“So we are trying to grow this economy with one hand tied behind our back. [Brendan: meaning traditional banks aren't loaning money]. But that doesn’t mean the entire economy will stagnate. It just means that credit will have to be allocated from non-bank sources. High yield corporate bond markets will flourish. Foreignholders of US risk free assets will switch to hard US asset investments. Money managers, private equity firms and hedge funds that do not have financially repressive guidelines will also take risk and prosper. There are headwinds from banks, but there are tailwinds from alternative credit allocation sources. We will still see investment in real risky endeavors – and the positive real returns will generate positive real growth.”

I agree. A new crop of companies is sprouting up that can successfully evaluate credit risk and line up borrowers, but that needs outside capital to make loans. This is the part of the economy that deleveraging has impacted most severely, and it is where consistent 9%+ returns will be found for the next half-decade.

I need to write a longer post on this important topic. More to come…

If you read between the lines, Germany’s proposal that a European Commissioner be appointed over Greek taxation and expenditures amounts to receivership for a sovereign nation.

Question: What is “Greece” if it doesn’t have control over monetary policy (because of the Euro) or fiscal policy (i.e. taxes and spending controlled by a European Commissioner)?  It will not be an independent country in any modern sense of the word.

I read Stratfor weekly – they have a unique, global perspective, clearly know their history, and pull no punches. This one in particular is worth reading.

Germany’s Role in Europe and the European Debt Crisis

There are two Americas. One is based on fierce competition, and one is based on father knowing best. Both Americas are large employers, but in only one America do bad decisions punish the decision-makers and their employees.

Both Capitalist America and Communist America deliver essential services to Americans, but with two differences:

1. Capitalist Firms that fail will disappear. Bureaucracies that fail will keep growing.
2. Communist America is entirely paid for by taxes on Capitalist America.

The Government Keeps Growing

In America, the proportion of our economy that is controlled by Bureaucracies that have no feedback mechanism for economic failure has been steadily growing for 100 years:

The Need For and The Cost of Central Control

Modern industrial nations need central control of certain essential functions: roads, courts, defense. But central control comes at a huge, inevitable cost: inefficiency.

Industrial nations whose pendulum swings too far over to Communism all crumble for one simple reason: humans are only efficient when they are competing.

The Tipping Point

There is a tipping point, when too great a proportion of a nation’s goods and services are provided by Communism based on taxes on Capitalism. Over that tipping point, the Golden Goose dies by 1,000 cuts, and nations stop growing. If you are in debt and you stop growing, you will default.

No one quite knows where that tipping points lies for the developed world, but Europe’s stagnation is an uncomfortable exploration of the danger zone.

Saving the Goose vs Dividing the Pie

As whole nations approach the zone of insolvency, the classic liberal/conservative argument about dividing the pie becomes a less useful metaphor. Instead we need to focus on Saving the Goose.

The US Census Bureau reported that 49% of households have one member receiving at least one type of government benefit.

The White House budget office estimates that 63% of federal spending next year will consist of checks written to individuals who performed no services in exchange (2012 budget – large file). That number has climbed from 18% in 1940 to 46% in 1975, and it will continue to rise in the absence of entitlement reform.

We need to resist the urge to characterize cutbacks as liberal or conservative because we’re spending money we don’t have. Stopping isn’t conservative, it’s merely sane.

Bureaucracies Never Go Away

Both Capitalist and Communist America are full of ambitious, power-hungry entrepreneurs. The Capitalist entrepreneurs fight each other for market share. If one firm expands in a static market, another shrinks or fails, leaving room for growth.

In Communist America, institutions also fail, but they rarely go away. Instead, failure is often rewarded by budgetary growth.  Under this Logic of Bureaucracy, the drug war isn’t successful, so we must not be spending enough to win, so the budget goes up every year.

The Power To Tax

Failed institutions grow by taxing the successful parts of the economy, transferring economic decisions about asset allocation from humans who have created economic success to those who administer economic failures.

Not Demagoguery

All of this talk of Communism may sound like demagoguery. You may be tempted to think that huge areas of nuance are missing. I would argue that they aren’t so critical to understand the big picture: Yes, we need some government, but nations that cannot control the growth of their government institutions will self-destruct as these institutions grow stagnant, growth disappears, and debt grows out of control.

Turning it Around

Unfortunately, turning this situation around will not be without extraordinary pain. We need to find the courage to dismantle failed institutions, and to rebuild only those that contribute to economic growth.

Let’s hope we choose to take our medicine soon, when unemployment is at 9%, rather than being forced to by the bond markets, when unemployment is at 21% (Spain), 17% (Greece), or 14% (Ireland).

Sounds like the 2012 US Federal Budget…

Chinese New Year 2012: Meaning and Predictions for the Year of the Dragon

The US has over $60 trillion in unfunded liabilities, mostly for social security, medicare, and veterans. That’s over $500,000 per household.

Retiree Imbalance Underlies Filing

Their “Economic Overview“ page contains links to all of their quarterly perspectives. Worth reading the last two of them.

“I support capitalism, but if somebody does anything that’s kind of questionable, then we have the right to ask all the questions,” said Jean Hampton, vice chairman of Carolina Patriots, a tea-party group based in Myrtle Beach.

Good to know that Jean “supports capitalism.”

GOP Split Over Attacks on Private Equity

Germany Sells Bills With Negative Yield for First Time Amid Crisis Concern

We’ve seen negative yields in the secondary market, but this is the first time bidders at a bond auction have turned negative.

Keep in mind that inflation in Germany is 2.1% (source Trading Economics) so these are real purchasing power losses.

The four page executive summary is well worth reading. The whole 241 page report is great if you like graphs and charts.  You can hit either from the link below.

IMF World Economic Outlook (WEO) – Slowing Growth, Rising Risks, September 2011 — Table of Contents

Of course small-value has a 2-3% premium over that, but not without risk.

All of this is evidence for over-weighting high-yield fixed income, our approach for the tough decade ahead.