The Great Recession

Sovereign

2012-01-12T13:31:00.005+11:00

"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 right downs 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

2011-10-21T15:55:00.002+11:00

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

2011-07-19T12:17:00.002+10:00

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

2011-05-17T12:25:00.002+10:00

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

2011-04-12T18:03:00.003+10:00

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

2011-02-16T14:43:00.004+11:00

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

2011-02-10T17:20:00.003+11:00

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

2010-12-01T14:05:00.005+11:00

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

2010-09-28T11:01:00.002+10:00

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

2010-09-08T12:32:00.005+10:00

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

2010-08-19T14:02:00.002+10:00

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

2010-06-04T12:09:00.002+10:00

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

2010-06-01T14:46:00.003+10:00

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

2010-04-08T09:08:00.003+10:00

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

2010-01-21T10:38:00.004+11:00

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

2010-01-15T11:35:00.002+11:00

"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

2009-11-18T16:29:00.002+11:00

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

2009-10-30T15:23:00.002+11:00

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

2009-10-26T14:12:00.006+11:00

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

2009-09-15T11:10:00.005+10:00

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

2009-09-03T09:07:00.004+10:00

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:

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.

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.

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

2009-08-21T15:52:00.004+10:00

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

2009-08-20T09:30:00.003+10:00

" 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?

2009-08-12T12:58:00.003+10:00

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

2009-07-30T18:17:00.003+10:00

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

2009-07-15T16:17:00.002+10:00

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

2009-07-15T15:57:00.005+10:00

"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?

2009-06-22T15:02:00.003+10:00

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

2009-06-12T11:09:00.006+10:00

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?

2009-06-11T09:57:00.004+10:00

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

2009-05-22T12:52:00.004+10:00

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

2009-05-08T16:47:00.006+10:00

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

2009-04-22T17:34:00.002+10:00

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

2009-04-01T18:05:00.005+11:00

"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

2009-03-27T17:07:00.003+11:00

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

2009-03-20T18:34:00.005+11:00

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

2009-03-11T11:36:00.002+11:00

An eponymous post (link above from the Australian).

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

Choo Choo

2009-03-05T13:32:00.003+11:00

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

2009-03-03T09:40:00.004+11:00

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

2009-02-27T17:58:00.004+11:00

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

2009-02-16T14:33:00.003+11:00

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

2009-02-03T11:43:00.000+11:00

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

2009-01-29T11:30:00.004+11:00

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

2009-01-16T10:40:00.001+11:00

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

2008-12-30T16:57:00.002+11:00

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

2008-12-10T14:12:00.000+11:00

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

2008-12-05T12:35:00.001+11:00

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

2008-11-13T17:56:00.001+11:00

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

2008-11-11T13:31:00.001+11:00

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

2008-10-24T15:08:00.001+11:00

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?

2008-10-15T19:37:00.001+11:00

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

2008-10-10T17:05:00.000+11:00

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

2008-09-15T17:57:00.002+10:00

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

2008-08-15T15:11:00.000+10:00

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

2008-07-11T11:37:00.001+10:00

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"

2008-06-18T10:36:00.000+10:00

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

2008-05-29T09:14:00.001+10:00

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

2008-03-18T13:33:00.000+11:00

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

2008-01-30T21:55:00.000+11:00

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

2007-12-19T09:36:00.000+11:00

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

2007-10-19T09:21:00.000+10:00

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

2007-09-10T15:35:00.000+10:00

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

2007-08-10T09:30:00.000+10:00

``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

2007-07-27T11:43:00.000+10:00

"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

2007-06-26T09:49:00.000+10:00

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?

2007-06-13T10:04:00.000+10:00

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

2007-06-06T13:56:00.000+10:00

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!!

2007-05-08T17:21:00.000+10:00

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?

2007-04-02T11:49:00.000+10:00

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

2007-03-08T10:20:00.000+11:00

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

2007-02-14T16:21:00.000+11:00

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

2006-12-04T14:07:00.000+11:00

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

2006-11-06T11:56:00.000+11:00

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"

2006-09-27T13:54:00.000+10:00

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

2006-07-27T13:52:00.000+10:00

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

2006-06-21T10:44:00.000+10:00

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

2006-05-24T09:57:00.000+10:00

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.

Contractions

2006-05-03T09:23:00.000+10:00

Anyone who follows this blog will know I regularly quote Stephen Roach at Morgan Stanley. Steve seems to have had a slight change of heart, the following is an except from his latest weekly article:

"No, I am not prepared to give an unbalanced world the green light. But it’s time to give credit where credit is due: First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns. Third, to the stewards of globalization for facing up to the imperatives of architectural reform. And fourth, to Asia -- especially China -- for recognizing the unsustainability of export-led growth models. Notwithstanding the risks noted above -- all of which need to be taken very seriously -- I am delighted that the global economy finally seems to be taking its medicine. Let’s hope the cure works."

http://www.morganstanley.com/GEFdata/digests/20060501-mon.html#anchor0

"Second, to central banks for collectively embarking on policy normalization campaigns."

The US Federal reserve embarked on "policy normalisation" in 1928 and 1929 in an attempt to reign in the prevailing market exuberance. There were three interest rate rises in 1928 and another 50 basis points in 1929. We are at the same stage of the monetary cycle.

Frankly, I feel I need to state this plainly; nothing any government or central bank can do can now avert a serious worldwide and US centric recession. The grossly excessive monetary expansion of the 1995-2005 period will correct itself. The damage has already been done. We are now at the beginning of a monetary contraction and it is inevitable that at some time market confidence underpinning asset prices will collapse.

I normally agree with Steve, but his most recent comments go very much like this:

I have been smoking cigarettes for 30 years. Just lately I started to cough up blood. But I realised my mistake and quit the smokes last week so everything should be fine.

Well things are far from fine. governments and central banks can undertake whatever surgery or remedial procedures that see as possible and necessary to try and minimise the impact of the of the monetary contraction, but the consequences of the expansionary excesses cannot be avoided.

It might sound a perverse thing to say but I am praying for a severe recession. The only reason I say that is that I don't want to live through a depression.

Monetisation versus Growth

2006-04-05T13:31:00.000+10:00

http://www.moneyweek.com/file/9347/is-the-us-facing-another-great-depression.html

An article from Dr Kurt Richebächer that discusses some of the issues associated with the extraordinary monetary expansion the US has experienced in this decade; how it is similar to that of the 1920's, and how it is not "growth".

Long Term Rates Rising

2006-03-08T09:01:00.000+11:00

http://www.smh.com.au/news/business/the-ground-shifts--longterm-rates-on-the-rise/2006/03/07/1141701513128.html

An article from the Sydney Morning Herald which I believe is a good pointer to the world economy being past the peak of monetary expansion and being in the early part of a monetary contraction.

Laundering the Trade Surplus

2006-02-20T16:34:00.000+11:00

But the banks, which purchased the dollars, just hold on to them, to lend or invest in dollar-denominated financial products. Thus, the exchange rate is stabilized to encourage exports.

I have been waiting for an article worth publishing for this month's update and I finally found it.

A point of view from the other side of the world's global imbalances. This article from Asahi discusses the implications of maintaining a massive trade surplus and its deflationary impact on the Japanese economy.

It correctly asserts (in my view) that the Japanese should be spending their trade surplus to support domestic consumption rather that recycling this money into US treasuries. The reality is that the Japanese holding of US dollars is not convertible at full value and any attempt to do so would likely trigger a precipitous plunge in the value of the USD.

http://www.asahi.com/english/Herald-asahi/TKY200602170164.html

Delaying Surgery

2006-01-10T09:34:00.000+11:00

http://www.morganstanley.com/GEFdata/digests/20060106-fri.html#anchor0

Reversals are possible on three fronts -- the liquidity cycle, the US property market, or the dollar.

We finished 2005 with a link to Steve Roach and will start 2006 the same way. Obviously it gets a little quiet over the festive period and we all have more important things to do. Of interest is certainly the continued strength in the price of gold. The most likely explanation appears to be petrodollars that are being recycled out of USD into bullion. Clearly someone has decided not to hold US dollars, and for good reason. The US budget and trade deficits continue to expand with apparently scant concern for their impact, or management.

China and Japan are caught in a "damned if I do, damned if I don't" scenario. If they decide not to continue to increase their holdings of US dollar denominated assets, ie Treasuries, they will induce the long expected collapse of the US dollar. This will inevitably lead in short term to higher US interest rates, falling asset prices, and an associated recession. By continuing to increase their holdings they buy time, but only in the sense that a cancer patient buys time by delaying critical surgery.

Again, it promises to be a very interesting year.

Views on 2006

2005-12-20T11:25:00.000+11:00

http://www.morganstanley.com/GEFdata/digests/20051216-fri.html#anchor0

Another excellent piece from Steve Roach on Waiting for Godot, economic syle.

Have a Merry Christmas and a Happy New Year all.

The Root Cause

2005-11-14T15:13:00.000+11:00

http://www.financialexpress.com/fe_full_story.php?content_id=107551

Untimately the unsustainable asset price bubbles and credit binges have one root cause...money supply. The monetary expansion we have all experienced in the last ten years has been championed by the US Federal Reserve and its dollar printing excesses.

In the last five years this expansion has become frenzied. A world awash will excess liquidity (cheap money) is everywhere I look, from bargain basement rates on massive debt tranches in infrastructure financings to being pestered to take out a home loan when I enter the local bank branch.

The linked article is a nice succinct piece that gets straight to the core issues.

Microcosm

2005-10-10T09:19:00.000+10:00

Delphi files for bankruptcy
[click title "Microcosm" for link to article]

I haven't headed up an article before on an individual company but now might be the right time to start. There is a swathe of ominous warnings circulating at the moment regarding the health of the US stock market. In our globalised world economy naturally that means the world stock market.

With inflation now more than a threat, it seems likely that the last ten plus years of monetary expansion may well have ended. As growth in the money supply continues to slow asset valuations will come under increasing pressure. Invariably our asset bubbles in equities and property will deflate and/or collapse. I like to think that a declaration of bankrupcy by General Motors will be a significant tombstone in this process.

Delphi is a huge auto parts manufacturer (185,000 employees) that was previously part of General Motors. It was spun off and floated as a seperate entity but with strong contractual ties to its original parent, GM.

Delphi's filing for Chapter 11 protection is yet another step in the inexorable unravelling of General Motors. With an astounding USD 130 billion of corporate debt/bonds on issue (through GMAC) General Motors has become a microcosm of the pre-recessionary US economy.

Breaking Point

2005-09-04T18:27:00.000+10:00

http://money.cnn.com/2005/09/02/news/economy/
katrina_widerimpact/index.htm

http://www.economist.com/agenda/displayStory.cfm?story_id=4362200

This blog has attempted to describe the fundamental economic imbalances they have layed the foundation for a severe and extended world recession driven primarily from the US economy, but with aggravating factors present in many other western economies.

The key factors have been:

chronic growing indebtedness,
negligible savings,
reckless expansion of the money supply,
and related non-CPI inflation,
speculative asset bubbles.

The previous post referred to oil. The first real casualty of extended monetisation and first effective and natural break on the world economy. The post prior to that, referred to the Chinese government's decision to rebalance the Yuan away from a US dollar peg.

If Katrina does indeed prove to be the precusor to the expected economic implosion no doubt many will make the argument that the recession was because of Katrina. The recession was not. That is like driving a car at high speed towards a wall and then blaming the wall for your broken legs.

I cannot see flexibility the US Federal Reserve has in lowering US interest rates, without precipitating a run on the US Dollar.

The US economy, in particular, has already been brought to breaking point. This hurricane potentially marks that spot.

Oil

2005-08-16T14:50:00.000+10:00

From Stephen Roach, Chief Economist, Morgan Stanley:

Courtesy of a full-blown energy shock, the venting of global imbalances can
no longer be deferred indefinitely.

http://www.morganstanley.com/GEFdata/digests/20050815-mon.html#anchor0

I haven't commented much on oil, and as for Peak Oil, I really have no idea if we are there or not. However, as to whether an oil price shock would be a likely precursor to the sort of economic correction that Steve Roach predicts, yes I think this is quite likely.

As for whether we are at Peak Oil? I don't even like to think about it. That is too bearish even for me! If we are at Peak Oil now, before the asset bubbles and debt binges correct themselves then the outcome will be nothing short of catastrophic.

So, if you tell me this is Peak Oil I will put my fingers in my ears and sing lalalala loudly to myself and think about investing in Californian real estate or Internet stocks.

KerPlunk?

2005-07-22T15:56:00.000+10:00

http://money.cnn.com/2005/07/21/markets
/bondcenter/bonds.reut/index.htm

"While a China revaluation at 2.1 percent was modest, the market's concern clearly reflected the critical role foreign central banks have played in keeping long-term rates low even as the Federal Reserve has raised short-term rate."

China has revalued its currently by a small margin of 2.1%, but more significantly it has stated that is will no longer peg its currency to the US dollar. Rather it will adopt a trade weighted basket of currencies to manage the Yuan against. I note also that Malaysia quickly followed China's example.

Now does this mean that China will rebalance its foreign currency reserves to reflect the Yuan's trade weighted basket?

http://www.forbes.com/home/feeds/ap/2005/03/11/ap1878397.html

"China's has the world's second-largest foreign currency reserves after Japan, with the equivalent of nearly US$610 billion (euro470 billion) at the end of 2004. That rose by US$209.9 billion (euro161.5 billion) last year, driven in part by a surging trade surplus.

Even as the reserves grew, the share of dollar assets held by China's central bank fell to 76 percent, down from 82 percent in 2003, Lehman Brothers said."

A significant reduction in the relative shareholding of US dollar reserves by asian reserve banks could precipitate a decline in the US dollar, or more precisely a crash. It will certainly be interesting to see how this plays out over the next few months.

Global Property Bubble

2005-07-04T11:44:00.000+10:00

It is amazing how long the US (and World) economy has been in Bubbletopia.

Back in the late 90's when the US dotcom bubble was at its height, a recession seemed inevitable. I don't think any observer, astute or otherwise, expected to be where we are now at the beginning of the 2005/06 financial year.

We should have had a solid recession and right now be in a bear market. Instead we are in a "conundrum". The US Federal Reserves' monetisation of the dotcom recession has both delayed and amplified the effect of the inevitable downturn.

I called this blog the Great Recession because I believe Depression will be the last word that government's will use to describe the coming economic implosion. The ramifications will most likely extend beyond 2010.

Since this blog commenced, sentiment has begun to shift, with bearish commentary moving from the "outsiders" like Stephen Roach, Peter Schiff, and Jim Puplava to mainstream commentators. The linked article: http://rismedia.com/index.php/article/articleview/10818/1/1/ is an example of this continuing and progressive shift in sentiment.

Certainly get your own personal expert financial advice on how to protect yourself. My own views are to:

stay out of leverage property,
minimise debt,
cash out equity including superannuation,
and consider gold to protect against currency devaluation.

I am not an investment advisor, nor is this blog about investment decisions. Again seek your own expert advice before making investment decisions.

Rage Against the Bubble

2005-06-02T10:43:00.000+10:00

This is an interesting article from the Reserve Bank of Australia on asset bubbles and monetary policy.

It is not interesting for the content, which is inaccessible to the non-quantitatively inclined, but for the topic itself.

The first sentence of the introduction reads: "In a low-inflation economy, the bursting on an asset-price bubble can have significant and long lasting-consequences, both for the economy and for the operation of monetary policy."

Really? Talk about world class arse covering!

Now let me think about this?

Are we in a low inflation economy? Yes!
Do we have an asset bubble? Why......yes we do!
Is it likely to burst? Um...well yes I think so!
Is the economy going to be totally flushed down the proverbial? Absolutely!

....and did the Reserve Bank do anything to prevent it? No. But we published this paper in June 2005 explaining that this was just about the happen...so it's not our fault....please blame the politicians.

There is a reason the Reserve Bank is independant, because unlike politicans they are supposed to be above short term politically motivated considerations.

http://www.rba.gov.au/rdp/RDP2005-04.pdf

The Sand Castle

2005-04-15T10:15:00.000+10:00

It is my sad duty to announce that we do indeed, live in interesting times.

U.S. Stocks Drop, Sending Benchmarks to 2005 Lows- Bloomberg

Oil Prices Rise From Near Seven - Week Lows- New York Times

IMF sounds alarm over US finances - AFP

IBM 1st-Qtr Profit Misses Estimates; Shares Tumble - Bloomberg

Three Sharp Years

2005-03-01T11:27:00.000+11:00

http://www.kitco.com/ind/Barbera/feb282005.html

I invite you to read Frank Barbera's excellent hypothetical future. It is both informative and entertaining.

"Stocks of all types are sold off furiously and even with Gold prices moving up toward $1,500 an ounce, gold stocks are sold off with reckless abandon as the XAU collapses by 100 points; down nearly 36% in a single day. At just over 4,000, the Dow and other blue-chip stock indices are now down 70% from their 2005 highs"

Welcome to 2005

2005-01-14T10:31:00.000+11:00

Welcome to 2005, the year of world economic implosion...hurrah! Let us start the year with an article on:

Warren Buffet - Dollar Bear

http://www.forbes.com/home/free_forbes/2005/0110/036.html

Follow the link to the Forbes' article on Warren Buffet's views about the US Dollar.

"Sooner or later markets win over the intervenors. The intervenors always run out of gas," says Buffett.

Begun These Currency Wars Have

2004-11-20T01:08:00.000+11:00

[graph sourced from www.kitco.com]

Sorry, but I just couldn't but help paraphrase Yoda on this one.

I was looking at a graph recently which I hope to post soon. It traces the price of gold in both US (USD) and Australian dollars (AUD). Until about the first week of September 2004 both the lines moved broadly in parallel. Since that time they have scissored away from each other.Gold had risen sharply in USD and fallen, ever so slightly, in AUD. Last night the US dollar fell another $0.75 against the Australian. There seems a likely chance that the US dollar has finally begun to collapse, and this may lead to a number of consequences:

1. The Currency Wars - the US needs to correct its trade deficit and a very significant depreciation in the US dollar is necessary to achieve this. Countries that don't have floating currencies (name starts with "Peoples Rep...") will need to repeg or float their currencies. Otherwise they may find tariff or embargo retaliation against their goods. The overall picture is much more complicated than this however. Without the US dollar as the world's reference currency, countries will have difficulty pegging their currency against a reliable measure. The Euro and gold are possible candidates to replace the USD. The repegging of the world's currencies against a new reference standard is likely to be an acrimonious affair.

2. Flight of capital - if the US dollar is falling everything else valed in US dollars is also falling (unless it is rising to the same extent or more in nominal dollars, i.e. gold). Holding assets in the United States means losing money equivalent to the decline in the currency. Investors will start to balk at future US denominated losses and move capital elsewhere.

3. Rising Interest Rates - as the US dollar falls the cost of imports rises; imports like oil and manufactured goods. This in turn fuels inflation. A key method for controlling inflation is to increase interest rates. This also helps stem the flight of capital, and the depreciation of the currency. Note that rising interest rates may be the United States' key export to the rest of the world in 2005.

4. Asset Bubble Implosions - POP! Yep, the US has them, and half the economies in the Western World. The equity ones we have seen before, the housing ones, well they are flat out spectacular. Ever wondered what those $600,000 inner city apartments will be worth at 15% p.a. interest rates and 15% unemployment, with banks unwilling to lend more than 50% of the purchase price?

5. Recession - rising interest rates tend to cause recessions. The 1970's is a good example of the economic effects of being in an upward cycle. Except that....

6. Depression - you didnt have historical record levels of household indebtedness throughout many Western economies as we currently have in the US, Australia and many oither places. As interest rates rise and unemployment increases these asset bubbles will burst. The level of wealth destruction will be unparalleled, and I include 1929-1932 in that analysis. Although, I believe that it is the closest comparison to what we will witness in the near future.

I was talking to a colleague recently who had just visited their share broker. One of the largest and most respected in the country. The broker's advice, don't hold more than 15% in equities. Now if you havent worked it out already they are paid to sell equities! Their bearish advice actually costs them money, a lot of money. I will finish with a second hand quote from the Chief Economist of that particular firm:"The Reserve Bank is sitting on a timebomb it can't defuse. Interest rates only have to rise 50 basis points and it's all over, and they know it."

US Dollar Collapse 2004

29th October 2004

2004-10-25T10:37:00.000+10:00

An anniversary.

75 years ago the long boom of the roaring 20's came to a rapid conclusion. Black Thursday was followed by Black Tuesday and together 60% of the value of the stock market was wiped out. If you held a basket of stocks at the beginning of October 1929 it would have taken 25 years for their value to be returned (1954 - assuming the stocks were not bankrupted).

In the 1920's there was radio and Radio Corporation of America. Today there is the Internet and Google.

The fundamentals of the US economy are clearly unsound. Sentiment is therefore the only thing left supporting the US stockmarket. The signs are ominous for an impending adjustment and the technical analysis I have seen suggests sooner, not later.

The US dollar is showing substantial weakness. The DJIA declined 1% on Friday. This morning gold looks like it may be commencing a breakout run.

This week, next month, next year. Who can know exactly until it happens. But whatever, the week it starts, our Kondratieff winter of discontent is set to return.

Debt Cancer

2004-10-12T21:16:00.000+10:00

Took me a while to realise that this is not a satire but an actual promotional advertisement. What does Camel plan for its follow up ad? "Camel : The Nightmare Noughties .....Not since the 30s has it been so easy to lose so badly"

1929 Reloaded

2004-09-19T20:00:00.000+10:00

The Debt Burden

This graph relates to the last post in the August thread.

The Debt Scenario. 1929 RELOADED.

Beginning of The Great Recession

2004-08-10T22:54:00.000+10:00

This site is to herald the coming of the next Great Depression which I have chosen to call the "Great Recession".

I am happy to stand on record that the unravelling of the Western, and especially English-speaking economies will commence in 2005.....perhaps 2006 at the latest. I make this statement August 10th, 2004.

Now lets address the reasons behind this unravelling, and how this will unfold.
When history looks at the reasons for this Great Recession 2006-2011 it will no doubt focus on the (almost) unparallelled expansion in the money supply during the period 1997-2004. This period roughly corresponds in history to 1921-1929, the "Roaring Twenties" leading up to leading up to the "Great Depression".

During the Roaring 20's the equity market in the United States grew dramatically on the back of a wild expansion in credit. This was fueled through equity investments on margin loan and through consumer spending on goods such as radios and motor vehicles, through what was then a new financing technique called 'hire purchase'.

The Great Recession has a similar pedigree, but with the added perils associated with mortgage refinancing and mortgage securitisation. These have perhaps been the two most critical drivers for the expansion in credit in the west from 1997 until 2004.

Alan Greenspan, in an effort to avoid a serious economic adjustment after the "Tech Crash" of 1997 has maintained interest rates at extremely, and retrospectively, irresponsible levels. Many of the world economies have followed suit and set likewise expansionary interest rates. In the case of Australia, while interest rates have been higher than those in the United States, they have also been extremely expansionary leading to rampant inflation (by other than conventional definitions).

How is this the case? Especially when the Consumer Price Index ("CPI") in both the United States and Australia has remained within "target" parameters. The simple answer is that the CPI is not a reliable measure of inflation, nor will it, in the future be considered a reliable measure of monetary policy.

These low inflation rates have translated themselves into a boom in household debt. This has been accompanied, in the U.S., by an massive expansion in government debt, and a current account deficit of 5% of GDP (at the time of writing).

Just as hire purchase and margin lending pump-primed the 1920's monetary expansion, so to has mortgage refinancing and securitisation fueled the nineties and noughties.
Mortgage refinancing is the easiest to explain. The ability to draw the equity from one's house through refinancing has exascerbated the credit boom considerably. Housing prices have risen greatly in many Western economies the US, UK, and Australia included. As housing prices have risen consumers have sought to access the equity contained in their properties. The mechanism for this has been refinancing - effectively securing a higher level of debt against the same asset.

Banks are (naturally) eager to lend, as high household debt translates into even higher profits. The funds released through refinancing have been directed to renovations and consumer spending. In Australia the car market has boomed and one must wonder exactly how many plasma TVs have been funded through mortgage refinancings.

Unfortunately, rises in housing values have been illusory. Real wages have not been rising and are most likely declining. Western workers are becoming LESS not more competitive. Lower paid workers in India, China, and Eastern Europe are competing against the West, and successfully so. Rental yields in Sydney for example, have declined from averages around 5% to averages around 2% or less.

In Australia, it appears that property prices have risen inversely to interest rates. Effectively, Australian households have maintained their mortgage debt service obligations as a percentage of income. So as interest rates have declined, borrowings have increased...either by renovating, upsizing, or refinancing for consumer purchases. The long term fundamentals for property investment have been undermined and purchasing behaviour for real estate has been driven by a continuous expectation of future capital gains.

But what if these property price rises over the last 8 years were to reverse themselves?
Mortgage securitisation is a more sinister and remote animal. But to explain its effect fully we must first understand how Reserve Banks try to control the money supply in the economy and the expansion of credit.

Banks in Western economies are generally controlled by a 'thing' called a "capital reserve". This specifies how much of their debt exposure needs to be offset by equity. This equity is held in reserve to insure against adverse circumstances...like a default on the debt they hold. However securitisation takes this debt off balance sheet; the mortgage debt is packaged into a bundle and sold off to bondholders. So effectively, the bank is no longer liable for this debt as it has been placed in a Special Purpose Vehicle ("SPV") which does not appear on the balance sheet of the bank. Hence, it does not affect the banks capital adequacy requirements. The bank can securitise as much mortgage debt as it likes with having to place equity in reserve.
The securitised debt is not protected under the umbrella of a reserve bank's capital guidelines. Defaults on securitised mortgage debt in 2007-2009 will no doubt be a key catalyst in the unravelling of the Western financial system.

So we find ourselves in August 2004, with the wood stacked, and the kindling primed (I think I smell kerosene also). So what will be the 'match' that lights the fire?

This debt expansion has ridden the back of historically low interest rates. Now excluding all other factors, eventually the debt burden of the expansionary economies would inevitably cause an adjustment in interest rates. Eventually the credit worthiness of these debt-ridden economies would progressively decline leading to a compensating increase in interest rates.
Recently several factors have combined to bring the 'flame' right to our faces. That flame is oil prices. At this moment we face a number of converging forces leading to a rise in oil prices:
- increased demand in developing economies, i.e. China and India
- the Iraq insurgency
- the possible Yukos liquidation
- the Venezualian recall vote of Chavez
- general capacity constraints
If expectations regarding oil supply get out of control through either physical supply limitations, or simply the mechanism of fear itself, then prices will rise, perhaps dramatically.

When that happens...the match hits the kindling, and it all starts. It could be very soon perhaps this month or next. If oil prices are reigned in then the adjustment may take until late 2005.

So what should I expect?

There inevitably will be massive declines in both property and equity markets with a wholesale destruction of wealth not seen since the early 1930's. There is a credible possibilty of a cascade failure in the banking system leading to a liquidity crisis (i.e. ATM's do not hand out cash).
As a medium term response, expect a full-scale rejection of economic rationalism and a vast increase in government economic regulation.

What do I do?

Well...number 1...number 2...and number 3...KILL DEBT! No matter what it takes, get out of any geared investments. Reduce debt at all costs!

Move to cash. Take your superannuation/pension out of equity into cash, and ideally true cash, not mortgage backed securities.

Move to gold. Gold has been a galactic dog of an investment pretty much since 1980, during the Afghanistan mania. However, gold moves inversely to the equity market. If you want to be more defensive than cash - choose gold. If the scenario outlined above proves true then gold will appreciate dramatically.

I am not a tranditional 'gold bull' and this is not a gold bull website....but if you want to take a position on the Great Recession then gold is it.

Lastly, if things come to pass as described then the next decade will represent a tremendous moral challenge for us all. I encourage you to confront this challenge with all the courage and human dignity that you can find.