Introduction

The best weather forecast comes from watching the trends: if the chance of rain increases as you get closer to the day of interest, it will probably rain….  So I start by looking at what has been happening to IMF, OECD, and World Bank predictions for economic growth for the next two years. Following that, I compare the US bank collapse and its outcome with what might happen in Europe.

Prediction Trends

Table 1 presents trends in IMF growth projections. The first column for each year gives their most recent estimate. The second column is the absolute difference between that projection and one they made in April 2010. Back then, the recovery from the global recession has occurred in most emerging nations. And even in the West, the recovery was gaining traction. But then, worries about sovereign debt in Europe started, and policymaking in Washington became dysfunctional.  The trend is not good: things are getting worse.

The IMF lowered its estimate for global growth by half a percentage point for 2011 and by 1.2 percentage points for 2012. The Eurozone was buoyed up by Germany in 2011, but things are expected to get much worse for Germany and the Eurozone in 2012: we ain’t seen nothing yet!

And I ask you: after all the experience the IMF has had, how could it have been roped into pushing a German austerity plan in Greece so severe and complex that it had no chance of working? And as I have reported, the strong Euro nations are now angry because the IMF is finally saying austerity in the “weak sister” Euro countries won’t work. Why did it take so long for the IMF to catch on?

And for something really worrisome, put the expected growth rate declines in the Euro countries that are in trouble against their projected unemployment rates, i.e., Greece 19.5% in 2013, Ireland at over 14%, and Spain approaching 23%! These are clearly recipes for more street riots and government overthrows.

 Table 1. – Trends in IMF Real GDP Growth Projections

Source: IMF, World Economic Outlook Database, various dates

The OECD adds a downside scenario to its predictions, where the downside is characterized by “intensification of Euro-Area crisis and excessive US fiscal consolidation”. And while I doubt there will be excessive fiscal consolidation in the US because it is an election year, the downside estimates are worrisome.

Table 2. – OECD Scenarios (real GDP growth rates)

Source: OECD

Similar “downside” scenarios have been done by industry associations. For example, IATA, the international airline trade body, estimates net profits at $3.5 billion in 2012 without a crisis but a loss of $8.5 billion with a crisis.

A Little Perspective                                            

For better or worse, we have a useful frame of reference for what is now happening in Europe – the US bank collapse followed by the global recession. In Table 3, indicates what happened then to the global economy.

Table 3. – Real GDP Growth Rates

Source: IMF, World Economic Outlook Database

The projected downturn numbers presented in Table 2 are quite serious relative what happened in 2008-2009. So let’s review what happened earlier and speculate about what might happen now.

The US Bank Collapse/Global Recession Revisited

As I have written, the “mechanics of the global recession were:

1. The inevitable downturn in the US real estate cycle, leading holders of mortgages and their derivatives to question their worth.
2. Most (more than 90%) of mortgages were OK, but the lack of documentation on their derivatives caused a complete meltdown in that market.
3. Word got out that US banks were on the verge of collapse.
4. Panic ensued, causing global losses of $50 trillion ($36 trillion equities, $14 trillion);
5. $50 trillion in losses is significant inasmuch as global GDP was running at $60 trillion annually.
6. The negative wealth effect of this loss lead to a drop in global spending (consumption and investment), and that spending reduction kicked off the global recession.
7. In early 2010, even the deficit and debt-ridden Western countries developed had started to recover, but then the Euro Crisis hit.

As Table 4 indicates, most stock markets have bounced back to 80%+ of their peaks in 2007. In contrast, real estate markets are still at their lows.

Table 4. – Stock Market Losses and Recovery

Source: Yahoo Finance

The Euro Crisis

Things are very dangerous in Europe. Several things could happen that would cause further global panic. Remember that unlike mortgages, where people can postpone borrowings, the weak Euro countries need to refinance existing debt and borrow more to cover government and balance of payments deficits. The IMF recently tallied up what the weak Euro countries will need in 2012 (Table 5). Recognize that no private sector investor wants to lend these countries money.

 Table 5 – Euro Country Financing Needs, 2012 (% GDP and Euros)

Source: IMF, Fiscal Monitor

And then there are the banks that apparently are of greater concern to the Euro leaders than its citizens. As in the US case with mortgage-backed securities, banks have bought sovereign debt from these countries, repackaged it, and sold some of it off with guarantees. In an earlier piece, I estimated country bank exposures to “weak sister” debt as a percent of total deposits as follows: France (16.5%), Germany (10.7%), UK (9.3%), US (9.3%). And the New York Times just reported that five of the largest US banks have exposures of $80 billion. So what could happen? How about a managed default/haircut? Or more worrisome, how about a unilateral default by one of the “weak sister” countries? What then happens to the required asset to default ratios of banks holding sovereign debt of the defaulting countries? Oh, maybe they are holding some form of insurance? The NYT reports that the five banks mentioned above have “insured” somewhere between $30 and $50 billion of their holdings. How? By credit default swaps and other derivatives. Hm. How did they work in the US case?

But things could get much worse. Rumors that banks are struggling could cause runs on banks. These are never good.

The Germans press on with austerity demands. They are now asking the Greek government to cede control over its finances. This suggestion did not go down well with the Greek government. It is hard to believe there will not be more government collapses and riots in the streets.

So what are the big financial players doing? Everyone is angry with the others. The IMF is pressing Eurozone countries to raise more money. The US is saying “this is a European problem”. And the Eurozone countries have just agreed that going forward, no Eurozone member can run a deficit greater than 1% of GDP. Okay. Splendid, just legislate it. They also issued a declaration to “restart growth and combat joblessness across the Continent”. What? You want to restart growth/reduce unemployment while eliminating fiscal policy as a way to achieve that end?

This is all make-believe stuff.

Investment Implications

The situation is extremely dangerous with no apparent resolution in sight. More panic is probable. For that reason, I will satisfy myself with the 4% to 6% returns I can get on emerging market debt (ELD and TGEIX) and US real estate (FRIFX).  

 Introduction

 As I have reported earlier, there are serious problems in banking, education, health, energy and defense in the US. The issues are complex, but there is a common theme running throughout.

Banking

US banks effectively collapsed in 2008. That resulted in a global panic and a stock market loss of $36 trillion. That capital loss caused a drop in expenditures worldwide and the global recession. What was the remedy? To bail out the banks that caused the problem and the passage of the 2300-page Dodd-Frank Bill in 2010. As I and others have asserted, the banks are no safer today than they were before their collapse. Why is this? Table 1 provides part of the answer.

Table 1. – US Lobbying Expenditures – Finance (mil. US$)

Source: Open Secrets

 Education

The US spends as much as any country per capita on education, but US test scores on reading, math, and science rank 18^th among developed nations. And yes, Chinese scores are higher. Table 2 offers part of the reason.

Table 2. – US Lobbying Expenditures – Education (mil. US$)

Source: Open Secrets

New York Governor Cuomo has pointed out that education has become a business in New York and only the students lack a union. And indeed, most of the lobbying for education is done at the state-local level, and Open Secrets covers only Federal lobbying.

Health

The US spends far more than any other developed nation on health care, and its health outcomes are the worst of any developed nation. Ouch! Why should this be? After all, I have reported that the findings of John Wennberg on how to reduce US health costs and improve performance are reflected in the Obama Health Care Bill. Unfortunately, that is not all that is included in the 1,017 page bill. Before any action suggested by Wennberg can be implemented, the Bill requires “stakeholder” approval. Table 3 gives a listing of the “stakeholders” and their Federal lobbying outlays.

Table 3. – US Lobbying Expenditures – Health (mil. US$)

Source: Open Secrets

Energy

When Obama was elected, there was considerable hoopla about converting to renewable energies, reducing pollution and the US dependence on foreign oil. What has happened since then? As I have reported, very little. US dependence on coal has increased, oil imports continue at high levels, and the US use of renewable energies remains insignificant.

Table 4. – US Lobbying Expenditures – Energy (mil. US$)

 Source: Open Secrets

Defense

 In the 20^th and 21^st Centuries, the US has been at war far more than any other nation. And recently, wars appear to be increasingly unfocused and unproductive. Was Eisenhower right to warn us about the military/industrial complex?

 Table 5. – US Lobbying Expenditures – Defense (mil. US$)

Source: Open Secrets

I repeat a quote by Robert Borosage:

“The country finds itself constantly at war. New presidents inherit the wars of their predecessors. They are faced not with deciding to go to war, but whether to accept defeat in one already in progress….And slowly, the great power declines from the inside out. The wars are costly, running up national debts. Vital investments are put off. Schools decline. Sewers leak. For a long time, circuses distract from the spreading ruin….Other societies become productive centers, capturing the new industries. Some begin providing better education for their citizens, better support for their citizens. Their taxes, not drained by the cost of wars past and present, can be devoted to what we used to call ‘domestic improvements.’

This is a very rich country…. But even wealthy countries must choose. We can afford to police the world – to sustain 800 bases across the globe, to station troops in Korea, in Japan, in Bosnia, in Europe, fight wars in Iraq and Afghanistan, sustain fleets to police the seas….South Waziristan, Yemen, Somalia, Kosovo, the Taiwan straits, the North Korean border, the seven seas – we can do this. But the result is that we are continually at war. And the wars cost – in money, in lives, in attention. And inevitably, domestic priorities, as well as emerging security threats that have no military answers, get ignored. A rich country, Adam Smith wrote, has a lot of ruin in it. We seem intent on testing the limits of that proposition.”

Conclusion

I look at the way China is run. With all its shortcomings, the Chinese Communist party fears the wrath of the people. It knows its hold on power depends on keeping them happy. In the US, do our elected people worry about representing the people’s interests? They might rationalize that they are while taking suggestions and contributions from the “interested parties”. But they are not. They are passing bad bills that only make things worse.

Does it matter whether the US President is Republican or Democrat? I don’t think so. The gravy train works for both parties.

Any reason to be hopeful? The money has to stop. I hope the Occupy Wall Street Movement gains traction.

Introduction

Since becoming the Managing Director of the IMF last summer, Christine Lagarde, a French lawyer, has been campaigning for both the Europeans and the Fund to raise additional capital to contain the Euro Crisis. More capital? Fine. You can never be too safe. Unfortunately, more capital won’t solve the Euro problem: it will only postpone its resolution.

What the IMF Does Well

Consider first what the IMF does well. If a country is suffering from inflation and a balance of payments deficit, it is usually because the government is spending too much. In such circumstance, the Fund agrees to lend the country some “transitional funds”, providing the government agrees to reduce its deficit and slow growth in the money supply. OK. The Fund normally does a good job at this.

The IMF in Europe – A Different Assignment

Let’s now consider what the Fund is being asked to do in Greece. There is no excess demand in Greece. In fact, the unemployment rate is 18.5% and expected to increase further next year. But there are large government and trade deficits. Why? Because Greece is locked into the Euro currency and cannot compete with the strong Euro countries. The strong Euro countries asked the Fund to develop a reform program so Greece can compete with Germany et al. As I have written earlier, the program is large and complex. It calls for new government wage structures, budget procedures, tax and expenditure reforms, pension reforms, education reforms, etc. It will never get implemented. What will happen if the Euro countries and Fund keep pushing? More riots in the streets and more Greek governments thrown out.

And the situation is no different for Italy, Portugal or Spain. Their economic systems are not as efficient as the Germans’. So as long as they are locked into the Euro, they will run growing government and balance of payments deficits. Austerity programs to reduce their deficits? The unemployment rate in Spain is already 23%!

More Money

Ms. Lagarde is calling for a “cushion” of $2 trillion, half raised by the IMF and the other half from the Euro countries. How will this money help Europe? Well, it will allow a postponement of the inevitable – just keep lending these countries money…. And it is certainly true you don’t want a run on banks to start.

Not everyone agrees with Ms. Lagarde. The US, looking over its shoulder at its deficit, has been decidedly unsympathetic. Annie Lowrey reported that a US Treasury spokesman said: “The I.M.F. cannot substitute for a robust euro area firewall. We have told our international partners that we have no intention to seek additional resources for the I.M.F.”

Conclusion – The Only Viable End Game

The IMF and Euro Countries are sleepwalking ahead with policies that will not work. I have earlier spelled out a way that the “weak sisters” could leave the Euro and go back to the Drachma. But it would be messy. I think there is a better solution:

• Austria, Germany and The Netherlands should leave the Euro and either go back to their own currencies or create a new one for all three;
• The “Weak Sisters” should announce a 100% debt default.

Austria, Germany and the Netherlands will have no problem in launching their own currencies. If they “walk”, the Euro will fall in value, making the exports of the remaining Euro countries more competitive going forward.

Negotiated partial defaults are never satisfactory. There are always a few that won’t agree and can make life difficult moving forward. The defaults will immediately improve the ratings of the defaulting countries. It will also mean the lenders who took the precaution to get their purchases insured will finally get paid (when is a default not a default?).

 Introduction

I have long argued that Greece is a hopeless case as long as it has to use the Euro as its currency. It cannot now and will not ever be able to compete with the more efficient Eurozone members (Germany, Austria, and the Netherlands). It appears the IMF is starting to understand this. There is also evidence of disagreements between the IMF and the strong Euro countries about next steps. In what follows, I briefly review the Greek case and what it means for the other “Weak Sisters” (Portugal, Spain, Italy) and world markets in the weeks ahead.

Greece – How Grim Can It Get?

So far, Greece has received €20 billion from the IMF and €60 billion from Euro countries. The money is doled out in tranches, the idea being that Greece has to meet certain performance targets before getting each tranche. It recently failed to achieve its targets but still got the latest tranche (€2.2 billion from the IMF and €5.8 billion from Euro countries because of just how desperate the situation is.

In the meantime, lenders are being asked to take a 50% “haircut” (for more on when a default is not a default, see my earlier article). The talks are not going well. There is a lot of money betting on a complete default. What will happen? How many have to sign up for the 50% haircut? I quote from the latest IMF Greek Standby Review:

“Should the debt exchange only reach 50 percent participation, instead of the near universal participation assumed so far, debt would peak at 179 percent of GDP, and begin to stall at around 145 percent of GDP post-2020. Even if the EFSF [Euro countries] covered the financing gap created by lower PSI [Greek creditors] participation, the debt would end at around 130 percent of GDP by end-2030….this level is already above what might be considered sustainable and moreover showing an only limited downward trend.”

The “haircut” talks have broken off. And on “haircuts”, there is one other point worth noting: the Greek banks. They hold a lot of Greek sovereign debt. Again, from the IMF Review:

“Current bank portfolios of Greek government bonds (GGBs) have a nominal value of about €45 billion (€39 billion book value after June 2011 impairments), compared to an aggregated core capital of €22 billion.”

Most of the domestic GGB holdings are with the six largest Greek banks (97 percent). In short, a write down/haircut on Greek sovereign debt of 50% would effectively bankrupt the six largest Greek banks.

The IMF–Mandated Reforms for Greece

When the IMF operates on its own, it goes into a country and figures out has to be done to turn things around. This will normally involve reducing the government deficit, reducing the rate of increase in the money supply, and various other policy changes). It then fashions a “standby agreement” with the country whereby it can get money from the Fund in tranches for the achievement of stated progress targets. In the case of Greece, the IMF focused on what Greece would have to do to become competitive using the Euro as its currency.

In all the years I have been covering the IMF, I have never seen such a long list of policy changes being demanded of any country. The general categories include: fiscal reforms, pension reforms, health sector reforms, Social Security reforms, government performance reforms, and economic system reforms. In order to achieve these objectives, the Greek government has agreed to foreign technical assistance in more than 20 different fields. Ok. So maybe if Greece did everything on the IMF list, they could stay in the Eurozone and compete with the Germans. But don’t hold your breath. This will not work.

The IMF Got It Badly Wrong

The IMF is aware that austerity policies cause unemployment to grow. Its own research concluded that a fiscal consolidation of 1% of GDP results in an increase of .3 percentage points in the unemployment rate. But take a look at what has happened in Greece. Things have gone terribly wrong. As Table 1 indicates, things are bad and getting worse. Just look at the revised projections for unemployment and growth.

Table 1. – IMF Projections and Reality

Source: IMF

I can imagine discussions going on among professional staff within the IMF. Some realize this effort is not going to work and are extremely angry that they got roped into this effort with the Euro countries. Others, the statesmen/diplomats of the Fund, are trying to hold things together. But the anger and frustration are growing.

Evidence of Friction

Last weekend, Andy Dabilis wrote a story documenting growing friction between the IMF and Euro countries over the Greek program. The Fund is apparently upset that Germany and other strong Euro countries has focused almost completely on getting Greece to reduce its government deficit. The IMF is now saying this one dimensional approach has failed. The IMF is upset that Greece is not being pressured by its Euro partners to go after tax evaders and implement the myriad of policy reforms discussed above. Dabilis reports that the IMF was “attempting to distance itself from a ‘counterproductive set of austerity measures’ imposed on the country under the insistence of the EU.”

Meanwhile, Christine Lagarde, the managing director of the IMF, is telling the Euro countries that the size of the second bailout for Greece needs to be increased by “tens of billions of Euros”.   

In short, everyone is pissed, recriminations are rampant, and the Greek program has failed.

Implications for Other Weak Sisters’ Stabilization Programs

Not clear. Germany will probably continue to insist on reducing government deficits, but the IMF will be looking far more closely at the impact of such austerity measures on unemployment and GDP growth. Recognize that Spain’s unemployment rate is already 23% and much higher for younger workers.

Global Impact

What will be the ripple effect of Eurozone problems be globally? Hard to tell. There is much more bad news to come. But some indication of the effect already comes from the downward revisions of GDP growth. In Table 2, I compare IMF growth estimates made in September 2011 with ones made in April 2010.

 Table 2. – IMF: Revised Growth Estimates

Source: IMF

Sadly for the global economy, things will get worse in Europe before they get better.

Introduction

Over the last 30 years, dramatic changes in the wine industry have occured. From being almost completely domiciled in four European countries (France, Italy, Spain, and Germany), it has spread worldwide to include the US, Australia, Argentina, New Zealand, South Africa, Chile and yes, China (7^th largest producer in 2011).

What changes can we expect in the next decade? The globalization of information is leading to changes affecting all industries. These changes include consolidation, specialization, and new production methods. These changes are affecting the wine industry as described below.

Consolidation

In wine, as with other alcoholic beverages, there are large economies of scale to be realized in marketing and distribution. As a consequence, there has been tremendous consolidation.

Table 1 provides just a hint on the enormity of the consolidations underway. Constellation is the largest wine company in the world, with Wine Business Monthly estimating that it sold 102 million cases globally (E&J Gallo global sales are estimated at 80 million). Note the number of brands each company has. In addition to brands, Bronco claims to have 585 wine partners. Fred Franzia of Bronco says they have more than 50 square miles (32,000 acres) of vineyards planted. Much of its business involves selling grapes to others. 

Table 1. – Leading Wine Companies and Their Brands

Source: Wine Business Monthly

But the consolidation goes beyond what is indicated above. Ste. Michelle is owned by Altria, the second largest tobacco company in the world (behind China National). And the 8^th largest wine company is owned by Diageo, the largest alcoholic beverage company in the world.

Specialization: Grape Farmer – Wine Maker – Wine Seller

Merriam Webster defines a vintner as a wine maker/merchant. That is how it used to be: wine makers usually sold the wines they made. In fact, it used to be that the grape farmer made the wine and sold it. No more. The consolidation described above has taken place largely because of the tremendous economies of scale in marketing and distribution. But specialization is also taking place in growing grapes and making wine.

So today wine entrepreneurs are thinking – why is grape farming any different than any other form of farming? Traditionally, grape farmers have been the vintners: they have grown grapes, made their wines and sold them. But why does this have to be? Why should a grape farmer know how to make good wine better than anyone else? So wine entrepreneurs are developing their own cadre of wine makers to scour the globe looking for grapes to make good wine. And to sell the wines they make? They buy up well-known wine brands and develop new ones.

This can perhaps best be seen in looking at what Fred Franzia of Bronco and John Casella of Yellowtail have done. Much of what follows comes from a great book by George Taber. Both are true revolutionaries, but their approaches are very different. Franzia gained notoriety via his Two-Buck Chuck (Charles Shaw) wines sold through Trader Joe’s. And Casella’s Yellowtail grew so rapidly that some estimate it now constitutes 50% of US wine imports from Australia. Their differences: Consider first grape growing. As indicated above, Franzia has 32,000 acres in wine growing. How does he use these grapes? Some he sells off as grapes/grape juice, some he makes into bulk wines (and sells off), and some he uses for his own wines. Here is a Franzia quote from Taber’s book:

“People don’t understand that we’re both buyers and sellers…. We buy grapes, and we buy wine. But we also sell grapes, and sell wines. We try to sell for more than we pay. We buy at $4 and sell at $6. And we do the same thing every day.” But with all his grape growing, Franzia says his wines only use 55-60% of his own grapes. He adds that his wines will never be 100% from his own grapes.

While Franzia is a grape farmer, Casella does very little grape growing. According to Taber, Casella grows only 5% of the grapes that go into his wines. The rest come from 650 different sources. He has 4 staffers that do nothing but buy grapes for him.

When it comes to making wine, Franzia and Casella are similar. Franzia has a team led by Ed Moody while Casella has a team of 11 wine makers headed by Randy Herron. And they make wines people like. A famous example is a Charles Shaw Chardonnay selling for $1.99 winning the 2007 California State Fair blind tasting wine contest against 350 other contestants where the average price was $28.50.

Casella, realizing that US consumers were used to relatively sweet wines, had his winemakers develop sweeter wines for the US market. Critics say the Yellowtail wines are getting better. And Casella has developed a new “Reserve” line of wines that are aged in oak with suppliers from France and the US.

Neither of them has any problem selling their wines through supermarkets, drug stores, whatever. Charles Shaw is sold exclusively at Trader Joe’s but his other 110+ brands can be found in any retail outlet with a wine license. And Yellowtail can also be found just about anywhere, including Costco.

What do these two revolutionaries tell us? No need to be a grape farmer – Casella is not. If you have good wine makers, they will find grapes to make good wines. Even though Franzia is a grape farmer, he (or more specifically his wine makers) buys grapes from others for his wines. And rest assured, these revolutionaries are not alone. According to Wine Business Monthly, Castle Rock ranked as the 25^th largest wine seller in the US, “owns no vineyard and no winery. And then we have 90+ Cellars. It buys excess wines with a 90+ ratings from wineries that produce them.

So what does all say about the future of the wine industry? Further specialization. The French regions with families that grow their own grapes to make their own wines will continue as long as people want to buy prestigious, expensive brands. But the future is not with them. The future? Wine makers scour the globe for grapes to make wines that appeal to different palates. “Terroir” will take on an entirely new meaning. Huge marketing/distribution companies will sell the resulting products wherever they can.

Blending

There is another growing phenomenon worth watching. It is becoming increasingly apparent that few people like wines from a single grape. Blending, or making wines from more than one grape, has been around for a long time. Even Champagne, unless it is a Blanc de Blanc, contains at least one additional grape for coloring or flavoring. And the Côtes du Rhône region of France has been making very good and reasonably priced blends (usually including Grenache, Syrah, and Mourvèdre) for time immemorial.

So what can we expect? Well, wine makers will no longer tied to particular wine growing plots. Instead, wine makers will be instructed to find grapes anywhere they can to make wines that taste good. We can expect more blending.

Conclusions

Assuming I am right about the future, what do we think? I am excited. I see more wine flavors and lower prices. And while I am quite content with the excellent Yellowtail Reserves (Pinot Grigio, Chardonnay, Cabernet Sauvignon, Merlot, and Shiraz) at $9, I am always interested in trying something new – grapes I don’t know and blends still to be discovered.

It will be very easy to become overwhelmed by the number of brands being marketed – from Table 1, I count 340+ from just the top six wine companies. So what is one to do when visiting the drug store, supermarket, and/or liquor store to buy wine? Drug stores and supermarkets sell wines at low prices, so if you know what you want – fine! But in liquor stores or wine shops, try to find someone who is really knowledgeable and hard working (they have to be hardworking to stay ahead of the curve), and see what they come up with for you. And as I have suggested, have your own wine tastings at home.

Wine “futures” should be exciting!

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