Friday, September 23, 2011

Debt 4 More Debt Is 4 Fools

A full four years after the debt crisis raised its ugly head as a sub-prime loan snafu, it has morphed into a "sovereign debt crisis".  And how could it not, since what intervened since then was basically a debt swap.  The private sector could not borrow furiously any more, so the government(s) stepped in to take over as the Permagrowth/Permadebt locomotive.

Private Sector Debt: Financial (red), Household (blue) and Corporate (green)

Debt of The Federal Government

In the United States the Federal Reserve printed money with gusto to buy Treasuries, and mortgage securities that no one else would touch.

M2 Money Stock Annual Rate of Change (%)

U.S. Treasuries Held by The Fed

Mortgage Securities Held by The Fed

In plain words, the only reason that the U.S. (and global) economy did not go into a full-fledged deflationary spiral  was the printing press and Ben Bernanke's helicopter.

But, like all not-so-very-good things, this too must come to an end;  and this time the locomotive is racing towards the end of the line and the hard brick wall known as  "the sovereign debt crisis".

Three or four years ago I said that a mild deflationary approach, a small dosage of a bitter medicine judiciously administered would be better than revving up the monetary helicopter: just a touch of Andrew Mellon's "liquidate and purge" , instead of a gross misapplication of Keynes's governmental stimulus.  It was counter-intuitive, yes, but along the time-tested lines of don't fight the previous war.

Obviously, it didn't happen, with governments (mostly the US and some of the EU) choosing to fight the private debt crisis with... even more debt of their own.    

As this blog's masthead warned, the result was as predictable as mud after a rainstorm.  The world now has no more appetite or capacity for even more dubious sovereign debt.  There's no one left to borrow or lend in such huge amounts, necessary to keep the Permagrowth/Permadebt model going, and the locomotive itself is in clear danger of being swept under the mud.

4warned we were, alright, but we thought we could a4rd to 4get the hard lessons of history, so now we are becoming fodder 4 fools.
4 shame...

Monday, September 19, 2011

Debt and The Second Law

A very short post today.

Debt is a call on future earnings, i.e. it presumes there will always be economic "growth" (however you may define it) in order to produce those future streams of income which will service the debt.  This is a condition I have called "Permagrowth".

But is it possible?

In the "real" world, where physical fact always trumps populist monetary neo-theology, Permagrowth is impossible by definition.  The Second Law of Thermodynamics reigns supreme, i.e. there is no perpetual motion machine - and can never be.

The entropy of the universe tends to a maximum is the "classical" expression of the Second Law, so I come up with a corollary: as the universe always tends to disorder, so debt always tends to default.

In other words, since Permagrowth is impossible so is Permadebt.

P.S. My blog is getting the attention of "comment advertisers", i.e. advertisers who hawk their wares under the guise of "I love your blog" comments.  Par for the course, of course, and I usually quickly clean up the comment section.  What is interesting, however, is that lately they are hawking gold, gold market tips, etc.  Nice contrarian signal, in my opinion.

P.P.S. Speaking of such ballistic charts, in a post four years ago (South Seas and China Seas) I posted the following chart, comparing the famous South Seas Bubble with the price of a (then unnamed) shipping company.

I did not mention the name of the company at the time because I felt it should not be singled out in what was, after all, an industry-wide bubble.  Nevertheless, some readers immediately identified the company as Dryships, a bulk-carrier shipping company.

Four years later, this is what happened.

Other than self-congratulation, my point is pretty simple: beware of all bubbles, no matter how "logical" they seem at the time.  In fact, the more "logical" they appear the closer they are to bursting.  The devil, as always, is in the timing, of course...

Tuesday, September 13, 2011

Germany's Choice

Germany is the world's #2 exporter, very close behind China.  In 2010 it exported a total of 960 billion euro, amounting to 42% of its GDP.  Its trade surplus came to 153 billion euro, almost 7% of GDP.  Impressive stuff, no doubt, and an achievement that Germans are justly proud of.

But, not all surpluses are created equal... 35 billion of that surplus, a whopping 23%, was accounted by just four countries: Italy, Spain, Greece and Portugal.  Yes, to a very large extent the PIGSs' munching at the trough was what kept Germans working in their factories.  And if you just add France, another country that is currently screeching towards the borderline of fiscal probity - at least according to financial markets - the numbers get even more interesting.  Germany's PIGS+F trade surplus jumps to 64 billion, a full 42% of Germany's entire trade surplus. In GDP terms (trade surplus is GDP-additive), PIGS+F surplus accounts for nearly 3% of Germany's economy. 

Germany Slurping With The PIGS

However, short-sighted and haphazard German talk of harsh reprisals are turning the country's best customers into pariah states.  Recently, a German politician even proposed that eurozone members that can't get their fiscal house in order, raus!, should have their flags fly at half mast at all EU sites.  Germany is not making any friends acting in this ham-fisted fashion.

Ah, you may say, Germany doesn't need to coddle dead PIGS anymore and can just export wonderfully advanced stuff to super-charged China. Really?  Germany had a whopping 23 billion trade deficit with China in 2010.

German people have a very serious choice to make here, and Mrs. Merkel is furiously waffling instead of leading and speaking clearly.  From one side of her mouth she's insisting that she's fully committed to the euro, the eurozone, etc.  From the other side emanate dire threats of bankruptcy, default, exit from the eurozone - even the EU itself, all directed at those very PIGS whose consumers are keeping her countrymen happily and gainfully employed.

She's got to tell Germans the truth, at long last: Germany is such an export powerhouse and fiscal icon precisely because the others aren't.  It takes two to tango, Mrs. Merkel...

Saturday, September 10, 2011

The Joe Engineer Indicator

Sometime ago I attended an alumni gathering arranged by my old college's Provost. Since he was making the effort to come such a long way I figured I had to go - plus it was good to see old friends again. The reason for this post, however, is not to share maudlin reminiscences (well, maybe a little..).

By way of background, my alma mater was a very competitive place, priding itself of creating "well-rounded" engineers by demanding grueling study and constant testing. Despite the rigour, or perhaps because of it, there was a Marines-like esprit de corps about the place, with few students choosing the easier science and management programs, also on offer. If any less-dedicated students managed to survive freshman year, they were hit with a sophomore year so outrageously demanding that a quarter of the incoming class dropped out. The campus store did a thriving business selling t-shirts with TEXUX emblazoned on them (no, it's not about Texas - phonetic accent is on the "U").

Did I say The Marines? An understatement. The faculty and staff were most aptly comparable to the Spanish Inquisition: you could choose between being converted into Joe Engineer or burning at the stake. On occasion they managed both: the very first student to ever graduate with a perfect 4.0 GPA did it 110 years after the school was founded.   He was actually my classmate and during graduation ceremonies some faculty members were so disappointed at the apparent laxity they grumbled the place was going to pot...

Not that we expected anything different, mind you. The very first thing they told us during freshman induction was: "Look to your left, look to your right - four years from now, one of you won't be at graduation". And they were not sad or ashamed about it, either.  Oh no, those SOB's were proud if not downright gleeful of their abilities to wean us out mercilessly. It was considered perfectly acceptable to hold mid-term exams on the very first day after spring break. While others hit the Florida beaches, we were expected to hit calculus.

You should have a pretty good picture of the place by now as it was some 30 years ago: Engineer Boot Camp. If you still think I'm exaggerating, how about this: the Dean of Students had the habit of patrolling the dorms at night in the company of a huge dog trained to sniff out controlled substances.

 Not A Pet, Tech-nically Speaking

Under the circumstances, my showing up for the Provost's alumni dinner could be better explained by the Stockholm Syndrome...

Imagine my surprise, then, when during the after-dinner presentation the Provost put up a slide showing that most seniors last year (35%) found jobs in.... finance. You could have pushed me over with a feather, because when I graduated my interest in financial markets - and eventual employment at an investment bank - were considered heresy. For many years I was the only member of my class to be employed in finance: almost exactly 0.35%. Go ahead, do the 100-to-1 math, because that's a darn good parallel to the financial and credit cycle from bust to bubble. Though the Provost came to the school years after my graduation and thus did not know me at the time, he called me a "pioneer" during the dinner. I guess I was flattered.

Funny thing is, lately I'm becoming increasingly interested in all things technical. You think...?

Am I a living, breathing Joe Engineer Contrarian Indicator? Could be...

Message To ECB: Why Not Sell CDS, Instead?

With the European debt crisis threatening to tear apart the very fabric of the EU itself, here's an idea (a weird one, I admit).  Instead of buying Italian, Spanish, Greek, etc. government bonds, the ECB could sell the equivalent sovereign credit default swaps (CDS).  

Greek CDS Soar

Yes, it means that the central bank will - in effect - guarantee the public debt of such nations, but it will do so only up to a defined limit (the amt. of CDS sold).  The benefits, beyond the immediate de-escalation of the crisis, are:
  1. The ECB does not balloon its balance sheet.
  2. No money supply issues (no sterilization needed).
  3. Much bigger bang for the buck through the use of derivatives.
  4. The ECB receives income for the protection sold.
Mr. Stark's resignation yesterday from the ECB board makes it clear there is sharp disagreement within the eurozone itself on how to handle the debt crisis - fair enough.  But this doesn't mean that things should be allowed to spin out of control.  In such times markets are guided 99.9% by psychology (fear) and cannot be allowed to wreck the entire European socio-economic structure, put together over so many decades.