Government Subsidies

 

A Step Back for the Free Market or Necessary Tool?

Government subsidies - widely discussed and controversial - something you can often hear about in the news, accompanied by pictures of protesting Greek farmers, who are blocking the Bulgarian border using brand-new new agricultural machinery. Sometimes it might be French or Spanish farmers, also blocking something, no matter what, causing millions of losses.

But let us start with the definition of "Government subsidy": A benefit given by the government to groups or individuals usually in the form of a cash payment or tax reduction. The subsidy is usually given to remove some type of burden and is often considered to be in the interest of the public.

Now that we know what subsidies are, lets check on some numbers. The European Union spends around €59 billion a year on farm subsidies. The Common Agricultural Policy (CAP) is the most expensive scheme in the EU - accounting for more than 40% of its annual budget.

According to the new EU budget, farm subsidies will consume some 38 percent of it for 2014-2020, equivalent to 363 billion euros ($485.7 billion) of the 960 billion total. In the last program period (2006-2014) it was 417 billion euros. The general conclusion is that we spend billions and billions of euros on this - but is it effective? We'll get back on this later.

Just after the budget negotiations, French President Francois Hollande quickly claimed victory, saying that France had managed to maintain its farm subsidies while other nations saw theirs cut - The relative share of agricultural spending in the European budget will decrease, but I made sure to preserve the funding destined for our farmers, he told at news conference after the end of the 24-hour talks. This leaves me wondering, if the EU members are part of the union, because they are willing to walk together for better future, or they just race in some contest for taking biggest piece of the cake. It's also bringing up some questions about the lobbies, that influence the policy of the union.

Overall, farmers in the 15 older EU member states benefit much more from the CAP than the newer members. Nationally France benefits most, with about 17%, followed by Spain (13%), Germany (12%), Italy (10.6%) and the UK (7%).

For example, France, Spain and Germany benefit more, compared to Romania and Poland, although, in these two countries there is more people employed in the agriculture sector in absolute terms. Even Greece gets more subsidies. Here's how it looks like:

Correct me if I'm wrong, but to me this pretty much looks like "double standard". It appears that EU government decided that French, Spanish,  and German farmers deserve more subsidies per capita of employees, compared to their colleagues from Eastern Europe. How is this going to help fix the "Two-speed Europe" issue? Let me know, if you have any idea.

I would like to kindly remind you, that it was not long ago (on a very sad occasion), when president Hollande stressed, that France will defend European moral values with all available tools. He even managed to spare a tear or two (although I'm not sure if it was for the victims or the European moral values). There was a lot of talking about patriotism, fighting and for people who want to defend their nation and their way of living. My intention is not to downplay the terrible tragedy in Paris, but to make a point, that France (and others as well) is more eager to pay attention to European values at it's convenience, but NOT when it comes to defend the principle for equality with the European citizens, living from the other side of what was once called "The Iron Curtain". I can't see a better example of this, than the allocation of the farming subsidies, and let's not forget, that we are talking about billions of euros.

While I was putting together all the information above, a famous quotation from Alexander Fraser Tytler (1747-1813) was crossing my mind all the time: A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.
Although these words were spoken more that 250 years ago, everyone can see the parallels with "modern" Europe. Picture again the protesting farmers, all the riots, strikes etc., but can you blame people for wanting better future and life? Usually, this is how it all starts, and finally you end with the march of Marine Le Pen in France, Nigel Farage in UK, Podemos in Spain, Law & Justice in Poland, Viktor Orban in Hungary, Tsipras' Syriza in Greece... Far-left and far-right parties are popping like mushrooms and all promise a better life, even if it means to leave EU. They promise more money and more prosperity, and most important - spending of more public funds - and people are buying it. And all this is multiplied by the ongoing migrant crisis. Alexander Tytler's words are so true indeed...
If you think that this problem is specific to EU - I will have to disappoint you. For decades US is subsidizing the corn production, which led to modification of the entire food industry, consuming habits and farming methods. Now 70% of all food products in US contain corn in some form. Corn products are the main ingredient of all junk food, and they are also what made it so cheap (with the kind help of government subsidies of course).

I'm focusing on this specific issue, because it is affecting directly the entire global economy - unfortunately in a negative way. In spite of the common understanding, government subsidies are hurting the economy, and are completely inconsistent, if you are committed to capitalism, which is our case. In addition to this, subsidies are also causing the people consuming habits to change - by making given food the cheapest, you also make it the most affordable for people. In the next part of this publication I'll try to picture the general negative trends, that are result of this particular type of government policy.

World Oil Crisis

Will it end soon, what are the reasons, and why people keep avoiding this term?

After spending some time to consider what should be my first publication, I decided to share my view on the recent turmoil in oil markets. This affects all of us, and like with any economic change - there is losers and gainers.

Fundamental Change

After hitting it's highest price ($146.46) in history on 2 May, 2011, oil is generally moving south. From technical point of view the price recently broke the low ($32.79) from January, 2009, which only makes the picture even more uglier.
 

In my opinion this is  not due to super cycle in the oil price, but a matter of fundamental change in the energy industry. The widening production and use of renewable energy will keep the pressure on oil price, and any bounce back will likely be hammered by speculators.
As we all well know, the de facto cause for sliding price is that the supply significantly exceeds the demand. First thing one will say, is that lowering the supply will bring prices back to more normal levels. However, looks like reducing the production is not on the OPEC agenda, or any other oil producer, and we keep getting signals for this very often (for example, the recent abandoning of production limits for OPEC).
The reason for this is one - market share. Each country believes, that if holds pumping for long enough, other producers will scale down due to low prices, and thus it will keep its market share on the back of the rest. In addition to this, lifting the sanctions on Iran (imposed 1979) will bring up more barrels on the market, and more specifically 500K soon after the lifting, and another 500K until the end of 2016. Just when you would say - that's all - and more things come up. After 40-year-old ban on crude oil exports US Congress decided to lift it. As a result, one more stream of oil is going to flow into the global glut. Because this is not enough, China started a transition from production-based to consumption-based economy, which will naturally reduce the demand (it is more accurate to say "rebalance the demand") for oil and other commodities. All this together makes the perfect storm for oil, and prices will keep sliding, even if there wasn't a fundamental change in energy industry, which only multiplies the effect.
Anyone with basic knowledge in geopolitics is well aware that for long time US and Saudi Arabia were allies supporting each other on all matters. Suddenly the lifting of the oil export ban in US, and the OPEC policy for protecting market share turned these countries in rivals. This will have deep consequences, especially in the Middle East, some of which we are already seeing, but it is whole another story. Some might say that lifting Iran sanctions is also part of this rivalry.
When we put all this together, it's not hard to understand why it's not likely to have sustainable recovery in the oil price.

But what about this fundamental change, mentioned in the beginning. Lets start with the oil demand in US and Europe, or the  developed markets.
As we can clearly see, ever since 2005 the oil demand in the developed world is slowly going down. The reason for this is the ongoing transition from fossil fuels to renewable energy. It is important to notice that lower demand is present not just during the last financial crisis, but also before and after - turning this into sustainable trend. It was not long ago when Bloomberg reported that "Wind power is now the cheapest electricity to produce in both Germany and the U.K., even without government subsidies..." The media also reported that  "The price of solar power will continue to fall, until it becomes the cheapest form of power in a rapidly expanding number of national markets. By 2026, utility-scale solar will be competitive for the majority of the world..." And there we go, this fundamental change started slowly but soon it will turn into avalanche. As all things in real life this have good and bad side, but the good one outperforms a hundred times the bad one. Indeed there will be a lot of countries to suffer from this fundamental change, and the rebalancing will take some time. The migration process, that we currently observe, is just a small piece of the picture, and soon the rest of it will start to reveal.
It's very important to say, that solar and wind power are endless, unlike oil, gas etc. This will practically lead to new industrial revolution. But, like most transitions from one age to another, it will be accompanied by severe concussions and shocks. These shocks will be lighter for the developed world, but will hit hard on the so called "petro-states". Some of them will probably manage to emerge, but other will collapse and never raise the same - simply because it will not be possible from geographical point of view (desert regions).
The fact that Saudi Arabia is considering to sell some part of Saudi Aramco, it's oil state company, is just another sign for the fire-selling of everything oil. If I have to put this in more simple manner - the defending of market share represents the wish oil producers to get rid of maximum quantities as possible, no matter if they admit it, or not. Of course this will only bring more glut to the market and keep the pressure on prices.


Why people don't call it "crisis"?

First of all - panic. If we start using the term "World Commodity Crisis", this will spur wide discussion for the causes and consequences, and as result, more and more investors will "realize" (something have to be in the main media streams for the people to believe it's true) that this is not just simple supply issue, but a fundamental change. Anyway, with prices charting new lows, we are getting closer to using this term.
It is important to say, that the initial effects of this transition will be generally negative all over the globe. The reason for this is that a lot of companies were boosting their investments, while prices were high. In addition to this, the fiscal stimulus (QE for example) and the extremely low interest rates, set by Central banks, artificially multiplied these investments without the needed fundamental factors being present. The result of this is big pile of bad loans, which sooner or later will start causing defaults (this is why it is "world crisis", and not just for the emerging markets). All this is just part of the damage done by central bankers, who decided, after the World Financial Crisis (most recent example), that they will fight recession using budget deficits, rates manipulation and fiscal stimulus - all tools of the Keynesians. I will give some special attention to these events/decisions in one of my next publications.
Interesting times are about to come, and for good or bad, we are the generation to make the transition.

How can this information help us for our trading decisions
As I mentioned in the summary of this blog, making informed decisions is extremely important for being successful. So how putting together all the information above can help an amateur make some profits? When it comes to trading it is not possible to offer universal solutions, but just to chart some general trends, thus anyone can benefit in consistency with their personal trading strategy. Here are the main trends I find useful:

- Commodity currencies


Shorting commodity currencies can be a great way to benefit. Most bright examples include Canadian dollar (CAD), Australian dollar (AUD), Russian ruble (RUB), Brazilian real (BRL). My first choice is CAD, since canadian oil producers are extremely vulnerable to low oil prices due to high production costs. For 2016 any close level to 1.40 in USD/CAD looks like a good one to me for shorting CAD. As long as we have oil prices below $40 I believe this is a good trade. As low oil prices keep pressure on canadian economy, the central bank will keep easing it's fiscal policy and lower interest rates, aiming to depreciate the currency and offset losses. AUD is also a good choice, as long as China is slowing with due its transition. Another thing to cause downward pressure will be the collapsing price of coal (Australia is the biggest exporter around the world).

- Oil related stocks

Shares of energy companies will keep sliding along with oil. While some will manage to emerge and adapt to the new reality, most will have hard times. Picking the winners will be more like gambling thus I prefer to stay out of this market, at least until it gets more clear who will survive the transition.

- Renewable energy related stocks

Most likely this will be the sector that will outperform all others. Investments here are still tiny part of the energy industry and the potential is great. At some point, with trillions starting to flow in this sector shares will likely skyrocket. If i had to make investment for the next 10 years this would be my choice. It is important to say that auto-industry will also play important role, with Tesla so far leading the race (good trade too I believe). When another big producer starts to emerge it will be great BUY opportunity in my opinion.


!!!Market speculation carries a high level of risk and can result in the loss of all of your investment!!!

 

 

About This Blog

Fellow readers, my name is Lyubomir Alov, and I have graduated in archaeology from Sofia University "St. Kliment Ohridski", Bulgaria. It sounds strange, but in this blog I will offer you my humbled opinion as non-professionalist on some basics in modern economy, as well as analysis of the actions taken by governments and central banks, and trends we observe in today's markets.
 

I consider myself for self-educated in the area of finances after trading on the stock and FX markets for 3 years now. Also, I have some "field" experience in projects, financed by government, which gave me a very good perspective of how public spending is made and regulated. Many of you will say, that I don't have the knowledge, practice or experience to provide such analysis, and that's why I will try to focus on the simple logic and facts in order to prove my points. However, I made the effort to read the pieces of some of the most influential and important authors, like John Locke, Adam Smith, Milton Friedman, Lawrence Summers, Joseph Stiglitz, Paul Krugman, and many others, even Karl Marx. The goal was to build myself a wide view on the economic theories and thus make better decisions in my trading activity. After some bad results in the beginning, and some good results later, I believe that I gained some knowledge and understanding about the powers that move markets, and respectively - our everyday life. My opinion is that each person should have enough information and understanding for the economy in order to make informed decisions, for example when voting for specific political platform or choosing type of investment, as this will affect their life in medium-to-long term, and in many cases - the life of their children.

Since I'm born in Bulgaria, I had the rare chance to observe at first hand two economic systems which are entirely opposite to each other, as well as the transition between them (especially this part, although it was useful experience, it's not something you want to be part of). I consider this for important, since the architecture of the transition (still in "progress") in question was based on economic theories that spark fierce discussions and forming of camps among modern economists - more specifically between the supporters of Keynesian theories and the supporters of Neoliberalism.
 

Also, this is the place to say, that English is not my mother tongue, so I give my apologies to all fluent speakers in advance. The reason for my choice is to reach wider audience.
Feel free to leave your feedback and comments, no matter good or bad - because after all:

In a time of universal deceit - telling the truth is a revolutionary act., George Orwell