Thursday, February 26, 2009

Unintended Consequences

I was going to post about "Green" today but this came up yesterday and is highly topical to what is going on right now.

Deflation is being writ larger and larger, and it is showing up beyond the narrow confines of the credit crunch in banking, finance and real estate.

Spain's Santander Bank - one of the world's largest - needs to raise fresh cash to shore up its balance sheet after suffering huge losses in mortgage lending. It is, therefore, offering to sell its 31.6% stake in CEPSA, Spain's second largest oil company. Nothing odd, so far.

But the (shocking) news is that it is offering to do so at a huge markdown: a range of 30-35 euros per share, versus a closing price of 67 euros just three days ago. That Santander has to provide a monstrous 50%+ discount for a crown jewel unrelated to finance is most assuredly a rude wake-up call. At least for those who still view generalized deflation as unlikely.

Ring, Ring - Deflation Calling

Well, ring-a-ding-ding..

Long-time readers may remember this post from March 2007 about the Spanish developing vacation real estate in even the most unlikely places (excerpt follows).

"I was in ... (south Spain)... a few months ago and I can confirm that the whole Costa del Sol, from Gibraltar to Almeria (about 500+ km), is one giant vacation construction site, with El Cheapest attached condominium projects machine-gunned from the water's edge up to the hills. We are talking, up one hill and down the other. I saw the saddest excess at Carboneras, at the far end of Almeria province, a grungy but laid-back factory town still undeveloped by comparison to, say, Estepona. Just around the corner (and down-wind?) from the huge, smoke-belching cement factory they are building this enormous "luxury" vacation-condo complex, having hollowed out an entire hill."

Here is a picture from another monstrous complex, under construction just north of the same factory, which I just found in Google Earth. The word "rape" - environmental and financial - does not do justice to what went on there.

Building Prosperity in Spain - a posteriori

I believe the sound of toppling deflation dominoes can now be heard clearly by everyone. Can anything be done to stop them from smashing into each other? The US and EU are trying, furiously creating new money (i.e. government debt) to replace the "liquidity" being drained away by the swift and merciless process of debt destruction. In this way they hope to shore up prices of all manner of assets, from homes in California to factories in Dalian and charter-less bulk carriers riding their anchors.

It all boils down to one objective, one fervent desire: Let's keep the Permagrowth Party going.

I will say it once more: Before it's too late, before untold trillions are wasted on supporting yesterday's corrupted and corroded "borrow-spend-inflate" economic structure, let's instead invest heavily in our (and our children's) Sustainable future.


  1. santander has subprime exposure in the u.s. and uk, plenty of lending going on in south america on top of their own spanish bubble. bear in mind that their commercial loans in spain are their bigger problem, not local residential lending: most vacation homes were financed by dutch and uk banks from where the buyers have been coming.

  2. This is just anecdotal, but anyway...
    I remember being in Malaga more than 15 years ago, in time-share heaven, with all of that disgusting beach front construction, with depressed Brits in little havens like the one described here drinking from dawn to dusk.
    It was SO depressing. So cheap and tawdry.
    I will not be unhappy to see this bubble burst.

  3. Karl Denninger has a post suggesting the source of the deflationary pull which also reinforces my impression of how Asian creditors will/are reacting to getting stiffed; they take it alot more seriously:

  4. The US and EU are trying, furiously creating new money (i.e. government debt) to replace the "liquidity" being drained away by the swift and merciless process of debt destruction.

    Government debt is not new money. It's existing money borrowed at interest.

    Admittedly, central banks "print" some money each year. But that printed money is a small amount compared to private credit creation and generally follows growth in the economy, it doesn't lead the economy. Short term fed liquidity schemes are not printing.

    If the U.S. embarks on a printing wealth scheme, the dollar franchise will be permanently impaired and the global economy will be turned upside down.

    Threatening to print or allowing a perception of printing IS an option. Actual printing is NOT.

  5. mab, you are wrong. Nobody prints money - ever. A nation's Treasury department sells a bond and credits their central bank.. who then does what they want with it. "Printing Money" (aka increasing the M0 money supply) is one of the options. TOMO/POMO are other options. Further QE is yet a third set of options. But the essence of the fact is that money is created through issuance of DEBT first, not by simply calling up the Denver mint and having them run the quarters machine full-out.

    Printing money, in and of itself, does not (and cannot) happen - that's inflation instantaneously because the demanded yield on the very next Treasury bond sale kicks up to cover the amount printed. You may be able to fool CNBC, but you can't fool the bond traders.

  6. Unsympathetic,

    You are incorrect. When the fed issues federal reserve notes against treasuries it is printing. This happens every year at every Western central bank. Fed notes do NOT pay interest and therefore they are not a bond or debt by any reasonable definition.

    Where do you think inflation comes from????

  7. Zero percent, instant maturity bonds.

    "Where do you think inflation comes from????"

    Inflation can come from credit creation. I thought there should be no doubt about it by now. When a bank gives my neighbor 1 million dollars loan to buy a fixer upper, all fixer uppers in my neighborhood instantly go up in price to 1M. Then some others borrow home equity from them to buy Hummers and Escalades. That inflates and sustains the prices of Hummers as well. The whole process described above had not a single dollar of money printing involved.

  8. Unsympathetic,

    One more thought:

    You may be able to fool CNBC, but you can't fool the bond traders.

    Really. Over the past ten years bond traders were selling treasuries, primarily to foreigners. Rather than buying treasuries for themselves, the bond traders were buying RMBS, CMBS, High Yield and Distressed.

    Good thing the bond traders are so smart and can't be fooled!

  9. Greenie,

    Inflation can come from credit creation. I thought there should be no doubt about it by now

    Short term inflation can and does come from credit creation. Not in the long term though.

    The world had no sustained inflation for a 1000 years. In fact, outside of periods of war, cost of living declined over time.

    Inflation is a policy choice.

  10. Mab wrote:

    If the U.S. embarks on a printing wealth scheme, the dollar franchise will be permanently impaired and the global economy will be turned upside down.

    Threatening to print or allowing a perception of printing IS an option. Actual printing is NOT.

    They will be forced to print or default. Those are the only two choices going forward. One or the other will happen before Obama's first (and likely only) term is up.

  11. Amen to your last two paragraphs Hells! However, me here modestly is beginning to suspect that it's human nature to strive for the permagrowth model (with a touch of greed added to the mix), so these fools in high office will probably never get it, much less collectively.

    Regards, keep up the excellent writing and insight. Your blog is a daily must read!

  12. Money today is created solely through debt creation, so when people stop borrowing and or paying back debt without renewing it, the whole system comes to a halt. Only solution is for a Gold or otherwise (Greenback) backed system and money would of course be created much slower, of course economic growth would be also less, but it would be stable. Without these huge boom, bust scenarios.

  13. So sad. Spain is such a beautiful place. Love the blog! Keep up the great work.

  14. H,

    I accept your premise about the need to go 'sustainability', but this will also require a fossil fuel input, which will have to be less and less each successive year. Less economic activity = less surplus = less ability to service existing debts (absent defaults)= social/political problems. Sustainability is not an endless piece of polymerized ethylene - its not a nice place to go, but go we will - by choice or by coercion. Those who have the 20:20 to observe history will know the direction, but not the destination. The 'selfish and adaptable' gene will survive.

    Brian P

  15. The lyrics to Carole King’s 1971 "It's Too Late" run incessantly as I read this blog; with some tweaking (nod to songwriters Carole King & Toni Stern):

    Stared at charts all morning just to pass the time;
    there's something wrong here there can be no denying;
    one of us is changing,
    or maybe we just stop trying;

    And It's Too Late, Bernanke
    now it's too late;
    though we really did try to make it
    Something will slide
    and slide, and slide;
    ...can't fight it,
    we just can't fake it,
    oh no no no

  16. Debt is inherently deflationary.

    The dirty culprit in this nasty cycle is debt. Debt creates artificial demand. Artificial in the sense that we only temporarily have this extra demand. We are borrowing this demand from tomorrow and sooner or later - the debt has to be paid back with interest.

    As with all cycles you can expect the dip to roughly equal the spike. Perhaps not in time limits but certainly in scale...and on the deflation side even more so due to the interest component.

    There are only two ways "they" (let's call them globalist banks) can prevent deflation: (1) is to force the people to take on more debt - won't work we've passed the tipping point of our ability to take on new debt and the trend is now to save. (2) is to print more money and get it in the hands of the people via another method like zero taxes or massive rebate checks (like $10k or more for each person)- that also isn't happening.

    The only way for inflation to get reignited is to reignite demand. That means getting actual money or increasing debt at the consumer end. All the dollars or credit in the banking "system" won't have any impact. The money has to get to the end of the supply chain and utilized for consumption of goods and services.

    Greenspan pulled off the turnaround last time by dropping interest rates below the rate of inflation. This effectively created hyperinflation as people increased their debt loads at a compounded 14.7% per year for over 7 years while wages trickled up 2.3%. Not only were people able to increase their debt loads but they also were able to extract savings via home equity extraction - on a level never experienced before ($300-$700 billion per year peaking in 2006).

    This is just the beginning...

    Here's the scenario....

    You've been loaning this person (Jake) more and more money for quite some time. Not a big deal since you create the money out of nothing. The money is created against the debt he takes on. You profit by siphoning off the interest and are a happy camper.

    Jake's standard of living gradually falls as the benefits of his labor are steadily siphoned away in interest expense. He doesn't really pay attention as its hidden in the gradual increases of the costs in the goods he acquires. Eventually it gets to the point where you are loaning Jake money to cover interest costs.

    Alarmed that your game might come to an end, you steadily lower Jake's interest costs (since the money is free to you anyways) in an effort to keep Jake producing and keep your interest coming. Jake responds by borrowing in ever increasing quantities as he is now fully addicted to debt. You remove all restrictions - accepting whatever collateral he proposes at whatever value he can assign to it.

    Finally Jake gets to the point that he can no longer keep borrowing. Jake has reached the tipping point and can no longer sustain the interest costs of his current debt.

    So the question is....Jake owes you a great deal of money. Jake is insolvent meaning he can no longer support the interest costs of the debt let alone pay you back principal.

    What do you do?

    You can forgive the debt - which could be a write off or the gift of debt free money; or

    You can seize the assets which, at any value, is still a very nice return since you created the money out of nothing; or

    You could seize the assets and put Jake to work directly for you. Jake becomes a slave to you. He keeps the assets producing and you now take all the benefits of his labor. You give him just enough to sustain himself and keep him producing.

    What is your choice?

  17. I will add my somewhat wacky comment to what I manage to understand reading post and comments.
    It strikes me that we are using the DEBT model as the predominant way in which to imagine our future, collectively, and individually.
    So, that means that our perception of time is conditioned by the way that we have translated our perception of the future into a debt model.
    I think that this endless inflation of debt (lol) is another manifestation of the way that we are refusing to pay OUR individual and collective debt to LIFE.
    In order to live, we OWE a death.
    Any solutions we find to these problems will have to take into account factors that are not purely economic, in the extremely limited definition that we have now given to the Greek "economos", the life of the house.

  18. Hell... stop the stupid hysteria about deflation. Thus far we're talking asset deflation. You can wax eloquent about deflation when we can fill a cart with groceries at the supermarket for $50, or when crude goes back to $10. Then you won't sound like some erudite arm chair economic theorist. Are you and Mish lovers, or something?