Wednesday, August 31, 2016

Fast Approaching Crisis

News of the U.K. withdrawal (“Brexit”) from the European Union drove the Dow Industrial Average down 611 points, but that was just the tip of the iceberg. More unsettling news is on the way on economic, political and social fronts. Events will be startling, severe and global.

France's president Hollande is losing support among the public, according to polls. Meanwhile, Marine Le Pen, leader of the opposition National Front political party, is gaining in the polls, which show she would easily get more votes than Hollande if the election were held today. She has stated that if she wins the April election she will immediately call for a referendum on a “Frexit,” that is, whether France should withdraw from the European Union.

In the long period leading up to the vote on the Brexit, the “stay in” voters held a comfortable lead over the “leave” voters until nearly the very end. An important factor—perhaps the decisive one—in the Brexit vote was increased concern the country was losing its “Britishness” because of the influx of Syrian immigrants. The EU policy calls from free movement of people across the borders of the individual countries. No need for passports. France has taken in far more Syrians than the U.K., and Hollande has stated his country will accept 30,000 of them, which is not likely to help him politically. After the terrorist attack in Nice, France, in July  that killed 84 people, the polling gap between Le Pen and Hollande widened. Sixty-one percent of the French now have an unfavorable view of the EU.

Brexit has compounded the strains on Europe's banks and Italy's in particular. “Brexit could lead to a full-blown banking crisis in Italy,” says Lorenzo Codogno, former director general of the Italian Treasury. A Frexit would add momentum for an Italian exit from the EU. But even before the Brexit, Europe was facing a looming banking crisis in Italy, which has $400 billion in bad loans, nearly 18% of the nation's loans. That is nearly ten times the level in the U.S., where even in the worst of the 2008-09 crisis, the level was only about 5%. Italian banks have nearly half of all the bad loans in the entire 19-nation euro zone.

In the crisis of 2008, Italian banks were inclined to roll over loans of delinquent borrowers and hope an economic recovery would rescue the borrowers and the banks. It didn't happen. Impaired loans are now quadruple the 2008 level—and still rising. On July 29, 2016, the European Banking Authority disclosed the result of stress tests on 51 euro zone banks. Italy's Banca Monte dei Paschi di Siena—the oldest bank in the world (since 1472) and the nation's third largest—finished dead last. The EBA concluded that bank would be wiped out if the global economy and markets were strained. The EBA test did not factor in negative interest rates or the effect of Brexit. Also, it didn't include any Portuguese or Greek banks and left out some of the smaller unprofitable Italian banks. So the situation is really worse than the stress test showed.

Germany is the largest economy in the euro zone, followed by France and Italy. United Kingdom, which had been in the number two spot, is already gone. If France and Italy leave, the euro zone will have lost three of its four largest members. That will likely spell the end of the European Union. Dissatisfaction with the EU is already growing in various other member countries. Recent polls in Germany, Spain and the Netherlands show almost 50% of their populations have negative views of the EU. In Austria, polls show anti-EU candidate Norbert Hofer has an edge in October's presidential election. And Greece probably will not be able to remain in the euro zone for long, said Alan Greenspan in a recent CNBC interview—a conclusion that certainly doesn't surprise me or anyone who has read my latest book. Greece now has a debt of 320 billion euros ($362 billion), about 175 percent of gross domestic product, and no one wants to lend that country any more money, having been disappointed by three bailouts already.

While banking problems are most severe in Italy, other banks in Europe and elsewhere too, have their problems largely because of the stupid policy of negative interest rates. Banks are in business to make a profit by making loans at a higher rate than they pay depositors for use of their money. When loans are made cheap by increasing the supply of money (quantitative easing) or negative interest rates, bank profits plummet. In the second quarter 2016, profits at the British bank HSBC, Europe's biggest lender, dropped 45% from a year earlier. At Santander, Spain's largest bank, the drop was 50%. And at Deutschebank, Germany's largest bank, profits plummeted 98%.

Not surprisingly, the decline in banking profits has been reflected in the banks' stock prices. The shares of Italy's largest bank, UniCredit, have lost nearly 70% of their value. Shares of the Royal Bank of Scotland has declined more than 55%, and those of Credit Suisse and Barclays are down by half. Since the start of 2016, twenty of the world's bigger banks have lost about $455 billion, a quarter of their combined market value.

Bank leverage is the a proportion of a bank's debts to its equity/capital. Deutsche Bank has leverage of 40 times. By comparison, Lehman Bros. had leverage of only 31 times when it imploded in 2008, setting off the global banking crisis.

The European Central Bank has assets of $3.5 trillion on its balance sheet, according to Yardeni Research Inc.'s June 2016 Global Economic Briefing: Central Bank Balance Sheets. In addition, the ECB is committed to purchasing another 80 billion of euro assets every month until March 2017 (which might be extended) in European sovereign bonds and corporate bonds, including junk bonds. However, ECB's capital, which determines its solvency is a mere $12.2 billion. If the ECB were a “real” bank, its leverage would be almost 287.

Deutsche Bank's chief executive John Cryan has warned of the "fatal consequences" of the European Central Bank's negative interest rate policy, which he said  punishes savers and is “working against the goals of strengthening the economy and making the European banking system safer.” He said low interest rates have dire implications for savers and pension plans. In fact, according to insurance giant Swiss Re, the U.S. Federal Reserve's low interest rates cost savers $470 billion in forsaken interest income between 2008 and 2013. It calculates that by the end of 2016 savers, retirees and pension funds will be shortchanged $752 billion.

Since the ECB introduced negative interest rates in 2014, the euro has lost 18% of its value. Worldwide there are now $13 trillion of government bonds with negative interest rates. More than 90% of Japanese government bonds have negative yields, as do about 84% of German government bonds.

In a 12-page damning analysis, Deutsche Bank compared the European Central Bank's mistakes to those made by the German Reichsbank and the U.S. Federal Reserve in the 1920s, which eventually helped lead the U.S. into the Great Depression. "That was a hundred years ago,” the report said, “but mistakes keep happening despite all the supposed improvements to central banking, from independence to better data and more sophisticated theoretical and econometric models." 

The mistakes keep happening because those theoretical and econometric models are fundamentally wrong. They are based on Keynesian economics—which means they are not economic at all; they are anti-economic. As Professor Robert Barro—who has studied Keynesianism extensively—put it: “The Keynesian model asks one to turn economic common sense on its head in many ways.”

Hunter Lewis, author of the book Where Keynes Went Wrong writes: “Keynes suggested that the government could print new money. That money would flow into the economy in the form of debt, and that would take the place of savings, but there is just no evidence for that at all, there is no logic behind that. In fact, if you want a good economy, what you need is savings, and you need to invest savings in a wise way...Of course, Keynes completely ignores the issue of how you are investing. For him, not only is any investment equivalent to any other investment, but spending is equivalent to investment.” He believed, said Professor Barro, that “more government spending is good even if it goes to wasteful projects.” Of course, it is not promoted as wasteful spending; instead it is called stimulus spending. 
Keynes claimed government spending created a multiplier effect as that money was, in turn, spent over and over again throughout the economy. The Obama administration based its massive stimulus spending program on a multiplier of 1.5, meaning that every dollar of government spending would lead to a $1.5 increase in the GDP. But Lewis says, “There is just no evidence” that spending ever cured a recession, and Keynes “wasn't particularly interested in evidence.” Professor Barro says, "What few know is that there is no meaningful theoretical or empirical support for the Keynsian position.” In my book, secondedition, I cite several academic studies proving this point. For example, a study by Barro and Charles Redlick found a multiplier effect of 0.4 to 0.7. A study by economics professor Gerald W. Scully covering sixty years of data found a multiplier of 0.46. When the multiplier is less than 1.0, it shows a negative effect: the benefits are less than their cost. I also include a graph (which I showed as Figure 2 here on this blog in June) showing the Obama stimulus act worsened—rather than reduced—the unemployment rate. The U.S. economy would have done better if the government had done nothing, rather than attempting to stimulate it.

There is extensive evidence that Keynsian policies of Franklin Roosevelt prolonged the Great Depression rather than curing it. And the same faulty doctrine has produced two “lost decades” of economic growth in Japan, which is now well into its third such substandard decade, while fear of a depression is growing. Nevertheless, Obama has been implementing the same failed doctrine throughout his presidency, and it has produced the weakest recovery from any U.S. recession since 1949.
The stock market today is one of the few economic aspects that some view as positive because stock prices have held up, but this requires further inspection. According to Goldman Sachs, buybacks have been the biggest driver of stock prices since the financial crisis. Companies have spent $2.5 trillion on “share buybacks” since then. A buyback is when a company buys back its stock from shareholders. This reduces the number of shares on the market and raises a company's earnings per share, which makes the company look good—it may pay a higher dividend—and may lift its stock price, but it doesn't make a company any more profitable. Low interest rates have allowed companies to borrow cheaply to buy their shares, as opposed to expending capital on business improvements, hiring and growing earnings.

Basically, rising stock prices correlate to higher earnings or the expectation of higher earnings; and if earnings are disappointing, stock prices will adjust accordingly. Here are some facts that indicate the high level of stock prices is out of whack with economic realities—and are due for a sharp downward adjustment:
  • The Standard & Poor's 500 index now has a P/E (price/earnings ratio) of 25. Only twice in history has this metric been this high: (1) at the top of the high-tech (“”) bubble that burst in 2000, and (2) in 2007 at the peak of the stock market before it and the housing/mortgage market collapsed into the Great Recession of 2008-09.
  • Earnings have moved in the opposite direction from stock prices. Earnings for the S&P 500 peaked in 2014 at $106 per share. Corporate earning for those same companies have declined for four straight quarters, and the end of the second quarter 2016 stood at $86.67 per share. This despite the fact that the Dow Industrials and the S&P 500 hit all-time highs in August.
  • Business investment fell 2.2% last quarter, the third straight quarterly decline in investments in property, plant and equipment, which hasn't happened since 2008-09.
  • U.S. companies are borrowing faster than they did during the dot-com bubble or housing boom.
  • Corporate leverage, which measures net debt against earnings, is twice as high as it was in 2007.
  • The real GDP growth rate for the year ending in June was a mere 1.2%—the weakest four-quarter rate since the Great Recession.
The stock market is thus very vulnerable in its own economic terms, but a major collapse here could also be triggered by an outside event such as a Frexit. Remember the 611 point drop in the Dow Industrials after the Brexist. After a Frexit, there won't be an immediate rebound as happened then, because there will still be the specter of an Italian banking crisis and the likelihood of Italy also exiting the EU. 

It is also possible that Italy will take the lead in exiting the euro zone rather than France, not just because of its banking problems but because of a referendum in October or November. The current prime minister Matteo Renzi, who has pursued reforms, is risking his future on a referendum over badly-needed constitutional changes. He says he will resign if the referendum fails. A “no”vote will not only bring about the downfall of his government but throw Italy's membership in the eurozone in doubt. If Renzi is gone, it is quite likely other parties will call for a vote on whether Italy should stay in the EU.

Another possible trigger for a stock market collapse and the fall of other economic dominoes could be the Fed instituting negative interest rates to try to “stimulate” (ha!) economic growth after a series of increasingly negative economic reports. That would be the final nail in the coffin of economic growth. It would reduce the available money supply in the banking system because people will simply withdraw money from their accounts and hide it under a mattress or equivalents. Even Commerzbank, the second largest bank in Germany, says it is considering storing cash in its own vaults to avoid paying the negative interest storage costs at the European Central Bank.

The aim of negative interest rates was to induce people to spend more and save less, on the faulty assumption this would improve the economy. It has produced the opposite effect. Central banks in Japan, Denmark, Sweden and Switzerland have adopted negative interest rates; but consumers in all those countries are saving more. They are looking out for their own future and want to replace lost interest income from savings and retirement accounts, not spend more. And banks in some countries, such as Switzerland, have responded to negative rates by making mortgage borrowing more expensive, not less as had been hoped.

Since the formation of the EU in the 1990s, there has been a concerted political effort to phase out gold in the international monetary system and replace it with a fiat currency, the euro. The euro experience has shown that an unlimited ability to print money with no backing cannot replace the effectiveness of a tangible monetary asset, gold. It may be useful, therefore, to look at the history of the EU's agreements on gold.

The first Central Bank Gold Agreement took place in 1999. At that time, central banks held nearly a quarter of all gold held above ground, about 33,000 tonnes. The second gold agreement (GBA2) took place in 2004. CBA3 and CBA4 followed in 2009 and 2014. The first clause in each of these four agreements began: “Gold will remain an important element of global monetary reserves.” In one of its first pronouncements, the ECB governing council decided the capital subscriptions of eurozone members would be paid 15% in gold and 85% in dollars or Japanese yen. (The capital subscriptions were based on population and GDP of the members.)

In a speech at Harvard's Kennedy School of Government in October 2013, Mario Draghi, head of the ECB and responsible for printing huge quantities of fiat euro, said, there are “several reasons” to own gold, among them “as a reserve of safety.” At the close of 2015, the world's centrals bank held about 31,400 tonnes of gold. The ECB held 503.2 tonnes, while national central banks held the rest. In 2014 the central banks bought 477 tonnes, the second highest amount in 50 years. In 2015 they bought 588 tonnes.

In the many centuries since the Chinese invented paper, there have been some 3,400 fiat paper currencies. All of them became worthless. There are no exceptions. The record is perfect failure: 100 per cent. The dollar will eventually become totally worthless, too. It may be a tossup whether the euro will get there first.

The rising gold price—and the fact that the central banks not only have thousands of tons of gold but are increasingly adding to it—shows a concern for safety and stability of money as a store of value. People throughout the world have the same concern and been increasing their buying of gold. Gold has answered the need for a store of value for 5,000 years. Quantitative easing and negative interest rates have never done so. Indeed, negative interest rates are unknown in 5,000 years of history.

However this issue plays out, gold will win in the end—because it best exemplifies the realities of the natural requirements of money—and its price will be much higher than it is today.

Monday, July 18, 2016

Health Risks of Banning Plastic Bags

It is becoming politically popular for cities and counties to ban single-use plastic bags for groceries and certain other items in the name of protecting the environment. People living in jurisdictions where such bans are being considered may benefit from my experience in Minneapolis.

Advocates of banning the bags claim they will be replaced by recyclable ones that will save money, energy and other resources in manufacturing and reduce municipal waste in landfills. Not true. Manufacturing the single-use plastic bags requires less than half the energy needed for compostable plastic or cloth bags and less than a third of what's required for paper bags. Making plastic bags requires less than 6 percent of the water needed to make paper bags. In a comparison of quantities of municipal waste by weight, the production, use and disposal of single-use plastic bags produced a net 15.51 pounds of municipal solid waste; compostable plastic bags, 42.32 pounds; paper bags, nearly 75 pounds.

I cited those facts in a letter to the Minneapolis Star Tribune when the city council was considering a ban on plastic bags. In that letter I first cited health risks because they are substantial and I thought council members would surely place human health above all other considerations. I was wrong. Nobody brought up the health issue at the city's meetings about banning the bags despite the Star Tribune having included on its editorial page some of my concerns about the health risk.

Not included was a warning that banning the single-use plastic bags was “creating a high risk of food poisoning,” according to Kofi Aidoo, probably the most highly qualified person in the world to speak on this issue. Here are his awesome credentials. He is president of the Royal Environmental Health Institute of Scotland, Professor of Food Safety and Microbiology at Glasgow Caledonian University (GCU) and program leader of the Food Bioscience Program at the University. He also leads GCU’s Food Research Laboratory, is a Fellow  of the Institute of Food Science and Technology (IFST) and of the Royal Society for Promotion of Health. He serves on the Joint Expert Committee on Food Additives, Contaminants and Natural Toxicants (JECFA) of the Food and Agriculture Organization/ World Health Organization. He is the author of 56 publications.

A reporter for the Sunday Post in the U.K. wrote: “We took a selection of reusable bags for analysis at GCU’s School of Health and Life Sciences. There were plastic and cloth types. Four of the nine fell into the heavily contaminated category.”

The lab analysis found staphylococcus aureus, a disease-causing bacteria that can grow and produce toxin. Yeasts and molds from food spoilage were regularly isolated. Asperigillus and Penicillium were the most common.” Professor Aidoo said, “Presence of these organisms on carrier bags could contaminate freshly-purchased open foods such as fruits and vegetables.”

Aidoo's concerns were echoed by Hugh Pennington, emeritus professor of bacteriology at Aberdeen University, who said banning plastic bags could result in “an increase in the number of cases of food poisoning”. Pennington has chaired two major inquiries into E. coli, including an outbreak in 1996 that killed 21 people. Although some studies report washing the bags is effective, Pennington says it “won't necessarily get rid of all of the bugs. The bag may look clean but you can still easily find these bugs." He also said flatly, “Any bag that's carrying meat, wrapped or unwrapped, shouldn't be used again.” Also, advocates of washing the recyclable bags don't include the cost of detergent, disinfectant or water hot enough to kill the bacteria.

Dr. Richard Summerbell is a professor at the School of Public Health at the University of Toronto and author of over 140 peer-reviewed scientific papers. He conducted a study which found “reusable grocery bags can become an active microbial habitat and a breeding ground for bacteria, yeast, mold, and coliforms.” The study also noted that the presence of yeast and mold may be of concern for people with compromised immune systems or allergies. In addition, the study showed that brand new bags, plastic or cloth, showed no evidence of bacteria, mold, yeast, or total coliform. It is important to note that the Canadian Department of Health validated the concerns of the Summerbell study.

In another study, microbiologist Dr. Charles Gerba said: “Our findings suggest a serious threat to health, especially from bacteria like E. coli, detected in half the bags sampled.”

USA TODAY reported a study conducted at a central California grocery store that “involved spraying bags with a bacteria not harmful to humans but transported in a similar way to norovirus, a leading cause of gastrointestinal disease linked to more than 19 million illnesses each year in the United States. The tracer bacteria was detected in high concentrations on shopping carts, at the checkout counter and on food items shoppers had touched but kept on the shelf.”

Reusable bags can transmit not only harmful bacteria but viruses. In Oregon, 9 of 13 members of a girls soccer team suffered vomiting and severe diarrhea from norovirus. Author of a study in the Journal of Infectious Diseases, epidemiologist Kimberly Repp explains “We demonstrated norovirus transmission without person-to-person contact. That’s why this is different.”

Dr. Gerba issued this statement: “This incident should serve as a warning bell: permitting shoppers to bring unwashed reusable bags into grocery and retail stores not only poses a health risk to baggers but also to the next shoppers in the checkout line." [Bold type is Dr. Gerba's] He also stated: “In reality, reusable bags are likely at fault much more often than we realize: cases often go unreported and uninvestigated.”

Like the norovirus, the influenza virus can by spread by contact with contaminated surfaces. An infected person who has touched his nose or eyes (conjunctiva) will transfer the virus to his hands and subsequently to other surfaces he touches, including a reusable shopping bag. The bag will then be able to transfer the influenza virus to others. A reusable bag coming from a home where there is illness, may be contaminated with the influenza virus. In the event of an influenza outbreak, it has even been suggested it may be necessary to require people to wash their bags before coming into the store or require clerks who handle bags to wear gloves.

Other diseases that can be caused by contaminated reusable bags include common cold, cold sores, conjunctivitis, croup, Giardia infection, lice, meningitis, rotavirus diarrhea, Respiratory syncytial virus (RSV), and strep.

Call7Investigators in Denver took several reusable bags from 7NEWS colleagues and a woman entering a grocery store and brought them to the University of Colorado Hospital for testing. Dr. Michelle Barron, the infectious disease expert there who analyzes lab results for a living, exclaimed, “Wow. Wow. That's pretty impressive.” Then, “Oh my goodness! This is definitely the highest count." She admitted she was shocked. “We're talking in the million range of bacteria," she said. Three of the samples had relatively low bacteria counts, posing little risk. Two had moderate risk, and two others had extremely high counts—330,000 to nearly 1 million colonies of bacteria. Four of the samples also had relatively high levels of yeast and mold.
To demonstrate the risk, the grocery bags were dusted with a substance that glows in the dark to show how harmful germs can travel. With the lights off, it was clear the Glo-Germ had not only stuck to our groceries, it was also on Marchetta's hands, the counter top, and in the cupboard and refrigerator.”

"We're trying to be environmental. I fully support that,” said Barron. “But not at the cost of your health."

At the very least,” says Aidoo, “people have to be given advice to clean these bags every time they use them." I doubt that many of the people who supported the ban would have done so if they had known they were going to have to wash them every time. Also, those most likely not to wash their bags are the homeless people, if for no other reason than they lack facilities to do so. So when they plunk down their unwashed reusable bag in a shopping cart or on the checkout counter, they pose a danger of infecting these surfaces for other customers.

The Keep America Beautiful campaign does not even rank plastic bags in the top ten sources of nationwide litter. Many major cities report less than 1 percent of municipal litter is from plastic bags, and many studies show that banning plastic bags has little or no effect on the total. In Minneapolis, Council Member Andrew Johnson spent an hour picking up litter in Minneapolis. He collected 498 items of which only 7 were plastic bags. He was one of only three members of the council to vote against the ban, which passed 10 to 3.

The campaign to outlaw plastic bags in the name of improving the environment is based on ignorance and misinformation. It will do the exact opposite and create health risks in the process. It will waste energy, water, and money. It will create inconvenience, waste people's time, deprive people of the liberty to exercise choice which has produced a more efficient, economical and safer product. Banning plastic bags is an attempt to achieve by political means what cannot be achieved by economic means, because it is unrealistic. It means government against the economy! Which means government against reality. There is nothing government can do to make an economic function more efficient than a free market; its only power is to make it less efficient and more costly—and, yes, environmentally inferior as well as dangerous to human health.