October 17 2013

This is the date of the potential U.S. default on its sovereign debt. If it occurs it will be blamed on a small section of the US Congress within the Republican Party referred to as the "Tea Party". It would be a catastrophe for the banking sector, the global financial system, and the indebted everywhere. Interest rates would likely rise dramatically in the space of a week. People exposed to large mortgages could be forced out of their homes in many cases. A social divide would develop between the cashed up and the indebted. Entire sectors of the banking industry could disappear. Oddly enough it could, in the medium term, turn out well for the U.S. It could prevent further indebtedness, lower the US dollar, force the US to rebuild its manufacturing base and restore its competitiveness. Whilst definately not in my personal interest, I realise in the medium term it could work out very well for the U.S. I suspect that the short term cost will be so high that any political party that did this to their own nation would end up paying a heavy price for at least a generation. However the Tea Party are a protest movement and not a political movement, as such, it is well within their mental space to embrace actions that would take the U.S. to a default. If it happens I suspect this Great Recession will well and truly feel like a Depression. It is now possible that U.S. Congressmen will do what the U.S. creditors are not prepared to do, call the bluff on the American Insolvency.

You are Here

A long time between posts! I will put it down to having a new born. Many people are legitimately asking where are we in the economic cycle. It seems to me that we are now finally on the verge of increasing inflation and interest rates. Ben Bernanke's decision to continue quantitative easing at its current rate will begin to leak into the real economy with concomitant increases in inflation and interest rates. The link for this post is an article reflecting on the views of the Governor of the Reserve Bank of India, who clearly is not a fan of the fantasy economics which seem to dominate the thinking of leaders over the last generation.

Horses to Water

http://www.businessspectator.com.au/bs.nsf/Article/currency-wars-australian-dollar-us-dollar-euro-rom-pd20121025-ZDQZ6?OpenDocument&src=sph

Many many posts ago I discussed the looming currency wars.  We are now there; as competitive devaluations start to take hold and fiat money as a system comes under sustained attack.  There is now a concerted effort across the major developed economies to inflate the global economy through sustaining, a now apparently intentional monetary expansion.  I say intentional because that is exactly what got us into this place in preceding two decades.  Instead of cutting a zero of the global balance sheet there now seems a considered desire to add another one.  Effectively this strategy now means a shift in power from savers in favour of debtors; sovereign, corporate, and individual. 

Maintaining high levels of inflation for even a period of a few years will greatly reduce the debt burden on debtors sovereign or otherwise.  It sounds like a plan, and indeed is until you think about the end game.  It may look something like:

• A breakdown in global trade with significant consequences for emergent economies.
• The politicisation of trade into alliance factions.
• Undermining of property rights driven by debasement of fiat currency systems.
• Re-emergence and re-entrenchment of more authoritarian systems of government.
• Armed conflict as a tool of government policy for managing dissent.

If history does repeat itself we may see the re-emergence of widespread localised conflicts especially for natural resources in the absence of effective world trade.  I think it is unlikely to be a global war per se but a series of regional conflicts.  Possible locations:

• South China Sea - China, Japan, Vietnam, The Philippines, and the US.
• Siberia - China and Russia.
• Mongolia - China and Russia.

The middle east is now far more unstable that it was before the disastrous Arab Spring which replaced totalitarian but stable secular governments with whatever may replace them; which will be anything but democracies.  I suspect that as much as it may try to avoid it Turkey will have a critical role as a focus point of conflict here.

Well a lot of geo-political speculation today.  I will go pack the crystal ball back up!

1934

http://www.businessspectator.com.au/bs.nsf/Article/Panic-has-become-all-too-rational-pd20120606-UZ2P6?OpenDocument&src=sph

 

Please find above a link to Martin Wolf's article covered in Business Spectator.

In this article Martin makes the following statement:

"Before now, I had never really understood how the 1930s could happen. Now I do."

 

This blog in heading towards its eigth year and I suppose I should comment on this statement. Martin seems at a loss to explain how poor decision making is leading inexorably towards disaster.  Unfortunately, as this blog has long maintained, this disaster started in the 1990's just as the previous one started in the 1920's.  The irresponsible expansion of money supply led to this situation.  This increase in money supply led to an expansion in credit.  The expansion in credit led to inflation, not in CPI's (largely) but in asset prices, like Spanish real estate or US shares.  As the asset values increased so did the apparent collateral to support the underlying debt.  In many cases this increase in asset values was realised as income and cashflow funded by the debt that was borrowed against the asset value.  This occured at many levels.  Individuals borrowing against their houses and spending the surplus from thier refinanced mortgages, and investment banks refinancing infrastructure and property and distributing the refinancing gain to equity investors.

Now the magic roundabout has stopped.  Now we all get off and now we begin to understand where we are:

• Unemployement in the teens and twenties.
• Wholesale collapse in asset values.
• Both governments and systems of government collapse.
• The rise of totalitarian states to replace weak democracies as people seek to blame anyone but themselves.  Greece may be the first.

The cycle is repeating itself.  Welcome to 1934.

 

Antigone and the Decline of the West

If Sophocles was alive today would he write of Antigone's need to bury the Euro.  I cannot be sure of that, but indeed, the Euro does need to be buried.  The Euro has been a stage curtain hiding the play beneath.  The play that had been going on beneath that curtain was a sad tale of nation after nation borrowing against the prosperity and competitiveness of other nations without a clear understanding on the consequences, or at worst, a reckless indifference to the inevitable reckoning.  Full and fair disclose here....I want this reckoning.  I want to see an accountable and well governed Europe and this is far from what is unfolding.  Greece is ungovernable.  The new French government seems set on agressively moving Europe into third world status.

Lets be abundantly clear.  There is NO growth option.  There is austerity and there is hyperinflation.  These are your two choices.  I only hope that Germany with its disasterous experiences in the 1920's understands the least offensive option here.  In fact, I would like to see nothing less that Germany withdrawing from the Euro as a clear message to those in Europe "living the dream" that the hyperinflation and currency debasement party is not one that plan to attend.

It now begins to appear that the Great Recession is something more that just an economic crisis like the Great Depression.  It is far more dire because it is not just parts of Europe but the United States as well; living beyond their means without the political will for accountability.  Therefore I must conclude that the both the economic, moral, and cultural strength, of the West has likely commenced a process of protracted crisis and extended decline.

Sovereign

"Sovereign" is a word you can expect to hear mentioned a lot in 2012 usually followed immediately by "risk" or "default".

We spent 2011 dodging and delaying what appeared to imminent defaults in Europe. Rather than follow the legitimate approach of recognising government insolvencies and the unsustainability of the Euro, European leaders continued to pursue what they perceived as the more morally praise worthly approach of continued bailouts and the potential for greater European fiscal union. This writer however believes, and has always argued that the national solvency issues should be recognised, accepted, and resolved in order to move forward. The "Club Med" nations of the Euro that are hopelessly insolvent should be cut lose fo the Euro and allowed to reorganise their debts and currencies on their own account.

The massive writedowns that need to occur in European banks should be allowed to proceed and if some disappear all the better. Those who have pursued prudent risk and lending policies (if any) will be rewarded; the only proviso I have is that depositors should be guaranteed by the State.

Pressure on government bond pricing has been significant over 2011. Perhaps 2012 is the year when interest rates across the developed finally start to realistically factor in the significant price of sovereign risk.

Whatever happens in Europe will seem like sideshow compared to the economic consequences of the Chinese economy finally discovering the theory of gravity. That remains a dice roll......

The Dismal Science

It is an interesting thing; to read about The Great Recession, now that we are actually in the middle of it. I cannot tell where the market will move tomorrow or whether Spain will default on its sovereign debt in 2 years. What I can tell you, and what I think any decent economist should be able to tell you in where we are in the "supercycle".

We can probably all agree on a few things:

• There was a boom fuelled by cheap debt leading to irresponsible investments and risk taking



• There was a credit crisis induced by defaults on securitised mortgages (read the first post!)



• Irresponsible monetary policy with overally low interest rates added fuel to this fire, accerating the boom, and exascerbating the bust



• We are in the bust - this is a severe prolonged global recession

So, if there is broad agreement on what caused the recession we are currently in, it seems mind boggling that no one sees ,with equally clarity, how this should be resolved:

• Debt caused the boom - deleveraging will correct it, by default or austerity



• Irresponsible lending practices led to excessive risk taking - reform and regulating the banking industry is required to see that this doesn't happen again (at least until Alan Greenspan II repeals the Glass Steagall Act II in the late 2060's)

Economic science (a stretch of concept), indeed all social sciences need to incorporate generational theory into their models. As Messrs Howe and Strauss have proven, history does indeed repeat itself.

What we call "The Great Recession", history may well call "The Second Great Depression" just as "The Great War" became "World War I".

Let's just hope history doesn't repeat in every way.

Two Waves Collide

One of the persistent features of the Great Recession is that we have not yet undertaken the necessary surgery to correct the underlying problem of how we reached here – chronic over indebtedness amongst developed countries. The deleveraging that should have occurred from 2008 has been continuously delayed.

In some countries, such as Greece, the situation is so dire and the country so hopelessly insolvent that default is the only option. It has now become blatantly clear that whilst monetary union was an idea that arose with the best intentions; the Euro has completely failed as an integrated currency for Europe. Perhaps there is a future for the Euro but amongst a smaller group of nations that can jointly sustain a relatively sound fiscal policy with broadly economic health. Not only is the default of a number of European countries inevitable it is necessary and desirable including all the concomitant ramifications of bank collapses for those that have not practiced risk adverse policies. Only when fictitious global capital has been erased can we start to rebuild the global economy on a sound basis. So as Europe continues its slow grind towards the end of the Euro the United States is playing its own version of Russian roulette with its debt ceiling. Again, the issue is not as simple as it appears. Yes the US should not continue to raise its debt ceiling, and yes and measures to this effect should have commenced a long time ago. However that fantasy argument that you can cut spending alone without addressing taxation suggests the naivety of the political establishment in the United States (read Tea Party).

If these two events occur simultaneously the impact on the global economy is likely to be extremely severe. It won’t look like a day at the beach and if it did, I wouldn’t go swimming in it.

(No link to a specific article today as this post has been informed by several.)

Interest Rates headed North

Please explore the link above from Karen Maley's article in Business Spectator. The article refers to Dominque Strauss-Khan adventures in a US hotel and its potential impact on Greece. In particular the arrest of DSK, may impair any (misguided) support for further Greek bailouts and precipitae a Greek debt restructure of default. The final line is the takeout and a heads up to any reader...

If investors ultimately lose confidence, we could be in for a complete re-rating of risk around the world, which would spark a huge sell-off in markets.

The huge sell off in equities would be accompanied by a rapid rise in global interest rates, leading to further defaults and plummeting asset prices globally.

US Debt Default Enters Mainstream Media

It seems that the unthinkable and yet inevitable is now finding its way into mainstream press - see the link above.

If default by stealth through continued debt monitisation, inflation, and dollar depreciation fails, the US may be forced into a de jure default on its debts. The constant bailouts of the European defaulters have simply delayed the inevitable. I greatly doubt for example, Greece's ability to reform its economy and service its debts post-bailout. The cleanest and less damaging approach would have been to let Greece default, withdraw from the Euro, and have economic restructuring forced upon it.

Political debate in the United States, to the extent it legitimately exists (which I question) alternates between two partisan extremes. Only the left are the quacks who apparently don't realise or care that there is a debt problem and would happily let the US spend itself into default. On the right are another bunch of quacks who apparently realise the existence of a debt problem, but in reality are just as predisposed to let the US default by cutting spending AND taxes simultaneously.

With this level of puerile discourse in the United States void of any mainstream meaningful economic debate the US truly appears in a period of extended decline, first economically and then shortly thereafter socially. The political aspect of its decline commenced decades ago with the counter-intellectualism of the conservative movement.

Checkmate

Please follow the link to Karen Maley's article in Business Spectator today. This is the most articulate and focussed article on the global economy put to press for sometime. Particularly, the conclusion, that we have simply prolonged the hangover from the GFC, rather than have begun to deleverage and rebuild. By transferring private debt to public debt we have greatly exascerbated the problem and created the real possibility of a string of sovereign defaults over the next decade.

Unfortunately it remains my firm view that we are far from recovery or any semblance of the pre-GFC "status quo".

There remains a severe economic reckoning still to unfold.

Consequences of mis-diagnosis

Ignoring how low rates created the crisis is like blaming the crash of the Hindenburg on bad weather, poor piloting, lazy ground crews, and overly emotional broadcast journalists, while ignoring the 200,000 cubic meters of flammable hydrogen gas that the airship held in its structure.

Please find the link above to Peter Schiff at his best. Clear evidence again that the decision makers in the U.S. remain oblivious to the courses of the Great Recession and will continue to exascerbate rather than treat the problem.

Given the vast monetisation of the US dollar currently underway the tide has definitely gone out of that inflation tsunami.

The Fourteen Speed Economy

In recent press, over the last year, Australia was described as being a "two-speed economy". The bouyant mining driven economies of Western Australia and Queensland contrasted against the more subdued, if not stagnant, economies of the eastern seaboard states. At the time is was speculated that the Reserve Bank's monetary policy was struggling to contain these two diverging economic zones. What we are seeing in Europe at the moment is in effect the "fourteen speed" economy, and it may well tear the Euro apart.

Please find attached a link to Business Spectator with an article from Martin Wolf at the Financial Times. Here Martin provides a pre-emptory autopsy of the Euro. The Euro was always an ambitous idea. Indeed it may have worked where it formed the common currency for a number of like economies operating in broad concert with each other. However as Martin outlines, the Euro has in effect contributed to, if not facilitated, many of the economic adjustments that are taking place in the PIIGS economies at the moment. These weaker member economies of the Euro need to devalue their currencies, increase there competitiveness and restart their economies. This clear is something they cannot do whilst they remain members of the Euro.

Stapling the struggling economies of the PIIGS to the economic powerhouses of Western Europe via the Euro has now been seen to be a misconceived idea. The euro may survive, or survive is a different form, perhaps within a smaller better vetted club. Then again, this decade may also see the return of some familar names, drachma, franc, and deutsche mark.

Currency Wars

This blog first alluded to the coming currency wars in 2004. Global economies are actively competing to debase their currencies in an attempt to maintain their export competitiveness. As national treasuries open up their printing presses the expansion in the money supply will have a number of effects. Initially it will cause their currencies to fall relative to stronger economies. In Australia the Aussie dollar is now on a ballistic trajectory that will bring it far beyond parity with the USD.

Latter consequences will be even more severe.

Gold is on an even more pronouced trajectory than the AUD and likely to go into orbit as fiat money is aggressively debased. No doubt in the end it will morph from a legitimate store of wealth and hedge against inflation into a bubble in its own right. This seems inevitable in a civilisation that is addicted to non-productive wealth. However, it is still a very long way from bubble territory yet.

Click on the link that will take you to the article from The Globe and Mail quoted the Brazilian Finance Minister, Guido Mantega.

Tail of the Dragon

The global economy remains firmly on track for a continued deepening of the Great Recession into a self confessed depression. In Europe the PIIGS seem content to splutter along with the heavily indebted economies on a ever more tenuous lifeline from the European Central bank and faint hopes of support from Germany.

The United States is an economic disaster zone with real unemployment approaching 20%, several states on the verge of tangible insolvency, and the US at a Federal level in a position of hopeless indebtedness and continuing to support the mercantilist policies of China through protracted inaction.

Australia remains in a state of prosperity apparently unparalled in western economies. A factor I confess to never anticipating. However I suspect that this merely conceals the extent of our future fall. We remain hitched to the tail of the dragon and our economic fate linked to our Chinese mineral exports (an economy still to pop its numerous bubbles).

The next stage of the slow motion train wreck we refer to as the global economy remains most likely a sovereign debt default leading to the repricing of sovereign risk and the concommitant currency adjustments that will in evitably follow.

Please click on the link above to Karen Maley's sombre article from today's Business Spectator on European debt and rising service costs.

Savings Rates

In a world of capital shortage, the countries where the shortage is least acute will do best. France, Germany and Italy, with double-digit savings rates, will outperform Britain, the United States, Canada and Australia, whose savings rates have consistently lagged.

Finally an article worth posting on this blog! An astute assessment of where we have come from, where we are heading, and why. I encourage you to click on the link above and read the article by Martin Hutchinson.

Frypan to Fire

An IMF sponsored period of 15 per cent unemployment and 15 per cent inflation would allow Europe to survive intact and make the adjustments necessary to combine the spendthrift economies with the thrifty in a way that genuinely works. It would be a protracted but endurable adjustment period but it would not be a catastrophe.

Please click on the link above to a excellent article in today's Business Spectator from Mark Carnegie. I would content that Mark's best choice "Plan C" will end up being more of a global choice than one confined merely to Europe. Unsustainable global indebtedness is only now finally being brought to account. The flight to quality to the US dollar that we have recently seen is truly a frypan to fire scenario.

Global interest rates will soon rise and this will be a phenomenon largely outside the control of individiual reserve banks.

Five years of 15% inflation would indeed be the best outcome for debtor nations by facilitating a structural default on their debts. The concept of sovereign risk has even begun to be comprehended by global markets.

Three Gets You Two

The link above takes you to a great article from Pimco's Bill Gross. In its core this article takes us to the reason why we are not at the end of the Great Recession. The global deleveraging has not yet begun. Rather than retire and reduce their debt burdens governments around the world have started the morning after the GFC hangover with a couple of Bloody Mary(s).

How governments approach deleveraging remains to be seen. In the context of the current level of global indebtedness in many economies such as Greece, austerity measures and rebalancing budget may simply not even be practical let alone politically viable. That leaves the propects of default of which I believe there are at least three distinct kinds (possibly more):

1. Repudiation - "I can't repay and even if I could I'm not going to try"
2. Negotiation - "I can't repay but I would like to if I could. How about you take 50 cents in the dollar and we call it quits"
3. Stealflation - "Actually I will pay you all the money I owe no problems.... I am however going to run inflation at 15% for 5 years and the $1.00 I owed you is now $0.12 real"

My money is still on the smart debtor governments running inflation at 15% for five years, or something similar.

I suspect over the next 5 years we will see all three solutions.

Greenspan and the Next Five Years

It has been a while between posts but today's has a worthy link.

Please see the link above to the article from Bloomberg which was reposted in today's Australian Financial Review. The article discusses Dr. Greenspan's 'legac'y and his view that the consequences of unregulated lending and expansive asset bubbles could not be forseen. Furthermore Dr. Greenspan a.k.a. the Maestro, a.k.a. Easy Al argues that lax monetary policy did not contribute to The Great Recession. Sigh. Fortunately it is no longer the sole duty of this blogger to defend a rational interpretation of economic management. The denial of responsibility for the worst economic mismanagement in recent history is perhaps predictable, but it is also now futile.

Where we will need magic in the next fives years is in extricating ourselves from the "monetary accomodation" and concommitant indebtedness that is characteristic of so many major global economies. There has been much discussion recently of Greece's precarious economic position and that of its fellow "PIGS": Portugal, Ireland, and Spain. Much larger economies are also mired in severe indebtedness such as Great Britain, Japan, and the United States. There appears at this stage of The Great Recession only one path open to work through this situation. Namely, that is to run inflation in the mid- to high- teens for a period of years to devalue the level of global indebtedness and effectively default on their obligations.

Any talk of "green shoots" or recovery in this environment is nonsensical. The first signs of reflation is asset prices is likely to be driven by a tide of inflation. Nominal prices may be rising while real prices stagnate or decline. There will be no return to the false prosperity of last boom until a decade has past, and global economies have deleveraged (probably by constructive default).

Sadly the worst of this is still to come.

Global Interest Rates on the Up

Interest rates are headed up sharply and quite possibly in 2010. Those countries that are pursuing responsible monetary policies such as Australia will suffer less that those with irresponsible and expansionary policies but the direction of interest rates will still be the same.

As Karen maley's article from today's Business Spectator (see link) states, the most exposed Euro block countries include: Portugal, Ireland, Greece and Spain. These countries are running unsustainably large deficits that should be causing their creditors in the bond markets much concern. These nations and their irresponsible policies may well jeopardise the Euro's future.

Even these nations may well be the tips of the iceberg as larger economies such as Great Britain, the United States, and Japan are also running large deficits, expansionary monetary policies and demonstrating a deficit of political will to fix their structural problems.

Currency instability and rapidly rising interest rates may well be the consequence. A debt default by one sovereign nation may be the catalyst that sends global credit to the wall and gold into the stratosphere.

2010

"The risk that deteriorating government finances could push economies into full-fledged debt crises tops a list of threats facing the world in 2010, according to a report by the World Economic Forum"

A repricing of sovereign risk in 2010 could be the catalyst for rapidly rising interest rates on a global scale and finally put an end to the bailoutorama that has characterised the GFC to date. The question remains will the US Dollar be repriced to reflect the innate insolvency of the United States?

Welcome back for 2010....more soon.

Plain Talking

In this article by Martin Wolf from the Financial Times (and quoted from Business Spectator) Mr. Wolf clearly lays down the essential and fundamental requirements for a sustainable economic rebalancing between China and the United States.

Mr. Wolf imagines the following threat from President Obama:

"I would then argue that China’s determination to thwart needed adjustment in exchange rates had become intolerable. The US is entitled to protect itself against such mercantilism. The trading system would be terribly damaged. But the alternative would be unbearable."

In decades of cold war with the Soviet Union the concept of Mutually Assured Destruction helped ensure that no nation would press the button. Sadly in this catastrophe there is no alternative. China and the United States will need to break there damaging co-depency, and when it occurs it will be a painful process for both parties and the wider economic community.

No Country for Old Bulls

Please check the link above to today's article from Alan Kohler at Business Spectator. The most interesting part of this article is actually, that with which the author disagrees, namely his quotes from Messrs. Newman and Sprott.

Maurice Newman, chairman of the Australian Broadcasting Corporation, and former chairman of the Australian Stock Exchange, is quoted as per follows:

“Between 1990 and 2007, we saw the biggest credit explosion and consumption binge in history. This liquidity created a deep fundamental disequilibrium between surplus and deficit countries. While financial markets have tried to redress this, they have been frustrated by well-meaning government intervention designed to soften the impact."

“In the US, the legacy of these policies is a mandated liability of $US111 trillion, which roughly equates to $US365,000 per man, woman and child, or $US1.3 million for a family of four. Only about 10 per cent of all these obligations have been fully funded. The rest are unfunded or underfunded commitments which will fall due over time. "

“In the meantime, the US government must borrow $US3.5 trillion over the next year which is equivalent to all the debt raised between 1789 and 1994. It will take 75 years of double digit growth to pay back."

“The 2009 budget deficit came in at a little over $US1.40 trillion or about 10.0 per cent of GDP and three times the shortfall of 2008. It is expected to reach US$1.5 trillion this year. The Obama administration’s own estimates project the ten year deficit to be $US9 trillion, recently revised up from $US7 trillion, so there is little improvement in prospect.”

These comments support what this blog has been asserting for some time. While the debt bubble has burst, the dollar bubble remains. As Mr. Newman most astutely implies these problems did not arise overnight but have been building as part of a medium term cycle over decades. Personally I was around the last 90's when I first perceived the early signs of bubbletopia.

The second quote is from a Mr. Eric Sprott, described as a Canadian fund manager and his comments on the U.S. deficit:

“…in order to satisfy US capital requirements, all existing investors would have had to increase their US bond purchases by 200 per cent in fiscal 2009. Foreigners, however, only increased their purchases by a mere 28 per cent from September 2008 to July 2009 – far short of what the US government required.“

"The US taxpayer can’t cover the difference either. According to recent estimates, tax revenue from all sources would have to increase by 61 per cent in order to balance the 2010 fiscal budget. Given that state government income tax revenues were down 27.5 per cent in the second quarter, the US government will be lucky just to maintain its current level of tax revenue, let alone increase it.”

“From 2004 to 2009, US unfunded obligations increased by an average of almost 50 per cent…while US government revenue increased by only 12 per cent. No company or government can increase its liabilities by more than four times the rate of its revenue and stay solvent for an extended period of time.”

Most interestingly Alan Kohler quotes these gentlemen, but disagrees with them. On the issues of timing I also see the possibility of a limited pick up in the Australian economy in the new year. However, no one can escape the short- to medium-term consequences of the American Insolvency.

It has been said before, but if there is a loss of faith in the US dollar the stampede to alternatives could trigger a number of changes in very rapid succession. These include rapid interest rate rise largely outside the control of central banks. Hopefully if we can continue our responsible monetary policy and continue to raise rates we could be well placed to again weather this global shockwave.

The reality is that there is no light at the end of this economic tunnel. The US' economic policies and concommitant spending are unsustainable. Currency collapse, economic depression and difficult longer term economic adjustments are inevitable now in the United States.

By the way if you are new to this blog I STRONGLY recommend you read the first post from August 10, 2004 where the Great Recession was described, predicted, and named well before the event.

On Trial

David Reilly's article in Bloomberg asks the question; who's face should adorn a US $1 million bill. His article postulates a Weimerian collapse of the greenback, and in this, he is now far from alone. The answer, he concludes, is inescapably correct, the US consumer should be the face of the new bill.

I would rather not issue a pardon so early for the villians of this disaster. Let's review his list of potential perps:

Ben Bernanke: Verdict: Case dismissed.

Helicopter Ben came far to late to the scene. The reality is that the factors that have created the Great Recession could be first observed in the mid- to late- 90's.

Bernie Madoff: Verdict. Guilty........but not of currency assassination.

George W. Bush: Verdict. Guilty.

Tax cuts, unconstrained spending, combined with the folly of the Iraq war, laid the foundations the US's disasterous economic state. The only redeeming feature of this administration was its consistency.......... in unrelenting awefulness at everything it attempted.

Wen Jiabao: Verdict. Not guilty by virtue of self defense.

Fascist China's relentless pursuit of mercantilist growth has served it well and the US has paid the price for its lack of vision (yes I know where I stole that from).

Henry Paulson: Verdict. Case dismissed.

In the line-up but no where near the murder weapon.

Richard Nixon: Veridct: Guilty of many things including introducing instability into the fiat system.

Unlike G.W. actually achieved a few things.

Alan Greenspan: Verdict: Guilty of first degree currency murder!

A feature of this blog from early on. Al's relentless easy money program mitigated the post dotcom recession by creating the foundations for a depression. Neither the stock market bubble, house price bubble, or debt securitisation bubble fazed easy Al.

With the collapse of the US dollar bubble his failure will be complete (yes I know). Welcome to the $1,000,000 bill Al!

Murder Suicide

Ed Harrison, writing in his blog Credit Writedowns has an arresting take on the subject: “With this trade war looming, one must wonder if Chimerica, the marriage of China and America as one economic entity, will end in murder-suicide, taking the global economy down with it.”

Follow the link above to Alan Kohler's article in today's Business Spectator. The concept of Chimerica, and economic union between the United States and China is a fallacy. It is best described as a co-dependency where China produces and America consumes. It is a core part of the Chinese mercantilist economic policy which has so damaged the US's productive base. It could be fairly said that this is not due to China alone, but over the last decade its has been the strongest contributor to this process. I was actually quite surprised with the Chinese response to the US tyre tarriffs. A trade war with China will hurt the US, but it would be a disaster for the Chinese economy. This would clearly be an area where quiet diplomacy would be in China's interest. Playing the trade war card with the US is in my opinion a grave strategic mistake from the Chinese. It seems that nationalistic sentiment, spured on as a tool of social control by the Chinese communist party is developing a life of its own. Nationalism and totalitarianism are the key foundations of fascism. A point no doubt that we will be increasingly made aware of as the economic relationship between China and the West breaks down and a new one rises to take its place.

The Elephant in the Room

I refer to today's Australian Financial Review, page 63, and the article titled "Bernanke's duty to come clean" written by Vince Hooper, at the University of New South Wales.

In this article Mr. Hooper has clearly outlined the reasons why (I believe) there can be no medium term global economic recovery.

"The world needs to know how the US intends to reduce its mountain of domestic and external debt."

True , I think the US needs to work it out first! Mr. Hooper outlines three ways the currently unsustainable level of US debt can play out:

1. The US does nothing but continues to accumulate further debt. Not actually a strategy or outcome, but a description of the current state of affairs.


2. The US selectively defaults on its debt obligations. Possible, but the concomitant annihilation of the US dollar will send us head first into Great Depression II. In my mind this is the doomsday deflation scenario. The flipside of this scenario is that lenders no longer support US's borrowings leading to a rapid rise in the US interest rates.


3. The US monetises its debt. This is the high-inflation scenario.

There is no easy way out of the hole the US has dug for itself. The reason Bernanke hasn't annunciated a strategy to extricate the US from its current unsustainable debt position is that there isn't one politically acceptable. The only way forward for the US is probably a combination of the following:

• global disengagement


• massive reduction in military spending


• lower standards of living


• reduced imports


• higher taxation


• currency devaluation


• progressive rebuilding of its industrial base

A cursory review suggests that this will need to be imposed on the US citizenry by circumstance rather than choice.

Cloak of Dollar Illusion

The dollar’s role as a good store of value is “questionable” and the currency has a high degree of risk

...or so says said Nobel Prize-winning economist Joseph Stiglitz. I couldn't agree more. The missing part of this article is what would happen if the world attempted to move to a new global reserve currency. I suspect that very quickly the great illusion of the US dollar would manifest itself as a gaping chasm. The comcommitant fall in the US dollar, the US standard of living, US consumption, and the US economy would plunge the the US and the rest of the world with it into a economic disaster.

It's not the the gaping chasm isn't here already ...its just covered by some precipitously placed Chinese silk.

Banananomics

" But it was a wise man who said, 'All I want to know is where I’m going to die so I’ll never go there.' We don’t want our country to evolve into the banana-republic economy described by Keynes."

Follow the link to the featured article from the New York Times penned by Warren Buffet. In this article Mr. Buffet makes a few comments reminscent of Paul Keating's famous "banana republic" speech of 1989. The then Treasurer of Australia warned that the country was headed into economic oblivion. He then induced a recession in Australia raising interest rates into the high teens. It was a brave move and one that earned him not inconsiderable political ire amongst a lage number of voters. Although I didnt lose my house in that one I have always held that decision in high regard. The consequences were ugly, there was a very painful period of adjustment, but Australia emerged stronger and entered a period of long term sustainable growth. I believe that the United States will soon face its banana republic moment also, as Buffet aludes to.

The question is, can the United States find anyone with the political will to make the right decisions.

Recession Over?

Apparently so, for a survey of economists who believe Ben Bernanke should stay as US Federal Reserve chairman. Hmmm, perhaps Alan Greenspan should run for President. The recession is only over to the extent that the depression hasn't begun. In truth though, I do forsee the possibility for an interim period were we crest another sentiment wave before beginning a downward turn.

May no mistake, from a personal perspective I wish it was over! I have no personal interest in living through a depression. The sad truth is that the United States, as per our previous post, remains insolvent. As long as its creditors continue to provide unlimited finance to its unlimited deficits, this charade will continue. History may determine in retrospect that the U.S. was already well beyond its capacity to service or repay its debt.

As I have said before these are still the good times for the United States and the rest of the world. A U.S. debt default de jure, or de facto (high inflation/low currency), will be catastrophic. While it is not necessarily imminent, when it happens, it may occur very quickly indeed.

Let's all hope that unlike August 2004 this time I'm completely wrong. I surely do.

The American Insolvency

This has been building for a long time. More and more you find references to the this issue in the mainstream press. I expect within 1-3 years the US dollar will commence an extended decline in value, however as this article suggests with currencies, swings in sentiment really can be dramatic.

A collapse in the US dollar will be a collapse in US power and influence and accordingly the influence and stability of the Western world. The economic consequences of the global financial crisis will seem mild in comparison to the collapse of the world's reserve currency. In the US the effect will be as severe as the Great Depression - although the US appears almost half way there now.

The real question is where will China land? Stable and assertive? Chaotic and dissolute? Or perhaps, an expansionist police state where miltary conflict is used to maintain public morale and order?

I sincerely wish the green shoots optimists were right. If the US was solvent they probably would be.

The Fourth Turning Revisited

I ran into this interesting article just after the last post. It is interesting because it links Howe & Strauss's work to the current unfolding economic disaster. It is a worthwhile read (although I do not have a view on Peak Oil).

The two key bodies of though which led me to originally foresee the Great Recession were:

- Howe & Strauss Generation Theory - especially The Fourth Turning, and
- Austrian Economic theory

I have posted the link before and its worth a refresh :

http://www.fourthturning.com/

The Long Haul

"the only recession since the Great Depression to wipe out all job growth from the previous expansion"

Please follow the link to this post's feature article from The Wall Street Journal. It is not commonly known but the real unemployment rate in the United States, when you adjust for underemployment, is running at around 16.5%. We already have unemployment running at mid-teens in the United States and we are still in the early stages of this process. I read commentators talking about "green shoots" I see none. What I do see is the United States running up astounding budget deficits and accumulating unprecedent levels of government debt.

There is plenty of ongoing talk now about downward pressure on the US dollar and questions around how long its fiscal prolifigacy can continue.

Despite all the good intentions of the Obama adminsistration and the woefful mess they inherited from the Bush adminstration I suspect they will oversee the comprehensive destruction of the US economy. Needless to say the rest of the world will follow it. This will destablise the world to such an extent that some form of serious global conflict would now appear inevitable in the next decade.

There is still that palpable sense in the community and the media that the good times will return. Unfortunately this generation has already seen their best of times.

We are a full generation away from recovery.

USD 134 billion anyone?

This article makes for a fascinating read whatever the truth of the matter is!

Bumbling would be Japanese billionare fraudsters, North Korean agents, or officials of the Japanese Treasury flogging US bonds off market. Enjoy!

Page Nineteen

Firstly, I have to apologise as the article I am quoting for today's blog is not online but from a print copy. So I will refer you to P.19 of the Australian Financial Review 12-6-09. Some quotes in context:

"America's fiscal obligations exceed any realistic prospect of it restoring its financial well being"

"(America) is for all intents and purposes, heading into a ditch financially"

On its deficits.. "This is not sustainable without consequences, including the risk of default on America's debt obligations and the collapse of the US dollar".

What articles like this often fail to do is appreciate the reverse of the implied argument. The implied argument is that the US must rapidly curtail its spending. In fact the reality is the opposite, it cannot. The consequences are precisely as the article states...debt default and currency collapse. Both of which are imminent in the medium term.

The consequences for the world of the collapse of the US dollar and a default from an economy that represents over 20% of global gross product is unparalleled. It marks a turning point in the future of the world, and the beginning of the decline of the English speaking cultures.

Bond Bubble Bursting?

The yield on 10-year bonds surged to its highest level since October at almost 4 per cent, sparking concern high interest rates could temper recovery.

It appears that bond investors are continuing to reprice sovereign risk on US Treasuries. I suspect it only has one direction....up. Like General Motors, the US is well on the road to insolvency, perhaps inevitably. Years of over spending on wasteful folly like meaningless wars such as Iraq combined with chronic under taxation have left the U.S. in financial ruin. The state of California (amongst many) is bankrupt financially and politically.

This US's condition been achieved by the Bush administration's prolificacy and Greenspan's ruinous monetary policy, not as some partisan U.S. conservative commentators have suggested, by the current administration. However, it is being exascerbated by the Obama administrations reponse to the crisis. Some of the crucial social policy initiatives needed to reform and modernise the U.S. as a contemporary state, such as a national public health care system, are necessary but no longer fundable. As more and more people in the US fall into unemployment so too will the intolerable sutuation of massive numbers of US citizens without public health care continue to rise. National public health care systems deliver necessary social equity and preserve human dignity whilst delivering a needed service at a lower percentage cost of gross domestic product. It is one of the few areas where empircial evidence strongly supports the notion of lowest cost government delivery. I appreciate that may be anathema to some of my readers. Of course, I have digressed.

If the current trend continues US bond prices, US interest rates, and inevitably global interest rates will continue on an upward trajectory despite the recessionary environment.

The Early Signs

Early tangible signs are emerging of a repricing in the both the US dollar and the British pound resulting from the active debasement of their currencies. As the link to the above article suggests markets are beginning to accept that the US dollar, in particular, is not adequately priced for sovereign risk.

In this blog I have restarted time-and-time again the inevitable consequences of US government deficits, and now with "quantitiative easing" the debasement of the US dollar has virtually moved into the sphere of the deliberate.

Progressively the US will have to pay more and more to foreign holders of its Treasury notes. Interest rates will now progressively start to rise and sentiment decline to a new nadir. The chance of a rapid collapse in sentiment and a run on the dollar remains real.

The Second Movement

We should congratulate the world leaders and central banks for the way they cooperated after the Lehman crash. We had the leaders and central banks of US, China, continental Europe, Japan, Russia and the UK all working together to achieve a common goal. It was unprecedented in global history and what they achieved was remarkable.

Above quote from Mr. Gottliebsen from Business Spectator. One of the best business reporting services globally..........except for this comment (link above).

Yes it is remarkable what the world's central banks have achieved. Together they have primed the global economy for stage two of the Great Recession. It is the part when you look back at 2008/09 as the good ole' days. The framework for extended global currency instability is now firmly in place. Sovereign risk is now primed with tangible default potential over the next decade across developed economies.

The severe depletion of personal savings over the preceding decade has now been matched and exascerbated by an even more severe depletion of government capital. As governments have no productive capacity in their own right this in effect further personal indebtedness to be serviced via taxation. The only different is it is far more likely to have been floudered away through inefficient government resource allocation ie, bailoutorama.

The lynchpin for stage two has always and will remain the United States. The eventual collapse of the US dollar will make the global financial crisis seem like a 2% fall in the Dow Jones. As governments rush to stabilise their own currencies against a rapidly falling US dollar global interest rates will rise dramatically in a very short time.

It will be interesting to see what the banks stress tests look like at -5% GDP, 15% CPI, and 20% full and partial unemployment in the United States.

Right now Australia seems to be doing better than most, but that will depend on just how hard the current government try to "save" us. Sadly we are just at the beginning of the second movement of this symphony.

The Inflationary Depression

Check the link above to Business Spectator and the comment from Alan Carr on the disburbingly resilent inflation despite the severe economic downturn. We are beginning to see the outlines of how The Great Recession is playing out. Following the Keynsian mantra governments around the world are seeking to spend their way out of this depression, and invariably are in the process of creating a severe stagflationary environment.

In the absence of productive growth this deliberate attempt to use the global printing presses to rescue the world economy will attack real incomes in a vicious way. Although a careful balancing act could prove the right medicine to deleverage the world - what the great minds are currently thinking - it will probably fall victim to its success. What the western world and particularly the United States needs now is to increases its domestic savings and reinvest in its productive capacity. The sad irony is while individual savings rates are rising government expenditure on frivolous bailout (and in Australia handouts) appears out of control.

You no doubt are asking what the irony is? If I am saving 10% of my income to invest productively why should I care what the government spends? The reason is that governments have no productive capacity in themselves. The government's debt is your debt paid through taxation just as your mortgage is your debt paid through monthly installments.

Imminent Social Dislocation

"When I travel around talking to groups and individuals about the crisis these days, what everyone wants to know is: when will it be over? In fact the question should be: when will it begin?"

Now is the stage when we will begin to see the worst of this crisis hit Australia. Although some people have lost their jobs there is not yet a pressing sense of desperation in the country. The reality is, this is a decade long phenomenon and as Alan Kohler writes in today's Business Spectator, the question is not when this will end but when it will begin. We are on the verge of a social calamity equal in severity to the Great Depression. People losing their jobs today may be out of work for a decade.

Our governments need to act now and decisively on employment guarantee mechanisms and government employment initiatives to ensure work is an option for all citizens. When cannot permit our society to decend into a situation where 15, 20 or 25% of the population have no work.

Our social order is at stake as is the human dignity of hundreds of thousands of Australians in the immediate future. Traditional unemployment benefits will not be enough, and imbecilic middle class handouts waste the nation's capital at a time of crisis.

From The Australian today the first news article discussing the "currency wars" that are about to commence. We raised that term in 2005 and now it is finally coming into play. China can no longer accept the sovereign risk on its US debt and currency holdings. With the United States opening the printing presses it is now on a possibly inexorable path to currency destruction.

Time and time again I have said, and I'll say again, this will lead to a rapid rise in global interest rates. Protect yourself.

Repricing Sovereign Risk

Less investor demand for bonds raises their yields, and consequently, lifts the interest that governments pay to bondholders. But because government bonds
are used as a benchmark for the interest rates charged all types of debt, including home mortgages, a sustained rise in their yields could ripple through the economy.

Is this the beginning of the end for bail-o-rama? The perception of "risk free" may well be changing. It will happen, the question is how fast, and whether this is the beginning. If so the US dollar and other bailout currencies may start to come under selling pressure. Once it starts expect a sharp reversal in interest rate trends.

20% Mortgage rates in 2012?

Maybe. Check the link to the article from the NY Times for a heads up.

Pet Cemetary

Check the above link to the article with the following headline quote:

The Federal Reserve's decision Wednesday to buy $300 billion in longer-term Treasury securities has ignited a firestorm, with analysts saying it will either cause a currency crisis or jolt the economy out of the morgue.

In the a) and b) option question printed above I think anyone who has followed this blog will realise what the answer is. Jolt the economy out of the morgue......conjures a imagine of a last minute resusitation and a pulse returning to the nearly deceased. I rather think of as a scene from Pet Cemetary. Initially everything seems OK, then you slowly begin to realise that the dead were best left dead. Helicopter Ben is finally getting a chance to fire up that whirlybird and commence his much anticipated monetary bombardment.

As the article alludes...so that article should state. This will preciptate a currency crisis and US dollar will finally collapse in value leading to a rapid upward correction in US and global interest rates. Real wages will fall as they fail to keep pace with inflation. The debt burden will be purged one way or not from the system.

The US will default, de facto, on its foreign debt causing sheer apoplexy in China. The US will then, unable to borrow externally, be forced to repair its domestic balance sheet and productive capacity. Slowly American savings will begin to rise and the U.S. will progressively return to productive growth....all other things remaining the same. But then again, they never do.

The Great Recession

An eponymous post (link above from the Australian).

Apparentlty the International Monetary Fund agrees.............this is The Great Recession.

Choo Choo

From Bloomberg:

The “rampant printing of currencies” won’t immediately lead to inflation as banks reduce borrowing and asset values decline, Bass, 39, wrote in the March 2 letter, a copy of which was obtained by Bloomberg News. “The greater concern is the potential inflationary time bomb that grows as governments continue to borrow, print” and stimulate economies.

You will have seen a stream of artciles here at this blog explaining how we are headed for significant increases in inflation associated with sovereign induced currency impairment and debasement. Unlike Mr. Bass, quoted in this article, I do not believe the US dollar will be immune at all. Indeed, it could be the greatest victim of global sovereign risk impairment.

Just remember when everyone says again, no one saw it coming, you saw the light at the end of a tunnel here, and yes, it was a freight train.

Thin Air

The title of this article needs very little additional commentary:

Britain's last policy hope: create money

There seems to be a consensus that the global reponse to the Great Depression shouldn't be repeated. It seems governments are committed on a path of mutually assured currency destruction. Unlike before we no longer have a gold standard as a modicum of restraint, so there is little constraint upon Central Banks going the full Weimar.

As Kohler was quoted in the previous post, sovereign risk is now the key issue.

I'm moving my super into gold.

Sovereign

Opening line to Alan Kohler's latest article in Business Spectator. Spot on!

At its heart, the global financial crisis is morphing from a credit crunch/real economy feedback loop into a problem of sovereign risk, and unfortunately there are few signs that politicians actually understand how much trouble we’re all in yet.

What Mr. Kohler is saying is that each government is trying to bailout its own economy simultaneously. The real danger is all this borrowing can't be repaid and that some major global economy is going to end up like Iceland.

I have always assumed the economy and currency to break first will be the US. It is borrowing more than it can repay. It was already running astounding deficits in the "good times" a legacy of the worst adminsitration in the Western World. The deficits under the Obama administration beggar belief! Those lending to the US now will not be repaid and although the default is unlikely to be de jure, it will be de facto. Firstly, default will occur via the rapid decline in the relative value of the currency and secondly through concomitant inflation that will accompany a substantial decline in the US exchange rate.

China, as the US's chief creditor is going to end up booking an unimaginable loss on its US treasury and currency holdings. It's playing a game of chicken and riding in both cars.

What the US really needs is to liquidate the excesses from its financial system, book the losses in its banking sector and commence the process of rebuilding its savings and capital base.

The Art of Being Wrong

The link to the above article is a a reprint ,of a reprint, from The Age.

Forecasters are now telling us we are in for an extended period of low inflation, and low interest rates. Just like their counterparts in late 19c. Bayer Pharmaceutical, they have it wrong.

Read this well informed article to understand why the upcoming cycle is likely to be stagflationary (like the 70's) rather than deflationary (like the 30's). Just as severe and unpleasant, but slightly more Weimar flavoured.

Schiff was Right

I recently read a post on www.europac.net where Peter Schiff felt the need to defend himself from a critic. This doesn’t surprise me. I call it the “Day Trader Mentality” which is the real reason we are in our current mess. It is the Generation-X get rich quick mentality that drove excessive risk taking, rather that considered, medium- to long-term value investing. Understanding economic cycles is not about picking the peak or troughs in markets but in developing a comprehension of what part of the cycle we are currently experiencing. The warning signals of the bubble economy had been growing since the 1990’s, with the first bubble emerging in the internet economy from 1996-2001; its collapse lead to a mini-recession. It should have been a full correction but Alan Greenspan attempted to monetise the recession away, possibly for political reasons. To achieve this, Greenspan floored US interest rates and delayed and greatly amplified the effect. Massive monetary expansion occurred with huge bubbles emerging in asset prices in both equity and property (especially the US). These asset prices were fuelled by cheap credit, leveraging and inappropriate pricing of risk. Securitisation and derivative products were key culprits in this process – as was cited in the very first post of this blog in 2004. As a result the recession of 2001-02 was smothered and has emerged as the Depression of 2008-2015, or as we like to say here the Great Recession. Where we are at now is really the beginning of the downward slope probably akin to 1931. The next two to three years will likely see the worst of it.

Mr. Schiff has my sympathies, he has been, and continues to be the most insightful and prescient economic commentator over the last decade. Unfortunately people who allow there own self interest to govern their thinking, those who operate without self examination or intellectual rigour, will always be jealous of those that do, especially when their follies are magnified by reality.

Do a search for “Peter was Right” videos on YouTube – that’s Peter Schiff not this one!

The Bailout Ocean

See the above link to a Bloomberg article:

“To everyone’s dismay, we believe some of Grandpa Ben’s predictions are playing out,” Greenlight said in the letter, a copy of which was obtained by Bloomberg News. “The size of the Fed’s balance sheet is exploding, and the currency is being debased.”

How very true. When hedge funds start buying bullion....that's got to be the biggest buy signal for gold I think I have seen. It is an astute article and another reference point to explain why the pundits forecasting long term low interest rates are dead wrong. For future reference

• the US bond market will implode


• the US dollar will fall precipitously


• US interest rates will rise dramatically in a very short period of time


• global interest rates, to various extents, will follow
  

This is an inexorable consequence of current actions, as the United States, already running unsustainable deficits, pushes its currency over the brink.

The Stability of China

Talk of a 2010 recovery is absolute rubbish.

Follow the above link to an article from today's Australian that correctly identifies the real risks facing the global economy and geo-political order. As we have stated here several times before; the current Chinese political compact between the government and its people is unsustainable and will unravel quickly in the face of economic recession. The resulting political discord is likely to lead to one of two outcomes both of which are equally unpalatable. Either China breaks as a coherent political entity or the Chinese Communist party will be required to conduct vicious and broadspread totalitarian suppression of its populace. The only way this could be successfully achieved in my opinion is with the unwaivering support of the People's Liberation Army.

The sort of support that you only get in a time of war.

Inflation Tsunami

The undersea earthquake may well be occuring but the wave is still very far from shore and no more than a bump in a far away ocean...but it is coming.

It is an unavoidable cliche that governments' solutions are inevitably worse that the original problems that they seek to fix. The link to the above article from John Kemp is another warning of the severely inflation consequences of current government monetary policy. This is a phenomenon not just confined to the US, but ultimately the US is the epicentre of current world economic events along with their co-dependant partner China.

If the US can manage inflation in the low teens for half a decade they may pull this off. This is dependant on whether the US dollar holds up or drops to 20% to 40% of its current value. More likely we will see a low US dollar, high inflation and high interest rates within 2-4 years.

but for now ..... Merry Christmas and a Happy New Year to all.

The Weimar Theory

This is an article I really enjoyed reading and I recommend you go to the above link.

"In the last ten weeks total Federal Reserve Credit increased by $1290bn. This is an increase of 151% over the same period a year ago, and an annualised rise since Sept 10th of 755%! This degree of expansion in “base” money is without precedent in the Fed’s history."

I share the authors view as the inflationary nature of current US Federal Reserve actions. However when he states that this is not the Great Depression (version 2) he is only partially correct. It is a multi-generational economic disaster precipitated by the same cultural and generational factors as the one that started in 1929. Its underlying characteristics of rapid monetary expansion, contained price inflation (for different reasons), and asset price bubbles are also shared.

A controlled increase in inflation will have very positive effect in reducing consumer indebtedness, as opposed to allowing deflation to persist which would be catastrophic. So we find ourselves in a balancing game where modest inflation will facilitate a de facto default on debt. I very much doubt we will see hyperinflation Weimar Republic style but high inflation levels, as in the high teens - and accompanying interest rates are very likely. While this would assist with mitigating consumer debt burden, it could also result in a rapid decline in real incomes as increases in consumer prices outstrip increases in wages.

Recession to Depression

Peter Schiff seems to have reached a degree of cult status with the circulation of the "Peter Schiff Was Right" video on YouTube. In fact, Peter was more precient that even that video shows. I recall an interview he gave in 2002 warning of the upcoming financial implosion. There are also some critics (jealous ones I assume) claiming that because Peter didn't pick exactly when the world economy would implode that somehow he was wrong. It is a laughable notion indeed, driven by the same get-rich-quick day-trader mentality which has proven the scourge of this generation.

Just as the irresponsible monetary expansion of the early part of this decade would ultimately lead to our current financial disaster, so to will the attempted remedies and bailouts that the US is currently in the midst of, turn a severe recession, into a US and global depression. I suspect it will be more intense in the US but certainly not confined to its shores. Let me quote a comment from the above linked article:

"... it's not just U.S. stocks and real estate that are going to lose value, but U.S. bonds. This is the last bubble yet to burst. I think we're going to see a collapse of the bond market sometime during Obama's first term, and interest rates are going to spiral out of control, and the dollar is going to just be destroyed."

Read again.....interest rates are going to spiral out of control. A US dollar collapse followed by global currency instability and sharply higher interest rates will make 2008 look like party compared to 2010/11. Unfortunately we are just at the beginning of the downward slope of a multi-generational economic downturn of broadly equivalent length and intensity to the Great Depression.

So if you are out telling people how this Recession will become a Depression ask how the economy would look if overnight everyones' mortage interest rate doubled.

Pallative Care

It seems a few governments, Australia and the U.S. included, are taking the opportunity to put distressed businesses on life support. Protectionism cannot be far behind.

Failing car manufacturers need to be restructured and rebuilt in both the US and Australia. I find it difficult to imagine that after spending (wasting) AUD 6.3b of taxpayers money supporting two US multinationals that additional "supportive" measures won't be considered.

The Day After

Please find a link above to Mr. Solberg’s article on the future of the US dollar from Prudent Bear.

You may wonder how a recession can become a depression? The suffering citizens of Iceland recent woke up over night to 6% higher interest rates the following day. A future run on the US dollar and its potential collapse as the world’s reserve currency remains somewhat ethereally between the possible and the probable. As the author points out, the current interventions in global markets are highly inflationary. I agree fully that inflation rate targeting is now a historical concept and central banks seem to have settled on inflation as the lesser of two evils. High inflation will help heavily indebted entities by reducing the relative size of their existing liabilities, however it will may also function as a mechanism for significant reductions in real wages.

As this article correctly identifies, the real danger for the world economy in Stage 2 of the Great Recession is a sudden decline in the value of the US dollar leading to the Federal Reserve being forced to rapidly rise US interest rates to protect the value of the currency. That’s the week you wake up one morning to find your mortgage rate 6% higher than the day before.

The Modern Lemming

As many of you who have been following this blog may be aware I am not the greatest fan of Mr. Greenspan. In fact, he was the one person who could have turned this whole affair into a recession, which we would have pretty much recovered from by now. Instead, by flooring the monetary pedal in the US with 1% interest rates he turned what could have been a post-dotcom recession into a multi-generational depression. Apparently overnight the maestro has testified before a US Senate committee (check the link above from The Australian). It now transpires that big Al believes he made a mistake. This is the quote I like the most from the article:

"Those of us who have looked to the self-interest of lending institutions to protect shareholders' equity (myself especially) are in a state of shocked disbelief,"

So let me get this right. You employ a bunch of baby-souled investment bankers who are remunerated on transaction volumes and size. You incentivise these people on the basis of annual bonuses and not long term value creation. You institutionalise structures through securitisation and derivative products to obfuscate risk at every opportunity………….and you trust banks will survive because notionally they have a sense of self-preservation?

Let me introduce you to a species you may need to familiarise yourself with Al…….Lemmus Lemmus.

So what's next?

Please note the link above to Mr. Gottliebsen’s article in which he responds to a series of ”so what happens next” questions. I would like to throw some of my thoughts against some extracts of his (check the linked post for the full article):

Stock market purge.
“There is, therefore, a good chance we have seen the bottom of the overall share and commodity markets, but not for those specific stocks that are destined for future troubles.”

I doubt we have seen the bottom yet for equity markets and residential property hasn’t yet adjusted to the crash. I expect the situation in Australia to be significantly better than the US, although the impacts will still be severe.

A downturn is unavoidable.
“We are still going to experience a significant world downturn. When President Bush says the US is going to quickly return to the old days, he is talking nonsense. Our Prime Minister, in warning of much tougher times, was telling the truth. Over time, this massive injection of money into the system may create inflation, which will require higher interest rates at a time of low demand – so called 'stagflation'. I am not forecasting that, but it is a danger.”

Agreed, and I see no reason why the US president would start telling the truth…..that would undermine an unbroken record. As for stagflation, I see this as a real risk, the monetary spigots are being set to full open all around the world. My take on the likely medium term value of the US dollar also reinforces my view that inflation and interest rates may disconnect from monetary policy and rise significantly.

More capital is needed
“It will take a year or so before we know. However, a large number of Australian companies currently need to restore their balance sheets and this market rally provides the opportunity.”

I suspect there will be a rally at some point where people start to believe, for a brief moment, that things will return to the way they were. However, the reality is that this recession is a 5-10 year event. As for the American banking system it is formally in “dead parrot” territory. The credit worthiness issues in the U.S. banking system are now migrating to the US government proper. The eventual unloading of US dollar holdings will be the phase that puts the “Great” into the “Recession”.

The China factor.
“Australia depends on selling resources to China and Japan for a big chunk of government revenue and if China falls over we will run into deep trouble. I don’t think that will happen.”

Under a seriously recessionary environment I do not believe China is an inherently stable nation. A serious “X factor” hangs over the future of China in an economic and socio-political environment unsupported by US monetary expansion. An socially unstable China with the US in an economic depression is not the setting for a happy world order.

A shift to long-term thinking.
“The winners on the share market will be the so called value investors – those who look at long term strategies and the ability of companies to perform. The current crop of highly paid short-term forecasters will pass. Extensive retraining will be required.”

Yeah well frankly you would want to be a long term investor. If you bought stock in 1929 you would have waited until 1954 for the Dow to reach the levels of its ’29 peak; this time around that would be 2032 folks. Same expectations should apply today.

Contractors will suffer.
“The economic downturn will lift unemployment but, much more importantly, the enormous area of independent contractor income will be affected. A great many families will still be receiving income, but they will be seeing a lot less of it because the companies they are working for need less of their services.”

Ordinary people will start feeling the impact of this recession in about 6 months to a year. Right now the average Joe may be hearing noise but doesn’t yet feel the pain. As this recession unfolds there will be a progressive step down in confidence. At the end of this decade I wouldn’t be surprised to see a majority of people with superannuation is cash.

Credit will tighten.
“Globally, banks are going to be much more cautious animals. Tighter bank lending means that commercial and resident (sic) property markets decline. One of the property areas hardest hit will be commercial property, where capital is hard to find and where there is extensive property on the market for sale.”

The only good thing about having a mortgage in times of declining property prices is that at least you have a mortgage! Those letters you get from the bank about adding another $10,000 credit limit to your card are an endangered species. Defaults on credit cards will become a series issue over the next five years. I expect credit, especially for young people will be very difficult to come by.

Director remuneration will be reined in.
“Globally, company boards that sign up for big executive remuneration packages, only to find that their company does not perform, will be dismissed. Directors will therefore be putting their job on the line with every generous package they sign.”

It is undoubtedly clear that cultural issues have contributed to some sub-optimal behaviour in this area over the last decade to say the least. But ultimately central banks especially the US Federal Reserve should bare the brunt of the blame. The failure of the American elite to support and protect the American people is an unsettling theme from this crisis and may have a profound effect on the future of that great republic.

Infrastructure finance will be tight.
“In Australia, interest rates will come down sharply. But governments are going to be shocked at the cost of funding infrastructure. Institutions backing past Australian infrastructure projects have been taken to the cleaners by over-optimism and bad financial structures. Regulation of prices and returns will need to be much more realistic and badly researched demand figures in non take-or-pay areas will be laughed at. “

As I work in this sector I am inclined not to comment other than to say I would expect the Federal government to be using infrastructure spend in the near- to medium-term provide fiscal stimulus to the economy. Construction on the Hoover Dam commenced in 1931 ….

Ratings agencies will lose clout.
“During the boom, credit controllers have had a decade of drought. Much of their activity was outsourced to rating agencies who handled it extremely badly.”

Ratings agencies I suspect will be another causality of this crash; I suspect their role in the undoing of the Western financial system will be the stuff on many Ph.D’s