more about this whole phenomenon. We've updated it this week, but it's a mouthful to explain and show. And we don't want to try your patience this week. We'll come back to it on Monday.
In the meantime, what is meant by the term 'complexity catastrophe'? Well, ironically, it's an easy term to explain. Any organisation or institution is really a network of interactions between people. The larger an organisation or institution gets, the more trouble it has in adapting to sudden, even existence-threatening changes.
Anyone from a large family knows this intuitively. The more people involved in a decision, the less likely you are to get any decision at all, much less one that pleases everyone and actually works. As the youngest in a family of 12 children, we know this as an iron law of the Universe: bigness defeats adaptability.
But bigness isn't automatically a liability in all instances. In evolutionary terms, bigness bestows upon an organisation or organism certain advantages. You can eat everything smaller than you, for example. That which you choose not to eat you can crush under your foot for amusement.
But in nature, big things don't adapt well to catastrophic changes in their environment or ecosystem. They are fit for purpose so long as things remain in a relative equilibrium. Throw a meteor strike or two into the mix and you've got yourself a die-off. The whole food chain gets rearranged. This kind of creative destruction was great news for mammals. It was last rites for dinosaurs.
Now, applying a natural world metaphor to the realm of politics and government is tricky, but let's do it anyway!
The European Union is a union of separate States. Those separate states are themselves unions of smaller regions, cities, and municipalities. And those municipalities are loosely organised networks of people that live in towns, villages, and neighbourhoods. The whole thing is a network, or a network of interconnected networks. There are over 500 million people in the network.
This is where the complexity comes in, when everyone is connected to everyone else. That sounds like some people's version of a better world. But in terms of evolution, that kind of interconnection, or interdependence, can lead to catastrophic paralysis and death for a complex system. It might be nice at an interpersonal level, but it does not promote survival at a Superstate level.
This all becomes clearer when you put it in terms of financial connections. The connections between people, in financial terms, are the nodes in the financial system. These connections are the stakes European banks have in sovereign debt. Or the connections European governments have with banks. And the connections investors have with banks and debt. Or the connection between depositors and banks. Everything is connected to everything.
When Jin complains of frail leadership, he may be ignoring a more basic fact: highly interdependent complex systems cannot be led. Yes, they are frail, but not for lack of leadership. They are systems that have evolved to a point where any further change could be fatal.
When these highly interdependent systems become too complex (as Europe's financial system is now) - when taking one action has unpredictable or undesirable consequences for other actors in the network - the only stable state is paralysis, which is not exactly a survival strategy either.
So perhaps Europe is holding very still because it's afraid that if it moves - in any direction at all - everything may come apart. At the very least, the organism/organisation that is Modern Europe cannot survive radical change. It cannot adapt. There is no way to cut Greece out of the Euro without having some negative consequence for other 'stakeholders'.
But maybe that's the real issue here: the reluctance to admit that there's no such thing as a free lunch.
The notion of a riskless society - with a generous social welfare net - is that nobody ever has to fail or suffer the consequences of their failure, and that all human suffering and misery will be outlawed and eradicated. This is like saying that lunch is free for everyone, every day.
This philosophy (utopian and beautiful in the abstract) has been extended to capitalism, where the State increasingly guarantees the losses while the profits are private or for shareholders. The idea of a riskless society is that everyone can and should be protected from everything all the time, including themselves.
Sooner or later someone is going to have to pay in Europe. And in Japan. And in America. The respective political systems in each region have tried to pass that cost off on to future generations by racking up debt. But the buyers are drying up. We are reaching the end game. Currency is being perverted and corrupted by the hour. The whole edifice is built on unsound money. It's cracking. It will fall.
The spoiled children of the Welfare State can march and chant all they want, but something can't come from nothing. Somebody is going to have to pay. It will be an object lesson for a whole generation of humanity. But that's a good thing.
The more we dilute or dull our sense of risk, the less safe the world becomes. Awareness of risk promotes survival because it teaches us how to manage danger without being eaten by a predator. The political-banking elite have tried to create a world in which there are no predators save the State. Now we are all in danger of being eaten
Not that we're hoping for a meteor strike. But have you ever seen a T-Rex's arms? They're tiny! If you can stay nimble, adapt, and mind your surroundings, you have a fighting chance. What else can you ask for?
Regards,
Dan Denning
for The Daily Reckoning Australia