Cheer Up! We are Over the Worst! Huh?

I have recently been astounded by some reports in the media. It appears that many outlets are collectively starting to call the end of the economic crisis. I am, of course, being very broad brush here and there are dissenting articles, dissenting media, but the trend is clear. Perhaps the most astonishing of the stories is this one from Time Magazine:

But, the great banking crisis of 2008 is over.

My response to this proposition is to ask what exactly would happen to the major banks if governments were to announce next week that they were no longer offering any bailouts, support or guarantees - that the government simply went back to pre-crisis business as usual? Does anyone seriously think that the banks would stand? Or would they be declared insolvent?

When I read an article like the one in Time, I can almost sympathise with the conspiracy theorists, as it is hard to believe that this anyone might write this without some kind of hidden motivation. Alas, I actually believe that the author actually believes this. This is a more scary scenario, as it reveals how completely lost/hopeless the mainstream media can be.

Perhaps the most interesting point in this upturn in optimism is the way that the media are presenting some pretty awful statistics. The method of presentation mirrors that of politicians, such as Barack Obama:

President Obama pointed to a 20pc rise in government-backed loans to small businesses last month and a "very significant" pick-up in mortgage refinancing as evidence that markets are improving. "We feel confident that as we deal with problems in the banking system that we're also fixing the non-banking sector when it came to auto and credit card loans," he said

According to Obama small businesses borrowing money that will only be lent with government guarantees is a good thing? As for mortgage refinancing, the actuality of the situation is:

Fannie Mae, the larger of the two government-sponsored entities that process refinancing requests under Obama's mortgage-relief plan, just began accepting automated applications from mortgage lenders on Monday, a spokeswoman said. As of Thursday, fewer than 1,000 loans had been refinanced under the program, said a Treasury official, though the official noted that the pace is expected to pick up dramatically in the weeks ahead.

So what we have here is a government backed programme, which has achieved a grand total, across the whole of the US, of 1000 loans, and those have been given to fund mortgages that are apparently not in trouble. More troubling is that anyone might think that people accepting government subsidies to make up for lack of equity in their homes might be a signifier of an improved economy.

An example of this kind of thinking in the media comes from Businessweek, who paint a picture of an economy possibly having reached the bottom of the slide. Whilst they add caveats to their discussion, they still paint a positive picture, as in the following section:

Consumers were far less tight-fisted in January and February than they were at the end of 2008. Retail sales excluding autos rose strongly in both months, after declining for five months in a row. And in March, car sales rose to a 9.8 million annual rate, from 9.1 million in February, while weekly store receipts continued to hint at fading weakness.

The point I would like to highlight here is the use of the expressions 'fading weakness' and 'less tight-fisted'. Also, note the use of 'annual rate', in which the figures are extrapolated to a year. I have seen this kind of language/presentation in other articles. A slow down in the rate of increase in unemployment becomes a sign of recovery, an uptick in any indicator from a very negative base becomes a sign of recovery. What these presentations are trying to hide is that the underlying figures are actually dire, but they are presented as positive - as they are less dire than they might have been. There is no reason to propose that these are signs of turning the corner, as they are just as likely a pause for breath in the downward slide, or might be a move to a slower but continuing decline.

One of the optimists in chief is Larry Summers, a White House economic policy aide. His positive remarks have been widely reported, but I like the Reuters reporting for the following passage:

The decorated economist said it remained unclear how long it would take for the economy to return to strong, sustained growth, though he did cite "anecdotal" signs of improvements in credit markets that would allow inventory cycles to return to normal.

In particular, I liked that they clearly point out that his comments are unsubstantiated. I suspect that the view from the White House (excuse the metonymy) is that a dose of 'confidence' will somehow 'magic' the economy back on to the right tracks. However, it is hard to see how confidence can magic the economy back into action when 654,000 people became unemployed in the US in the previous month. Once again, in the article I used for the statistic, there is a positive spin placed upon this abysmal figure by some analysts:

"The good news is that the trend in initial claims isn't worsening. The bad news is that the level of claims still speaks to a very weak labor market," said Briefing.com analysts in a note to clients.

How anything about such massive lay-offs can be 'good news' is simply puzzling. 'Yes', the figures could be worse, but that they are not worse does not represent 'good news'. As for a 'very weak' labour market, the word abysmal is more to the point.

An excellent pricking of the optimism bubble is provided in Canadian Business, which says the following in response to news that new home sales had risen in the US:

Take that housing report. Sales may be up, but median prices for new homes continued to decline, tumbling 18% in February from a year earlier, to US$200,900. As Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University, explains, "It's helpful to think of the U.S. housing market as effectively two markets. There's the market in foreclosed properties, where, if prices drop dramatically, it stimulates some economic activity." (That explains the recent uptick in sales in such hard-hit markets as Surprise, Ariz.) However, the rest of the market remains "stalled," Retsinas adds. "It's hard to imagine that market recovering until we see a full economic recovery across the U.S."

What all of this 'good news' represents is that the speed, the rate of acceleration of the decline, may have slowed in some areas for a brief period, or positive spins on negative figures. In all cases the statistics are being measured against horrendous bases, and in all cases there is no signifier of a new upward trend, just isolated statistics.

Having said this, it does occur to me that, at some point, all of the newly printed money being pumped into the world economy must have an effect. I have long discussed the inflationary effects of the surge in money printing, and at some point this must feed into a sustained rise in asset prices. However, this will not be a rise based upon an increase in the value of the assets, but rather a price rise due to the devaluation of money. In the event that this takes place before a $US collapse, expect to see such inflation portrayed as a signifier of recovery. The fact that such a 'recovery' will be a precursor to massive or hyper inflation will, no doubt, pass the optimists by.

I suspect that what we are seeing at the moment is 'bad news fatigue'. The bad news over the last year has been relentless, and I think that what we might be seeing is the start of a reaction against this. Perhaps it is simply a case of, in the broadest sense, people just becoming tired of hearing negative news, and are simply looking for any sign that might be hopeful.

Note 1: Acrobat 747 commented on my article on the RMB as the new reserve currency, suggesting that the Chinese economy is too small. A commentator 'Novice' responded by pointing out the problems of measuring GDP, and I would agree with that point. One of the themes of this blog is that GDP is a flawed measure of the wealth in an economy.

Note 2: Tiberius posted a very interesting link, which describes the US government undertaking economic 'war games'. The following is a quote from the article:

In the end, there was sobering news for the United States – the savviest economic warrior proved to be China, a growing economic power that strengthened its position the most over the course of the war-game.

This 'game' may well have ramifications in US policy making. It is one of those articles that could easily be passed by, but which may have reported something with profound influence on future policy. It is only possible to speculate on how much influence it may have, but it is quite possible that, just by playing out the scenarios, the US may be forced to confront its inherent economic weakness. To quote Tiberius:

Whatever happens, I don't think the US will take it laying down.

I think that he may be right. The US government must now be painfully aware of the vulnerable position of the US economy with respect to China. One way or another, they will have to confront the challenge posed by the rise and rise of China. We can only hope that the response is appropriate, as I can see no other way than directly addressing Chinese quasi-mercantilism directly, and that is a scary path.

Money Moving to 'Safety in Asia'?

It seems that Alastair Darling is declaring no tax rises in the UK, despite the deterioration of the government financial position. Other comments by Gordon Brown have been supportive that this will be the UK government position. Of course, what this means is that the government will continue to borrow, and borrow ever more heavily. Estimates of borrowing for all kinds of figures are floating around, but most of the have been far to conservative (but nevertheless alarming enough - I would reference this but am having troubles accessing some websites). Those that are predicting massive increases in borrowing are not accounting for the scale of the coming contraction.

So it seems that the irresponsibility goes on; the lack of any grasp of the severity of the situation continues. As I keep saying, the only way out of the crisis is structural reform (see solutions to the left), but the government answer is to continue to bury its head in the sand of debt. To mix my metaphors slightly, it seems that the solution is move ourselves ever deeper into the quagmire, and this can only delay the possibility of recovery. Furthermore, this is a very loud signal the UK's creditors, and will at the very least hasten the drying up of lines of credit, and speed the decline of the £GB. Both of these will naturally feed off the other, as they are both effects are based in lack of confidence, and one will reinforce the other. The day of default moves nearer.

I have also just seen some news over the shifts in the stock markets. It seems that London and European markets have been dropping, whilst the Asian markets were rising.

It is far too early to tell, and I do not normally bother commenting on short term fluctuations in markets (as you really need to be 'within' the markets to see the thinking behind the short term movements). However, in the context of what has been happening, could this be a process of money moving from West to East. In the current climate, this would be a reasonable reaction. If, as I expect the $US, £GB and Euro (to a lesser extent) are about to take a further battering, then we have to ask whether the markets are moving ahead of the declines (but will also precipitate the decline they are fleeing from). The Western currencies will almost certainly devalue against the emerging economy currencies overall (ignoring the China currency problem) so this could be strategic manoeuvring. Clearly, those who move their money early, will stand to gain. The nature of the downward slide in currencies may be bumpy along the way (sentiment being one of the drivers), but the slide will certainly happen. Is the market thinking this way (markets do not, of course, have their own intentionality, so I hope you will forgive the metonymy)?

This would appear logical, but there is some illogic in the activity. Whilst I do not believe (and I do not know enough about these countries to be certain) that they will be hit as hard as the UK and US, Australia and New Zealand are also going to suffer in the crisis. Bearing this in mind, it is curious that their markets also gained, though this could be positive sentiment on the back of other Asian gains.

It is, of course, too early to tell, but it would certainly be a natural thing to move money into Asia at this stage in the crisis. Of course, if this happens on any scale, then a bubble in Asian stock markets is the next logical outcome.

However, I am moving into speculation here which is not the general aim of this blog. I think we need to sit back during this period, and let the markets absorb the final details of the bailout in the US before we can see how quickly sentiment will turn back to the negative. I am guessing that markets are on a knife edge of irrational optimism, or complete despair, and they might move any direction in the short term. However, short to medium term the only direction of Western markets (US and UK in particular) is down......

If that happens will money be safe in the East? I think that the Eastern markets will also follow the West down at some point, but how much by is a less clear issue, and the falls would need to be considered in the light of the currency movements. Whatever the case, I would speculate that the Eastern markets do present a better prospect overall due to the currency movements, but present risks as well (as I have discussed in previous posts). As I have also emphasised previously, in this kind of turmoil, there is no safe place for money. Too much hangs on sentiment, and that is not a very safe thing on which to risk money.

Note Added 23 September: With regards to the above post, a small apology. I am not sure that it is as clear as it should be - perhaps a little too rushed on this occasion, and also it is a little too speculative. However, I will leave it as it is, as one of the underlying principles of the blog is to leave each post untouched except for dated notes and additions. It does, however, raise an interesting question. What will the market do to try to save the value of their money before the currency devaluations?

The inevitablility of devaluations are becoming evident to the market; the $US will devalue, as will other Western currencies (the £GB in particular). This is no secret, as a recent Telegraph article points out:

'But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable – the US dollar will have to take another major fall'

With regards to the £GB, some may be taking comfort in the headline strengthening agains the $US, but this is only temporary, as the £GB is going to be found to be weaker even than the $US. Also, as I have pointed out before, it is not the measure of the Western currencies against each other that should be watched, but how they measure against the currencies of the emerging markets. The same Telegraph article says this of the £GB:

'Ironically, despite the pound’s comparative strength against the dollar – having risen from just above $1.75 in the past few weeks – it remains extremely weak against other world currencies, due to investors’ fears about the UK’s own home-grown problems.'

In a crude analagoy, measuring the sick against the sick is not the best way to understand the health of a person. Just because both are suffering from an acute fever, but one person's temperature is higher than the other, does not make the less sick person healthy.

What of the Euro? The Euro economy is such a mixed bag of basket cases (e.g. Italy) and stronger economies (e.g. Germany), that it is difficult to see how this currency will move long term, except that it will also fall against the emerging market currencies. How far is a difficult question. In the short term, it might strengthen, as the market clings on to the lifeboat of past certainties.

Returning to the original post, what happens if money starts to move out of the West into the East (and emerging markets). Whilst the early movers into these markets will retain their wealth, the movement of money out of the Western economies will precipitate currency falls. At the same time, the movement of money into the emerging markets will destroy wealth within the emerging markets, because the assets purchased with a falling currency will leave someone holding devalued currency. As such, as the money moves out, the currencies will drop ever faster....but will still manage to inflate asset prices in the emerging economies.

This means that the more that money is transferred to the emerging markets, the more that the investors will be buying into overinflated assets with ever greater sums of devaluing currency. As such, as the underlying value of the assets will not justify the prices, the value of the transferred money will in any case be destroyed in the future. The only winners will be those that buy into the assets early. They will lock in the value, even if the asset bubble bursts at a later point. However, even these assets will be at some risk because as the debt money-go-round collapses, the exporting countries will see exports fall, and therefore will suffer their own pain. As I suggested in the original post, the upside is that some of this pain will be ameliorated by having assets in a stronger currency.

All of this is to ignore the political and other risks in the emerging economies, which makes all such investments risky (e.g. what happens if the damage in the West does tip China into recession? See post on China).

As you will note, as I have mentioned in previous posts, in the current turmoil there is no safe haven, excepting possibly gold, and I have already warned one reader to make sure to look closely at the history of gold prices before jumping into that market (I have not followed gold prices such that I have a sense of where the price can or will go in the current circumstances).

The bottom line in all of this is that the correction is ongoing, and there is no real way to stop the 'wealth' destruction that was always inevitable. Only the most astute, and fastest moving in the West will manage to hold onto the current vale of their assets.

Note 2: It seems that Paulson is now pressuring other countries to follow him on his course of bailouts and that the US stockmarket suffered from falls today. The wildcard at this stage of the crisis was always going to be the question of how governments would react. Instead of addressing the underlying problems, they are trying to 'magic' them away. Such actions can only delay and, as I have pointed out many times, worsen the crisis. As such, it seems that the wildcard of government action has proven to be action to exacerbate the crisis. With such action, the situation can only go downhill.