Sunday, April 27, 2008

Debt Rattle, April 27 2008: Keep Your Eyes on the Bond Market

Stoneleigh: Central bankers cannot prevent a huge increase in risk premiums, which will send rates for all long term borrowing much higher in nominal terms. Against a backdrop of credit deflation, real interest rates will be even higher. There is no safe level of debt to be carrying when interest rates go through the roof and your income becomes uncertain. This is a recipe for sky-rocketing defaults, and in a highly leveraged world that feeds a vicious circle of positive feedback.

Credit Crack-Up Being Ignored
Now let's pay attention to another area for a minute I've talked about before - the bond market.

When PIMCO goes short the long end of Treasuries, you better pay attention. And they have - negative 18%, from their last disclosure. That means 18% of their position (in total!) is net short treasuries.

This is a bet on a massive crack-up in the bond market, with rates skying higher and prices falling through the floor. I've written about this before, but folks, believe me, if Bill Gross is on this, you better pay attention. If he's wrong he's going to get murdered, but if he's right the entire economy, especially housing, is going to get murdered.

Yes, murdered worse than it already has.


Simple - right now 30 year fixed mortgages are about 6%. If we get a bond market crack-up and the 10 year goes up 200 basis points (2%), for example, Bill's short bet (assuming he's short the 10) is worth 2% x 10 (duration) or an instantaneous 20% profit.

But what happens to your house? Well, mortgage rates will probably rise by the same 200 basis points, or go from 6-8%. That's a 33% increase, which will result in a roughly 28% loss in buying power for home purchasers!

It will also hit other types of debt such as credit cards but the difference 200 basis points makes on a 20% credit card interest rate (10%) is far less than the impact on debt with less "spread", such as mortgages.

So this "crack up", should it occur and be mild, results in your house losing 28% of its value. Should that "crack up" be severe, say, a 500 basis point rise (not out of the realm of possibility; see the late 70s into 1980) the consequences would be catastrophic (a loss of 50% of value, essentially "all at once.")

And that's on top of what your home's value loses from bubble deflation - this change is additive but immediate, as the impact on money available happens now, not through the process of the bubble unwinding.

Stoneleigh: I have a great deal of respect for Doug Noland, but I disagree with him here that the recent actions of central bankers could lead to another year of speculative excess. I think the current rally is nearing its end, which would signal the next phase of the credit crunch. As significant as recent actions by the Fed and the BoE have been, I don't think they can do more than inspire fleeting optimism, and without confidence those actions cannot restore liquidity. Confidence is liquidity.

The Meaning of Stage II
Otherwise intelligent financial commentators argue that today's rising energy and food prices are not a "monetary phenomenon." Instead, these price pressures are said to be due to strong demand from China and India - wealthier consumers choosing to upgrade their diets. But both the Chinese and Indian economies (and many others) are now operating with virtually unlimited Credit - a unique combination of rampant domestic Credit growth coupled with massive foreign financial flows. As I've explained ad nauseam, U.S. Current Account Deficits and dollar impairment are the root cause of scores of runaway domestic Credit systemic that comprise the Global Credit Bubble. This historic Bubble is everywhere and in everyway a monetary (Credit) phenomenon.

It is my argument that Stage II Means another year of massive U.S. Current Account Deficits. This would Mean, for one, a prolonging of the massive flow of liquidity into international central bank reserves (creating domestic Credit in the process), sovereign wealth funds, and (to a lesser extent) the hedge fund community. The consequences from a further ballooning of this Unwieldy Global Pool of Speculative Finance are not at all clear. Secondly, another year of U.S. Deficits would Mean another year of excessive liquidity flows into the already overheated economies throughout Asia, the Middle East and elsewhere. Importantly, these Monetary Processes and Inflationary Dynamics are by now well entrenched and extraordinarily powerful after years of unrelenting excess. Resulting Monetary Disorder should be expected to go to increasingly destabilizing extremes (think NASDAQ 1999 and subprime 2006!) - and indeed we're seeing evidence for as much in near $120 crude, the global food price spike and related hoarding, and wildly unstable and speculative global financial markets.

It is in this context that I believe U.S. policymakers are today unknowingly risking global financial and economic catastrophe. They are, of course, fixated on domestic concerns and are willing to do any and everything in a desperate attempt to sustain the U.S. Bubble Economy. They are oblivious to both the heightened risks associated with today's Current Account Deficits and to the various linkages of their policies to Heightened International Monetary Disorder. Stage II is fraught with great but not easily recognizable risks.

It is my view that there are significant risks associated with postponing the inevitable adjustment to the U.S. Bubble Economy. As I've attempted to explain previously, the amount of Credit necessary to sustain our uniquely maladjusted Economic Structure is unmanageable. It is unmanageable for our troubled banking system, for our troubled GSEs, and for the expansive money-fund complex - for risk intermediation generally. Stage II Means great risk to the heart of contemporary "money." The problem rests on the reality that "pre-adjustment" Credit (borrowings associated with many businesses and enterprises that will be uneconomic come the arrival of the post-Bubble backdrop) is inherently vulnerable. And as discussed above, today's U.S. Credit is extraordinarily destabilizing in its effects upon the Global Credit Bubble and Resulting Monetary Disorder.

I am at this point more convinced than ever that only a severe crisis will instigate the necessary adjustment to the distorted and imbalanced U.S. and global economies. One is then left with the disconcerting view that Stage II will lead our authorities to exhaust all policy measures in a futile attempt to sustain the unsustainable. The obvious question: how long does the lead up Crisis Stage II last? I would today guess a number of months, although I wouldn't at all be surprised if it was rather short. What will be the impetus for Crisis Stage II? A spike in interest rates, a run from U.S. Treasury and agency debt, a disorderly drop in the dollar, another bout of derivative and Credit market implosion, or acute global financial tumult should be considered leading candidates based on Stage II ramifications. Or it could easily be something completely unexpected, perhaps even war.

One Guy Who Has Seen It All Doesn't Like What He Sees Now
Peter Bernstein has witnessed just about every financial crisis of the past century.

As a boy, he watched his father, a money manager, navigate the Depression. As a financial manager, consultant and financial historian, he personally dealt with the recession of 1958, the bear markets of the 1970s, the 1987 crash, the savings-and-loan crisis of the late 1980s and the 2000-2002 bear market that followed the tech-stock bubble.

Today's trouble, the 89-year-old Mr. Bernstein says, is worse than he has seen since the Depression and threatens to roil markets into 2009 and beyond -- longer than many people expect.

Mr. Bernstein, whose books include "Against the Gods: The Remarkable Story of Risk," sees two culprits. One is the abuse of securitization -- the trend for banks to hold fewer loans on their books and instead turn them into securities that were sold to other investors. The other is simply years of overborrowing by financial institutions and consumers alike.

Mr. Bernstein is hopeful that Federal Reserve intervention will prevent deflation and depression, but he says there is no guarantee.

Triple-A Failure
In 1996, Thomas Friedman, the New York Times columnist, remarked on “The NewsHour With Jim Lehrer” that there were two superpowers in the world — the United States and Moody’s bond-rating service — and it was sometimes unclear which was more powerful. Moody’s was then a private company that rated corporate bonds, but it was, already, spreading its wings into the exotic business of rating securities backed by pools of residential mortgages.

Obscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A — it was just as safe, in theory, as other triple-A securities.

Over the last decade, Moody’s and its two principal competitors, Standard & Poor’s and Fitch, played this game to perfection — putting what amounted to gold seals on mortgage securities that investors swept up with increasing élan. For the rating agencies, this business was extremely lucrative. Their profits surged, Moody’s in particular: it went public, saw its stock increase sixfold and its earnings grow by 900 percent.

By providing the mortgage industry with an entree to Wall Street, the agencies also transformed what had been among the sleepiest corners of finance. No longer did mortgage banks have to wait 10 or 20 or 30 years to get their money back from homeowners. Now they sold their loans into securitized pools and — their capital thus replenished — wrote new loans at a much quicker pace.

Mortgage volume surged; in 2006, it topped $2.5 trillion. Also, many more mortgages were issued to risky subprime borrowers. Almost all of those subprime loans ended up in securitized pools; indeed, the reason banks were willing to issue so many risky loans is that they could fob them off on Wall Street.

But who was evaluating these securities? Who was passing judgment on the quality of the mortgages, on the equity behind them and on myriad other investment considerations? Certainly not the investors. They relied on a credit rating.

Thus the agencies became the de facto watchdog over the mortgage industry. In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.

Nothing Left To Lose At Ambac
Does Ambac have any credibility? I think not. Nonetheless, lets assume the top side of Ambac's estimate that they can generate $1.5 billion as policies mature. To be fair, let's also assume that Goldman Sachs analyst James Fotheringham is correct that Ambac needs to raise $3.4 billion each to fill capital shortfalls.

That is $1.9 Billion that Ambac needs to raise to which Robert Haines, an analyst at CreditSights Inc. says "We question its ability to access the capital markets anytime soon."

But once again, let's give Ambac the benefit of the doubt. Let's assume that Ambac can raise $1.9 billion.

At Thursday's close Ambac had a market cap of $1 billion and a closing price of $3.76. To raise $2 billion at these prices would cause a massive shareholder dilution making each share worth about 1/3 what it is worth today. That would make each share worth about $1.25. There are delisting rules at those prices.

By the way, Bloomberg is reporting "Ambac's new business slumped 87 percent last quarter after ratings companies threatened to strip the insurer of its AAA status".

Amazingly Moody's, Fitch, and the S&P did not downgrade Ambac after this fiacso. I guess the intent is to hold on to those ratings all the way to zero. The excuses at S&P were pathetic....

....exactly how much new business is Ambac going to bring in now? Business is down 87%. With that, I wish to repeat what I said the other day in Ambac expects losses of 81.8% of underlying collateral: "Ambac is not going to get much if any guarantee business. And a guarantee business that does not get guarantee business is guaranteed to go bankrupt. It's as simple as that."

Ambac could have raised money at $40, $30, or $20 far easier than it can raise money at $3.76. Ambac is down a mere 96% in less than a year. What does it have to lose now by saying it will not raise capital? There is quite literally nothing left for Ambac to lose.

That begs the question: Is there is any credibility left to lose with Dick Smith, Managing Director, at the S&P either?

Stoneleigh: It has been my view for some time that the euro was close to topping on instability in the euro zone, and that the dollar would rise as the euro fell - on short covering and a flight to safety. I think we're in the early stages of this process now, although the flight to safety component has yet to materialize. I would expect that to begin building once the recent market rally is over and the decline begins again. My guess is that a dollar rally, once underway, could last for several months at least.

Euro dives as wheels fly off eurozone economy
The euro has suffered its sharpest drop in four years as a blizzard of weak data from Germany, Belgium, France, and Spain spark fears that economic contagion may be spreading from the Anglo-Saxon world to Europe....

....David Owen, an economist at Dresdner Kleinwort, said Europe would soon be engulfed by the twin effects of a "collapse in export volumes" and a slow motion credit squeeze. "The wheels are coming off the eurozone economy," he said.

BNP Paribas warned clients yesterday that the "decoupling story" was no longer credible. "We see Europe in the early stage of a credit crunch, and if we are right credit supply will shut down," it said. Key governors of the European Central Bank began to back away from their hawkish stance of recent weeks, clearly disturbed by the market perception that they are mulling a rate rise to choke.... off price rises. Inflation has reached a post-EMU high of 3.6pc on surging oil and food costs.

Jean-Claude Trichet, ECB president, went out of his way yesterday to brief journalists that "sharp" currency moves had "possible implications for financial and economic stability", a coded threat of co-ordinated intervention by world central banks.

The comments caused a second scramble for dollars in mid-day trading as speculators rushed to cover "short" positions against the greenback....

HBOS to debate cash call as property investments struggle
Board directors at HBOS, Britain's biggest mortgage lender, will tomorrow discuss potential plans to tap shareholders for billions of pounds of fresh capital.

The bank, which will accompany its annual meeting on Tuesday with a trading update, was last night undecided about such a move, which will be formally debated at a board meeting tomorrow.

HBOS's core tier-one equity of 5.7 per cent is well above regulatory requirements, although some directors are understood to believe a rights issue would be sensible owing to the perilous state of Britain's mortgage industry.

HBOS is considering raising as much as £4bn; it is also expected to reveal a writedown of up to £3bn at its AGM....

....British banks have come under pressure to raise capital because of the sharply declining value of many of their assets.

HBOS, for example, is facing credit-crunch related problems at two of its biggest property investments, Crest Nicholson and McCarthy & Stone, both of which it co-owns with the Scottish businessman and philanthropist Sir Tom Hunter.

Where was the wise man?
Nodding toward Mr. Rubin’s acute sense of the volatility of the markets, he adds that the only thing Mr. Rubin “is dismissive of is people who are certain of things that are inherently uncertain.”

Mr. Rubin encouraged Goldman to move into more treacherous markets like proprietary trading and commodities trading. Even so, he now says he was always concerned about the dangers posed by risky futures and derivatives trades, having seen how the pell-mell use of futures contracts exacerbated the 1987 stock market crash.

Shortly before leaving Goldman to head up President Clinton’s National Economic Council, Mr. Rubin says, he met with Richard B. Fisher, the chairman of Morgan Stanley, to discuss the idea of imposing stricter margin requirements on futures trading. Mr. Rubin says the idea died after the Chicago Board of Trade told him “we will make sure Goldman Sachs never trades another future on the C.B.O.T. if this went ahead.”

Did Robert Rubin Jeopardize Financial Stability to Protect Goldman Sachs?
That is what he claims, according to the NYT. The NYT reports that Rubin claims that he was considering imposing stricter margin requirements on futures trading when he was leaving Goldman Sachs to take a top position in the Clinton administration. According to the article, Rubin claims he abandoned the plans when the Chicago Board of Trade told him “we will make sure Goldman Sachs never trades another future on the C.B.O.T. if this went ahead.”

A spokesperson for the company that now owns the C.B.O.T. denies that any such threat was ever made, but this is an incredibly important news story. The implication is that a top official in the Clinton administration, who subsequently became Treasury Secretary, altered regulatory policy based on a threat made against his former firm.

If such a threat was actually made, then it should have been reported to the F.B.I. and some people connected with the C.B.O.T. should be sitting in jail right now. If Mr. Rubin was actually prepared to alter regulatory policy to serve his former firm, then he clearly had conflicts of interest that made him unqualified to hold a top government position.

Freddie Mac takes lead in GSE mortgage purchases
Freddie Mac, the second-biggest funder of U.S. home loans, on Friday took the lead in the government-sponsored enterprises' efforts to stabilize the market with mortgage purchases last month.

Agreements by Freddie Mac to buy mortgages soared to the highest level in nearly five years in March after the company's regulator eased capital constraints. The larger publicly traded GSE, Fannie Mae, also boosted its commitments but fell short of analysts' expectations.

Freddie Mac entered contracts to buy $43.5 billion in loans last month, sharply up from $14.8 billion in February and the most since July 2003 as refinancings hit record heights. The contracts portend future growth in the McLean, Virginia-based company's investment portfolio, which increased to $712.5 billion in March from $709.5 billion in February.

Washington-based Fannie Mae said its mortgage purchase commitments rose about $5.9 billion to $31 billion in March, the most since September.

The boosts were expected after the Office of Housing Enterprise Oversight last month reduced the mandatory capital levels that Freddie Mac and the larger Fannie Mae must hold. The move by OFHEO was considered a way to provide stability to the ailing U.S. mortgage and housing markets by increasing the purchasing power of the GSEs by $200 billion.

While Fannie Mae fell short in March, it was probably due more to investment timing rather than policy, analysts said. The GSEs must answer to increased pressure to shore up mortgage funding from key lawmakers, and from the Bush administration that until recently viewed the size of the GSE investments as more harmful than helpful to the U.S. financial system.

"They've got a gun to their head to start to get into this market," said Paul Miller, an analyst at Friedman, Billings Ramsey Inc in Arlington, Virginia.

Bush Urges Expanded Government Role in Buying Student Loans
President George W. Bush urged Congress to pass legislation that would give the federal government more authority to buy student loans from banks and other private companies, saying the credit crunch has put pressure on college students.

``A slowdown in the economy shouldn't mean a downturn in educational opportunities,'' Bush said in his weekly radio address.

As of April 24, more than 50 lenders, accounting for 14 percent of the private student loan volume, had withdrawn from the guaranteed student loan program. About 7 million borrowers will need more than $68 billion in federal loans this academic year, according to Education Department estimates.

More U.S. Households Seek Help With Utilities
More U.S. households are falling behind on their utility bills and seeking public assistance, according to groups that arrange for help. They fear a record number of families will face utility shutoffs in coming months, reflecting fallout from a distressed housing market and rising prices for food and energy.

"The underlying problem is many families are becoming poorer and have to pick which bills to pay," said Mark Wolfe, executive director of the National Energy Assistance Directors' Association, a group that represents state directors of energy-assistance programs. Some states are attempting to buy some time by delaying the date at which utilities are allowed to begin disconnections. That is often prohibited during the winter because it could be life-threatening. Connecticut extended a moratorium on shutoffs to May 1 from April 15 this year....

....Some states have seen double-digit increases in the number of families receiving public assistance to pay their utility and fuel bills. The increases go as high as 80% in Nevada and 44% in Oklahoma. States control how they dole out their share of the $2.5 billion in federal funds distributed under the Low Income Home Energy Assistance Program. Many states are asking Congress to provide more funds for energy assistance.

Trader at center of $73B French bank scandal lands a new job
He was tied this year to one of the largest securities scandals in history and faces charges ranging from forgery to unauthorized computer use, yet the former trader at French bank Societe Generale is gainfully employed, again.

Jerome Kerviel, who shook global financial markets when the bank revealed $7.14 billion in losses tied what it says were unauthorized trades, has landed a new job as a computer consultant.

Stoneleigh: I disagree with this, as I disagree that the current sky-high food prices will last. I think the commodity complex is close to topping and should show sharp declines in the not too distant future, which is not to say that supply is not currently tight or that population is not a problem. Clearly both those things as true, but that is not the whole story. Commodity tops, like equity bottoms, are typically sharp spikes driven by fear and exaggerated by speculation. They are typically followed by equally sharp reversals once it becomes clear that the trend has gone too far.

Over the long term, energy and food will inevitably become more expensive in real terms due to both scarcity and the extreme level of economic disruption that deflation will herald. However, that does not mean that prices must stay high in nominal terms for years to come. My view is that we'll see substantial falls in nominal terms (not adjusted for underlying changes in the money supply), but likely a rise in real terms as purchasing power should fall faster than price during credit deflation. Lower nominal prices do not necessarily imply greater affordability.

Deflation will greatly reduce demand, even for essentials, because demand is not what one wants, but what one is ready, willing and able to pay for. In a world where the collapse of the credit component drastically reduces the available money supply, purchasing power will be scarce indeed.

Population explosion means oil at $100 a barrel is here for years
'A whole load of stuff could come apart here," warned Art Cashin last week on CNBC - the US business channel. "This oil thing - it's gettin' crazy".

Cashin was talking from the floor of a nervous New York Stock Exchange.

After 46 years "in the pit", the gnarled trader is rightly seen as the man with the clearest idea of what "the market" is really thinking.

And he's right. The oil price is now "kinda' crazy". On Tuesday, crude hit $119.90 a barrel - 87 per cent up on a year ago. The spike was widely attributed to rebel attacks on Shell's Nigerian oil facilities, which threaten to undermine global supplies.

On Friday, prices climbed again, skimming $120 once more. The given reason this time was problems at Exxon's Nigerian plant - along with the threatened strike at the UK's Grangemouth refinery, potentially affecting 70 North Sea drilling platforms.

But while events in Scotland, and the Niger Delta are unfortunate, they don't explain why the crude price is so high.

These localised issues may have added a few dollars to oil in recent days, but for several years now, the fundamentals have been pushing fuel costs relentlessly up. And my view, however frightening, is that oil prices will now average more than $100 a barrel for many years to come.


Anonymous said...

thanks it helps clear up a lot of the circumlocution.

On a practical consideration of Credit Crack-Up Being Ignored if/when bonds do blow out is that a time one should be looking to begin to move from cash to bonds?

snuffy said...

The question is how long can an "economy"exist when the fuel supply that drives it is becoming more scarce and is for all intents,can not be replace in a "timely" manor.2011 is the supposed best guess by most of those at TOD,if recall correctly.That is a hop,skip and jump from now....I don't see crash coal-to-liquid fuel conversion,or anything like what is truly needed to address this...the only thing I see is a last-man-standing attitude from the administration that wants to trade our troops blood for middle east oil.Should they take a whack at Iran on the way out,all bets are of.
It occurred to me that this would be a excellent way to hit the "reset"button on the US economy....if they hit Iran,all kinds of little goodies could be rammed thru congress,and those who object ,silenced by cries of "Theres a war going on!!"ect.ect.ect.The old saing if you only have a hammer,all problems look like nails...may apply.The only thing this administration seems to be able to do is start wars....this next war might be seen as a way to "fix"all problems it faces'.

Greyzone said...

The allegation that the entirety of oil's recent price runup is due solely to the decline of the US dollar is wholly refuted by work done and posted by eastender in the April 27 Drumbeat at TOD. There IS a component of the price increase that is attributable to exchange rate issues and dollar decline. But the larger component remains simply supply/demand scarcity.

Therefore, those of you expecting a crash in commodities prices may be in for a shock. I have said this before - this recession is not like any other recession in the history of the human race. The rules are changing. The pseudoscience bullshit voodoo called economics is going to get its guts ripped out over the course of the next 2-3 decades as overpopulation and resource scarcity take us in directions that probably none of us can fully expect.

Do NOT think that the current recession is going to resemble anything that we've seen before. Even Mish (Mike Shedlock) doesn't see this yet and I respect him lots because he's a pretty clear thinker.

The early stages of this crackup may resemble what has gone before. But over time I expect it to deviate into something wholly new and unexpected. And mostly I expect worse, lots worse.

Farmerod said...


I don't think Stoneleigh or you fundamentally disagree that oil will continue to get ever more "expensive". She's just saying that the nominal price will go down as the money supply declines. When $750T fake money tries to convert to 1 or $2T cash, sticker prices on everything, on average, will decline. This is not to say there won't be as many people wanting, but increasingly unable, to pay for these goods.

Ilargi said...


You start off with a bit of a weird idea. I don't know of anyone who has claimed that the entire oil price rise is due to the dollar's downturn. So I think there's nothing to refute there.

Still, a lot of people in the energy corner -and elsewhere- fail to acknowledge the influence of the currency value shifts, which have been significant. I posted an article on price rises in the UK (which were wrongly called inflation), and compared a 15.5% increase in prices with a value drop for the pound vs the Euro of 16.5%, same period.

Likewise, Ford announced surprise profits this week. Which are in USD, while Ford sales are largely in countries with stronger currencies; so no real profit there, just more dollars that are worth less.

None of this means there are no price increases in the eurozone, or something like that. Gas is easily at $10 a gallon in parts of Europe, for instance. But you do need the perspective provided by a currency losing 40% of its relative value in a few years time, otherwise you lose the overview.

I agree with you that most of the economic textbooks and wave theories are ready to be thrown out the window. As for commodities, ideas about prices rising or falling are not worth much either, once everybody starts fighting about them:

I suggest you all read Clive Maund:

Powerful Bullmarket In Us Stocks Looms As The Us Prepares For Global Hegemony...

Stoneleigh said...

Snuffy and GreyZone,

I don't see any crash energy conversion programmes, or in fact much of an economy few years down the line. People don't build much of anything in a depression, and they generally have a hard enough time maintaining what they already have. I expect much of our infrastructure to fall into various states of ruin.

Initially, I expect a very substantial reduction in demand, even for essentials, due to people's inability to pay for them (the consequences of which are likely to be extremely unpleasant). Prices should go down in nominal terms due to that and to the effects of speculation to the downside replacing speculation to the upside. The speculators don't care which way prices are moving - they make money in either direction by chasing momentum. As I have said before though, lower prices do NOT mean greater affordablity where purchasing power is falling faster than price.

However, the reduction in demand for essentials is very likely to be followed by a large reduction in supply due to the shear scale of economic disruption that full-blown deflation entails. Capital will be scarce, risk (both financial and physical) will be high, resource wars are likely to break out in many places, distribution systems will collapse, damage will be caused by those with nothing left to lose etc etc. There will probably be huge disparities in price and availability both spatially and temporally, which will mean a state of constant short-term crisis management and no economic visibility.

I expect this to be accompanied by considerable political repression, following perhaps an initial anarchic phase. I agree with GreyZone that it won't look like anything in living memory, and the effect will seem even worse because we have so far to fall in comparison with where most of us would have been prior to previous depressions. However, reading Naomi Klein's The Shock Doctrine gives us a small foretaste of how the early stages might play out.

Initially, wealth disparities are likely to increase substantially as much of the population is dispossessed. However, in the longer run serious downturns are typically nature's wealth redistribution mechanism, albeit with the closer approximation of parity at the lower end of the scale. The current level of wealth of today's super-rich could not exist in the long term without the underpinnings of the energy-rich economy that facilitated such a level of accumulation. Basically, as globalization breaks down, so do the wealth conveyors it has enabled. I covered this in my March 2007 TOD essay Entropy and Empire.

Anonymous said...

From what I read Mr. Maund doesn't seem worried that deflation will catch up with the U.S.

And an economic collapse would only slightly slow the War industry.

Stoneleigh said...

While I agree with Ilargi on many things, including that much of economics will be discarded, I still think there is much to be learned from studying how previous bubbles have played out - particularly the serious ones such as the Tulipmania (1630s) and the South Sea Bubble (1720s). The reason is that the best models to describe those events are not 'market models' per se, but human nature models based on the human propensity towards herding behaviour. The laws of human nature - and the emergent properties of behaviour at the population level - have not been repealed.

I disagree with Clive Maund, who wrote the article Ilargi links to above, not because I don't think the US will make a resource grab (they clearly will), but because I don't think they will be successful, and that therefore there won't be the energy or the wealth available to drive a bull market in US stocks.

Essentially, Clive Maund extrapolates current trends into the future with no regard for the effect of the bursting of the largest speculative bubble ever known. Also, I think he misunderstands the nature of the resource grab by suggesting it was meant to fuel American cars in a largely intact American economy. I think it was undertaken to fuel the American military, and that none of the oil is ever likely to be seen by the American consumer.

Oil will be far too strategically important to be wasted on joy-riding, or even activities currently seen as essential by the erstwhile middle-class (who will in any case not need to drive to jobs they no longer have in a few years time). The closest the American public might be expected to get to that oil will probably be the receiving end of the domestic political repression it's likely to fuel.

I think Iraq is best understood as a putative overseas fuel depot where the oil can lie safely beneath the ground while the population above ground that once constituted Iraqi domestic demand is allowed to kill each other with abandon, and is assisted in the task by the occupying forces. After all, Jeffrey Brown's Export Land Model, shows that domestic demand in oil-producing countries is rapidly reducing the amount available for export, and one way to deal with that is to remove the domestic demand.

Personally I think this strategy is doomed to fail, however, as the level of chaos involved if this model were to be applied to other countries in the region as well would probably be uncontainable. I think the blowback would be enough to send the whole region up in flames, so to speak. Martin van Creveld's The Transformation of War gives a very useful perspective on the prospects for success in asymetric warfare.

Stoneleigh said...

Crystal Radio,

I would recommend short term bonds as a cash equivalent, especially if you have too much for it to be practical to keep it all in cash. I don't recommend long bonds though, as yields will rise and prices fall.

If you own a long bond and you want your money back, you either have to find a buyer or you have to wait for many years. If your bonds are paying much less interest than newer bonds of comparable maturities, because the risk premium was lower when you bought them than subsequently, then you may lose money or even find it difficult to find a buyer (depending on the level of risk aversion). The alternative of waiting many years is probably a recipe for losing your principle given the coming economic upheaval.

scandia said...

Neighbourhood news...I live in the downtown core of Guelph ,Canada. Encountered police and distressed people on my way to a meeting this morning. A large quantrant of the downtown core was vandalized during the night. So far no witnesses. Last count 180 cars and counting. CAA making some money towing cars away. Appears to be a well planned assault on car owners? why? by whom?

Anonymous said...

Like so many, I want to thank Stoneleigh and Ilargi for their effort and analyses. Reading TAE is a little like reading the prognosis of oncologists charting my cancer (I don't have cancer, though I certainly live in a world succumbing to cancer.) I have to wonder why I continue to read--and believe it's because I need to know what's happening so I can do what little I can for my family and friends.

On the whole, I agree with Michael Ruppert when he says:

"I am now 57 years old. I will not survive the crash and transition phase of Peak Oil. I will not see whatever kind of sustainable civilization might emerge from the wreckage of my species' gross mismanagement of the planet and itself."

Michael is too optimistic when he suggests any of us might see a sustainable civilization arising, but it is certainly true there is more to human nature than herd behavior. To see it, though, you have to take your eyes off the herd, which from a survivor's perspective is not a very practical thing to do.

That said, though, there's not a doubt in my mind Stoneleigh and Ilargi are contributing far more to civilization than most of us. Thank you.

Anonymous said...

Stoneleigh comment:

"...I think it (invasion of Iraq) was undertaken to fuel the American military, and that none of the oil is ever likely to be seen by the American consumer..."

So true, at TOD this point has never sunk in on the narrow EROI mentality that reigns supreme over there of how actual decisions about energy exploration (exploitation) are made in the world of RealPolitik

The U.S. military is essentially fighting for it's own fuel supply.

Incestuous and perverse in the extreme. It's like some twisted variation of an Oedipus Complex.

'Mom' is the oil, 'Dad' must be Iraq.

The Lizard said...

Snuffy says:
"silenced by cries of "Theres a war going on!!"ect.ect.ect.The old saing if you only have a hammer,all problems look like nails...may apply."

"America" the political entity, having decided that social perfection has been acheived and that therefore all problems we still have are the result of concerted attack by outsiders, tackles all social problem by declaring war. There's a war on drugs, a war on poverty, a war on terrorism, and several un-named and un-spoken wars.

Sooner or later, all "foreigners" are a problem, and have war declared against them.

Prepare to die at the hands of "democracy".

The Lizard said...

"The U.S. military is essentially fighting for it's own fuel supply.

Incestuous and perverse in the extreme. It's like some twisted variation of an Oedipus Complex.

'Mom' is the oil, 'Dad' must be Iraq."

This is brilliant.

Keep thinking.

Anonymous said...

Thanks Stoneleigh, what actually brought that question on was not only Genesis's mention of bonds but as well something I read once about the best position to be in during the '30s, first in cash and then into bonds. This time it, as you say, it will not be in long bonds at any rate.

About oil prices, I had this thought.

If the total world economic engine is slowing demand intensity will be reduced giving possible price reduction as allowed by production rates. By this I mean we will continue to use all the oil available but at a diminished rate of price increase and possibly a negative rate. Purchasers will drop out of the running quicker than the rate that oil production drops.

I hope I am making myself clear, but in any case, feel free to drop as many rocks on that thought as its merit dictates:)

Greyzone said...

Stoneleigh, you just noted that infrastructure is going to be negatively impacted by a depression. A large fraction of the world's oil supply today comes from very complex, advanced and expensive oil infrastructure. That infrastructure is under constant and serious wear. Remove that and oil supply may collapse faster than the economy collapses. Since this is at least possible, the price of oil could continue to rise against an otherwise depression scenario. Same with any other resource whose availability collapses faster than the deflation occurs.

And as is clear so far, the economy has not yet collapsed with the speed which many expected. Again, this may not play out at all like any prior economic event.

My point here is that due to overpopulation and resource constraints, the current collapse may very well not look like anything we've ever seen before. And it may play out on a time scale that seems totally unintuitive to us. While it is useful to study history, even economic history, it's also useful to understand the intertwined events going on around us in biology and physics - things which the pseudoscience of economics almost completely ignores.

Ilargi: I agree that resource wars are likely and at that point, all the market watching can be kissed goodbye. We're headed in strange directions, sir, and none of those driving seem to have a map.

Stoneleigh said...


Let me clarify further. I expect the decline in oil prices to be temporary, and quite likely in nominal terms only, as demand falls before supply is seriously compromised. The impact of a collapse of the money supply on demand would a a rapid event relative to the decay of infrastructure, although it is possible that the collapse of large parts of the distribution system for 'above ground reasons' could also be relatively rapid in many places. I don't think the world market for oil will last in its current form, hence prices would be expected to vary in different places depending on the local circumstances.

I don't expect energy or food to be 'cheap' going forward, even if their prices fall in nominal terms. I think their affordability will get much worse, but I warn about the likely decline in nominal prices as investors place their bets based on nominal prices. There are times when you may not want to be long on oil (or other commodities) and I would say this is one of them. I expect a great deal of price volatility going forward, meaning that taking any position is likely to be very risky. Market-timing speculators will probably have a field day though.

In the longer term, I expect energy and food to increase in price drastically - likely in nominal terms as well as in real terms (an increase in nominal terms against a backdrop of a collapsing money supply would mean that prices were going through the roof in real terms). I would expect attempts to limit this through price controls, but price controls bring their own problems, namely shortages.

Access to necessities may become very difficult, and quite likely a function of who you know, as it was in the Soviet Union, especially post collapse (see Alena Ledeneva's description of the blat economy, or economy of favours, in the post-Soviet era). In challenging times, descent into the politics of the personal is very likely.

Anonymous said...

I read Claud Maund's article this morning (ref. in a comment above).

It's the most depressing thing I've read in a long time.

If it's true, we're evil (the U. S.)

If it's not true, we're royally screwed.

Actually, probably both are true.

Anonymous said...

Sorry. "Clive" Maund.

Bigelow said...

I appreciated the quote from Ruppert, here is one from Jay Hanson:

“In other words, the economist serves no function in society except to protect the ruling elites from public scrutiny while they loot the planet.” -- A MEANS OF CONTROL, 02/00

Stoneleigh said...

I'm glad I'm not an economist then :)

Many of the assumptions built into modern economics are patently untrue - perfect information, perfect competition, self-correcting markets so that market failures should not happen, efficient markets, rational utility maximization etc.

Understanding money and power is better done through understanding human nature and the emergent properties of human behaviour at the population level (ie real politik).

Anonymous said...

That Claud Maund article brings up a question in my mind about who decided to eat who. I have the feeling that the situation was viewed in the east as too stable and served US interests with in particular Iraq and Sadamn as being rather chastened and mailable.

When the opportunity of the twin towers presented itself the preparations for the invasion of Afghanistan and Iraq were not prepared for and look to be the quick work of the current administration. This rather than a plan fully prepared for by the pentagon for these occupations. I would think that from the experiences of the US military in Vietnam and thereby the realized need for a competent bureaucratic structure to work with that the existing structure would not have been destroyed holus bolus. I think we are looking at the work of a few neocon goofballs who had an image of a slate being wiped clean so it may be written over in ones own words, as per Naomi Klein, (The Shock Doctrine). I think they (The US) has essentially blown it as far as what Claud Maund feels the outcome will be, hedgonomy and that yummy great big bull market.

scandia said...

I am dumbstruck or struck dumb by the decision to keep such banking secrets in England especially when transparency, lack of trust is the cause for current uncertainty!Why shouldn't a bank suffer a stigma for mismanagement?!Can this really be true and legal, that untold amounts of taxpayers money will be doled out to unnamed banks and the people should just suck it up! I'm sure the average Brit feels better now that something has been done.Reminds me of a recent article by Homer-Dixon in the Globe that said corporate leaders didn't like being criticized. Gee, I didn't realize they had such sensitive feelings.I've been wondering how it serves for Homer-Dixon to come to their defence? Let's pull our forelocks and be damn glad of a job!