Debt Issuance: Boom to Bust

A short post today.

First of all, may I wish everyone a very Merry Christmas and Happy New Year.

Secondly, a rather interesting chart (click to enlarge) from the Bank of International Settlements (BIS) latest Quarterly Review.

Global Issuance of Debt Securities Has Collapsed

The global boom of floating trillions of new bonds in 2007-08 has - predictably - become an out and out bust this year, as the credit crisis takes a knife to the appetite for more debt. Notice that the amounts in the charts are net, i.e. after accounting for maturities.  

Despite all the talk of massive sovereign bailouts, the figures show that there is very little increase in the total amount of debt outstanding.

Debt of The Financial Sector

Here's a scary chart, one that I believe explains why the current Debt Crisis merits capitalization, and why it won't go away easily - certainly not by merely "printing" money and giving it to the FIRE sector (finance, insurance, real estate).

 USA:  Financial Sector Debt Soared Sixteen-fold Between 1952 and 2008

In a most dramatic way, the chart shows that in the United States debt issued and owed by the financial sector (banks, insurers, brokers, etc.) soared to nearly one third of all debt outstanding.  A similar pattern is observable across the entire Western economy.

The process gathered steam between 1995 and 2005 because of:

(a)  financial speculation (leverage, derivatives, etc) and,
(b) securitization of all manner of bona fide and financially engineered loans, from mortgage debt and credit card receivables, to CDS hybrids (CMO's, CDO's, CPDO's, etc).

The end result was the financial/debt/monetary bubble that burst spectacularly in 2008 - and is still bursting, since the shadow-banking bubble machine has not been shut down.

It is, therefore, highly ironic that the Debt Crisis caused by a virulent out-of-control financial sector has now infected the once safest haven of them all: government debt.  Bankers, brokers, money managers and rating agencies - whose inter-connected behinds were collectively rescued from self-immolation three years ago - now lash out at the very governments whose deep pockets (a.k.a. taxpayers) saved their bacon.

Italian Government 10-Year Bond Yield

Putting it another way, the massive expansion of finance and its subsequent collapse is suffocating the world's real economy.  We need hundreds of billions of fresh capital to invest in productive projects like energy and network infrastructure, but the FIRE sector is demanding (blackmailing?) that governments continue to dump good money after bad down a bottomless pit, one dug by their own greed and perfidy.

Of course, governments are not innocent babes in this operatic auto-da-fe.  First, they foolishly deregulated finance, a notoriously self-serving, risk-loving and cyclical business (for example, by abolishing the Glass-Steagall Act).  And then, they kept looking the other way while finance mutated and morphed into a menacing giant, albeit one with extremely weak legs.

It is high time that governments act decisively and forcefully to reverse the "financialization" of the real global economy.  We cannot survive, never mind thrive, on the "free-markets" mantras of  Wall Street and City alone.    The FIRE sector must be forced to de-leverage.

There are many ways to do this: higher capital requirements, strictures on own-account trading, transaction taxes, regulating off-balance sheet derivatives.  In my opinion all of them, and more, must be implemented.  The purpose is as simple as it is difficult: Kill the beast before it kills us.

Is There Life After Debt?

Fact: The debt crisis is global - and, yes, this includes the so-called creditor nations, such as China.  After all, in our fiat currency world it takes a debit in order to create a credit.  

The way we got into this mess is well known: the West foolishly (even criminally, if you ask me) gave up its industrial/manufacturing base and the high earned-income jobs it generated, replacing them with services and low value-added jobs.  However, it didn't lower its consuming and spending habits to balance the losses, instead it piled on debt from vendor nations, and constructed Rube Goldberg asset bubble contraptions that attempted to generate "wealth" out of thin air (e.g. real estate, derivative-based bonds, etc.).

 Anyone Still Making Anything in the US?

As the chart above shows, the process of de-industrialization is not new, at least not in the U.S. where goods-producing jobs have fallen steadily over the last 60 years, from 40% to 13.8% of total non-farm payrolls.  As a direct consequence (in my opinion) wage and salary income has dropped from 68% of total personal income to just a little over 50% (see chart below).

Earned Income Has Dropped Drastically

Consequently, total debt soared to 550% of earned income - even excluding debt of the financial sector (see chart below).

 Can The Real Economy Sustain This Debt?

This chart raises one very important question: can the real American (and Western) economy sustain its debt load, or will it collapse under it? To put it another way: Is there life after debt?

The answer to this question involves much more than quantitative easing, classical econometric ratios, or Tea Party dogma.  We must go straight to the heart of the global " Permagrowth" economic paradigm, the one we have been using and abusing for well over a century.  In this outdated and obviously crumbling model, debt and growth are intrinsically linked, one becoming the enabler for the other in a sort of pushme-pullyou perpetual motion machine.

But it can't go on. Debt is a call on tomorrow's growth - and if such growth is impossible then the debt becomes untenable. The Earth's diminishing resources, benign climate included, can no longer sustain Permagrowth, therefore we cannot repay or even adequately service the immense debt/credit loads we have created.

Yes, there is life after debt.  But it will be very different from the consumerist Shangri La we had become used to.  I believe we are headed towards a low-intensity, decentralized type of macro-economic paradigm where energy and most consumer goods are produced locally from renewable sources, and where the sociopolitical system is likewise decentralized.

The important question is this: can such a paradigm shift be accomplished relatively smoothly and peacefully, or will it take a major upheaval? I really don't know..

P.S. On the eurozone: Dear Mrs. Merkel (or is it Ms.?), when your entire neighborhood is on fire it is not a good time to argue the bad structure and poor management practices of the Fire Department.  Rather, please make sure the firemen have plenty of water and leak-proof hoses.

Ninety-Nine Percent

In the last 30 years the top 1% of Americans saw their real, after-tax  income increase nearly fourfold. And how about the "other" 99%? Look below (click to enlarge)...

One picture is worth a thousand words

The chart appears in an article in The Economist (Income Inequality in America:The 99 Percent), which includes the following passage:

...the data are powerful because they tend to support two prejudices. First, that a system that works well for the very richest has delivered returns on labour that are disappointing for everyone else. Second, that the people at the top have made out like bandits over the past few decades, and that now everyone else must pick up the bill.

Couldn't have said it better myself (and I don't frequently agree with The Economist).

The chart in The Economist article comes from a very interesting study done by the US Congressional Budget Office.  The following chart is on its cover.

The Battle For Europe

From all the news flow out there it appears to me that we are nearing a so-called "inflection" point in the European debt crisis.  After a summer and early fall of spinning wheels to no end, European leaders are faced with a stark choice: finally do something serious, or watch the entire euro structure fall apart with unimaginable consequence for the European Union as a whole.

There is a eurozone summit meeting this weekend, to be quickly followed by another one three days later on Wednesday.  If the Franco-German axis (no, I do not use the term lightly) does not reach a mutually satisfactory agreement on Greece, expanding the EFSF and bank recapitalization then the inflection will point straight down.

The Battle for Europe is, tragically, being fought by generals who are well out of their depth.  They created a continent awash in funny money and a population that for decades felt entitled to their comfortable - albeit debt financed - lifestyle. Oh yes, even the holier than thou Germans;  I mean, how else could  those "other" Europeans afford to buy millions of BMWs, Airbuses and Miele washers exported by Germany if not through debt?  It's not as if Kalamata olives or jamon Serrano have much value-added, after all. And vacations in Terremolinos, Rhodes or Costa Brava are on perennial all-inclusive, cheapest-is-best  offer...

 Let's Hope It Doesn't Come To This, Again

Europe desperately needs a whole new cadre of strong and decisive leaders who will turn things around.  Maybe the current ones will see the light and pave the way for them by gracefully bowing out, after taking whatever steps are necessary right now to forestall implosion. But, I'm not holding my breath..

SNAPpy? Surely Not.

I occasionally look at the US Dept. of Agriculture data on food stamps (now called Supplemental Nutrition Assistance Program - SNAP) because, in my opinion, it provides a much better "on the ground" feel of the real economy.

It certainly doesn't look snappy.

Data: USDA SNAP

As of July 2011 a record one in seven Americans, or 14.5% of the country's entire population, was receiving food aid.  That's far above the 9% mean over the last 30 years.

Steve Jobs

Steve Jobs, the co-founder of Apple, died yesterday, age 56.  He was one of those very few people who changed the world for the better and who will always - and uncommonly - be remembered with admiration and fondness.

Have a Beautiful Trip Steve

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...

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...

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. 

Data: Federal Statistical Office

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...

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.

It's Time To Tax

The following story appeared in Reuters and made my stomach turn.

Some U.S. firms paid more to CEOs than taxes: study

 Here's an excerpt:

"Compensation for the 25 CEOs with pay surpassing corporate taxes averaged $16.7 million, according to the study, compared to a $10.8 million average for S&P 500 CEOs. Among the companies topping the IPS list:

* eBay whose CEO John Donahoe made $12.4 million, but which reported a $131 million refund on its 2010 current U.S. taxes.
* Boeing, which paid CEO Jim McNerney $13.8 billion, sent in $13 million in federal income taxes, and spent $20.8 million on lobbying and campaign spending
* General Electric where CEO Jeff Immelt earned $15.2 million in 2010, while the company got a $3.3 billion federal refund and invested $41.8 million in its own lobbying and political campaigns.

Though the companies come from different industries, their tax breaks fall into two primary areas.

Two-thirds of the firms studied kept their taxes low by utilizing offshore subsidiaries in tax havens such as Bermuda, Singapore and Luxembourg. The remaining companies benefited from accelerated depreciation."

I can fully understand Warren Buffet's call for more (and better structured) taxation.  And how else can the U.S. ever get out from under the massive debt pile?

Look at the chart below.  If we merely revert to more historically "normal" tax receipts as a percentage of GDP (excluding social insurance which is a completely different issue) the extra revenue will come to some 4% of GDP, or $900 billion per year.  The federal budget deficit in 2010 was $1.17 trillion.

 Chart: The Big Picture

US Tax Revenue as a Fraction of GDP by Component

The Eurozone: A Family Snapshot

Given what is going on in the eurozone at the moment, I thought it would be nice to have a snapshot picture of it, circa 2010.

 Data: Eurostat (2010)

Ninety percent of the Eurozone's GDP is produced by just seven countries

Before you reach Greece, number 8 on the list with a mere 2.5%, you are already up to 89.99% of total GDP.  That is to say, the "black sheep of the family" is a relative spiffle and its fiscal troubles should have been dealt with firmly and - most importantly - FAST.  It didn't happen, so the debt crisis has been allowed to fester and spread, threatening to become a serious systemic issue for the entire European Union.  A huge mistake for Europe's leaders, particularly Frau Merkel and Monsieur Sarkozi who should have known better.  Much better.  

After the collapse of the USSR and America's Bush II, it seems that it is now Europe's time to go through its very own Era of Total Ineptness.

History is a harsh mistress whose cycles shall not be disturbed, indeed...

Sudden Debt Redux: Where Are We Now?

Sudden Debt was started five years ago warning of excess in debt, asset bubbles and the end of the "Permagrowth" model.  Today, some of the most egregious excesses have been reversed or at least arrested after wrenching and painful adjustments to the real economy.

Here are some relevant charts (all apply to the United States).

• Total debt as a percentage of GDP is still extremely high, but at least it has stopped growing.

 

• The debt service ratio has come down significantly, mostly through rock-bottom interest rates engineered by the Fed.

• The personal saving rate is rising, even if only slowly.

• Residential real estate, the biggest bubble of them all and Mr. Greenspan's biggest mistake, has burst spectacularly.

The charts above tell me, at least, that the Permagrowth model of the US (and global) economy is finished and must be replaced with something entirely new.  I simply cannot imagine that we will just roll over and once again start pumping the same old bubbles of consumption, debt and real estate as remedies for "low growth".  History teaches us that it can't be done: once a bubble is burst it stays burst for a long, long time and any attempts to re-inflate it ends in wasted time and resources  (Just look at Japan..).

What we need, instead, is a paradigm shift.  My choice is to focus on raising earned income and savings,  investing the surplus in renewable energy and resource management, basic R&D and technical education.

Gold vs. Debt and GDP

Continuing a bit from the last post's subject, here's another comparison between gold and US debt: The value of the entire amount of gold in existence in the world vs.  total debt of the USA (a proxy for global debt), and global GDP.

According to the World Gold Council there were a cumulative 169,100 tonnes of gold mined by the end of 2010, all of it still in existence since gold practically does not degrade, react, corrode, etc.   At the recent high price of $1,800/troy oz. its total market value was $9.8 trillion, or 16% of global GDP.

Using data from the Federal Reserve (US debt) and the US Geological Survey (annual global gold production) I come up with the following chart.

The value of gold is essentially a psychological phenomenon, since it has very few tangible uses. At 15% of global GDP, up from 5% just six years ago, it seems to me like it is discounting a lot of panic (the euro will fall apart, the West will inflate away all of its debt, the US will devolve into a second-rate power, etc. etc.).

They Are Scared Witless..

In this post's title "they" are speculators/investors (are there any true investors left in this world, I wonder?) and "witless" means exactly that: they have taken leave of their wits (assuming they had any to begin with, of course).

Proof? The following charts, showing:

(a) The price of gold soaring to new highs, apparently discounting a heavy bout of inflation in the future and,

(b) The yield on 10-year US Treasury bonds crashing to near new lows, apparently discounting future deflation.

Gold Flying High

10-Year Yields Collapsing

It stands to reason that this situation is untenable and can only occur when speculators are very, very scared, running about like chickens with their heads cut off.  I am a long-term investor myself, a natural-born contrarian bent on spotting exactly such nonsensical divergences.

Markets always provide tremendous opportunities to level-headed contrarians at two nexus points: bubble bullishness and panic.  Characteristic to both is the absence of common sense, observable and easily calculated by simple arithmetic (ratios are as far as you have to go).

For example, the ratio of gold price to 10-year yields stands now at 776 (it went as high a 850 a couple of days ago).  Just three years ago it was at 210...

The witless in search of "safe" havens, indeed...

As The World Burns

Well, now it's official:  The Debt Crisis is global.  But what lies at the heart of it? What are the economic fundamentals which have created it?

In a word, "China".  Oh, I don't mean that China as a nation is at fault, that it is to be blamed for the profligacy of Western consumers and their politicians' astonishing inability to lead, predict or - at least - to react properly.  No, I use "China" as a label for our present borrow-spend-inflate assets economic paradigm

In the last couple of decades we in the West have moved a huge portion of our manufacturing to China and become junkies of debt-financed ultra-cheap goods.  Said finance provided by China, of course.  It doesn't take a PhD in economics to spot the imbalance, of course.  As I have said many times before, the Debt Crisis is not the disease but a symptom, albeit a lethal one.

What is the proper remedy?  Nothing less than a global shift in the economic paradigm: we urgently need to move away from global consumerism to local "investism" (to coin a word).  Invest in what? you ask.  Green energy, mass transport, environmental amelioration, recycling, responsible resource management - and these are just a few items that have the very real potential to create a boom in local manufacturing and skilled jobs for a very long time, measured in decades.

Think of it this way: what is more important for our own present and our kids' future?  A third (and fourth and fifth) pair of cheap sneakers, or a new solar power plant?  Another V8 4x4 monster, or a new electric railway?  A fossil-fuel economy that resembles a roller-coaster nightmare, or an increasingly feasible electric utopia?

It's time to wake up from the bad dream and get to work building our very own Utopia.

PS For my European friends: Do you seriously think you can have a common monetary policy (the euro) without a common fiscal policy? Do you, really?

L'Affaire Strauss-Kahn

Il n'y a aucune coincidence dans la (haute) finance (pronounce in French for maximum rhyming effect).

Well, well, well... the prosecution is furiously back-pedalling on its charges against Mr. Strauss-Kahn.  It seems the chambermaid is not exactly the unspoilt lily of veracity she claimed to be.  As the Reuters article in the link puts it: "Case against Strauss-Kahn near collapse".

Being in the field for over a quarter century I have learned, often the hard way, that weird coincidences simply do not exist in finance.  If it seems too good (or too bad) to be true, it is safe to bet that it's not true.  

So, let's make no mistake here: there were way too many and powerful interested parties that wanted Mr. Strauss-Kahn out of the way.  Who?  In Latin, we ask: qui bono? (who stands to benefit?).

I'm not going to bother with the obvious French presidential race political stuff.  Instead, I think it was NOT a coincidence that the European debt crisis got much worse right after Mr. Strauss-Kahn, a confirmed euro-booster, got arrested and paraded publicly in manacles.

I'll go back to watching summer sunsets, now.  But I think the summer is about to get much, much hotter from here on.

A Blast From The Past

I have been re-reading Gustave LeBon's The Crowd, the 1895 classic on the psychology of herd ("crowd") behavior.  The French social psychologist was the first to scientifically and methodically study crowd behavior outside the criminal classes.

Here are a few bon mots:

• Crowds amass mediocrity, not intelligence.
• Compared to individual persons, crowds are always intellectually deficient.
• Crowds cannot help but exhibit excessive credulity.
• When in a crowd, an individual's faculties of observation and critical ability vanish.
• Events witnessed by the largest number of people must be questioned most of all.

 I am sad to say that Hitler, Mussolini and Bernays (Freud's nephew) were fans of this book, putting it to ungodly and unhealthy use (Bernays convinced women to smoke).  Ah... propaganda, thy name is Herd.

And what do financial markets have to do with crowd behavior?  Well, actually, the proper question is: when do financial markets not have anything to do with crowd behavior?

The Land of "Miracles"

Greece... land of Pythagoras, Plato, Pericles - and more platitudes than you can shake a stick at. 

Nevertheless, here's one more from a Greek bank professional: Greece is the land of miracles.  (I'm certain he didn't quite mean it as a compliment).

To wit, ANYTHING can happen there. Here's a handy comparison from recent history.  

• First, a current chart of the 5-year CDS (credit default swap) on Greek government bonds (click to enlarge).

 Greek CDS

•  Second, a chart of what happened in the Greek stockmarket some 10 years ago.

Greek Share Prices 1997-1999

Get my point, via chart comparison?  The place is basically looney-tunes and CANNOT be analyzed or predicted in any rational, by-the-numbers method.  For clues, best dust off the psychotherapy manuals and be prepared for excess, negative AND positive.

• Third, here's how the share bubble burst after the year 2000. The "miracle" of 1999 turned into dust shortly thereafter.

Now, given the excess of emotional swings apparent above, I wonder what may happen to Greek CDS prices in the not-so-distant future?

You Call This Global Leadership?

The US government is about to be shut down in the next 24 hours over the federal budget impasse.  Here are the only numbers you need:

Federal spending is approx. $3.7 trillion, the deficit this year alone is projected at $1.4 trillion - and the politicians are squabbling over spending cuts amounting to $33-40 billion;  that's  1% of spending and 2.9% of the deficit.  You gotta be joking, right?  

Obviously they are not, so I must conclude that their heads are so deep into the sand that they are in danger of being swallowed whole into their self-made political sand-trap.  If they call this leadership on a global scale then I suggest we call in the Greeks...

You Call This Global Leadership?

It's Greek To Me

The amount of hot air emanating from Washington DC has increased exponentially as politicians are arguing about the size of next year's budget deficit, but no matter what they decide it will be, in a word, monstrous.

To illustrate just how bad things are in the good ol' USA fiscally-wise, here's a helpful comparison:

Not fair to compare the US to Greece, you say?  Correct, because the figure for Greece is for the general government, i.e. it includes all local and municipal budgets, whereas for the US it involves the federal government only.

So, yes, it's Greek to me...

How Green Was My Valley

The world is changing right in front of our eyes and politics are - finally - starting to reflect this.

In last Sunday's elections, voters in the German state of Baden-Wurttemberg elected a Green Party prime minister (governor) for the first time in the country's history, trouncing Mrs. Merkel's conservative CDU and significantly altering the wider political balance for the entire nation.  It should be noted that the state of Baden-Wurttemberg was a conservative party stronghold for 58 years in a row. The nuclear disaster in Japan doubtless had something to do with it, but I believe it was going to happen anyway. 

Germany is way ahead of every other major nation in shifting electricity generation to renewable/green sources.  In the past 25 years the entire increase in production has come from such sources (see chart below - click to enlarge).

 Chart: IEA

Germany - Going Green

So, yes, Germany's "valley" is very green, indeed.  Are the rest of us going to do something about it, or are we going to stay stuck in the past and suffer the consequences?

Oh, and if you're wondering: How Green Was My Valley is a classic film from 1941 about a Welsh coal -mining town.  From IMDb: "This story of a Welsh valley's turn-of-the-century descent from pristine paradise to despoiled coal mining region, is told in flashback form by Huw Morgan, an old man who has decided to leave the valley forever."

The World's Banzai! Moment

Banzai!: A traditional Japanese exclamation meaning "ten thousand years" (somewhat equivalent to our own "hooray!").  Often used in the context of a banzai attack, a last ditch desperate charge.

Centuries from now when historians examine our time, I imagine they will conclude it took an earthquake, a tsunami and a nuclear catastrophe for people to finally snap out of  their Permagrowth lethargy - the one  induced by rampant consumerism, excess debt and  the unchecked use of poisonous "black"  fossil and nuclear energy.  Japan may be featured as villain or angel, depending on which path it chooses to take after the current emergency is over.

Will it go green and reach for Sustainability, or will it stay black and remain blinded by Permagrowth?

First, let's look at where the country stands right now:

• Japan is one of the world's blackest nations energy-wise.  In 2008 97% of all energy supplied came from coal, oil, gas and nuclear sources (see chart below, click to enlarge). 

Chart: IEA

Japan: A Black-Energy Nation

•  Japan is one of the world's most highly indebted economies. In mid-2009 total debt stood at 472% of GDP, up from 245% in 1980 (see chart below, clock to enlarge).  The most rapid escalation came after 1990 as the government started borrowing heavily in an attempt to keep the Japanese  Permagrowth model running.  It failed, and the economy has been stagnant for years, no matter how many bridges to nowhere it built.  Importantly, most of this debt is internal and serviced from local savings, preventing outright collapse.  However, financing reconstruction after the earthquake-tsunami-nuclear disaster is another matter altogether.

Data: McKinsey Global Institute

Japan: A Country Awash In Debt

Right now, then, Japan is certainly a Permagrowth "villain".  But catastrophic events can often lead to radical change and - who knows? - in the aftermath Japan may well become a Sustainability "angel".  It already exhibits some sustainable-like elements: Japanese society is stable and technologically sophisticated, with zero population growth and high living standards.

When seen from the perspective of Permagrowth Japan is perceived as weak (e.g. no GDP growth);  but from the Sustainability viewpoint a weakness may very well be an advantage (e.g. zero population growth).

I sincerely hope that the Japanese people, justly famous for their stoicism and perseverance in the face of serious trouble,  cry "banzai!" and choose Sustainability for their reconstruction model.  If they do and succeed (which they will), it will be the entire world's Banzai Moment.

Assuming this happens, then renewable energy will be a big winner.  I recently bought some shares in FAN, an exchange traded fund that tracks the ISE Global Wind Energy Index.  Given its recent bottom-scratching performance (see chart below, click to enlarge) I think it's a decent candidate for fans (pun smile) of long-term buy-low, sell-high strategies.

First Trust Global Wind Energy ETF

Yet Another Three Sigma Event

Not all natural catastrophes are as "natural" as they appear: the mega earthquake and tsunami in Japan may be as natural as they come, but the ongoing nuclear disaster is anything but..  

What has apparently happened is that, while reactors were  properly and safely shut down after the quake, the systems required to cool down their 6% residual fission had to operate on power supplied by diesel generators which, however,  were flooded by the tsunami and immediately knocked-out.  Oh yeah, they were NOT located on high ground, the plant designers relying instead on a seawall to protect them (ask any ship architect were emergency generators  must be placed).  

Then again, such monster 10 meter tsunami waves were not supposed to happen, right..? Now, does this ring the Nuclear Hubris Bell, or what? 

(If you do anything in the aftermath of this,  I  insist it is to read and apply Nicholas Taleb's extremely appropriately titled The Black Swan: The Impact of the Highly Improbable: With a new section: "On Robustness and Fragility")

Or, does it remind us of that other three-sigma event that was also never supposed to happen?  You know what I'm talking about: the sudden collapse of investment-grade alphabet-soup bonds which were transmuted from toxic waste into "ultra-safe" investments.

Before the global financial crisis hit,  I often compared the debt and derivatives situation to a chemical (or nuclear) reaction approaching a "critical" point.  Such a reaction may proceed for quite some time without any adverse effects, but if left unchecked it can create an explosion within a split second.

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A Graphic Representation of A Critical Reaction

High debt and nuclear power have something in common: they are inherently unstable, so no matter how "robust" you try to make their containment systems they can never be 100% safe.  Furthermore, the adverse effects from three-sigma accidents involving them are obviously widespread and dangerous to the extreme.  

So, why do we keep using them?  Why do we still fuel our Permagrowth economy with Debt and Nukes, instead of earned income and renewable energy?  I shall leave the answer to others, but I firmly believe it to be a huge mistake.

Private Debt Comparison: USA v. Greece

The "Greek Debt Crisis" is once again in the forefront since the EU leaders are meeting today and tomorrow - yet again - to figure out how to deal with it and the larger issue of debt and competitiveness inequalities across Europe.  The discussion on debt, however, focuses almost exclusively on government borrowing - a mistake, in my opinion.  

Here's a chart that compares Greek and US private sector debt (households and corporations) as a percentage of GDP (it excludes financial sector debt).  Note how fast Greek private debt rose once the country entered the eurozone: it literally exploded from 44% of GDP at the end of 2000 to 111% at the end of last year.  Membership to the club had its (extremely dubious) privileges.

Greek Private Sector Debt Zoomed (excludes financial sector debt)

This debt explosion fueled private consumption and, thus, GDP growth.  Does it sound familiar?  Of course it does;  in the last decade Greece and the US went "shopping" for their economic models at the exact same bargain store: Debts 'R Us.

For another (admittedly more questionable) comparison, in the next chart I include debt of the financial sector.  It changes our perspective, doesn't it?

This Chart Includes Financial Sector Debt

Including financial sector debt leads to double counting for some of the debt (e.g. securitized mortgage loans) and distorts the picture considerably.  However, it does provide a valid warning that has to do with inter-connectivity, counter-party risk and financial globalization (think Bear Stearns, Lehman and falling dominoes).

Let's hope that Europe's leading lights (smile) figure out a solution...

Update: After pulling an all-nighter, EU leaders agreed to extend the duration and lower interest  rates on Greek loans.  More intriguingly, they also agreed to allow the financial stability fund (EFSF) to purchase government bonds in the primary bond market, i.e. when new bonds are issued. 

This appears a pretty good compromise between outright purchases in the secondary market and no purchases at all.  Properly implemented, it will:
 
(a) Provide real incentive for over-indebted countries to put their financial houses in order fast so they can go back to borrowing from the free market, benefiting from the underlying purchase support. 
(b) Convince markets there is real commitment to help eurozone countries when and if needed, but keeps the pressure on governments to reform their economies.

In other words, it's a workable combination of carrot and stick - the latter being  absolutely necessary to appease Mrs. Merkel's angry German voters who objected to outright bond purchases in the secondary market, viewing them as bailouts for profligate Greeks.

Deja Vu, All Over Again

The current situation in the Arab world reminds me strongly of the end of the Soviet Union and its Warsaw Pact allies in the early 1990's.  Though the Arabs do not have a centrally-controlled power structure like that of the late USSR, they nevertheless possess many more similarities, chief among them a reliance on a single core activity (oil vs. military), authoritarian/dictatorial regimes and enormous social inequalities.

It looks as if the Arab "Berlin Wall" is crumbling right in front of our very own eyes.  What it means for our hydrocarbon energy regime is impossible to predict.  It could be that radicals take over and attempt to hold the world hostage to much pricier oil.  Or, it could be that they pump all-out to satisfy popular demands for social goods and services, driving prices much lower.  No one really knows.

What is crystal clear, however, is that we urgently need to create to our own renewable, locally produced, stable energy sources and finally become independent of the Arab "street", as well as the Arab "sheiks".

Real Reason For Real Optimism

I'm stricken with a bad case of blog-writer's block.  It's not the first time, so I know how to get by until the spirit grabs me once more: recommend a book or two or, as is the case today, send readers to an article I find interesting.

Soaking Up the Sun to Squeeze Bills to Zero, appearing in today's NY Times, made me feel happy, optimistic and vindicated for my long-held belief that it is absolutely achievable to transition to a Sustainable Economy regime powered largely by renewable energy.

The article describes how the new 222,000 sq. ft. Research Support Facility of the National Renewable Energy Lab (Dept. of Energy) in Golden, Colorado uses a net zero amount of energy via widely available and cost-effective technologies.

But did it cost the taxpayer an arm and a leg to construct this super-efficient office building?  From the article we learn that: "Ultimately, construction costs were brought in at only $259 a square foot, nearly $77 below the average cost of a new super-efficient commercial office building, according to figures from Haselden Construction, the builder."

I'll say it once again... It CAN BE DONE.  Please read the article.

The RSF in Golden, Colorado

 

Designed to Provide Maximum Day-Lighting Throughout the Building

It's Not Game Over, But We're In Overtime

Commenting on the previous post on QE a reader asked (hat tip: shtove):  "Are you saying the Fed has managed this quite precisely - replacing lost credit with its own version, only so much and no more?"  

This is my answer:

It's not only the Fed that is "managing" this.  In fact, it's mostly the Treasury, the Chinese and the Oil Arabs who are 100% complicit in global monetary policy, even as they appear to be "mad" at the US. The Arabs are a slightly different case than the Chinese because they are one-item, one-export economies and  ruled by dictatorships, but they are not too different.  

The enormous bump in current federal budget deficits is a textbook Keynesian response to the burst bubble;  it is obviously financed by issuing Treasury bonds - and who buys them? Essentially, those with surpluses, i.e. the Chinese and the oil exporters. If they stop buying, the US economy will tank and their  own exports will come crashing down.  Simple stuff (which also explains to a great degree why Sustainability and Renewable Energy are anathema to The Establishment).

• But the bond buyers ARE getting antsy.  It's always caveat emptor, after all.   Keep this firmly in mind, because - among other things - it explains why the Chinese President got the Full Monty treatment from Obama (e.g. State Dinner at the White House), when Bush II had given him only a working lunch a few years back (what, bagels, cream cheese and Snapple?).  The Chinese Emperors  demanded deep kowtows and memories of Empires Past are once again very much alive. (But, we should remember that the Japanese had become similarly insufferable twenty-some years ago and look what good it did them..).

Anyway, to the degree that it is able the Federal Reserve is also buying Treasurys by artificially inflating its balance sheet (i.e. by "printing" money = QE1, QE2, etc.).  Obviously, it can't buy all the extra Treasurys with "funny money" because then we will get hyperinflation and the dollar will tumble uncontrollably.  It is, therefore,  imperative that the Sino-Arabs go on buying lots and lots of Treasurys.

Foreign Purchases of Treasury, Agency and Corporate Bonds

  This Is What Happened After 2000...

The financial elites in all countries involved are smart people;  far from being naive simpletons, they are 100% aware of what the game is all about.  But they have to play by the rules and they have to listen to popular sentiment (or appear to do so).  It is crucial, therefore, that popular sentiment be shaped accordingly.  Thus,  the propaganda machine has gone into high gear, with the Anglo-American financial and media communities extremely hard at work bad-mouthing the euro.  The vital purpose is to avoid serious "competition" for bond purchases and keep the money flowing into Treasurys (and gilts, to a much smaller extent).  Inundate the crowd with breathless messages about the Euro Crisis (in capitals, of course) and the job is half done.

So, let's get this straight: there is no Euro Crisis in FACT, other than the one that is being whipped up by the likes of FT, Bloomberg, Reuters, WSJ, Roubini, Rogers and The Economist. As a reader aptly said, "Greece is a sideshow". It's smoke, pure and simple, to hide the wreck of the Anglo-American balance sheets.

That's why lately I've been focusing on debunking this Euro Crisis myth. Because once that's understood to be nonsense, the REAL debt crisis becomes quite starkly clear:

THE US AND THE UK ARE FOR ALL PRACTICAL PURPOSES BANKRUPT

Continuing bond purchases by the Chinese and Arabs are masking reality, but when - not if - they stop buying, it's GAME OVER.   I don't know when this will be;  like all empires in decline, the ultimate bust may take a long time.  But we are in overtime right now and the "players" are still using the same old failed game plan.

I'll leave it at that, but in closing I wish to recommend a book that sheds plenty of light on how empires crumble from within.  In this case it's about the Soviet Union, but the lessons and implied warnings are universally applicable.

The Dead Hand: The Untold Story of the Cold War Arms Race and Its Dangerous Legacy deals with the Reagan-Bush/Gorbachev-Yeltsin era and reads almost like a novel.