Noting that “investor enthusiasm for government debt from the eurozone’s (risky) southern periphery persists unabated,” Evergreen Gavekal’s Charles Gave believes investors will find themselves bumping up against some hard truths imposed by simple accounting (truths).”
Eurozone: Why does consumption receive the same weight as investment in economic modeling?
Hedge fund manager Gave then dives into a simple economic formula that has become perverted, like much of economic thought over the past decade or so. Measuring economic growth based on consumption is like measuring happiness based on one’s waistline. “To my simple mind,” Gave writes in his investment letter, “the only thing that matters is the consumption plus investment element of the equation. That’s because consuming today makes me feel good today, while investing facilitates more consumption for my nine grand children.”
This hits at a core problem with GDP calculations, Gave says. “The only people who believe that a current account surplus is the sign of a well managed economy are called ‘mercantilists,’” he writes. “They confuse the current account with a profit and loss statement and always end up broke.”
Providing consumption the same weight with investment in an economic formula is rather like the Sharpe ratio that provides the same risk weight to upside deviation as it does to downside deviation: it just doesn’t make sense.
But that’s not all.
Eurozone: Why do foreigners trade for a promise of debt?
Gave takes a step back to consider how foreigners are so willing to trade hard goods for debt in a currency. “Nor could I ever figure out why taking the goods and services I labor to produce and exchanging them with a bunch of foreigners in return for their promise to pay me at some point in the future should contribute to my well-being,” he writes, appearing to take a subtle swipe at countries who accept and store the Greenback in exchange for hard assets.
Eurozone: Spain in focus
Gave takes on Spain as an example of a southern European nation in trouble. Ironically pointing out that the Spanish ten year notes dropped to their lowest level since 2005 – investor demand for and belief in Spanish debt is back to pre-2008 levels – he notes what he considers unwarranted optimism. “Now everybody tells me that Spain has ‘turned the corner’ and that there is ‘light at the end of the tunnel’ (as US general William Westmoreland said about the Vietnam war, just weeks before the Viet Cong’s surprise Tet Offensive),” Gave writes. “I hope there really is some light, given the beating Spain’s poor citizenry has taken, but I am not confident.”
The Gave makes a comparison between depression era economics and the current Spanish situation. “In a depression, the current account always improves since returns on invested capital collapse,” he writes. “Capital flees,” he notes. As a result, “unemployment going through the roof” as government debt to GDP ratios (a measure of leverage and margin) soar from 30% of GDP in 2007 to close to 100% today.”
How will it end? Who will bear the cost? “Someone has to pay,” Gave notes. “Ultimately it will be children who are not yet born.” Meanwhile, he notes, today the average Spaniard has a standard of living roughly -20% below the level ten years ago. “Bravo for the euro!”