Friday, October 31, 2008

Our "Trailers"

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 They are stuck in an outdated growth model, quite obviously at odds with financial, environmental and geopolitical reality.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 economic Luddites.

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?

Monday, October 27, 2008

Fed To Cut Rates... And??

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:
  • The Greenback.
  • 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..

Saturday, October 25, 2008


What do the following charts have in common?
  • A chart of collapsing bulk carrier shipping rates, showing an over-the-cliff plunge of over 90% for the largest Capesize vessels.

Bulk Carrier Rates (Chart from: Dryships)

  • 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.

Thursday, October 23, 2008

Don't Buy This Book (Not!)

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.

Whatever You Think, Think The Opposite is written by Paul Arden, a former executive creative director for Saatchi & Saatchi.

Here's an excerpt, apropos of Messrs. Greenspan, Paulson, Brown, Sarkozi, :

"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."

So: Don't Buy This Book, will ya?

Wednesday, October 22, 2008

A Note For Readers

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...

Food And Drugs

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.

Monday, October 20, 2008

Those Dirty "D" Words

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...

Wednesday, October 15, 2008

The End Of The Debt - Asset Economy

Start with a few simple truths:
  • 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.
  • 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

Monday, October 13, 2008

What Next, Knee Jerks?

(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...

Friday, October 10, 2008

Designed To Fail

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.

Thursday, October 9, 2008

Brave New World

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.

Wednesday, October 8, 2008

Two Charts

The Federal Reserve of NY publishes the following two charts in its National Economic Indicators series.

  • 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.

Tuesday, October 7, 2008

Knock, Knock

Remember the old, silly schoolboy joke? (I'm showing my age here...)

"Knock, knock"
"Who's there?"
"Banana who?"

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.

Dry Bulk Shipping Rates (Chart: Dryships)

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.