Letter Re: Europe, Japan, or China: Who May Go Off the Economic Cliff First?

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Jim,
I believe that the world is on the verge of a possible economic meltdown. I think that there is just too much debt (both governmental and private), not enough assets, and with a end result of the financial system breaking down with devastating consequences.
 
There are some common problems that the countries I will be looking at  all share. The first is high debt levels that cannot be repaid. However, the more important factor is negative demographics in these countries.  I think that national demographics do not receive enough consideration when analyzing a country's economic potential. This is a mistake. Demographics are probably the single most important issue that should be examined. For example, a country could have massive natural resources available for both domestic use and export. But if this nation has a elderly and child 'bulge' with a very small working age population that doesn't have the manpower to exploit these resources, then the resources will provide this country with very little economic benefit.
 
The title of this article asks a question. The honest truth is that I don't know what the exact answer is (or when).  I think it will be Europe first, but Japan isn't looking so hot either. China is a export-driven economy. Yes, they have some serious problems too, but I think they won't truly take a hit until either Europe or Japan go off the rails first.
 
 
EUROPE
 
I think Europe's economy collapses first because of something originally designed to help the area's economy: the Euro Currency. Having a regional currency used by multiple European countries is a idea that has failed completely. When a nation controls it's national currency it can devalue the currency if it's economy slows down. A devalued currency will make that nation's exports cheaper for its neighbors to buy. More exports leads to a higher level of economic activity and the end result will be a pick up in economic output overall (Please keep in mind that these are general economic theories, and they may not work every time in every country. If a nation has no exports then a currency devaluation does them no good, since the price of their imports will rise).
 
Since most of Europe uses the Euro Currency, and not their former national currencies (the Italian Lira, French Franc, Greek Drachma, etc) there can be no currency devaluation at the national level in a effort to goose exports and sell more of that nation's cheaper goods to its neighbors. This is why European countries like Greece, Spain, Portugal, and Italy have been mired in recession for the last couple of years. the 'easy' way for them to get their national economies back on track by boosting exports through devaluation is no longer a available option.
 
These countries now have to boost their economic output by much harder methods: internal labor market reform, (translation: working more for less) opening up protected industries to competition to make them more productive, decreasing governmental control of the economy, and other ideas that aren't well liked by the locals.
 
Things are beginning to reach a breaking point in Europe. Yes, I have written in previous articles that I  thought the Euro Currency would be collapsing by now. And maybe I am wrong this time as well. I have underestimated the ability of European politicians to keep kicking the Euro Currency can down the road in their desire to keep things from imploding in Europe. Last year, I did not expect that European Central Bank President Draghi would make his infamous "Whatever it takes" comment and then unveil the ECB's plan to buy unlimited amounts of European sovereign debt in order to keep bond yields low (BTW, one year after Draghi announced the ECB bond-buying plan, there is still today no formal plan, idea, document or even anything sketched out on a soggy cocktail napkin on how exactly the ECB would conduct it's bond buying operation and how the plan would actually work).
 
The general Unemployment levels across Europe are  hitting all time highs of around 12%. Youth (18-to-25 years) unemployment in countries like Greece and Spain are around 50-to-60% and rising. Since more people are unemployed, this means economic activity is negative pretty much across Europe (Germany is still positive, but not by much) High unemployment and lower growth have two bad effects on a country's finances. First, government has higher expenditures due to increased numbers of unemployed citizens needing government-provided social support. second, governments take in less tax revenue from both businesses and employed individuals. Higher government expenditures and lower incoming revenues can really raise government debt levels. This is why Greece needs another  multi billion Euro Bail-Out (it will be their third or fourth, I have lost track) The Italians may soon be asking for one also. And the Spanish are lining up for their second hand out. Even the French aren't in such great economic shape anymore, and may soon be needing financial help.
 
The bottom line is that Europe is in trouble and there is no real way out of it until they kill the Euro Currency and go back to previous national currencies. The Euro Currency has become a noose that is slowly strangling European economic growth. Even if the Euro is killed tomorrow, Europe isn't out of the bad economic woods yet. European demographics are ugly. Too many retirees, not enough workers, and not enough Europeans having kids to sustain national populations going into the future. All national Social Security type programs are basically legal ponzi schemes. There needs to be a steady source of incoming workers starting to pay into the system to replace the retiring workers who will soon be receiving payments from the system. Thanks to the postwar 'Baby Boomer' generation that is starting to retire, Social security programs will soon have more money flowing out of the system then into it. (This is just not a European problem, The USA will have to deal with the exact same issue)
 
High levels of unemployment, exploding debt levels, decreased government revenues, no national currency that can be devalued: add it all up and things are grim in Europe and getting worse by the day. Europe's current downward spiral cannot continue. Something will break, and it will be soon.
 

 
JAPAN
 
Japan is the only country in the entire world with a demographic picture that makes Europe's look easy to fix. Europe's demographics are bad. Japan's demographics  are horrible, ghastly, terrible, and hideous.  Europe has bad sovereign debt problems. Japan's debt problem is simply impossible to fix. They will default someday, probably within the next two years. Japan is reaching the point of no return, and they have few options left.
 
What does the number 'One Quadrillion' represent? If you said "That is the Yen-denominated figure of all outstanding Japanese Government debt they have issued", then you  just won a free drink on me. Congratulations!  Yeah, that number is accurate. Honestly I'm not sure exactly just how many zeros there are in a Quadrillion, 14? 16? I do know that if you started at 'One' and counted one number every second until you reached One Quadrillion, you would be counting for 32 million years. Does that sound like a number that Japan will ever be able to pay back?
 
For the last two years, a milestone has been  achieved in Japan, but nobody in Japan should be popping a bottle of Veuve Clicquot champagne in celebration yet because the milestone reached was not a good one. The milestone reached was that the sale of adult 'Depends' style diapers now outsells regular baby diapers. This is because Japan has the fastest growing elderly population in the entire industrialized world. Nobody comes close to the speed that which Japan is becoming old. Once again, demographics are key. If national demographics are bleak, there just isn't much a country can do to fix it.  Japan is no exception. Unless Japan starts  making some huge gains in robotics starting tomorrow and starts developing 'Cylons' (I admit it, I'm a big 'Battlestar Galactica' fan), then going forward they just will not have enough workers replacing all the retiring elderly. Japan does control the value of the Yen, and they have been devaluing it ("Abenomics") but they have a slight problem. Thanks to World War Two, they aren't the most well liked country in Asia ( to put it mildly). They have few friends in the region who want to buy cheap exports from Japan. And thanks to some current nationalistic events regarding disputed territory involving China and Japan, Japan's largest export customer, China, has stopped buying Japan's goods. So even if the Yen gets devalued massively, it won't help much regarding China's  lack of desire to now  buy Japanese products and services.
 
Making a bunch of robotic worker 'Cylons' is about the only option Japan has left, since they allow almost no migration into the country. The economic picture is getting so bleak that they have had around ten (yes, 10) different Finance Ministers in the last five years. One FM actually committed suicide while he held the post. Another had to  resign and be checked into a mental hospital because the job was so stressful. If you have the time, look up on 'Youtube' some speeches by a billionaire Hedge Fund Manager named Kyle Bass.  He lays out Japan's ugly economic future quite well.
 

 
CHINA
 
Just when you thought it would be safe to pick up Asia's economic pieces once Japan explodes, here come the Chinese. Unlike Europe and Japan, the Chinese actually have a growing economy. But they have problems. Thanks to China's 'one child' policy, they will soon be hitting some unique demographic issues. Because of the policy and a Asian preference for baby boys, there will soon be a generation of Chinese males without girlfriends or wives who will be caring for four grandparents all by themselves. Personally, I can barely manage my own life, so the idea of taking care of elderly relatives doesn't have much appeal. Luckily, I am not facing this prospect, but a lot of males in China soon will be, and I wish them the best of luck cause they will need it.
 
Bad demographics aren't the only issue mainland china faces. Due to them becoming the manufacturing center of the world, all that industrialization has produced massive environmental damage that will takes decades to heal. Their factories rely heavily on coal-fired power plants for energy.  Burning all that coal is another factor in China's environmental problems and is also a issue regarding health problems.
 
There are economic problems as well. When the global economy tanked in 2008, the Chinese central government kept their economy growing by launching a multi trillion Yuan stimulus package. This backfired due to the fact that  many construction projects were launched that were completely unneeded. Think 'bridges to nowhere' on a massive scale. The Chinese built entire cities that stand vacant with very few residents. This overbuilding also produced rampant property speculation, resulting in local governments making bad real estate investments that are now badly  underwater. The speculation also led to large amounts of shady deals and outright criminal activity that has no positive benefit to the nation. The central government is now so concerned about bad debt levels at the local government level that they are conducting a massive audit of local finances to get handle on just how big this problem could be. My prediction is that what the central government learns from the audit of local book keeping will result in a whole bunch of local commissar type folks getting lined up against a wall in a police station basement and.... not walking out again, ever.
 
I know it makes for pretty depressing reading, but these are some of the things I see ahead for the global economy. Even the best-case outlook still results in  a lot of uncertainty that will soon be upon us. And the worst case means that we could be looking at: Regional conflict?, Economic meltdown? World war? It is something that we all need to keep a eye on. - CDWT

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This page contains a single entry by Jim Rawles published on August 5, 2013 12:33 AM.

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