The long-standing attitude toward Europe is that it is an anti-free-market continent that should be of little interest to investors. That was the right view, but the recent European election results may suggest otherwise – which should be hugely interesting to international investors.
It has been becoming more free-market oriented, coming closer to the US economic system as evidently in the last four European elections – 1994, 1999, 2004 and 2009 over a period of rapid EU expansion with membership from 12 countries in 1994 to 27 now.
Couple of weeks back, someone sent me an interesting article that classify the various EU parties and their alliances and that will be a platform for formation of my point of view.
Broadly, we can classify Europe into three broad groupings – (i) Socialist/Green – believing in strong state control over the economy, (ii) Centre-right, which often nationalist but believing in a free-market economy but more welfare payment than in the United States and finally (iii) Centrist/Other, either small centre parties holding the balance of power in domestic parliaments or the inevitable residue of the unclassified.
Since 1994, EU elections have shown the following trend:
• 1994 – 12 countries with Socialist Group 1 parties 249 seats of 567 (44%), Group II of 40% and Group III of 16%
• 1999 – 15 countries with Socialist Group 1 parties 270 of 626 (43%), Group II of 45% and Group III of 12%
• 2004 – 25 countries with Socialist Group 1 parties 283 of 732 (39%), Group II of 45% and Group III of 16%
• 2009 – 27 countries with Socialist Group 1 parties 243 of 736 (33%), Group Ii of 45% and Group III of 22%.
Can you see the trend now? This is because with more new countries of former members of the communist bloc with an aversion to many aspects of government control. Productivity growth has been generally slower in Eastern Europe than in the United States – but not much slower with good education systems and heavy foreign direct investment of those countries that allowed them to catch up with the rich West.
Look for my next point of view on the US economy under Obama.
Tuesday, June 30, 2009
Monday, June 29, 2009
End of Recession
I have been hearing a lot of ‘green shoots’ lately, but am also filtering tons of misleading data with my 2 computer screens and 16 windows opened almost every-night. Friends, fund managers and commentators alike are singing praises of recovery and markets are ready to rise. To that, I politely say – RUBBISH!
There will be a recovery but not right now. St Graham said, in the short run, the market is a voting machine, and in the long run, it is a weighing machine. It means that the voting is based on current sentiment, but what the market weighs in the long run is earnings. The market tries to forecast future income streams and it gets it wrong as often as it gets it right!
We have the first balance sheet recession in 70 years, yet they want to compared garden-variety recessions to what we have now. Air, trucking and rail shipping is down 20% year-on-year and global trade is down about 30% in the major exporting countries.
The hidden problem is going to be most evident and painful in the unemployment numbers. The research paper by the San Francisco Federal Reserve generally supports projections that labour market weakness will persist and I believe the relatively low level of temporary layoffs and high level of involuntary part-time workers make a jobless recovery similar to the one experienced in 1992 a plausible scenario.
In the 1970’s and 80s, job losses were quick and deep, but the recovery was also quick. In the last two recessions, job recovery was noticeably slower, giving rise to the term ‘jobless’ recovery. It was the lacking of hiring, not firing, that was responsible for the slow employment recovery. The US now has less manufacturing jobs, so the rehiring process has been much slower in recent recessions.
Personal income from wages and salaries was down US$12bn in May, so how did income go up? A large increase in ‘government social benefits’ and a decline in personal taxes accounted for all the gain and then some. The increase was the effect from the recent stimulus package, which in my view, is transitory. The only different of this method from home equity withdrawal is that taxpayers are on the hook this time.
Final thought for today – The Congressional Budget Office released another report saying that the current deficit levels are unsustainable, either taxes must increase by $440 billion or spending must be cut by a like amount, or some combination. If the new health-care and other program are enacted, the number comes closer to $700 billion! Raising taxes by that amount will dip us back into recession.
There will be a recovery but not right now. St Graham said, in the short run, the market is a voting machine, and in the long run, it is a weighing machine. It means that the voting is based on current sentiment, but what the market weighs in the long run is earnings. The market tries to forecast future income streams and it gets it wrong as often as it gets it right!
We have the first balance sheet recession in 70 years, yet they want to compared garden-variety recessions to what we have now. Air, trucking and rail shipping is down 20% year-on-year and global trade is down about 30% in the major exporting countries.
The hidden problem is going to be most evident and painful in the unemployment numbers. The research paper by the San Francisco Federal Reserve generally supports projections that labour market weakness will persist and I believe the relatively low level of temporary layoffs and high level of involuntary part-time workers make a jobless recovery similar to the one experienced in 1992 a plausible scenario.
In the 1970’s and 80s, job losses were quick and deep, but the recovery was also quick. In the last two recessions, job recovery was noticeably slower, giving rise to the term ‘jobless’ recovery. It was the lacking of hiring, not firing, that was responsible for the slow employment recovery. The US now has less manufacturing jobs, so the rehiring process has been much slower in recent recessions.
Personal income from wages and salaries was down US$12bn in May, so how did income go up? A large increase in ‘government social benefits’ and a decline in personal taxes accounted for all the gain and then some. The increase was the effect from the recent stimulus package, which in my view, is transitory. The only different of this method from home equity withdrawal is that taxpayers are on the hook this time.
Final thought for today – The Congressional Budget Office released another report saying that the current deficit levels are unsustainable, either taxes must increase by $440 billion or spending must be cut by a like amount, or some combination. If the new health-care and other program are enacted, the number comes closer to $700 billion! Raising taxes by that amount will dip us back into recession.
Sunday, June 28, 2009
Warning from China
China launched another attack on US and clearly showing its unhappiness on how spendthrift Uncle Sam is running up its huge debts and debasing the US dollar.
Prime beneficiary – gold. In April, China disclosed that it had stealthily increased its holding of gold to 1,054 metric tones from just 600 tonnes in 2003 and now Mr Li Lianzhong, who heads the economic department of the Party’s policy research office, argues that China’s gold holdings as a share to total foreign exchange reserves should be much higher, in view of higher percentage of share of gold in the foreign exchange reserves of the United States, Italy, Germany and France. Based on numbers from World Gold Council, China’s gold as a percentage of foreign exchange reserves is estimated at 1.8% versus US of 78.3%, Italy of 66.1%, Germany of 69.5% and France of 73% respectively.
If China sells Treasuries, that would weaken the already troubled US dollar, and effectively a double barrel effect on the price of gold – pushing gold prices up as China buys gold and pushing the value of the dollar lower, which in turn will push gold even higher because gold is priced in dollars!
China would need to acquire seven times as much gold as it has now to match the world average of gold as a percentage of foreign reserves.
Prime beneficiary – gold. In April, China disclosed that it had stealthily increased its holding of gold to 1,054 metric tones from just 600 tonnes in 2003 and now Mr Li Lianzhong, who heads the economic department of the Party’s policy research office, argues that China’s gold holdings as a share to total foreign exchange reserves should be much higher, in view of higher percentage of share of gold in the foreign exchange reserves of the United States, Italy, Germany and France. Based on numbers from World Gold Council, China’s gold as a percentage of foreign exchange reserves is estimated at 1.8% versus US of 78.3%, Italy of 66.1%, Germany of 69.5% and France of 73% respectively.
If China sells Treasuries, that would weaken the already troubled US dollar, and effectively a double barrel effect on the price of gold – pushing gold prices up as China buys gold and pushing the value of the dollar lower, which in turn will push gold even higher because gold is priced in dollars!
China would need to acquire seven times as much gold as it has now to match the world average of gold as a percentage of foreign reserves.
Thursday, June 11, 2009
The Tale of Two Investors
What kind of investor are you? I was particularly struck by this tug-of-war between two distinctly different types of investment mindsets among my friends that I met last week. On one hand, scores of my buddies are keeping their eye on the ball – the massively bearish fundamentals on the economy and on the other hand, many of my friends seem eager to make money right now. Standing on the sidelines and watching other profits in these bear market bounces is driving them crazy.
In case you hadn't noticed: Over the past year of financial turmoil, the "safe haven" premium of precious metals has offered about as much support as a rubber ducky in a tsunami. Despite a string of powerful rallies, silver and gold remain well below their March 2008 peaks. It goes without saying that the greatest opportunities in precious metals were not had by those who played the "disaster hedge" card; but rather by those who timed the trends as they developed, regardless of the fundamental backdrop.
Bob Prechter is in the latter group. Amidst the buzz and whirl of the most bullish backdrop in precious metals' recent history, gold and silver prices soared to new, all-time highs and calls for a "New Gold Rush" and "$30 Silver" flooded the mainstream airwaves. Yet Bob alerted subscribers to an approaching top in the March 14, 2008 Elliott Wave Theorist.
On the other hand, the Federal Reserve’s balance sheet has exploded, with total reserve bank assets now standing at $2.079 trillion. This same time last year, total assets stood at $1.181 trillion. Such a huge reserve certainly has the potential to catalyze inflation (indeed a hyperinflation), but only if the Fed Chairman Bernanke liquidates the assets that make up the reserve accounts. Simply put, there is no inflation if the Federal Reserve refuses to turn those assets into cash and dump that cash into the economy.
In deflation, you would expect a relatively flat curve, but it's been steepening not because of inflationary pressures. Those who view it as a green shoot for recovery and future inflation do not understand why the curve has steepened so much and so fast. This country's recent fiscal policies have necessitated a massive debt, and the resulting Treasury sales are simply overwhelming the bond market. What should be a flat curve -- fitting the deflationary cycle we are in -- is artificially steep due to the lack of demand for long-dated Treasuries at auction. There has been no demand from foreigners for the long bond at 4% or 4.5%.
In short, I believe the easy gains have already been made, and the losses on any downside move could be very sharp and swift, erasing any profits that have piled up, especially those who have been loading up with high beta stocks. I think there are serious asset classes de-leveraging, hence you could ended with higher vulnerability if the market makes a move back toward lower levels (a high possibility, in my opinion) or once investors come back to the grim reality that economic conditions have not yet improved much at all.
In case you hadn't noticed: Over the past year of financial turmoil, the "safe haven" premium of precious metals has offered about as much support as a rubber ducky in a tsunami. Despite a string of powerful rallies, silver and gold remain well below their March 2008 peaks. It goes without saying that the greatest opportunities in precious metals were not had by those who played the "disaster hedge" card; but rather by those who timed the trends as they developed, regardless of the fundamental backdrop.
Bob Prechter is in the latter group. Amidst the buzz and whirl of the most bullish backdrop in precious metals' recent history, gold and silver prices soared to new, all-time highs and calls for a "New Gold Rush" and "$30 Silver" flooded the mainstream airwaves. Yet Bob alerted subscribers to an approaching top in the March 14, 2008 Elliott Wave Theorist.
On the other hand, the Federal Reserve’s balance sheet has exploded, with total reserve bank assets now standing at $2.079 trillion. This same time last year, total assets stood at $1.181 trillion. Such a huge reserve certainly has the potential to catalyze inflation (indeed a hyperinflation), but only if the Fed Chairman Bernanke liquidates the assets that make up the reserve accounts. Simply put, there is no inflation if the Federal Reserve refuses to turn those assets into cash and dump that cash into the economy.
In deflation, you would expect a relatively flat curve, but it's been steepening not because of inflationary pressures. Those who view it as a green shoot for recovery and future inflation do not understand why the curve has steepened so much and so fast. This country's recent fiscal policies have necessitated a massive debt, and the resulting Treasury sales are simply overwhelming the bond market. What should be a flat curve -- fitting the deflationary cycle we are in -- is artificially steep due to the lack of demand for long-dated Treasuries at auction. There has been no demand from foreigners for the long bond at 4% or 4.5%.
In short, I believe the easy gains have already been made, and the losses on any downside move could be very sharp and swift, erasing any profits that have piled up, especially those who have been loading up with high beta stocks. I think there are serious asset classes de-leveraging, hence you could ended with higher vulnerability if the market makes a move back toward lower levels (a high possibility, in my opinion) or once investors come back to the grim reality that economic conditions have not yet improved much at all.
Tuesday, June 9, 2009
Will Cable Get Pounded?
Last year, the pound was soaring to all time highs against the dollar. However, when the financial crisis hit the US, it was as quickly that the UK was just as exposed, if not more so. Risk aversion reigned and every investment that was deemed risky crashed as global investors fled to safety.
For the last three months, this trade has been in retracement mode. And the further it retraced, the more it has fueled optimism in the outlook for a recovery. Even commodities finally showed some life, which as a result, the US dollar and 10-year Treasuries have been sold. Also, noting Washington’s mushrooming deficit, generated by massive government borrowing to fuel its economic recovery plan.
Nevertheless, in the face of this strength, the cable has to deal with two harsh blows.
Firstly, two weeks ago, Standard and Poor’s downgraded the outlook of UK’s AAA credit rating, yet the pound proceeded to rally over 7% in the following weeks.
Secondly, the political scandal struck when members of Prime Minister Gordon Brown’s cabinet were exposed for personal spending jaunts with taxpayer money and the subsequent series of resignation of senior members of ruling Labour party from cabinet following a call for Brown to resign.
Well, at one hand, the strength of pound to a great extent had everything to do with the across-the-board retracement of the collapse of the US dollar, but I sense the wholesome retracement in financial market has reached some very significant inflection points and this feed-good rally may have run its course, if we see further signs of green shoots.
My concern is that when confidence is being manufactured by a rising stock market in simple retracement mode during the worst economic period since the Great Depression… look out for sharp sell-offs in currencies, commodities at the same time. For currencies, when this rally subsides, the biggest gainers are likely to experience the sharpest declines. As for the pound, it is already feeling the heat.
Bottom line – we could already entering Round 2 of the risk aversion trade and that could mean major downside for pound and possibly the AUD as it has climbed 31% in three months, tracking the US stock market closely all along the way.
For the last three months, this trade has been in retracement mode. And the further it retraced, the more it has fueled optimism in the outlook for a recovery. Even commodities finally showed some life, which as a result, the US dollar and 10-year Treasuries have been sold. Also, noting Washington’s mushrooming deficit, generated by massive government borrowing to fuel its economic recovery plan.
Nevertheless, in the face of this strength, the cable has to deal with two harsh blows.
Firstly, two weeks ago, Standard and Poor’s downgraded the outlook of UK’s AAA credit rating, yet the pound proceeded to rally over 7% in the following weeks.
Secondly, the political scandal struck when members of Prime Minister Gordon Brown’s cabinet were exposed for personal spending jaunts with taxpayer money and the subsequent series of resignation of senior members of ruling Labour party from cabinet following a call for Brown to resign.
Well, at one hand, the strength of pound to a great extent had everything to do with the across-the-board retracement of the collapse of the US dollar, but I sense the wholesome retracement in financial market has reached some very significant inflection points and this feed-good rally may have run its course, if we see further signs of green shoots.
My concern is that when confidence is being manufactured by a rising stock market in simple retracement mode during the worst economic period since the Great Depression… look out for sharp sell-offs in currencies, commodities at the same time. For currencies, when this rally subsides, the biggest gainers are likely to experience the sharpest declines. As for the pound, it is already feeling the heat.
Bottom line – we could already entering Round 2 of the risk aversion trade and that could mean major downside for pound and possibly the AUD as it has climbed 31% in three months, tracking the US stock market closely all along the way.
Monday, June 8, 2009
What You Have Not Been Told?
Even knowing that the 9.4% US employment rate – the worst in a quarter century is scaring enough!
What the government has not told us is that this official number is grossly understated. It doesn’t even begin to count the millions who suddenly find themselves trying to live on a part-time income or the millions more who have given up looking for a job altogether.
In essence, I believe the worst layoffs are yet to come, not only from giants like Chrysler and General Motors but also from millions of small businesses across America. That will put a big stress to recent bank ‘stress’ tests, which assumed an average unemployment rate of 8.9% this year.
One thing I note is that the unemployment rate is highly correlated with the delinquency rate on mortgages - means that it is now virtually inevitable that mortgages defaults and foreclosures will surge far more.
History teaches us that despite the hype and happy talk coming from Washington and Wall Street, the fundamental trend will always prevail. Please avoid a whole new round of stinging losses! It doesn’t take a rocket scientist to figure out what is coming next. Just connect the dots – consumer spending is 70% of the US economy and those consumers are now either out of work or are terrified that they could be the next to lose their jobs. The message couldn’t be clearer.
Treasury Secretary Tim Geithner traveled to China last week to reassure Chinese officials that they would get the budget in control and that the investment in US bonds is safe. I doubt that Chinese would believe a word of it.
False recoveries are nothing new. This is because major recessions in the past have been interrupted by small upticks in growth. Even if the leading economic indicator (LEI) has hit a cyclical low that doesn’t means the recession is over! History shows that the time between the LEI’s low and the beginning of the economic recovery can be as much as four quarters apart.
What the government has not told us is that this official number is grossly understated. It doesn’t even begin to count the millions who suddenly find themselves trying to live on a part-time income or the millions more who have given up looking for a job altogether.
In essence, I believe the worst layoffs are yet to come, not only from giants like Chrysler and General Motors but also from millions of small businesses across America. That will put a big stress to recent bank ‘stress’ tests, which assumed an average unemployment rate of 8.9% this year.
One thing I note is that the unemployment rate is highly correlated with the delinquency rate on mortgages - means that it is now virtually inevitable that mortgages defaults and foreclosures will surge far more.
History teaches us that despite the hype and happy talk coming from Washington and Wall Street, the fundamental trend will always prevail. Please avoid a whole new round of stinging losses! It doesn’t take a rocket scientist to figure out what is coming next. Just connect the dots – consumer spending is 70% of the US economy and those consumers are now either out of work or are terrified that they could be the next to lose their jobs. The message couldn’t be clearer.
Treasury Secretary Tim Geithner traveled to China last week to reassure Chinese officials that they would get the budget in control and that the investment in US bonds is safe. I doubt that Chinese would believe a word of it.
False recoveries are nothing new. This is because major recessions in the past have been interrupted by small upticks in growth. Even if the leading economic indicator (LEI) has hit a cyclical low that doesn’t means the recession is over! History shows that the time between the LEI’s low and the beginning of the economic recovery can be as much as four quarters apart.
Sunday, June 7, 2009
Rare Case of schizophrenia!
Stocks are rising, bonds are plunging! Rarely in my lifetime have I seen these suffer from a more extreme case of schizophrenia!
Almost never I seen bonds follow stocks at this close intimacy, but it makes sense as plunging bonds represent surging interest rates and that potentially could turn out to be pure poison for corporate profits, in turn, will be reflected in plunging stocks.
While this chain reaction sounds logical, but it doesn’t always unfold immediately.
And right now, the schizophrenic gap between bonds and stocks could not be more obvious or extreme - Just since early April, while the Dow has risen by more than 12%, the price of 30-year Treasury bonds has fallen by nearly 12%. My view is that no stock rally can withstand this pressure for long. Yet, strangely that's precisely what hordes of "professional" portfolio managers are recommending: a full house of stocks in your investment portfolio.
Investors that I talked to over the last three weeks seemed to agree with me. It is the madness of crowd – vaguely cognizant of the budget deficit crisis that driving bond markets into a collapse and on other hand still buying stocks in a knee jerk reaction to Wall Street hype.
Rallies in bear markets have an annoying habit of running up significantly following periods of dismal performance. Right now I'm looking to key indicators in sentiment, value and interest rates that suggest we are probably at or near the buying opportunity of a lifetime...something I've noted repeatedly since last March when sentiment reached the lowest levels in recorded history.
Almost never I seen bonds follow stocks at this close intimacy, but it makes sense as plunging bonds represent surging interest rates and that potentially could turn out to be pure poison for corporate profits, in turn, will be reflected in plunging stocks.
While this chain reaction sounds logical, but it doesn’t always unfold immediately.
And right now, the schizophrenic gap between bonds and stocks could not be more obvious or extreme - Just since early April, while the Dow has risen by more than 12%, the price of 30-year Treasury bonds has fallen by nearly 12%. My view is that no stock rally can withstand this pressure for long. Yet, strangely that's precisely what hordes of "professional" portfolio managers are recommending: a full house of stocks in your investment portfolio.
Investors that I talked to over the last three weeks seemed to agree with me. It is the madness of crowd – vaguely cognizant of the budget deficit crisis that driving bond markets into a collapse and on other hand still buying stocks in a knee jerk reaction to Wall Street hype.
Rallies in bear markets have an annoying habit of running up significantly following periods of dismal performance. Right now I'm looking to key indicators in sentiment, value and interest rates that suggest we are probably at or near the buying opportunity of a lifetime...something I've noted repeatedly since last March when sentiment reached the lowest levels in recorded history.
Thursday, June 4, 2009
Short Term Pleasure
Stocks could touch crazy levels. Commodity prices are rebounding, but sovereign default is showing sign of stress with widening fiscal deficit.
Something has to give way and it has to snap with possibility of a currency crisis. Think about this – central banks around the world are pressing on with huge amounts of money, but the real economy is not strong enough for all this money to be absorbed. U.S. businesses filed 40% more bankruptcies in May than a year ago as companies including RH Donnelley Corp, auto parts maker Visteon Corp and apparel retailer Anchor Blue Retail Group Inc. were pushed into the red by a struggling U.S. economy. According to Automated Access to Court Electronic Records (AACER), a database of U.S. bankruptcy statistics used by attorneys and lenders, 7,514 commercial entities filed for bankruptcy last month, compared to just 5,354 a year ago. The May figure was twice as high as the number of filings two years ago
Naturally, it is going to stocks, real estate, commodities and it is again a mistake what they are doing by sharing short-term pleasure, but long term pains. This will result in a much higher and serious inflationary pressure, much higher interest rates in response in later part of our lifetime, hence the associated impact of on higher unemployment and possibly a worse-off growth prospects down the road have yet to fully feed through.
Credibility of US dollar and couple of major currencies is already in doubt. It may be something that none of us have at the moment, but the truth is not too far and possibly could be too spicy to handle, if not without a good care.
World is becoming more protectionist and leaders made solvent banks to take over insolvent banks with support of huge print machine and then both banks failed in the end. This is pretty similar to experience of the 1930s but the key difference is that we do not actively engage the printing machine then, now we will have to face the serious consequence of recalcitrant inflation.
I doubt anyone, especially the politically elected government, to see and afford pains of unemployment and greater amount of hardships. Bernanke said the threat of deflation has eased, but surging debt is causing interest rates to rise, "Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance," he said, according to Reuters.
Thanks to the U.S. Treasury, investors can now switch some of their savings over to what could be a superior "legal tender." Called "Gold Dollars," this govt.-approved money spends like regular dollars - but it's backed by physical bars of 24-karat gold.
Something has to give way and it has to snap with possibility of a currency crisis. Think about this – central banks around the world are pressing on with huge amounts of money, but the real economy is not strong enough for all this money to be absorbed. U.S. businesses filed 40% more bankruptcies in May than a year ago as companies including RH Donnelley Corp, auto parts maker Visteon Corp and apparel retailer Anchor Blue Retail Group Inc. were pushed into the red by a struggling U.S. economy. According to Automated Access to Court Electronic Records (AACER), a database of U.S. bankruptcy statistics used by attorneys and lenders, 7,514 commercial entities filed for bankruptcy last month, compared to just 5,354 a year ago. The May figure was twice as high as the number of filings two years ago
Naturally, it is going to stocks, real estate, commodities and it is again a mistake what they are doing by sharing short-term pleasure, but long term pains. This will result in a much higher and serious inflationary pressure, much higher interest rates in response in later part of our lifetime, hence the associated impact of on higher unemployment and possibly a worse-off growth prospects down the road have yet to fully feed through.
Credibility of US dollar and couple of major currencies is already in doubt. It may be something that none of us have at the moment, but the truth is not too far and possibly could be too spicy to handle, if not without a good care.
World is becoming more protectionist and leaders made solvent banks to take over insolvent banks with support of huge print machine and then both banks failed in the end. This is pretty similar to experience of the 1930s but the key difference is that we do not actively engage the printing machine then, now we will have to face the serious consequence of recalcitrant inflation.
I doubt anyone, especially the politically elected government, to see and afford pains of unemployment and greater amount of hardships. Bernanke said the threat of deflation has eased, but surging debt is causing interest rates to rise, "Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance," he said, according to Reuters.
Thanks to the U.S. Treasury, investors can now switch some of their savings over to what could be a superior "legal tender." Called "Gold Dollars," this govt.-approved money spends like regular dollars - but it's backed by physical bars of 24-karat gold.
Monday, June 1, 2009
GM fact sheet
After weeks of negotiations between the US administration, bond-holders and the United Auto Workers (UAW), General Motors, the largest automaker in the US, filed for Chapter 11 bankruptcy.
The administration’s plans are for a quick sale process that would see the company split in two. A leaner ‘new GM’ is expected to emerge from bankruptcy in 60–90 days, while ‘old GM’ will remain under court protection with a set of assets that will eventually be liquidated.
The current plan for the restructuring of a ‘new GM’ includes: US$30bn from the US administration, in return for a 60% equity stake in ‘new GM’, as well as roughly US$8.8bn in debt and preferred stock; US$9.5bn from the governments of Canada and Ontario, in return for a 12% equity stake in ‘new GM’, and US$1.7bn in debt and preferred stock; a 17.5% stake in ‘new GM’ provided to a Voluntary Employee Beneficiary Association trust (VEBA) that provides healthcare benefits for UAW retirees; and a debt-for-equity swap for existing GM bondholders, providing 10% of equity in ‘new GM’.
While this plan could be rejected in the bankruptcy courts, this is highly unlikely. Especially given that the administration has stated that its US$30bn in financing is conditional on the transaction being approved by 10 July.
As part of its restructuring plans GM intends to close 11 US facilities and idle another 3 plants. This is expected to impact between 18,000 and 20,000 UAW workers and should delay the pace of recovery in the US economy.
The collapse in auto sales during 2008 wiped almost 5% off retail sales for the year. And while such a severe decline in demand is unlikely to be repeated, the closure or GM plants, coupled with the existing temporary closure of Chrysler plants, could wipe a further 0.5% from industrial production.
But the impact could have been much worse. A proportion of the government’s contribution will be used to ensure that the company can still pay employee wages during the bankruptcy process. GM is also likely to seek authority to continue to pay suppliers, as well as honour existing warranties and dealer incentives.
Indeed, with domestic auto production running at nearly 5 million units annually, and sales at over 9 million units, a sharp rebound in auto production is expected, even if it is delayed.
And the GM that emerges from bankruptcy will likely be considerably more competitive, with profitability able to be sustained with US auto sales running at 10 million units. This is only slightly above current demand, and compares to a minimum profitability level of 16 million units prior to restructuring.
Yet the key is that while GM’s bankruptcy may delay recovery, the orderly manner in which it will occur will ensure that the recovery is not derailed. With new manufacturing orders now running considerably above output levels, a sharp bounce in production is expected in the next few quarters as the inventory cycle turns.
The administration’s plans are for a quick sale process that would see the company split in two. A leaner ‘new GM’ is expected to emerge from bankruptcy in 60–90 days, while ‘old GM’ will remain under court protection with a set of assets that will eventually be liquidated.
The current plan for the restructuring of a ‘new GM’ includes: US$30bn from the US administration, in return for a 60% equity stake in ‘new GM’, as well as roughly US$8.8bn in debt and preferred stock; US$9.5bn from the governments of Canada and Ontario, in return for a 12% equity stake in ‘new GM’, and US$1.7bn in debt and preferred stock; a 17.5% stake in ‘new GM’ provided to a Voluntary Employee Beneficiary Association trust (VEBA) that provides healthcare benefits for UAW retirees; and a debt-for-equity swap for existing GM bondholders, providing 10% of equity in ‘new GM’.
While this plan could be rejected in the bankruptcy courts, this is highly unlikely. Especially given that the administration has stated that its US$30bn in financing is conditional on the transaction being approved by 10 July.
As part of its restructuring plans GM intends to close 11 US facilities and idle another 3 plants. This is expected to impact between 18,000 and 20,000 UAW workers and should delay the pace of recovery in the US economy.
The collapse in auto sales during 2008 wiped almost 5% off retail sales for the year. And while such a severe decline in demand is unlikely to be repeated, the closure or GM plants, coupled with the existing temporary closure of Chrysler plants, could wipe a further 0.5% from industrial production.
But the impact could have been much worse. A proportion of the government’s contribution will be used to ensure that the company can still pay employee wages during the bankruptcy process. GM is also likely to seek authority to continue to pay suppliers, as well as honour existing warranties and dealer incentives.
Indeed, with domestic auto production running at nearly 5 million units annually, and sales at over 9 million units, a sharp rebound in auto production is expected, even if it is delayed.
And the GM that emerges from bankruptcy will likely be considerably more competitive, with profitability able to be sustained with US auto sales running at 10 million units. This is only slightly above current demand, and compares to a minimum profitability level of 16 million units prior to restructuring.
Yet the key is that while GM’s bankruptcy may delay recovery, the orderly manner in which it will occur will ensure that the recovery is not derailed. With new manufacturing orders now running considerably above output levels, a sharp bounce in production is expected in the next few quarters as the inventory cycle turns.
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