Thursday, September 25, 2008

No helicopter drops?

What the government did in the spring was a clear and simple helicopeter drop. Bernanke sat in front of congress and told them about $160 billion should do the trick. It went right into a black hole, as it bulled Walmart stock a little and was gone in a few weeks. This move isn't a helicopter drop and if they go through with it, most likely it will prevent the stimulus helicopter drops needed to get the economy going, the way it has been done in the past, because this bailout weakens the US financial position. To go further and roll out more spending or as far as that goes, more tax cuts would likely be counter productive, as over consumption got us here in the first place and it can be directly traced to government and Wall Street financing.

This, on the other hand is a swap. If the Congress holds the banks feet to the fire, we are actually talking about a program to reduce bank capital or thin it out, not replace it. The plan Bernanke and Paulson put out was a flat gift, which is probably what is needed for the short term as much as I hate to say it. What I would like is that the bad banks just went broke and the government then acquired the assets and liquidated them over time. Something tells me there are too many default swaps out there to let the group go insolvent and shit would fly around the world until everything was brown. Thus, attempting to maintain the status quo with some strings attached was probably a good idea, even though it was also borderline criminal.

The reason I don't believe this does much over the short term is the economy is 2 or 3 steps slow now in credit creation. I won't go into details here, except to say that the system has failed to create enough credit to keep the ball rolling and the system has had too many losses to start the pump again very quickly. Thus we are looking at a swap here, much like the RTC did in 1990. Does anyone recall an inflationary spiral in 1990 besides one in the stock market and one associated with the Gulf War? There was actually a downtick in inflation that followed this mess, to the shock of everyone.

There are a couple of things different now than in 1990. For one, we didn't have the next step in credit creation to take, which was all this crap that they are now stuck with from the CDO's to FNM/FRE. I don't think the financial postion of the US was in better shape in 1990 from a government standpoint either. But, they had an interest rate spead in 1990 that could be lowered and widened on the assets provided. Where do you go from a 2% short term/ 3.8% 10 year spread? Not too far, especially if they have to support the dollar next. I think the t-bill is sending a signal that we are going back to 1% soon and the dollar will be supported short term because the rest of the world is about to join us there.

First of all, we are looking at one of the great farces in history, a blackmail that we are going to be forced to swallow. As much as most of us bears would like to see these bull bastards get zero for their stock, the problem is the problem is so big that the Fed is out of funds and the whole system probably fails, not only in the US, but around the world. It is almost like playing Russian roulette where if the gun doesn't fire, the house is going to fall in on you. The vast marjority of us don't want to lose our money and I wouldn't snicker if you are a gold bug either because police with no paychecks in chaos don't show up for work as we saw in New Orleans, but instead join the looters.

There is absolutely no way out of this. If we prop the banks, this solves the immediate problem, ala putting our finger in the dike. The system is still going to have to deleverage. If there was sufficient capital, sufficient good credit, this mess wouldn't have happened in the first place and it is clear that the higher income people in the US are going to pay for this mess longer term. We are going to see a restriction in credit, which is going to really piss a lot of people off, but what else can come out of this? There cannot be a return to subprime, blindfolded lending and I find it highly doubtful that there is much toxic junk marketed for a long time to come under the guise of top rated credit. This means lower demand from all circles.

What is a depression? I think it is a collapse in capital goods demand. What do we have here? Clearly a capital shortage. You can devalue the dollar, up value the dollar or whatever, but it won't increase the flow to the US from China to fill up Walmarts. The most visible capital spending crazes are going on in China and much of Asia and I would venture that most of their massive growth has been coming from their capital spending craze, not their other output. The whole thing has been fed by a speculative inflow of hot money chasing return, as was demonstrated by their stock market boom and following bust, not exports as supposed. They are buying oil just like we are, iron ore, coking coal, copper, you name it. Then there is the boom in Arabia, where a major world skyline has appeared overnight. I doubt this stuff goes on, as the fuel for it all has been exported American credit. They could replace the dollar, but what would continue the flow of credit? I say all this goes into the box and the price of commodities that go into capital expansion go into the crapper.

I know a guy that I talk about this stuff to quite often. He has a brother that is a street guy in California. His brother got a credit card for $3000, maxed it out and now don't know what to do. The guy lives in a homeless shelter and got a credit card with a pretty nice line of credit. This is what built Asia and broke the banks. The recent string of Presidents, Congressmen and others hasn't been too anxious to end this as it kept the game going.

When I grew up , we had recessions every 3 to 4 years and they were planned and usually not so bad. Then LBJ launched the Great society, fought the Viet Nam war and flooded the world with credit. Inside of 9 years, the dollar was pushed off the gold standard and the business cycle was in ruins. Devalued dollar meant leverage was less forceful in doing anything and the recessions got to be something to be avoided at all costs, as President after President went to slaughter in the 1970's. There were 2 problems that were fixed by Reagan(I know I am going to be debated here), spiraling government spending and tax bracket creep. If Reagan had dropped the tax brackets 10% instead of 20%, maybe capped unearned income at 60% instead of 50% and indexed for inflation, his plan might have worked perfectly or at least much better, but I think he also knew the tax bracket creep game had been allowed to run too long. Politics is beside the point, as what Reagan did worked to the point that it created an expansion that lasted most of his term, most likely becaused he wiped out the shot of speed the Congress typically gave the economy and replaced it with requests for spending cuts and a military expansion. The fact that the trend for interest rates turned down was another factor and maybe a bigger factor than anything else but it too was traced to the political scene. That and the creation of a market for some new financial products, derivatives.

Bush I lost in 1992 because he was probably 6 months early in his term, meaning he was 6 months early in running for election. Had the election been in May 1993 instead of November 1992, I doubt the economy stupid would have played. Bush I had to fade the first deflation game and part of it was probably taking a tax increase. Clinton walked into a new game, new derivatives, cleaned out banking system, the GSE's deciding they could write all the mortgages in the world and a Treasury secretary who could sell anything, fresh from sucking all the money out of Mexico for Goldman Sachs. Rubin knew the prosperity game came out of leverage and I believe his aim was to create a bubble and a favorable view of Wall Street (by the end if the 1990's, everyone loved Wall Street in politics). If you read Greenies book, you realize that Rubin convinced Greenie, who always worked on the fringe of Wall Street that there were no such things as bubbles. I believe Greenie wanted to prove the central bank could fix anything and went along(had he not tried, some idiot would think for the rest of time this could be done). Because the credit machine was so big, the distribution of money(balances belonged to one group to the extreme, debts to another group) in the bank so poor, the game ran on. When it bursted, Greenie came with a new money game called the carry trade and Bush with tax cuts and a war. Anything but to come face to face with the dreaded recession(probably depression by 2001) word. Things weren't getting better for the guys on the bottom, but they did have a job and credit cards came in the mail.

So here we are, at the end of a long economic cycle. There has been almost 30 years since we have had a recession worse than the previous one. Some say 1990 to 1992 was the worst economy since the depression, but I think credit was just tougher, not the real economy worse. The rebound was weak, but the depth of that recession was much less than the 1980 recession that they called a double dip (that was a political lie made up over years, as that one started in 1979) which was worse than the 1975, which was worse than the 1971 or whatever year it was. The 2000 one wasn't as bad as the 1990 one and this one is going to be worse.

One has to look at the string of artificial demand that has circled the world to realize that to deleverage means a collapse in that demand. The 1930's was a capital goods collapse. People can drive the cars on the street in the US for another 20 years before they had to have a new car and maybe car sales go to 12 or 13 million instead of the bubble level. That is 4 or 5 million cars less in capital goods needed. China's exports drop, the financial burden of a bubble economy hits and their building boom stops or slows. That is a massive decline in capital spending. The capital spending to do capital spending also declines, whether it be mine production or machine tools to make machine tools. Who needs the latest PC to run their business? Best guess is very few can't go another year or 2 without one.

Here is the question. I think the economy moves to survival mode, which means that gasoline and food take over the concern of most people, followed by a roof over their head with the desire to get the latest TV or cellphone and service moving to the rear. This crisis has probably thrown the election to Obama, who will attempt helicopter drops at the expense of the rich then have to address the other problem, which is the deficit. The government is going to have to prepare for war, which means that the stream of money paid out for goodies is going to decline. My guess is the near term goal is that something be done to weaken the economies of our likely foes and piling up payments to give them leverage over us isn't going to solve the problem. We have been leveraging up for 70 years or more and the leveraging game is over.

Maybe the gold bugs are correct and this results in hyperinflation, but I think we are going to see a deep recession worldwide that is going to reveal a massive liquidity squeeze due to the fact the punchbowl has been drained. It hasn't been taken away, the host is just flat out of punch. In that vein, I think we deflate and the world joins us.

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