Tuesday, June 7, 2011

What Will We Call It? Maybe the The Great Default.

If you ask me, there's a growing sense that this time around it's different.  There is an odd expectation that we've come to the end of our economic road.  It's as though between Europe, Japan, and the USA that we've kicked the debt can as far as we can get away with. 

Like the story of the Emperor's Cloths there's no denying that the obligations of so many nations are too large to think they can be met.  There's no believable logical plan that squares away the liabilities using realistic revenue and growth projections.  I think the experts know it and most ordinary people, without any economic or accounting knowledge and just plain common sense, know it too.

Recently Moody's stated publicly that schemes being considered to "modify" Greece's debt would constitute a "default."  It reminded me of the expression, "putting lipstick on a pig."  There's just no denying the pig. 

The debt problems around the world are like a tinder box ready to be ignited by a spark - an event that causes the world to declare one debtor nation in default.  The flames of default will be fanned from the PIIGS to Japan, burning a giant path of financial destruction.  It would be an event for the record books. What shall we call this historic economic catastrophe?  Surely the Great Recession is to weak, and besides, that was declared over.  While it may technically be a "Double Dip" that hardly seems a sufficient or worthy monicker. There was WWI and WWII so maybe labeling it The Great Depression II is appropriate.  I kinda like the idea of calling it what it will be, The Great Default.

The part that's confusing is that while everyone's insolvent, we have different mechanisms for forestalling the seemingly inevitable. In the USA, congress can spend money that it doesn't have by telling the Treasury, which is like America's banker, to just lend it the money (as long as congress let's them) and the Federal Reserve can print (I'd like to say "out of thin air") all the money it needs to buy the Treasury's debt and thus fund the government.  Whereas, in the case of Greece and other insolvent Euro countries they have to borrow from responsible bankers who follow rigid guidelines and formulas to calculate and limit how much a country can afford to borrow.  And, after they've effectively lent the country that amount the bankers then proceed to make up ways to let the countries borrow many fold more than the country can ever hope to repay.  The mechanisms are different but in the end it is the same story of ridiculous unsustainable debt. 

There is lies the $64 trillion dollar question.  When does sustainable debt become unsustainable?  We've gotten away with unsustainable debt for so long that the phrase is becoming an oxymoron.  (Pause to think about that one.)

Maybe not.  Maybe the reckoning I've blogged about (and emailed about before I discovered blogging) and that real economists and writers have written about is finally and inexorably at our doorstep. Gosh I hope not!  Just because I write about it doesn't mean I want it to happen.  Frankly it scares the heck out of me! 

But back to the purpose of this post.  I'm looking for a name.  What will we all call this historic collapse of world debt?  Again, I say call it what it is.  After all, if our failure to face financial realities is largely what got us all in this mess, then it seems proper to begin to solve our problems by admitting to ourselves and everyone the insolvent entities we've become.  As such, the most suitable name for the event that marks our coming awareness of this historic moment is The Great Default. 

The thing about a default is that the debts go away, but the debtors and creditors do not. Portugal, Ireland, Italy, and Greece are not going away.  Neither is Belgium, Sweden, Denmark, Spain, Japan, or the USA.  Assets can be shifted around, but countries can't be.  So what are Germany and France going to do when Greece defaults?  Recently economist Andrew Lilico wrote an article that appeared in The Telegraph, and which I've linked to, entitled "What will happen when Greece Defaults."  Andrew's article is a succinct blow-by-blow rundown of the way you'd think the dominoes should fall and while I agree with him we all know that things seldom go exactly according to plan. 

I wonder if any self-respecting and reputable economist has conjectured in a readable white paper the way it might play out if what I've dubbed The Great Default where to happen, say next week or so?  If one of my few but highly worldly and intelligent readers (brown nosing blog style) has come across such a document please direct me to it in a comment to this post..

It seems to me that the Great Default may play out a bit like a game of Monopoly that the players don't want to end.  When I was a kid we used to play that game quite a bit at my friend Seth's house.  In our little make believe world of high finance "The Banker" would just dole out more money.  This would happen until the Bank was out of money because the one of us with all the money never wanted to give their money back to the bank.  I'd have to agree that he analogy between a played out game of Monopoly and the world's debt crisis is an over simplification.   By the same token, there is a natural yearning to find a simple way out of the mess we've gotten ourselves in.

Why the yearning?  To answer this question I return the point I made above about why I hope I am wrong about the need to call this The Great Default or any other thing.  The yearning for a simple solution is because the thought of it really happening it terribly frightening!  If we look past the mechanics of the economics and consider the likely social and individual consequences, the realities that matter the most on a human scale are very hard to think about.

Ultimately, if you're an optimist like me, you have to believe that we'll work our way out of this and come out the other end stronger for it.  So I am sure we'll find a way to kick the can over the wall and find ourselves on whole new open stretch of road to go down! 

Saturday, June 4, 2011

The Suspense Is Killing Us

The economists were looking for 180K new jobs in May and even that was revised lower from a much higher number.  We got 54K!!  Now the debate and fear is whether the economy just reversed from growth on our way to a "double dip" recession.  It could be reversing in a very big way and if it does we have congress and President to thank for spoiling a good thing we've all been calling a recovery. Politicians in Washington are playing political chicken over the debt ceiling and deficit and the suspense is going to kill us before the crash does.

Some blame rising commodity prices for the economic slow down.  Oil prices and commodity prices are no doubt putting a strain on both businesses and consumers.  Rising commodities have more to do with speculation that supply & demand.  Does anyone really believe that oil went from $70.00 a barrel to $115.00 because in the last 6 months we used so much more of it?  Seriously!  While inflation is a concern, I share Bernanke's opinion that it's transitory.  If you look back a few posts in this blog I've already addressed my view on inflation and why I don't believe it's all bad.  The reason the jobs and other economic data have just recently indicated that the economy is on the skids is because everyone put on the brakes for fear that we're going broke. What's new?  The USA is broke. Not only is the USA broke, so is most of Europe and the civilized world. Being broke is nothing new and fortunately even that issue is not the problem TODAY!  The problem today, the problem that produced the horrendous jobs report in May is all the fear that congress is stirring up because they can't do their dam jobs!

The problem is that delays in taking serious action on the deficit/debt and raising the debt ceiling have frozen the leaders of capitalism.  CEO's, CFO's, and entrepreneurs across the USA are sending a loud message to congress - fix the f'n problem!!  With literally what could be weeks before financial Armageddon what company wants to hire new workers or add inventory?!     

Fortunately there is a solution.  Unfortunately, the solution runs contrary to what you and I were taught when we grew up.  You and I have been taught that money does NOT grow on trees.  We been taught that money doesn't come out of thin air either.  Well, we've been taught wrong!  Last time I looked dollars and euros were made with material that comes from trees.  And, the really large amounts of money are transferred on computers which is about as close as you can come to thin air.  But seriously,  the reason our economy hasn't already reverted to a time when we traded animal skins for meat carcasses is the because of the greatest invention since the wheel - currency.  Currency in common denominations that flows easily across hands and across seas enables economies around the world! 

For a period of time the conventional wisdom was that currency, being worthless paper, had to be "backed" by something with more intrinsic value - Gold & Silver.  Those days are long gone and all that really backs currency today is "faith" and credibility.  So for the sake of brevity can we simply say that a worthless country has worthless currency. 

Hopefully you're with me on my next point.  America and Europe are not worthless.  Granted there are some serious questions about credibility, but I wouldn't call any of us worthless.

We're not worthless and the real reason the economy did a 180 degree reversal in May is because of the growing concern in the world of business & finance that the folks with the printing presses in the USA and Europe have all decided that there's too much currency floating around and they're afraid to print more of it.  The inflation hawks aren't willing to move a few more trillion dollars into the economy for fear that it will devalue the currency and thus create inflation. HELLO!  Have you considered the alternative??!!  If you really want to "control inflation" and see some major devaluing don't raise the debt ceiling!  You ain't seen devaluing till the market digests that idea!  If that happens we really will be back to bartering because we'll all be out of work. 

The economy needs more money circulating, not less!  Negative inflation is still a bigger threat to our economy than inflation.  Try to sell your house!  Or maybe we should ask the 18% unemployed and under-employed if they think the economy is too robust and needs more tightening.  The inflation hawk cries look at hirer oil prices.  To that person I say buy a new car with a 1.9% rate car loan and replace your 10 year old car that get's 19 miles to the gallon with a new safer and better quality car that gets 30+ miles to the gallon and then come show me your gas bill compared to last month.  In addition to reducing your net cost of transportation you'll also be helping the economy!  To the hawk who points to the huge increase in the cost of cotton I say have you shopped at Kohl's lately?!  You can practically buy a whole wardrobe for $500.00.  To the person who complains about food prices I say split a dinner at a your favorite Italian restaurant where the portions are large enough for two anyway.  Inflation is not the problem we are afraid it is.

What we need is for Washington please stop playing political chicken over taxes and spending cuts because you're about to crash into one another and kill us all.  Republicans and democrats are playing political chicken in order to get the positions they want going into the 2012 election.  Most games of chicken end without a crash because there is at least one chicken. And all the chickens in Washington better shift their focus from their own party's political survival to the survival of the world's financial system.  We are getting to the point where none of the chickens or all us barnyard animals will live to see the next election if they don't do so very very soon!! 

It's time for both republicans and democrats to veer off and announce a plan that combines fiscal austerity with more reckless borrowing and spending.  How's that for an oxymoron.  It is moronic because ultimately only a moron can think that the government can afford to cut the deficit to zero by August.  Nor can we survive without more monetary stimulus to offset the fiscal austerity that really is needed.  It is not a question of whether we will continue to print money we don't have.  Forget what you've been taught growing up - money does grow on trees and come out of thin air.  But so long as we use our money fabricating superpowers responsibly it can be OK.  History is proof of that.  And the last time we forgot it we pushed the economy into the Great Depression!  Nobody knows that lesson better than Bernanke, thank goodness!!  

The big unknown if you ask me is whether we (Washington and Europe too) can print money responsibly.  And that is a question for, dare I say it, Wall Street.  Yup, the same Wall Street wolves that some folks believe created the last financial crisis and the Great Recession will be the same ones to decide whether the world will be saved by the plans that the chickens in Washington come up.  So here we are waiting for the chickens to be thrown to the wolves.  Talk about the proverbial wolf guarding the chicken coup.

I just wish they'd get it done and announce whatever backroom deal they're coming up with because in the game of chicken it's typically the suspense that kills you.  And, in the case of the political chicken in Washington suspense is killing the world economy. 

Wednesday, June 1, 2011

Make A List of Reasons - Why this economy has a lot of reasons to grow

One minute demand inflation is heating up.  The next the economy is slowing down and commodities are falling.  One quarter the economy is picking up and the next it's starting to lose steam.  It's hard to find a trend line that popular opinion is willing to stick with.  The animal spirits are all over the place.  Fiscal tightening in the USA coupled with European austerity and bank tightening in China all would suggest the economy is going to slow.  I have a list of reasons I think not and I bet you have a list too.  Follow me here.

Start a list of the stuff you need.  On my short list I need a new roof, a new wall oven, a new car, new carpeting, a new lawn tractor, and a new suit and a sport jacket.  How about you?  I bet you've got a bunch of big purchases you've put off.  Add on a few things you really want to do like a nice vacation, maybe a Broadway show, a faster smartphone, an iPad2, and that big landscaping project.  I believe people's lists of needs & wants has never been longer because as a country we've never put off so much for so long.

Age and obsolescence make an increasingly compelling case to add to our list.  As all our stuff gets older much of it simply wearing out. But a lot more of it is becoming obsolete. What I mean by obsolete is that thanks to innovation in technology, design, and materials a lot of stuff we once enjoyed is becoming less attractive to us.  Take your phone or computer for example.  I don't need new phone, my Droid2 works fine. But the new one available is 4G and I want it!  I don't need a new laptop, but the new ones are so much lighter and better. In some situations the improvements that come from innovation nearly pay for themselves.  We are seeing this when it comes to more energy efficient solutions when eventually the savings from energy efficiency virtually pay for the capital cost of replacing the old item, for example with an old hot water heater or with incandescent light bulbs. 

If you think you've got a long list, just imagine what some families in developing countries need. A young Chinese or Indian couple that is upwardly mobile and joining their country's version of the middle class has a list that would make you count your blessings if you compared.  This is a reality that isn't being lost on General Motors, let alone KFC!

Can you guess what else is wearing out!  You body!!  OK, maybe not your body, but I can assure you there's a half million other bodies that need new knees, hearing aides, eye glasses, and dental work.  The Great Recession has forced a lot of people to put off taking care of themselves.  Time marches on and as it does it takes its toll on our health and appearance.  Fortunately, when we find the money we'll also find that improvements in technology, design, and materials have provided for some pretty attractive options in this area as well. 

My list, your list, and the lists of things people around the world want and need keeps growing.  The recovery will see to it that we have the means to cross-off some of the items on our lists.  Or is it the other way around?  It's the list that will see to it that we have a recovery!

Wednesday, May 25, 2011

What do Greece and a Youngstown Ohio Homeowner Have In Common?

While the two are literally a world apart, Greece and a homeowner in Youngstown Ohio have something in common.  They are both so indebted and under collateralized that they have no hope of repaying. The difference is that the homeowner in Ohio and their bank have accepted reality - that default was inevitable - and the Europeans are about to.

The ECD and IMF and European banks are still trying to modify Greece.  The Ohio homeowner is past that!  The creditor in the case of the Ohio homeowner tried modifications too, but in the final analysis there was no way to achieve any viable situation without massive debt forgiveness.  Due to the complicated legal structure of the loan and all the interested parties upstream, as well as the ramifications such a policy action would have on other loans, a straight write-down of the balance was not possible.  In the end for the homeowner, foreclosure was the only option.

In effect, the foreclosure results in a write-down for the bank anyway.  But where does that leave the homeowner?  Better off!!  The homeowners credit may be ruined, but by the time of the foreclosure their credit was destroyed already anyway.  At least after the foreclosure the homeowner is off the hook for the mortgage note.  They are effectively released from their indebtedness and free to start life over financially. And, they can go rent or purchase a different house for a lot less than they were on the hook for before. On the other hand, the bank and whatever investor that owned or insured the loan is left with the loss. Repeat this scenario enough times and you've got the mortgage crisis which ultimately grew so vast that it morphed into the financial crisis of 2008 the fall of Lehman, Fannie & Freddie, AIG, and others.

But what about Greece - who's better off when Greece realizes that there is no hope of repaying their debt and just defaults? What happens when mass opinion in Greece is that the stresses of continuing the struggle to pay its debt is simply not worth it to them!  Like the homeowner who realized that it was better to accept a new reality, eventually Greece will do so too.  Eventually the homeowner decided, and Greece will too, that they need to walk away from their obligations and let the chips fall.  And like the homeowner who enjoyed living in their home for as long as they could while continuing to mount up more and more unpaid debt and interest while enjoying free rent, Greece is going to soak up as much time and debt as possible before they pull the plug. 

If it were just Greece, and if it were just one homeowner or even one town of homeowners, the creditors would just lick their wounds and life all around would go on normally except for the debtors.  If the default of either the homeowner or Greece were an isolated case, the debtor is up the proverbial "shits river without a paddle."  But it's not just Greece and it wasn't just one homeowner that is drowning in debt.  Therein lies the difference in the financial dynamics which threatens the world's financial system. 

Like the USA housing crisis, the scope of European countries that are insolvent is such that if one defaults and the others follow a crisis is set off.  I know it seems like there is already a crisis, but I believe what we have now is "strain."  A crisis will be the day Greece or Belgium or some other country throws in the towel and defaults.  Unlike the current situation with the USA housing crisis which has been adjusted for with USA banks, in the case of the "PIIGs" and others default is not yet "baked into" the Euro or world banking system. While the USA banks have written down their mortgage losses, the European banks have not written large scale defaults into their capital structure.  If one of the insolvent European countries such as Greece defaults, the banks will have no choice but to adjust their financial balance sheets to take into account these defaults on a massive scale.  Once they do they become greatly under-capitalized. Then, like the USA banks, they will need the bailout!  It will be the sequel to the book, and now the movie, "Too Big to Fail."  

From a practical standpoint, the credit rating companies are forcing the issue.  Which only raises the cost of carrying the debt to these countries and puts more pressure on them to default. The straw will eventually break the camel's back. It could be today or tomorrow or next week, but eventually Greece and a half-dozen other Euro-member countries are going to give their European friends the bird.  It's notable that in the case of the Ohio homeowner they also had to give up the keys to their home.  Whereas, at least Greece residents get to stay in country. Greece may be better off - even better off than the homeowner in Ohio.

I'd love to play this scenario out further because the outcome sure doesn't end here.  But that's all the time I have for this post!

Tuesday, May 10, 2011

Can you say QE3?

It's been widely assumed that QE2 is the end of quantitative easing and that there will not be a QE3.  Could the Federal Reserve be willing to risk the economy contracting as result of the Fed pulling back the punch bowl cold turkey, at the same time congress is doing major fiscal tightening?  With the Federal Reserve buying nearly 70% of Treasury issuance do they expect to simply stop buying and still have successful auctions? I don't buy it.  QE3 may not look like QE2, and it may not even be branded "QE" any #, but I think whatever the Federal Reserve calls what they're doing it will "walk and talk like a 'QE' duck."  So what might it be?

I have a few thoughts about this.  (Not surprising.)  My first hunch is that they do some restructuring of their balance sheet in cooperation with the Treasury such that they extend the terms on shorter term T'Bills to longer terms.  By converting their 1, 2, and maybe 3 year notes to 10+ years they reduce the strain on holding successful actions by reducing the need to refinance these notes as they come due over the next few years.  Second, the Federal Reserve could to look for a way to write down their MBS holdings, thereby giving relief to the obliges.  This would be a great back door way to give relief to the housing market and at the same time help to further repair banks and mortgage holders balance sheets.  No doubt that would produce liquidity that would make its way into the economy.  Last but not least, they have to find a way to motivate banks to push their reserves into the economy.  Maybe they will stop paying interest on reserves. 

Do you remember when Paulson, Geitner, and Bernanke dreamed up TARF and produced a three page document that sailed through congress in a few days to save the world financial system from ruin?  My sense is that something is brewing that will be announced before QE2 wraps up and the debt ceiling needs to be raised.  What they come up with will have to be sold to the financial markets and congress.   It will have to include something from Congress on adjustments to entitlements and other spending in order for the whole package to be credible.  It will be pitched, with the help of the President, as the best (only) way to save the Federal government from default.  But it will also be sold as positive solution that will put America back on solid ground and lead to years of economic expansion. 

If this happens, and the Federal Reserve and the Treasury can pull this off with the help of the President, I think Dow 16K is a real possibility! 

Saturday, May 7, 2011

On the Edge of Mutual Destruction

We are finally on the edge of financial mutual destruction.  If congress fails to address our deficit and debt crisis in a credible way and investors around the world lose faith in Treasuries and the dollar collapses the USA standard of living will be destroyed.  American's buying power will be annihilated.  Then what?

There's no question that IF this happens the world will be thrust into a great depression!  The USA is the biggest customer on the planet and if we stop buying international goods and services from around the world because our dollars are so devalued our pain becomes the pain of the entire world and everyone's economy. Talk about "too big to fail," there isn't any country that could bailout the USA.  If our boat sinks we're taking everyone to the bottom with us!  But that's a BIG IF!!!!

We've been bad.  We spent too much. We're virtually insolvent.  But so is Japan, Ireland, the UK, Spain, Portugal, and dozens of other countries!  Have you looked at the Debt to GDP ratios in France and Italy?  Forget about Belgium, Denmark, Norway, and Switzerland!  Euro zone Debt to GDP is higher than the USA!  You have to wonder who's lending everyone the money cause we're all broke. 

Sure there are some countries with a great debt to GDP ratio.  Those are the countries supplying the world with natural resources or who have exploited their workers and kept their vast populations living in poverty.  (Can you guess the names of these countries?)  They have also been huge buyers of USA treasuries.  Who's better off?  Well, let's see what happens when we stop buying their stuff and their debt, valued in dollars, is nearly worthless as well!!

The bottom line is that if America goes bust we're taking all of these countries with us. So where would you like to be living the day America goes broke? If you ask me, I'd rather be living in America when it goes bust than in China!!  Somehow the image of civil unrest in America seems less scary to me.  And what will Saudi Arabia do with all that oil if American's start burning more gas and coal and conserving energy because we can't afford to buy OPEC oil?

What's the value of a dollar, or any currency for that matter?  None of it (currency) is backed by anything more than faith & confidence in the financial system of the Nation that prints it.  It's only worth anything if you believe it's worth anything!  So, do you believe in the "worth" of America?  Pick a country, any country!  What's it worth?  Seriously, what is the worth of a country?  When I think about it, if you ask me, America is still very wealthy!  I could give you a long list of reasons why but that's not the point of this blog post. 

We are going go the edge of the cliff here.  In financial terms, America and a slew of other countries are for all intensive purposes insolvent. If America goes over the cliff the rope tied to most of the developed world will take them over the cliff with us. It will be mutual financial destruction!  Nobody wants that, so we all need to step away from the edge.  The problem as I see it is that no body has figured how to "step back" in a way which will enable people around the world to believe once again in the value of the USA dollar or the Euro.  But I am pretty much sure that we will find a way for the same reason that nuclear war has not happened yet.  Most people and most countries are not suicidal.

It should be very interesting to listen to how Fed Chairman Bernanke, ECB President Trichet and China's Chairmen Hu all talk us off the ledge.  Listen up people.

Monday, April 4, 2011

Two Moments at Holocaust Museum

We chose to come to Washington as way to celebrate Mary's last chemo treatment and to see two things we've wanted to see for some time. One was the Capital monuments (from the outside) with Cherry Blossoms in Bloom. The other the Holocaust Museum.
 
The span of from the Capital building, through the Mall, to the hill perched with the magnificent Washington Monument looking over the reflecting pond with the Jefferson Memorial and all around the spectacular planted flowering Cherry Blossom trees has to be one of the most remarkable scenes on earth.  The other,  the Holocaust Museum, everyone on the planet should see and know what others had to witness so we may never again be a witness.
 
"I call heaven and earth to witness this day: I have put before you life and death, blessing and curse. Choose life -- that you and your offspring shall live"   Deuteronomy 30:19
 
Spending the day between two such extreme contrasts is evidence to the remarkable range of human capacity.  On the one hand, the most profound horror and on the other hand the most profound glory.
 
Two moments from my experience shocked me.  In addition to thousands of photos, the Museum set up exhibits with physical remembrances.  Things like concentration fence posts that would have been be run with electrified barbed wire, the wooden prisoners' barracks (cells), an operating table where unimaginable atrocities occurred, thousands & thousands of shoes from people who removed them to take their last steps.  It is all so so horrible! 
 
As we made our way around, I found a few minutes when I could be alone inside an actual rail car that transported the Jews, and others, to the "final solution."  The museum wisely provides places for private meditation.  One of mine, was this rail car.  I think I was alone, but I don't know.  It was dark with only filtered light. The wood floors and ceiling where all scratched.  I paused and closed my eyes and put my hands flat on the boards and let my imagination run.  Voices came to me!  Many voices, little children, mothers, an old man.  They weren't speaking to me - the voices were talking to one another and I just listened.  They said different things - but they all were about the same thing - FEAR!!  Oh, my G-d, the FEAR.   
 
"What have you done? Hark, thy brother's blood cries out to me from the ground!"  Genesis 4:10
 
The other moment that grabbed me with my own personal fear was a juxtaposition in time and space.  I had just exited a glass room where an audio tape played narrations of survivors' memories.  One listens and may cry or want to scream.  How could they survive?  But that is not the part that grabbed me with fear.  I must have been in that room for a little while and when I came out I noticed I was in a re-creation of a concentration camp.  I stepped into a foreign and frightful place.  There are photos of prisoners all around the walls, with museum visitors wandering through and mixing in with the images.  Then it struck me!  I had lost Mary.  My eyes searched and for just fraction of time, maybe 2 or 3 seconds at the most, I imagined the unimaginable.  Then I saw her hat - the hat with the flower that she wears to hide her bald head.  Her beautiful head, her beautiful face.  Relief!!  And then I thought to myself, I couldn't stand 2 seconds and their nightmare lasted for eternity. 
 
"Only guard yourself and guard your soul carefully, lest you forget the things your eyes saw, and lest these things depart your heart all the days of your life, and you shall make them known to your children, and to your children's children."  Deuteronomy 4:9