The brain is a mysterious organ, capable of incredible functions. We often give it too much credit however, as it is largely run by it’s programming. Bad input produces bad output. Creative independent thought is rare. As such our view of the world is seen through the lens of our teaching, but that is tempered with our experiences. If our experiences mesh with our programming our beliefs are confirmed and strengthened. If our reality does not mesh with our programming, our perception of something is strained. The effect of such a strain can develop in various ways. An absolute denial of the reality gap can occur in which the belief is steadfastly held despite overwhelming evidence to the contrary. Occasionally our experiences are so extreme that the belief cannot hold up and there is a loss of faith. The land in between is a period of reflection, open mindedness, and indecision. Cultural inertia is very powerful but there are moments in time when reality is so at odds with the prevailing belief that it forces people to re-examine the default position, and if enough people do so, and adopt a new perception, a cultural shift will occur, and in time those who maintain the old belief will look foolish.
Currently a strain is developing on our perception of our financial system. Our cultural programming is being tested against a strong flow of evidence that challenges it’s very foundation. Our strongly held belief in the stability of the financial system is weakening. The mass of people are unaware of how dire the situation is, but make no mistake, those who are on the front lines are very worried. The high priests of the economy are squirming because their model, their belief system, is not meshing with reality. They keep pulling on the same old levers but the desired effect is not happening. When a model is failing, distortions reveal themselves such as gyrating stock markets that are unhinged from the fundamentals. Extreme measures are taken to react to the distortion which only serves to exacerbate the condition because they are not addressing the root problem. A crisis brought about by excessive debt and low interest rates cannot be cured by creating more debt and lowering interest rates to zero. Below the headlines, complex manipulations of the markets are ongoing in an effort to disguise the fragility of the old model. When pressed, Greenspan admitted his model was flawed. The only reason we have not had a complete meltdown is because the governments of the world have backstopped the financial system with unlimited guarantees. The underpinnings of the global financial system now rely on the government's ability to keep the faith, except that the math doesn't care how strong our faith is. It is what it is.
The minds of the financial gurus and the legions of followers are going through extraordinary lengths to rationalize the desperate measures that go against their own preaching. Free market capitalism and stock market gains were heralded as the gospel when profits were generated from the risk taking. Now that those risks are not being rewarded, but are instead bankrupting them, everyone who has taken a loss is looking for a government bailout. People forgot what risk is. You can't enjoy the big gains without the associated risk of big losses. The big banks made a series of bad bets and now they have gaping holes in their balance sheets. Few people know how deep these holes are since the truth is shrouded in secrecy. The money pledged thus far may not be enough. Bankers don’t trust bankers anymore. They don’t want to lend to each other because internally they know how dire the situation is and they don’t want to risk their capital with another bank that might be in a similar position. The government was forced to guarantee all loans. The credit freeze is loosening as a result. There is a calm. By that measure there has been an improvement. One thing is for certain, we will not know how bad things truly are until the bitter end, at which point it will be too late. Denial is the name of the game here. The central banks are in full blown damage control. The world is in a crisis brought about by taking on excessive risk and debt at all levels, and now the high priests in their wisdom are transferring that debt load from the banks onto the public. They are unwilling to claim responsibility for the failure of their policies. Instead they talk as though this was an unexpected act of God that could not have been foreseen. Not true. There was a chorus of intelligent, informed, outspoken people who sounded the alarm but they were dismissed as doomsayers. The public are becoming skeptical. For now they are cautiously holding onto their faith but there is a strain.
The economic model that we have been living under for the past few decades has been an experiment in financial engineering. The Central bankers and governments adopted an interventionist economic model. Rather than leaving the money supply stable and paying only for what we can afford, we as a society have bravely steered a course toward the path of least resistance. If there is a recession, stimulate the economy by spending more. If we can't afford something, borrow to get it. If there isn't enough money, print some more. We grew up with an ever improving standard of living or so it seemed. Many of us don't have a memory of hard times. We were led to believe that the modern economy can be managed to avoid significant downturns. A cult of buoyancy has evolved. Markets are not allowed to go down. The government always intervenes. The problem is that every time they intervened to correct an imbalance, it triggered an unintended consequence that required yet another intervention. Intervention after intervention required more and more adjustments to maintain the economic model. The underlying problems were only delayed, manifesting itself in a more extreme way down the road.
Meanwhile the money supply has continued to grow because it's easier to give away money than it is to take it away. The subsequent inflationary pressure has grown as well. Rather than abandon the constant financial meddling that created these imbalances, the government chose to meddle with the statistics that demonstrated the unpleasant effects of their meddling. Inflation and unemployment rates are no longer measured as they were in the past. If the price of beef goes up, that doesn't count because we can still afford chicken. If the price of a car goes up, that doesn't count because we are getting a better quality vehicle. If a worker has been out of a job for over a year, that doesn't count, because he is no longer considered an active job seeker and therefore is not unemployed. The statistics have been massaged to underestimate the reality. That has only served to disguise the failure of their policies, keep the population misinformed, and benefit those in control. For example, if the government is obligated to keep pensions indexed to inflation and the inflation rate is in the double digits, that cuts into their budgets. It's easier to manipulate the statistic down rather than ask the taxpayers to pay more and to receive less. The economy has not performed nearly as well as we have been lead to believe. Most of the perceived gains have been the result of excess credit and creative book keeping. This approach has been systematic for quite awhile now and the strain of the debt burden is at last revealing itself in a catastrophic way.
Our standard of living will deflate back to where it deserves to be. Where that will be, no one really knows. We are in uncharted territory. The day of reckoning will come and we haven't seen it yet. The governments intervened in an unprecedented extreme way. Look around you and ask yourself if your world has changed in an appreciable way. Chances are it hasn't, yet this financial crisis is real. The underlying problem has not been fully reckoned with. As long as the global economy is geared toward feeding a consumptive US that is out of money, there will not be a substantive recovery. A structural rebalancing needs to occur. If I, and the folks I pay attention to are correct, the next leg down will break the faith of the people. A cultural shift is underway and those who continue to invest according to the old gospel will look foolish. Most financial experts and advisers have lost credibility because they failed to see the worst financial crisis in modern history, yet they insist that they can forecast the nuances of a nascent recovery. The culture of credit is being discredited. The holy churches of the financial world are in decay.
Friday, June 26, 2009
Sunday, May 24, 2009
We are out of money
At last some straight talk from the President. Obama stated the obvious in a television interview. "We are out of money". This should be alarming. It wasn't. Ho hum. Yawn. No one cares. The stock market is up. But for the world's most powerful nation to be essentially bankrupt, out of money, and needing excessive amounts of new credit just to keep operating is something that all investors should be extremely nervous about. The US, and other indebted nations, won't be able to spend their way out of debt. That's crazy talk. The debts need to be paid off or be defaulted. Personally people have no choice but to spend less, save, or sell assets in order to pay down their debts. Governments have more flexibility because they can issue bonds with the full backing of the tax base. Government bonds are seen as safe havens, enabling deficit spending which politicians can't resist. They need the discipline of the gold standard. However, an interesting development is unfolding. Just as the high risk individual gets squeezed with higher interest rates on the credit card, so are governments.
Foreign investors hold a sizable portion of the US debt. That debt will not likely be paid back in full, or if it is, it will be with worthless dollars. They know this as they continue to watch the US rack up huge deficits and they aren't impressed. That was the risk they took when they bought the bonds. Don't feel sorry for them. But what can they do and what are the next moves? The first most obvious move for them is to stop giving the US any more credit by purchasing US Treasury bonds, or at least buy less of them. This is already happening. That's why the Fed has been forced into a quantitative easing mode. When the principle buyers pull out of the market, interest rates need to rise in order to attract them back. Except rising interest rates will overwhelm a very fragile debt saturated economy. The Fed doesn't want to see an economic meltdown. When no one else is willing to buy the bonds needed to finance government operations, it moves into the bond market to buy them with money that doesn't already exist. The bonds are bought with new money. New debt for the taxpayer to bear. All those bailouts and stimulus that are meant to cure the economy is being paid for by diluting the value of the existing currency.
The second obvious move foreign creditors would do is to start selling their US holdings. The problem with this is that if they do this en masse, it will flood the bond market with an oversupply which will further depreciate the value of the foreign reserves and may possibly trigger an avalanche of selling as everyone will run to the exits at the same time. No one wants to see that happen. Instead, foreign creditors will first want to gradually sell off the more risky longer term bonds in small chunks without any fanfare. Buyers of longer term bonds are in short supply at the moment because few people have faith in the US to make those bonds good upon maturity, so they are asking for higher rates to compensate for the added risk of default and inflation. A rising interest rate scenario will kill any chance of a recovery because this makes servicing the debt more difficult. The cost of loans of all types will rise, most importantly though, mortgages. There is a consensus that the real estate market has to stabilize before any recovery is sustainable. How high will they go before buyers step in? That is the big question. Moderately higher rates are healthy for recovering banks. They make more money. A dramatic spike in rates will kill them.
The Federal Reserve, the well spring of new money, has stated it will be the buyer of last resort. It will fight this upward bias of interest rates with quantitative easing in an effort to keep mortgage rates low and inject liquidity into the economy. Bernanke believes he can control interest rates by soaking up the demand. However the unintended consequence of this intervention is that it undermines the confidence of bond holders even further as inflation fears rise with the money creation. Sometimes less is more. The market will pressure Bernanke to buy the bonds that they are just itching to sell. It's a battle the Fed will lose because the sell side can overwhelm the buy side. Even though the Fed can print as much money as required to buy anything at any price, it is loathe to do this because it will crash the dollar in the process. Yet that is the course they have embarked on. They can potentially wind up owning most of the Treasuries if it continues to pursue this policy. A cycle will be established where the bond market will continually push interest rates higher, forcing the Fed to intervene time and again. This will drive out foreign equity as they sell into the Fed's buying, and the government will not have it's funding source anymore. It will have to tax and spend less. Read less money for personal consumption, social programs, health care, education, pensions, etc..
The public and media are focused on the stock market but the story of real importance is the bond market. The 10 year Treasury is of particular interest right now. The Fed first felt it necessary to intervene in March back when it was at 3%. They drove the rate down temporarily to 2.5%, but it has since climbed back up and has spiked up to 3.65 this week. The bond market is forcing Bernanke's hand. Will the Fed intervene again? Does Bernanke have faith in his printing press to get them out of this mess? He has staked his reputation on it. Or will he recognize the perilous downward spiral of quantitative easing, once it stops becoming a theoretical play thing? If he backs off the easing, long term interest rates will naturally rise, and trigger yet another debt crisis which will be devastating as the defaulting loans cascade and the faith of the people is demoralized. There is no easy way out of this one. The world is not as rich as we think. There is more debt than wealth and the world economy is moving toward a monetary bottleneck. All indebted nations are competing for the same capital and bond auctions will fail to attract enough buyers to meet the growing deficits. Many governments will simply run out of money. At the end of the line there is no one to bail us out. Governments will be forced to cut back on spending, increase tax rates, devalue the currency, or perhaps they will acquire the money by more creative means, such as engineering a stock market collapse to drive money out of stocks and back into the perceived safe haven of bond markets. Politicians will always take the path of least resistance. Expect volatility going forward.
Foreign investors hold a sizable portion of the US debt. That debt will not likely be paid back in full, or if it is, it will be with worthless dollars. They know this as they continue to watch the US rack up huge deficits and they aren't impressed. That was the risk they took when they bought the bonds. Don't feel sorry for them. But what can they do and what are the next moves? The first most obvious move for them is to stop giving the US any more credit by purchasing US Treasury bonds, or at least buy less of them. This is already happening. That's why the Fed has been forced into a quantitative easing mode. When the principle buyers pull out of the market, interest rates need to rise in order to attract them back. Except rising interest rates will overwhelm a very fragile debt saturated economy. The Fed doesn't want to see an economic meltdown. When no one else is willing to buy the bonds needed to finance government operations, it moves into the bond market to buy them with money that doesn't already exist. The bonds are bought with new money. New debt for the taxpayer to bear. All those bailouts and stimulus that are meant to cure the economy is being paid for by diluting the value of the existing currency.
The second obvious move foreign creditors would do is to start selling their US holdings. The problem with this is that if they do this en masse, it will flood the bond market with an oversupply which will further depreciate the value of the foreign reserves and may possibly trigger an avalanche of selling as everyone will run to the exits at the same time. No one wants to see that happen. Instead, foreign creditors will first want to gradually sell off the more risky longer term bonds in small chunks without any fanfare. Buyers of longer term bonds are in short supply at the moment because few people have faith in the US to make those bonds good upon maturity, so they are asking for higher rates to compensate for the added risk of default and inflation. A rising interest rate scenario will kill any chance of a recovery because this makes servicing the debt more difficult. The cost of loans of all types will rise, most importantly though, mortgages. There is a consensus that the real estate market has to stabilize before any recovery is sustainable. How high will they go before buyers step in? That is the big question. Moderately higher rates are healthy for recovering banks. They make more money. A dramatic spike in rates will kill them.
The Federal Reserve, the well spring of new money, has stated it will be the buyer of last resort. It will fight this upward bias of interest rates with quantitative easing in an effort to keep mortgage rates low and inject liquidity into the economy. Bernanke believes he can control interest rates by soaking up the demand. However the unintended consequence of this intervention is that it undermines the confidence of bond holders even further as inflation fears rise with the money creation. Sometimes less is more. The market will pressure Bernanke to buy the bonds that they are just itching to sell. It's a battle the Fed will lose because the sell side can overwhelm the buy side. Even though the Fed can print as much money as required to buy anything at any price, it is loathe to do this because it will crash the dollar in the process. Yet that is the course they have embarked on. They can potentially wind up owning most of the Treasuries if it continues to pursue this policy. A cycle will be established where the bond market will continually push interest rates higher, forcing the Fed to intervene time and again. This will drive out foreign equity as they sell into the Fed's buying, and the government will not have it's funding source anymore. It will have to tax and spend less. Read less money for personal consumption, social programs, health care, education, pensions, etc..
The public and media are focused on the stock market but the story of real importance is the bond market. The 10 year Treasury is of particular interest right now. The Fed first felt it necessary to intervene in March back when it was at 3%. They drove the rate down temporarily to 2.5%, but it has since climbed back up and has spiked up to 3.65 this week. The bond market is forcing Bernanke's hand. Will the Fed intervene again? Does Bernanke have faith in his printing press to get them out of this mess? He has staked his reputation on it. Or will he recognize the perilous downward spiral of quantitative easing, once it stops becoming a theoretical play thing? If he backs off the easing, long term interest rates will naturally rise, and trigger yet another debt crisis which will be devastating as the defaulting loans cascade and the faith of the people is demoralized. There is no easy way out of this one. The world is not as rich as we think. There is more debt than wealth and the world economy is moving toward a monetary bottleneck. All indebted nations are competing for the same capital and bond auctions will fail to attract enough buyers to meet the growing deficits. Many governments will simply run out of money. At the end of the line there is no one to bail us out. Governments will be forced to cut back on spending, increase tax rates, devalue the currency, or perhaps they will acquire the money by more creative means, such as engineering a stock market collapse to drive money out of stocks and back into the perceived safe haven of bond markets. Politicians will always take the path of least resistance. Expect volatility going forward.
Saturday, May 9, 2009
Stressed Out
It's hard to keep up with the news flow these days. Stories that would have normally been headline and analyzed to death by the popular media are being glossed over as though they they have little importance. Financial observers whose job it is sort this stuff out are stunned. The natural reaction when immersed in a chaotic environment is to focus on what we can handle, what we know. People are attempting to latch onto some sort of explanation. Humans crave order and predictability. Irrational, random events need to be explained and put into a framework. The mind will do incredible leaps to rationalize the absurd. Contradictory data is ignored. This environment is prime for charlatans, dressed up in suits of respectability, to spread soothing thoughts to the masses in hopes of personal gain. At the fringe are conspiracy theorists who speak of a covert master plan designed to establish a new world order. Stock market crashes, planes exploding into buildings, wars, currency destruction, all figure into the equation. On the other end of the spectrum are the main stream press owned and controlled by corporate interests. The news is reactionary, superficial, and border on propaganda. The news flow has had a pronounced shift of sentiment lately. The recent converts to doom and gloom have had their fill and now green shoots of optimism are the rage. The worst financial crisis in memory apparently has been solved in less than a year. Let the good times roll.
The long awaited stress tests of the largest US banks are out at last. Some need to raise a few more billion of new capital as a buffer to meet the worst case scenario but overall the banks are healthy. They are making money again. The real estate market is bottoming. Consumer sentiment is on the rise. Stock markets have had a robust 30 percent gain. Unemployment rates are abating. The stimulus is in the pipeline stoking economic growth going forward. Time to invest! This is the drum beat heard in the press. For many people whose lives haven't been dramatically changed due to a job loss, looming bankruptcy, and foreclosure, the crisis probably doesn't seem real. People still wake up in the morning and have their cup of coffee and go about their business. The nest egg that is meant to finance retirement is smaller but that is a long term investment so no problem. Investments always go up over the long term. Everyone says so. The system is working. Order is established.
Or perhaps the positive spin of the stress tests was just the latest example of market manipulation that a Cartel of private international banks are orchestrating to further their grip on the global financial system. The very design of the fractional reserve system ensures that the money supply must inflate to pay off the interest on the existing debt. The Federal Reserve, a privately owned cartel acting under the auspices of a government agency, earns interest on every dollar it creates from nothing. It is in it's best interest to inflate the money supply. Debt begats more debt, causing the value of the dollar to shrink, until the interest on the debt eventually outstrips the ability of the economy to service it. The financial system strains under the pressure until it must eventually buckle. We are close to that point. The Fed-led cartel knowingly created the conditions to ignite such a crisis to further their end game, which is global domination. How else to explain why the actions taken by the central banks and paid off politicians seem so counter intuitive? They must surely know that quantitative easing never works. It is a road to hell. They are openly and covertly manipulating the markets and the economic data to obfuscate the true nature of the dire situation that is unfolding. The intent is to prolong the illusion of growing wealth and prosperity, while sucking the last drop of wealth from the masses, until the day of reckoning is put into play. The result will be the inevitable destruction of the dollar and from the ashes a new global currency will be created and controlled by the Cartel. Order is established.
The stress tests that caused so much stir and anxiety are a sham. The tests were supposed to put the banks through a rigorous set of assumptions of a worst case scenario so the regulators can shore up any weak spots to prevent another meltdown. This on it's own is disturbing. This should be ongoing both internally and through the regulatory agencies as part of normal operations. Clearly it was not. Executives hoarded millions while making some of the worst decisions possible, after all taking down the global financial system isn't an easy task. That takes a lot of talent. These are smart individuals. They had to know the risk models were faulty. It is more plausible that they were designed to rationalize their bloated incomes while the regulators turned the other way. They will get their piece down the road. Greed ran amok and fortunes were made.
History repeats in the short sighted news cycle of the day. The same people have developed new risk models. The assumptions used for the stress tests were not rigorous. Insiders with the banks refer to them as a feather test. They were designed to promote false confidence in the public to prop up equity values of the financial sector. The political climate is no longer ripe to blatantly fund more bailouts to insolvent banks since credit still isn't flowing to Main Street, which was the point of the whole exercise. The public overwhelmingly didn't want the first TARP. A second isn't politically palatable at the moment. The CEOs of the major banks had a big pow wow with Obama at the White House and they all emerged with smiles and calm reassurances that everything is just fine. Announcements of bank profits followed, triggering the latest rally. The campaign to restore confidence has been evident. The news flow has dramatically changed as even obvious bad news is spun in a positive light. Last December there was a consensus that bankruptcy for the automakers was not an option. They were bailed out which bought time. Now they are going into bankruptcy and the same people who passionately argued it would be devastating are rather sanguine about it.
Trillions of bail out money and government guarantees have been handed out to the banks, and yet to this day we are still questioning their solvency. The true extent of their losses has been cloaked by accounting gimmicks. The toxic waste that was clogging the system, it's still there. Accounting rules simply changed overnight that allows the banks to value foreclosed homes at whatever price they feel is right, as opposed to what they are actually worth if sold on the market. No more problems. Stocks of the banks, that were poised to become worthless, have bounced off the bottom. Bearish investors got the short squeeze, forcing them to cover, pushing prices even higher. Then fund managers who have had their portfolios hammered and have been desperate to hold onto remaining investors, and their job, see the market push higher so they pile in so as not to miss the rally. The headlines in the business news speak of recovery and green shoots. The bottom is in. It all becomes self propelling once this dynamic establishes itself. Now the banks can go to the market and raise new capital, with the blessing of the positive stress tests. The system is working.
What I struggle with when trying to find an explanation to the seemingly irrational markets is figuring out what the top economists with the levers of the monetary system in their hands actually believe. Do they believe in what is being sold to the public? Are they so egotistical and sure of themselves that they don't harbour any doubts about the course they have chosen? Or do they privately know the financial framework is rotten and doomed to failure and the best they are hoping for is to mitigate the fall, so it does not unravel in a catastrophic way. So they buy time, float trial balloons, leak stories, test theories in an ad hoc fashion, let Lehman Brothers and Chrysler fail, watch the outcome, learn, adapt, prepare for the big battles. The fundamentals are awful. Smaller banks are regularly going bankrupt. The FDIC, the agency that guarantees deposits in the banks, just recently requested more funds. If a big bank goes down they will insure as much as AIG did. There isn't enough money in the pot because the models don't allow for systematic failure. We are already at the worst case scenario thresholds that the stress tests allowed for. If it gets worse, the irrational exuberance of the new bull market will rapidly deteriorate into chaos again. Our minds don't want to go there. Order has been established. Rally on.
The long awaited stress tests of the largest US banks are out at last. Some need to raise a few more billion of new capital as a buffer to meet the worst case scenario but overall the banks are healthy. They are making money again. The real estate market is bottoming. Consumer sentiment is on the rise. Stock markets have had a robust 30 percent gain. Unemployment rates are abating. The stimulus is in the pipeline stoking economic growth going forward. Time to invest! This is the drum beat heard in the press. For many people whose lives haven't been dramatically changed due to a job loss, looming bankruptcy, and foreclosure, the crisis probably doesn't seem real. People still wake up in the morning and have their cup of coffee and go about their business. The nest egg that is meant to finance retirement is smaller but that is a long term investment so no problem. Investments always go up over the long term. Everyone says so. The system is working. Order is established.
Or perhaps the positive spin of the stress tests was just the latest example of market manipulation that a Cartel of private international banks are orchestrating to further their grip on the global financial system. The very design of the fractional reserve system ensures that the money supply must inflate to pay off the interest on the existing debt. The Federal Reserve, a privately owned cartel acting under the auspices of a government agency, earns interest on every dollar it creates from nothing. It is in it's best interest to inflate the money supply. Debt begats more debt, causing the value of the dollar to shrink, until the interest on the debt eventually outstrips the ability of the economy to service it. The financial system strains under the pressure until it must eventually buckle. We are close to that point. The Fed-led cartel knowingly created the conditions to ignite such a crisis to further their end game, which is global domination. How else to explain why the actions taken by the central banks and paid off politicians seem so counter intuitive? They must surely know that quantitative easing never works. It is a road to hell. They are openly and covertly manipulating the markets and the economic data to obfuscate the true nature of the dire situation that is unfolding. The intent is to prolong the illusion of growing wealth and prosperity, while sucking the last drop of wealth from the masses, until the day of reckoning is put into play. The result will be the inevitable destruction of the dollar and from the ashes a new global currency will be created and controlled by the Cartel. Order is established.
The stress tests that caused so much stir and anxiety are a sham. The tests were supposed to put the banks through a rigorous set of assumptions of a worst case scenario so the regulators can shore up any weak spots to prevent another meltdown. This on it's own is disturbing. This should be ongoing both internally and through the regulatory agencies as part of normal operations. Clearly it was not. Executives hoarded millions while making some of the worst decisions possible, after all taking down the global financial system isn't an easy task. That takes a lot of talent. These are smart individuals. They had to know the risk models were faulty. It is more plausible that they were designed to rationalize their bloated incomes while the regulators turned the other way. They will get their piece down the road. Greed ran amok and fortunes were made.
History repeats in the short sighted news cycle of the day. The same people have developed new risk models. The assumptions used for the stress tests were not rigorous. Insiders with the banks refer to them as a feather test. They were designed to promote false confidence in the public to prop up equity values of the financial sector. The political climate is no longer ripe to blatantly fund more bailouts to insolvent banks since credit still isn't flowing to Main Street, which was the point of the whole exercise. The public overwhelmingly didn't want the first TARP. A second isn't politically palatable at the moment. The CEOs of the major banks had a big pow wow with Obama at the White House and they all emerged with smiles and calm reassurances that everything is just fine. Announcements of bank profits followed, triggering the latest rally. The campaign to restore confidence has been evident. The news flow has dramatically changed as even obvious bad news is spun in a positive light. Last December there was a consensus that bankruptcy for the automakers was not an option. They were bailed out which bought time. Now they are going into bankruptcy and the same people who passionately argued it would be devastating are rather sanguine about it.
Trillions of bail out money and government guarantees have been handed out to the banks, and yet to this day we are still questioning their solvency. The true extent of their losses has been cloaked by accounting gimmicks. The toxic waste that was clogging the system, it's still there. Accounting rules simply changed overnight that allows the banks to value foreclosed homes at whatever price they feel is right, as opposed to what they are actually worth if sold on the market. No more problems. Stocks of the banks, that were poised to become worthless, have bounced off the bottom. Bearish investors got the short squeeze, forcing them to cover, pushing prices even higher. Then fund managers who have had their portfolios hammered and have been desperate to hold onto remaining investors, and their job, see the market push higher so they pile in so as not to miss the rally. The headlines in the business news speak of recovery and green shoots. The bottom is in. It all becomes self propelling once this dynamic establishes itself. Now the banks can go to the market and raise new capital, with the blessing of the positive stress tests. The system is working.
What I struggle with when trying to find an explanation to the seemingly irrational markets is figuring out what the top economists with the levers of the monetary system in their hands actually believe. Do they believe in what is being sold to the public? Are they so egotistical and sure of themselves that they don't harbour any doubts about the course they have chosen? Or do they privately know the financial framework is rotten and doomed to failure and the best they are hoping for is to mitigate the fall, so it does not unravel in a catastrophic way. So they buy time, float trial balloons, leak stories, test theories in an ad hoc fashion, let Lehman Brothers and Chrysler fail, watch the outcome, learn, adapt, prepare for the big battles. The fundamentals are awful. Smaller banks are regularly going bankrupt. The FDIC, the agency that guarantees deposits in the banks, just recently requested more funds. If a big bank goes down they will insure as much as AIG did. There isn't enough money in the pot because the models don't allow for systematic failure. We are already at the worst case scenario thresholds that the stress tests allowed for. If it gets worse, the irrational exuberance of the new bull market will rapidly deteriorate into chaos again. Our minds don't want to go there. Order has been established. Rally on.
Thursday, May 7, 2009
Bankers and Parasites
A parasite has two strategies. It can feed off the host until it's presence overwhelms the host's defenses leading to illness or death. This strategy will work as long as it can easily find new hosts. If the balance between parasite and host favours the parasite, the parasite will rapidly infect the population until it reaches such a low density that the parasite is unable to find new hosts and the parasite's demise is at hand as well. Or a parasite can ensure it's survival by feeding off the host but do no harm. The parasite stays with the host while it's eggs or young are expelled and they are required to find a new host. The banks have parasitic qualities. It feeds off the interest paid by the host community, the borrowers. There's nothing bad about parasite-host relationships. The balance between the two is of importance. The bankers have taken just enough in the past to ensure their success without threatening the health of the economy. The discharge of new debt has been able to locate new hosts leading to an expansion of the credit industry. However, we have reached a point in the relationship where the banks have saturated the economy with debt. There is very little room for growth, as there is a dearth of willing and able borrowers. The food for the banks is withdrawing, threatening their survival. The relationship between the banks and economy at this stage is what is about to play out. We are in an unstable position where the dynamics of host and parasite are in flux.
The world economy is slowing down. It has to. A consumptive economy eventually depletes it's savings and reaches a point where it has to produce again or face the inevitable collapse. The US economy is consumptive. It has fed off it's store of wealth since it outsourced it's manufacturing to cheaper, more efficient nations. The typical Asian works harder, longer, and for less. China is the largest foreign holder of US debt, not because they have full faith in the potential growth of the US, but because they know the money they lend will be recycled back to them when the American consumer buys it's exports. What started out as China feeding off of the US, has reversed, and now the host has become the parasite feeding off the wealth of China. This dynamic is changing. The US consumer is spent. They are cutting back on spending because their debt burden has become too honorous and their perceived wealth has eroded. The demand for China's exports is diminishing. It follows that China is receiving less money and they have less profits to cycle back into the US. The US is losing a major creditor which has allowed them to maintain a high standard of living, while China's largest market which has fuelled their growth is shrinking. This relationship is due for a rebalancing.
The US has gone from being a creditor nation to a near bankrupt one. A growth industry of the US that has developed has been it's innovative debt products. Large institutional investors purchased loads of US debt wrapped up in complicated bundles. There was a belief that the US consumer could continue to spend borrowed money with no limit. This notion crashed a year ago when a critical number of home buyers foreclosed on the mortgages and these debt bundles became toxic as no one wanted to buy debt that may not be repaid. There was too much risk involved so the market for these debt instruments froze. The holders of this debt refused to sell them at market values because they would take a beating on their investment. The so called credit crisis began in earnest. Banks saw their assets vanish as real estate prices plunged. Debt is only as good as the promise to repay and many promises have been broken. The lucrative business of selling debt has hit bottom and for an economy based on selling and spending credit, this is bad news. Reality is slowly settling in that people can't spend what they don't have. The demand for credit has withdrawn even with interest rates approaching zero. Few banking institutions want to lend and fewer people want to borrow. The product of the banking industry is failing to find new hosts.
The central banks and the politicians they control sense their potential demise. Thus they have decided to become the lender and spender of last resort in an effort to stimulate the economy while average people are reckoning with their personal debt. The banks are squeezing them. A parasite will do only what it knows. It feeds off it's host. The Federal Reserve of the US is owned by private banks. It is the bank for bankers so naturally it will do what is in the best interests of the banks first and not neccesarily the people at large despite what they claim. They believe that what is good for banks is good for the economy. They believe that credit creates business and wealth. The parasite believes it's survival is critically important for the survival of the host. Actually, the economy is struggling because the parasite has infected the population with it's toxic debt and it will not let the system cleanse itself by letting the bad loans default. The bankers and politicians will not accept responsibility for their greed and flawed policies. They have manipulated the monetary system to their benefit, acquiring wealth and power over the years. Governments and all the businesses that depend on it's seemingly unlimited spending have expanded, consuming a larger and larger portion of the wealth generated from the productive part of the economy. The burden placed on people who produce the neccessities of life and are at the base of all economies is taxing, and ultimately the balance will have to be restored to a more equitable level.
The question that remains to be answered is how the parasite-host relationship plays out. Will the attempt to save the banks at all cost take the productive economy down by sucking all the working capital out of the system, until it is in such a dismal state that the bankers and the debt they produced wither away, leaving the essential vestige of a bloated industry? Or will the debt that was pumped out of the banks be subjected to the harsh reality of the marketplace, and force those who took on the risk, take the loss, wiping out a few banks and businesses but leaving behind a leaner, deflated economy intact? Neither choice is pleasant. There will be hardship and ruin as the economy struggles to keep the peace and feed the people. My guess is that the present strategy of throwing money and resources at the banking industry will persist until there comes a turning point when it will become all too obvious that the money creation is having little positive effect while the imbalances become more pronounced. Increasing debt cannot cure a debt crisis. It exacerbates it. We are living in a strange time when what was once considered bad is now good. Intuitively, piling on more debt doesn't lead to prosperity. I choose to trust my common sense that reducing debt is a better strategy in the long run. Extend that belief outward to the economy and the result will be a deflationary environment that will see the banking industry become less profitable, but the economy as a whole will be more stable once the balance is restored.
The rebalancing must occur. It won't be easy but the years of living comfortably on the backs of cheap Chinese labour and credit are over. China will have to accept that the credit they extended to the US will not likely be paid back. It will default one way or the other. The US dollar will likely collapse in value. The US needs to start manufacturing again. The banks depend on the demand for debt for it's growth. Without borrowers they have no business. In an ideal world there would be no debt and the people of the world would live their lives doing what they need to do to live as comfortably as they can, living within their means. This is disastrous for bankers. The reality is that the economy will not collapse. Food will still be grown, oil will still be pumped out of the earth, cars will still be manufactured, clothes will still need to be sewn, doctors will still heal the sick, and there will still be a need for banks. Life will not come to a stand still because of a monetary crisis. The resources of the world that the population lives off of will still be available. The economy will reorganize. The labour of the people is what keeps the economy running, not debt creation. The host does not depend on the parasite for survival.
The world economy is slowing down. It has to. A consumptive economy eventually depletes it's savings and reaches a point where it has to produce again or face the inevitable collapse. The US economy is consumptive. It has fed off it's store of wealth since it outsourced it's manufacturing to cheaper, more efficient nations. The typical Asian works harder, longer, and for less. China is the largest foreign holder of US debt, not because they have full faith in the potential growth of the US, but because they know the money they lend will be recycled back to them when the American consumer buys it's exports. What started out as China feeding off of the US, has reversed, and now the host has become the parasite feeding off the wealth of China. This dynamic is changing. The US consumer is spent. They are cutting back on spending because their debt burden has become too honorous and their perceived wealth has eroded. The demand for China's exports is diminishing. It follows that China is receiving less money and they have less profits to cycle back into the US. The US is losing a major creditor which has allowed them to maintain a high standard of living, while China's largest market which has fuelled their growth is shrinking. This relationship is due for a rebalancing.
The US has gone from being a creditor nation to a near bankrupt one. A growth industry of the US that has developed has been it's innovative debt products. Large institutional investors purchased loads of US debt wrapped up in complicated bundles. There was a belief that the US consumer could continue to spend borrowed money with no limit. This notion crashed a year ago when a critical number of home buyers foreclosed on the mortgages and these debt bundles became toxic as no one wanted to buy debt that may not be repaid. There was too much risk involved so the market for these debt instruments froze. The holders of this debt refused to sell them at market values because they would take a beating on their investment. The so called credit crisis began in earnest. Banks saw their assets vanish as real estate prices plunged. Debt is only as good as the promise to repay and many promises have been broken. The lucrative business of selling debt has hit bottom and for an economy based on selling and spending credit, this is bad news. Reality is slowly settling in that people can't spend what they don't have. The demand for credit has withdrawn even with interest rates approaching zero. Few banking institutions want to lend and fewer people want to borrow. The product of the banking industry is failing to find new hosts.
The central banks and the politicians they control sense their potential demise. Thus they have decided to become the lender and spender of last resort in an effort to stimulate the economy while average people are reckoning with their personal debt. The banks are squeezing them. A parasite will do only what it knows. It feeds off it's host. The Federal Reserve of the US is owned by private banks. It is the bank for bankers so naturally it will do what is in the best interests of the banks first and not neccesarily the people at large despite what they claim. They believe that what is good for banks is good for the economy. They believe that credit creates business and wealth. The parasite believes it's survival is critically important for the survival of the host. Actually, the economy is struggling because the parasite has infected the population with it's toxic debt and it will not let the system cleanse itself by letting the bad loans default. The bankers and politicians will not accept responsibility for their greed and flawed policies. They have manipulated the monetary system to their benefit, acquiring wealth and power over the years. Governments and all the businesses that depend on it's seemingly unlimited spending have expanded, consuming a larger and larger portion of the wealth generated from the productive part of the economy. The burden placed on people who produce the neccessities of life and are at the base of all economies is taxing, and ultimately the balance will have to be restored to a more equitable level.
The question that remains to be answered is how the parasite-host relationship plays out. Will the attempt to save the banks at all cost take the productive economy down by sucking all the working capital out of the system, until it is in such a dismal state that the bankers and the debt they produced wither away, leaving the essential vestige of a bloated industry? Or will the debt that was pumped out of the banks be subjected to the harsh reality of the marketplace, and force those who took on the risk, take the loss, wiping out a few banks and businesses but leaving behind a leaner, deflated economy intact? Neither choice is pleasant. There will be hardship and ruin as the economy struggles to keep the peace and feed the people. My guess is that the present strategy of throwing money and resources at the banking industry will persist until there comes a turning point when it will become all too obvious that the money creation is having little positive effect while the imbalances become more pronounced. Increasing debt cannot cure a debt crisis. It exacerbates it. We are living in a strange time when what was once considered bad is now good. Intuitively, piling on more debt doesn't lead to prosperity. I choose to trust my common sense that reducing debt is a better strategy in the long run. Extend that belief outward to the economy and the result will be a deflationary environment that will see the banking industry become less profitable, but the economy as a whole will be more stable once the balance is restored.
The rebalancing must occur. It won't be easy but the years of living comfortably on the backs of cheap Chinese labour and credit are over. China will have to accept that the credit they extended to the US will not likely be paid back. It will default one way or the other. The US dollar will likely collapse in value. The US needs to start manufacturing again. The banks depend on the demand for debt for it's growth. Without borrowers they have no business. In an ideal world there would be no debt and the people of the world would live their lives doing what they need to do to live as comfortably as they can, living within their means. This is disastrous for bankers. The reality is that the economy will not collapse. Food will still be grown, oil will still be pumped out of the earth, cars will still be manufactured, clothes will still need to be sewn, doctors will still heal the sick, and there will still be a need for banks. Life will not come to a stand still because of a monetary crisis. The resources of the world that the population lives off of will still be available. The economy will reorganize. The labour of the people is what keeps the economy running, not debt creation. The host does not depend on the parasite for survival.
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