Michael Pettis has some interesting stuff in his site this week about savings rates, trade and deflation. I am in the early stages of the article, but it occurs to me that I need to write something here on the subject rather than lose it in his comments section. I believe the entire game to be a credit phenonmenon, including the idea of savings, which is nothing more than debt recycled from one account to another and has absolutely nothing to do with substance. i believe in the case of international trade, it actually relates to the credit excess in one country to the detriment of another. I also believe that due to the inconvertiblilty of currencies like the Chinese that savings is done by the central bank and thus there is a curtain drawn between trade and the Chinese currency. Thus all dollars drawn in for investment and trade are impounded to the extent that they aren't needed to buy minerals or other raw materials. The domestic economy has its own market separate from the international accounts. In this matter, a domestic economy could have no debt at all or piles of it, backed on the other side of the equation by savings.
Michael brings up the idea of the Obama administration encouraging savings, which is bordering on absurd. The entire Obama plan is no different than the Bush plan except more obscene on the consumption side. The only consumption he seems to not care for is energy and seems to be leaning toward endowing corporate USA and Wall Street the right to consume energy at the expense of the common every day man. This protest will be for another posting, as it is one of the greatest fascist programs of all time.
Back to savings. If someone can tell me how savings in this world economy can correspond to something besides debt, I would like to learn. This idea is kind of like the money going into the stock market, when anyone with a brain can figure out that money only changes accounts from idiots to smart people. Even if I take $100 and stick it in a matress, it is nothing more than the representation of something owed by the Federal reserve and that something is actually a paradox as it is generally a note in the amount of what I have plus interest due and represents a mathematically impossible equation other than someone taking a haircut. Investing in stocks is nothing more than an exchange of assets and has nothing to do with savings, a real pitfall for those that fool with that market and have no financial training other than what their brokerage companies can give. Speculation is no exchange or investing at all, but instead informed gambling at best.
In any case, housing in China costs about the same as in the US, yet according to what I have read by Andy Xie in Caijing, Chinese incomes are about 1/7th US. I am guessing that the Chinese consumption of housing is roughly 40% of US so the relative cost of housing is about 280% US. They aren't buying this out of their pockets, but are being financed in some fashion. My best guess is the same debt segregation of lending to the industrial so the flow can support the real estate markets that was probably part of the Japan bubble. In some fashion it is all debt.
Depressions last because there is no plan on how to give the haircut on debt and redistribute economic power. As long as there isn't a depression on the horizon it appears that all are left to fend for themselves, but once a crisis is threatened it is unheard of that the owners of Citicorp, Goldman Sachs, Bank of America, UBS, etc. should be replaced and the underlying equity be wiped out and replaced out of the current stock of money. I know the pain that pensioners would go through, but careful examination will reveal that much of this side of the equation has already been looted by Wall Street academic and actuarial formulas that just aren't true over the long term of economic cycles.
There is only one way the Japanese economy fell into the hole it fell into and that was an excess of debt. We heard for years that the Japanese savings rate was 20% to 25% of GDP. Well, what did that mean but the debt rate was also increasing at an amazing rate. Back in the 1980's, I recall the trade deficit with Japan was in the $100 billion range. I don't know about the rest of the world because Japan had to import all its raw materials or at least a very high percentage, but lets say they were even with the rest of the world. In this event, if their GDP was $1.5 trillion, then they were saving about $300 billion, $200 billion domestically. This implies that their debt level against their economy was increasing about 13% annually and their debt level was doubling less than every 6 years against GDP.
The US/China situation is also figured backwards. The situation wasn't fueled by a high China savings rate, but by a run away credit phenonomenon in the US that originated out of the activities of Government sponsored enterprises, namely FNMA, FHLMC and Sallie Mae. Collateralized were home equity and the future value of labor. It was only natural that this excess flowed beyond the US borders given the desperation with which developing countries needed developed world currencies. But, it wasn't the lending back of the money which made this bubble possible. It was only natural that the money was either used to acquire property, minerals or debt from the nation of origin. Had the US government not run deficits, had the GSE's and Wall Street finance not loosened lending standards, the lending back of money would have mattered very little and the trade would have never happened.
If I saved $1000 and loaned it to company A, of course company A would owe me back my savings plus the rent on the money commonly called interest. If Company A then wrote a check to B for $1000 and B saved the money by lending it to Company C, then the same process would occur. There would be $1000 in money in the system and $2000 in savings and debt. If A or C spent that money and cannot get it back, the debt cannot be collected and the savings really doesn't exist. Only the $1000 exists.
Once the gold standard was done away with, money was replaced with debt. The cash in my pocket is backed by the debt on reserve at the Fed, which is payable only in the notes I possess in my pocket along with the other notes in circulation. Interest is due on these notes, so the Fed is always pulling money out of the economy independent of the other activities they employ to keep the system inflated. In any case, this would be the only money that we have independent of the Fed and the sovereign debt. The money created by banking takes on a property sort of like the example in the prior paragraph, in that most of the assets backing the money at any given time are uncollectable. The difference between the bank money and the savings example is that the bank has created the money without any prior savings, instead acting as surety or guarantor of the credit they have extended. When it becomes apparent that the bank can no longer act as surety, the system no longer trusts them and they become like Citicorp and if they are large enough, they create a credit crunch all by themselves. Banks wouldn't lend to each other meant banks wouldn't lend to Citicorp, who had an amazing interbank liability that couldn't be paid. The black hole is still present, it has merely moved from Citicorp to the government which will at some point have no other alternative than to tax the economy and relocate the black hole where it has been all the time, the banking system.
Savings, debt and collateral all serve to create each other. Only in this manner can the Japanese situation be explained. The Japanese answer to the problem was more debt, which in general would be inflationary, but in this case or in the case of maximum payable principal and interest is deflationary. This is what a depression really is, maximum payable principal and interest and the longer the effort to support the money supply goes on, the worse it gets. Irving Fisher was wrong, though his thesis of swelling dollars over the short term was correct. He forgot that the dollars spent a lot of years shrinking. When the result of several business cycles and government solutions to recessions piles up to debt in the amount of several times GDP, then too much has been borrowed out of the future to go on and continue to consider the debt legitimate and the money real in any sense. Like all psychological pain, it is created and made worse by the continued avoidance. No one wants to lose their status quo except the debtors.
Sunday, August 9, 2009
Wednesday, August 5, 2009
What green shoots?
The surface news seems to propel the stock market daily while the economy is propped from all angles. But, the news is bullish only if you consider pyric victories positive. Seems the oil markets take every report that is less bad than the prior to mean the surplus that is spilling out into the streets will soon disappear and boost prices ever higher. Some say this is a weak dollar, but the markets haven't been cleared for some time, regardless. The same is occurring in the copper markets, a product that is clearly cornered and stockpiled in massive quantities in China. Much is riding on these two commodities alone, most likely including the future profits of Goldman Sachs and many hedge funds. Should these markets crater, it is quite possible that the too big to fail that are involved, along with the independent producers of oil and the mining companies around the world would need a bailout.
The recent improvement in unemployment claims is being spun as a sign the recession is over, while in fact a recession that supposedly began in December 2007 showed no losses of employment of this size prior to 2009. Thus the economy is still declining at a pace that exceeds any during the first year of the recession, yet the recession is over? Nothing I have seen can be farther from the truth.
I believe the news is being made up as we go along. I recently read Murray Rothbards chapter in the book A New History of Leviathan that the Fed expanded holdings by a factor of 6 between 1929 and 1932 and the inflation did no good. We are told this didn't occur in the modern press as Bernanke does the same thing today. The budget of the US expanded 40% while the receipts of the government collapsed by 50%, making the gap between receipts and expenditures 60%. Still no inflation of prices and no recovery. Nothing could be more similar than the response between 1929 and 1932 and today than what Rothbard wrote here.
The solution in the US is to create an even bigger consumer debt bubble, while the banking industry is under pressure to preserve capital. I recently had my credit lines cut, though I had maintained a perfect record and paid all balances in full. Thank God I don't need the credit at this time. What are they doing for people that are really cashed out?
Then we have the home sales. Home sales never left the bubble stage from what I can deduce from past sales figures I have seen. The speculators have never left the market while the government is recreating a new subprime market with government subsidies and guarantees. In the meantime, the economy collapses while all this is going on. The recent rising new home construction figures were below anything prior to this recession for the past 50 years, yet you would think the financial side of the mortgage market was fixed and new homes were selling like hotcakes with legitimate lending. Nothing could be farther from the truth nor can what is being done at this time be sustained without government props. There is no private housing market in the US today, nor is one likely to appear any time soon.
In the meantime, mid sized banks in the growth areas of the country are now beginning to collapse. Colonial Bank of Montgomery, Alabama, an entity I had done business with in the past is open only because the regulators need the money to close it. The same is evidently true of Guaranty Bank, a former division of Temple Inland, another entity my family dealt with in the 1990's. There is another I am not familiar with, a bank that starts with C, I believe in Florida. I believe much of this is prime mortgage related lending along with failed housing projects. My dealing with Colonial was in the conforming mortgage market. These 3 failures alone will wipe out the FDIC.
The problems with the FDIC are why they had to construct the TARP fund. I believe Citi alone is a $400 billion hole and it is a lot easier to hope than to pay. This wasn't the first time Citi was broke. Much of what was missing has been covered up by government guaranteed financing for companies from Goldman Sachs to General Electric and everything inbetween.
Those playing in the mortgage business need to take a haircut and they can't. From what I understand, most of the foreclosed properties are being withheld from the market for 2 purposes. One to keep the weak market from being glutted and the other to keep the effects of the suspension of mark to market intact. Should the properties be sold, the losses would have to be recognized and there would be more banks to bail out, not to mention other financial entities. Those hoping for massive gains from holding housing in the next few years are going to be disappointed. In fact, I wouldn't be surprised to see a rent war break out if the highly likely weak recovery transpires. So much of the next economic wave depends on a resumption of real estate construction and I find it highly unlikely for anything near the bubble trend to ever return, nor anything close to the old peaks prior to the bubble. The same holds true for the commercial side of the game as well, as I expect retail real estate to be a disaster along with much of the other commercial property as well. I have attempted to last through a real estate bust and witnessed an entire metropolitan area of real estate related investment and construction businesses go broke. In the 1980's, the 2 largest home builders in the US, both based in Houston, imploded. Despite the size of this bust, I have yet to hear of a large builder going bust. My guess is that either the bubble was so big that even at reduced prices there was profit in the inventory or they are being carried as well under the label,too big for their creditors to let fail. Nothing here measures up to me. The bust will take longer to work out than even the least optimistic of analysts because the bubble was so much larger than prior bubbles and the market is growing so much slower than it was in 1980 or 1990.
All of these problems in the real estate market not only threaten the solvency of the financial system, but they do something few understand at this time, deprive the system of future loan collateral. This is going to be the real impact of this bubble going forward, the inability to tap home equity by the masses for a long time to come for things like retirement income, consumer spending, stock market investment and debt retirement along with all other major forms of spending. Also gone is a major portion of the move up housing market. We have only seen the tip of the iceberg here.
There is much more to the housing market that is beyond fix. For one, the market is saturated. Second, high interest rates penned up demand in the 1980's and much inflation wasn't passed on. As rates fell, FNMA developed more and more programs of qualification and the securitization of the mortgage market, demand erupted for housing against a fixed supply. As time passed, housing wasn't built for occupation, but for speculation. When I entered the real estate business in the late 1970's, much the same thing was going on, except Volker and inflation caught up with the cashflow market and put a damper on the bubble market. Underlying demand from the boomer generation was such that a collapse in the price of housing didn't transpire then. What did go on was people were paying extra over and above rents to get ahead of inflation as home owners or reap appreciation as speculative investors. The investor games didn't go on for long unless the borrowers were real pros with pockets deep enough to stay in the game.
What followed this bubble up is no longer present. There isn't a pent up demand from excessively high interest rates or a fast growing home buying age public. Thus there is an owner occupied percentage in the US that is likely higher than can be sustained along with interest rates that can only go up from here, unless there is no recovery. Then prices of homes will continue to sink.
The last green shoot comes from China. The Chinese recovery is more a flood of money pushed into the streets along with doctored statistics. I have read some things about the Chinese real estate market, which has to be 4 or 5 times the size of the normal US market, but only for a temporary period of time. The real business in China is building, not manufacturing and I am reading of entire cities of empty buildings. Thus, once this surplus is exposed, once the speculative bubble bursts and once the truth about the Chinese economy comes to the surface, the whole game washes out. It appears that the Chinese housing game has about 5 to 10 years left then the dance stops. I don't mean it slows down, but just flat stops. They have enough housing under construction right now for about 70 million people and enough capacity to build about 50 million worth of housing annually. There are only about 300 million people left to move from the rural areas, thus 6 years minus what is already sitting around vacant and the game is done. I don't even bring up the fact that the Chinese population is set to start expiring at a massive rate in a few years as the 1 child policy begins to take its toll. This is not good news for the mining industry and for those that believe in peak oil as already being reached. It is good news for the rest of us, save the fact that the economic impact on the world is going to be great.
So you have it. Green shoots is one of the biggest fairy tales in economic history. I think we had a muddle through economy a few years ago. This time, we are likely to see a just lay there economy. The effect of this on economic growth and corporate profits is going to be devastating. Stocks and retirement funds are going to shrink to next to nothing and life as we know it is going to change. It would be very beneficial to all if I am wrong here, but I don't believe that is going to be the case. I look for the Dow to possibly touch 10,000, maybe even a little higher, then the bear to come out again, stronger than he was the first time. The government will forget about saving the banks this time and start working to save itself.
The recent improvement in unemployment claims is being spun as a sign the recession is over, while in fact a recession that supposedly began in December 2007 showed no losses of employment of this size prior to 2009. Thus the economy is still declining at a pace that exceeds any during the first year of the recession, yet the recession is over? Nothing I have seen can be farther from the truth.
I believe the news is being made up as we go along. I recently read Murray Rothbards chapter in the book A New History of Leviathan that the Fed expanded holdings by a factor of 6 between 1929 and 1932 and the inflation did no good. We are told this didn't occur in the modern press as Bernanke does the same thing today. The budget of the US expanded 40% while the receipts of the government collapsed by 50%, making the gap between receipts and expenditures 60%. Still no inflation of prices and no recovery. Nothing could be more similar than the response between 1929 and 1932 and today than what Rothbard wrote here.
The solution in the US is to create an even bigger consumer debt bubble, while the banking industry is under pressure to preserve capital. I recently had my credit lines cut, though I had maintained a perfect record and paid all balances in full. Thank God I don't need the credit at this time. What are they doing for people that are really cashed out?
Then we have the home sales. Home sales never left the bubble stage from what I can deduce from past sales figures I have seen. The speculators have never left the market while the government is recreating a new subprime market with government subsidies and guarantees. In the meantime, the economy collapses while all this is going on. The recent rising new home construction figures were below anything prior to this recession for the past 50 years, yet you would think the financial side of the mortgage market was fixed and new homes were selling like hotcakes with legitimate lending. Nothing could be farther from the truth nor can what is being done at this time be sustained without government props. There is no private housing market in the US today, nor is one likely to appear any time soon.
In the meantime, mid sized banks in the growth areas of the country are now beginning to collapse. Colonial Bank of Montgomery, Alabama, an entity I had done business with in the past is open only because the regulators need the money to close it. The same is evidently true of Guaranty Bank, a former division of Temple Inland, another entity my family dealt with in the 1990's. There is another I am not familiar with, a bank that starts with C, I believe in Florida. I believe much of this is prime mortgage related lending along with failed housing projects. My dealing with Colonial was in the conforming mortgage market. These 3 failures alone will wipe out the FDIC.
The problems with the FDIC are why they had to construct the TARP fund. I believe Citi alone is a $400 billion hole and it is a lot easier to hope than to pay. This wasn't the first time Citi was broke. Much of what was missing has been covered up by government guaranteed financing for companies from Goldman Sachs to General Electric and everything inbetween.
Those playing in the mortgage business need to take a haircut and they can't. From what I understand, most of the foreclosed properties are being withheld from the market for 2 purposes. One to keep the weak market from being glutted and the other to keep the effects of the suspension of mark to market intact. Should the properties be sold, the losses would have to be recognized and there would be more banks to bail out, not to mention other financial entities. Those hoping for massive gains from holding housing in the next few years are going to be disappointed. In fact, I wouldn't be surprised to see a rent war break out if the highly likely weak recovery transpires. So much of the next economic wave depends on a resumption of real estate construction and I find it highly unlikely for anything near the bubble trend to ever return, nor anything close to the old peaks prior to the bubble. The same holds true for the commercial side of the game as well, as I expect retail real estate to be a disaster along with much of the other commercial property as well. I have attempted to last through a real estate bust and witnessed an entire metropolitan area of real estate related investment and construction businesses go broke. In the 1980's, the 2 largest home builders in the US, both based in Houston, imploded. Despite the size of this bust, I have yet to hear of a large builder going bust. My guess is that either the bubble was so big that even at reduced prices there was profit in the inventory or they are being carried as well under the label,too big for their creditors to let fail. Nothing here measures up to me. The bust will take longer to work out than even the least optimistic of analysts because the bubble was so much larger than prior bubbles and the market is growing so much slower than it was in 1980 or 1990.
All of these problems in the real estate market not only threaten the solvency of the financial system, but they do something few understand at this time, deprive the system of future loan collateral. This is going to be the real impact of this bubble going forward, the inability to tap home equity by the masses for a long time to come for things like retirement income, consumer spending, stock market investment and debt retirement along with all other major forms of spending. Also gone is a major portion of the move up housing market. We have only seen the tip of the iceberg here.
There is much more to the housing market that is beyond fix. For one, the market is saturated. Second, high interest rates penned up demand in the 1980's and much inflation wasn't passed on. As rates fell, FNMA developed more and more programs of qualification and the securitization of the mortgage market, demand erupted for housing against a fixed supply. As time passed, housing wasn't built for occupation, but for speculation. When I entered the real estate business in the late 1970's, much the same thing was going on, except Volker and inflation caught up with the cashflow market and put a damper on the bubble market. Underlying demand from the boomer generation was such that a collapse in the price of housing didn't transpire then. What did go on was people were paying extra over and above rents to get ahead of inflation as home owners or reap appreciation as speculative investors. The investor games didn't go on for long unless the borrowers were real pros with pockets deep enough to stay in the game.
What followed this bubble up is no longer present. There isn't a pent up demand from excessively high interest rates or a fast growing home buying age public. Thus there is an owner occupied percentage in the US that is likely higher than can be sustained along with interest rates that can only go up from here, unless there is no recovery. Then prices of homes will continue to sink.
The last green shoot comes from China. The Chinese recovery is more a flood of money pushed into the streets along with doctored statistics. I have read some things about the Chinese real estate market, which has to be 4 or 5 times the size of the normal US market, but only for a temporary period of time. The real business in China is building, not manufacturing and I am reading of entire cities of empty buildings. Thus, once this surplus is exposed, once the speculative bubble bursts and once the truth about the Chinese economy comes to the surface, the whole game washes out. It appears that the Chinese housing game has about 5 to 10 years left then the dance stops. I don't mean it slows down, but just flat stops. They have enough housing under construction right now for about 70 million people and enough capacity to build about 50 million worth of housing annually. There are only about 300 million people left to move from the rural areas, thus 6 years minus what is already sitting around vacant and the game is done. I don't even bring up the fact that the Chinese population is set to start expiring at a massive rate in a few years as the 1 child policy begins to take its toll. This is not good news for the mining industry and for those that believe in peak oil as already being reached. It is good news for the rest of us, save the fact that the economic impact on the world is going to be great.
So you have it. Green shoots is one of the biggest fairy tales in economic history. I think we had a muddle through economy a few years ago. This time, we are likely to see a just lay there economy. The effect of this on economic growth and corporate profits is going to be devastating. Stocks and retirement funds are going to shrink to next to nothing and life as we know it is going to change. It would be very beneficial to all if I am wrong here, but I don't believe that is going to be the case. I look for the Dow to possibly touch 10,000, maybe even a little higher, then the bear to come out again, stronger than he was the first time. The government will forget about saving the banks this time and start working to save itself.
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