Wednesday, July 04, 2007

A Liquidity Nightmare: Drowning On Cash

also published on:

The Facts Or The "Con" In Con-Game:

In 2005, Stephen King, managing director of economics at HSBC and also a columnist for the news site stated that there was a crisis of faith among central bankers. Two years later, we can see why this confession should have read as: central bankers must stick to their pseudo-religious tones to proliferate public delusions of invincibility.

On the American front, the worst is yet to come for the housing market declared a quite famous Keynesian and Clinton' s economic advisor Nouriel Roubini. The subprime mess is so far bottomless and many expect more debt liquidation to work through the system. There were about 800 billion of loans that were given to people with bad or limited credit histories. Millions of people have yet to discover in the mail that their mortgage has gone up 40-50%. Some have gotten loans with so-called teaser rates of 1%. Those have seen their monthly payments too quadruple recently. Houses prices will have to go down. Because it is the housing market that sustained the whole economy and it will ripple through.

We're not talking of a small recession here. It is perfectly reasonable to forecast a 50-70% drop at this stage! History repeats itself. A Bloomberg headline speaks of an upcoming "bloodbath". The primary cause of the early 1990's recession was a real estate boom that turned bad due to speculative buying and lower credit standards. The problem is that this time it will be a lot more devastating. It is the worst housing market since the depression says Mr. Butler who oversees the trading desk and operations for over 12,000 individual and corporate clients, both in the United States and abroad at EverBank World Markets. As if it weren't enough, a big wig at the Credit Suisse stated that the "housing chain" is endangered. As to wonder whether he was referring to a "chain letter". To be fair, some are less alarmists but still foresee a widely disperse pain for the next few quarters. In its two page article "Bubble Mania In China" put on the net as of May 29. 2007, Wachovia's analysts stated that:

Since psychology has become more important that
fundamentals, we need to ask what would dampen
Chinese enthusiasm and confidence - after all
confidence is the "con" in con-game
Alas this definition couldn't be more appropriate since the Chinese stock market went up 400% from January 2006. If you think this is hysterical, wait there is more: a pattern of appalling confidence exposed by the USAtoday stating that the amount of government debt is equal to $516,348 for every U.S. household, while by comparison, U.S. households owe an average of $112,043 for mortgages, car loans, credit cards and all other debt combined. A grand total that is a little bit more than 628,000 dollars! So when the Chinese and even Japanese will realize the futility of keeping their USDs, one of the most popular doomsday scenario will play out. A Forbes columnist confirms that China accumulated $20Bn of dollar-based reserve monthly and without its sweatshops the country cannot export profit margins already under pressure. As a result we should expect more dollar reserve accumulation says a JP Morgan analysis. For how long exactly? Musical chair games are not ever lasting. Some nations are already scaling back and diversifying. Which is why the Euro has gained value against the USD. But a growing number of economists lean toward the end of the "world dollarization" whose effects will be devastating.

The carnival of debt goes beyond the U.S: at the other end of the world, Australians owe a staggering $160 -and counting-for every $100 of disposable income. Reserve Bank figures show that families are now siphoning a record 12 per cent of their disposable incomes to cope with interest payments. Closer, in the UK, the warnings have followed one another for about at least 5 years. The latest one (31st May) was as dramatic as the previous ones: Britons are edging ever nearer to a debt nightmare. According to the Registry Trust, up to a million households will face court action over their debts this year. On the Old Contient, the situation is truly appalling: Europe's Credit Bubble More Dangerous Than China's

And it is not all: a columnist (working for and whose articles are definitely a must read in my view) explains why a $12 trillion monster threatens globalization. He has interviewed a London-based global head of currency research at Morgan Stanley tells us to expect our doom by 2015 (this dealine is much too optmistic in my view). 12Tn is the current size of the U.S. economy, and it could create interesting problems for the world economy.

Having gotten themselves into an untenable situation, Asian governments are mulling how to use the money.
Let's just hope they do it wisely and carefully. Nothing less
than the future of globalization may hang in the balance.

Considering our global hyper-leveraged environment this is all would help detonate very likely the credit derivatives bubble on the Old Continent, which a financial Times journalist summarized here. The buy low, sell high insurance risk against defaults is what derivatives are in a few words. Economists regard the current situation as a Ponzi scheme, derived from an infamous conman in early 20th century, and whose scheme eventually collapsed. This would also be enough to send tremors throughout the system. With the American consumers behaving like spending robots running out of steam, it wouldn't be wise to bet on what seems "an ever lasting prosperity". In fact the USD has already lost 30% against all major currencies. Pundits who watch the sputtering housing boom (read: the beginning of the end) still believe in a recovery some time later this year or early 2008. But if the currency has already lost 30%, since its 2002 peak, it means that 1,000,000 condo is now 700,000 worth bucks. Many currency traders see the dollar lose another 10-15% before it stabilizes. Stabilization is the word to sustain con-fidence of course. This very extremely bad news: it will backfire and may prompt the US debt holders to dump their (worthless) dollars as more investors begin to do the same at record pace. The cynicism of this ugly tale is that there isn't one single major currency that is worth investing in it anymore. We are awash with liquidity, not wealth... awash with debts!

The planet is a debt neutron bomb, which was engineered by people thinking they can get rich by just embracing endless speculation while the masses mesmerized by their success have come to believe that "saving" was an obsolete concept. The big squeeze of the world consumers along with the sweatshops' exploitation have led to the birth of highly creative financial instruments never seen before.

Now one really has to wonder why the Democrats are in the hurry to raise the minimum wage standing now at $5,15 and which is scheduled to rise in 3 steps up to $7,25 an hour as of mid-2009. Considering the awful economic big picture, after the complete demise the plan surely would make more sense since at least 40% of the population will be without a job. CEOs will surely appreciate to have 2 employees for the price of one. Yep, dear readers, this is the harsh reality which is going to replace the rosy scenario that has played out so far. Look closer: this wage increase sounds like the beginning of communism. The ever profit seekers called corporation executives could easily be tempted to extend this new law whenever they see it fit and the 40% would quickly ten become 50... 60%? And when this time comes, many are going to finally understand the hoax behind such "socialist intention" and so-called tax-cuts. There never was any real tax-cut by the way. Like so many other things in the world where con-fidence has taken over the rules of Knowledge: it is a myth. Tax-cut was in fact replaced with inflationary pressures caused by a government whose budget is definitely out of control since 9-11. Deficit spending has a price and soon the bill will come due. This time we cannot ask the next generation to hold the bag.

How grave is it? Let's summarize the latest Greenspan's comment. He said that there was very little risk (if none at all) to see China dump the US treasuries because there wasn't any buyer out there. With nearly 60 trillion liabilities and the need to sell $2.5BN of debt daily to stay afloat, there are at least 70% of all the banknotes printed by the Federal Reserve abroad, held by central banks for the most part. Since the dotcom crash the same central banks were driven to buy the US dollars to support the world boom, so the countries they manage could also profit. This is what does currency hegemony. If the world currency is deadly inflated, the others must do the same to avoid a recession and/ or remain competitive. Japan is the most blatant example in the sense that the yen must remain cheaper than the greenback to remain productive. But as we now can see with the plunging dollar, that strategy was doomed since the start. At least Greenspan admits:

"We cannot continue this rate of growth in
China and the Third World. This cannot
continue indefinitely," Greenspan said in a
speech. "Some of these price/earnings
ratios are discounting nirvana."

As usual such a warning comes too late. Cheap money has a curse: it gives an impression of wealth while it discourages or gobbles savings. And fatally when the cycle has played out, we have a recession or worst a depression.

Have you noticed the aggressive trade mood between America and China lately? The red hot Chinese economy was fed with easy electronic money all the way long, and with the participation of the US consumers maxing out their credit cards or morphing their houses/condos into ATM machines. But now with the housing bust that has begun this year (and which is already affecting the wallets of so many) protectionism has become a daily preoccupation. You will not hear on TV what is the real cause of the tensions. The truth is that the Sino-US marriage of convenience is breaking up as the US households' willingness to borrow and spend gets exhausted. It is not without a reason that the instruments against defaults called "derivatives" have risen 24 percent in the first quarter to a record $533 trillion, BIS said as of June 10, 2007. Considering the state of the world economy, the problem is that those derivatives have been insuring "junk" for quite a while.

Yes for junk, you read well and if you've got difficulties to get the full picture, Steven Pearlstein has written a useful article about the current equity takeover, which depicts how to get filthy rich in 'Wall Street Paradise'. High valuations driven by cheap debt reached a new level. Although it is hard to see why one would buy a firm 10 times (or more) its generating profits, on Wall Street it is now accepted as conventional wisdom. Pearlstein agrees that predicting when the magic will end is kind of tricky. The expansion of America and the rest of the world were based on the delusion. In the developing countries too borrowing went without any restraint, $900bn between 2005-07. The moment of convergence is fast approaching and when that happens, we'll see an alignment of dominoes fall one by one.

As if it weren't enough, the Dutch bank ABN fears a global housing crash, citing the soaring borrowing costs, which could spark a housing slump on a 'global scale'. To add to the infamy, early June The Bank for International Settlements - BIS - made the same comment about the corporate section, sending a dire warning: the current takeover boom across the world is being funded by ever greater levels of debt, storing up trouble should rising inflation lead to a sharp rise in interest rates. But that was nearly two weeks ago or so. Since then, on June 25 more precisely, BIS sent another chilling reminder:

...years of loose monetary policy has fueled a
dangerouscredit bubble, leaving the global economy
more vulnerable to another 1930s-style slump than
generally understood... BIS pointed to a confluence
a worrying signs, citing mass issuance of new-fangled
credit instruments, soaring levels of household debt,
extreme appetite for risk shown by investors, and
entrenched imbalances in the world currency system...

According to 'Implode-O-meter' 86 major U.S. lenders have gone under as of June 22, 2007. Until yesterday only middle and small size lenders were concerned, so many wouldn't take the anti-bubble crowd seriously. The collapse of a first B-I-G domino such as Bear Stearns left many speechless. Once again one could read more about this dramatic event on the Net than in the printed news. The first day after the fund's demise, the rumor of a bailout circulated like a wild fire. Should this option go ahead, it would be the largest since Long-Term Capital Management LP that received $3.5 billion from 14 lenders in 1998. Cynically speaking, inflation adjusted the Stearns' bailout is still a lot cheaper. Never mind, Wallstreeters continue to play their favorite musical chair game, turning a blind eye to the warnings concerning the hedge funds that have been labeled "unregulated businesses" which desperately need oversight. Last May 03, 2007, even the New York Federal Reserve warned that hedge funds pose a great risk.

Qui bono? Who benefits? ... Follow the money as usual: Piggybacking' roils credit industry, corruption running deep within lending industry. Sure, there will always be consumers trying to get a free ride but if freebies must be paid by the entire nation, then we have a serious problem and have to admit that President Andrew Jacskon was right when opposing and shutting down the 2nd National Bank in 1833. How About going back to the gold standard as congressman Ron Paul recommends?

Philosophical Insight:
Hope is a vain word. Unless followed by actions, hopes never come true. Hope is the ecstasy of masses and this is why big changes all go through social disruptions. Daydreams and reality often - if not always - reveal a great disconnect capable of shattering everything. The "Axioms of Freedom" come down to "no force and no fraud". The primary nemesis is group thinking and pejoratively "herd mentality". Controlling the money supply means controlling these "herds". This is how societies have been working since ever, and this at every level you look at. From the stock market gamblers and brokers to the powerful lobbies and smaller communities. Here is a pertinent question: could you name one government program that has been successful? If you have any hesitation, please go back to the page one of this essay and reread it very slowly. Whatever your culture and the country you live in "group thinking" has nothing to offer but the same diatribes. The "group" requires everybody to agree constantly to survive. And this is collectivism in its most subtle form. This is the very nature of lobbying. Lobbies are punished, financed or rewarded depending on the issues. That is what power is all about and why (any kind of) war is a government program. This is nothing less than fights between "herds". Much of the misery in this world is man-made. Sure, free association is allowed but if we do not learn that the "group" has only a very limited power in itself, we'll ever be able to work toward the betterment of society. This is something that the Founding Fathers of America had well understood. They drafted the U.S Constitution in that way, to make sure that the powers-that-be remain controllable.

Recommended reading:
FREE-EBOOK: What Has Government Done To Our Money?