Tag Archives: International

Global challenges Local opportunities

Global challenges Local opportunities

Article writen by Daniel Lacalle for the international magazine IM (Intelligent Magazine Inquisitive MInds) talking about the recent elections in the Eurozone. 

The recent elections in the Eurozone have shown that the risks to the European project remain. In Germany, an insufficient victory from Merkel, the collapse of the social democrats and the rise of the alternative right and extreme left have surprised many.

Global challenges Local opportunities

However, it was predictable. The relief rally in the Euro versus its trading currencies and the bullish tone of equity and bond markets after the French elections and the victory of Macron were, in many ways, based on a very optimistic view of strengthening of the current European model. Markets quickly forgot that almost 40% of the voters in France decided to support radical anti-EU parties at both sides of the political spectrum. The German elections showed that this bullish perception was a mirage. In Germany, almost 30% of the vote went to radicals.

The European Union is ignoring this trend and soldiering on with what Brussels calls “more Europe”, which often means more interventionism and central planning. And citizens are not happy with this. Instead of seeing Brexit as a warning sign and an opportunity to improve the European Union strengthening freedom, openness and diversity, the separation of the UK has been taken as an opportunity to advance in an incorrect model that mirrors the French “dirigisme”, a central-planned, heavily intervened model.

The European Commission published in September a surprisingly euphoric docu- ment declaring the end of the crisis thanks to “the decisive action of the European Union”. However, that positive tone contrasts with a growing discontent among European citizens. There is no denying that the European Union is in recovery mode, and that is a positive. Business confidence is rising, and manufacturing indices are in expansion. However, the pace of said expansion has moderated in the past months, and challenges remain. The European economy is not “in shape”, as the European Commission boosts, and this explains a significant part of the rising populist and radical vote.

According to the Bank of International Settlements and Merrill Lynch, Europe has more zombie companies today than before the crisis, i.e. companies that generate operating profits that do not cover their financial costs, despite all-time low-interest rates and an unprecedented monetary stimulus. European banks, at the end of 2016, had more than 1 trillion in non-performing loans, a figure that represents 5.1% of total loans compared to 1.5% in the US or Japan. Europe has gone from financial crisis to financial crisis, and recently we have had new episodes in Italy, Spain and Portugal.

But the key problem is unemployment. The European Commission “certifies” the exit from the crisis with unemployment of 9.1%, maintaining all its labour market rigidities, an unemployment rate that is more than double that of countries with flexible work legislations and dynamic business environments, such as the United States or the United Kingdom. More importantly, underemployment is still very high. In 2016 there were 9.5 million part-time workers in the EU-28. In addition to this, 8.8 million persons were available to work, but did not look for a job, and another 2.3 million persons were looking for jobs, without being able to start working in one within a short time period, according to Eurostat.

The European Union must look at the diversity of cultures and stop pursuing uniformity at any cost.

The tax burden in this period has been raised throughout the EU -with some exceptions, such as Ireland- with an average tax wedge of 45% on workers and 40% on companies. If we look at economic imbalances, the main ones are public debt of almost 90% of GDP and poor growth which, at an estimated 1.7%, is almost half its potential. Many politicians blame the European crisis on austerity. However, data debunks that myth. The winner of the crisis in Europe has been the bureaucratic system. With public spending averaging over 46% of GDP, an annual deficit of over 1.7% on average, and 90% debt, talking about austerity is simply incorrect.

These figures show that the European Union is far from being “in shape”, as the Commission states, and the election results prove that authorities and member states cannot continue to ignore the lack of engagement of a growing part of the population with the directed-economy and bureaucratic nature of this European model.

According to the Intelligent Regulation Forum and with the official data of the European Union for 2015, the member countries are subject to more than 40,000 rules by the mere fact of being part of the EU institutions. In total, including rules, directives, sector and industrial specifications and jurisprudence, they estimate that there are some 135,000 obligatory rules.

The European Union is 7.2% of the world population, 23.8% of the world’s GDP and 58% of the world’s welfare spending. If this model wants to survive, it needs to pay more attention on boosting growth and supporting job creators, or the whole of it will crumble under the rising debt and ageing population problem. The biggest problem for the Eurozone is demographic. Average age in the largest Eurozone countries ranges between 44 and 47. At the same time, United Nations estimates that the European Union population will peak and start shrinking in less than two decades. Less people, and older.

Ageing presents many challenges. The cost of healthcare and pensions rise, while tax revenues decrease as consumption and investment slow down. This demographic challenge creates a fiscal and productivity challenge that can only be reversed by attracting high added-value investment and incentivizing high productivity sectors. By ignoring these risks, the EU runs the risk of falling into the glorification of centralized planning first and foremost, absolute uniformity, and obsolete interventionism that has nothing to do with the plural, free and diverse United States of America.

There are evident solutions. There are clear positives about uniting countries to boost growth, employment and opportunities, but it makes little sense to try to copy a model, the French one, that has created stagnation for the better part of two decades, high taxes, unemployment and diminishing competitiveness. As such, the main solutions come from more Europe but less Brussels, something that many politicians might dislike, but it is an absolute necessity in the face of growing opposition to the existing model.

First and foremost, the taxation system cannot continue to be a burden on small and medium enterprises, who are responsible for more than 70% of added value and employment in the European Union, and a growing weight on the middle class, which suffers a tax wedge that ranges between 10 and 20 points higher than in the United States or the UK. The European Union needs to understand that consumption and job creation are not going to improve if the burden of the ever-expanding welfare state and government spending falls on the two economic agents that can drive the economy to a better shape, companies and the middle class.

The European Union must look at the diversity of cultures and stop pursuing uniformity at any cost. Inequality is not a policy, but a result. There is no improvement in inequality if all the measures are directed at redistribution of a diminishing pie. The best solution to inequality is jobs. And this cannot come if excessive regulation and uncompetitive taxation continue to drive the policy of the Union.

Global challenges Local opportunitiesAccording to the PriceWaterhouseCoopers report “Paying Taxes”, average number of hours used to comply with regulation and taxes is higher in the European Union than the average of the OECD and the US, by between 6 to 15% more. These burdens make it more difficult for small companies to grow and become large enterprises. The European Union also shows a worrying trend of weaker transition from small to medium and large company, as well as relatively smaller companies than the US in each of the categories. A small company in Europe has, on average, less employees than one in the US. The high cost of labour, particularly social contributions, and the rigid legislation make it more difficult to make hiring decisions.

Therefore, the European Union must think local to address global challenges. Boost the positive differences of each community, reduce the tax wedge and bureaucratic requirements for small and growing businesses, improve the disposable income of the middle class by cutting taxes and supporting families to address the demographic issue by providing income tax deductions and making it easier for families to raise children.

The solution is simple but complex. Politicians in Europe like to believe that all must be organised and directed by them. But they should pay more attention to the rising radicalism. Radicalism cannot be fought by doing more of the same, but by giving those that felt left behind the tools to thrive. Not through inefficient subsidies and government spending, but through freedom.

Direct link to IM Magazine here.


For a Competitive Energy Policy

20/9/2014 El confidencial

“Industry will gradually lose its competitiveness if this course of increasing subsidies is not reversed soon”, Kurt Bock, CEO BASF

Europe needs to exit the crisis through competitiveness and security of supply.

Europe must change an energy policy that has forgotten companies and households with the objective of  being “the greenest of the class” without paying attention to costs and competitiveness.

European companies and families cannot continue to bear the costs of planning mistakes and subsidy generosity, because the situation is dramatic.

Europe’s energy policy has forgotten companies and households with the goal of being the greenest of the class.

In Europe, electricity costs are on average 50% higher than in the USA and in industrial gas, almost 75%. Between 2005 and 2012, thanks to the shale gas revolution, gas prices in the US fell by 66%, while in Europe they were up 35%. In turn, power prices in the United States fell by 4% while soaring 38% in Europe. It’s the difference between an energy policy that promotes efficiency and replacement through low costs, and Europe’s policy of promoting forced substitution through subsidies.

European companies are among the ones paying the highest prices for electricity and gas in the OECD. A German medium-sized industrial company pays twice the electricity tariff than a counterpart in Texas, according to Ecofys. The average of the Spanish industrial sector pays more than twice what the comparable US one.

The “green” policies and the development of renewables have allowed wholesale electricity prices to fall; while at the same time, adding fixed costs and subsidies, consumer prices have skyrocketed . For example, in Germany wholesale generation prices have fallen nearly 38% since 2005 and the average electric bill has gone up 60%. A mistake that destroys jobs and businesses that needs to be tackled. In countries like Spain  we must differentiate wind power, which represents 20% of the energy generated in 2013 and 19% of the cost, from solar, which represents only 5% of energy produced and 20% the total cost of generation.

Green policies and the development of renewables have allowed the price of wholesale electricity down; but adding CO2 costs, fixed costs and subsidies, consumer prices have soared

The European Union is less than 14% of CO2 emissions in the world, but 100% of the cost. Interestingly, despite the green policies of  the EU, the United States has reduced CO2 emissions since 2005 by 12% to 1994 levels, a more significant reduction than Europe’s.

All these problems result in lower industrial production, increased offshoring of companies, difficulties to compete and, of course, less employment.

For these reasons, the energy policy of the European Union must comply with the principles of safety, diversification and competitiveness.

Keep betting on renewables without passing the bill to businesses and families. Subsidies must be changed to tax incentives, as in the US. This prevents planning mistakes when estimating demand, subsidies and costs as the tax incentives are only provided when demand is real through agreements with consumers (PPAs, power purchase agreements). Every year I hear that solar will be competitive next year. And every time I hear it, the electricity bill goes up.  After nearly a decade of subsidies, solar and wind technologies promoted by many leading European companies are competitive and at grid parity in some countries, without subsidies. To continue to demand subsidies in mainland Europe is at least suspect.

Addressing the problem of overcapacity . Europe cannot be “green” yet subsidize inefficient coal technologies, pay unnecessary capacity payments, or maintain excess capacity, with reserve margins above 17%. And all paid by consumers.

Replacement, not accumulation. Europe cannot allow new generating capacity when consumers pay the accumulated excesses. The new generation capacity has to come from replacement, and the change should be done at lower costs.

Addressing the problem of overcapacity. Europe may not want to be the greenest yet subsidize inefficient coal technologies hold unnecessary capacity payments, payments for unjustified subsidies interruptibility or maintain excess capacity … And all paid by consumers

Solving the problem of security of supply,developing local energy sources  -shale gas, oil, renewables-, as well as improving interconnection between European countries to use “hubs” to reduce dependence from Russia and other countries, using the various -almost idle- storage facilities and regasification terminals.

Do not demonize technology in a regional and ideological way . Citizens should know that replacing nuclear and gas power with renewables would increase electric bills by three or four times. Remember that the average best price of renewable generation is today 68 euro/ MWh, “only” twice the wholesale price in Germany, and 30% higher than in Italy.

Electricity prices in Europe in 2003 were among the lowest in the OECD and today they are some of the highest. Why? Because the final consumer bill was loaded with all kinds of fixed concepts. In Spain more than 62% of the bill are regulated costs, taxes and subsidies. The European average is 54%.

Europe’s energy policy can not be about “not in my garden”. Pretending to eliminate nuclear power plants when most countries have a few miles, in France, dozens of nuclear reactors, is ridiculous. France has the lowest power prices in Europe and a safe, reliable and competitive nuclear fleet is one of the reasons why tariff prices have not soared. The other is that France did not jump to subsidize tens of thousands of Gigawatts of expensive renewables in early stages of technological development. As long as nuclear power is competitive, efficient and safe, Europe must continue taking advantage of it.

The challenges faced by Europe in its energy policy are enormous. But the opportunity is exciting, and the foundation to make Europe a competitive, self-sufficient world power is already in place.

Technology replacement should be achieved through lower cost,  the same way as crude oil ended with whale oil . Not because it was decided by a committee, but because the cost was lower.

The mistakes of 2007 began with optimistic estimates of demand growth, with errors of up to 35%, and so it came to be the first time in history since the industrial revolution in which governments incentivised the most expensive technologies. Europe’s decision to substitute cheap energies for expensive ones have cost many lost jobs and industries.

Security of supply must be achieved, also, from a flexible and diversified energy mix which must be cheap and efficient. Not via subsidies, but through the tax incentives that prevent “fake demand signals” and prevent overcapacity.

Energy is the cornerstone of the future of Europe. Sinking competitiveness would likely worsen the crisis. Europe has the tools, using all technologies, to ensure an abundant and cheap energy supply. Anything else would bring it to repeat the mistakes of 2007.



Important Disclaimer: All of Daniel Lacalle’s views expressed in this blog are strictly personal and should not be taken as buy or sell recommendations.

US GDP Growth Estimates Plummet

Consensus US GDP


Finally…. consensus capitulates.


From The Wall street Journal morning ledger: “2014 is likely to go down as yet another disappointing year of economic growth for the U.S, according to the latest Wall Street Journal survey of economists. The 48 surveyed economists mainly cited the absence of a big spring bounce after a sharp contraction in the winter as the cause of the predicted slump. As the Wall Street Journal’s Kathleen Madigan reports, the July consensus of GDP growth of just 1.6% this year – adjusted for inflation – is quite a plunge from the 2.2% expected just a month ago. The forecasters estimate real gross domestic product grew at an annual rate of 3.1% in the second quarter, down from the 3.5% gain projected in last month’s survey. The consensus view sees growth of about 3% in the second half. “We were flat-lining in the first half,” said Diane Swonk of Mesirow Financial. “We are in another difficult year, instead of the ‘lift-off’ year we expected.” Along with the downgraded GDP forecast, respondents were evenly split about an upside or downside risk to their forecasts – something of a sea change from the results of the six previous months. In each of those surveys, about 3 out of 4 economists thought the risk was that the economy would grow faster than their forecasts expected. One problem has been the unexpected sluggishness of consumers.


According to the Census Bureau, New Single-Family Home Sales plunged -8.1% M/M in June to a seasonally-adjusted-annualized-rate of 406k homes.  On a Y/Y basis, new home sales fell -11.5% versus +2.6% previously.  Furthermore, it is important to note that there were significant downward revisions to the prior months.  The month of May was revised lower by a record -12.3% to 442k (504k prior), April was revised lower to 408k (425k prior), and March was revised lower to 403k (410k), representing a downward revision of -86k over the past three months!  There were monthly declines across the U.S., as new home sales fell in the Northeast (-20.0% M/M and -27.3% Y/Y), the South (-9.5% M/M and -17.4% Y/Y), the Midwest (-8.2% M/M), and the West (-1.9% M/M and -9.4% Y/Y).  (acc to Boenning & Scattergood)

Additionally… The expected capex recovery is simply not happening, as Morgan Stanley points out.

dismal capex

And here’s what I said on November 23rd 2013 in “The US Growth Mirage“:


The mirage of our days may be the expectation of 2.9% growth in the United States in 2014. And it also sells a lot.The US is growing. All is well. Unemployment is low. Expansionary policy works. Does it? Not only it is not, but the most important economists of the Federal Reserve are warning about it.Look at yesterday’s GDP by categories: The “headline” +3.6% growth hides a meagre +1.9% ex-inventories. Q3 Consumer Spending +1.4%, was the weakest since December 2009. Business Inventory added 1.7% to +3.6% GDP, the most since 2011. In fact, REAL FINAL SALES (CORE GDP, EX-INVENTORIES) WAS ACTUALLY REVISED DOWN TO JUST 1.9%. 

The perverse incentive to flood markets with easy money generates a massively leveraged economy (check margin debt, at record highs), moves capital to the financial sector and sinks productive investment. Gross Domestic Product (GDP) is becoming more like a soufflé , filled with air . Not only companies spend less, but the money is used to buy back stock, pay dividends and exchange capital in mergers and acquisitions, and not for added productive investment.

Between 1996 and 2006 the largest companies in the U.S. (S & P 500) invested about one trillion dollars per year, of which 70% was devoted to capex and R&D while 30% to buyback and dividends. Since 2009 the annual number of total invested capital has soared to over $2.3 trillion, but 45% is used to buy back shares and pay dividends. In fact, neither the figure of productive investment or R&D have increased substantially, inflation-adjusted, since 1998. That is, the ‘free’ money from the expansionary policy is used  for protection, reducing the number of outstanding shares, merge and return cash to shareholders, not to expand organically  (data from Goldman Sachs, Morgan Stanley).

The U.S. has created nearly half of all the money supply of its history in the past five years, and has lived the longest period ever seen without raising interest rates, and yet the labour participation rate (percentage of civil population of the United States with over 16 years of age or more who have a job or are actively looking for one) has fallen to 1978 levels, 62.8%. Some explain this due to “the demographic effect”. However, adjusting for these demographic changes -there are fewer young workers and the older ones are living longer-, the labour force participation and employment has not improved since 2010 while the country engaged in money printing like crazy. Improving unemployment by ‘taking people off the lists’, as in Europe in the early 90s. Meanwhile, almost half of the working population in the U.S. earns less than $40,000 per annum.

Private sector payroll

From Michael Purves: “Payrolls this week report came in with an impressive 203k gain and a 7.0% unemployment print. More importantly the jobs additions drew from a wide variety of sectors, including manufacturing, and not the lower wage and more temporary job additions we have seen in earlier reports.

The underemployment rate (U-6) also fell from 13.8% to 13.2%, representing the sharpest percentage drop  since 2008.   The most significant aspect of this report is not the numbers per se, but that the numbers were achieved in the context of notably higher interest rates.  However, there are still notable signs of  weakness: the participation rate (despite an uptick this morning) is still in a down trend, and we are still not seeing a significant improvement in average hourly earnings, or average weekly hours”.

Additionally, personal income decreased 0.1% and disposable personal income (DPI) decreased 0.2% in October.

personal income decreased

Monetary policy is proving to be a key driver of massive inequality, and benefiting only those that held assets or have access to massive debt.

The greatest swindle since the miracle medicine men of the Wild West is to say that monetary policy is redistributive and social. But do not worry, they say, “next year, it will be better”, “Just wait.” Look at the Hiring Plans Index since 2011 (graphs from MS).

Hiring Plans Index since 2011The balance of the U.S. Federal Reserve is rapidly approaching a staggering $4 trillion dollars, buying about a billion a year in bonds, yet the economy is growing well below its potential … but also that potential is deteriorating .

QE does not create jobs exhibit 1:

QE does not create jobs
Exhibit 2: Federal Reserve Balance Sheet Expansion vs Job Creation
Federal Reserve Balance Sheet Expansion vs Job Creation

In the last two weeks I’ve read two excellent reports from Federal reserve economists William English and David Wilcox warning about the deterioration of the actual and potential growth of the United States. The  graph of one of these reports shows how the correlation between potential and real GDP has broken, well below the trend from 2000 to 2007.

Potential GDP

Companies do not invest in productive activities and job creation because conditions for confidence are simply not there. Artificially low rates and printing money may deceive a few analysts, but not presidents and CEOs of companies that have been able to be leaders and global competitors despite any government interference.

Tax increases and financial repression destroy consumption, money velocity and job creation in the medium term.

Goldman Sachs estimates that in 2014 capex and productive investment will grow by 9%. Analysing estimates and guidance for 2014 of most S&P 500 companies, I doubt it. At best, it will be flat year-on-year.

Government cannot replace private sector capex. Despite the low government bond yields and eternal lift of the debt ceiling, the U.S. continues to generate a massive deficit, projected at around $744 billion for Fiscal Year 2014. To ‘fill’ the loss of productive investment, assuming -which is a lot- that governments would spend wisely- the deficit would have to shoot another half a trillion dollars, and with it comes higher tax increases, more financial repression and… less productive investment.

True, banks are stronger and have less risk and government is borrowing at low rates. Of course they are, with a QE that is an equivalent of 6.7% of US GDP as an annual gift.

Increasing money supply by 6-7% to grow GDP by 2% is not growth, it’s stretching the pizza dough. However, a problem of wrong incentives, creating fake money and artificially low rates not only dilutes the real growth but impairs its potential one. The solution that Keynesian economists offer? … Repeat. “Until investors give in” as Paul Krugman says. More fuel to the fire.

As growth is poor, what they propose is more booze to the alcoholic. Low rates forever. Yes, many members of the U.S. central bank, like Charles Plosser,  expressed doubts about the effectiveness of monetary policy, and begin to propose measures to control the madness limiting the ability of the Fed to buy assets and expand its balance sheet, but these are still voices in the desert. If you really think that forcing the machine will revive investment and job creation because it is decided by a committee, it will not happen. Until the job creators clearly see the opportunities, investment will remain low.

 investment will remain low

Reasons for concern:

  • Credit conditions are deteriorating alarmingly, which leads me to believe that productive investment will stagnate in 2014 . Estimates of increase of 9% do not agree with any of the messages thrown by the companies that published results and guidance.
Credit conditions
  • Deterioration of the leading indicators of job creation, new businesses, corporate margins and capex have accelerated since September and came into contraction long before the government shutdown.
  • Estimates of profits in the industrial and consumer sector have fallen between 8% and 10% for 2014.
  • In March, another drama on account of the debt ceiling and overspending  and no small risk of tax hikes. With the popularity of President Obama at a minimum-37% -, the likelihood of tax increases to ‘the rich’, which is always translated into ‘tax hikes for all’, is high.
  • The so-called Obamacare -mistakenly sold as the panacea of universal public health-, means about 52 billion dollars in new taxes to small businesses in particular, and the lowest estimate of the negative impact on employment that I have read is 800,000 people .

Yes, I know. For the stock market investor most of this is irrelevant. The worse, the better, and $85 billion of monthly asset purchases by the Federal Reserve, even if it is trimmed, makes everyone happy because the ‘helicopter money’ only helps the financial sector and the state, so we will ‘party like it’s 1999′ for a while. Furthermore, investors are protected by many companies who do not fall into the trap of easy money, because they are the first to suffer when the music stops.

I am sure that the innovative spirit of the country will prevail, but to estimate its economic development through the moves of a stock market impacted by share repurchases and ‘laughing gas money’ may be an illusion. Richard Koo warned that the U.S. is engaged in “the QE trap” from which you can not get out easily or comfortably. As Fleetwood Mac … Can’t Go Back.



Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations.

Russia may remain cheap for a while

The geopolitical landscape created by the Ukraine crisis and the ongoing sanctions against Russian interests from both the EU and US have made the MICEX Index fall 4% YTD.

For investors, the main things to consider:

– Russian stocks are cheap and they have always been. Headline multiples disguise a market where the semi-state owned companies tend to pursue a strategy that is less focused on total-shareholder-return than on maximizing capex. State intervention and value destructing investments have been some of the factors behind the de-rating of Russian stocks.

On the flipside, Russian independent companies have been following a very shareholder oriented policy (think Novatek, for example), reacting inmediately to rumours and creating value by being focused. So the index large weights cloud a market where some companies do shine and develop solid strategies.

Therefore, for investors, the key is stock picking, not index buying… and focusing on clear strategy independent companies, not necessarily on the “headline cheap” multi-megacap conglomerates. These are OK for a short term technical trade driven more by oil price momentum and geopolitical risks easing.

– Ruble strength is likely as oil prices remain high, and with low debt and little financial dependence on foreign entities, Russia can sustain the economic slowdown created by sanctions better than the EU debt-ridden countries with strong commercial ties with Russia. The current oil price-ruble combination prevents any risk of economic collapse in Russia and, to a limited extent, the state can substitute for foreign lenders in strategic sectors. However, without a big pick-up in inward investment and domestic confidence, the economy will not be able to move from near stagnation to the sustainable 3-4% annualized growth it needs, according to Chris Weafer. Russia’s balance sheet and budget are solid and the government can afford to provide domestic funding to banks or to raise public investments.

– Besides the human tragedy, the consequences of the MH17 crash may also be less lending from European banks to Russian companies, which could make the Russian economy even more isolated on markets. The direct impact on European credit is likely to be contained however, as exposure to Russia is already limited (with the exception of Austrian banks), according to RBS. But in a worst-case scenario, Europe remains dependent on Russian gas. Today there is no risk as gas inventories are at five year highs (83%) but any cuts to supply could make several countries vulnerable during the winter.

– The US is imposing sanctions with the EU’s pocket. The US has very limited exposure to Russia, while the EU -and countries such as Italy or France in particular- are heavily exposed.


Additional read: Check Chris Weafer, one of the top experts on Russia, from Macro Advisory.


Important Disclaimer: All of Daniel Lacalle’s views expressed in this blog are strictly personal and should not be taken as buy or sell recommendations.