The Crisis is Steadily Moving Towards Denouement

First of all, apologies for the lack of posts recently. I have simply not had the time to post.

Are others seeing that there is a slow and steady unwinding of the economic situation? There now appear to be signs of substantial cracks the edifice of the illusion economy. A review of the news sees several apparently unrelated stories, but nevertheless they cumulatively represent the underlying flaws in the attempts to hold back the underlying reality of the world economy.

First of all, there is the ongoing saga of Dubai, the exemplar of the worst excesses of property speculation:

Fresh fears about Dubai's ability to resolve its huge debt mountain returned to global stock markets today as shares across America, London and Europe tumbled.

In America, the leading Dow Jones industrial index fell 111.63 points to 10,278.48 at 3.40pm in New York.

Earlier today, Abdulrahman al-Saleh, Dubai's finance minister, admitted that six months may not be enough to restructure Dubai World, the state-owned conglomerate which owns Nakheel, the property developer.

It later emerged that Nakheel made first half losses of $3.65 billion, according to Bloomberg, after taking a huge writedown on the value of its land and developments. Two weeks ago, the Dubai Government asked creditors to grant Dubai World a six-month standstill on its repayments of nearly $60 billion of debt. Dubai World then announced plans to restructure $26 billion of its liabilities.

Likewise, there are the ongoing problems of Greece, perhaps an outrider for the larger Western economies. Greece presents another crack in the edifice of confidence in government debt:

The agency placed the country on credit watch negative, meaning it is likely to lose its A- rating within months. The country already has the lowest credit rating in the eurozone, but has come under greater scrutiny amid fears that its newly-elected government may avoid imposing significant cuts on the public finances

[and]

Following the recent crisis in Dubai, investors have become doubly sensitive to the risks of sovereign debt crises, with others warning that the UK is similarly exposed.

S&P also revised its outlook on Portugal’s sovereign-credit rating to “negative” from “stable”, blaming a deterioration in public finances.

As I have previously argued, if the UK falls, the US will soon follow. In the meantime, President Obama is reacting to a swathe of bad news with yet more 'stimulus' spending, at a time when the creditors to the US are already very nervous:

WASHINGTON – President Barack Obama called for a major new burst of federal spending Tuesday, aiming to jolt the wobbly economy into a stronger recovery and reduce painfully persistent double-digit unemployment.

Despite Republican criticism concerning record federal deficits, Obama said the U.S. must continue to "spend our way out of this recession" as long as so many people are out of work. More than 7 million Americans have lost their jobs since the recession began two years ago, and the jobless rate stands at 10 percent, a statistic Obama called "staggering."

Congressional approval would be required for the new spending, the amount unspecified but sure to be at least tens of billions of dollars.

This new stimulus comes on top of the news that the fiscal situation in the US is already in an absolutely appalling state:

In October and November, the government spent $292 billion more than it took in, the nonpartisan Congressional Budget Office said.

That was even worse than the same period last year, when the government was on its way to posting a record $1.4 trillion deficit for the fiscal year that ended Sept. 30.

The federal budget has been battered by the worst economic downturn since the Great Depression of the 1930s, as tax revenues have plunged and spending on safety-net programs like unemployment insurance have skyrocketed.

What we are seeing is the ongoing unwinding of the many bubbles, and that the forecasts and announcements of the end of the crisis are indeed premature (which has long been my argument). Even Bernanke is admitting that there are ongoing and deep problems, and the $US continues to decline:

The dollar resumed its slide against the yen, euro and other currencies after climbing in recent days amid hopes the US might stage a quicker-than-expected rebound.

On Monday, however, Fed Chairman Ben Bernanke said the world's largest economy was facing "formidable headwinds" — including a weak job market, cautious consumers and tight credit — that would limit the pace of recovery.

Obama expressed shock at the relentless rise in unemployment, but around the world a dire situation continues to deteriorate. This is just one example from the Times:

London traders were also unnerved by new data on industrial production, revealing flat output in October, signalling that Britain, which is still in recession, has made a weak start to the fourth quarter. The CBI also published its industrial trends survey, which showed factories expect output to fall in the coming months.

The weak data was released ahead of the Pre-Budget Report tomorrow when the Chancellor is widely expected to reduce his forecast for Britain's economic growth this year from a decline of 3.5 per cent to 4.75 per cent.

Meanwhile, European markets were unsettled by Fitch’s decision to cut Greece’s sovereign debt rating to BBB+ from A- with a negative outlook - the first time in 10 years a major ratings agency has put Greece, the eurozone's weakest economy, below an A grade. Fitch cited fiscal deterioration as the reason.

Also weighing on European stock markets was worse-than-expected German industrial production data. German industrial output fell 1.8 per cent in October, largely as a result of weaker production of machinery and cars, against expectations of 1.1 per cent growth.

As ever, the nervousness about the situation continues to be seen in the price of gold:

GOLD soared through US$1,200 (S$1,657) as investors and speculators feared renewed US dollar weakness following President Barack Obama's decision to substantially boost the war effort in Afghanistan.

Other factors that have boosted the demand are worries about quantitative easing, that is, money printing in the US and UK, punitively low interest rates for savers seeking a home, fears of renewed inflation and persistent turmoil in the Middle East.

Uncertainty in Dubai with expectations of bailouts and a general rise in oil and other commodity prices are other reasons.

There are some curiosities in the news, such as the ongoing rise in house prices in the UK. One just has to ask why house prices might be rising in a sinking economy to know that this is yet another illusion. After all, with unemployment rising, where is the money coming from? One article suggests that it is a lack of supply of houses for sale as the driver, but it is certain that the rise in prices does not reflect the real economy.

Essentially, any review of the news shows that the attempts to reflate economies with printed money and massive government borrowing are simply not working. The cash for clunkers, the massive spending on 'make work' projects are a dead end. Printing money with no economic foundation will simply not work.

The one thing that might work, the reforming of the economic structure of the troubled economies, is the one thing that is never considered. In the early days of the blog, I wrote some examples of how the UK economy might be reformed. I am not sure that the UK will be able to even afford to support the reformed economy that I proposed. It is too late. Instead of using credit to manage the transition to a more lean and competitive economy, credit has been used to try to hide the reality of the economic situation. The same might be said of other economies, such as the US.

I keep on asking how long can this continue? How long before the illusions shatter? I am amazed that it has lasted this long.

Note 1:

In an early post during the bailouts, I mentioned that all of the money given to support the UK banks was not to protect little old ladies' savings, but to support overseas creditors. This is what I had to say in a post titled 'The UK and the Silent Bank Run' (written March 2009, but I think I argued this point at the outset of the bailouts, but can not find the article):

If we think of the numbers that we are looking at, it becomes self-evident why the endless bailouts by the government are falling into a black hole. The government is having to bail out the banks to repay these overseas investors such that, as fast as the money is pumped in, it is pumped straight back out to meet the demands of overseas depositors. With the banks sitting on mountains of toxic debt, with no market left for the sales of these toxic assets, there is nowhere to turn except to the government.

It is as I have long suspected. I have always been of the view that this is not really just about bailing out little old ladies with their savings held by RBS, but also about bailing out all of the overseas investors who stand to lose so much money.

This is an article in the Telegraph:

British taxpayers stand behind more than £167bn of toxic assets in the US, Ireland, the Middle East and beyond, it has emerged as the Treasury disclosed details of what Royal Bank of Scotland has dumped in the state insurance scheme for bad debts.

Most of the £281.9bn of assets RBS has placed under taxpayer protection are based outside the UK, with loans secured against everything from negative equity properties in Dublin to hedge fund assets in Caribbean tax havens and container ships docked in ports around the world.

I suspect that this is just the tip of a very large iceberg, and the same will be found for the US. What we have witnessed is the salvation of the banks to protect overseas creditors. These were the same creditors who flooded the economies of countries like the UK and US with money, which in turn created the asset price bubbles and credit bubbles. In the case of the banking industry, it is heads I win, tails I win. It was never about protecting the small domestic depositors, but bailing out overseas investors.

Note 2:

A slightly rushed article as I am still pressed for time. However, I hope it provides some evidence that we are a long way from any real or sustainable recovery.

Banking Bailouts - Why they will help bankrupt the US and UK

Note Added 2nd October:

For visitors from the US, the example given below uses the UK. Except for some local details, the principles apply just as much to the US as the UK. Original post continues below......

I have written about the banking bailout several times, but thought that an analagy might help to clarify the reasons why I oppose all bailouts. However, rather than starting afresh I will continue on with the analogy that I used at the start of an essay that I wrote back in November, 'A Funny View of Wealth'. The analogy made at that time follows (note how at that time the common view was that the economy was a success! Hard to believe now...):

'I am going to start by looking at the world from the point of view of many modern economists. Whilst none of the economists would accept that what I am about to portray is their belief, when you look hard, you will find that this must be their basic belief. If not, then they have no justification for their pronouncements of success for the UK economy.

Imagine a family living in the UK, not an atypical family, not a typical family, but an ordinary middle class family. We will call them the Wilsons. The father has a job in management for a chain of retailers, and earns £30,000 per year. The mother has a good job in a local hotel where she is the marketing manager and earns £30,000 per year. They therefore have an income of £60,000 a year. They have two children at the local school.

The Wilsons have purchased a home, which cost them £300,000, which is five times their combined income, using a 95% mortgage. The house has increased in value by £30,000 a year, in each of the three years since they purchased it. They are very pleased to see their house growing in value, as it is like having another earner in the house, except this earner pays virtually no tax on the income, making it an even better earner than themselves.

The Wilsons have a relatively large mortgage, but interest rates are low. Despite this, they struggle to balance the quality of life that they enjoy against their income. As such, they make use of credit cards to occasionally purchase items. Each year, for three years, they have added £6000 to the family debts through overspending on the ‘little luxuries’ in life, such as holidays, and new goods for the house. At the end of the second year in the house, Mr. Wilson decided that he would fulfil his dream of owning a Mercedes, and re-mortgaged the house to realise £20,000 of the increase in value of this asset. He used this as the down payment on the car, and took a loan for £20,000 to pay for the remainder.

Overall, the Wilsons non-mortgage debt stands at £18,000 for the credit cards, and £15,000 remains of the loan for the car. They are starting to find the payments on these debts are stretching them, and they seem to be using the credit cards a bit more often than before.

Next door to the Wilsons live the Jones family. The Jones family know and respect their next door neighbours. They can see how successful they are. They are always doing something to the house, making improvements, and they seem to be living the good life. Only recently the Wilsons bought a new Mercedes and Mr. Jones feels a little jealous, as he would love a Mercedes too.

The Jones family, have less income than the Wilsons, but every year they save a few thousand pounds. They have no debt except for their mortgage, and only spend what they earn. They purchased their house at the same time as the Wilsons, and are steadily paying their mortgage. Their belts are tight, but they get by, and look forward to better days ahead.

Which of these two families is the more wealthy family?

The answer largely depends on whether you are an economist who has been a cheerleader for the boom of the last ten years, or whether you are a person grounded in the real world. The Wilsons have been the motor of growth in the Anglo-Saxon economies. Apparently we have gone through a period of sustained growth and, in moments of hubris (Gordon Brown in the UK being a wonderful example), we promote the ‘success’ of the Western economies to the rest of the world. The trouble arises when we ask a simple question; ‘Where is this growth?’'

At this moment in time, both the UK and US economy are at the stage where the Wilsons are now having trouble servicing their debts. They seems to be pouring more and more money into interest payments, and with the increase in interest payments, they are finding that they are now borrowing ever more just to stand still. The situation is even worse though, as the retailer at which the father works is now struggling. Business is so bad that they have stopped evening opening hours (e.g. in the real world there has been a reduction in shifts at car plants), which means that the income coming into the house is dropping. The hotel is doing badly too, and there are mutterings about shortened hours, or even redundancy there too. Every day that goes by, the equity in their house disappears and they will soon be going into negative equity. One evening the Wilsons look at their family balance sheet and fall into despair.....they can see that they can not afford to continue as they are and that they are sliding towards bankruptcy. Fewer and fewer lenders are willing to lend to them, and the terms of lending are getting more and more onerous.

However, even as they are despairing, there is a knock on the door. Mr. Wilson answers the door, and finds a man in a slick suit smiling at him. He is from the 'Slick and Friendly' loans corporation, and he is going door to door drumming up new lending business. For a small arrangement fee, and high interest payments, he will solve all of their problems with a lump sum loan.

Mrs. Wilson is excited, as she can now buy the new computer for her son, and Mr. Wilson can renew his membership at the golf club. The question here is; should they take the loan?

The answer is, of course, obvious. The only time they should consider such a loan is if they had certain prospects of a massive boost in their income with which to pay off the loan. As far as I am aware, not even the most blind and foolish analysts or commentators are proposing that this is the case for the US or UK economies. As such, what would we recommend for the Wilsons?

There is really only one solution. They absolutely must reduce their expenditure (no more little luxuries for a long time), and they should also look at reducing their expenditure sufficiently such that they can start to repay the principle on the loan. Only through such tough action will they be able to improve their situation in the long term, and avoid the very real risk of bankruptcy. After all, their income is dropping, and with the prospect of further falls.

I can think of no clearer way of expressing the stupidity of these bailouts. As I have said before, they are just an extension of the delusion that has collectively been gripping economists, politicians and the public alike. In short, time to face reality, and it is not going to be pleasant.

Note 1: I have come accross a very interesting paper from an economist in the US. He is suggesting the US is bankrupt. It is (painfully) gratifying to see that an academic economist 'gets it', though (as always) I wish that the pessimists like myself were wrong. The paper is not easy going, but if you can get through the maths, it is powerful material.

Note2：Why is it that perfectly rational people, who would readily advise individuals not to become too indebted, will advise that a country mired in debt should seek to solve their problems by borrowing more money? I would take a guess that Paulson and Bernanke would not recommend that the Wilsons continue to borrow. Why then do they recommend such a course of action for a national economy? It is genuinely baffling......

The Bank Carnage Begins...

Yet again there is a flood of bad news, as the problems of the economies of the West are now being laid bare.

Lehman Brothers is the the latest casualty, and Merril Lynch have jumped into the arms of safety (so they think). The result of this will be a further collapse of confidence. Read this from the Telegraph:

"We as a company are wondering where to put our money. We've had a board meeting this morning and we can't be the only ones. If you have a sizeable sum of money, where the hell would you put it?"

And this (from here):

'Jon Moulton, founder and managing partner of private-equity firm Alchemy: "These really are unprecedented days. This is not stress testing this could be testing of where the failure point lies "What we're going to see is extreme instability in the markets. These kind of things make the probability of a deep recession more likely not less likely." However he said that the publics' savings are probably safe: "Bank deposits, building society deposits it's pretty unlikely the Government's going to let people lose money on those."

To this we can add the following (from here):

'Confidence among British businesses is languishing near a record low as consumers retreat in the face of slumping house prices.'

And finally (from here):

'Investors' flight to safety saw the dollar weaken sharply against the yen, the euro and sterling, while US government bonds and gold rose. The cost to shield corporate debt from default also surged on fear the turmoil on Wall Street will tip the global economy into a recession.'

They just do not get it, that there is no place of safety in the OECD (except maybe the Yen). As I look on I wonder at these institutions, with there highly paid economists. I wonder that they still can not see what is now staring them in the face. It is really quite shocking.

I have long been predicting the economic collapse, and said that it had already started. Now is the period of acceleration. My blog has, for a long period of time, been detailing the underlying problems, as well as some long term solutions. I think regular readers will see that the situation is deteriorating according to the script that was written, and almost perfectly in line with what I have proposed will happen.

My fear at this stage is that the politicians of the UK, and the West, will not accept the hard reality of the world as it stands, a world of hyper-competition. A world in which the efficient, the clever, and the fast moving will win. As I look to the horizon, I see no politician with the vision to manage the current crisis.

For the regular readers of the blog, they will be aware that the current banking crisis will just be the prelude to the more serious collapses as a second credit crisis erupts. As ever, I yet again advise that you have several bank accounts with immediate internet access. Get ready to move your money at short notice in the next 2-3 months, but the speed of acceleration is such that it could be sooner.

I have only detailed a few items of the news. I could say a lot more, but to no avail. What I have predicted is now in progress and now, at the stage, the course of events are fixed, and now the game must play out.

I can only apologise for such gloom, but looking at the current state of affairs, I can see no silver linings. I must apologise that I have little comment to add, as I have already detailed what is to come. It would be far more exciting to present a startling new prediction, some startling new perspective, but excitement has never been my aim, just a detailing of the reality of the situation.

For those new to the blog, I suggest that you start at the beginning of the blog, in the archives, and my first post. At that point you will see how inevitable this all is. As you read through the blog, you will find all of this detailed, and the reasons why will be explained.

Note Add 16 September:

Anatole Kaletsky, the Times columnist, has now reversed his previous optimism which I highlighted to illustrate the foolishness of mainstream economic thought. He now has this to say:

'It looks as if the prophets of doom may have been right after all.'

He then goes on to say that the crisis of the moment is due to the 'punitive' measures taken by Paulson against the shareholders of Fannie Mae and Freddie Mac. His theory is that the shareholder should not have had to take the pain of the nationalisation of the institutions. It is quite extraordinary how these people are allowed to write their columns. His last column was congratulating Paulson's action for restoring confidence, but now Paulson is in the wrong?

Interestingly (and unsuprisingly for the regular readers of this blog), there was an article in the Telegraph asking the question of how safe is money in UK banks. The conclusion of the article is far too optimistic, but the fact that the question is being raised speaks volumes. The article does not even consider any of the large banks being at risk, but there is no surprise there either. It is clear that the columnists seem to have a unique talent for wisdom in hindsight.

On an unrelated subject, I thought I would just reiterate why I wrote this blog. It is largely because I could see the current crisis coming, and I could see the complacency of the mainstream economists, and alslo the complacency of the politicians. As each month goes by, it seems that my understanding of the situation is proven to be more accurate than that of the mainstream. Whilst it is always gratifying to be proven right, I had hoped to be proven wrong. I do not want to see the UK, and the West, fall from the heights. It is for this reason that I have written articles on structural reform. I would like to see the West recover from the current disaster, but could see no answers coming forward for how this would be achieved. I hope that my ideas have greater credibility if only from the principle that, if you can demonstrate a genuine understanding of the problem, the solution that is proposed is more likely to be correct.

I had also hoped that this blog would prove to be very successful (by which I mean gaining a large readership). As it is, according to my website statistics, I have a large number of regular readers. I have avoided using my name in the Blog as I do not want to be well known. My purpose is to try to change the views of my readers, and in particular to try to prepare people for the changes that are necessary. Whilst I am grateful for my regular readership taking the trouble to read my thoughts, it is sadly still not enough. I have emphasised that we need to reform sooner rather than later. We need to start now.

As such, if you are one of the regular readers, then I would ask that you do something for me. I would like you to forward the address of the site to five people that you know. If you think that I have an accurate understanding of the situation, and you think that I am presenting some workable solutions, then the more people that are aware of these ideas, the greater the chance that people will be ready to accept the hard solutions. If you wish to do so, send the links of what you believe are the most pertinent posts, and hopefully those you recommend this blog to will also be persuaded of the reality of the situation, and the necessity for change.

Once again, sorry for such a gloomy post, but I am really not pleased to see the direction of the economy, even though it is exactly as expected.

Fannie Mae and Freddie Mac - What does it mean?

Note added 9 September:

The Times columnist, Anatole Kaletsky, has this to say about Freddie Mac and Fannie Mae:

'Anyone betting against this package is, therefore, betting that the US economy is doomed to irreversible and inevitable decline. Such a bet has always been wrong in the past and is likely to be wrong again this time. So Sunday's probably was the Big One - and a US economic recovery is now assured.'

As will be seen below, I am not so optimistic. The idea that the biggest government intervention in history is seen as a 'good thing' suggests that the markets themselves (a curious metonymy, like they have agency?) have lost faith in themselves and the economies that they constitute.

Original post continues.......

A very quick post on the nationalisation of Fannie Mae and Freddie Mac. There appear to be very positive responses to the US government nationalisation of these institutions.

The first point to note here is that this will help the battered balance sheets of the UK banks, as many of them hold debt issued by these institutions. This is good news for the UK banking system. However, having seen the positive, it is worth considering the negative. If these two institutions were in so much trouble due to the collapse in the US housing market, what of the UK institutions?

I have often predicted runs on some of the major UK banks in the coming months, and the saga of Fannie Mae and Freddie Mac just continues to confirm my worst fears. The recent headlines do not mention that one of the problems for these institutions was that they were indirectly buying into the US sub-prime market, but the big question today is one of how you might define sub-prime. My own view is that, with a collapsing housing market and rising unemployment, there is an awful lot of sub-prime out there. However, in the case of the UK banking system, unlike the US mortgage giants, the UK lenders will be exposed to huge amounts of souring consumer credit, as well as souring commercial lending.

The big question this raises is to where it might be that the UK banks might be able to raise the finance to shore up their balance sheets. For a while, sovereign wealth funds looked like one option. However, as is reported in the Economist, they have already had their fingers burnt in the banking market, and are unlikely to come back for more pain. The Economist suggestst that. perhaps, private equity will come to the rescue, but this appears to be a forlorn hope. One has to ask why they would take on such risk.

The reality is that the UK has been bailing out the banks for some while, through the special liquidity schemes. How long can this go on?

The other problem that arises is illustrated by the US example. The US government has taken on huge liabilities meaning that, one way or another, the US taxpayer is going to pick up the bill for the problems in Fannie Mae and Freddie Mac. It is worth being 100% clear on what that means. It means that the productive parts of the economy will be picking up the bill for the financial disaster. In other words the problems of Fannie Mae and Freddie Mac will hobble the productive part of the US economy.

As the US government is aware, the collapse of the mortgage giants would have seen a systemic crisis in the whole banking system, in both the US and the OECD. They have chosen not to have the crisis. Is this a good thing?

I will confess to, for once, being unsure. On the one hand I can game out the consequences of the collapse of the institutions, and can see the financial meltdown that would follow. On the other hand there is the reality that this would create the rebalancing of the world economy faster, creating the opportunity for the OECD to make the necessary structural reforms to compete with the emerging economies. In other words, I wonder whether this is not a case of prolonging the agony? It returns to the analogy I made in a previous post about falling from a height, or climbing down a ladder.

In the case of the UK, I wonder whether the UK government will have the financial wherewithal to actually have a choice in the matter. When the next credit crisis strikes, I expect confidence in the UK economy to be at a very, very low point, and the only way the government will be able to finance the bail outs will be through 'printing' money, with all of the negative consequences that entails.

It will be interesting to watch the reaction to the nationalisation in the coming weeks. I suspect there will be a brief bounce in confidence, but that the underlying economic problems will quickly dent that confidence. The trouble is that there is no escaping the reality that there must be a massive rebalancing in the world economy, and no amount of intervention can stop that process. In such circumstances, it is quite possible that, in the long term, such bailouts will only create more pain than gain.

For the UK, perhaps bailing out the two mortgage giants may delay the next credit crisis for a few months, but nothing more than that.....and the longer the delay, the worse the crisis that will follow.