Wednesday, February 24, 2010

Smelling the Coffee

The deflation story begins to get mainstream traction, and it is openly admitted that we have been in "mild deflation" for the last year:

It has been noted that world trade contracted some 12% last year:

Demand for new homes (and thus new home sales) suddenly and "unexpectedly" falls to a record low (duh!):

And home loan demand in generall fell off a cliff in January

In the meantime, the number of banks on the FDIC's "problem child" list leaps 27%

all because of the unfolding crash in commercial real estate:

Which means business is bad and hiring is going to be weak going forward. And so Consumer Confidence is down:

Because unemployment/underemployment is hovering at 20%

(in the depths of the Great Depression, unemployment measured around 25%. If it were measured the same way today, it would be between 20-22%)

Got the picture? We are in the beginning stages of a deflationary spiral. The Fed throwing money at the banks will not get us out. There are only two paths:

1. Let it all correct. Let the market mechanism cleanse the debt and revalue all the assets and start over. It will be a big, painful crash, and two or three years of further pain, and then we'll be off to the races again.

2. The Japanese path, whereby we allow banks to refuse to acknowledge the bad loans and write them off, thus tying up potentially productive assets which would normally be available at "fire sale" prices so that the next generation of entrepreneurs can't get started. This eventually ends with an even bigger crash than option 1.

Option 2 was only possible for the Japanese because of their massive savings surplus and their positive balance of trade (i.e. they are an export driven nation.) The U.S. has neither of these qualities. What we do have is a really strong military and the world's reserve currency. That may be enough to implement the Japansese policy if we choose. It may not. The Chinese, the Russians, and the Arabs will collude together to resist such a policy for their own reasons.

2010 is going to be fun. Buckle your seatbelt.

Remember, debt bad. Savings good. Frugality is back in vogue. Backup plans need to be in place for a short to medium term emergency. Buy some gold and silver (which are correcting nicely, but still have further down to go before the next rally stage. I wouldn't be surprised to see silver in the $12-$13 range, and gold at around $1000.)


Monday, February 15, 2010

Europe Begins Disintegrating

Watchers have been skeptical of the viability of Europe and the European Union for a long time. The Euro has been the object of scorn for some time among forward-thinking economy watchers.

There is a fundamental flaw in the Euro. There is a great disparity between the thriftier and more productive Northern Europeans and the less disciplined nations of Southern Europe. There are other issues as well. Language. Cultural cohesion. History. But the main issue is the monetary. I would argue that cultural issues underlie the monetary issues, but that is neither here nor there.

Greece is unravelling at an alarming speed. They're spending more than they're making, and if they are to be bailed out, it will be at the cost of the Northern Europeans, especially Germany. Germany is in no mood, for her own social safety net is under stress and her own exports are still down more than they would like. Behind Greece are Spain, Italy, Portugal, and Ireland.... the so called PIIGS. Each of these countries has a huge deficit and no real way to deal with it. Each is bound by treaty to maintain their deficit at a level far below where they are at now. The stability of the Euro depends on each country sticking pretty closely to its agreed-upon financial targets. There will probably be riots in Greece before this is all over with. The banking class has siezed the rights to everything from lottery profits to airport landing fees in Greece, leaving the government with an even smaller pot of money with which to pay out social benefits and run the country.

The cracks in the European Union (and thus the Euro) are becoming alarmingly obvious. So much so that an analyist for one of the oldest and most respected French banks, Societe General, has publicly proclaimed his opinion that the Euro is toast.

Why do we care over here on this side of The Pond, dear Reader? For two reasons.

1. Because of financial instruments called derivatives, literally everything is connected to literally everything else in one way or another. A failure of one component can literally cause the whole world's system to crash. It has almost hapened twice before. In 1998 the Russian government defaulted on its debt, and one hedge fund, Long Term Capital Managment almost exploded the whole world's financial system. In the Fall of 2008 one money market fund with exposure to Lehman Bros debt "broke the buck." That means that investors could no longer be assured of getting back at least one dollar for every dollar they deposited in the money market fund. Money market funds are billed as bank accounts, but they were not insured like bank accounts up until that day. Thus a depositor could lose everything and there would be no insurance entity to cover the loss. The fear caused by that one event caused individuals and companies to begin withdrawing their money on deposit with money market funds. The amounts were substantial. Within a matter of hours it became obvious that a global "bank run" was unfolding. The U.S. Government stepped in and pledged to insure money market funds and that one act restored confidence and stopped the withdrawls. We were literally hours from a complete worldwide systemic meltdown. Imagine not being able to buy food or gasoline or medicine or baby formula, or pay your utility bills, or use your credit card because no transactions of any kind could be processed. Cash would very quickly cease to circulate and be hoarded. It would be economic armageddon. The government was trying to figure out how to feed people if it happened. Given the response to Hurricane Katrina, I am not confident of effective government help. I am confident of anarchy followed by suspensions of our civil liberties and confiscation of certain very useful items for self defense and provision for one's family. I'm confident of that because that did happen after Katrina.

Well, the Powers That Be want us to think that they've solved all those problems and that those sorts of things can't happen again. The trouble is that's a lie. The problems are literally unsolvable. They are the byproduct of a fundamental flaw in our monetary system. The more complex the system grows and the more time that passes, the more unstable the whole thing will get. Sooner or later Babylon will fall, and great will be the fall of it. It will affect every man, woman, and child on the planet when it happens. It will take weeks to months to cobble together a patchwork response. You had better be able to take care of you and yours during that time. It will come. It is inevitable. If Greece's default doesn't do it, Ireland's might. Or Spain's. Or Portugal's. Or the breakup of the European Union. We will survive it, but it will come. How much you suffer during that time is in your hands right now. Think food, fuel, units of trade (such as cash and gold and silver) an alternative source of heat and a store or source of potable water. Don't count on any utilities for at least a little while. They may be there, they may not. What happens when the power company can't pay for coal, or the coal mine can't pay for fuel to run its machines, or the city can't pay the electric company to power its well pumps? We lose those things at least temporarily.

2. We care because this provides further support for the deflationary scenario. Part of what is necessary for deflation to unfold in the U.S. is for the dollar to be "the last man standing" among all of the world currency options. We've already seen the Yen in trouble because of Japanese debt, the Euro is now in trouble because of EU debt. The three last remaining stores of value are gold, the Yuan (the Chinese currency) and the Dollar. The Dollar ought to be in trouble because of debt, but it's not yet. The Yuan isn't a good bet because the Chinese are holders of massive amounts of Dollars. The Dollar is by far the best short-term candidate. I think gold will ultimately be the last man standing, but it is in very short supply. Silver may well be an acceptable substitute.

As always, do your own due diligence and make your own decisions. My basic advice is still the same. No debt. No unneccesary purchases. Save money. Buy a little gold and a little silver.


Thursday, February 4, 2010

From the Other Side of the Pond

America slides deeper into depression as Wall Street revels
December was the worst month for US unemployment since the Great Recession began.

By Ambrose Evans-Pritchard
Published: 6:35PM GMT 10 Jan 2010

History repeating itself? President Obama has been accused by some economists of making the same mistakes policymakers in the US made in the Great Depression, which followed the Wall Street crash of 1929, pictured Photo: AP
The labour force contracted by 661,000. This did not show up in the headline jobless rate because so many Americans dropped out of the system. The broad U6 category of unemployment rose to 17.3pc. That is the one that matters.

Wall Street rallied. Bulls hope that weak jobs data will postpone monetary tightening: a silver lining in every catastrophe, or perhaps a further exhibit of market infantilism.

Dow slides on poor jobs reportThe home foreclosure guillotine usually drops a year or so after people lose their job, and exhaust their savings. The local sheriff will escort them out of the door, often with some sympathy –– just like the police in 1932, mostly Irish Catholics who tithed 1pc of their pay for soup kitchens.

Realtytrac says defaults and repossessions have been running at over 300,000 a month since February. One million American families lost their homes in the fourth quarter. Moody's expects another 2.4m homes to go this year. Taken together, this looks awfully like Steinbeck's Grapes of Wrath.

Judges are finding ways to block evictions. One magistrate in Minnesota halted a case calling the creditor "harsh, repugnant, shocking and repulsive". We are not far from a de facto moratorium in some areas.

This is how it ended between 1932 and 1934, when half the US states declared moratoria or "Farm Holidays". Such flexibility innoculated America's democracy against the appeal of Red Unions and Coughlin Fascists. The home siezures are occurring despite frantic efforts by the Obama administration to delay the process.

This policy is entirely justified given the scale of the social crisis. But it also masks the continued rot in the housing market, allows lenders to hide losses, and stores up an ever larger overhang of unsold properties. It takes heroic naivety to think the US housing market has turned the corner (apologies to Goldman Sachs, as always). The fuse has yet to detonate on the next mortgage bomb, $134bn (£83bn) of "option ARM" contracts due to reset violently upwards this year and next.

US house prices have eked out five months of gains on the Case-Shiller index, but momentum stalled in October in half the cities even before the latest surge of 40 basis points in mortgage rates. Karl Case (of the index) says prices may sink another 15pc. "If the 2008 and 2009 loans go bad, then we're back where we were before – in a nightmare."

David Rosenberg from Gluskin Sheff said it is remarkable how little traction has been achieved by zero rates and the greatest fiscal blitz of all time. The US economy grew at a 2.2pc rate in the third quarter (entirely due to Obama stimulus). This compares to an average of 7.3pc in the first quarter of every recovery since the Second World War.

Fed hawks are playing with fire by talking up about exit strategies, not for the first time. This is what they did in June 2008. We know what happened three months later. For the record, manufacturing capacity use at 67.2pc, and "auto-buying intentions" are the lowest ever.

The Fed's own Monetary Multiplier crashed to an all-time low of 0.809 in mid-December. Commercial paper has shrunk by $280bn ($175bn) in since October. Bank credit has been racing down a hair-raising black run since June. It has dropped from $10.844 trillion to $9.013 trillion since November 25. The MZM money supply is contracting at a 3pc annual rate. Broad M3 money is contracting at over 5pc.

Professor Tim Congdon from International Monetary Research said the Fed is baking deflation into the pie later this year, and perhaps a double-dip recession. Europe is even worse.

This has not stopped an army of commentators is trying to bounce the Fed into early rate rises. They accuse Ben Bernanke of repeating the error of 2004 when the Fed waited too long. Sometimes you just want to scream. In 2004 there was no housing collapse, unemployment was 5.5pc, banks were in rude good health, and the Fed Multiplier was 1.73.

How anybody can see imminent inflation in the dying embers of core PCE, just 0.1pc in November, is beyond me.

Mr Rosenberg is asked by clients why Wall Street does not seem to agree with his grim analysis.

His answer is that this is the same Mr Market that bought stocks in October 1987 when they were 25pc overvalued on Shiller "10-year normalized earnings basis" – exactly as they are today – and bought them at even more overvalued prices in 2007, long after the property crash had begun, Bear Stearns funds had imploded, and credit had its August heart attack. The stock market has become a lagging indicator. Tear up the textbooks.