As this Year of Our Discontent slowly grinds into the (less-than) festive season, a collection of unintended consequences that have occurred in the last 12 months.
From regulatory hands-off to Madoff (dedicated to the SEC).
From a home to call your own to Home Alone (dedicated to the sub-prime market).
From a bull in China to a bull in a china shop (dedicated to believers in perpetual motion).
From full of ships to a ship of fools (dedicated to the shipping bubble).
From copper to cropper (dedicated to the commodity bubble).
From dear oil to oil, oh dear! (dedicated to Peak Oil - in capitals - and Goldman's analyst who called for $200/bbl).
From laissez-faire to less-is-fair (dedicated to salary cuts, forced vacations and the job market in general).
From Friedman to Friedman (dedicated to Milton and Thomas, respectively).
From BRIC to bric-a-brac (dedicated to developing economies).
From the yen carry trade to the carry-out counter (dedicated to spread indigestion).
From correlation trades to poor relations (dedicated to money for nothing).
From Credit Default Swaps to Schweppes Club Soda (dedicated to indigestible free lunches).
Merry Christmas to one and all and may the New Year bring whatever you wish (so take care what you wish for).
Yours truly is going to abstain from posting for a few days, concentrating instead on friends, family, food and drink - not necessarily in that order. Toodles..
Two of the largest sectors of the US economy are housing and automobiles. Both are reeling (see charts below).
Looking at the charts, we observe that both industries had been on a more or less continuous uptrend since 1990-92 - until they jumped off the cliff in 2007. What happened? It's quite simple, really: houses and autos are the #1 and #2 most significant purchases people make in their lifetimes, usually financing both. That's where easy-easier-easiest credit came in: in just a few years household debt as a percentage of GDP jumped from 67% to nearly 100% (see chart below). In other words, between 2000 and 2007 we over-borrowed and over-spent on houses and cars, satisfying future demand for many years to come. No matter how low the Fed takes its rates (a record low 0.0% - 0.25% as of yesterday), people are not going to rush to borrow to buy such big-ticket, long-lasting items anytime soon. They do not need them, because they've already bought them. It follows that household lending - the driving force behind finance in recent years - is also going to be down on its heels for many years.
Conclusion: don't go bottom-fishing in these sectors just yet. Instead, investors will be better off looking for The Next Big Thing. What's that? My bet is on alternative energy and everything that revolves around it, such as smart electricity grids. A wholesale shift from "black" to "green" will necessarily require massive investment and will, also necessarily, lead to a shift from consumption to saving, in order to finance it. This will pose significant challenges to the retail and traditional services sectors, too.
I fully expect a long period of massive Creative Destruction to unfold, i.e. OPPORTUNITY. Any and all ideas from readers are welcome..
Continuing from yesterday's post, a reader asked to see margin debt as a percentage of account value. This would give a better picture of the degree of leverage. Unfortunately such data do not exist - at least not in the public domain. Instead I have done the next best thing: margin debt as a percentage of total US market capitalization. Here is the chart:
Data: NYSE, World Federation of Exchanges
P.S. I am sure you have all seen the boot-iful Bush video. All I have to say is: Duck and Cover
The amount of margin debt as reported by NYSE has plunged to $233 billion in October (latest figures available) from a high of $381 billion reached in July 2007. It's pretty certain that it has declined even further in the last 1 1/2 months, given the recent performance of markets.
I must caution that we live in the Age of Derivatives and therefore speculative leverage can be taken on in many more ways than plain old margin debt (e.g. CDS). Still, there is no question that de-leveraging is happening very fast.
The latest 3-month US Treasury bill auction resulted in 0% rate and was oversubscribed four times. How about that, for deflation and risk aversion, eh?
I am not surprised. This is the hangover following the wild easy-credit party that ultimately saw financial engineering elevated to the same position as real engineering (yes, I was offended). The same party that created the awesome stupidity of $65 trillion in credit default swaps which first allowed piling on much more debt than prudent, and which are now inhibiting the cathartic process of its quick demise.
What's next? Will free money (for the federal government, anyway) result in another Greenspanite bubble? No, no time soon. This development is not something that the government wants, you understand. It clearly underscores the fact that deflation is happening as we speak, that assets carrying even the smallest amount of risk are shunned in favor of mere capital preservation. The debt trap has become - predictably - a deflationary liquidity trap, American economists' and policy makers' greatest phantom menace since 1929.
I will, thus, say it once more: instead of allowing this deleterious process to drag out for years by attempting to preserve debt (as the Fed and Treasury are doing now), we must instead allow it to be destroyed, to be liquidated in as orderly a fashion as possible, as quickly as possible.
The number of non-farm jobs in the US declined by 533,000 in November, the largest drop since 1974. But because absolute numbers almost absolutely lie, here is a chart of the same number as a percentage of the civilian labor force. At 0.34% the reading is still pretty bad, I'm afraid.
And if this recession is the worst since the Great Depression, as most analysts are now constantly reminding us, this number is going to get much worse in the very near future.
This explains Mr. Obama's haste to announce a vast new program of infrastructure spending, from roads and bridges to schools and "green" projects. No question, this president-elect wants to hit the ground running come January.
The most intriguing, and in my opinion most worthwhile, project in his agenda is the so-called smart electric grid. It would allow power generators to communicate directly with their customers over the same wire that provides electricity, down to each individual appliance. This has the potential to radically transform the entire industry, finally taking it from the 19th century into the 21st. This is also where America excels: the application of modern technology (in this case information and communications) to the creation of an entirely new paradigm.
Mark my words: if the new president is successful in this, the entire world is going to be transformed. And knowing how things work in America it will happen fast. The profit motive will see to it.
Today, an oblique homage from the dismal science (economics) to Erwin Schrodinger, a real scientist. As you may recall, he was the quantum physicist who discovered the eponymous equation (simplified version below).
Schrodinger's Equation For A Single Particle In Three Dimensions
Are we having fun yet? Is this gibberish not what you signed up for when you clicked on Sudden Debt today? Do try to hold on, however, because Mr. Schrodinger most famously also devised the well-known cat-in-the-box thought experiment- and that's our topic today. (After a fashion, anyway...).
Just like the cat inside the box, is the US economy currently dead or alive? Does it follow quantum mechanics, meaning that the two states are superimposed and the economy is both dead and alive? Finally, does the mere act of observing the state of the economy affect the outcome?
Let's start from the latter: yes, observation does affect the economy - if the observer is a presumed expert like the Fed Chairman or the NBER, whose dicta carry considerable weight. (Well, not so much their actual looking at the economy as what they say about it - the analogy with quantum physics is not perfect, but you get the point.) More significant is the fact that they have to look at the economy and they have to pass judgment on its health. Unlike the physicist running the cat experiment, these experts are obligated to look inside the box and thus collapse the superimposed states into one.
Currently, every expert has quite apparently looked at the economy and pronounced it dead. In fact, the NBER just post-dated their death certificate and now says that the recession started a full year ago, in December 2007. Could it be that the dismal scientists are currently attempting to convince us that the worst is already behind us? I mean, how can one constantly observe a cat and only decide today that it died a year ago, hoping that the pronouncement will bring it to life tomorrow? The mind boggles... even quantum mechanics doesn't allow for such cavalier treatment of time.
For my money, the economy is still inside the box - it is still both dead and alive. Some dead sectors (finance, real estate) are superimposed upon some others that are very much alive (alternative energy, organic farming/food). Yet other sectors are both dead and alive at the same time, like the auto industry which is dead at the combustion engine end, while being reborn at the plug-in hybrid end.
There is opportunity around, that's for sure. Just make sure that your money's on the right cat.
In previous years and decades whenever a third world country would get into financial difficulty it would turn to the IMF for a bailout. Because of the way the global financial system was structured in the post-Bretton Woods era (World Bank, IMF, WTO, etc.), the US was always in the forefront of such efforts. The bailout examples are numerous and well known: Latin America, Mexico, Asia, Russia. By and large the process worked pretty well, based on the premise that in an interconnected world if your neighbor's house is on fire you don't haggle about the garden hose.
Let's explore this fire simile a bit further.
Picture the US as the Global Fire Department (GFD). In the last ten years or so the GFD became extremely irresponsible. It ignored the fire safety of its own firehouse, which became choked with highly flammable material (i.e. debt and derivatives), and relaxed the rules about the health and fitness of its firemen (i.e. oversight and regulation were weakened).
Seeing this, the good citizens in the neighborhood (i.e. other western nations) also adopted the same attitude. And why not? If the fire department itself didn't care about all that dead wood and turpentine piling up in its own back yard, why should they? A whole raft of nations from the UK and Australia, to Bulgaria, Poland, Iceland and Romania bought the same highly flammable "growth" model. Borrow - spend - inflate assets - borrow.
It was only a matter of time until a fire started somewhere. Unfortunately, it started in the worst possible place: the GFD firehouse itself. Predictably, the unfit firemen could not contain it and the fire quickly spread to the rest of the town. So, who's going to put it out now and how?
The current plan is to take all that dry firewood and turpentine and stow it someplace else: to replace and guarantee private debt, plus issue additional government debt. But with the entire town now threatened by the blaze, that's just a delaying tactic. What we need is less wood and less turpentine, plus more, better and smarter firemen. And even that's not enough. The entire town should get together to fight this fire before it scorches everything in its path.
Previous IMF bailouts transferred some of the risk from, say, Mexico or Argentina to the IMF (essentially, the US) by providing fresh loans and guarantees. By current standards, the sums involved were tiny: $20-50 billion.
But the US cannot perform a similar IMF bailout on itself, as it is currently attempting to do. The United States IS the IMF. Astronomical guarantees and bad-asset purchases merely transfer and spread out the problem internally, instead of solving it. There is simply way too much debt; too much dead wood, too much turpentine and, naturally, no one else wants it in his back yard. Just think of China, Japan, the Gulf States or Russia and how much US debt they have already piled up. How much more "firehouse debt" are they willing to accept, particularly when the flames are already licking their own houses?
What we need right now is water: a.k.a. debt liquidation. And the longer we fail to recognise this simple fact, the longer we fail to provide it, the worst it's going to get later on.
Can Old Dogs Learn New Tricks?
President-elect Obama is currently hiring firemen, his economic policy team; and it doesn't look good. They are the exact same bunch that let the firehouse get full of tinder in the past, if they didn't necessarily also strike the match. I sincerely hope they can teach new tricks to old dogs - but does Larry (Summers) look trainable to you? Woof.
Final thought (and Happy Thanksgiving to all): Turkeys destined to become roasters think they live in gobble heaven, right up to the point they turn into Butterballs. We got to change the way we look at things folks, and the past isn't necessarily the best guide to the future.
How many trillions does it take to save a financial system? Sounds like a bad joke involving ethnic electricians and light bulbs. In many ways, it is.
According to a Bloomberg story, the total amount pledged so far by the Fed alone is a staggering $7.4 trillion. Readers are encouraged to perform for themselves the appropriate arithmetic calculations and come up with GDP, dollars per person and other appropriate ratios for what this unfathomable number really means outside the virtual world of finance. (Actually, let me save you the trouble: it means nothing. It's just money.)
But how about some alternative uses for this capital. What would $7.4 trillion buy?
Provide a 40% subsidy for 5,000,000 wind turbine. Even better...
Provide government loan guarantees for an almost unlimited number of wind turbines.
I'm focusing on wind turbines because they provide the closest cost/benefit to conventional power generated by coal-fired generating stations. And that's before any environmental benefits are taken into account.
Feel free to substitute your favorite program for taking our economy into the 21st century. I believe it's high time to leave behind 19th century technologies and their attendant socio-economic models - don't you?
So how many trillions does it take to save our current system? None. Think about it..
Some readers have been kind enough to point out that in my older posts, going as far back as two years now, I accurately predicted the current mess. A few more have asked for a list of "Best of..." posts but I must respectfully decline for a simple reason: there's no accounting for individual tastes. What strikes me as particularly brilliant (insert very loud scoff) may seem as utter nonsense to someone else.
So, if you feel so inclined, please scroll back to the past and pick and choose as you see fit. There are lots of self-explanatory charts, so the slogging won't be as tough as it may seem at first.
[Insert: OK... if I could choose just one post as "particularly brilliant" (scoffs and guffows definitely encouraged) it would be this oneThe Greenback: Toward A New Monetary Policy.]
On to the future, then.
My first boss, a bear of a man called Stan, used to say: "I know about yesterday. What are you doing for me today?" He was a right old bastard, but I must grudgingly admit that he got results.
So, in no particular order, what's on my radar screen today?
The market "chatterboxes" are now at fully anguished scream mode. The "financial and economic crisis" is topic number one at the evening news, radio, newspaper headlines, websites, blogs - everywhere. It has definitely permeated to the daily conciousness of the legendary "average person".
My physical therapist called me on the phone three times this week (my daily sessions having ended a couple of months ago), to ask for advice on his holdings. He was very troubled - almost panicked. I gave him the same anodyne I always give non-pros - and silently thanked him for the contrarian signals he is providing.
Everywhere you turn you hear "This is the worst crisis since the Great Depression". In other words, markets are already pretty much discounting a future very similar to it. Not quite there yet, but relatively close if we judge by a single - but extremely important - indicator: oil prices have collapsed by an eye-popping $100 per barrel. Dry cargo charter rates are down by an even more astonishing 95%. And everything has happened with unprecedented speed: just 3-4 months. Hmmm...
Finance is essentially finished as a business model for the foreseeable future because deleveraging will go on for years. Investors should look elsewhere for returns; my choice is renewable energy and sustainable resource utilization, particularly proven technologies such as wind, organic farming and the peripheral opportunities arising from them. Sorry, no stock tips from me - you must do your own research. And be prepared for the long haul, because there won't be any instant gratification out there. Another intriguing area is genetic/molecular medicine, but I am woefully ignorant on the subject. Biology was my worst subject in school.
Right now - and only for the short-term (i.e. up to 6 mos.) - I'm focusing on tactical moves and not on grand strategy. Market psychology being as horrible as it is, and negativity having permeated the very lowest reaches of the popular consciousness, I am looking for a relief rally (always the contrarian, I am). Perhaps such a rally will be caused by Mr. Obama's conservative, market-pleasing choices for Treasury and State secretaries (probably Summers and Clinton respectively). Still, if there are no real, hard decisions on dealing with our global economic problems I will view such a rally as an oportunity to sell instead of buying.
And, as always, a warning:Caveat emptor/venditor. Tactical radars, analyst crystal balls, gypsy Tarot cards and such mumbo-jumbo are ALWAYS subject to interference and interpretation.
With interest rates being slashed by central banks all over the world readers may be interested in trying their hand at MoPoS, or the Monetary Policy Simulation available at Swiss National Bank's site. Yes, you too can be Ben (or Jean-Claude, Jean-Pierre, Mervyn, or whomever catches your gaming fancy).
For your further (pictorial) inducement to attempt wonkish policy behavior in the privacy of your own parlour, here is a chart of the effective Fed Funds rate (0.38% yesterday). Sad to say it is very near the dreaded liquidity trap condition that spells "GAME OUT" in MoPoS, as it also does in real life. Just ask the Japs.
The idea for this post came to me as I was reading Tom Friedman's important new book Hot, Flat and Crowded in which he advocates a green economy as a way out of the current financial, environmental and geopolitical crisis. He envisions a wholesale transformation of the current Dirty Fuels System into a new Green socio-economic paradigm. Let's call this The Green Revolution - a rapid and radical process of change towards an alternative system. So far, so good and I strongly agree with him.
However, he believes that technology - as yet unspecified and undiscovered - will be the sole key in accomplishing this shift by providing cheap, clean and plentiful electrical energy to sustain our current growth model. In other words, technology will find a solution so that we can keep Permagrowing. Like every other economic analyst lacking a solid grounding in science and engineering, he confuses the massive application of cheap (fossil) energy in the last century with fundamental scientific advancement. He is blindsided in believing that what we did with cars and computers we can do with energy. Sadly, he is completely wrong.
I won't go into a great explanation of why, because this blog is geared towards those with a solid understanding of the physical world. Suffice it to say that Permagrowth requires huge amounts of concentrated energy sources to produce useful work (it is work that matters, not energy) and that diffuse solar, wind and geothermal simply cannot substitute for oil, gas and coal. Please look up the Second Law of Thermodynamics if you need more background. In the words of Sir Arthur S. Eddington : " .. if your theory is found to be against the second law of thermodynamics I can give you no hope; there is nothing for it but to collapse in deepest humiliation." Technology can't "save us" because science itself simply can't (technology being the application of science).
So, I am afraid that Mr. Friedman, though well intentioned, is making a parallel mistake to Mr. Greenspan's who, having witnessed what the computer revolution did for information systems, believed that financial engineering could similarly revolutionize finance (e.g. CDS). An extremely costly mistake, to say the least.
In plain words, Green Permagrowth is simply not possible. Instead, we should aim for and work towards Green Sustainability.
OK, let's move to the more contentious "class struggle" part of the title, one that I am sure instantly evokes anti-Marxist howls of protest. After all, the term was essentially monopolized by erstwhile communists. (There are a few readers who even call me a commie. Ha! I am about as bolshie as Warren Buffett is poor). Instead, I use the term "class struggle" in the spirit of the American and French revolutions, the Civil War , or the racial and feminist movements . All were based on class struggles revolving around the evolution of a "middle" class.
Which brings me to this point: the current Sudden Debt/Permagrowth/Dirty Fuel System produces an unprecedented concentration of wealth into the hands of a tiny minority of society. In the US, a miniscule one percent of the population now owns 40% of ALL wealth, including bank deposits. The so-called "middle class" has been eviscerated, indebted and increasingly stuck in a low-pay job environment. In effect, there is no middle class: there is a 5% sliver composed of the ultra, super and comfortably rich and then there is everyone else.
So, how are we to embark on a Green Revolution, which will by necessity require the creation of a more evenly distributed energy system (remember the Second Law), if society is not similarly and more equably composed? Will the rich elite, created and concentrated by the outgoing Permagrowth system voluntarily promote this necessary transformation, or will it do so only after a "class struggle"? I don't really know, but I must observe that history points us to the latter conclusion. After all, the Industrial Revolution followed the French/American Revolutions...
To close on a musical note: from Handel's opera Rinaldo the incredibly beautiful aria Lascia ch'io pianga, performed by Sarah Brightman. The lyrics are quite apropos...
Let me weep over my cruel fate and sigh for freedom.
May my grief mercifully break those chains of anguish.
Fact 1: There is too much debt in the economy to be properly serviced by the earned income generated. Total debt has doubled as a percentage of disposable income in the past 25 years.
Figure 1
Why did it happen? Because wages and salaries (i.e. earned income) were kept artificially low in the name of "competitiveness", while consumption was boosted through ever increasing debt.
What does it mean? Assuming even more debt and/or replacing private debt with public, as is currently happening, cannot resolve this fundamental problem. Instead, debt must be liquidated.
Fact 2: Saving has disappeared in the US. Every penny earned is consumed.
Figure 2
Why did it happen? The stagnation of real wages and salaries meant that less income could be saved and had to be consumed to maintain the American Lifestyle. In addition, way too much social emphasis was placed on consuming vs. producing.
What does it mean? The US economy cannot finance itself internally and has to rely on foreign investors and lenders. Unless reversed, this trend spells big trouble geopolitically.
Fact 3: There was wholesale removal of manufacturing from the economic base after 2000 (aka China's "miracle"). Millions of well paid jobs were replaced by service sector jobs, many in the very low-pay area of leisure and hospitality (waiters, chambermaids, etc.).
Figures 3 and 3a
Why did it happen? Because neo-liberal and neo-con policy makers made a conscious decision to replace manufacturing with its pesky labor unions and associated politically troublesome middle class, with an indentured social class of dependent service workers. All in the name of "free" markets, of course.
What does it mean? The imminent end of the US as a superpower. Supercomputers and fuel cells are not developed by a java-and-jelly donut economy. Globalization means that education, knowledge and technology are, in fact, fungible and transferable. In the absence of a local base of utilization high value-added jobs are free to go where they please.
Conclusions a) Debt must be liquidated and earned income increased. b) Saving must be increased by reducing consumption in order to fund investment (preferably in energy infrastructure) and to reverse the loss of geopolitical importance. c) Manufacturing must be emphasized in order to regain technological leadership.
In an extensive article about the failure of Merrill Lynch (How the Thundering Herd Faltered and Fell), NY Times' insightful Gretchen Morgenson clearly lays the blame where this blog has, repeatedly, for two years: credit default swaps (CDS). In particular, she points out the toxicity of synthetic CDOs, bonds that were created by selling CDSs on mortgage pools and/or indexes.
"Do Credit Default Swaps and CDOs increase or decrease stability and systemic credit market risks? ......... I will state my conclusion right away:
Today's market arrangement intensifies existing trends. It pushes credit spreads lower than usual on the virtuous side of the credit cycle and will likely boost them higher when the trend turns vicious."
And how about yesterday's decision by our "trailers" to raise AIG's bailout to an astonishing $150 billion? Yes, that's all about CDSs, too. AIG was one of the world's largest underwiters of credit insurance, particularly against mortgage default risk, and the bailout is designed to prevent the CDS market from getting completely unstuck.
Now, let's ponder this: why not let the CDS market get unstuck? Why not tell all market participants that taxpayer money will not be forthcoming and that they should resolve their problems on their own? It could actually work out very well - very little "retail" money is involved in this market and in the absence of public largesse the 10-20 big players would be forced to sit down and work things out between them. Yes, there would be large losses, or actually as things stand right now, there will be reversals of very large mark-to-market gains for CDS owners. And is that a bad thing? Why should the federal government in effect guarantee the gains of speculators with scarce taxpayer money?
Because, if you haven't figured it out yet, this is exactly what is going on. The "saving the global financial system" pablum fed to the public through the media is just that: mush.
The chief of General Motors described bankruptcy as having "unimaginable consequences", asking instead that the government give it $50 billion for a bailout. The trough is not only depening, it is widening as well.
Well... why not let the company go into Chapter 11 reorganization - that's what bankruptcy usually means for corporations - and get rid of a large portion of its debt obligations? What's so terrible about it? The law is quite adequate in protecting the business as an ongoing concern, including provisions for employees and suppliers. So why not?
Yes, yes, I know... the horrible green monster of deflation. When one of the largest corporations in the world wipes out its debt in one stroke, it makes the picture pretty darn clear for everyone to see. And that's still unthinkable in the Bernankean/Pelosian "inside-the-box" universe. The "trailers" are still stuck in Luddite mode, unwilling to accept that what we need is debt liquidation and not debt preservation.
What about this alternative, instead: let GM go bust, then provide it with government loan guarantees to turn itself into the largest manufacturer of alternative energy automobiles and - why not - even wind turbines and associated machinery. Think of it as a major step in the war mobilization of industry - a war declared against environmental destruction, resource depletion and geopolitical dependency. It would also be a loud message that the United States will no longer fight Resource Wars, like the ones going on in Iraq and Afghanistan. (Note: I urge everyone to read the book by the same title by Michael Klare. It is a must in understanding what's going on in the world.)
It would also be a signal that the Age of Permagrowth is over and that the United States is now claiming the lead position in the Sustainable Era. We can do it right now, or we can wait and become followers. This is the inflection point ladies and gentlemen: Right Here, Right Now. ____________________________________________________________
Monday Morning Update:
Researching wind energy companies, I came upon several news stories about the current credit crisis creating delays in financing wind farm projects. This may be understandable in the short term, but downright criminal in the medium to long term. Here is a great opportunity for those 3/4 of a trillion dollars to do some REAL good, i.e. provide loan guarantees for such proven technology projects.
Instead, our "trailers" are today rushing to provide ADDITIONAL bailout money to AIG. Hello?? Are any grey cells still functioning in there??
From our crystal ball dept. (always cloudy conditions there):
Before this so-called "crisis" is over dividend yields on the S&P 500 will be significantly higher than AAA/Treasury long bond yields. As in 2-3x higher...
Look at the historical chart below. And ponder what this (cloudy) prediction means for stockmarkets.
The election of Mr. Obama as President exemplifies the best that is America: the ability to look forward and shape our future unfettered by the chains of the past.
So let's apply the same principle to formulate and put in motion:
A renewable energy policy that breaks our dependency on petro-dictatorships, saves the planet's environment and creates millions of highly skilled jobs.
A new social contract that brings the middle class to the forefront.
A new economic model that stresses sustainability, saving and production.
A foreign policy that makes us once again the beacon of hope.
Congratulations Mr. Obama. Our hopes, aspirations and dreams are with you today.
Perhaps nothing better exemplifies the rise and fall of the virtual economy in the US like Las Vegas. The poster child for the service economy, it combines almost every sector of so-called "growth": recreation, hospitality, real estate, finance, marketing.
The party is now clearly over. After years of continuous expansion in gaming revenue and convention activity, this year is shaping up as a outright bust for America's desert kingdom.
To provide an idea of the amounts involved, gaming revenue in 2007 came to $10.9 billion and the economic impact of conventions to $8.5 billion. There were 39.2 million visitors staying a total of 44 million nights at an average room rate of $132/night.
The rate of growth in household borrowing has been slowing for almost two years now, dropping to 1.4% annualized in the second quarter of 2008 (see chart below). It is almost certain that when the Fed releases third quarter data (due in Dec. 12) the rate will show a household credit contraction, i.e. a negative rate.
Data: Federal Reserve Z1 Report
I believe this is a positive development leading to a lower debt burden and a more sustainable economic model, overall. Unfortunately, our "leaders" are doing everything possible to avert such an outcome. They are stuck in an outdated growth model, quite obviously at odds with financial, environmental and geopolitical reality. So from now on I shall call them our "trailers" - they are nothing more than modern day economicLuddites. Let's focus on geopolitics, an area that should theoretically be of particular expertise amongst our leaders... oops, I meant trailers. How much brains does it take to realize that continuous credit expansion vs. earned income leads mathematically to a vast wealth transfer to commodity producers, particularly the petro-dictatorships. We are not only putting the rope around our own necks - we are financing it, too!
And how about the environmental effects? Our trailers' actions aim to salvage the borrow-consume model, i.e. Permagrowth. It's simply not possible on Terra; not with nearly 3 billion Indo-Chinese now clamoring to join Our Club.
OK then, let's borrow a few trillion dollars on the government's credit, by all means. But for heavens sake, let's invest it wisely to transform our economy and society while it is still possible. Because it soon won't be: a) the lenders won't lend to us (US) and b) the environment won't wait. Or how about this novel idea: let's finance everything ourselves by increasing our saving rate back to a double digit percentage, like we did 20 years ago, instead of spending every penny. Shocking, eh?
The Fed is planning to cut rates by another 50 bp (0.50%) this week, bringing their target for Fed Funds down to 1%.
Wonderful.. and how is that going to help, exactly? I mean, help the so-called "real" economy and not the panicky, tormented souls of financial regulators who are grasping at any blow-by straw to make them look like they are "doing something".
Official rates are already so low that another half of a percent will do absolutely nothing to ease the huge debt burden crushing the US economy. An economy that in recent years willingly (or was it, in fact, forcibly?) abdicated its position as a premier manufacturer and heavy duty productive user of capital. Lowering the cost of borrowing would be great - if there were thousands of healthy businesses eager to borrow and apply the funds to new plant and equipment, to hire new workers and to fund research and development. But, there aren't - that was last century's economic model.
Today we are captives of the Asset Economy, the FIRE Economy, the On-Margin Economy, the Capital Gains Economy, the Debt-Above-The-Eyeballs Economy. What productive use of capital are we talking about now, for heaven's sake?
So what are lower rates supposed to do? Hope that millions of low income Americans will suddenly rush to buy new houses, putting themselves into more hock than they are already? Charge more Christmas trinkets to already maxed-out credit cards and hope the devil doesn't care? Induce hedge fund managers, who are staring hundreds of billions of liquidations in the face, to rush out and buy more stocks on fresh margin? Make insurance companies underwrite more disastrous credit default swaps?
None of the above, of course. The upcoming cut, which will very likely be coordinated with other central banks around the world, is a shameless political move designed to palliate the voting, but unfortunately clueless, public. Nothing more - and nothing less, in this political season that is threatening to deal a crushing blow to the (clearly outgoing) Republican party.
One more time, then: what we need is LESS debt and not more, or cheaper, debt. Cancel it, destroy it, bankrupt it, wind it down, liquidate it - call it what you may, but the end result must be the same. A saner ratio of debt to earned income.
How to do it? Rational , thinking people may come up with a variety of ways; mine have been stated over and over again:
Direct government support of alternative energy and economic sustainability efforts ($700 billion is a lot of money to waste on bailing out bad debt).
I'll borrow a line from Thomas Friedman's new book Hot, Flat, and Crowded. He's quoting John Hennessy, the president of Stanford University: "Today's energy-climate challenge is a series of great opportunities disguised as insoluble problems."
What a great way to view our world and its challenges. Instead of silly, worthless rate cuts..
A chart of the Reuters CRB Index that tracks a wide range of commodity prices. Looks similar, doesn't it?
Here's the simple explanation.
A commodity bubble was fueled by massive amounts of liquidity (aka debt) that was available (aka issued) during the past few years. While the speculative frenzy was going full blast, traders were tempted to keep large and growing stockpiles of everything from coal and iron ore to wheat and soybeans in order to make large capital gains. This produced increased pressure on transport demand, particularly for the largest vessels possible (Capesize). Incremental boat supply being particularly slow to materialize - unlike, say, CDOs - charter rates went through the roof.
But when the credit bubble popped, everything else followed, too: the dominoes fall with great speed in our globalized world. So, don't look for charter rates to recover materially until stockpiles are worked down and fundamental physical demand (i.e. consumption) comes into line with commodity production rates.
Being a successful contrarian is the ultimate revenge. Let me give you an example: as little as a year ago none other than Alan Greenspan kept singing the praises of credit derivatives, while yours truly was calling them for what they proved to be: a man-made disaster born of greed.
Was Greenspan unintelligent (to put it mildly)? No. He was just going with the flow, joining the rest of the inside-the-box thinkers. Sad, for a man of his obvious smarts. And was I so smart? No. I was just willing to go against the flow, willing to Think The Opposite.
So, here is a book that I think EVERYONE should read. It is smart, humorous and EXTREMELY useful (cheap, too). You can read it in 30 minutes (lot's of pictures, small format), but I promise it will be the most profitable half hour of your life. And I bet you will keep it close by in times to come.
In fact, I think we should all buy a few dozen and hand them out as Holiday presents this year. I know that's what I'll be doing.
Here's an excerpt, apropos of Messrs. Greenspan, Paulson, Brown, Sarkozi, et.al. :
"TRAPPED.It's not because you are making the wrong decisions, it's because you are making the right ones. We try to make sensible decisions based on the facts in front of us. The problem with making sensible decisions is that so is everyone else."
This blog was started in December 2006 as a way to more widely share my views (and warnings) about the disastrous course we had embarked on, i.e. allowing a debt explosion to shape and undermine the national and global economy.
There is a large amount of data and charts that were posted early on. I pretty much hate repetition, so I view those postings as "required reading" for anyone who wishes to get a basic understanding of where this "Crisis" came from. (I also hate patting myself on the back,but I do have to say it: "I told you so". That and $5 will get you a grande latte). The first purpose of this post, therefore, is to urge readers to go back to the very early postings.
The second one is to explain my current stance: Ladies and gentlemen, the situation is unfolding almost entirely as I expected and laid out in hundreds of postings in the past. Thus, now is the time for yours truly to engage in patient observation from the safety of a previously arranged "safe place" (financially speaking). When the proverbial doo-doo is furiously hitting the fan it's not smart to predict where it will land, but to take cover and wait.
Essentially, there isn't much to say that I haven't already said before, including what we should be doing to ameliorate this self-inflicted disaster, instead of the Knee Jerks' actions so far.
I do hope that the next US administration will see the light and change course. We will know as soon as the next Treasury Secretary is nominated. If he/she is one of the usual Our Gang(sters) from Wall Street/Park Ave. then we will be in for more trouble (e.g. Larry Summers, who is all over TV these days trying to sound oh so eminently grise). I do so hope that Mr. Obama realizes that CHANGE requires... change.
Anyway, please do go back to the early postings if you have the inclination and time...
Two charts from our "less commonly publicized economic data" Dept.
Americans receiving food stamp assistance rose to a record 29.05 million persons in July 2008 (latest data available). That's 9% more than a year ago - and that's before the credit crisis started hitting in earnest.
People are starting to cut back on drugs - the prescription kind. According to a NY Times article, the number of filled prescriptions has dropped for the first time in at least a decade.
No more comments needed...Ok, just one: don't bet on permagrowth in the medical services sector, either - ageing baby boomer effects notwithstanding.
Deflation is finally making its way into the popular media, as this editorial from the New York Times clearly shows ("The Bubble Keeps On Deflating"). After mentioning the obvious trouble in the real estate sector, the article focuses mostly on the likelihood of a rising tide in corporate bankruptcies, caused by past credit excesses, e.g. cheap and dirty loans for buyouts by private equity funds (a particular pet peeve of yours truly). There is even note of complicating factors like credit default swaps (CDS) - another item very often examined in this blog.
As the editorial points out, so far there have been few major corporate bankruptcies. The question is, however, what happens if (or more likely, when) failures start to increase rapidly. Will the CDS market be able to absorb the shocks and act as a crisis attenuator, as its adherents claimed not long ago? After all, they had piled on trillion upon trillion of unregulated credit insurance, betting heavily on continued sunny credit weather.
Or will CDSs instead become amplifiers of trouble?
Defaults may very well swamp the CDS market and create a negative amplification effect, multiplying several-fold the losses sustained by the financial system. One single corporate bankruptcy can cause many more losses than the amount of its entire debt outstanding, as multiple CDS dominoes fall and cascade through all those who issued them with abandon.
Governments and regulators are ill-equipped to handle what is happening, hampered as they are with imperfect understanding and lack of relevant experience. So, they just do what they have always done: throw money (ours) into the problem, inadvertently feeding more fuel into a growing credit fire that requires debt cancellation "water", and not additional debt "oil".
Paraphrasing the fictional Gordon Gekko, "Deflation and default are good". ________________________________________________________ Update on CDS
Today (10/21) is the day of reckoning for Lehman's CDS settlements. Some $400 billion notional is said to be at stake and we'll soon know (?) who's holding the bag. Other than AIG, who wrote credit insurance on anything that fogged the mirror and has already choked on it, several formerly high-flying hedge funds are also said to be on the hook...
This is only the first major bankruptcy and the market seems to have already dealt with it, even breathing a (temporary?) sigh of relief. I'm not sure it will do so with the next one, though...
The only way to create (fiat) money is to borrow it; debt is money and money is debt.
Money creation, i.e. borrowing, at a pace faster than GDP growth and earned income has lead to a run-up in asset prices.
Borrowing at a pace faster than earned income is unsustainable because debt cannot be serviced properly; it ultimately becomes a self-destructive Ponzi scheme.
A collapsing Ponzi scheme wipes out debt and slashes asset prices until the balance between income and debt is restored.
Therefore...
All actions designed to maintain a Ponzi scheme are - mathematically - certain to fail.
Let's look at what happened in the US in the last few years. One chart says it all:
Total Debt as a Percentage of Disposable Income (Data: FRB Z.1)
Debt has exploded upwards, rising much faster than income: ===> Ponzi.
Therefore, re-capitalizing banks, brokers, pawn shops, French bakeries or nail salons by issuing huge amounts of even more debt is simply not going to work. In fact, it will make matters worse when the whole thing inevitably comes crashing down.
Corollary: the only way to "save" an economy that relies on a self-destructive, vicious cycle of borrow-inflate-spend-borrow is to chuck it and replace it with a new macro-economic model. Period. _______________________________ P.S. If you want to find out the differences (and some similarities) between today's situation and 1929, this is the best book about the Crash, by far: The Great Crash 1929 by John Kenneth Galbraith
(Please excuse any and all inappropriate characterizations contained in today's post. As regular readers know I try hard to be very civil - but even I have limits; and I'm really pissed off today.)
Well, well... Talk about knee-jerk reactions by ignorant, panicky politicians guided solely by pleading, nearly destitute financiers..
In what may go down in history as the fastest ever ideological volte-face, the entire West is rapidly nationalizing its banks. After the US and Great Britain, eurozone members agreed yesterday to throw away public money by the hundred-billion bucketful. They will re-capitalize their own rickety financial institutions, vowing to prevent the closing of even a single bank.
What they are doing is the wholesale commitment of heretofore unthinkable sums of public money - that's your money, in case you didn't realize - for the bailout of institutions that completely and hubristically scorned their obligations to the public trust; obligations that were placed upon them by regulators who, admittedly, fell asleep at the wheel. And politicians are asking us, the average Tom, Dick and Henri, to fund them anew so that they can... what? Start the whole process once more?
Unfortunately, most people don't in fact realize that the torrents of "government " money that is so casually being thrown about is their very own; that it is they who are financing this Knee Jerk Boondogle. What's worse, their scheme has a snowball's chance in Hell of working out. No matter how many newly borrowed (i.e. taxed) dollars, euros, rubles or kronor are thrown at it, this problem will persist for a very simple reason: as the masthead says, a debt crisis cannot be resolved by incurring more debt.
The "establishment" is desperately trying to avoid the inevitable: deflation. With deeply ingrained institutional memories of the Great Depression guiding them, mental-lemming leaders cannot see past their cartoonish understanding of financial history. Note to George, Gordon, Nicola and Angela: watching black and white documentaries from the 1930's and listening to Bernanke does NOT constitute financial education. Grow up and read a few books (some even appear on the sidebar of this blog). Today's situation bears no resemblance to the 1930's and therefore dealing with it requires a completely different course of action.
Let me put it this way: it is you elected (at best) ladies and gentlemen that have previously set and/or allowed the financial Navy Seals to wreak havoc upon the population at large. And now you ask us to scrimp and save to make matters right, while allowing the demolition goons to keep their toys? In the immortal words of Brigadier General McAuliffe during the Battle of Bastogne: "NUTS". Or, if you prefer a more Continental reference, from Waterloo: "MERDE".
I have more to say, but this is a family-oriented blog so I'll stop right here before Good Housekeeping removes their Seal of Approval...
I have mentioned this in the past, but given current events it bears repeating: Credit Default Swaps (CDS) are instruments that do much more damage to the "real" economy than good. Beyond more esoteric reasons, there is a very simple observation; in previous downcycles bankruptcies acted to "re-boot" the economy through debt destruction. Once the obligation was written off, it disappeared for good and did not encumber the economy - as a whole - any further.
That's no longer the case because the existence of CDS's means the debt obligation stays in the system intact, even though it may no longer be the original debtor's obligation but encumber the CDS issuer/writer. In fact, with multiple contracts having been written against a single issuer or index the total obligation is multiplied several-fold.
Result? No easy and fast catharsis through crisis, one of the most valuable aspects of market capitalism.
According to ISDA, the derivatives dealers' association, there were $54.6 trillion (yes, with a "t") of CDS outstanding globally as of mid-2008, a slight decline from $62.2 trillion at the end of 2007, but up almost 100-fold from just seven years ago. And if I hear the argument "it's only notional" once again, I will very casually say two words: counterparty risk. And it's not as if I haven't been screaming (almost obscentities) about them for the past two years...
Mark my words: there is more to this crisis that has not fully unfolded yet.
The US government announced that it may take ownership stakes in banks in order to promote lending. What exactly are they going to do, call out the Guard to round up the good citizens, frog march them to the bank and force them to take out overdrafts at the point of a gun? How incredibly, unfathomably short-sighted... Can't these people see past their noses? (No, in fact they cannot).
Rule one of finance (amongst many such number ones): never let them see you sweat. And the entire US banking/finance/government establishment is sweating so much that it is drowning the whole world in their worry.
Take Mr. Bernanke, for example: he's expanding the Fed's actions on a daily basis - to no avail. He has entirely misdiagnosed what is happening as a severe, but transient crisis of confidence that can be overcome by piling on more and more government debt. In fact, however, we are at the starting point of a deeper, wider and radical transformation of the global economy, one that will ultimately lead us away from the faux riches of Permagrowth and towards a more sustainable future.
Finance as practised in the last 30 or so years has no place in this brave new world. There is no room - or any need whatsoever - for chop-and-shop LBO strippers, asset pumpers, market operators, derivatives designers, financial engineers... No, this gallery of rogues has seen the end of their days. Instead, relationship finance will fast make a comeback, if only because the manufacture and placement of unprovenanced securities to faceless "investors" is no longer possible. From now on real investors - the only ones still left standing - will ask for every detail and reason behind their potential investments.
And the market knows... The collective wisdom of millions acting in their self-interest has ground market prices of old-style financial companies into dust. That's no coincidence and no "crisis", either. It's the most obvious sign that the Pony Express is no more... And like all major turning points there will be plenty of opportunity for those with foresight, once the dust settles.
First, the net issuance of corporate bonds has plunged 77% from the high reached in 2007. A lot of the decline can be accounted by the total seizure of the mortgage market and the related products (CDO's, CMO's, etc.).
But it is the next chart I find more interesting. Equity proceeds, i.e. IPOs and secondary offerings, were running negative since 2004. Repurchases, LBOs, etc. were removing equity from the economy very fast. The process reached a dizzying peak of -280 billion dollars in the last quarter of 2007 alone, meaning that equity was being removed at a pace of $1.12 trillion per year! This fact alone was enough to account for the puzzling behavior of the stockmarket - until recently.
Well, what a difference a year makes... net equity removal is now down -71% from the peak and pretty soon I expect the process to reverse. Or, actually, I expect that very little activity will be taking place in the takeover/LBO/private equity business for the next couple of years. The plunge in oil prices is rapidly removing a main source of funding from those guys, i.e. oil money.
Replace "banana" with "deflation" these days and the joke is not so silly any more. Prices for a variety of assets and commodities are plunging almost uncontrollably now, raising the very real prospect that we are in for a long, drawn-out period of deflation. Just look at real estate, stocks, crude oil, industrial metals, agri commodities... everything is well off the highs reached a few months ago.
There is a plethora of charts around, but I find the one below particularly illuminating. It shows that shipping rates for dry bulk cargo (e.g. coal, sugar, salt, iron ore, fertilizer, etc) have collapsed by almost 50% in the last few months. Shipping is a very competitive, free-wheeling global business with minimal regulation, so what happens there is a good indicator of actual conditions in the "real" economy.
Obviously, then, things are rather serious in the "real" economy. In a nutshell, the current crisis is destroying debt (a.k.a. money), which is perforce lowering all prices. The silliness of policymakers the world over is that they keep acting to artificially prop up asset prices, via replacing private with public debt. That's a remedy straight out of 1930's Keynesian economics, but it won't work because it can't work. There's simply way too much debt out there, compared with current earned income.
What to do? It's quite simple, really: let the debt fail and thus free the vast majority of the people from a big portion of their onerous obligations. It's going to come to that sooner or later, so better make it sooner and get it over and done with. Oh, and keep in mind the social pyramid of debt: comparatively few people are going to get hurt when debt fails. - the very wealthy. The wealth disparity has never been greater in the West, at least in modern times..
Yes, I know this is exactly opposite what Dr. Bernanke, the supposed expert on the Great Depression, advocates. But he and Secretary Paulson are dead wrong. Like all failed generals, they have prepared for and are fighting the last war, instead of the current one.
Some people who read and comment on this blog ask what is my "solution" to the most crucial problem of our economy: too much debt vs. low earned income. I thought I had provided a broad outline, but let me now present a more comprehensive one.
A few initial points:
First, let's agree that this is theproblem. That's not as self-evident as you may think; for example, most denizens of Wall Street and Washington (and many other financial centers and capitals) strongly believe that the root cause of the current crisis is low asset values, e.g. low home prices. This is evident from their actions thus far, which are all directed at supporting asset prices. This knee-jerk reaction also saves their own bacon from being thrown onto the sizzling skillet. (How very convenient..)
Assuming you agree that this is the fundamental problem, the solution becomes obvious: we must reduce debt and/or raise earned income. Ideally we should do both concurrently in order to restore balance as quickly as possible.
In close parallel, let's also agree that we are reaching the limits of our current energy-intensive, growth-at-all-costs socio-economic model; indeed, I strongly believe we have already exceeded them. In some ways, the tremendous expansion of debt vs. earned income proves this point: debt has allowed us to keep consuming, borrowing from tomorrow that which we cannot earn today.
Therefore, the "solution" - what I term "The Alternative" in this post's title - must perforce involve a fundamental, structural shift in our socio-economic structure. There are already abundant hints around that many people "get it": several countries (e.g. Germany) are rapidly shifting to sustainable energy sources; organic/bio food and other consumer goods are gaining ground fast, not only because they are healthier, but also because they are economically more sustainable. Popular media are increasingly focusing on such issues.
If you agree to the above (and you certainly don't have to), let's move on.
We are presented with:
A problem: too much debt vs. income and,
A need: to transform our Permagrowth society into a more sustainable one.
Thus, we are presented with the opportunity to use the process of satisfying need (2) to also solve problem (1), i.e. (1) + (2) = (3)....=>
3. The process of socio-economic transformation can create millions of well-paid jobs in the technology and manufacturing sector, plus all the ancillary areas like education and servicing, and it will do so for decades. A crucial key is localization and distributed production of goods and services, i.e. a return of the "local" vs. the "global" economy.
Globalization may remain a factor in some sectors, but distributed and localized production of energy, commodities and manufactured goods means it will recede as a broad force shaping the new era.
The exact policy details need to be worked out as we go along, but it is significant to note that such mainstream popular policy shapers as Thomas Friedman are already jumping on this bandwagon. His new book is called Hot, Flat and Crowded and advocates exactly such a solution. I feel vindicated, to say the least...
The government's actions to forestall the debt crisis have gone from bad (shotgun marriage of Bear Stearns to Morgan), to worse (nationalization of Fannie and Freddie) and now dto ownright hilarious. Those Beltway Bozos are effectively planning to nationalize the entire US mortgage market (conservatively put at some $11 trillion) - hello!!? Pretty soon we'll all be saying "a trillion bucks just ain't what it used to be".
You said how much???
I can truly understand the visceral revulsion of all politicians, Americans and others, to even a whiff of deflation. The Great Depression has left an indelible mark on everyone, including its most ardent student, Mr. Ben Bernanke the current Fed Chairman. But is throwing more money at everything that is gridlocked the proper way to resolve the current problem?
In a word, no. Our fiat money is nothing but debt, so issuing even more of it obviously does not deal with the root cause of the crisis, i.e. too much debt vs. earned income. In promoting the $700 billion plan Messrs. Bernanke and Paulson are merely reacting in knee-jerk fashion, instead of engaging in more thoughtful analysis and proper action. They are just furiously dancing the old-time Wall Street fandango: all flash, little substance. Keep the money moving around as fast as possible and hope most good citizens get dizzy and confused and finally decide to go home to watch I Love Lucy.
