The Deadly Dozen

I have been thinking about the the forces distorting the global economy. In the long run, the distortions don’t matter, because economies are bigger than governments, and eventually economies prevail over governments. Here are my dozen problems in the global economy.

1) China’s mercantilism — loans and currency. The biggest distortionary force in the world now is China. They encourage banks to loan to enterprises in order to force growth. They keep their currency undervalued to favor exports over imports. What was phrased to me as a grad student in development economics as a good thing is now malevolent. The only bright side is that when it blows, it might take the Chinese Communist Party with it.

2) US Deficits, European Deficits — In one sense, this reminds me of the era of the Rothschilds; governments relied on borrowing because other methods of taxation raised little. Well, this era is different. Taxes are high, but not high enough for governments that are trying to create the unachievable “permanent prosperity.” In the process they substitute public for private leverage, and in the process add to the leverage of their societies as a whole.

3) The Eurozone is a mess — Greece, Portugal, Spain, etc. I admit that I got it partially wrong, because I have always thought that political union is necessary in order to have a fiat currency. I expected inflation to be the problem, and the real problem is deflation. Will there be bailouts? Will the troubled nations leave? Will the untroubled nations leave that are the likely targets for bailout money?

4) Many entities that are affiliated with lending in the US Government, e.g., FDIC, GSEs, FHA are broke. The government just doesn’t say that, because they can still make payments.

5) The US Government feels it has to “do something” — so it creates more lending programs that further socialize lending, leading to more dumb loans.

6) Residential real estate is still in the tank. Residential delinquencies are at all-time highs. Strategic default is rising. The shadow inventory of homes that will come onto the market is large. I’m not saying that prices will fall for housing; I am saying that it will be tough to get them to rise.

7) Commercial real estate — there is too much debt supporting commercial real estate, and too little equity. There will be losses here; the only question is how deep the losses will go.

8 ) I have often thought that analyzing the strength of the states is a better measure for US economic strength, than relying on the statistics of the Federal Government. The state economies are weak at present. Part of that comes from the general macroeconomy, and part from the need to fund underfunded benefit plans. Life is tough when you can’t print your own money.

9) The US, UK, and Japan are force feeding liquidity into their economies. Thus the low short-term interest rates. Also note the Federal Reserve owning MBS in bulk, bloating their balance sheet.

10) Yield greed. The low short term interest rates touched off a competition to bid for risky debt. The only question is when it will reverse. Current yield levels do not fairly price likely default losses.

11) Most Western democracies are going into extreme deficits, because they can’t choose between economic stimulus and deficit reduction. Political deadlock is common, because no one is willing to deliver any real pain to the populace, lest they not be re-elected.

12) Demographics is one of the biggest pressures, but it is hidden. Many of the European nations and Japan face shrinking populations. China will be there also, in a decade. Nations that shrink are less capable of carrying their debt loads. In that sense, the US is in good shape, because we don’t discourage immigration.

About David Merkel 144 Articles

Affiliation: Finacorp Securities

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website ( Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

In 2008, I became the Chief Economist and Director of Research of Finacorp Securities. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm.

Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.

I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

Visit: The Aleph Blog

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