Over There, Then And Now

Just in case anyone thinks the grass is greener over yonder, i.e. across the Atlantic Pond (globalization having shrunk everything in size), here is an article by The Telegraph's eminent Ambrose Evans-Pritchard to remind us that "sudden debt" was how the world bubbled its economy to the bursting point. And the consequences.

Scary read to be found here: Failure to save East Europe will lead to worldwide meltdown.

We see that "in Poland, 60pc of mortgages are in Swiss francs. The zloty has just halved against the franc." How about that? By comparison, US sub-prime loans appear almost benign and boring.

And.. "Austria's finance minister Josef Pröll made frantic efforts last week to put together a €150bn rescue for the ex-Soviet bloc. Well he might. His banks have lent €230bn to the region, equal to 70pc of Austria's GDP."

I should remind everyone that after the 1929 stock market crash the global economy seemed to hold together - for a while. It was not until 1931 and the collapse of an international bank that the entire world spun into the Great Depression. Location of said bank? Yes, Austria*.

From today's stock market perspective, however, it is troubling that we have not yet seen any significant rebound from November's lows. The market is just going sideways, in a rather tight range.


By comparison, the Dow managed a near 50% jump in 1930.

DJIA 1929-1933

Which begs the question: is today's market action discounting the past (i.e. being scared of a repeat Great Depression) or is it discounting the future (i.e. hoping for a rather swift economic rebound)? I think it is doing both, which is why it is range-bound for nearly four months. Simply put, even professionals have no idea whatever which way the market will "break" (up or down) and are thus sitting on their hands.

Think deer, headlights, truck. But will the truck hit the long-horns or the short-horns? Beats me. But there IS an alternative possibility, derived from the maxim that "the market strives to make fools of the largest number of participants possible": the truck is stopped, albeit with the lights on. Oh dear...

In that case we will just have to scrape a living by selling volatility to both long- and short- horns.

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* The Creditanstalt Bank failed in May 1931. It was closely linked to the global Rothchild network.

Short Sunday Musings: Words v. Pictures

It's Sunday and global financial markets are closed. In the absence of bid-offer gyrations the mind spins a little slower and has the chance to see things somewhat differently, perhaps more clearly. Even the qualities of light and colour are richer, more saturated somehow. Time stretches to its potential, striving to claim the full extent of space.

Ahh, perception is everything. So, here goes something about that.

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A picture is worth a thousand words, they say. How true.

The headline of the BBC story immediately caught my attention: "Global warming underestimated", it proclaimed and warned that "the severity of global warming over the next century will be much worse than previously believed."

The story continued:

"Speaking at the American Science conference in Chicago, Prof. Field said fresh data showed greenhouse gas emissions between 2000 and 2007 increased far more rapidly than expected.

"We are basically looking now at a future climate that is beyond anything that we've considered seriously in climate policy," he said.

Prof Field said the 2007 report, which predicted temperature rises between 1.1C and 6.4C over the next century, seriously underestimated the scale of the problem. He said the increases in carbon dioxide have been caused, principally, by the burning of coal for electric power in India and China."

The whole story is quite short; you should read it here.

But my point is about the picture that accompanied it..

This Is Not About Us

A polar bear... for heavens' sake, a cuddly polar bear - and in a pristine frozen landscape, at that. The less than subtle message: this whole global warming schtick is all about a couple of bears in some godforsaken frozen place a million miles away. "Move on, this is none of our concern", screams the photo, despite the dire warnings of the text.

How about this photo, instead?

Not A Drop To Drink

Or this one?

Global Warming Is A Burning Issue

And this one..

Global Warming Hits Home

Finally..

Global Warming Is All About Us

And if you think all of the above have nothing to do with debt, money or the price of beef in Iowa.. well.. perhaps you should look into emigrating to Mars.

Carbon Tax or Carbon Trading?

In discussing "green" energy the following question inevitably arises: should we tax "black" energy (coal, petroleum, gas, etc.) or should we instead install a cap-and-trade regime whereby emissions are capped at a given level and entities can trade pollution permits?

The main argument for taxation is simplicity, whereas for cap-and trade is the certainty of a pre-determined volume of emissions. The EU already operates an active emissions market, quite successfully at that. See below for a chart of futures prices for CO2 emissions (click to enlarge).

Source: European Climate Exchange

We can immediately see the Achilles heel of a market-based cap-and-trade system: as prices for CO2 permits drop - recently from 30 euro/ton to 8.85 euro/ton - industry can simply put off becoming greener until economic conditions improve. This regime, therefore, does not drive continuous greening but does so only on a marginal basis: pressure to change varies with economic activity, since most activity is still "black".

The answer to the tax or trade question is quite simple: both. Taxation, ideally steadily rising on a pre-determined basis, will constitute the constant pressure towards "greening", whereas the permit trading system will provide variable impetus for marginal profits. Think of polluting, in broad terms, as running a business that has both fixed and variable costs.

Now, couple the above with one more "missing link", the appropriate monetary system (see my recommendation for The Greenback), and we're off to the Green Races.

Remember Decoupling?

A bit over a year ago (post of January 21, 2008) I posed the following question:

If the global economy has become highly integrated, as so many say ("globalization"), isn't it illogical that parts of it will decouple by a wide margin and just keep going strong, despite weakness in the US, EU and Japan (70% of global nominal GDP)?

The reason for the question was the hyping of "decoupling" by a bunch of talking-head econo-analysts as the way forward for the global economy.

The answer finally came - in spades - today:

Chinese exports contracted by 17.5% in January, the steepest in 13 years, and the third month of contraction. Imports contracted even more (43.1%, the worst since data begun being collected in 1995). Full details here.

Instead of decoupling some of its newer cars, the global economy train has derailed in toto. And it really doesn't look very good going forward, either; inventory-to-sales ratios in the US are zooming higher. Remember that the US and Europe account for 50% of Chinese exports.

From AAA To Zero

The government is preparing yet another bank rescue plan, this time hoping that private investors will be willing to buy "toxic" assets at a greatly reduced price. The government would provide a put option to the buyers, i.e. a guaranteed floor price.

Here, then, is my suggestion for the floor price: zero.

I know this won't promote the sale of a whole lot of radioactive CDO's, CPDO's, etc, and thus won't lead to a clean-up of bank balance sheets. But zero is, in fact, a very realistic price - at least for a great deal of those so-called assets. Why?

Because...

• The cascade structure means that most of the tranches (i.e. all except the super-senior) are worth zero once the underying assets (mortgages) default at a rate beyond a certain benchmark. This benchmark, based on highly optimistic historic assumptions, was overtaken a long time ago.

• The fees involved in structuring such products "sucked away" a large portion of the stated face value and probably the entire residual value. Consider the whole cycle involving the purchase of a newly-built home: the builder's profit, the realtor's/saleman's commission, closing costs, the mortgage originator's commissions, the loan packager's fees, the investment banker's fees, the broker's commissions. Add it all up and it easily comes to 20-25%.

• Home prices have plunged fast and furious, wiping out the security deposit of the original borrower - if there was a deposit in the first place. Look at this example from Florida:
  

Put everything together and you come up with this disturbing conclusion: even the super-senior tranches are highly suspect of being worth exactly nothing. In fact, given local ordinances on property upkeep, back real estate taxes, etc., there is a good possibility that whoever gets title to homes after prolonged foreclosure proceedings may end up owing more money than the property is worth.

In such cases even zero is too much to pay for "toxic assets" and that's why the government should provide no better floor price than that.

Bankers In Paradise

It was decades ago, I was young and I was on vacation in Honolulu, Hawaii. Jimmy Buffet was appearing live at an outdoor stage someplace in Waikiki Beach, singing "Cheeseburger in Paradise".

Fast forward to today. Speaking in the 128th Assembly for Bank Directors Janet Yellen, president of the San Francisco Fed, said that many of the economy's current dynamics are similar to the Great Depression, requiring "urgent, aggressive action". Furthermore, "the economy is in the midst of a downward spiral, and that calls for strong policy responses".

Given the current reduced state of banks all over the nation and massive bailouts in the trillions, one would expect the meeting to be held at the Chicago airport Ramada Inn. Cookies and weak coffee free, anything else you have to pay out of your pocket.

Instead...

Welcome to the Kohala Coast on the Big Island of Hawaii...


The Fairmont Orchid is the site of the 128th Assembly for Bank Directors, February 5-8, 2009. The Fairmont is set on 32 acres with a white sandy lagoon and aquamarine waters, five restaurants, and the largest petroglyph field in the Pacific.

Ocean view rooms start at $424/nite. But, hey! They can afford it - they have a really rich Uncle.

Those guys are incredible...

The Economics of Stagnation

From the Always Uncertain Predictions Dept. comes today's exhortation to all economists: dust off your (very) old textbooks and learn to live with (and perhaps love) an economy in stagnation - at least for a few years.

To wit, our Cloudy Ball predicts that, unlike previous economic cycles, the US will not see a rapid rebound after the current recession hits bottom and will instead scrape along at a -1% to +1% rate. Let's look at what the Ball is seeing..

Exhibit En (I'm counting in Danish today): Population growth has been declining from 1.4% annually in the early 1990's to 0.8% now. Population is (always) destiny; in recent years its growth came mostly from foreign immigration and that's going to slow down further as the recession bites and creates fewer opportunities for migrants.

Annual Population Growth (%)

Exhibit To: Layoffs are at the highest level in 27 years. More importantly, continued claims for unemployment insurance are at 4.8 million - the highest ever - meaning that laid-off workers cannot find a job quickly. And most importantly, prospects of a quick rebound in job creation are dim because of the nature of the economy: low-end service jobs, part-time jobs and underemployment are widespread.

Continued Claims for Unemployment Insurance (thousands)

Exhibit Tre: Pre-consumption. The explosion of debt meant that in previous years people consumed much more than they needed to, or could afford, versus their income. Household debt soared from 60% of disposable income to 102% in a mere eight years. Remember home equity loans, the house-as-credit-card scheme? People satisfied their consumption needs far into the future and won't be back spending with abandon any time soon. Putting it another way: don't overestimate the American consumer.

Soaring Debt for Households

Exhibit Fire: Saving is the new ethos. For an economy that's 75+% consumption the result is obvious, at least until we replace the borrow-spend-inflate assets model with a work-save-invest model. As they say in the fashion business, black is the new red.

Save For A Stormy Day

Exhibit Fem: Interest rates for long term Treasury bonds are at lows not seen in multiple decades (10-year bonds touched 2.1% before rebounding to 2.9%), even with quantitative easing and fiscal stimuli in unprecedented amounts. The bond market, at least, is betting heavily on a long, drawn out period of economic weakness, most probably out-and-out-deflation.

Gentlemen Prefer Bonds

Pricing Green Energy

I have been reading an interesting paper about alternative energy investing. It was authored by the World Economic Forum, that supra-national, self-congratulatory establishment pow-wow held annually at Davos, Switzerland. It's called Green Investing: Towards a Clean Energy Infrastructure and can be accessed here in PDF form. When this most exclusive Club of Clubs for the PTB crowd takes Green to heart - as it apparently has - it is time for everyone to realize that it's no longer an activist issue but has gone 100% mainstream.

Within the paper appears this sentence: "It should be noted that any comparison of levelized costs of different energy sources is a minefield". Never one to be easily dissuaded by risk of explosion (or is it exposure?), I put forward a simple formula for calculating the cost of "green" energy when comparing it against "black" energy.

Here it is:

P= Pb - Of - Oc

where,

• P is the price of green energy.
• Pb is the "basic price" of green energy, without subsidies, as normally calculated for any project including cost amortization, financing, operating expenses, etc. For example, right now onshore wind energy costs 9-13 US cents per kWh .
  
• Of is the current value of options to lock in the price of a conventional fuel (e.g. coal or natural gas) at today's prices over the entire expected lifetime of the green energy plant (e.g. 30-50 years).
• Oc is the current value of options to lock in the cost of carbon taxes/permits at today's prices of an equivalent-sized conventional power plant - again over the expected lifetime of the green plant.

Obviously, option prices should be calculated on a per kWh basis.

In this way green energy prices will reflect two crucial adjustments:

a) Stripping out the risk (i.e. cost) of fuel price volatility. Most green energy alternatives, such as wind, solar, tidal and geothermal, use no fuel and thus are not subject to "black" fuel price adjustments.

b) Stripping out the risk (i.e. cost) of carbon permit price volatility. Green energy is obviously not subject to carbon emission costs.

Comments invited.

About Protectionism (and Salary Deflation)

As the new $800 billion stimulus bill is being put together, a clause about "Buy American" contained within it is stirring fears of protectionism. The clause would require all projects funded through the bill to use American-made steel, etc.

Sounds very reasonable, but lots of (interested?) parties are against it claiming it would result in a wave of countermeasures against the US. In particular, they resurrect the old bugaboo of the Smoot-Hawley Tariff Act, often blamed for exacerbating the Great Depression.

This analysis is just another example of knee-jerk thinking from "inside the box". In addition to objecting to the above clause, this line of post hoc thought is also responsible for other misguided and inappropriate actions, such as massive bank bailouts, zero interest rates and quantitative Fed easing.

Why? Because what really happened was not globalization of trade but an abrupt and massive relocation of manufacturing capacity, mostly to China. The US alone has "exported" an incredible 4.5 million manufacturing jobs in just seven years, an unprecedented economic event of historic proportions. Other western nations have done the same.

Gone to China: 4.5 million manufacturing jobs

What did we exchange these jobs for? Loans of Chinese labourers' savings in the form of US Treasury and other bonds, i.e. debt. This insane policy of national emasculation will surely go down as one of the worst mistakes in the history of all empires.

OK, so why is "Buy American" a good idea? Because, first of all, it is most definitely NOT protectionism - just look at the above chart. And also because...

a) It will work towards slightly rebuilding manufacturing capacity and well-paid jobs.
b) It will encourage localization of production and distribution, sorely needed in a world of diminishing resources and environmental degradation.
c) It more fully recognizes real production costs, as stricter US environmental and social protection regulations must be adhered to, as opposed to the anything-goes regime in China.

...and...

President Obama (annual salary $400,000) has recommended that compensation for bailed-out executives be capped at $500,000 annually. Oh ho, ho! That's not even enough to pay for pool maintenance, never mind food and drink. But it is a most definite sign of deflation - even if it is highly populist and very popular with the hoi polloi.

Compare the measly 500K with compensation at Citi during 2007, to pick just one example. Click to enlarge for legibility.

From Citi Annual Report 2008

I am aware of the restricted stock provisions of Mr. Obama's proposal, but even so I bet a ca. 97% reduction in lucre as loot is most definitely deflation.

It's a SNAP

SNAP is the brand-new acronym for the old US Food Stamp program; it stands for Supplemental Nutrition Assistance Program. I guess "food stamps" was too old fashioned and, well, kinda depressing - as in "the greatest economic crisis since the Great Depression".

Call it what you may, as of November 2008 (latest data available), the number of Americans needing help with the most basic requirement of life, to wit eating, jumped 14% from the same month last year.

Data: USDA

If you look at the data going back to 1969 you will see a definite correlation between food assistance and the economy: recessions result in higher participation and booms in less. For example, the 1991-93 period saw 30% more people receiving benefits, while during 1994-2000 participation dropped back sharply as the economy expanded.

What is most interesting, then, is that despite the supposed economic expansion after 2003 more and more people needed to go on food stamps. As of November 2008 their number was at an all time record 31.1 million - a number that has since certainly gone higher with increased unemployment.