Interesting Times

Coalescing at this moment are several factors. We are seeing the damage wrought by excessive easy credit since the tech bust in 2000. Consumers are facing very high inflation and energy prices. (We list inflation and energy prices separately because the latter are frequently removed from inflation calculations). Ethanol inebriation is lining the pockets of big business while driving food prices upward. For the first time in the mechanized age the world has out eaten its grain production. This grain saving deficit has been with us for three years and may be largely due to biofuel production. The third and perhaps largest coalescing entity is the major war that has been in planning for the last half century.

A market correction was urgently needed after the tech bubble burst in 2000. Contributing to the size of the tech bubble was a vast amount of money spent on Y2K augmentation. The reality of the magnitude of the needed downturn was obscured by the events of September 11. At that time crude oil was about $20 dollars a barrel, today it’s nudging $78. Rather than allow a significant market adjustment central banks all over the world dropped interest rates encouraging a “Monty Pythonesque” kind of borrowing. A defacto couple employed as a fry cook in a diner and a second understudy for the role of a tree in “Munchkins On Ice” could borrow $450,000 for a townhouse. Easy additional credit allowed them to furnish the house based on a supposed increase in the value of said property. Large numbers of loans like this were issued with no insurance. They have become known as “Sub Prime” mortgages. Not all mortgages are sub prime; many do not represent such high risk.

It is estimated that 5 trillion dollars was released into the American economy as a result of this escapade into easy credit. $250,000,000,000 of this began to circulate in the day-to-day business world. Think carefully about this. A quarter of a trillion debt-based dollars are pumped into an economy that urgently requires a downward correction. This is money that would otherwise not have been there. A party ensued. This additional liquidity went a long way to deflecting the attention of the average citizen from pondering the cost of the Iraq war. This war cost will soon hit one trillion dollars, it will double that before it is over.

Sub Prime

Hmmm, what’s in a name? Tell me, dear reader; does the name “Sub Prime” fill you with confidence? Apply it to other aspects of life: Sub Prime tuna? Sub Prime seat belts? Sub Prime holiday? Sub Prime hotel accommodation? Sub Prime halftime show?

Who in their right mind would sell anything sub prime? Who would be stupid enough to buy it?

In simple terms mortgage lenders bundle their mortgages together in packages. These are sold to well-cashed funds. Many of these funds are unregulated hedge funds. These bundled together mortgages are sold as CDO’s (Collateralized Debt Obligations). Mortgage and hedge funds group CDO’s into tranches (Tiers or Classes). They pay returns on profit made by debt repayments to these funds.

The ratings agencies contribute to this cycle by applying an AAA rating to funds comprised of a group of A rated funds. It is assumed that an AAA fund may suffer the failure of one or two of its components but the rest will remain strong. This may prove to be a less than wise approach.

All of this works nicely while people continue to pay their debts. We must learn that lending institutions have their own “f” word. All businesses relying on liquidity in the mortgage market hesitate to use it. Only desperadoes and low-lifes can utter it. Never must it migrate from the gutter to the boardroom and never must the common man include it in his vocabulary. Today, the beast has escaped. Foreclosure is everywhere.

Significant anxiety in the mortgage market was visible in early 2006 when I wrote “Big Debt and Beads of Sweat”. In 2007 interest rates on many Sub Prime mortgages began to reset upwards. Several major funds have begun to feel the heat. Bear Stearns recent trouble was a small foretaste of the things to come. Two of their bottom end funds have collapsed. The lowest fund is now worth nothing, zero, nada, zip, ziltch. The second lowest is worth about nine cents on the dollar. We are now regularly reading of funds that are either collapsing or suspending redemptions on their lower grade products. Almost every time you open a financial publication today you read about increasing foreclosures and distressed funds. The imminent danger to you and I is that many of these funds will use their prime investment money to support sub prime related CDO’s.

The spin doctors are telling us that sub prime troubles will not affect other funds, Alt-A Mortgage funds are secure, this situation will not enter the broader economy and that corporate credit will not be limited. They are lying and they know it.

The GDP Shibboleth

... then they would say to him, “Then say, ‘Shibboleth’!” And he would say, “Sibboleth,” for he could not pronounce it right. Then they would take him and kill him at the fords of the Jordan. Judges 12:6

GDP is one the Shibboleths of the day. Let’s assume you and your neighbor find yourselves locked in a legal dispute in 2008. Your family GDP in 2007 was $200,000 dollars. (GDP being loosely defined as the total of all trade carried out by your family in that period). Your 2008 conflict with your neighbor costs you $120,000 dollars in legal fees. The legal fees produced nothing yet added to your GDP. Using the government’s model your 2008 GDP would actually be $320,000. In all your GDP would increase but your family will fall behind. A case in point is the boost in GPD attributed to Alaska in the wake of the Exxon Valdez cleanup. GDP went up but the state fell behind.

War is the biggest GDP booster of all. The horrendous cost is carried by the taxpayer and accounted as increased Gross Domestic Product. That money, all debt driven, also filtered into the US Economy. (The same on a different scale is happening in the UK among many others.) We are not suggesting that war is the only engine of growth in the US. In July 2007 residential construction was responsible for 5% of GDP.

In summary easy credit in the last few years coupled with war spending has dosed up the US economy with excess liquidity. We have been told that our various economies are strong based on GPD which in turn is largely energized by war.

The “One T Turnaround”

During the Reagan era a group of contractors believed they could build the Star Wars defense system. I recall watching a science show on the topic when a spokesman stated that the project could succeed if the President would provide a “T Dollar”. That’s what he called it. He wanted a trillion dollars ($1,000,000,000,000). How could that happen? Who would ever have that much money in one place I thought? That was then, this is now. Our manufacturer in chief, China is sitting on more than that today (1.2T$).

Recently US officials asked the Chinese to buy more treasury bonds to prop up the ailing mortgage industry. As the Chinese buy government and private bonds, US money is returned which can then be loaned to buy more stuff from the Chinese who will buy more bonds etc.

Bathing The Chinese?

Something big is coming. There are two ways to control the impact of the trillions of dollars held by the Chinese, Japanese, South Koreans, Taiwanese and Indians. One is to let it all continue as it is. The USD will continue to slide while the other currencies appreciate together. This will gradually shut down trade and force western countries addicted to easy credit and cheap goods to revitalize manufacturing. This process is not underway today as we are still buying cheap imports by the truckload. There is no stomach for this as Free Trade is still the order of the day.

The second approach is to collapse the USD and drive the planet into crisis. The rapid collapse of the USD would cause the Chinese to take a bath. It is not only foreign trading partners who would take a loss, the homeland would enter Weimar times. Savings would be wiped out. The result of this would require the issuing of a new currency. This would set the stage for a North American style-trading block. Considering this, the open borders policy with Mexico is no mystery.

Portents Of The Demise Of The USD

The Saudis, according to former “Economic Hitman” John Perkins have agreed they would only sell oil in US Dollars. This gave them protection and access to key petrochemical technology. Other countries are not so forthcoming. Iraq under Saddam refused this and Iran has recently begun its multi currency bourse. While this does not benefit Americans and those nations tied solely to the US Dollar it is a windfall for any giant corporation or bank doing multicurrency trading. It is strangely ironic that Western businesses built on the back of a strong dollar can now benefit dramatically from its decline. Perkins astutely comments that we have moved from the gold standard to the oil standard. While the Saudis commitment to trading oil in the USD only remains, Iran and other Gulf states are now accepting other currencies.

The USD is devaluing rapidly. Last year the east coast was awash with British tourists buying up the bargains. (By bargains we mean cheap stuff imported from China.) In early July it was suggested that the Canadian dollar would actually achieve parity with the USD and other currencies are showing similar trends.

But, But, But The Stock Market

Allow me to quote Richard Daugherty here: “Investors are borrowing record sums of money to finance trades on the New York Stock Exchange.” …. How much money? The Journal continues, “So-called margin debt, a broad measure of leverage, jumped 11% to $353 billion at the NYSE in May, up from nearly $318 billion in April.”

The stock market does appear to be flying high and all is not what it seems.

Following is a quote from economist Robert J Samuelson in an article on the Great Depression “There had been warnings. Many commentators complained before the crash that the market was driven by speculation. A lot of stock was bought on credit. Between the end of 1927 and October 1929, loans to brokers rose 92 percent. At the start of October, loans equaled nearly a fifth of the value of all stocks.

A real estate boom not unlike our own occurred prior to the great depression. It centered on Florida while the current bubble is global. The current bubble is driving a great deal of cash toward the stock market. Put simply the above mentioned five trillion dollars eventually ends up in the hands of the traders. It is further curious that the German stock market went wild through most of the Weimar hyperinflation period. Pay attention to the parallels!

What To Look For?

Some have attempted to recalculate today’s numbers against 1990 criteria. John Williams from Shadow Stats is one example. He is not alone. There seems to be a general feeling among ‘recalculators’ that we are in a global recession today. They are suggesting that the US M3 money supply is growing at about 12%. The M3 supply in Australia is reported to be growing at a whopping 14%. The point here is that the M3 money supply may not be the best indicator of inflation but it should not be ignored. For more than a year there has been no US M3 money supply data published. It would seem that the downward trend has a long way to go. The US economy will lead the way.

Specific events to watch for are:

* The failure of many funds, hedge funds will collapse drawing others with them. We are hearing guarded comments that it may be common practice for many big funds to be paying CDO redemptions and other obligations from more traditional reserves. By traditional we mean superannuation and long-term savings. We dread the possibility. * Bank Failures * Watch for a continued drop in housing prices. Excess inventories caused by over construction and increasing foreclosures will bloat the size of the glut and produce deflation in this market. * Retail businesses tied to the housing industry will slow down taking others with them * Businesses serving the lower end of the luxury market will be impacted. * The trillions of dollars held by China etc will be used to buy up local resources, businesses and mining rights. If the USD plummets rapidly Chinese money will be used in panic buys. We are already seeing farms in the Midwest going to Asian owners at fantastic prices. * Price inflation followed by deflation in key markets leading to an admission that most Western countries have been in recession for about 2 years * Depression * War

The Question Is

Do you wish you had never read this article?