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

Mainstream

The original purpose of this blog was to highlight that irresponsible monetary policies that had placed the world, particularly the U.S., in a position that would lead to a massive correction and severe economic downturn. The reality is that this is no longer the hypothesis of a lone blogger but the overwhelming theme running through main stream media. Over the last four years I have looked for articles to link to this blog to try and support this argument. What were previously a few isolated voices has become a screaming, discordant chorus. The papers are riddled with references to the "severe recession" and a few to economic "depression".

Let me recap on some key statements from my first post in August 2004. Yes it is self indulgent, but I'm a blogger after all:

"Defaults on securitised mortgage debt in 2007-2009 will no doubt be a key catalyst in the unravelling of the Western financial system"

"There is a credible possibilty of a cascade failure in the banking system leading to a liquidity crisis"

"massive declines in both property and equity markets with a wholesale destruction of wealth not seen since the early 1930's"

And for the near future:

"As a medium term response, expect a full-scale rejection of economic rationalism and a vast increase in government economic regulation"

As for my prediction on gold......the appreciation in the gold price we have seen over the last four years was primarily driven by commodity price appreciation. What we are now seeing for the first time is the very beginning of the re-monetisation of gold. My guess is for a 15-25 times appreciation in the gold price over the next 5 to 10 years. I'm no gold bug and I certainly could be wrong....lets wait and see.......

Total Meltdown

With Lehman Brothers filing for bankrupcy today and Merrill Lynch being acquired by Bank of America the U.S. has lost three of the big five investment banks in the past year. Organisations that survived the Great Depression have fallen victims to the Great Recession. The consequences of the Lehman failure will mark a key point in the transition of the "credit crisis" from a financial services phenomenon into a broad based economic downturn not unlike that seen in the 1930's. Uncertainty and volatility will now become the trademarks of the end of this decade. Allow me to quote a little from the article linked above:

it’s unlikely to be a slow-motion train wreck this time. With Lehman in liquidation, and Washington Mutual and AIG on the brink, the credit market would likely shut down entirely and interbank lending would cease. In his newsletter yesterday, Nouriel Roubini wrote: “What we are facing now is the beginning of the unravelling and collapse of the entire shadow financial system

This is not contrarian, gold bug, doomsday press (as it largely was when this blog started) this is mainstream journalism in mainstream media.

By 2010, so says this blogger, a mood of pervasive pessimism will have decended across the US and the World akin. The breakdown in the World order from the undermining of global economic stability will quickly flow from the economic to the social and political spheres. Economies such as China, built on the monetary expansion of the 90's and 00's will slow and faulter. Their implied covenants of personal feedom exchanged for prosperity will be invalidated. Their populations will become restless.

This will play out just as the 1930's did. The story will be old, the names and faces will be new.

The 2010's are unlikely to be a happy decade.

End of Deflation Exported

Click on the link above to access Alan Kohler's article "Deflation no longer duty free".

I find it quite amazing just how clear this all seems to the commentators after the event.

Yes, mobilisation of labour in China and India kept inflation subdued despite excessive monetary expansion. It suppressed the price of consumer goods whilst property and equity markets skyrocketed. For an extended period we have had true inflation, being expansion in the money supply, running much higher than headline inflation figures. Probabably around 6-8% most of his decade.

The interesting part now is really what sort of recession we are going to have...inflationary or deflationary.

The jury is out on this one.

Capital and Labour

Capitalism sowed the seeds of its own demise because the benefits of a decade-long boom accrued to capital, with nothing flowing to labor. Telling workers who hadn't had a decent pay raise for years to tighten their belts once the good times ended proved disastrous.

Click on the link above to access Mark Gilbert's article from Bloomberg entitled: "Granddad, Tell How Capitalism Committed Suicide".

As you know I always look for the just the right articles to set the pitch for these posts. The comment about labour and capital is a critically important one. It invariably underlies the difference between a real economic expansion aka 1945-1965 and a monetary expansion aka the nineties and noughties. In a real expansion the value of labour increases and the purchasing power of consumers rise through increased income. This is a sustainable expansion. In a monetary expansion, which has just ended, the purchasing power of consumer rises through increased access to debt and is driven by gearing not productivity and wealth.

...and that folks is why what we going to witness in the next few years will be a repeat of the 1930's and not the 1970's.

-Prem

More of the "D Word"

Just a short post. Another reference to the Bank of International Settlments and the "D Word".

With oil prices on a ballistic trajectory the world economy seems headed for rough times. Is this merely and expression of the monetary expansion, or are we at "peak oil". Stay tuned!

Downward

Energy and food prices are soaring. The housing market continues to collapse. Government revenue is falling, and taxes are rising. Airlines are jacking up fares and fees while reducing service. Banks are pulling credit lines. Auto companies are cutting production once again. Even investment bankers are losing their jobs.

By 2008 the mainstream press has caught on to the unfolding economic reality, that is, that the United States is in the early stages of a severe economic downturn. The debasement of the US dollar has continued consistently across the period of this blog. The monetisation of this period is well and truly flowing into massive inflation with commodities, oil and food all experiencing significant price increases. While the deception of "core inflation" becomes ever more disconnected from the inescapable reality of "real inflation".

With the possibility of peak oil soon migrating from a fringe concept to a mainstream mantra the way the world looks at its future may change in far more radical terms than global warming could ever do. The link above to the article from the Washington Post is a solid anchor point from which to anticipate the next five years.

A Long Time Ago in an a Economy Far Far Away

My apologies for the less frequent posts it what may seem the most interesting period of this site. You can be assured that we are now exactly where this blog speculated we would be in August 2004. The Great Recession is well underway, this is no false start. I read on the front page of the Australian Financial Review yesterday, the phrase “not since the Great Depression”, I suspect will sadly become more commonplace in usage.

As the Great Recession unfolds you will read a lot of commentators writing about how the recession began with the debt crisis in Quarter 3, 2007. Economic catastrophes like the one we are witnessing didn’t begin a year ago. They began a decade ago. The recession we are witnessing now is the final culmination of the dotcom mania of the 1990’s. Back in 2001/02 following the NASDAQ collapse we were in a mini-recession . It was a timely and necessary recession to purge financial markets of the excesses of the internet mania that had gripped the world in the immediately preceding years. Unfortunately this recession wasn’t allowed to transpire. I say unfortunately because in a free economy sometimes markets get it wrong and a correction with its associated consequences becomes necessary. That market was the NASDAQ. To avoid an imminent recession and possibly the political consequences for the new US government, the US Federal Reserve decided to monetise the problem away. By dropping interest rates to 1% the Fed effectively delayed and amplified the problem. Over the next six years the excess liquidity in the global financial system became massive excess liquidity.

This expanding sea of liquidity migrated from the NASDAQ to US property markets creating an incomprehensible boom of rapidly rising property prices, reckless lending standards, billowing personal debt, fraud and complicity. Almost every asset class over the last five years has seen tremendous increasing in values, in no small part driven but the almost unlimited amount of leverage available to finance them.

The sub-prime meltdown was the first step in markets recognising the unsustainable nature of this irresponsible lending frenzy and asset price appreciation. It commenced a process that will ultimately prove cathartic for the world economy.

What lays ahead? Within three years the following are possible:
· personal debt, even mortgages, will be hard to come by to average earners
· stock markets indices will be below half of their 2007 peaks,
· gold will trade over USD 2,500/oz,
· the US unemployment rate will be into double digits.

No doubt this economic upheaval will begin to create geopolitical instability. If the Chinese economy collapses as a result of a massive US induced global recession it may not survive in its current form or as a unified state.

The "R" Word

Welcome back to 2008, I hope you all had a good break - I certainly did.

The "R" Word is everywhere.

Equity markets around the world have finally caught up with debt markets and declines are now regular and daily, interspersed with short lived rallies. The US Fed has reacted with its typical disregard for monetary restraint and seems intent on trying to monetise the problem away.........again. We may see interest rates rise to to the levels seen in the 70's and 80's if this policy continues. I can't see it working this time. The market's core sentiment has finally changed from greed to fear and I doubt it will abate any time soon.

There may be an equity rally later this year, but by the end of 2008 no one will be predicting a recession - it will be here. What people still won't have grasped is the length and severity of this recession. This recession will likely have significant geo-political consequences for the world.

We will continue to follow the Recession of 2008 throughout the year as it develops into the Great Recession. More in February.

Stagflation

As we reach the end of 2007 it now is abundantly clear in the markets and finally the mainstream media that things are not well at all in the US and I would argue by extension, the World's economy. The market is apprehensive and fearful of the future. Debt markets have seized up, prompting massive central bank interventions which will inevitably prove inflationary.

In the US, as growth slows, inflation rises, prompting justified concerns that the US is moving into an inflationary cycle. Equity markets which has traded sideways in 2007 will likely connect with debt markets and trade downwards in real terms in 2008. Governments and their agencies seem reluctant to purge the excesses of the monetary expension that has accelerated over the last fivs years, despite the fact that this is the cathartic medicine that markets truly need.

At this point it seems inevitable that 2008 will seen the 'R' word beginning to be used more frequently, particularly in relation to the US economy. By the end of 2008 we will most likely see the consequences of the US slowdown flowing into the world economy with Asia and Europe following.

The article linked above refers to the European central banks injection of EU350b into the capital markets. However, risk aversion remains high. Eventually if banks remain reluctant to lend, asset prices will come under increasing valuation pressure, and by a natural extension equity prices.

While 2007 may still pass as a Merry Christmas, 2008 may not be so cheery.

But for now a Merry Christmas and a Happy New year to all.

A Rock and a Hard Place

Click on the title of this article to read David Galland's paper from Kitco Casey. I concur with the general view of this article that the US Federal Reserve is facing a difficult choice. On one hand the extended period of uncontrolled monetary expansion has led the US economy into what is now clearly a pre-recessionary period. The credit crunch and housing market collapse are both in their early stages. They are part of a natural market driven corrective process which should appropriately lead the US economy into a recession. This would be at its nature a deflationary correction with widespread falls in asset prices leading to de-monitisation. What Mr. Galland has identified is the second choice the Fed has, and ultimately a far less responsible one. That is, to restart the process of monetary expansion.

There is one key problem with the "inflate to success" approach, namely the US dollar. The US dollar has been under extended selling pressure for sometime and is in the woes of an extended decline.....an extended but orderly decline. The risk with the remonitisation approach is that foreign holders of US dollars finally have enough of the steadily declining value of their investments and pull out of the US currency and treasuries en masse. This was recently described by one Chinese commentator as the "nuclear option". Nuclear is the right descriptive term, and this is pretty much the assumption that the US Fed is working from; namely that the consequences of wholesale dumping of US dollars are mutually unacceptable to both sides of the transaction.

It is unclear at this stage as to whether the consistent falls in the USD could at some stage transpire into a genuine rout.

Neutering Monetary Policy

Treasury Gain May Falter; Foreign Holders Flee Dollar

"The dollar's slump to a 15-year low against six of its most actively traded peers is turning the gains into losses for international bondholders, prompting China, Japan and Taiwan to sell. Overseas investors own more than half of the $4.4 trillion in marketable U.S. government debt outstanding, up from a third in 2001, according to data compiled by the Treasury Department. "

Please click on the title of this post to link to the Bloomberg article.

That is pretty much the sort of headline I expected to read when "it" all began. The sunshine boys of the financial markets are calling for a rate cut because this year's bonuses look at risk. However the second part of the equation is the US dollar. Like nitrogycerine in liquid form things go along fine as long as there aren't any sudden movements. Well there have been a few sudden movements and the US dollar may be headed for its long overdue repricing....read explosively downwards.

Now when your currency is under selling pressure and has broken through key support levels the last thing you want to do is drop interest rates. In fact, that could precipitate a full scale run on the dollar which in turn would lead to swift and substantial rate rises.

If the current diversification out of the US dollar turns into a rout expect to see rapid rate rises to support the currency. Naturally this will push the US economy and the rest of world along with it into a stonkingly massive recession.

Watch that dollar.

Zero Liquidity

``There are securities which simply can't be priced because there is no trading in them,'' Timothy Ghriskey, chief investment officer at Solaris Asset Management LLC in Bedford Hills, New York, said in an interview today. ``There are no bids for them. Asset-backed securities, mortgage loans, especially subprime loans, don't have any buyers.''

BNP Paribas announced that it was halting withdrawals on three of its funds with investments in the sub-prime market. The reason for this is that it would be unable to cashout redemptions in these funds. To cash out redemptions from a fund normally you would have to sell a percentage of your portfolio. Unfortunately, for BNP, and more unfortunately for the unitholders in its funds, those assets are essentially worthless. The quaint euphamism "total lack of liquidity" is the equivalent of saying "absolutely worthless".

This is the point in markets where greed really does turn into fear. If you are an investor in any of these funds it is the first one out who stands a chance to recover all or part of your investment value. Whereas "Cash is Trash" has been the motto for investors over the last five years it is rapidly becoming the very opposite.

Is this a healthy market correction driven by an overdue re-rating of risk; or the small of smoke before the house burns down? Watch closely.

Jitters

"Global Bond Risk Premiums Soar as Investors Seek Safest Assets"

There appears to be a re-rating of risk sweeping through global markets, a flow on from the sub-prime meltdown which apparently will not be quite as contained as has been speculated.

There are a lot of "interesting" things happening in markets at the moment. A wholesale re-rating of risk can potentially have a broad based inpact on the pricing of debt and equity by pushing up risk premiums and consequently pushing down prices.

The US dollar (add China/Japan) liquidity spigot is still fully open. It seems that investment markets may be so soaked with liquidty as the moment that they can no longer absorb any more. It is possibly we may see continued inflationary pressures concurrent with a decline in prices in asset classes.

The Central Banker's Bank

Today's feature article is from the Sydney Morning Herald (link above) quoting the annual report of the Bank for International Settlements. The title of the article is "Great Depression fall looms".

'In its annual report the Bank for International Settlements noted that the conditions which led up to the Great Depression of the 1930s and the Asian crises in the 1990s were reflected in the current environment. '

Of course the article will be dismissed by most readers, most business people, most people in banking and finance, most economists. For most people they will need a 7% rise in their mortage interest rate, or a termination notice before they have a concept of recession or economic depression. When this horrible reality becomes apparent to all there will be one question asked, and it will be asked repeatedly "How did this happen?" Everyone will want to explain why they were betrayed or misled and how their government's central bank failed to protect them from themselves. Like the generations born in the 20s' to 40's our children will grow up in an environment where debt and incumberance are frowned upon and moderate living well regarded.

What me Worry?

Apparently Big Al was speaking recently to a group of U.S. investors who canvassed the pertinent question.....should we be worried about the Chinese choosing not to hold, or to decrease their holdings of US Treasuries.

Big Al of course responded with the Alfred E. Neuman response, slightly paraphrased. Click the title of the post to check out this article.

It is remarkable for two reasons. Firstly, the frank admission (that Mr. Schiff often asserts) that China is the US's "lender of last resort". That is, no one else would be there to buy US Treasuries if the Chinese were not in the market. Secondly, that this unstable and potentially disasterous set of affairs is of no concern. Make no mistake about this, if the Chinese did choose for whatever reason to walk away from its massive holdings of US Treasuries the title of this blog would swiftly move away from conjecture into current affairs and then into history.

Geckoism

This month's feature article is from Forbes, citing a number of similiarities between current economic and market conditions and the mid 1980's....

--"Real gross domestic product… grew at a seasonally adjusted annual rate of 1.3% in the first three months of the year. That was down sharply from growth of 2.5% in the fourth quarter of 2006 and was the slowest rate of growth since the first quarter of 2003." The Wall Street Journal, April 28, 2007.

--"The U.S. economy, battered by foreign competition, grew at a sluggish 0.7% annual rate during the first three months of the year ... The gross national product, the broadest measure of the country's economic health, has not expanded at such a low rate since the end of the 1981-1982 recession." Associated Press, May 21, 1985.

Makes for an interesting read. The more I contemplate the prevailing economic conditions the more I believe the root cause lies with: excess liquidity driven by excess US dollar production (read Treasuries) driven by irresponsible US economic policy and unsustainable deficits. Markets usually have self corrective mechanisms however the mercantilist policies of China and Japan in particular are ensuring that the US dollar is not being appropriately priced.

Ultimately a correction to the global liquidity glut will be associated with a re-rating of the US dollar probably associated with a significant decline in value and a sharp rise in US, and then, global interest rates. The 'valuation crisis' that this article describes will lead to the pricking of the world's innumerable asset bubbles accelerating the decline in liquidity.

However, rather than this correction being a bull market hiccup as suggested, it will be the beginning of an extended bear market and so the more accurate comparison remains the late 20's. Why I take this position is influenced both by a view on the economic fundamentals we are currently seeing and an intergration with generation theory which would predict a crisis of this scale. To explore this link yourself I would recommend familiarising yourself with Howe and Strauss's conceptual framework at www.fourthturning.com

Best run since 1927! Yippee!!

Dow: Longest bull run in 80 years
Blue-chip gauge matches 1927 record for longest up streak; Alcoa bid for Alcan, falling oil prices help.

You have to love articles like this. A big cheer and hurrah. Best times since 1927! Cheer! Cheer! Hip hooray!

Sigh. I was only thinking today that I hadn't found an article worth linking to the blog, but any article that trumpets just how great it is to be in a repeat of the late 1920's really has to take the award.

Nothing much of interest in the article except the pervading sense of irony.

Tariffs Anyone?

This month's highlight article is from The New York Times on the imposition of trade tariffs on paper imports from China. The article discusses the possibility that additional tariffs may be imposed on other manufactured goods.

http://www.nytimes.com/2007/03/31/business/31trade.html?_r=2&ref=business&oref=slogin&oref=slogin

Apparently, the US Commerce Secretary wants to retain some of his country's industrial capacity. It is about time frankly. The Chinese have effectively bought the United States' industrial capacity from them over the last 10 years. I doubt they will get anything much else of value out of their hoard of US dollars, should they try to actually buy something substantial with them. The articles goes on to say:

"The stock market at first reacted negatively to the news, on fears that a trade war with China could erupt, harming the dollar as well as stocks of companies that rely on trade with China. But stocks later recovered, ending the day barely changed. "

I sort of suspect that this market bouyancy may not continue should tariffs be broadly extended. Hmmm, what's the last time I think something like this happened........

http://en.wikipedia.org/wiki/Smoot-Hawley_Tariff_Act

Until next month.

Volatility

This month's post features a link to an interesting article from Jim Jubak featured on The Street.

http://www.thestreet.com/_tsccom/newsanalysis
/investing/10342797.html

Ultimately the current excessive monetary expansion and related global asset price bubbles will reverse into a recessionary contraction. As with the cause of the expansion, the contraction will also be a monetary phenomenon, but it may well be first expressed through the markets.

Unwinding of the yen carry trade, as Jim points out, may be beginning to have an effect on global equities. As always, one can't overplay any single trend or event. Eventually one, or a combination of events will become the 'match' as I like to refer to it.

Only the he well informed can smell the petrol, but everyone will see the fire.

2007 Kickoff

http://www.morganstanley.com/views/gef/archive/2007/20070212-Mon.html

I see Steve Roach is back plowing the fields of monetary responsibility, barren as they currently are.

More shortly.

Benign Neglect

The US dollar has come under selling pressure over the last fortnight trading down against other major world currencies between 2-3%.

The critical issue is not one of direction but speed. If momentum gathers against the dollar it could force US interest rates up inducing a significant monetary contraction. We would then enter a stagflationary period of higher interest rates and lower growth. This could come as a short sharp shock to the global economy.

It is worth following the pace of the US dollar's devaluation over the next months.

Mixed Messages

http://www.bullnotbull.com/archive/shorting-opportunity-2.html

A well written article from Mr Nystrom.

The apparent schism between markets and underlying economic information continues unabated. It is not just confined to the United States, the Australian market is also pushing the ASX into new heights. However, these are VERY different economies. The US economy, as far as I can see is supported by its only significant export ....the US dollar. It has currently started to slide again. I still believe very strongly that a siginicant fall in the US dollar accompanied by higher US driven interest rates will precipitate a global recession through massive asset price deflation. But....when this will happen is still unclear to me, and more likely than not will be induced by other factors or a set of adverse circumstances.

The US trade deficit is now just shy of $70b/month. All I can say is the foundation for this occuring is present and the supporting factors have been intensifying over the last two years.

"Angel Gear"

Since my last post in July there has been a continuation in the struggle between the forces of beardom and bulldom.

Equity markets continue to trace sideways. Central banks seem unable to decide if inflation or deflation is the greatest threat to the status quo. The recent data from the US shows that the housing bubble has finally started to deflate and possibly burst. There is now active talk of a decline in demand mitigating inflationary pressures and of the US Federal Reserve suddenly reversing monetary policy. Which I suspect will be a bit like switching into neutral while coasting own a hill...generally regrettable.

Ultimately nothing, and I mean nothing, will demonetise the world economy like a fall in the value of the US dollar. This is precisely what a reduction in US interest rates would now precipitate.

So, although it seems paradoxical, the reversal of monetary policy at this point, if it occurs, may be the "Angel Gear" shift that leads us to the Great Recession.

Crest of the Wave

I really enjoyed the following article from itulip and it follows nicely on from the comments at the end of last month's post.

http://www.itulip.com/forums/showthread.php?t=252

There is a very perceptable change in sentiment taking place at the moment. Let's take a look at the key factors that are shaping current economic commentary:

Interest rates are universally on the rise.
Everywhere you look Consumer Price Indices are rising and central banks are responding with interest rate rises in an attempt to contain inflation. This is almost universally a post-monetisation hangover and the inevitable result is a stagflationary environment. Normally this would precipitate a recession, but with a world economy lathered in government and personal debt the consequences may be more severe.

Equity markets are trading sideways.
Markets are efficient, but not smart. That is why smart people make money from them. They reflect a collective position. An extended cycle of sideways trading is actually worse than a correction in my opinion. It suggests that the collective consciousness of the market is reassessing itself. In colloquial terms the bear is rising from hibernation. While the economic fundamentals support a bear market in equities, until the core psychological sentiment of the market changes it will not formally begin its bear cycle.

Oil prices are surfing the crest.
The monetary expansion has translated into consumption and debt in the US and production and savings in Japan and China. The US has been able to fuel this expansion through ever growing deficits and government debt. If you think of 'core' CPI as the very tail end of the expansion then oil is on the crest of the wave. The inflation in the money supply has expanded economic activity, which is not necessarily productive activity. Rising oil demand has reflected this expansion and is in turn driving producer and consumer price inflation in its wake.

Political environment is unstable.
Well, this is a relative statement. One could say the political environment is always 'unstable', but now perhaps particularly so. America's military adventurism is beginning to prove unsuccessful. Civil war is now a virtual certainty in Iraq. Afghanistan was not brought under control and a lower level insurgency persists there. Iran continues to compete with North Korea for the 'Rogue State of the Week' award. Together with Syria it funds its Hezbollah brothers in Lebanon who are forcing the entire country to pay for the sins of a relative few. Israel is taking the predicable course of action and using its vastly superior military capabilities to assert its will upon its adversaries. This could be more of the same, or a step-by-step decent into a Nostradamean nightmare.

Again, and as always, we need the patience to watch history unfold, but unfolding it is.

The Yen Factor

http://www.bloomberg.com/apps/news?pid=10000101&sid=awNin16JW6lY&refer=japan

There has been a lot written recently about the Yen carry trade and how its unwinding might impact global liquidity and markets. I don't have a feel for its historical impact on the global monetary expansion, I don't think I have read a commentator who has a definite view on this either. Opinions on the possible impact of the unwinding on the Yen carry trade extend from:

a) will have a negative influence on gloabl asset prices to,
b) will induce a global economic implosion.

I suspect we need to sit and wait for July and see what impact a 25 basis point rise in Japanese interest rates has on capital flows in and out of Japan.

It does seem relatively clear that recent global interest rate rises are starting to have a significant impact on speculative excesses and global equity markets are currently reflecting this in sideways and downwards trading cycles.

Over the next year I suspect sentiment will gradually erode as the monetary contraction takes hold and the lack of upward momentum on asset prices turns into a comprehensively downward trend.

The Failure of Monetary Policy

http://www.morganstanley.com/GEFdata/digests/20060522-mon.html#anchor0

I have a lot of faith in the fact that this period of time with be of great interest to economic historians. Steve Roach is 110% on track when he identifies the fundamental failing of central bank monetary policy in his most recent article.

Inflation targeting hasn't worked and the CPI has not been an accurate measure of monetary expansion. This thinking will not survive past the coming recession.