Friday, December 4, 2009
Thursday, December 3, 2009
Parking Space for Non Performing Loans
The real estate market will soon recover and this whole financial crisis will be just a bad memory. This was exactly the reasoning of the Japanese authorities when the real estate market collapsed in 1990. The very obvious solution was to ensure that the debt accumulated in funding the real estate bubble could be parked safely away from prying eyes while patiently waiting for the real estate market to recover and the real estate prices to grow back to the levels required to settle the loans. Sadly it turned out to be a twenty year wait but the non performing loans could not remain parked in the private sector for such an extended period. Parking space required grew each time the problem was moved and the taint of government with it.
The tale starts in 1970 when eight Jusens were established. Seven by major banks and financial sector players with shareholdings dispersed amongst the players for each Jusen to avoid subsidiary status. The eighth was founded by Agricultural Finance Cooperatives which were banks (also called deposit taking institutions at the time). The Deposit Taking Institution definition was telling as it defined the status of the entity as a bank or not and not the fact that an entity may be making loans. The purpose of the Jusens was to finance mortgage loans for the household sector but they were not to take deposits and would therefore not be banks. The shareholder banks would provide all the funding required.
The non-bank status allowed the Jusens to escape regulatory scrutiny with the full knowledge and blessing of the political regime and the BOJ. The Ministry of Finance (MOF) actively participated with a policy of profit padding reminiscent of a protective cocoon of naval attack craft around vulnerable aircraft carriers nicknamed the convoy system (gosoo sendan hooshiki) to promote cartels and safeguard banking profits from unacceptable competition (Rosenbluth&Thies, 2000). Also called a “survival of the weakest” policy (Milhaupt, 1999).
The basic Jusen setup was a very simple structure which made a mighty contribution to the real estate bubble in Japan.
The Shareholder Banks in turn were also receiving generous liquidity support from the BOJ and all the building blocks for a real estate bubble were in place. Soon other banks described as non-founder banks were also lending into the Jusens. The Jusens in turn did not restrict its mortgage lending only to households but expanded into the (at first) lucrative lending for property development. Globalisation, market liberalisation and internationalisation arrived in Japan in the 1980’s and together with epic loose monetary policy in the wake of the 1987 soon too be forgotten crash of the stock exchanges, accelerated lending growth into real estate to a fever pitch, with the Jusens out front. Dark tales are told of how even the Yakuza got involved in the real estate business in many ways including by providing jiageya (a land turner) who would clear the way for large real estate developments by for example “convincing” obstructive small land owners or tenants to cooperate.
The Nikkei peaked in Dec 1989, the real estate bubble popped and by late 1990 the Jusens were in trouble with non performing loans. The MOF inspected the Jusens for the first time ever in 1991 and concluded that almost 40% of the loans were non performing (Milhaupt, 1999). The response were predictably to underplay the problem as was shown later and to develop plans aimed at parking the problem out of the way while waiting for the real estate market to recover. The initial write off for the Jusens was around $5million. See the table of losses published by the DIC (Deposit Insurance Corporation of Japan) further down for the disclosed losses after a final restructuring effort in 1996 which closed the Jusens down.
The structurers of the Jusens never anticipated any failure and it transpired that clear allocation of losses when they arrived could not be done. Soon the previous partners in the joint ventures were arguing who should bear the losses and in which percentages. Some argued for loan ratios, other argued for control ratios and fingers were pointed at the MOF as responsible. The MOF was forced to intervene in the growing Jusen crisis. MOF involvement “stabilised” the volatile situation within the greater context of the Japanese financial crisis with hints of public support and implied guarantees but was ultimately based on the vain hope that the problem would resolve itself as soon as the economy had been reflated.
The temporary parking space provided for the non performing loans policy was so successful that Visiting Executive Professor Masaru Yoshitomi concluded in his lecture at the Wharton School, University of Pennsylvania published 17 April 1996, thus:
The parking space provided by the MOF supported by the BOJ’s ultra loose monetary policy with limitless liquidity provision and zero interest rates or near zero interest rates combined with the envisaged “overhauling of the current financial and regulatory system” failed to generate the 3 percent or so growth path for Japan. In fact, the by then around 75% non performing loan problem of the Jusens grew to an almost total conversion to non performing status. An attempt to raid the treasury to clean the Jusen slate met with fierce political resistance. The Founding Banks and the MOF were forced to thrash out a painful deal in 1997 to “permanently” deal with the Jusen nightmare. It was implemented by dividing up the non performing loans amongst the MOF and the Founding Banks with provisions for greater disclosure and transparency. Yet again the non performing loans were shifted from the previous parking space at the Jusens to the MOF, the Deposit Insurance Corporation (DIC) and the balance sheets of the Founding Banks on a 15 year envisaged repayment structure.
It did not take long to realise that the banks simply could not cope with the additional losses of non performing loans going bad and as early as March 1998 the MOF was obliged to inject capital into failing banks. Nine years into the Japanese Financial Crises having provided parking space for non performing loans for all that time and yet again the Japanese authorities faced another banking crisis. Rosenbluth & Thies (2000) describes it as follows:
The history of the Jusen problem after the parking space deal can be seen in the numbers published by the DIC in the RCC – Secondary Losses of Jusen Account table hereunder:
Source: Deposit Insurance Corporation, Japan
(Click on the table for a larger view)
It is clear, looking back upon the past twenty years of the Japanese Financial Crises that the ultimate parking space for most of the non performing loans were found on the balance sheet of the Japanese Government, those of the Jusen and of the banks alike. The policies of providing parking space to “stabilise” bubble excesses has mired the Japanese economy in a deflationary depression for two decades and saddled a younger generation of Japanese with a depressing Government Debt burden of a quantity that will haunt their economic life for more than a generation.
Only those afflicted with that special kind of blindness of them-who-do-not-wish-to-see would be able to look upon the policies of the FDIC, the FHA and its wards Freddie, Fannie and Ginnie together with the antics of the Fed to provide parking space for non performing loans will fail to see the parallel with the recent history of the Jusens. The not so blind will note how the taint of bailouts and stimulations festers in this still growing parking space and contemplate a future perhaps akin to the vehicles abandoned at the Dubai International Airport car parks. Those who watch the growing sovereign debt burdens may eye the IMF and the World Bank for parking space when the next sovereign debt default announces its arrival.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 December 2009
References:
1. Rosenbluth & Thies, 2000 – The Electoral Foundations ofJapan’s Banking Regulation, Electronic copy at: http://ssrn.com/abstract=1158646
2. Milhaupt, 1999 - Japan’s Experience with Deposit Insurance and Failing Banks: Implications for Financial Regulatory Design?, Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, August 1999, pp. 21–46.
3. Yoshitomi, 1996 - The “jusen” debacle and Japanese Economy, The Long-Term Credit Bank of Japan Research Institute.
4. Felson, 1998 - CLOSING THE BOOK ON JUSEN: AN ACCOUNT OF THE BAD LOAN CRISIS AND A NEW CHAPTER FOR SECURITIZATION IN JAPAN, DUKE LAW JOURNAL Vol. 47:567, pp 567-612.
5. Organized Crime Registry, 1996 - Who got Yakuza into our banking system?, http://orgcrime.tripod.com/yakuzabanking.htm
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
The tale starts in 1970 when eight Jusens were established. Seven by major banks and financial sector players with shareholdings dispersed amongst the players for each Jusen to avoid subsidiary status. The eighth was founded by Agricultural Finance Cooperatives which were banks (also called deposit taking institutions at the time). The Deposit Taking Institution definition was telling as it defined the status of the entity as a bank or not and not the fact that an entity may be making loans. The purpose of the Jusens was to finance mortgage loans for the household sector but they were not to take deposits and would therefore not be banks. The shareholder banks would provide all the funding required.
The non-bank status allowed the Jusens to escape regulatory scrutiny with the full knowledge and blessing of the political regime and the BOJ. The Ministry of Finance (MOF) actively participated with a policy of profit padding reminiscent of a protective cocoon of naval attack craft around vulnerable aircraft carriers nicknamed the convoy system (gosoo sendan hooshiki) to promote cartels and safeguard banking profits from unacceptable competition (Rosenbluth&Thies, 2000). Also called a “survival of the weakest” policy (Milhaupt, 1999).
The basic Jusen setup was a very simple structure which made a mighty contribution to the real estate bubble in Japan.
The Shareholder Banks in turn were also receiving generous liquidity support from the BOJ and all the building blocks for a real estate bubble were in place. Soon other banks described as non-founder banks were also lending into the Jusens. The Jusens in turn did not restrict its mortgage lending only to households but expanded into the (at first) lucrative lending for property development. Globalisation, market liberalisation and internationalisation arrived in Japan in the 1980’s and together with epic loose monetary policy in the wake of the 1987 soon too be forgotten crash of the stock exchanges, accelerated lending growth into real estate to a fever pitch, with the Jusens out front. Dark tales are told of how even the Yakuza got involved in the real estate business in many ways including by providing jiageya (a land turner) who would clear the way for large real estate developments by for example “convincing” obstructive small land owners or tenants to cooperate.
The Nikkei peaked in Dec 1989, the real estate bubble popped and by late 1990 the Jusens were in trouble with non performing loans. The MOF inspected the Jusens for the first time ever in 1991 and concluded that almost 40% of the loans were non performing (Milhaupt, 1999). The response were predictably to underplay the problem as was shown later and to develop plans aimed at parking the problem out of the way while waiting for the real estate market to recover. The initial write off for the Jusens was around $5million. See the table of losses published by the DIC (Deposit Insurance Corporation of Japan) further down for the disclosed losses after a final restructuring effort in 1996 which closed the Jusens down.
The structurers of the Jusens never anticipated any failure and it transpired that clear allocation of losses when they arrived could not be done. Soon the previous partners in the joint ventures were arguing who should bear the losses and in which percentages. Some argued for loan ratios, other argued for control ratios and fingers were pointed at the MOF as responsible. The MOF was forced to intervene in the growing Jusen crisis. MOF involvement “stabilised” the volatile situation within the greater context of the Japanese financial crisis with hints of public support and implied guarantees but was ultimately based on the vain hope that the problem would resolve itself as soon as the economy had been reflated.
The temporary parking space provided for the non performing loans policy was so successful that Visiting Executive Professor Masaru Yoshitomi concluded in his lecture at the Wharton School, University of Pennsylvania published 17 April 1996, thus:
In conclusion, the recent performance and recovery of the real economy is decoupled and isolated from the banking “crisis” in Japan. Therefore if both the Government and the public correctly handle the Jusen liquidation and other banking problems through overhauling the current financial and regulatory system, the Japanese economy will launch on the new underlying growth path of 3 percent or so with better shape of both real and financial sectors. (The “jusen” debacle and Japanese Economy)
The parking space provided by the MOF supported by the BOJ’s ultra loose monetary policy with limitless liquidity provision and zero interest rates or near zero interest rates combined with the envisaged “overhauling of the current financial and regulatory system” failed to generate the 3 percent or so growth path for Japan. In fact, the by then around 75% non performing loan problem of the Jusens grew to an almost total conversion to non performing status. An attempt to raid the treasury to clean the Jusen slate met with fierce political resistance. The Founding Banks and the MOF were forced to thrash out a painful deal in 1997 to “permanently” deal with the Jusen nightmare. It was implemented by dividing up the non performing loans amongst the MOF and the Founding Banks with provisions for greater disclosure and transparency. Yet again the non performing loans were shifted from the previous parking space at the Jusens to the MOF, the Deposit Insurance Corporation (DIC) and the balance sheets of the Founding Banks on a 15 year envisaged repayment structure.
It did not take long to realise that the banks simply could not cope with the additional losses of non performing loans going bad and as early as March 1998 the MOF was obliged to inject capital into failing banks. Nine years into the Japanese Financial Crises having provided parking space for non performing loans for all that time and yet again the Japanese authorities faced another banking crisis. Rosenbluth & Thies (2000) describes it as follows:
“Between October 1998 and October 1999, Long-Term Credit Bank and Nippon Credit Bank were nationalized, five other major banks were declared insolvent (Nikkei 10/18/1999), and many others have merged with healthier institutions.” (The Electoral Foundations of Japan’s Banking Regulation)
The history of the Jusen problem after the parking space deal can be seen in the numbers published by the DIC in the RCC – Secondary Losses of Jusen Account table hereunder:
Source: Deposit Insurance Corporation, Japan
(Click on the table for a larger view)
It is clear, looking back upon the past twenty years of the Japanese Financial Crises that the ultimate parking space for most of the non performing loans were found on the balance sheet of the Japanese Government, those of the Jusen and of the banks alike. The policies of providing parking space to “stabilise” bubble excesses has mired the Japanese economy in a deflationary depression for two decades and saddled a younger generation of Japanese with a depressing Government Debt burden of a quantity that will haunt their economic life for more than a generation.
Only those afflicted with that special kind of blindness of them-who-do-not-wish-to-see would be able to look upon the policies of the FDIC, the FHA and its wards Freddie, Fannie and Ginnie together with the antics of the Fed to provide parking space for non performing loans will fail to see the parallel with the recent history of the Jusens. The not so blind will note how the taint of bailouts and stimulations festers in this still growing parking space and contemplate a future perhaps akin to the vehicles abandoned at the Dubai International Airport car parks. Those who watch the growing sovereign debt burdens may eye the IMF and the World Bank for parking space when the next sovereign debt default announces its arrival.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 December 2009
References:
1. Rosenbluth & Thies, 2000 – The Electoral Foundations ofJapan’s Banking Regulation, Electronic copy at: http://ssrn.com/abstract=1158646
2. Milhaupt, 1999 - Japan’s Experience with Deposit Insurance and Failing Banks: Implications for Financial Regulatory Design?, Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, August 1999, pp. 21–46.
3. Yoshitomi, 1996 - The “jusen” debacle and Japanese Economy, The Long-Term Credit Bank of Japan Research Institute.
4. Felson, 1998 - CLOSING THE BOOK ON JUSEN: AN ACCOUNT OF THE BAD LOAN CRISIS AND A NEW CHAPTER FOR SECURITIZATION IN JAPAN, DUKE LAW JOURNAL Vol. 47:567, pp 567-612.
5. Organized Crime Registry, 1996 - Who got Yakuza into our banking system?, http://orgcrime.tripod.com/yakuzabanking.htm
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Tuesday, November 3, 2009
The Cruellest Tax of them All.
Who is John Galt? – Ayn Rand from Atlas Shrugged
Humanity has shown many times that we can be extremely cruel and equally capable at rationalising it away. Taxation comes in many forms and is often not apparent. A well disguised tax is a boon for governments. The cruellest tax of all is a one hundred percent tax on income, disguised and capable of being rationalised as “good”.
Imagine for a moment a peasant farmer who has to hand over a hundred percent of his crop to a feudal lord. It is easy to see the injustice of such a tax. Yet we have a hundred percent tax in our midst and there is no moral outrage. It is the zero interest rate policy. Fortunately that other destroyer of savings, Quantitative Easing, is off the table for the time being.
We rationalise it away as a benign economic policy aimed at restoring economic prosperity. No questions asked. All “policy” happens by government decree. Do not buy into the slight of hand that the central bank is not part of the machinery of government. So the Central Bank can “follow” a zero interest rate policy but the reality of this tax is lost on the population.
Let’s put it up for scrutiny. Would a saver willingly agree to an economic environment of zero interest rates? Certainly not. Would a debtor prefer a zero interest rate? Absolutely. The saver and the debtor would negotiate a “price” for the use of money saved under normal willing economic participant conditions. That price for use of funds is interest.
The Central Bank enters the negotiation between saver and borrower and by counterfeiting money is able to destroy the negotiating base of the saver. Counterfeiting money through policies of unlimited liquidity provision is “price control” over interest rates instituted to force interest rates to zero. The interest income of the saver is completely taxed away.
I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair. Back to the tax.
Savings will migrate to term assets for meagre interest income but that income has more to do with a term premium than with interest, the cost for use of funds. No-one has any moral standing to defend a policy that dispossesses the interest of the saver however, the indiscriminate redistribution of this “interest” tax is even worse.
The normal standards for a tax are that it must be fair and it must be evenly distributed. The “for the public good” argument is that tax may be levied disproportionately usually with reference to some wealth measure. In simple terms, the rich must pay more and the poor must pay less. A zero interest rate policy tax fails dismally when it is tested against this framework. There is no discrimination. All savers are taxed their entire interest rate. Some savers, usually the wealthier and more sophisticated savers can institute counter tax measures and are able to avoid or escape the zero interest rate tax to some extent. Most can’t and they fund the redistribution.
Looking at the redistribution of the saver’s interest we find the same indiscriminate principles being applied. Is it being distributed by an elected body, fairly and equitably in the interest of society? No. Who are the recipients of the interest that has been stripped from the savers? Obviously the borrowers and it takes place with no reference to the wealth, income or other discerning standards which would normally apply. By which standards do society decide that Homeowner X who bought a property priced beyond his means and who borrowed in excess, must be subsidised by Pensioner Y who had saved to survive the income drought of old age. Why must BIG BANK A have access to zero or near zero cost of funds to carry all those loss making loans while Saver B can no longer afford his child’s tuition?
So the zero interest rate tax strips the interest income from savers and hands it to government, morally justified as stimulating the economy through deficit funding. It is of no use to run up huge deficits if it involves paying a high interest rate, is the justification. Strip the interest and hand it indiscriminately to over-extended borrowers many of which had used the borrowings to speculate on asset inflations. Strip the interest and hand it to the banks to “repair” their balance sheets and to “carry” the bad debts. Strip the interest and hand it to the developers who overinvested in property, capacity or trading. Strip the saver of interest to fund the carry of compounding unliquidated losses.
How totally one sided. Rip off the savers and give to the borrowers. Not even the socialist dictate of Karl Marx which proclaims that everybody should contribute according to ability and receive according to need, can contain the injustice of a zero interest rate policy tax. Surely nobody can have a zero need and a one hundred percent obligation to contribute. Neither can anyone claim one hundred percent contribution from savers against a zero contribution from borrowers (the bank margin excluded).
So, next time when the Fed or the Bank of Japan or the Bank of England proclaims its devotion to a zero interest rate policy, stop and ponder for a moment the injustice to the saver. Think on the co-operative spirit of society and ask why these Central Banks consider it fair, moral and just to strip savers of their income in their quest for self preservation. When you hear the phrase, “interest rates will remain at zero for longer” question the imposition of hardship on the saver for longer. Contemplate the weight of the burden on a small and responsible portion of society and the economic consequences of such self serving behaviour by Central Bankers with the support of Central Government.
In your heart, if you have a heart, you will know that robbing the saver is not moral. You will realise that the indiscriminate redistribution of income rights from the responsible and the cautious to over burdened borrowers, speculators, government and risk seeking banks serve not the short or long term interests of economic society. Most of all do not rationalise this mean policy and indiscriminately cruel tax into a benign and caring action by Central Banks.
Look no further than the escalation in Total Public Debt and compare it to the Federal Interest Outlays to see but a portion of the sacrifice extracted from savers. See how the debt expanded exponentially but the cost of funding the debt dropped dramatically. Interest tax need not be calculated or declared because the tax has already been calculated, declared and transferred to government through the application of the zero interest rate policy of the Fed.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 November 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Humanity has shown many times that we can be extremely cruel and equally capable at rationalising it away. Taxation comes in many forms and is often not apparent. A well disguised tax is a boon for governments. The cruellest tax of all is a one hundred percent tax on income, disguised and capable of being rationalised as “good”.
Imagine for a moment a peasant farmer who has to hand over a hundred percent of his crop to a feudal lord. It is easy to see the injustice of such a tax. Yet we have a hundred percent tax in our midst and there is no moral outrage. It is the zero interest rate policy. Fortunately that other destroyer of savings, Quantitative Easing, is off the table for the time being.
We rationalise it away as a benign economic policy aimed at restoring economic prosperity. No questions asked. All “policy” happens by government decree. Do not buy into the slight of hand that the central bank is not part of the machinery of government. So the Central Bank can “follow” a zero interest rate policy but the reality of this tax is lost on the population.
Let’s put it up for scrutiny. Would a saver willingly agree to an economic environment of zero interest rates? Certainly not. Would a debtor prefer a zero interest rate? Absolutely. The saver and the debtor would negotiate a “price” for the use of money saved under normal willing economic participant conditions. That price for use of funds is interest.
The Central Bank enters the negotiation between saver and borrower and by counterfeiting money is able to destroy the negotiating base of the saver. Counterfeiting money through policies of unlimited liquidity provision is “price control” over interest rates instituted to force interest rates to zero. The interest income of the saver is completely taxed away.
I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair. Back to the tax.
Savings will migrate to term assets for meagre interest income but that income has more to do with a term premium than with interest, the cost for use of funds. No-one has any moral standing to defend a policy that dispossesses the interest of the saver however, the indiscriminate redistribution of this “interest” tax is even worse.
The normal standards for a tax are that it must be fair and it must be evenly distributed. The “for the public good” argument is that tax may be levied disproportionately usually with reference to some wealth measure. In simple terms, the rich must pay more and the poor must pay less. A zero interest rate policy tax fails dismally when it is tested against this framework. There is no discrimination. All savers are taxed their entire interest rate. Some savers, usually the wealthier and more sophisticated savers can institute counter tax measures and are able to avoid or escape the zero interest rate tax to some extent. Most can’t and they fund the redistribution.
Looking at the redistribution of the saver’s interest we find the same indiscriminate principles being applied. Is it being distributed by an elected body, fairly and equitably in the interest of society? No. Who are the recipients of the interest that has been stripped from the savers? Obviously the borrowers and it takes place with no reference to the wealth, income or other discerning standards which would normally apply. By which standards do society decide that Homeowner X who bought a property priced beyond his means and who borrowed in excess, must be subsidised by Pensioner Y who had saved to survive the income drought of old age. Why must BIG BANK A have access to zero or near zero cost of funds to carry all those loss making loans while Saver B can no longer afford his child’s tuition?
So the zero interest rate tax strips the interest income from savers and hands it to government, morally justified as stimulating the economy through deficit funding. It is of no use to run up huge deficits if it involves paying a high interest rate, is the justification. Strip the interest and hand it indiscriminately to over-extended borrowers many of which had used the borrowings to speculate on asset inflations. Strip the interest and hand it to the banks to “repair” their balance sheets and to “carry” the bad debts. Strip the interest and hand it to the developers who overinvested in property, capacity or trading. Strip the saver of interest to fund the carry of compounding unliquidated losses.
How totally one sided. Rip off the savers and give to the borrowers. Not even the socialist dictate of Karl Marx which proclaims that everybody should contribute according to ability and receive according to need, can contain the injustice of a zero interest rate policy tax. Surely nobody can have a zero need and a one hundred percent obligation to contribute. Neither can anyone claim one hundred percent contribution from savers against a zero contribution from borrowers (the bank margin excluded).
So, next time when the Fed or the Bank of Japan or the Bank of England proclaims its devotion to a zero interest rate policy, stop and ponder for a moment the injustice to the saver. Think on the co-operative spirit of society and ask why these Central Banks consider it fair, moral and just to strip savers of their income in their quest for self preservation. When you hear the phrase, “interest rates will remain at zero for longer” question the imposition of hardship on the saver for longer. Contemplate the weight of the burden on a small and responsible portion of society and the economic consequences of such self serving behaviour by Central Bankers with the support of Central Government.
In your heart, if you have a heart, you will know that robbing the saver is not moral. You will realise that the indiscriminate redistribution of income rights from the responsible and the cautious to over burdened borrowers, speculators, government and risk seeking banks serve not the short or long term interests of economic society. Most of all do not rationalise this mean policy and indiscriminately cruel tax into a benign and caring action by Central Banks.
Look no further than the escalation in Total Public Debt and compare it to the Federal Interest Outlays to see but a portion of the sacrifice extracted from savers. See how the debt expanded exponentially but the cost of funding the debt dropped dramatically. Interest tax need not be calculated or declared because the tax has already been calculated, declared and transferred to government through the application of the zero interest rate policy of the Fed.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 November 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Sunday, October 25, 2009
Ground Zero
I’ve had many mentors during my career who shared with me their wisdom. One friend told me, Sarel there are two business rules that you must comprehend and apply. The five finger rule and the two finger rule. Showing his right hand and counting from the thumb he said: “The five finger rule is, What’s-In-It-For-Me?” The two finger rule he said is, “Buy low, Sell high.” Silly rules easily made off as platitudes yet they sneak up upon you when you analyze your investment and economic environment.
So we ask of the stock exchange; is it time to buy or time to sell? Buy low and sell high. Perhaps we look at residential property and ask if it is time to buy or sell. Buy low and sell high. What about commercial and industrial property? Buy low and sell high. How about government bonds? Buy low and sell high.
These questions are asked within a relative frame of reference but when we ask the bond question it is when we hit ground zero. The “risk free” short term interest rate is set at zero. Zero is as low as it gets, it simply cannot go lower. Zero interest rates plus a risk premium for term funding and one has the bond rate. Bonds are an inverse investment, thus a zero short interest rate is the highest price base possible for bonds. Bonds are as expensive as they can get. That is ground zero for bonds and it originates from a zero interest rate policy
The zero interest rate policy is at the epicentre of the economic distortion. It sends shock waves via investment channels to distort the investment landscape into a twisted and contorted vision of what aught not be. No market can exist without buyers and sellers yet a zero interest rate policy gives zero interest to the saver. The seller of savings is offered nothing, zero and is driven out of the market to be replaced by the central bank providing liquidity. It is an ultimate distortion, one that cannot be corrected unless the central bank withdraws from the position of the saver. That can only be accomplished by increasing interest rates and the economic consequences that follows such structural re-adjustment. It is a ground zero trap.
Having driven the saver out of interest bearing investments is but the start of the process. Where will the saver turn? The three pillars of investment, interest bearing securities, property and shares. Bonds will suffer huge capital losses if interest rates were to move away from zero. So investors must choose between recovery or permanent zero short interest rates. Residential property is a bubble in deflation. Commercial property is a bubble in deflation. Any professional investor in property will know that property is valued on a yield basis and that yield is tied to interest rates. Property has the same inherent pricing structure as bonds; its value is at a maximum when interest rates are at its lowest. Again lower than zero it cannot be.
The first two pillars of investment look decidedly shaky. The saver moves along and plunges into shares but in the search for yield start behaving just as mortgage bankers did taking on the sub prime debt, the no documents - no questions asked investment decisions. Investment funds are channelled into emerging markets on the flimsy argument that these economies can do the heavy lifting to get the global economy on the road to recovery. Exactly how that is supposed to take place is shrouded in mystery.
So we stand back and observe how the structural aberration of zero interest rates forces investment funds into classic stock exchange inflations and see the absence of harmony with the real economy. The participants in this asset inflation are well aware of it but hoping for a rescue from a recovery which by definition cannot co-exist with zero interest rates.
Yet even the stock exchanges are unable to contain the push of zero interest rates. Investment funds spill over into commodities and further distort emerging market investment. Exchange rates between weak economies and strong economies express as strong currencies for minions and weak currencies for giants. We note leading indicators measuring the stock exchange exuberance and the results of relentless “green shoots”, “better than expected” and “stimulations” propaganda to mislead investors further into risky assets. Emerging markets pile on debt and stock exchange investments in “strong currencies” which their populations can never hope to repay. Debt, which is uncovered for exchange rate risk since the currencies are appreciating. Debt, when it is called will drop their currencies faster than the mercury in a tropical storm. These emerging markets will default as they must just as weak unsuitable debtors had to default on their mortgage loans. The only difference is the bubble in residential property and the bubble in emerging market currencies. “House prices never fall” is a much stronger hope to cling to as opposed to “emerging currencies will keep rising”. Pushing giant economies’ stimulation liquidity into emerging markets is no panacea for the global economic woes, nor will it restore any of the structural deficiencies of abused monetary and fiscal policies. A weak currency policy of giant economies is the script for sovereign defaults. Special Drawing Rights from the IMF cannot prevent sovereign defaults. It will only deepen the debt trap when the illusion of bubble currencies is exposed.
Here is where we need to apply the five finger rule? What’s in it for the emerging markets (or what was in it for the sub prime borrower)? What’s in it for the investor in emerged markets who looks beyond the yield pick-up (or what was in it for the mortgage and investment bankers who dabbled in sub prime debt and its securities and did not consider the liquidity trap of rising residential property prices)? What’s in it for investors to participate in stock exchange inflations, (or what was in it for those who fell over the cliff)?
The ultimate “what’s in it for me?” question is the one governments will soon be asking about stimulations. What is government looking to get out of stimulations? Government will look at its own pocket and will ask the question, “do we get more tax as a result of our stimulations?” and the answer will be patently clear. Ground zero for fiscal policy will be the realisation that stimulations are not a miracle economic cure and as with zero interest rates, a fiscal choice will be made for permanent structural distortion or a new beginning. Japan chose the former on monetary and fiscal policy. Will all leading economies follow the example of Japan into a twenty year economic wilderness?
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
25 October 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
So we ask of the stock exchange; is it time to buy or time to sell? Buy low and sell high. Perhaps we look at residential property and ask if it is time to buy or sell. Buy low and sell high. What about commercial and industrial property? Buy low and sell high. How about government bonds? Buy low and sell high.
These questions are asked within a relative frame of reference but when we ask the bond question it is when we hit ground zero. The “risk free” short term interest rate is set at zero. Zero is as low as it gets, it simply cannot go lower. Zero interest rates plus a risk premium for term funding and one has the bond rate. Bonds are an inverse investment, thus a zero short interest rate is the highest price base possible for bonds. Bonds are as expensive as they can get. That is ground zero for bonds and it originates from a zero interest rate policy
The zero interest rate policy is at the epicentre of the economic distortion. It sends shock waves via investment channels to distort the investment landscape into a twisted and contorted vision of what aught not be. No market can exist without buyers and sellers yet a zero interest rate policy gives zero interest to the saver. The seller of savings is offered nothing, zero and is driven out of the market to be replaced by the central bank providing liquidity. It is an ultimate distortion, one that cannot be corrected unless the central bank withdraws from the position of the saver. That can only be accomplished by increasing interest rates and the economic consequences that follows such structural re-adjustment. It is a ground zero trap.
Having driven the saver out of interest bearing investments is but the start of the process. Where will the saver turn? The three pillars of investment, interest bearing securities, property and shares. Bonds will suffer huge capital losses if interest rates were to move away from zero. So investors must choose between recovery or permanent zero short interest rates. Residential property is a bubble in deflation. Commercial property is a bubble in deflation. Any professional investor in property will know that property is valued on a yield basis and that yield is tied to interest rates. Property has the same inherent pricing structure as bonds; its value is at a maximum when interest rates are at its lowest. Again lower than zero it cannot be.
The first two pillars of investment look decidedly shaky. The saver moves along and plunges into shares but in the search for yield start behaving just as mortgage bankers did taking on the sub prime debt, the no documents - no questions asked investment decisions. Investment funds are channelled into emerging markets on the flimsy argument that these economies can do the heavy lifting to get the global economy on the road to recovery. Exactly how that is supposed to take place is shrouded in mystery.
So we stand back and observe how the structural aberration of zero interest rates forces investment funds into classic stock exchange inflations and see the absence of harmony with the real economy. The participants in this asset inflation are well aware of it but hoping for a rescue from a recovery which by definition cannot co-exist with zero interest rates.
Yet even the stock exchanges are unable to contain the push of zero interest rates. Investment funds spill over into commodities and further distort emerging market investment. Exchange rates between weak economies and strong economies express as strong currencies for minions and weak currencies for giants. We note leading indicators measuring the stock exchange exuberance and the results of relentless “green shoots”, “better than expected” and “stimulations” propaganda to mislead investors further into risky assets. Emerging markets pile on debt and stock exchange investments in “strong currencies” which their populations can never hope to repay. Debt, which is uncovered for exchange rate risk since the currencies are appreciating. Debt, when it is called will drop their currencies faster than the mercury in a tropical storm. These emerging markets will default as they must just as weak unsuitable debtors had to default on their mortgage loans. The only difference is the bubble in residential property and the bubble in emerging market currencies. “House prices never fall” is a much stronger hope to cling to as opposed to “emerging currencies will keep rising”. Pushing giant economies’ stimulation liquidity into emerging markets is no panacea for the global economic woes, nor will it restore any of the structural deficiencies of abused monetary and fiscal policies. A weak currency policy of giant economies is the script for sovereign defaults. Special Drawing Rights from the IMF cannot prevent sovereign defaults. It will only deepen the debt trap when the illusion of bubble currencies is exposed.
Here is where we need to apply the five finger rule? What’s in it for the emerging markets (or what was in it for the sub prime borrower)? What’s in it for the investor in emerged markets who looks beyond the yield pick-up (or what was in it for the mortgage and investment bankers who dabbled in sub prime debt and its securities and did not consider the liquidity trap of rising residential property prices)? What’s in it for investors to participate in stock exchange inflations, (or what was in it for those who fell over the cliff)?
The ultimate “what’s in it for me?” question is the one governments will soon be asking about stimulations. What is government looking to get out of stimulations? Government will look at its own pocket and will ask the question, “do we get more tax as a result of our stimulations?” and the answer will be patently clear. Ground zero for fiscal policy will be the realisation that stimulations are not a miracle economic cure and as with zero interest rates, a fiscal choice will be made for permanent structural distortion or a new beginning. Japan chose the former on monetary and fiscal policy. Will all leading economies follow the example of Japan into a twenty year economic wilderness?
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
25 October 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Tuesday, September 29, 2009
Monday, September 28, 2009
The Taxman’s at the Door
Tax is about to hit you like a bare fisted punch in the eye. You will be stripped of all your income, assets and savings as government drowns in deficits and debt. Is this the way it will turn out? Not likely. Certainly, government is drowning in deficits and debt but the taxation will arrive wrapped in the silky touch of the best propaganda machinery ever devised by masterful spin doctors. Your unprotected wealth, income and savings will more likely be dragged naked over a coral reef to die a slow death by a million tiny cuts. Then, when you look upon the dry corpse of your once liquid wealth consider this; all stimulations must be paid for in tax!
Here is the need. Would you dare to extrapolate this chart into the future?
How much taxation will it take to turn this chart down?
The tax will arrive in direct taxes for those who cannot revolt. To the others it will arrive in the form of indirect taxes disguised as anything but tax.
The official Corporate and Individual tax data to the end of 2007 look like this.
A bursting tax bubble has thrashed 50% off the previous $400billion corporate income tax take. Who talks their book when they say we have a recovery under way (see also charts further down)? Don’t you just love a bubble economy and the 1, 2, 3, 4 tax spikes? This is the business of maximizing tax income for government. Now visualize in your mind the spike that will be required to replace the direct and indirect tax collections from the 2003-2007 bubble episode.
FED data ends on 01/01/2008 and Personal Income Tax Receipts were still peaking. Growing unemployment is going to play havoc with this number.
Again the 1, 2, 3, 4 tax spikes. For a more up to date macro assessment complete with projections into a murky future we turn to data from the White House Office of Management and Budget.
The question may be asked; how often do we see significant declines in tax receipts? Rarely.
The events of 1929 are clearly relevant given that it was the only other previous incidence in more than a hundred years, apart from the year post WW2 which saw a significant drop in tax income. The data from the White House covers this period in detail.
The 1929 crash and its aftermath share another very important characteristic with the 2007 crash and its aftermath, a significant debt bubble. So how does the fiscal experiences of the depression compare with the modern experience of a debt bubble?
The tax collected by government saw a dramatic decline of 52.6% in the aftermath of the 1929 crash, while government spending was certainly in stimulation mode. Notably, taxation accelerated in spectacular fashion by 251% from $1,9bil in 1932 to $6.4bil in 1938. Growth during this period remained anaemic. In fact, the GDP growth fell dramatically from 1930 to 1933 and even by 1940 had not yet regained the GDP level of 1930 in spite of government stimulations in the 1930’s greater than anything implemented fiscally since 2007. Monetary policy was the dominant choice since 2007 but I have written often on monetary policy, here the focus is on fiscal policy. Observe that a weak economy is no protection against increased taxation.
The modern debt bubble has been under construction from 1980 until it popped in 2007. The chart hereunder picks up the story in 1990.
So much for counter cyclical fiscal behavior when tax receipts fell short of government spending in each of the boom years of 2003 to 2007. Tax collections though down, still held up in 2008 but took a 17.8% tumble into 2009. Again we note the discrepancy between tax collection and all the talk of recovery together with the exceptional performance of stock exchanges. The 2009 estimates have been presented on the 25th of August 2009 and should be close to the expected actual number. Expectations of a rise in tax collections in 2010 may be premature. The experience in 1929 where tax receipts not only dropped by more than 50% but also did not recover to the 1930 level until six years later in 1936 may indicate potential for a less favorable outcome than the current expectation and estimates.
The subset of Income Tax data yields further interesting data.
The official estimates of Income Tax collections are optimistic, particularly regarding individual taxes which are expected to exceed the 2007/08 levels by 2012. No tax recipes are expected to fall below 2009 levels and income tax collections will start rising as early as 2010 according to current estimates. I expect the tendency of downward revisions in actual tax receipts so prevalent in the Mid-Session Review of the Budget released in August 2009, to be with us for at least thru 2010.
Be sure to note the dramatic shift towards relying on personal income taxes in the modern USA budget. What will be the origin of the tax growth when the best case scenario is a “jobless” recovery and unemployment has yet to level out? Also, for a better perspective on a trillion dollar stimulation consider carefully how it equates to the total per annum Income Tax collected from individuals as averaged between 2005 and 2009. It is of particular interest to see that estimates of Corporate Income Taxes are for a fast recovery to 2007 levels and then to remain static until 2019. I find this projection a combination of opportunism and pessimism, even contrived when one observe the relentless growth projected for Individual Income Taxes against the static projection for Corporate Income Taxes. When the politicians say “Read my lips - no increased taxes”. Don’t. Rather read the charts.
Now for a look at Income Taxes during the period 1934 to 1938.
The burden was shared equally between Individual and Corporate Income Taxes during this period of economic history. The real story remains the dramatic increase in tax collected in the shadow of fiscal deficits and stimulations. Taxes in both categories increased more than 3 fold over this period. It is no coincidence that the Emergency Banking Relief Act of 1933 was passed in March 1933 confiscating Gold holdings to boost the coffers of the state. The need was great and gold confiscation was a tax against “hoarding”, popular with all non gold owning voters.
Stimulation remorse will be of no help. What’s done is done. The tax bill is in the post. TAX is what pays back government debt, a bit of inflation just hides the method and hyperinflation pays nobody. Hyperinflation simply destroys the economy and the currency. Hyperinflation means a lot of pain but no net real gain for anybody, including government. Thus do not look upon hyperinflation as an escape route from the inevitable reality of taxation unless you are prepared to pay the ultimate economic price.
The USA has its international debt in US$’s, while most other countries’ international debt is denominated in a currency other than its own. Any depreciation of the US$ against other currencies will depreciate the international debt of the USA but at a huge cost to imported inflation. It is taxation from behind that most precious and coveted international comparative advantage, the reserve and trade currency of the world. Having the reserve currency of the world allows one the use of money creation to sneak taxation across international borders, yet it is but one of many advantages. Only the most desperate politician would cash in this chip for a short term stealth tax gain. When they do, they may prompt the Chinese and all other funding nations to ask the question; “whose tax base is it anyway?”
Stimulations from central government in whatever form they may take are “fly-now-pay-later” schemes. Japan tried the stimulation-and-recovery trick recently and it failed. In 2009 everybody is pinning their hopes on a global stimulation-and-recovery trick to work. Children marvel at magic tricks but they do not actually believe in them. Intelligent adults seem to have bet their entire economic futures and their children’s economic fortunes on the trick of stimulation and recovery. A spontaneous economic recovery may rescue the global economy. In the ensuing boom Government can collect the required tax shortfalls without a taxpayer backlash. That is the wistful thinking. Cause and effect says it is more likely that the excessive abuse of debt may force a realignment of economic structural distortions. No recovery but, as with the housing bubble and like a bad hangover, the government debt will remain after the stimulation bubbly has been consumed.
The bullish thesis is entirely reliant upon the “stimulation-and-recovery” trick. The fear that shows the white of their eyes at any talk about withdrawing “stimulation” is sufficient to expose the anchor of the bullish thesis. The bears fear “stimulation” equally but not for it’s so called potential to heal the economy, rather for its potential to cause bear rallies. Thus the bulls love stimulations for it allows speculative trading with the support and blessing of government while slaughtering the bears. It may be a tragic drama or an exiting adrenalin rush depending on your favourite candidate but in the bigger picture it is the cost of the game and who will foot the bill that counts.
Government will kick the tax can down the road until it runs out of credit like every reckless borrower eventually must. The alternative is debt revulsion for public debt but that is a responsible outcome where the opportunism of cashing in on stimulations is more likely to draw the crowds. Again, Japan has set the example running up public debt four fold since 1990 and reaped only a 20 year deflationary slump in return.
Consider the harm to the Japanese taxpaying generation who will have to pay for that gratuitous spending frenzy.
Look upon the projected US Government Spending from 2010 to 2019 (hereunder) and the very first chart in this essay of US Total Public Debt, then contemplate who will pay, when the taxman comes knocking…
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 September 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Here is the need. Would you dare to extrapolate this chart into the future?
How much taxation will it take to turn this chart down?
The tax will arrive in direct taxes for those who cannot revolt. To the others it will arrive in the form of indirect taxes disguised as anything but tax.
The official Corporate and Individual tax data to the end of 2007 look like this.
A bursting tax bubble has thrashed 50% off the previous $400billion corporate income tax take. Who talks their book when they say we have a recovery under way (see also charts further down)? Don’t you just love a bubble economy and the 1, 2, 3, 4 tax spikes? This is the business of maximizing tax income for government. Now visualize in your mind the spike that will be required to replace the direct and indirect tax collections from the 2003-2007 bubble episode.
FED data ends on 01/01/2008 and Personal Income Tax Receipts were still peaking. Growing unemployment is going to play havoc with this number.
Again the 1, 2, 3, 4 tax spikes. For a more up to date macro assessment complete with projections into a murky future we turn to data from the White House Office of Management and Budget.
The question may be asked; how often do we see significant declines in tax receipts? Rarely.
The events of 1929 are clearly relevant given that it was the only other previous incidence in more than a hundred years, apart from the year post WW2 which saw a significant drop in tax income. The data from the White House covers this period in detail.
The 1929 crash and its aftermath share another very important characteristic with the 2007 crash and its aftermath, a significant debt bubble. So how does the fiscal experiences of the depression compare with the modern experience of a debt bubble?
The tax collected by government saw a dramatic decline of 52.6% in the aftermath of the 1929 crash, while government spending was certainly in stimulation mode. Notably, taxation accelerated in spectacular fashion by 251% from $1,9bil in 1932 to $6.4bil in 1938. Growth during this period remained anaemic. In fact, the GDP growth fell dramatically from 1930 to 1933 and even by 1940 had not yet regained the GDP level of 1930 in spite of government stimulations in the 1930’s greater than anything implemented fiscally since 2007. Monetary policy was the dominant choice since 2007 but I have written often on monetary policy, here the focus is on fiscal policy. Observe that a weak economy is no protection against increased taxation.
The modern debt bubble has been under construction from 1980 until it popped in 2007. The chart hereunder picks up the story in 1990.
So much for counter cyclical fiscal behavior when tax receipts fell short of government spending in each of the boom years of 2003 to 2007. Tax collections though down, still held up in 2008 but took a 17.8% tumble into 2009. Again we note the discrepancy between tax collection and all the talk of recovery together with the exceptional performance of stock exchanges. The 2009 estimates have been presented on the 25th of August 2009 and should be close to the expected actual number. Expectations of a rise in tax collections in 2010 may be premature. The experience in 1929 where tax receipts not only dropped by more than 50% but also did not recover to the 1930 level until six years later in 1936 may indicate potential for a less favorable outcome than the current expectation and estimates.
The subset of Income Tax data yields further interesting data.
The official estimates of Income Tax collections are optimistic, particularly regarding individual taxes which are expected to exceed the 2007/08 levels by 2012. No tax recipes are expected to fall below 2009 levels and income tax collections will start rising as early as 2010 according to current estimates. I expect the tendency of downward revisions in actual tax receipts so prevalent in the Mid-Session Review of the Budget released in August 2009, to be with us for at least thru 2010.
Be sure to note the dramatic shift towards relying on personal income taxes in the modern USA budget. What will be the origin of the tax growth when the best case scenario is a “jobless” recovery and unemployment has yet to level out? Also, for a better perspective on a trillion dollar stimulation consider carefully how it equates to the total per annum Income Tax collected from individuals as averaged between 2005 and 2009. It is of particular interest to see that estimates of Corporate Income Taxes are for a fast recovery to 2007 levels and then to remain static until 2019. I find this projection a combination of opportunism and pessimism, even contrived when one observe the relentless growth projected for Individual Income Taxes against the static projection for Corporate Income Taxes. When the politicians say “Read my lips - no increased taxes”. Don’t. Rather read the charts.
Now for a look at Income Taxes during the period 1934 to 1938.
The burden was shared equally between Individual and Corporate Income Taxes during this period of economic history. The real story remains the dramatic increase in tax collected in the shadow of fiscal deficits and stimulations. Taxes in both categories increased more than 3 fold over this period. It is no coincidence that the Emergency Banking Relief Act of 1933 was passed in March 1933 confiscating Gold holdings to boost the coffers of the state. The need was great and gold confiscation was a tax against “hoarding”, popular with all non gold owning voters.
Stimulation remorse will be of no help. What’s done is done. The tax bill is in the post. TAX is what pays back government debt, a bit of inflation just hides the method and hyperinflation pays nobody. Hyperinflation simply destroys the economy and the currency. Hyperinflation means a lot of pain but no net real gain for anybody, including government. Thus do not look upon hyperinflation as an escape route from the inevitable reality of taxation unless you are prepared to pay the ultimate economic price.
The USA has its international debt in US$’s, while most other countries’ international debt is denominated in a currency other than its own. Any depreciation of the US$ against other currencies will depreciate the international debt of the USA but at a huge cost to imported inflation. It is taxation from behind that most precious and coveted international comparative advantage, the reserve and trade currency of the world. Having the reserve currency of the world allows one the use of money creation to sneak taxation across international borders, yet it is but one of many advantages. Only the most desperate politician would cash in this chip for a short term stealth tax gain. When they do, they may prompt the Chinese and all other funding nations to ask the question; “whose tax base is it anyway?”
Stimulations from central government in whatever form they may take are “fly-now-pay-later” schemes. Japan tried the stimulation-and-recovery trick recently and it failed. In 2009 everybody is pinning their hopes on a global stimulation-and-recovery trick to work. Children marvel at magic tricks but they do not actually believe in them. Intelligent adults seem to have bet their entire economic futures and their children’s economic fortunes on the trick of stimulation and recovery. A spontaneous economic recovery may rescue the global economy. In the ensuing boom Government can collect the required tax shortfalls without a taxpayer backlash. That is the wistful thinking. Cause and effect says it is more likely that the excessive abuse of debt may force a realignment of economic structural distortions. No recovery but, as with the housing bubble and like a bad hangover, the government debt will remain after the stimulation bubbly has been consumed.
The bullish thesis is entirely reliant upon the “stimulation-and-recovery” trick. The fear that shows the white of their eyes at any talk about withdrawing “stimulation” is sufficient to expose the anchor of the bullish thesis. The bears fear “stimulation” equally but not for it’s so called potential to heal the economy, rather for its potential to cause bear rallies. Thus the bulls love stimulations for it allows speculative trading with the support and blessing of government while slaughtering the bears. It may be a tragic drama or an exiting adrenalin rush depending on your favourite candidate but in the bigger picture it is the cost of the game and who will foot the bill that counts.
Government will kick the tax can down the road until it runs out of credit like every reckless borrower eventually must. The alternative is debt revulsion for public debt but that is a responsible outcome where the opportunism of cashing in on stimulations is more likely to draw the crowds. Again, Japan has set the example running up public debt four fold since 1990 and reaped only a 20 year deflationary slump in return.
Consider the harm to the Japanese taxpaying generation who will have to pay for that gratuitous spending frenzy.
Look upon the projected US Government Spending from 2010 to 2019 (hereunder) and the very first chart in this essay of US Total Public Debt, then contemplate who will pay, when the taxman comes knocking…
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 September 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Tuesday, September 22, 2009
Dr Copper speaks on the economic recovery
It is said that copper (Cu) has a PhD in economics. The logic is that copper is found in almost every human economic endeavour and it is representative in all economies around the globe. The simplistic approach is that all the pertinent information about copper will be reflected in its price. Bare bones, look at the price action of copper and it will tell you what is happening in the economy.
Well, let’s interview Dr Copper and find its views on the state of the global economy.
First the basics, where are we?
Source: Kitco.com
The five year price action says “V” shape recovery. That is when one does not place too much emphasis on the bubble-like behaviour between 2004 and 2009. The five year volume data brings some uneasiness to the basic price action observation. Stock levels are still high and they are now also rising in a “V” shape. Where is the devil’s ton, that one ton of extra production which tips the price into a downward plunge?
One year price action is, of late more muted. The rising stock levels are seemingly in harmony with a lateral movement in the US$ price action since July 2009.
Looking only at copper in US$ terms does not represent a global picture. How does Dr Copper express itself in the major economies and some regional economies? It would also be useful to have a global benchmark which will be representative of currencies and commodities. Gold is the natural choice.
GOLD
Copper is expressed in ounces of gold in the same way as the copper price can be expressed in any currency. The price action of copper expressed in gold shows a peak and decline as opposed to the lateral price movement in US$.
Price action is what we are interested in and having established a gold benchmark we can now observe the relative currency performance against the benchmark.
US$
Short term flat and in step with benchmark but copper is becoming more expensive in US$ than in gold of late.
Euro (EU)
Short term flat and the Euro price trend for copper relative to the benchmark is about the same.
Japanese Yen
Short term trending down in Yen but copper relative to the benchmark is becoming more expensive in Yen.
UK Pound Sterling
Short term trending down and copper is becoming more expensive relative to gold in terms of Sterling.
Chinese Yuan
A short term rising copper price in Yuan and only very recently becoming more expensive relative to the benchmark.
Brazilian Real
A short term falling copper price in Reals and more expensive relative to the benchmark.
Indian Rupee
The Indian Rupee copper price has hugged the gold copper price like a lovesick teenager for most of this period. The short trend for the copper price in Rupees is flat and to trend more expensive relative to the benchmark.
Australian $
The short term copper price trend in Aus$’s is down. Price action against the benchmark is in lockstep.
South African Rand (ZAR)
Similar to the Aus$. Short trend copper rand is down.
Polish Zloty
The copper price in Zloty’s is trending flat and is becoming more expensive relative to the benchmark.
Dr Copper is somewhat stingy with its price action information on the economy and the current trends are anything but robust. The copper price was up strong in some currencies, not so strong in others. Now the copper price is trending flat to down in most cases. The results can be summarised in a table.
Chinese stockpiling is probably behind the price trend in the Yuan price of copper. The rest is giving a weak down signal at this stage. Only the two gold producers and the EU managed to hold their own against the gold price of copper.
The tentative results can be supplemented by looking at the relative price change in the various currencies since the beginning of the year. How did these currencies perform relative to copper?
The relative performances can be expanded to also measure the standing of the currencies against the gold price of copper. The Euro no longer performs when assessed in absolute terms and the Real is on top with absolute performance. Now if Dr Copper would just tell us whether we should consider the Brazilian economy strong or weak? Ditto on the Indian economy.
Extracting information from Dr Copper by looking at the price action is a tedious process. The “V” shaped recovery as presented in US$ price of copper has more to do with a weaker US$ than with a recovery in the global economy when one compare the performance of copper against gold and particularly commodity producing country currencies. Stockpiling and diversification from currency risk takes another bite from the uptrend in the copper price, neither of which is indicative of an economic recovery. The short term copper price trend gives a weak downward signal in spite of the continued need for store-of-value diversification.
Dr Copper says that we should be weary of proclaiming a “V” shaped recovery and in fact should be careful with any claims to a recovery until we see some more solid evidence. The warning is a bit more pronounced when Dr Copper and gold speak in unison on currencies and the devil’s ton is lurking in rising stockpiles.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
23 September 2009
© Sarel Oberholster
(Click on any of the charts for a larger version.)
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Well, let’s interview Dr Copper and find its views on the state of the global economy.
First the basics, where are we?
Source: Kitco.com
The five year price action says “V” shape recovery. That is when one does not place too much emphasis on the bubble-like behaviour between 2004 and 2009. The five year volume data brings some uneasiness to the basic price action observation. Stock levels are still high and they are now also rising in a “V” shape. Where is the devil’s ton, that one ton of extra production which tips the price into a downward plunge?
One year price action is, of late more muted. The rising stock levels are seemingly in harmony with a lateral movement in the US$ price action since July 2009.
Looking only at copper in US$ terms does not represent a global picture. How does Dr Copper express itself in the major economies and some regional economies? It would also be useful to have a global benchmark which will be representative of currencies and commodities. Gold is the natural choice.
GOLD
Copper is expressed in ounces of gold in the same way as the copper price can be expressed in any currency. The price action of copper expressed in gold shows a peak and decline as opposed to the lateral price movement in US$.
Price action is what we are interested in and having established a gold benchmark we can now observe the relative currency performance against the benchmark.
US$
Short term flat and in step with benchmark but copper is becoming more expensive in US$ than in gold of late.
Euro (EU)
Short term flat and the Euro price trend for copper relative to the benchmark is about the same.
Japanese Yen
Short term trending down in Yen but copper relative to the benchmark is becoming more expensive in Yen.
UK Pound Sterling
Short term trending down and copper is becoming more expensive relative to gold in terms of Sterling.
Chinese Yuan
A short term rising copper price in Yuan and only very recently becoming more expensive relative to the benchmark.
Brazilian Real
A short term falling copper price in Reals and more expensive relative to the benchmark.
Indian Rupee
The Indian Rupee copper price has hugged the gold copper price like a lovesick teenager for most of this period. The short trend for the copper price in Rupees is flat and to trend more expensive relative to the benchmark.
Australian $
The short term copper price trend in Aus$’s is down. Price action against the benchmark is in lockstep.
South African Rand (ZAR)
Similar to the Aus$. Short trend copper rand is down.
Polish Zloty
The copper price in Zloty’s is trending flat and is becoming more expensive relative to the benchmark.
Dr Copper is somewhat stingy with its price action information on the economy and the current trends are anything but robust. The copper price was up strong in some currencies, not so strong in others. Now the copper price is trending flat to down in most cases. The results can be summarised in a table.
Chinese stockpiling is probably behind the price trend in the Yuan price of copper. The rest is giving a weak down signal at this stage. Only the two gold producers and the EU managed to hold their own against the gold price of copper.
The tentative results can be supplemented by looking at the relative price change in the various currencies since the beginning of the year. How did these currencies perform relative to copper?
The relative performances can be expanded to also measure the standing of the currencies against the gold price of copper. The Euro no longer performs when assessed in absolute terms and the Real is on top with absolute performance. Now if Dr Copper would just tell us whether we should consider the Brazilian economy strong or weak? Ditto on the Indian economy.
Extracting information from Dr Copper by looking at the price action is a tedious process. The “V” shaped recovery as presented in US$ price of copper has more to do with a weaker US$ than with a recovery in the global economy when one compare the performance of copper against gold and particularly commodity producing country currencies. Stockpiling and diversification from currency risk takes another bite from the uptrend in the copper price, neither of which is indicative of an economic recovery. The short term copper price trend gives a weak downward signal in spite of the continued need for store-of-value diversification.
Dr Copper says that we should be weary of proclaiming a “V” shaped recovery and in fact should be careful with any claims to a recovery until we see some more solid evidence. The warning is a bit more pronounced when Dr Copper and gold speak in unison on currencies and the devil’s ton is lurking in rising stockpiles.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
23 September 2009
© Sarel Oberholster
(Click on any of the charts for a larger version.)
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Friday, September 18, 2009
Twin Peaks and the macro economic model of debt.
The correlation between the Dow and the Nikkei has been picked up by a number of other authors since the publication of the first Twin Peaks. It is of limited functional use without understanding the fundamental thesis behind its original creation and also the method of comparison.
It is statistically near impossible to have a visible and enduring correlation between the peak of the Nikkei in 1989 in Japan and the peak in the Dow in 2007 in the USA. To marvel at the correlation is to be distracted by a sideshow. The relationship between the peaks must also only be established at the peaks and not rebalanced thereafter. Rebalancing the correlation will facilitate a very close match but will defeat the whole object of the assessment for it will not allow the market drift to break off the correlation.
The thesis behind the twin peaks correlation is that Japan and the USA were and are implementing a similar macro economic model dominated by similar monetary and fiscal policies in two different economies in two different time periods. It therefore opens the probability that the outcomes in the two economies would tend to be similar. What then is the model?
This macro economic model is built upon dominant Central Government and Central Bank policy interventions based on mutually complimentary Monetary and Fiscal policies.
The first phase is dominated by a loose monetary policy whereby liquidity flows to the markets are maximised. These flows are channelled through the use of regulation and institutional design into asset inflations which are described as “wealth effects”. The conduit for the liquidity is mostly private debt formation anchored in asset collateral. Inflation in consumables is actively managed and discouraged. The underlying monetary policy floods the economy with liquidity to the point of debt saturation and follows the inevitable course to zero interest rates. Boom conditions are created during this first phase which boosts Central Government tax flows for “easy” fiscal conditions.
The advent of debt saturation in the private sector causes the collapse of the asset bubbles and the boom conditions disappear. The economic model now enters a second phase where Central Government is starved of taxable income. Monetary policy is shifted to accommodate rapid debt formation for Central Government. Every attempt is made to re-inflate the asset bubbles. Central Government in turn accelerates its spending, usually under the guise of so called “stimulation” ignoring falling tax inflows. Central Government will enjoy a “honeymoon” period within which it accelerates spending while placing no additional tax burden on its citizens. In fact, Central Government may even be using some of the debt to subsidise some or all taxpayers. Examples are tax rebates or “cash-for-clunkers” programmes. Monetary policy continues to maximise liquidity absorption but it manifests predominantly as Government debt. The honeymoon period is accommodated by a widening of the tax gap, the gap between Government spending and Government income from taxation. The “deficit”. The government pledging its future taxes to the money lenders.
The liquidity not destroyed in the collapse of the asset bubbles now teams up with the Central Government supply of liquidity to search out anything that may function as a store of value. Favourites are long life commodities and Stock Exchanges. The market for “stores of value” is soon in “inflation” conditions which will last for the duration of the “honeymoon” period of tax deferment.
The third phase is a long drawn out stage of stagnation and deflation. The unbreakable, undeniable law of taxation will assert itself. Government must tax for its spending. Dollar for dollar, pound for pound, yen for yen, yuan for yuan, euro for euro or whichever currency you wish to work in. The tax may be direct and visible or indirect through redistribution of the value of money away from taxpayers towards Government. A portion of the tax will be deferred to the future through Central Government borrowing but such borrowings are also subject to the laws of diminishing returns. Central Government debt formation is not divorced from the markets even with monetary policy support and will face increased resistance with each dollar increase in borrowing. The third phase is entered at the point where Central Government is forced to start closing the tax gap.
An alternative outcome for the third stage is economic and currency destruction in a hyperinflationary depression. It requires a policy of relentless “quantitative easing” whereby the Central Government ignores markets altogether to process its debt formation via unbridled money creation. I discuss this potential outcome in “War on Savings” which can be found on my blog.
Keynesian lore will propose that the economy will start growing as a result of the “stimulations” but it is simply a wish for rescue and certainly not a forgone conclusion. The irrefutable truth is that debt is not income and government spending can never be “income” for it can only originate as direct taxes (redistribution of someone else’s income), indirect taxes (monetary redistribution of purchasing power), or as debt which is simply deferred tax. There is no way around the law of taxation. Government must eventually tax dollar for dollar for its spending (the only question is who it will be – citizens of the USA or perhaps the savers of China?). That is the stasis trap of the third phase. Government debt formation slows down as it must. The tax gap can no longer be financed or expanded. Government and society now face the consequences of having spent the future.
Central Government must deal with the tax gap and the consequences of its own debt while the private sector must content with the consequences of its debt. Bubble formation is no longer an option as both the private sector and the public sector are soaked to saturation in debt. This is the set-up for the “lost decades” economic model.
The stock exchanges are but one place where we can monitor the development of the phases. We are presently in the tax honeymoon phase where society is growing polarised into “debtors” (often also called optimists, patriots or consumers) who believe that given enough “stimulation” a new boom will defer consequences once again; opposed by “savers” (often also called pessimists, traitors or hoarders) who are desperately trying to preserve the value of their savings. Both groups are looking at stock exchanges to obtain capital appreciation for debt repayment or capital protection against money creation. The Nikkei tells us a part of the story of the outcome for the Japanese participant who had to deal with this economic model. In the Twin Peaks charts I track and compare the outcomes of Japan and the USA as but one facet of the developments in an economic model built upon foundations of debt.
Here are the updated charts to Thursday 17th September 2009.
(Click to enlarge)
The Dow has moved above the Nikkei much like the first phase of the correlation after falling below the lows of the Nikkei in March 09. The correlation will have to reassert in a downward move towards a Dow of 5000 at around the end of May 2010 (Data table points; 5208 on 29 May 2010) to remain valid. It will take longer and go lower if recent history were to repeat. This correlation now runs over 488 data points from 9 October 2007 to 17 September 2009.
That is the near picture. Now for a look at the macro chart.
(Click to enlarge)
The keen observer will note the first bounce peak in the Nikkei (on the October 2008 grid) against the current levels of the Dow. I can give the data points for the 2020 lows or the 2026 lows but it would assume this correlation staying in place until then. For now, observation will do. I would prefer to heed the warning inherent to these charts and hope for outcomes which are not steeped in habitual debt formation, private or public.
I repeat my previous observation. These charts are not for day trading. These are trends within a macroeconomic argument. There is no statistical basis for a correlation of this duration and its continuation will be supportive of the underlying economic thesis. The thesis will have to be re-assessed in time, based on the outcome of this facet as well as all the other dynamics. I see no reason to revise or abandon the thesis at this stage and now am keenly interested to see if or when the correlation in the downswing reasserts.
Happy hunting.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
18 August 2009
Ps. I will continue to track the peaks and will publish another update should we see an interesting development. Otherwise expect an update in another two months.
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
It is statistically near impossible to have a visible and enduring correlation between the peak of the Nikkei in 1989 in Japan and the peak in the Dow in 2007 in the USA. To marvel at the correlation is to be distracted by a sideshow. The relationship between the peaks must also only be established at the peaks and not rebalanced thereafter. Rebalancing the correlation will facilitate a very close match but will defeat the whole object of the assessment for it will not allow the market drift to break off the correlation.
The thesis behind the twin peaks correlation is that Japan and the USA were and are implementing a similar macro economic model dominated by similar monetary and fiscal policies in two different economies in two different time periods. It therefore opens the probability that the outcomes in the two economies would tend to be similar. What then is the model?
This macro economic model is built upon dominant Central Government and Central Bank policy interventions based on mutually complimentary Monetary and Fiscal policies.
The first phase is dominated by a loose monetary policy whereby liquidity flows to the markets are maximised. These flows are channelled through the use of regulation and institutional design into asset inflations which are described as “wealth effects”. The conduit for the liquidity is mostly private debt formation anchored in asset collateral. Inflation in consumables is actively managed and discouraged. The underlying monetary policy floods the economy with liquidity to the point of debt saturation and follows the inevitable course to zero interest rates. Boom conditions are created during this first phase which boosts Central Government tax flows for “easy” fiscal conditions.
The advent of debt saturation in the private sector causes the collapse of the asset bubbles and the boom conditions disappear. The economic model now enters a second phase where Central Government is starved of taxable income. Monetary policy is shifted to accommodate rapid debt formation for Central Government. Every attempt is made to re-inflate the asset bubbles. Central Government in turn accelerates its spending, usually under the guise of so called “stimulation” ignoring falling tax inflows. Central Government will enjoy a “honeymoon” period within which it accelerates spending while placing no additional tax burden on its citizens. In fact, Central Government may even be using some of the debt to subsidise some or all taxpayers. Examples are tax rebates or “cash-for-clunkers” programmes. Monetary policy continues to maximise liquidity absorption but it manifests predominantly as Government debt. The honeymoon period is accommodated by a widening of the tax gap, the gap between Government spending and Government income from taxation. The “deficit”. The government pledging its future taxes to the money lenders.
The liquidity not destroyed in the collapse of the asset bubbles now teams up with the Central Government supply of liquidity to search out anything that may function as a store of value. Favourites are long life commodities and Stock Exchanges. The market for “stores of value” is soon in “inflation” conditions which will last for the duration of the “honeymoon” period of tax deferment.
The third phase is a long drawn out stage of stagnation and deflation. The unbreakable, undeniable law of taxation will assert itself. Government must tax for its spending. Dollar for dollar, pound for pound, yen for yen, yuan for yuan, euro for euro or whichever currency you wish to work in. The tax may be direct and visible or indirect through redistribution of the value of money away from taxpayers towards Government. A portion of the tax will be deferred to the future through Central Government borrowing but such borrowings are also subject to the laws of diminishing returns. Central Government debt formation is not divorced from the markets even with monetary policy support and will face increased resistance with each dollar increase in borrowing. The third phase is entered at the point where Central Government is forced to start closing the tax gap.
An alternative outcome for the third stage is economic and currency destruction in a hyperinflationary depression. It requires a policy of relentless “quantitative easing” whereby the Central Government ignores markets altogether to process its debt formation via unbridled money creation. I discuss this potential outcome in “War on Savings” which can be found on my blog.
Keynesian lore will propose that the economy will start growing as a result of the “stimulations” but it is simply a wish for rescue and certainly not a forgone conclusion. The irrefutable truth is that debt is not income and government spending can never be “income” for it can only originate as direct taxes (redistribution of someone else’s income), indirect taxes (monetary redistribution of purchasing power), or as debt which is simply deferred tax. There is no way around the law of taxation. Government must eventually tax dollar for dollar for its spending (the only question is who it will be – citizens of the USA or perhaps the savers of China?). That is the stasis trap of the third phase. Government debt formation slows down as it must. The tax gap can no longer be financed or expanded. Government and society now face the consequences of having spent the future.
Central Government must deal with the tax gap and the consequences of its own debt while the private sector must content with the consequences of its debt. Bubble formation is no longer an option as both the private sector and the public sector are soaked to saturation in debt. This is the set-up for the “lost decades” economic model.
The stock exchanges are but one place where we can monitor the development of the phases. We are presently in the tax honeymoon phase where society is growing polarised into “debtors” (often also called optimists, patriots or consumers) who believe that given enough “stimulation” a new boom will defer consequences once again; opposed by “savers” (often also called pessimists, traitors or hoarders) who are desperately trying to preserve the value of their savings. Both groups are looking at stock exchanges to obtain capital appreciation for debt repayment or capital protection against money creation. The Nikkei tells us a part of the story of the outcome for the Japanese participant who had to deal with this economic model. In the Twin Peaks charts I track and compare the outcomes of Japan and the USA as but one facet of the developments in an economic model built upon foundations of debt.
Here are the updated charts to Thursday 17th September 2009.
(Click to enlarge)
The Dow has moved above the Nikkei much like the first phase of the correlation after falling below the lows of the Nikkei in March 09. The correlation will have to reassert in a downward move towards a Dow of 5000 at around the end of May 2010 (Data table points; 5208 on 29 May 2010) to remain valid. It will take longer and go lower if recent history were to repeat. This correlation now runs over 488 data points from 9 October 2007 to 17 September 2009.
That is the near picture. Now for a look at the macro chart.
(Click to enlarge)
The keen observer will note the first bounce peak in the Nikkei (on the October 2008 grid) against the current levels of the Dow. I can give the data points for the 2020 lows or the 2026 lows but it would assume this correlation staying in place until then. For now, observation will do. I would prefer to heed the warning inherent to these charts and hope for outcomes which are not steeped in habitual debt formation, private or public.
I repeat my previous observation. These charts are not for day trading. These are trends within a macroeconomic argument. There is no statistical basis for a correlation of this duration and its continuation will be supportive of the underlying economic thesis. The thesis will have to be re-assessed in time, based on the outcome of this facet as well as all the other dynamics. I see no reason to revise or abandon the thesis at this stage and now am keenly interested to see if or when the correlation in the downswing reasserts.
Happy hunting.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
18 August 2009
Ps. I will continue to track the peaks and will publish another update should we see an interesting development. Otherwise expect an update in another two months.
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Monday, August 24, 2009
Bank Corpses on Friday Nights
“The pursuit of the Bank's vision will express itself through leadership in the formulation, implementation and monitoring of policies and action plans for fighting inflation, stabilisation of the internal and external value of Zimbabwe's currency and of the financial system in a manner that gives pride of achievement to Zimbabweans across the board.” Mission Statement of the Reserve Bank of Zimbabwe
The banking Angel of Death descends like a curse on Friday nights to claim the lives of banks. Bankers must fear this weekly curse sufficiently to pack their cardboard boxes on Friday nights. One has to avoid the embarrassment of the Lehman employees who had to run from press photographers clinging to their boxes. Most unflattering and not good press for their next employment interview. So they probably keep their personal belongings at home over week-ends.
I want to concentrate on the vulnerabilities of systemic risk but a list of which bank died when for those interested can be found at this link http://www.fdic.gov/BANK/HISTORICAL/BANK/index.html . This Friday it was Guaranty Bank with assets of $13billion and a few others, last Friday it was Colonial Bank the 27th largest bank commercial bank in the USA according to Wikipedia and assets of $25billion and a few others. The fact is these banks are dead. The FDIC had 305 problem institutions and 21 failed institutions on its list as at 31 March 2009. We'll have to count the corpses at year end again. The reality of systemic failure is alive and well.
Negotiations over the week-end between survivors of the Friday Night Curse, the Fed and State Regulators will arrange for the removal of healthy organs, the surviving portfolios of debt. Deposit insurance from the FDIC will kick in to guarantee the courageous survivor brave enough to “take-over” the dead bank and will “share” losses. The Fed will shield the brave warrior from defaults with asset buybacks and showers of liquidity. Central Government will throw in a few more loss absorbing arrangements to sweeten the deal if needed. Until next Friday’s visit from the banking Angel of Death.
The reality is that these banks have died. It is no takeover. It is a redistribution of portfolios while the structure and business of the dead bank is cremated before sundown on Saturday night. All in all a morbid event reserved for week-ends. The hole in the economy is re-inflated with printing press money. Comes Monday the sunshine of a growing economy and the success of the Fed in saving the global economy from systemic collapse must be celebrated. On Mondays we joyously dance on the graves of the dead banks; long live the FED.
It is the systemic cycle of death. The Japanese came to know it well. Their politicians also celebrated recovery at every possible opportunity while hiding the systemic decay under the printing press. Reassurances of a return to the boom only faded after about 7 years had elapsed from that fateful December 29th 1989. If on Mondays the stock exchanges of the world look a bit shaky, it’s because of healthy profit taking (we certainly won’t mention dead banks and other doom and gloom events that firmly belongs to Saturday mornings).
What is all this raving about you may ask? It is about the process of systemic risk and a characteristic that systemic failure will never be admitted even when it is patently visible to all. There is a very good reason.
Systemic failure has two components. The first is failure of debt formation and the rise of a seemingly endless stream of defaults. It is in this phase that banks fail and creditors are parted from their savings by government sponsored initiatives to “forgive debt” offering creditors a fraction of their capital, or else… Having stripped the creditors of their savings does not repair the hole in the economy. It only moves the hardship from one spot in the economy to another. One which everybody seems to think is more able to absorb the loss. As Karl Marx has said, each to contribute according to his ability and each to receive according to his need. GM needs the money, AIG needs the money, CIT needs the money, Chrysler needs the money and even Readers Digest has negotiated a pre-arranged bankruptcy. A carwash system whereby any old dirty debt riddled business is taken to the drive through bankruptcy carwash to emerge sparkling clean and debt free on the other side compliments of a benign government and flabbergasted creditors. Thus the creditor had the “ability” and the debtor has the “need”. Sorry creditor, it’s not personal (it is political). The broken business model is saved until the next crises.
Transferring defaults to creditors is just one more way of discounting the future to today. The saver intended to use the savings for some future consumption which will no longer happen. It is replaced by the consumption that has happened and is now paid for by way of default. Most important, the saving has been wiped out, gone, transferred form the future to the past. Down we go on a slippery slope towards the second systemic event.
The destruction of the functional value of the currency. There are a number of components to this phase.
1. The destruction of the store of value characteristics of a currency.
2. The destruction of the value of the currency for settlement of cross border transactions (the exchange rate).
3. The destruction of the currency as a sovereign means of exchange thus destroying its ability to function as a money in any way (domestic settlements).
Zimbabwe knows all about currency destruction despite their very ironic mission statement. They no longer have a currency and mostly uses US$’s as a surrogate. Talk is they are contemplating a new currency backed by gold. Their stock exchange acted as a pretender store of value for a while and in the initial stages of the hyperinflation process was the best performing stock exchange in the world. The Zimbabwean Stock Exchange totally collapsed even before the Zimbabwean dollar was discontinued and only opened in February 2009 as a dysfunctional exchange hardly trading at all. Perhaps that is why the Zimbabwe government is not offering to back their currency with the stock exchange, only a real store of value will do. (Will all governments only offer responsible monetary management at the very end?) I have been told by Zimbabweans that the gold jewelers did very well during the rise and fall of hyperinflationary Zimbabwe.
Where the first phase is a deflationary phase, the second is the transition to asset bubbles, inflation and hyperinflation. A global deflation is terrifying but an economic process that we can survive. A global or just USA hyperinflation is an economic event of such finality that I place it on faith in the hands of intelligent people to prevent this outcome. The hardships of deflationary adjustment will be candy floss to the poison of a hyperinflationary event in the USA. I stubbornly believe that this outcome will be prevented politically.
The extent of undermining the functional value of the currency will dictate the extent of the inflationary pressure. Channeling money creation to assets is the preferred activity in a post debt bubble monetary environment. At first it will lead to the development of asset inflations in perceived stores of value. This does not yet alter the deflationary bias of the economy.
Hyperinflations across sovereign economies are associated with the destruction of the currency as a means of settling international transactions and in the final instance in the destruction of a currency to the extent that it can no longer function as a means of settlement of transactions within its sovereign borders. The epicenter again is money creation particularly in the interaction between the Central Bank and the banking sector of which the new open channel between the Fed and the erstwhile Investment Banks is a money creation distribution channel which pose severe asset inflation risks. This risk will be exacerbated where such banking entities are also primary dealers of Central Government debt securities. This channel is a money creation highway.
A government cannot debase through money creation its debt obligations by undermining the international value of its currency without severely damaging its ability to settle international transactions. There is no easy raid on foreign savings down this road.
It required the political desperation of a Weimar Germany or the monetary and fiscally but also politically reckless unrepentant political systems typical to recent hyperinflationary emerging economies to push an economy into hyperinflation. There is as yet no example of a failure of political processes in a modern democratic developed economy, which opened the door to hyperinflation. I sincerely hope to never see one.
Japan’s economy has very strong governmental control elements and a history of hyperinflations, yet they have averted the destruction of the currency since the advent of the Japanese crisis almost 20 years ago. They opted in stead for the stasis of monetary carries, i.e. the practice of creating money to contain any systemic collapse.
Destruction of a money is a relative process, one currency’s value against the value of all other currencies in the world and against all potential alternative stores of value. Stores of value will become extremely popular when all governments globally were to engage in policies aimed at destroying or undermining the relative value of their currencies. Even dubious “store of value” asset classes such as shares may be regarded as stores of value. From this is born the unique power of the US$ as reserve currency of the world to transfer the savings of the international saver in UD$ debt assets to a US$ creditor.
Second phase money creations are not a solution for the problems of the first phase. Currency destruction or a lesser undermining of the relative value of the currency in “carries”, will accelerate and deepen economic collapse from the monetary excesses of the first phase. Containment of the systemic events does exactly that. It undermines the sovereign and international value of the currency and postpones any recovery further into the future when it discounts income and tax receipts to today while transferring savings from those perceived by government as “able” to those perceived by government as “in need” (the government also has needs of its own).
Relative political power comes into play. Voting strength and the numbers are weighed in favor of the debtors. The power of the printing press is only a power to redistribute the wealth of a nation or in the case of the US$ the wealth of nations. It certainly does not create wealth. The redistribution allocations of the printing press are crude, patently unfair, fraught with self preserving ideals of politicians (and the head of the FED is certainly a politician), corrupt in allocating to powerful self serving interest groups and devastating to savers of which pension savings as a class is probably the most vulnerable.
Do not bow down and pay homage to the printing press for its ways are not the way to economic salvation. Do not succumb to the lure of asset inflations in your search for value. Take control of your savings and pick your stores of value with great care when you hear the beat of hammers nailing up the corpse of just one more bank on a Saturday morning.
“Admission’s free you pay to get out” Hellacious Acres (Words & Music by Paul Williams and Kenny Ascher – from a Star is born.)
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
25 August 2009
27 August 2009. The latest information from the FDIC is: 416 troubled banks. 81 banks have been taken over so far for 2009.
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
The banking Angel of Death descends like a curse on Friday nights to claim the lives of banks. Bankers must fear this weekly curse sufficiently to pack their cardboard boxes on Friday nights. One has to avoid the embarrassment of the Lehman employees who had to run from press photographers clinging to their boxes. Most unflattering and not good press for their next employment interview. So they probably keep their personal belongings at home over week-ends.
I want to concentrate on the vulnerabilities of systemic risk but a list of which bank died when for those interested can be found at this link http://www.fdic.gov/BANK/HISTORICAL/BANK/index.html . This Friday it was Guaranty Bank with assets of $13billion and a few others, last Friday it was Colonial Bank the 27th largest bank commercial bank in the USA according to Wikipedia and assets of $25billion and a few others. The fact is these banks are dead. The FDIC had 305 problem institutions and 21 failed institutions on its list as at 31 March 2009. We'll have to count the corpses at year end again. The reality of systemic failure is alive and well.
Negotiations over the week-end between survivors of the Friday Night Curse, the Fed and State Regulators will arrange for the removal of healthy organs, the surviving portfolios of debt. Deposit insurance from the FDIC will kick in to guarantee the courageous survivor brave enough to “take-over” the dead bank and will “share” losses. The Fed will shield the brave warrior from defaults with asset buybacks and showers of liquidity. Central Government will throw in a few more loss absorbing arrangements to sweeten the deal if needed. Until next Friday’s visit from the banking Angel of Death.
The reality is that these banks have died. It is no takeover. It is a redistribution of portfolios while the structure and business of the dead bank is cremated before sundown on Saturday night. All in all a morbid event reserved for week-ends. The hole in the economy is re-inflated with printing press money. Comes Monday the sunshine of a growing economy and the success of the Fed in saving the global economy from systemic collapse must be celebrated. On Mondays we joyously dance on the graves of the dead banks; long live the FED.
It is the systemic cycle of death. The Japanese came to know it well. Their politicians also celebrated recovery at every possible opportunity while hiding the systemic decay under the printing press. Reassurances of a return to the boom only faded after about 7 years had elapsed from that fateful December 29th 1989. If on Mondays the stock exchanges of the world look a bit shaky, it’s because of healthy profit taking (we certainly won’t mention dead banks and other doom and gloom events that firmly belongs to Saturday mornings).
What is all this raving about you may ask? It is about the process of systemic risk and a characteristic that systemic failure will never be admitted even when it is patently visible to all. There is a very good reason.
Systemic failure has two components. The first is failure of debt formation and the rise of a seemingly endless stream of defaults. It is in this phase that banks fail and creditors are parted from their savings by government sponsored initiatives to “forgive debt” offering creditors a fraction of their capital, or else… Having stripped the creditors of their savings does not repair the hole in the economy. It only moves the hardship from one spot in the economy to another. One which everybody seems to think is more able to absorb the loss. As Karl Marx has said, each to contribute according to his ability and each to receive according to his need. GM needs the money, AIG needs the money, CIT needs the money, Chrysler needs the money and even Readers Digest has negotiated a pre-arranged bankruptcy. A carwash system whereby any old dirty debt riddled business is taken to the drive through bankruptcy carwash to emerge sparkling clean and debt free on the other side compliments of a benign government and flabbergasted creditors. Thus the creditor had the “ability” and the debtor has the “need”. Sorry creditor, it’s not personal (it is political). The broken business model is saved until the next crises.
Transferring defaults to creditors is just one more way of discounting the future to today. The saver intended to use the savings for some future consumption which will no longer happen. It is replaced by the consumption that has happened and is now paid for by way of default. Most important, the saving has been wiped out, gone, transferred form the future to the past. Down we go on a slippery slope towards the second systemic event.
The destruction of the functional value of the currency. There are a number of components to this phase.
1. The destruction of the store of value characteristics of a currency.
2. The destruction of the value of the currency for settlement of cross border transactions (the exchange rate).
3. The destruction of the currency as a sovereign means of exchange thus destroying its ability to function as a money in any way (domestic settlements).
Zimbabwe knows all about currency destruction despite their very ironic mission statement. They no longer have a currency and mostly uses US$’s as a surrogate. Talk is they are contemplating a new currency backed by gold. Their stock exchange acted as a pretender store of value for a while and in the initial stages of the hyperinflation process was the best performing stock exchange in the world. The Zimbabwean Stock Exchange totally collapsed even before the Zimbabwean dollar was discontinued and only opened in February 2009 as a dysfunctional exchange hardly trading at all. Perhaps that is why the Zimbabwe government is not offering to back their currency with the stock exchange, only a real store of value will do. (Will all governments only offer responsible monetary management at the very end?) I have been told by Zimbabweans that the gold jewelers did very well during the rise and fall of hyperinflationary Zimbabwe.
Where the first phase is a deflationary phase, the second is the transition to asset bubbles, inflation and hyperinflation. A global deflation is terrifying but an economic process that we can survive. A global or just USA hyperinflation is an economic event of such finality that I place it on faith in the hands of intelligent people to prevent this outcome. The hardships of deflationary adjustment will be candy floss to the poison of a hyperinflationary event in the USA. I stubbornly believe that this outcome will be prevented politically.
The extent of undermining the functional value of the currency will dictate the extent of the inflationary pressure. Channeling money creation to assets is the preferred activity in a post debt bubble monetary environment. At first it will lead to the development of asset inflations in perceived stores of value. This does not yet alter the deflationary bias of the economy.
Hyperinflations across sovereign economies are associated with the destruction of the currency as a means of settling international transactions and in the final instance in the destruction of a currency to the extent that it can no longer function as a means of settlement of transactions within its sovereign borders. The epicenter again is money creation particularly in the interaction between the Central Bank and the banking sector of which the new open channel between the Fed and the erstwhile Investment Banks is a money creation distribution channel which pose severe asset inflation risks. This risk will be exacerbated where such banking entities are also primary dealers of Central Government debt securities. This channel is a money creation highway.
A government cannot debase through money creation its debt obligations by undermining the international value of its currency without severely damaging its ability to settle international transactions. There is no easy raid on foreign savings down this road.
It required the political desperation of a Weimar Germany or the monetary and fiscally but also politically reckless unrepentant political systems typical to recent hyperinflationary emerging economies to push an economy into hyperinflation. There is as yet no example of a failure of political processes in a modern democratic developed economy, which opened the door to hyperinflation. I sincerely hope to never see one.
Japan’s economy has very strong governmental control elements and a history of hyperinflations, yet they have averted the destruction of the currency since the advent of the Japanese crisis almost 20 years ago. They opted in stead for the stasis of monetary carries, i.e. the practice of creating money to contain any systemic collapse.
Destruction of a money is a relative process, one currency’s value against the value of all other currencies in the world and against all potential alternative stores of value. Stores of value will become extremely popular when all governments globally were to engage in policies aimed at destroying or undermining the relative value of their currencies. Even dubious “store of value” asset classes such as shares may be regarded as stores of value. From this is born the unique power of the US$ as reserve currency of the world to transfer the savings of the international saver in UD$ debt assets to a US$ creditor.
Second phase money creations are not a solution for the problems of the first phase. Currency destruction or a lesser undermining of the relative value of the currency in “carries”, will accelerate and deepen economic collapse from the monetary excesses of the first phase. Containment of the systemic events does exactly that. It undermines the sovereign and international value of the currency and postpones any recovery further into the future when it discounts income and tax receipts to today while transferring savings from those perceived by government as “able” to those perceived by government as “in need” (the government also has needs of its own).
Relative political power comes into play. Voting strength and the numbers are weighed in favor of the debtors. The power of the printing press is only a power to redistribute the wealth of a nation or in the case of the US$ the wealth of nations. It certainly does not create wealth. The redistribution allocations of the printing press are crude, patently unfair, fraught with self preserving ideals of politicians (and the head of the FED is certainly a politician), corrupt in allocating to powerful self serving interest groups and devastating to savers of which pension savings as a class is probably the most vulnerable.
Do not bow down and pay homage to the printing press for its ways are not the way to economic salvation. Do not succumb to the lure of asset inflations in your search for value. Take control of your savings and pick your stores of value with great care when you hear the beat of hammers nailing up the corpse of just one more bank on a Saturday morning.
“Admission’s free you pay to get out” Hellacious Acres (Words & Music by Paul Williams and Kenny Ascher – from a Star is born.)
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
25 August 2009
27 August 2009. The latest information from the FDIC is: 416 troubled banks. 81 banks have been taken over so far for 2009.
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Sunday, August 23, 2009
Run from your Money
Cash is trash, they say. You have to be fully invested, they say. Oil is going to $85, they say. The Dow Jones is going to 10,000, 12,000, 16,000 or more, they say. Buy copper, they say. Fill the warehouses with commodities or float fully loaded oil tankers but whatever you do you must run from your money. Interesting, why?
Because the central banks of the world has slipped the leach on the printing presses and the global economy is drowning in liquidity. The new game in town is to get hold of printing press money, preferably first and to convert it into a “store of value”. Flipping cash for stores of value is the way to go. Cash burning a hole in your pocket has a whole new meaning.
Funny thing about stores of value is the market chemical reaction to cash-is-trash liquidity flows. It changes colour like a magical chemical experiment and previous stores of value turn into red hot speculative assets, the next big thing. No longer is there any store of value intentions. All that remains is speculation on the next price increase. Flipping to the next big fool with a wad of cash to get rid of.
China said we will rid ourselves of the dollars and buy commodities. The Chinese population gets access to easy debt and floods the Hang Seng and Shanghai Composite with buy orders. “Investors” and Investment Banks draw down the cash and buy oil and the Dow. Get away from the sidelines and commit your cash is the refrain. The dollar is going to crash get out. Who knows what the miners do when they end up with all the cash?
Bubble, bubble, toil and trouble goes the nursery rhyme. Inflation is alive and well and living with the previously known as “stores of value”. Incredibly, gold is the Cinderella of the stores of value. Perhaps gold’s money prince will meet her at midnight when all other so called stores of value will be exposed as the ugly sisters.
Keynes’ saying “the market can be irrational longer than you can stay solvent” is another misguided observation of an interventionist. Are all these people really stupid? Were they stupid when they flipped houses? No, they were and are riding the wave of massive debt formation (then) and liquidity formation (now). The behaviour to get rid of the cash is fully consistent with the very logical and rational conclusion that the printing press money is actually worthless. Get it, get rid of it and let some other idiot hold the worthless trash.
Sharing the same thought is a recipe for group hysteria and bubble formation. Those who bought as a store of value are mightily pleased that their store of value has appreciated by 20%, 50%, 100% or more. Soon all thought of “store of value” is gone and rabid speculation takes its place. Value is counted daily with soaring stock exchanges and multiplication in commodity prices. Look at that, I was trying to preserve value and boy, did I preserve value…
It becomes the bluff and the double bluff, the triple agent on the inside. The stores of value can only be stores of value when they are firmly entrenched in the real economic environment. The flow of liquidity detaches these stores of value form reality and the noisy crowds form. Reasons to anticipate a reconnect to reality at some future date are legion. Shares in bubble, no way – the economy is in recovery and the stock exchange is anticipating that recovery by at least 6 months (property never goes down in price, you know). I suppose that the “stock exchange” was anticipating a boom until it crashed. Oil is running out and there is an economic recovery underway (I have seen a green shoot with my own eyes). Soon the lack of demand will catch up with the heady price, which in fact is still far too low for the serious shortages which may occur then.
Economics is about “cause and effect”. The reality disconnect is “effect and cause”. Companies post excellent results (not better than expected low ball estimates but the real thing) and the effect is that the share price rise. Cause = profitability and increased income stream. Effect = rising share price.
The liquidity disconnect turns it on its head. Effect = rising share price. Cause = profitability will improve at some stage in the future. The real cause is printing press money. Hoping for something is not the same as identifying a real cause. I can start a rabbit farm anticipating a massive demand for cheap red meat but I suspect I will end up with lots of rabbits to feed and no money. Well, at least I would have rid myself of all that trashy printing press money.
The world is running out of oil but the effects may only be felt in 20 or 30 years provided nothing happens to change that outcome. The dramatic demand adjustment to an oil supply squeeze in the 1970's proved the case for economic rebalancing to oil shocks. It is not wise to invest in or trade oil as if the “peak oil” day is today when the rest of the economy is not adjusted for that event. Ask the question, is it demand or printing press money in the driving seat? High and rising oil prices are a disconnect with the economic reality of demand today. Price distortion caused by printing press money will cause economic rebalancing. Incessant meddling with price formation and discounting future income to today (cause) will perpetuate and accelerate violent economic adjustments (effect) in proportion to the distortions caused. What an excellent example the cash for clunkers programme is of meddling with price formation and discounting future income to today. The giant of all gigantic meddlings with price formation and discounting future income to today is the policies of zero interest rates which abolish interest on savings (just add the banking margin to zero for the lending rate) and Quantitative Easing allowing Central Government to excessively discount its future income (taxes!) to today. Christians will know that even Jesus demanded the usury that the saver is owed (Mat 25:26-27 “His lord answered and said unto him, Thou wicked and slothful servant, thou knewest that I reap where I sowed not, and gather where I have not strawed: Thou oughtest therefore to have put my money to the exchangers, and then at my coming I should have received mine own with usury.”).
Understanding the inflations of the printing press requires an understanding that inflation will express where the printing press money ends up. Meat and potatoes prices will inflate if the money ends up in meat and potatoes. House prices will inflate if the money flows via debt formation into houses. Zero interest rates, Quantitative Easing and unlimited liquidity drive investors out of money and into stores of value. The inflation goes with the flow. Follow the flow to identify the inflation. Asset inflations always end up deflating when the flow slows. There is no need to remove the flow. The cycle of exponential growth only needs to be broken and the money flow asset inflation will deflate.
Run from your money and rush into inflated assets. Run from the US$ and into some inflated 3rd world currency (emerging markets are the next big thing, you know; they say emerging markets will save the global economy). Emerging economies with a dictatorial political or utterly corrupt political system where politicians are not inflating their money supply (or are they printing at 25%pa or even 50%pa and have been engaging in unofficial Quantitative Easing for ages). How promiscuous savings can be, whoring in dark corners with the printing press crowd.
Make sure your savings avoid the STD’s of printing press money when you pick your stores of value. Buying into asset inflations sets you up for the next bubble collapse from which only the nimble or the lucky escapes.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
23 August 2009
© Sarel Oberholster
Ps This is a rambling satire on the insanity of building economic foundations on printing press money and the self congratulations that goes with it. I logically and a bit more boringly explain the process of a flight to stores of value in “War on Savings” which is available as a PDF download on my blog.
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Because the central banks of the world has slipped the leach on the printing presses and the global economy is drowning in liquidity. The new game in town is to get hold of printing press money, preferably first and to convert it into a “store of value”. Flipping cash for stores of value is the way to go. Cash burning a hole in your pocket has a whole new meaning.
Funny thing about stores of value is the market chemical reaction to cash-is-trash liquidity flows. It changes colour like a magical chemical experiment and previous stores of value turn into red hot speculative assets, the next big thing. No longer is there any store of value intentions. All that remains is speculation on the next price increase. Flipping to the next big fool with a wad of cash to get rid of.
China said we will rid ourselves of the dollars and buy commodities. The Chinese population gets access to easy debt and floods the Hang Seng and Shanghai Composite with buy orders. “Investors” and Investment Banks draw down the cash and buy oil and the Dow. Get away from the sidelines and commit your cash is the refrain. The dollar is going to crash get out. Who knows what the miners do when they end up with all the cash?
Bubble, bubble, toil and trouble goes the nursery rhyme. Inflation is alive and well and living with the previously known as “stores of value”. Incredibly, gold is the Cinderella of the stores of value. Perhaps gold’s money prince will meet her at midnight when all other so called stores of value will be exposed as the ugly sisters.
Keynes’ saying “the market can be irrational longer than you can stay solvent” is another misguided observation of an interventionist. Are all these people really stupid? Were they stupid when they flipped houses? No, they were and are riding the wave of massive debt formation (then) and liquidity formation (now). The behaviour to get rid of the cash is fully consistent with the very logical and rational conclusion that the printing press money is actually worthless. Get it, get rid of it and let some other idiot hold the worthless trash.
Sharing the same thought is a recipe for group hysteria and bubble formation. Those who bought as a store of value are mightily pleased that their store of value has appreciated by 20%, 50%, 100% or more. Soon all thought of “store of value” is gone and rabid speculation takes its place. Value is counted daily with soaring stock exchanges and multiplication in commodity prices. Look at that, I was trying to preserve value and boy, did I preserve value…
It becomes the bluff and the double bluff, the triple agent on the inside. The stores of value can only be stores of value when they are firmly entrenched in the real economic environment. The flow of liquidity detaches these stores of value form reality and the noisy crowds form. Reasons to anticipate a reconnect to reality at some future date are legion. Shares in bubble, no way – the economy is in recovery and the stock exchange is anticipating that recovery by at least 6 months (property never goes down in price, you know). I suppose that the “stock exchange” was anticipating a boom until it crashed. Oil is running out and there is an economic recovery underway (I have seen a green shoot with my own eyes). Soon the lack of demand will catch up with the heady price, which in fact is still far too low for the serious shortages which may occur then.
Economics is about “cause and effect”. The reality disconnect is “effect and cause”. Companies post excellent results (not better than expected low ball estimates but the real thing) and the effect is that the share price rise. Cause = profitability and increased income stream. Effect = rising share price.
The liquidity disconnect turns it on its head. Effect = rising share price. Cause = profitability will improve at some stage in the future. The real cause is printing press money. Hoping for something is not the same as identifying a real cause. I can start a rabbit farm anticipating a massive demand for cheap red meat but I suspect I will end up with lots of rabbits to feed and no money. Well, at least I would have rid myself of all that trashy printing press money.
The world is running out of oil but the effects may only be felt in 20 or 30 years provided nothing happens to change that outcome. The dramatic demand adjustment to an oil supply squeeze in the 1970's proved the case for economic rebalancing to oil shocks. It is not wise to invest in or trade oil as if the “peak oil” day is today when the rest of the economy is not adjusted for that event. Ask the question, is it demand or printing press money in the driving seat? High and rising oil prices are a disconnect with the economic reality of demand today. Price distortion caused by printing press money will cause economic rebalancing. Incessant meddling with price formation and discounting future income to today (cause) will perpetuate and accelerate violent economic adjustments (effect) in proportion to the distortions caused. What an excellent example the cash for clunkers programme is of meddling with price formation and discounting future income to today. The giant of all gigantic meddlings with price formation and discounting future income to today is the policies of zero interest rates which abolish interest on savings (just add the banking margin to zero for the lending rate) and Quantitative Easing allowing Central Government to excessively discount its future income (taxes!) to today. Christians will know that even Jesus demanded the usury that the saver is owed (Mat 25:26-27 “His lord answered and said unto him, Thou wicked and slothful servant, thou knewest that I reap where I sowed not, and gather where I have not strawed: Thou oughtest therefore to have put my money to the exchangers, and then at my coming I should have received mine own with usury.”).
Understanding the inflations of the printing press requires an understanding that inflation will express where the printing press money ends up. Meat and potatoes prices will inflate if the money ends up in meat and potatoes. House prices will inflate if the money flows via debt formation into houses. Zero interest rates, Quantitative Easing and unlimited liquidity drive investors out of money and into stores of value. The inflation goes with the flow. Follow the flow to identify the inflation. Asset inflations always end up deflating when the flow slows. There is no need to remove the flow. The cycle of exponential growth only needs to be broken and the money flow asset inflation will deflate.
Run from your money and rush into inflated assets. Run from the US$ and into some inflated 3rd world currency (emerging markets are the next big thing, you know; they say emerging markets will save the global economy). Emerging economies with a dictatorial political or utterly corrupt political system where politicians are not inflating their money supply (or are they printing at 25%pa or even 50%pa and have been engaging in unofficial Quantitative Easing for ages). How promiscuous savings can be, whoring in dark corners with the printing press crowd.
Make sure your savings avoid the STD’s of printing press money when you pick your stores of value. Buying into asset inflations sets you up for the next bubble collapse from which only the nimble or the lucky escapes.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
23 August 2009
© Sarel Oberholster
Ps This is a rambling satire on the insanity of building economic foundations on printing press money and the self congratulations that goes with it. I logically and a bit more boringly explain the process of a flight to stores of value in “War on Savings” which is available as a PDF download on my blog.
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
Tuesday, July 28, 2009
The Pile High Club
“A British oil trader in line for a $100m (£60m) bonus is expected to pitch his employer Citigroup into direct conflict with the US treasury after a clampdown on excessive pay by the Obama administration.” 1
How big is the trading profit that allows one trader to qualify for a $100m bonus? How big is the trading position (compounded) which yields a profit big enough to reward one trader with $100m?
The Energy Information Administration advises in their July 2009 Short-Term Energy Outlook that “world oil consumption was down an average of 3.0 million barrels per day (bbl/d) from the fourth quarter of 2008 through the second quarter of 2009.” They further report that US retail sales of electricity in the industrial sector declined by 12% during the first quarter compared to previous year levels. Brent crude was averaging around $45 from Nov 08 to March 09 and then joined the stock exchange rally to trade around $70 at present. The economic dichotomy is the possibility that the oil price increases when demand is falling. Not just any increase but increase by around 56%.
The answer is simple. Speculation. Speculation that the oil price would be higher in the future. This would normally be based on speculation that demand would increase and that would be based on speculation that the economy may be in recovery. What kind of recovery is a speculation driven price increase of 56% anticipating?
I would assert that there is not sufficient evidence of an economic recovery to even claim economic recovery and there is certainly not enough evidence to suggest that such a recovery will explode demand into a market suffering from over capacity to cause a price spike of 56%. Thus this speculation has nothing to do with economic recovery or any expectation of a major improvement in demand.
This speculation has to do with money, piles of it. The “printing press” has been plugged into the trading desks of the “Investment Banks” and they are using it. Clearly having access to unlimited liquidity at near zero interest rates with not nearly enough quality borrowers to lend it to, is no deterrent to channelling the cheap money into other banking activities.
The absolutely obvious destination is anything that would qualify as a store of value. Gold use to be the preferred vehicle but that would invite the anger of the Central Banks. Oil is a very suitable substitute. Liquidity getting out and a market large enough to absorb the flow of liquidity are prerequisites. Sufficient depth and scope in derivatives also help. Stock exchanges are another good destination. Who cares about demand or silly economic theories? We make our own, remember Goldie Locks?
Members of the Pile High Club just plug the liquidity into the Oil market and watch the oil price rise when demand is falling. Soon the crowd realises that the place to be is in oil and a stampede starts. Timing is everything, the Pile High Club exits while the crowd is coming in and guess who then become “investors with a 2-3 year view”?
“He is credited with buying every available oil futures contract in 2003, when they were priced on the basis that crude prices would remain stable. Over the next few years the demand for oil surged and prices soared to more than $150 a barrel, making Hall and Salomon Brothers owner Citigroup hundreds of millions of dollars.” 1
There is doubt about the “surging” demand for oil over the period 2003 to 2006 but then who cares?
“Net revenues in Trading and Principal Investments were $10.78 billion , 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009.” 2
How big was the quarterly pile at Goldman Sachs to yield $10.78 billion in trading profits?
Assess this strategy. The liquidity will create demand and will inflate the asset class. It creates a bubble and the bubble collapse when the liquidity driven trades are withdrawn from the asset class. Those in first and out first always win. The members of the Pile High Club. The playing field is tilted at 85 degrees in their favour, they can never lose (not so?). Unless they overstay their welcome, then the trading wipes out the bank overnight. It is also a zero sum game, which means someone will lose. Sometimes the Pile High Club is operating in concert in a market and then there are casualties (just ask Society General about the huge rouge trade which was funded but no-one knew about it).
The Pile High Club will trade the futures, options, in fact all available derivatives and even the physical.
“Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.” 3
“"Storage continues to be an option for traders and we see bookings running through at least the end of August, with several of them adding options to extend storage into September," a shipbroker said. U.S. investment bank JPMorgan Chase & Co (JPM.N) has hired a crude supertanker to store gas oil off Malta's coast, a unusual sign traders were looking to take advantage of the weaker crude oil freight rates to store distillates. [ID:nL3650783] The ship would have to be cleaned to hold the refined fuel.
Crude rallied to over $69 a barrel this week, the highest in seven months, as optimism about the global economy outweighed concern about poor fundamentals in oil markets.
Crude oil in floating storage fell in late May to around 90 million barrels from around 100 million barrels as prompt crude prices rose and narrowed the discount to prices further out. [ID:nLS679181] That discount was key to traders storing oil at sea to make profits by selling it later.” 4
The reality is that the access to unlimited liquidity opens the door to a speculative strategy for the Pile High Club which can ignore any economic reality for as long as they can “Cash and Carry”. Thus they can anticipate higher prices when demand is falling. It is like playing poker at a table where bets can be raised without limits and one or a small number of players have pockets deep enough to clear the table every time irrespective of the hand of cards that they hold.
Trade with the money you say, surely you must realise that you can only see the money after it had entered the market and will only realise that it has left after it has gone. Playing at the table with the Pile High Club is dangerous and soon the only players at the table are the members of the Pile High Club. It is then when the accidents happen.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
1. Phillip Inman, 26 July 2009, Citigroup set to clash with Washington over executive pay, guardian.co.uk; http://www.guardian.co.uk/business/2009/jul/26/citigroup-executive-pay-bonuses
2. 14 July 2009, Press Release, Goldman Sachs.
3. Alaric Nightingale, 19 Jan 2009, Morgan Stanley Hires Supertanker to Store Oil in Gulf (Update2), Bloomberg; http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIbVHft2R3SE
4. Luke Pachymuthu, 4 Jun 2009, Oil products stored at sea jump to 41 million bbls, Reuters; http://www.reuters.com/article/GCA-Oil/idUSTRE5534JQ20090604
How big is the trading profit that allows one trader to qualify for a $100m bonus? How big is the trading position (compounded) which yields a profit big enough to reward one trader with $100m?
The Energy Information Administration advises in their July 2009 Short-Term Energy Outlook that “world oil consumption was down an average of 3.0 million barrels per day (bbl/d) from the fourth quarter of 2008 through the second quarter of 2009.” They further report that US retail sales of electricity in the industrial sector declined by 12% during the first quarter compared to previous year levels. Brent crude was averaging around $45 from Nov 08 to March 09 and then joined the stock exchange rally to trade around $70 at present. The economic dichotomy is the possibility that the oil price increases when demand is falling. Not just any increase but increase by around 56%.
The answer is simple. Speculation. Speculation that the oil price would be higher in the future. This would normally be based on speculation that demand would increase and that would be based on speculation that the economy may be in recovery. What kind of recovery is a speculation driven price increase of 56% anticipating?
I would assert that there is not sufficient evidence of an economic recovery to even claim economic recovery and there is certainly not enough evidence to suggest that such a recovery will explode demand into a market suffering from over capacity to cause a price spike of 56%. Thus this speculation has nothing to do with economic recovery or any expectation of a major improvement in demand.
This speculation has to do with money, piles of it. The “printing press” has been plugged into the trading desks of the “Investment Banks” and they are using it. Clearly having access to unlimited liquidity at near zero interest rates with not nearly enough quality borrowers to lend it to, is no deterrent to channelling the cheap money into other banking activities.
The absolutely obvious destination is anything that would qualify as a store of value. Gold use to be the preferred vehicle but that would invite the anger of the Central Banks. Oil is a very suitable substitute. Liquidity getting out and a market large enough to absorb the flow of liquidity are prerequisites. Sufficient depth and scope in derivatives also help. Stock exchanges are another good destination. Who cares about demand or silly economic theories? We make our own, remember Goldie Locks?
Members of the Pile High Club just plug the liquidity into the Oil market and watch the oil price rise when demand is falling. Soon the crowd realises that the place to be is in oil and a stampede starts. Timing is everything, the Pile High Club exits while the crowd is coming in and guess who then become “investors with a 2-3 year view”?
“He is credited with buying every available oil futures contract in 2003, when they were priced on the basis that crude prices would remain stable. Over the next few years the demand for oil surged and prices soared to more than $150 a barrel, making Hall and Salomon Brothers owner Citigroup hundreds of millions of dollars.” 1
There is doubt about the “surging” demand for oil over the period 2003 to 2006 but then who cares?
“Net revenues in Trading and Principal Investments were $10.78 billion , 93% higher than the second quarter of 2008 and 51% higher than the first quarter of 2009.” 2
How big was the quarterly pile at Goldman Sachs to yield $10.78 billion in trading profits?
Assess this strategy. The liquidity will create demand and will inflate the asset class. It creates a bubble and the bubble collapse when the liquidity driven trades are withdrawn from the asset class. Those in first and out first always win. The members of the Pile High Club. The playing field is tilted at 85 degrees in their favour, they can never lose (not so?). Unless they overstay their welcome, then the trading wipes out the bank overnight. It is also a zero sum game, which means someone will lose. Sometimes the Pile High Club is operating in concert in a market and then there are casualties (just ask Society General about the huge rouge trade which was funded but no-one knew about it).
The Pile High Club will trade the futures, options, in fact all available derivatives and even the physical.
“Morgan Stanley hired a supertanker to store crude oil in the Gulf of Mexico, joining Citigroup Inc. and Royal Dutch Shell Plc in trying to profit from higher prices later in the year, two shipbrokers said.” 3
“"Storage continues to be an option for traders and we see bookings running through at least the end of August, with several of them adding options to extend storage into September," a shipbroker said. U.S. investment bank JPMorgan Chase & Co (JPM.N) has hired a crude supertanker to store gas oil off Malta's coast, a unusual sign traders were looking to take advantage of the weaker crude oil freight rates to store distillates. [ID:nL3650783] The ship would have to be cleaned to hold the refined fuel.
Crude rallied to over $69 a barrel this week, the highest in seven months, as optimism about the global economy outweighed concern about poor fundamentals in oil markets.
Crude oil in floating storage fell in late May to around 90 million barrels from around 100 million barrels as prompt crude prices rose and narrowed the discount to prices further out. [ID:nLS679181] That discount was key to traders storing oil at sea to make profits by selling it later.” 4
The reality is that the access to unlimited liquidity opens the door to a speculative strategy for the Pile High Club which can ignore any economic reality for as long as they can “Cash and Carry”. Thus they can anticipate higher prices when demand is falling. It is like playing poker at a table where bets can be raised without limits and one or a small number of players have pockets deep enough to clear the table every time irrespective of the hand of cards that they hold.
Trade with the money you say, surely you must realise that you can only see the money after it had entered the market and will only realise that it has left after it has gone. Playing at the table with the Pile High Club is dangerous and soon the only players at the table are the members of the Pile High Club. It is then when the accidents happen.
Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 July 2009
© Sarel Oberholster
Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .
1. Phillip Inman, 26 July 2009, Citigroup set to clash with Washington over executive pay, guardian.co.uk; http://www.guardian.co.uk/business/2009/jul/26/citigroup-executive-pay-bonuses
2. 14 July 2009, Press Release, Goldman Sachs.
3. Alaric Nightingale, 19 Jan 2009, Morgan Stanley Hires Supertanker to Store Oil in Gulf (Update2), Bloomberg; http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aIbVHft2R3SE
4. Luke Pachymuthu, 4 Jun 2009, Oil products stored at sea jump to 41 million bbls, Reuters; http://www.reuters.com/article/GCA-Oil/idUSTRE5534JQ20090604
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