Violence in the streets, hostility in parliaments, grim demands of austerity. Hmm … another day, another euro.

But hold the baguette! I reckon the union and the euro will survive this annus horribilis. We’ll probably see a few defaults as sovereign debt – what each country owes its creditors – is written down or off. (My money’s on Greece, Portugal and Spain, in that order. If Italy goes, all bets are off.)

While battered to within an inch of its life, the euro and the European Union (EU) will surprise us all and live on to smoke those super strong cigarettes and neck double espressos for breakfast.

The reason? The EU stands to lose much more from a break-up than it would gain. Originally a French/German idea, the EU was seen as a way to bind the region following the collapse of the USSR. 20th century Europe had torn itself to shreds twice and a union presented a historical opportunity to create a metaphorical scabbard for those sabres, while also opening up new markets for everyone.

A chaotic European collapse might generate waves of resentment and recrimination that could end in feuding economic blocs or, even worse, bloody conflict. And while they may complain the loudest, the BSD’s – Germany, France and the Netherlands – have done pretty well so far in terms of trade volumes. They know what side their croissant is buttered on.

Fate may be on the EU’s side. Data out of the U.S. is starting to paint a pretty picture of recovery. Sure it’s all finger-painted stick figures at this stage but employment is rising, inflation is stabilising, housing is bottoming and, thanks to the declining dollar, exports are up. Meanwhile, the latest NAB report on the Chinese economy points to a soft landing.

And although the year will be a shocker for Europe no matter what, we may not have to worry. If the Mayans are right, we’ll all be gone by December 21.

Further to my recent blog Cyber-structural unemployment, an artificial intelligence researcher in Singapore has developed a robot with a virtual mouth. The “Kissinger” is the size and shape of a cricket ball with touch-sensitive lips that can detect and copy how your partner kisses. An extra touch of intimacy to a long-distance relationship or or just plain weird?

To spend or not to spend?

British Conservative leader and now Prime Minister, David Cameron, proclaimed the “Age of Austerity” in 2009. Miriam-Webster dubbed it the word of the year in 2010. Europe grappled mightily with austerity through 2011. And by 2013, our Labor Government, in a tip of the hat to austerity, has promised to balance the budget.

But now, in little ‘ole 2012, we are starting to see some of the results of all this austerity. And those results are not great.

First, let’s back up and take a stab at a definition. Austerity, as an economic policy, aims to cut government deficits by reducing spending, services and benefits.

With our economy doing pretty well, government cuts have been relatively painless. But in countries like Greece and Spain and Italy and Ireland … well, we’re talking strikes, mass protest, civil disobedience and disaffection.

The belief in Europe is that if governments slash spending and balance their budgets they can bolster private-sector confidence and hence confidence in a European government’s ability to pay its debts.

Counter to this thinking is the traditional economic wisdom that during a recession governments should stimulate the economy with extra spending, even if they must borrow to do so. Think GFC stimuli by Obama, Rudd and Chinese Politburo.

Sure, the thinking goes, balanced budgets in the long term will reduce interest rates (encouraging growth) and lead to smaller debt repayments allowing tax cuts, which also increase growth. But austerity in the short term lowers income and raises unemployment because all that stimulating government spending is removed from the economy.

The thinking continues that a weaker economy generates less tax revenue, which offsets the initial savings benefit from the austerity. Therefore, austerity in times of recession can actually make it harder to balance the budget, not easier.

But the austerity crowd, including much of Europe’s policy elite and many in the U.S., is unbowed. It insists that “expansionary austerity” is the key because confidence is the key. Some have even urged Obama to “do a Cameron”, meaning implement strict, British-style austerity.

So, how’s austerity going? To borrow a phrase from Nobel Prize winning economist Paul Krugman, has the “confidence fairy” materialized?

Not so, according to British think tank, the National Institute of Economic and Social Research. These pointy heads took changes in real GDP since this recession began, and compared it to past recessions. The results were alarming.

It seems Britain grew faster during the Great Depression than it is now. Four years into the Depression, Britain had recovered to its previous GDP peak. Four years into this recession, Britain isn’t even close to recovering its lost ground.

Meanwhile, recent employment figures in the U.S. have been surprisingly good. So perhaps it’s lucky for Obama he didn’t “do a Cameron”?

Things are slowing slowly and that’s a good thing.

With the trouble in Europe and the sluggish U.S. economy, an orderly Chinese slowdown is preferable to a crash.

The data from the latest NAB report on the Chinese economy shows that tighter monetary policy over the past year has achieved its goal of a soft landing. Domestic activity eased and GDP growth dipped slightly to end the December quarter at 8.9%, the slowest rate in more than two years. (GDP in 2010 was about 10%.)

Inflation ended 2011 at 4.4%, a little higher than the central bank’s target of 4% (our target is 2% to 3%). Inflation is important because too much of it reduces the central bank’s ability to use interest rates to stimulate demand.

On the subject of inflation, the pointy heads at NAB have two main concerns for 2012. First, a lot of money has been injected into the economy over recent years and this may become a problem. Second, rising incomes may push up prices. An interesting side bar is ongoing power shortages, caused by adverse weather conditions and low prices conspiring to ramp up consumption. The fix is in; the government put up electricity prices in 2011, but this is putting further pressure on inflation.

Europe accounts for more than a fifth of China’s exports, so it’s not surprising that those exports declined steadily over 2011. But imports also softened, leaving the trade surplus a little higher at US$16.5 billion. Surprisingly, retail sales in the December quarter were up nearly 18.1% on a year ago, despite the headwinds of tight credit, slowing growth and inflation.

Over all it’s a good outcome for Australia. Our major trading partner is continuing to grow but not at a scary pace, and it still has wiggle room to ease interest rates to fire up growth. Oh and happy Chinese NY, apparently this is a big one. Jeez, I hope it doesn’t dragon.

I’ll leave you with an unrelated thought from Alan Kohler of Business Spectator: “These days big government is ascendant and capitalism is in crisis, thanks to an excess of debt plus the fragmenting, democratising, pirating effect of the Internet. In fact, the way central banks in Europe and the United States are controlling the financial system these days with their emergency liquidity programs, we virtually have a centrally planned economy in the West. Meanwhile, the world’s most successful economy is a communist dictatorship.”

The robots are coming…

The concept of robots arose in the early 20th century; storytellers imagined how these mechanical workers would help us out. Since the late 20th century, robotic technologies have created everything from automated production lines to cute robot dogs. And now we’re putting robots on the battlefield. Better them than us, eh?

Let’s blow our minds a little: pundits reckon the robotics industry is about where the personal computer revolution was in the early 1970s. For some perspective, imagine being transported from 1975 to the present, and seeing people talking to invisible friends on tiny, brightly coloured, mobile computers that boast apps for everything.

According to a group of experts assembled for The Economist’s ‘The World in 2012′ series, robotics will impact our economy in unexpected ways over the next 25 years. And the coming generation of robots won’t just be hardware; it’ll include a software layer that will replace a lot of jobs.

Take Google or Facebook, which have very few employees relative to their size and impact. Robots and intelligent systems pretty much do the job. At the supermarket, self-service machines are replacing checkout chicks, ATMs mean less work for bank tellers, and voice recognition means virtual assistants can answer the phone 24 hours a day without the need for a ciggy break.

There’s even a robot out there reviewing evidence and transcripts, set to replace armies of paralegals and lawyers. Then there are the 200,000 robot-assisted surgeries a year involving tiny incisions that create less tissue damage and hence a quicker recovery.

As Discern Analytics managing director Paul Saffo said, “We’re all waiting for the robotics revolution. It’s just over the horizon … Over the next few years you can expect to hear the term, ‘cyber-structural unemployment’ and it won’t be a cyclical downturn, but structural, permanent.”

Did I just hear the Chinese bubble bursting? I’m afraid so. And before it’s done deflating, we might hear a lot more: thunderous landslides, screams of panic, etc.

Alarmist? Maybe. But when the stakes are this high, even a “maybe” warrants genuine concern.

Of course, this bubble started with China’s mother of all stimulus plans in 2008/2009. Gordon Chang, an international lawyer and China analyst, has spent much of the past 30 years living and working in China. He puts it this way: by 2009 the Politburo had dumped about $1.1 trillion into a then $4.3 trillion economy. (He’s referring to an easing of lending, in addition to direct stimulus.)

These mind bogglingly huge inputs created growth, but also created a stock market bubble, a property bubble and inflation. And the faster something goes up, the faster it comes down.

How fast? Inflation, at a modest 1.5% in January 2010, rose to 6.5% by July 2011. But that’s just for starters.

The property agent, Homelink, reports that new home prices in Beijing dropped by 35% in November. You heard that right, folks. More than a third in a month. Another property agency, Centaline, estimates developers have 21 months of unsold inventory in Shanghai and 22 months in Beijing.

According to Gordon Chang, in mid-2010, the state electricity grid in China reported that 64.5 million apartments showed no electricity usage for more than six consecutive months. That’s enough housing for 200 million people. Most of it empty.

If these astronomical numbers don’t convince you, consider the surveys that show the rich and super rich in China are, in growing numbers, thinking of leaving the country. That means getting passports and ensconcing their families in comfortable Western cities. That’s what Gordon Chang calls a leading indicator.

If things are going pear shaped fast, what does it mean for us Aussies? To paraphrase and twist the old sin city adage, what happens in China doesn’t stay in China. The real estate collapse is already nailing the construction industry. Since mid-year, steel production in China is down about 15%. And where do we sell most of our iron ore? I don’t need to answer that, do I?

The big question is whether the Politburo can engineer a soft landing. But imminent political change in China isn’t helping. At the end of 2012, the Communist Party will start changing the members of the Politburo Standing Committee. Those guys are the top of the pops. And change means uncertainty, which means weakness, which means power struggles and so on.

So if we don’t get a soft landing and the real estate crisis spreads through the Chinese economy, contagion style, then it’ll be more than steel that tanks. Demand for commodities – our economic specialty – will go off a cliff, taking a chunk of our prosperity with it. Alarmist? I certainly hope so.

Andrew Pegler – 13 January 2012

If you’ve travelled, you’ve probably realized that Australia can be expensive.

Cars cost a motza. Food isn’t cheap. And real estate prices just plain hurt. It’s enough to strain our cherished notions of the lucky country.

The Centre for Independent Studies (CIS) has recently taken up the cause with a report on why many of our prices are too high, why the government is to blame, and what the government should do about it.

First the caveat: the CIS is a pro-business organisation. Like many of its ilk, the CIS is quick to blame the government for our woes, but not so eager to praise it when things go well.

With that in mind, let’s proceed. The CIS finds that Sydney is the sixth most expensive city in the world – more expensive than New York, Rome or London. Further, Australian house prices have climbed from three times the median household income in the 1980s to nine times the household income in Sydney.

But we all know Sydney is expensive. What about the rest of the country?

The CIS takes aim at bananas, of which imports are banned for quarantine reasons. It says the ban contributes to the $13.98/kg price as of April, 2011. Whoa there! Cyclone Yasi had a bit to do with that. As an aside, the report mentions that bananas were $2.30/kg before the cyclone, only marginally more than America’s $2.16/kg.

Books and cars are also in the firing line. The report says the Copyright Act 1969 results in books that cost two to three times the price of overseas equivalents, while failing to drive sales to Australian authors. No disagreement from me: cheap books means more readers, and last time I put a coin in the Common Sense Machine, it said the more literate a population the better.

Similarly, the CIS suggests scrapping the remaining import duties on cars, abolishing the luxury car tax and allowing the private importation of certain used vehicles.

All in all, some good suggestions. Most of us, after all, find it hard to make ends meet.

But if we’re trying to gauge whether Australians really have it worse, we need to consider the other side of the ledger. Comparing median household income is a good place to start. In 2007, the Aussie median was AUD$66,820. Two years later, in 2009, America’s median was a much lower AUD$49,777.

Low-cost public health is another factor. We only spend 8.7% of GDP on healthcare. That compares to 9.8% in the UK, 11.4% in Canada and a whopping 17.4% in America.

I could go on (higher minimum wages, family tax benefits, the ability to study at university without paying upfront fees, etc.).

So are we really worse off than so many other countries? It’s a big and complicated question. For what it’s worth, here’s my gut feeling: sure, we should make some tough decisions in pursuit of lower prices, but it’ll take more than a survey or three to disavow me of the notion that we’re the lucky country.

Andrew Pegler – 6 January 2012

What’s the story with gold these days?

Short answer: it involves central banks and the never ending geopolitical quest for world dominance. Now for the long answer…

Through much of 2011 gold was on a tear, even pushing through USD 1,900 an ounce, capping off a decade-long bull run. By September, the price was crashing, into the mid-$1,500s (it’s since recovered some).

All this price movement has taken some of the gloss off gold, has gold watchers confused and even has some of them questioning gold’s traditional role as a safe haven.

But underneath the short-term price fluctuations a few powerful players are engaging in some serious brinkmanship. How powerful are these players? Well, Putin, Chavez and Chinese Politburo powerful.

These chaps are buying up gold, and lots of it. Central banks around the world, led by the Chinese and Russians, are expanding their reserves for the first time in a generation. The World Gold Council reports that these and other government institutions may have purchased 450 tonnes of gold in 2011, compared to only 142 tonnes in 2010.

Sometimes they buy publicly: Putin has been photographed manfully fondling ingots. Chavez sent shockwaves through gold markets in August when he pulled Venezuela’s 99 tonnes of gold from the Bank of England’s vaults and flew it back to Caracas.

Sometimes they buy under the radar: China’s admission that it has increased its gold reserves by 450 tonnes in the past five years is notable for what it omits. If they declare 450 tonnes, how much have they really purchased?

If we try and read these gold-plated tea leaves, what patterns do we find swirling at the bottom of the cup? One thing is clear: Putin, Chavez and China all have something in common – they’re not big fans of the US.

Putin has described America as living beyond its means, like “a parasite” on the global economy. China often scolds America’s indebtedness and let’s not even start on Chavez’s feelings about the U.S.

They all agree that American dollar dominance – built as it is on huge debt – is bad for the global financial system. And buying gold is their way of doing something about it. The more they hold in gold, the more they diversify their massive portfolios. Which means they can hold less Greenbacks, and be less exposed to, and dependent on, America.

So it’s a power play, folks. Global domination ‘n all that. The game that never ends. It’s far from being the only factor affecting the price of gold but it is worth keeping a lazy eye on as the ancient story of the yellow metal continues to unfold in 2012.

Andrew Pegler – 23 December 2011

Greek spreads now mean more to us than tzatziki.

The European Union emerged in the early 1990s as a French-German idea to bind the region after the unexpected collapse of the USSR. 20th century Europe had twice torn itself to shreds and a union seemed like a great way to bury the well-used hatchets. But the great coming together hasn’t worked as planned: Greek spreads now mean more to us than tzatziki.

Germany, disillusioned by its debt-happy neighbours, is no longer reserved about wielding its economic and political clout. Its hard line against the credit binge of the Club Med nations has won out and it is now reshaping the union.

European leaders (sans the Brits) have agreed on a new fiscal pact calling for tighter regional oversight of government spending. This is a good move; the euro crisis didn’t need more can kicking down Stimulus Road. It needed a long-term overhaul of membership rules.

These new structures will force errant borrowers to mend their ways. Then, with the EU’s fiscal future more certain, it’s hoped the European Central Bank will take a kinder view of the basket case countries, and start buying up their bonds. This should force down their yields and reduce the chances of a European implosion.

But we are not out of the woods yet. Expect the cold winds of a recessed Europe to buffet the global economy for another year or two. Down Under, this will translate into investment tentativeness, moths in consumer wallets and another nail in the coffin of Aussie manufacturing.

And how will this affect interest rates? Let me preface my thoughts by quoting John Kenneth Galbraith: “The purpose of economic forecasting is to make astrology look respectable”.

With that in mind, let’s have a crack: I reckon the RBA will move rates down until the middle of next year, settling around 1% less than current levels. The Bank will sit tight for a bit and then slowly nudge rates upward for the rest of the year. So put a lobster on the nose of a .25% rise on Melbourne Cup day 2012. But don’t hold me to it, I’m an Aquarian after all.

Andrew Pegler

What if the fat lady does sing?

Right now the news out of Europe is bleak. The occasional static about rescue packages and glimmers of hope are ephemeral. But wait, there’s more! Just as it seems like it couldn’t get worse, S&P puts 15 European nations on credit watch! (Yes, that S&P, the company that rated the subprime mortgages AAA+ and we all know how that turned out…)

As outlined in last week’s missive, the problem is that Ireland, Greece, Spain, Portugal and Italy – and probably a few others yet to be revealed – have borrowed too much. If, for example, Greece were to default, the fear would be contagion, domino effect, tumbling house of cards, etc.

Italy is the current poster child of woe. It is $AUD 2.5 trillion in the hole with an $AUD 540 billion payment looming next year. The chances of it meeting that under current market conditions are, well … your guess is as good as mine.

Right now we face two possible outcomes. The first has the fairy tale ending. The European Central Bank (ECB) takes bold action to reduce borrowing costs for Italy, Spain and other heavily indebted countries. We avoid kicking the can down the road again, and, after a year or two, things settle and the EU moves forward, albeit with some tighter regulations.

The second option has more of a Brothers Grimm feel. The liquidity crisis turns into a solvency crisis and then into a meltdown followed by a European depression. The “Club Med” nations, amongst others, get their marching orders and another union, centred around Germany and France, pops up with centralized budget oversight and tight legal constraints on how much debt national parliaments can issue.

If we go down that yellow brick road, may I suggest dumping the name “euro”? That brand is somewhat tarnished. I’m thinking the Frerman?

The countries not invited to the party will either group together to form a sub-union of also-rans, or just go back to using their old currencies.

Meanwhile we’ll continue tankering out our backyard to satisfy the countless Asian nation building projects set to shape the 21st century. We really are the lucky country eh?

Posted by Andrew Pegler

Posted by Andrew Pegler

What does it means to hear the market is “deserting” or “attacking” a particular European country?

In other words how and why is the market giving countries like Greece and Italy – and increasingly France – such a hard time? Well just like the GFC before it, Europe’s woes all come down to debt, except this time it’s public sector or government debt. Most of these problem countries (you can add Spain and Portugal to the above list) are running deficits, which are financed by borrowing, largely from the private sector.

This financing works as follows: banks and other private sector players, known collectively as the dreaded “market”, buy government bonds that pay a prescribed interest rate, known as a yield, for a fixed period of time, known as the term. At the end of the term, known as maturity, the government returns the money to the bond buyer, i.e. it repays its debt.

Under normal circumstances this works just dandy. When a government needs money it issues bonds. The market knows the yield in advance (the profit) and knows it can’t lose on the investment (because governments pay their debts, right?).

But now the market is becoming increasingly panicked/terrified/spooked (choose your dramatic descriptor) at the possibility that some of these countries won’t repay their bonds. All of a sudden those guaranteed investments are becoming high risk. And as the investment truism goes: the higher the risk, the higher the return. In return for taking on increasingly risky government bonds, the market is demanding higher yields as compensation.

For example, the recent Italian attempt to raise funds in a bond auction went so badly that their five-year yield rose to 7.8%. That means the Italian government is borrowing at 7.8%. Six months ago the yield was 3.5%. This is big cheese. An upward tick of 1% in bond yields can cost a government billions in extra interest payments.

But it goes much further than a bigger interest bill. European economies are stagnant. Unemployment and welfare costs are up. Taxes are down. Savage cuts aimed at reigning in deficits just exacerbate the problem by further depressing the economy and further shaking market confidence, which drives up bond yields even higher.

It’s a vicious cycle that now has Greece’s one-year bond trading at yields of over 300%. And the fear of contagion – one country’s collapse leading to another – is even making it hard for the poster child of prudence, Germany, to raise money.

That’s what happens when the market “deserts” or “attacks” a country – or countries. It gets ugly, fast. And in the case of Europe, pretty soon, something’s gotta give.