Monday, June 9, 2008

Debt Rattle, June 9 2008: Leaving the eye of the hurricane

Children playing with stack of worthless currency, Germany 1923.

Stoneleigh: This is what central bankers want you to think they're worried about, so that you won't try to cash out, precipitating bank runs and a general asset price collapse. They know perfectly well that we are facing deflation, not hyperinflation, but at the end of the day someone needs to be the empty bag holder.

Stoneleigh: The lull in the markets since the March 17th low was the eye of the hurricane - a period of deceptive calm that lasted long enough for complacency, and faith in central bankers, to be restored. The fed postponed the inevitable, but has not prevented it.

Mainstream commentators such as Ambrose Evans-Pritchard (below) are now prepared to say publicly that central bankers cannot save us from the consequence of a mountain of bad debt, namely debt deflation. He muddies the waters, however, by calling a food and energy price spike inflation, while pointing out that money supply measures in both Europe and the US are pointing in the opposite direction. Inflation and deflation are monetary phenomena, not price movements.

Central bankers have been engaged in a splashy smoke-and-mirrors show to disguise the looming threat of deflation, but that threat will become much clearer during this next phase of the credit crunch. It appears set to begin with another round of bank failures - most likely Bradford&Bingley in the UK and Lehman in the US. In a world of meaningless ratings, look to credit default swaps to show where the market vultures smell blood next. In fact keep your eyes on the credit default swap market anyway - at $62 trillion, CDSs carry the force of the other side of the hurricane.

Federal Reserve and ECB can no longer save us from the consequences of our debt
The ECB demarche is ominous for the rest of us as well. We may be watching a replay of the Bundesbank's ill-judged rate rise in October 1987, which sent the dollar into a tailspin and triggered the Black Monday crash.

Any tilt to monetary tightening is a dangerous gamble at this delicate juncture. The world is facing an almighty clash between two opposing storm systems.

The West is in the full grip of a debt deflation as years of credit abuse come back to haunt it. The East - loosely speaking - is in the blow-off phase of an inflationary boom. Russia, Ukraine, Vietnam and the Gulf are out of control. China has dithered beyond the point of no return. It is they who have repeated the errors of the 1970s, not the West.

It will take central banking skills of great subtlety to pilot these seas. Slavish adherence to "inflation-targeting" and other such totemism and pseudo-science will ruin us all.

Yes, we face an oil and food price spike. Call that inflation if you want, but note that Europe's M1 money supply has contracted over the last five months. America's M1 has turned deeply negative, while M2 and MZM growth has collapsed.

America is going from bad to worse. A net 861,000 people joined the dole in May, pushing the unemployment rate from 5pc to 5.5pc. US house prices have fallen 14.4pc over the past year (Case-Shiller index). Miami is off 25pc.

The Mortgage Bankers Association says 8.8pc of all US house loans are in default or arrears. Negative equity has engulfed 11m households.

The "AA" rated tranches of 2007 sub-prime mortgage debt are now trading at 12pc of face value (ABX index); the "BBB" grades are down to 5pc. The debacle is reaching the 2004 vintage debt. We moved a step closer to a meltdown in the US municipal bond market last week when the "monoline" insurers Ambac and MBIA lost their "AAA" rating from Standard & Poor's.

Roughly $1,100bn (£559bn) of insured debt must be downgraded in lock-step. This will force pension funds to liquidate holdings. A fire sale looms....

....We are in uncharted waters. The easy trade-off between growth and inflation that so flattered asset prices for a quarter century is over. The monetary lords can no longer shield us from the full consequences of our debts. Nor do they want to.

After ten years the euro is facing up to its first serious test
Last week, Jean-Claude Trichet, the President of the European Central Bank, gathered with fellow euro-worthies in Frankfurt to be photographed next to a giant cake.

However, having attended the single currency's 10th birthday party, eurozone policy-makers could now be suffering from a permanent hangover.

A decade on, the single currency area is still enduring the co-ordination problems that have bedevilled it from the outset. And, such are the difficulties in running a huge currency bloc, now with 15 member states, that Trichet's attempts to temper inflationary expectations last week simply made price pressures much worse....

....This eurozone, of course, has a very basic problem. France is set to grow almost 2 per cent this year, Italy barely at all. The credit crunch has sent Spain into a tailspin, but Germany will probably muscle its way through. So where should the ECB set interest rates?

Since mid-2007, they've remained at 4 per cent. But Trichet hinted last week that with eurozone inflation now at 3.6 per cent - way above the 2 per cent target - rates may need to rise. That may suit inflation-averse Germany. But it could crucify debt-driven nations such as Italy, Spain and Ireland.

And the ECB's policy headaches just got even worse. Trichet's clear signal on rates caused the euro to rise, which sent the dollar crashing. As the world's two biggest currencies, the euro and the dollar tend to see-saw.

However, that dollar fall, in turn, sent oil spiralling (as crude is priced in greenbacks) all the way to $139 a barrel. That, of course, raises Europe's energy costs, so provoking more eurozone inflation. Trichet merely compounded the problem he was trying to solve.

Stoneleigh: Willem Buiter has a laughably mild view of what Britons will have to endure. Only small wage increases? Real incomes 2-3 percent lower? Unemployment a percentage point higher? An unpleasant few years? I think not. Skyrocketing unemployment, a complete loss of bargaining power for most people and therefore wage cuts in nominal terms (ie much larger cuts in real terms against a deflationary backdrop) are on the cards. And monetary tightening - to control phantom monetary inflation - will aggravate all of those factors, in the UK and beyond.

Willem Buiter urges Bank to raise interest rates
Britons must steel themselves for a fall in living standards which could be as sharp and painful as in the 1970s, as the western world faces up to a new era of stagflation, a former Bank of England policymaker has warned.

Willem Buiter, one of Gordon Brown's first appointees to the Bank, said Britons face a "painful couple of years", and urged the Monetary Policy Committee to raise rates twice to cap inflation......

....While Prof Buiter said inflation would remain under control, the experience for consumers would be comparable with the previous oil price shocks.

"The increase in commodity prices has been more broad-based [than in the previous oil shocks] so from the point of view of living standards it could be just as bad now as it was then," he said, adding that as well as having to contend with sharply higher prices, people would face small increases in wages.

"Real incomes could be 2pc or 3pc lower than they could otherwise have been - that will be painful. It's a shock to the standard of living, and it will be an unpleasant few years. Unemployment will rise - perhaps by as much as a further percentage point this year."

Next Phase of the Credit Crisis to Hit Credit Default Swaps $62 Trillion Market
While attention has been focused on the relatively tiny US „sub-prime“ home mortgage default crisis as the center of the current financial and credit crisis impacting the Anglo-Saxon banking world, a far larger problem is now coming into focus. Sub-prime or high-risk Collateralized Mortgage Obligations, CMOs as they are called, are only the tip of a colossal iceberg of dodgy credits which are beginning to go sour. The next crisis is already beginning in the $62 TRILLION market for Credit Default Swaps....

....A Credit Default Swap is a credit derivative or agreement between two counterparties, in which one makes periodic payments to the other and gets promise of a payoff if a third party defaults. The first party gets credit protection, a kind of insurance, and is called the "buyer." The second party gives credit protection and is called the "seller". The third party, the one that might go bankrupt or default, is known as the "reference entity." CDS's became staggeringly popular as credit risks exploded during the last seven years in the United States . Banks argued that with CDS they could spread risk around the globe.

Credit default swaps resemble an insurance policy, as they can be used by debt owners to hedge, or insure against a default on a debt. However, because there is no requirement to actually hold any asset or suffer a loss, credit default swaps can also be used for speculative purposes.

Warren Buffett once described derivatives bought speculatively as "financial weapons of mass destruction." In his Berkshire Hathaway annual report to shareholders he said "Unless derivatives contracts are collateralized or guaranteed, their ultimate value depends on the creditworthiness of the counterparties. In the meantime, though, before a contract is settled, the counterparties record profits and losses -often huge in amount- in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)." A typical CDO is for five years term.

Like many exotic financial products which are extremely complex and profitable in times of easy credit, when markets reverse, as has been the case since August 2007, in addition to spreading risk, credit derivatives, in this case, also amplify risk considerably.

Now the other shoe is about to drop in the $62 trillion CDS market due to rising junk bond defaults by US corporations as the recession deepens. That market has long been a disaster in the making. An estimated $1,2 trillion could be at risk of the nominal $62 trillion in CDOs outstanding, making it far larger than the sub-prime market.

Wall Street Banks Land First Blow in Battle Over Clearing Swaps
Goldman Sachs Group Inc., Morgan Stanley and 14 banks and brokerages dealt a blow to futures exchanges in the battle to shift trading in the $62 trillion credit-derivatives market to a model the Wall Street firms control.

Clearing Corp., the Chicago-based clearinghouse owned by the companies, will guarantee trades at Depository Trust & Clearing Corp. by September. That gets the Chicago firm and its backers access to fees on trillions of dollars of credit default swaps.

``It will give the dealers an edge over the exchanges,'' said Brian Yelvington, a strategist at CreditSights Inc. in New York. ``The exchanges would have to get to 'critical mass,' which is much harder for them to do without the broker-dealer community using them.''

The banks aim to sidestep exchanges such as CME Group Inc. in the race to use a clearinghouse model for risky trades that led to the demise of Bear Stearns Cos. Clearinghouses, which are capitalized by their owners, diffuse default risk and help create daily prices. Trading is now conducted bilaterally, exposing each side to the possibility of default.

More than bragging rights are at stake. Banks and brokers could have earned a $31 billion profit on the $62 trillion of outstanding credit-default swaps, assuming a 5 basis point spread between bid and ask prices.

Stoneleigh: Geithner worries that financial regulation might 'make the system less safe', but it is difficult to see how the system could be any less safe than it is currently.

Geithner Calls for More Fed Authority to Prevent Future Crises
Federal Reserve Bank of New York President Timothy Geithner called for greater central bank authority over banks so the financial system can better withstand shocks and recover from the credit crisis.

In addition, the Fed's lending programs to commercial and investment banks will remain ``until conditions in money and credit markets have improved substantially,'' Geithner wrote in an op-ed article for the Financial Times.

Officials are searching for ways to prevent a repeat of the decline in credit, sparked by the subprime-mortgage bust, that's cost banks $389 billion in writedowns worldwide and led the Fed to rescue Bear Stearns Cos. from bankruptcy in March. Geithner's comments build on congressional testimony he gave in April.

``It is important that we move quickly to adapt the regulatory system to address the vulnerabilities exposed by this financial crisis,'' Geithner said. Officials must be careful not to write rules that ``make things worse'' and ``distort incentives in ways that may make the system less safe.''

Lehman Loses $2.8 Billion, Plans to Raise $6 Billion
Lehman Brothers Holdings Inc. reported a $2.8 billion second-quarter loss, the company's first since going public in 1994, and plans to raise $6 billion to help it survive the collapse of the mortgage market.

The fourth-largest U.S. securities firm fell as much as 11 percent in New York trading after saying in a statement it would sell common and preferred shares. The New York-based company sold about $130 billion of assets in the quarter and cut mortgage-related holdings and leveraged loans by 20 percent.

Chief Executive Officer Richard Fuld, who said he was ``very disappointed'' with the results, is adding to the $8 billion he raised since February to quell concern that the global credit-market contraction would bring his firm down. Banks and brokerages have raised more than $285 billion to make up for almost $390 billion in writedowns and credit losses since the start of last year.

``It's kind of sobering for people who have been listening to the company these last six to nine months that they had everything under control,'' said David Hendler, an analyst at CreditSights Inc. in New York. ``It shows that the market continues to be difficult. I would say Lehman's probably not the only broker that has these kinds of pressures.''

Lehman to raise $6 billion in capital
Lehman Brothers says it will raise $6 billion through a stock issuance, and expects a second-quarter loss of approximately $2.8 billion due to more pain from the credit crisis.

The nation's fourth-largest investment bank said Monday it expects to post a loss of $5.14 per share for the quarter ended May 31. It made $489 million, or 81 cents per share, in the year-ago period.

Lehman says it will raise capital from both common and preferred stock.

Stoneleigh: As this article says, perceptions can become reality. In other words, actions affect perceptions, which in turn drive further actions. George Soros calls this reflexivity. I call it a positive feedback spiral based on human herding behaviour in the markets.

Lehman Cuts $130 Billion of Assets to End Bear Stigma
As Lehman reports its first loss since the New York-based company's spinoff from American Express Co. in 1994, Fuld is doing everything he can to ensure that Lehman survives another year as the fourth-largest securities firm if not the next 10. Trouble is he's discarding some of the elements that enabled Lehman to report faster earnings growth from 2002 to 2007 than any of his competitors except Goldman Sachs Group Inc.

Lehman posted a record second-quarter loss of $2.8 billion today and said in a statement that it plans to raise $6 billion from outside investors. To reduce market risks, the company unloaded about $130 billion of holdings during the quarter. At least $18 billion of the assets were tied to mortgages and leveraged-buyout loans that plummeted in value, said a person with knowledge of matter, who declined to be identified because the figures haven't been disclosed.

``They're doing all the right things, such as de-leveraging aggressively, but these are stressful times, and they don't always get the credit they deserve,'' said UBS AG analyst Glenn Schorr, who has a ``neutral'' rating on Lehman. ``Although Lehman is very different than Bear, there's one similarity, and that's what could undo all the other positives: perceptions can become reality.''

Barclays May Get Funds to Replace Capital, People Say
Barclays Plc, the U.K.'s fourth-biggest bank by market value, may sell shares to replenish capital depleted by asset writedowns, two people with knowledge of the matter said.

The fund-raising would bolster the London-based company's so- called Tier 1 capital ratio, which trails Edinburgh-based HBOS Plc and Royal Bank of Scotland Group Plc. Barclays needs at least 7 billion pounds ($13.8 billion) to strengthen its balance sheet as asset markdowns increase, according to estimates from analysts at Lehman Brothers Holdings Inc. and Citigroup Inc.

``Many people are surprised they haven't pushed the button by now,'' said Robert Talbut, chief investment officer at Royal London Asset Management, which own Barclays stock.

Chief Executive Officer John Varley said as recently as May 12 that the company may have to raise capital. Barclays shares have declined 27 percent since then, twice as much as the eight- member FTSE All-Share Banks Index.

Stoneleigh: Not being able to get one's money out is going to become a more an more familiar story. Thanks to a long credit expansion, there are far more claims to wealth than there is wealth to go around. Many of those claims will be extinguished, with those of relatively small players whose wealth is being 'looked after' by others being most acutely vulnerable. Good luck getting anything for retirement out of a large public pension fund for instance.

Banks Say Auction-Rate Investors Can't Have Money
The 65-year-old real estate investor from Toms River, New Jersey, said he hasn't had access to cash the bank invested for him in auction-rate preferred shares ever since the market seized up in mid-February. Even when Biddar agreed to sell $100,000 worth of the securities to Fieldstone Capital Group, Charlotte, North Carolina-based Bank of America wouldn't release the bonds, saying the transaction wasn't in his interest, he said.

``I can't do anything,'' said Biddar, who was so eager to unlock his money that he was willing to accept 11 percent less than what he paid for the securities. ``Bank of America got me into these securities that are supposed to be as safe as a money market, and now they won't get me out.''

Bank of America, UBS AG, Wachovia Corp. and at least four dozen other firms that sold $330 billion of securities with rates set through periodic bidding are thwarting attempts to create a secondary market that would allow investors to access their cash, according to investors. Dealers claim they are saving customers from needless losses on securities they marketed as similar to cash-like instruments.

``By allowing customers to sell at a discount, the banks allow customers to establish damages,'' said Bryan Lantagne, the securities division director for Massachusetts Secretary of State William Galvin. Lantagne is head of a task force for nine states looking at whether brokers misrepresented the debt as an alternative to money-market investments.

At least 24 proposed class action suits have been filed since mid-March against brokerages over claims investors were told the securities were almost as liquid as cash.

Investors ranging from retirees to Google Inc. in Mountain View, California, have been trapped in auction-rate bonds for more than three months after dealers that ran the bidding suddenly stopped supporting the market as their losses mounted on debt linked to subprime mortgages. Before February, dealers routinely bought securities that went unsold, reassuring investors that they could get their money back on a moment's notice.

Giant Calif. land partnership files for Chapter 11
A 15,000-acre California real estate partnership that has the nation's largest public employees pension fund as its main investor has filed for Chapter 11 bankruptcy protection.

LandSource Communities Development LLC issued a news release late Sunday to announce the bankruptcy filing in U.S. Bankruptcy Court in Delaware. The partnership's assets include 15,000 acres of undeveloped land north of Los Angeles in the Santa Clarita Valley, making it one of the largest land deals to falter amid the national housing glut.

The California Public Employees' Retirement System, its main investor, did not immediately return calls early Monday.

Analysts Lose 17% for Investors in Brokerage Picks
Investors who followed the advice of analysts who say when to buy and sell shares of brokerage firms and banks lost 17 percent in the past year, twice the decline of the Standard & Poor's 500 Index.

Buying shares on the advice of Merrill Lynch & Co.'s Guy Moszkowski, the top-ranked brokerage analyst in Institutional Investor's annual survey, cost investors 17 percent, according to data compiled by Bloomberg. Deutsche Bank AG analyst Michael Mayo's counsel to purchase New York-based Lehman Brothers Holdings Inc. lost 59 percent. Citigroup Inc.'s Prashant Bhatia still rates Merrill ``buy'' after its 56 percent retreat from a January 2007 record.

Of the 39 analysts tracked by Bloomberg who follow stocks in the Amex Securities Broker/Dealer Index, 32 produced losses for investors. Investors who bought brokerages on ``buy'' recommendations, sold when they switched to ``hold'' and speculated prices would decline when analysts said ``sell,'' lost 17 percent in the last year through June 3, compared with the S&P 500's 8.5 percent drop.

Frank-Dodd Rescue Prolongs Housing Crisis by Deferring Defaults
Dan Castro favors cutting the amount of money that some delinquent homeowners owe him so they can qualify for government help and avoid foreclosure. He's not sure other mortgage-backed securities investors feel the same.

For legislation being considered by Congress to work, they would have to.

``You'll never get everybody on board,'' said Castro, chief risk officer for New York-based Huxley Capital Management.

Proposals advancing in the Senate and House of Representatives would call for the federal government to insure as much as $300 billion in refinanced mortgages, potentially saving up to 2 million borrowers from foreclosure, according to one of the sponsors, Representative Barney Frank. Declining home prices will mean that one-third of those borrowers will default again, prolonging the deepest housing crisis since the 1930s, said Michael Carliner, former economist at the National Association of Home Builders in Washington.

``Clearly, if you recast the mortgage lower and it still goes bad, you're just prolonging the agony and making the loss severity worse than it is now,'' said Castro, formerly chief credit officer at GSC Group and managing director of structured finance research at Merrill Lynch & Co.

In addition to counting on investors to cut the principal they are owed, the bills, backed by Senator Christopher Dodd, a Connecticut Democrat, and Frank, a Massachusetts Democrat, would require borrowers to keep making their monthly payments even as they are given an incentive to stop. Holders of second-lien mortgages also would have to consent to taking losses of more than 99 percent.

Wealth Evaporates as Gas Prices Clobber McMansions
Sky-high gasoline prices aren't just raising the cost of Eugene Marino's 120-mile round-trip to his job in the Washington area. They're reducing his wealth, too.

House prices in his rural subdivision beyond the Blue Ridge Mountains in Charles Town, West Virginia, have plunged as commuting expenses have soared. A four-bedroom home down the street from his is listed for $239,000, after selling new for $360,000 five years ago.

Homeowners in the exurbs aren't the only ones whose assets have taken a hit because of the surge in energy costs. Companies such as General Motors Corp. and UAL Corp. are writing off billions of dollars in plants and equipment that are no longer viable in an age of dearer oil. The destruction of wealth and capital will weigh on U.S. growth for years to come.

``Our whole economy reflects the relative costs of energy: the cars we drive, the houses we occupy, the kinds of factories we have and the equipment in them,'' says Dana Johnson, chief economist at Comerica Bank in Dallas. ``I'm expecting relatively large changes in all of these things.''

The loss of wealth could be a double whammy for the U.S. economy. In the short run, it depresses demand as homeowners save more and spend less, and companies fire workers. Longer run, it curbs productivity growth, as firms shift their focus from increasing worker efficiency to reducing energy costs.

Subprime casualties find no need to sweat the big stuff
Remember that old saying: owe the bank a thousand dollars and you're in trouble, owe the bank a million dollars and it's in trouble.

That no longer applies. What with inflation and all, the truism has been upgraded. These days it takes a million and a billion respectively.

But the principle is the same. In fact, those who have taken the banks for a ride in the past few years - generously relieving them of the billions they were desperate to lend - have never had it so good.

Perhaps you haven't noticed, but of all the big companies that hit the wall in January and February, not one has been placed in receivership.

When global credit markets ground to a halt early in the new year, any company with short-term debts lined up like sheep for the slaughter. Consider the list: Centro Properties, Centro Retail Trust, MFS, City Pacific, Allco Finance, ABC Learning Centres.

And yet, unlike during the last great meltdown two decades ago, not one of them has been sent to the graveyard.

That's not to say it won't happen. But in the past few months, every time a major debt deadline has loomed, the banks have left the directors and executives to sweat it out until the last minute, and then announced an extension.

It happened with Centro last week. Massive debts were due on Friday night last week. There were no surprises when the deadline passed because, while Centro has some decent assets, it doesn't have two spare cents to rub together.

But it took until Monday before the banking syndicate gave the company the green light to continue trading.

So why not just put them out of their misery? Why prolong the agony for everyone involved when it's clear some of these companies have no chance of survival in their current form?

The answer is the banks have become smarter with the way they deal with miscreant borrowers. They've adopted a de facto American approach to corporate collapses. And it's an approach primarily designed to their benefit.

Legally, Australia adopts a hardline approach to corporate collapse. If a company's directors believe it is insolvent, they are obliged by law to appoint an administrator. If a secured creditor such as a bank is concerned about a company's ability to repay its debts, it can approach the courts and have a receiver appointed to look after its interests.

But once a receiver or liquidator is appointed, the bank loses control and merely stands in line for a slice of whatever the liquidator retrieves.

Dangers ahead for U.S. markets
Global financial markets open this week still in shock from Friday's dramatic surge in oil prices and plunge in stock prices -- and facing new doubts about the U.S. consumer's ability to help spur a recovery in the struggling economy.

Asian stock markets were falling early today and the battered dollar continued to lose ground against other major currencies as investors braced for Wall Street's starting bell.

There was a bit of relief in energy prices: Crude oil futures slipped $1.14 a barrel to $137.40 in electronic trading Sunday evening in New York. But that was just a sliver of the $10.75-a-barrel jump Friday to an all-time high of $138.54.

And in another reminder of what unprecedented oil prices are doing to Americans' pocketbooks, AAA on Sunday said the nationwide average price of gasoline crept up to a record $4 a gallon -- a level California already had surpassed.

The latest tumult in energy prices and financial markets is likely to focus a harsher spotlight on this week's economic reports, including the number of contracts signed to buy existing homes in April, May consumer price inflation and the first June survey of consumer confidence.

"It shouldn't be a surprise that the economy is weak. The question now is whether it's accelerating to the downside," said Don Rissmiller, chief economist at investment research firm Strategas Research Partners in New York.

That was the message some investors took away Friday after the government reported a fifth straight month of job losses in May and a leap in the unemployment rate to 5.5% from 5% in April -- the biggest one-month jump in 22 years.

Corn Jumps to Record on U.S. Midwest Rain, Crude Oil, Dollar
``With concerns about weather-related production losses, surging oil prices and the weaker dollar have fueled speculative demand for agricultural products that are fundamentally strong because of tight supplies,'' Daisuke Yamaguchi, an analyst at futures broker Yutaka Shoji Co. in Tokyo, said today.

Corn for July delivery rose as much as 22.25 cents, or 3.4 percent, to $6.73 in after-hours trading on the Chicago Board of Trade and stood at $6.675 as of 11:59 a.m. London time. The contract gained 8.6 percent last week, the biggest gain in 10 weeks. New-crop December corn traded as high as $6.985 a bushel.

Prices for the cereal have gained 69 percent in a year, fueled by growing demand for grain-fed meat in Asia, market speculation and the push to grow corn for ethanol. Wheat, soybeans and palm oil also reached records this year, sparking food riots from Haiti to Ivory Coast.

United Nations Secretary-General Ban Ki-moon last week said the world needed to invest as much as $20 billion a year on agriculture to tackle soaring food prices.

Global food supply is a growing problem
Food riots. Scores of panicked people protesting, burning effigies and chanting. Shops being ransacked, supplies running out as soon as they come in, and stricken communities stockpiling rice, bread and water for fear of going without. These have happened in Haiti and Egypt in recent months as the price of scarce food has soared.

But what if they happened on the streets of Bromley? Or Newcastle? Or Bath? As bizarre as this might seem, the prospect of UK food shortages has started to be taken seriously by food manufacturers and retailers.

The global food shortage has raced to the top of the political agenda in recent weeks due to a nasty combination of increasing demand, falling supply and ever-costlier production and selling prices. At the United Nation's Food and Agriculture Organisation (FAO) conference last week, Jacques Diouf, the FAO's director-general, said that $30bn (£15.3bn) a year is needed to relaunch agriculture in the developing world and avert future threats of food conflicts.

Ban Ki-moon, the UN secretary general, said world farm production will need to rise by 50 per cent by 2030 to meet growing demand. Last week Gordon Brown, the Prime Minister, told the House of Commons that the UK needed to sign new trade agreements to "get food prices down". On Thursday he raised the topic of food with José Manuel Barroso, the European Union President, as a matter of priority.

There are four trends driving global food scarcity: global population growth (it is expected to grow from 6.7bn to 9bn by 2042), the increasing use of crops for fuel rather than food, the Westernisation of diets in the Far East, and a diminishing bank of farming land due to urbanisation and climate change. Market speculation is also mooted as a factor.

Brazil, Vietnam, India and Egypt have already imposed food export restrictions to protect the produce that they've got. And now big businesses in Europe are starting to stand up and take note.

Earlier this month UK supermarkets including Netto and WM Morrison were forced to ration sales of rice in response to supply problems and price rises.


cj said...

Firstly want to state how much I appreciate The Automatic Earth! It is wonderful that there are sites such as these that shed the light on what is in fact transpiring in the world.
I am somewhat at a loss as to where I should store my wealth in this deflationary market. I have been in precious metals. Wondering if that is the best place to be. I am not an expert by any means when it comes to these things. Any thoughts?

cj said...

Love your blog! In a deflationary world where would one store ones wealth? I have been in the precious metals market, but am having some doubts about its stability in a deflationary market.

Stoneleigh said...

Thanks :)

The more control you have over your own wealth, the better your chances of keeping it in a world where claims to wealth outstrip actual wealth by at least 100 to 1.

You need liquidity - cash and cash equivalents (ie short term treasuries) - but I would trust it to the banking system. Too many banks have fatal solvency problems that central bankers can mask for only so long.

Of course you should have no debt, as debt becomes a millstone round your neck very quickly in a deflation where real interest rates will be very high.

Precious metals are an insurance policy. Their price is likely to fall significantly, but if you have other bases covered then it may be worth keeping them, so long as you're fairly sure you won't need to rely on the money for years to come. You would need to own actual physical metals though. A certificate wouldn't be worth the paper it was printed on at some point. Personal control is very important.

The general advice I have given before is this:

*Hold no debt (for many this means renting)
*Hold cash and cash equivalents (short term treasuries)
* Don't trust the banking system, FDIC or no FDIC
* Sell (or short if you can afford to gamble) equities, most bonds, real estate, commodities, collectibles
* Take control of some of the necessities of your own existence if you can afford to do so
* Try to reduce or eliminate structural dependencies that make you vulnerable to disruption
* Build social capital if you can as social networks can insulate you from upheaval

Anonymous said...

Hi Stoneleigh,enjoy and agree with your comments but apart from short term fluctuations how do you feel oil, hydro and alternate energy would hold up. To my mind as long as there is some sort of structure to this civilization they will be around but I haven't a decided position whether the advantage would be to hold some or be out.

I do definitely like ducks though and have found holding a duck in reserve will pretty much guarantee an egg every day. Got a Kaki-Campbell recently and am amazed that that duck has laid an egg practically every day since we got her. I would honestly advise everyone to do their banking on a duck , on oil I am not so sure.

scandia said...

Crystalradio, Love your " quack" advice! Best not to put all one's eggs in one basket! Etc...Etc...

cj said...

Thank you for your reply.

If the US Dollar is crashing why would want to stay in cash or cash equivalents?


Anonymous said...

If banks can't be trusted, can credit unions be trusted? In your opinion, would my CD at a bank be safer if I moved it to a credit union? Or, are you saying, I should just get the money from the bank CD and store the cash at my house in a heavy-duty safe? Thank you,
Anonymous reader

Stoneleigh said...


I think the dollar is likely to show a strong rebound as deflation kicks in, with a corresponding fall in the euro.

The reason to hold cash is that purchasing power will be in very short supply. Most of our effective money supply is currently credit, and credit is going to disappear, gradually at first and then accelerating. Credit deflation is not a gradual process once the tipping point has been reached, which means that you may get relatively little notice of serious problems on the horizon.

Without credit, we will see just how little actual money there is, and how valuable it will then become. What it's worth against other currencies will be less important than what it's worth locally in terms of the necessities of your own existence, or (if you're particularly lucky) in terms of assets available for pennies on the dollar.

During the great Depression, there was no shortage of resources. What there was was a shortage of money thanks to deflation. We're heading for the same predicament again, only worse this time as every measure is worse than in 1929, yet we have far fewer skills and resources (and far higher expectations).

Cash is king in a deflation.

Stoneleigh said...

Credit unions may be a better risk, so long as they're very prudently managed. I would make sure you have at least several months worth of cash on hand though, in case you have difficulty accessing your money when you need to. The more personal control you have over your assets, the better. Be careful about home storage though - there are risks everywhere and you have to choose the ones you can live with.

It can take a while to build up cash on hand, as if you withdraw a large sum all at once you can find yourself red-flagged as a potential criminal. Governments are becoming increasingly distrustful of cash and don't really see any legitimate reason for citizens to hold it. The fact that it's depositors own money doesn't enter into the calculation. As with most things, if you can see an event coming where everyone is going to want to do the same thing at the same time, then make sure you beat the rush.

Once we're in the grip of bank runs, the chances of getting any of your money out will be very low. For most it will be gone for good, as banks could only afford to pay out less than a cent on the dollar if everyone wanted their money back at once.

Farmerod said...

For what it's worth, and at the risk of repeating myself ad nauseum, I've concluded that Canada Savings Bonds are the best bet for large sums of money. Held outside an RSP, they come in the form of a certificate, cashable at any financial institution that may have cash. They're relatively secure in that even if they're lost or stolen, you can still get your money once you prove who you are. And they're backed by the federal government itself so things have to get REALLY bad for CSBs to be a bad store of value.

Anyway, I'm still looking for a better idea than CSBs if anyone has any. It's been suggested that I could get a better return than CSBs by buying provincial government bonds but, if they have to be held in an account at a financial institution, then you have to make sure that particular institution is going to stay in business. But, at this point, I'm not really interested in whether the bond pays 2.5% or 3%. Not LOSING 90% on many other 'investments' makes the difference in postive return negligible.

Stoneleigh said...

I quite agree OC. The important thing is to be outside financial institutions, and to make short term financial commitments if possible, in order to maximize flexibility.

I'd stick with federal bonds rather than provincial. Higher yield means higher risk, and higher levels of government will have first dibs on tax receipts. Municipalities will be worst off - squeezed for revenues and inundated with desperate requests - hence any kind of municipal bonds should be avoided.

As I've said before, the return OF capital is more important than the return ON capital.

Anonymous said...

What is the best way to directly purchase short term treasuries? How secure is the TreasuryDirect method? Is it preferable to purchase treasury bills vs notes, or combo of both?

What is your opinion of a Vanguard IRA treasury money market fund vs an IRA credit union insured CD? Which is safer to preserve capital? Thank you,
Anonymous reader

Farmerod said...

I can't comment on treasurydirect but I do recall there being a discussion on that over at Ticker Forum a few months ago and I suspect the topic comes up frequently.

cj said...

Interesting thoughts. Do you think that I should cash out of silver so that I hold actual cash? I don't have a lot of silver, maybe $65,000. I do however have some thoughts concerning a current silver shortage. Silver is used heavily in industry. The US military uses silver in warheads etc. There are extensive uses in other industries. If there were a global recession that could certainly affect silver use, but a silver shortage could have significant implications. Any thoughts?


Anonymous said...

I have a question regarding deflation. Americans may have borrowed to the hilt and as credit disappears cash in US dollars may be in short supply here in the states. But foreign governments (Chinese, Saudis, etc.) have several trillion dollars in sovereign wealth funds. How does this impact deflation? If cash is then king will that make them the kings?

Stoneleigh said...


Silver is primarily an industrial rather than a monetary metal. In a severe depression, demand for silver would fall dramatically and so would it's price. Gold should fall too, but it should hold more of its value than silver. Selling now would make you a paper profit.

If you reckon you might need the money (for instance if you have no other way to raise some liquidity) over the next few years, then you're probably better off selling now while you can still get a good price. If, on the other hand, you think you can afford to hold it (in physical form under your own control) for the duration of a depression and beyond, then it would make a good insurance policy in a world where the forms of insurance we're used to are unlikely to be available.

If you had to sell during a depression you would get a low price and the transaction could even be physically dangerous. Private ownership of precious metals has been illegal before and could be again. That wouldn't stop you owning them, but it would make it problematic to trade them for things you might need if push came to shove, especially if you lived in a rural area far from black markets.

Personally, I'd rather buy myself a measure of control over a few of the necessities of my own existence than own metals I might not be able to trade. Also, flexibility in the face of uncertainty can be very useful, and flexibility is what liquidity buys you.

cj said...


A few further thoughts.

What backs paper money? In the days ahead I feel that what will really matter is what people need. That will truly drive the market, not the imagined market. The current market is mostly imagination, hallucinated wealth. We have strayed so far from reality that we have lost touch.
To put my wealth into the paper world does not make much sense to me. The commodity world, the world of what is really needed for human beings to live is where reality is. There is of course the issue of personal affect on the world regarding investment in that which others need to live. Is there really any way out? I am beginning to think not.
We are collectively facing a paradigm shift, a change that will affect all of those on this planet. I personally need to look at what my part is in this unfolding drama. I would like to think that there might be some way that I can protect myself and my family, but I really wonder if that is possible. We have done this to ourselves. It isn't the fault of someone else, the evil government or whatever you choose to pick, it is a matter of personal responsibility. That is a hard pill to swallow!!
I will continue to communicate with you if you wish. I long that there be those who are willing to allow their lives to change. We all need to be willing to change our lives. The fact is we have no choice!!!


Stoneleigh said...

Anonymous reader,

Buying the shortest term government obligations you can is generally best, as you are not then tied to finding a buyer in order to get your money back. You can choose to roll them or not every 30-90 days, so you can be flexible.

Direct ownership, rather than shares in a fund, is preferable. The more control you have over your assets, the greater the chance you'll be able to keep them in a scramble for wealth.

Stoneleigh said...


I agree that putting everything into liquid form could leave you vulnerable to disruption in supply of necessities. I generally suggest that people get rid of debt first, then balance a measure of control over necessities (eg well and septic for water, water filters, energy storage and/or renewable energy production, hand tools, basic supplies, greenhouse, self-sufficiency books etc) with the provision of liquidity.

Anything you could do to reduce your reliance on money would be a good idea. Social networks are ideal for this if you're so minded. You'll still need enough to pay property taxes and bare necessities at the absolute minimum though, so putting aside liquidity reserves to see you thought a period of upheaval would be advisable. I usually suggest at least several months worth.

Preparing to navigate your way through a depression involves facing far higher risks than anything you face now, no matter what you decide to do. There are no ironclad solutions, and only some risks can reasonably be anticipated and prepared for. You may still need to be both right and lucky.

The money supply is like an inverted pyramid, with higher and broader layers further and further removed from the underlying real wealth. Cash is very close to the narrow base of the pyramid - in other words it will be recognized as money long after most other erstwhile money equivalents have been discarded.

For the long version of my take on the credit crunch (from August 2007) see The Resurgence of Risk - A Primer on the Developing Credit Crunch.

Anonymous said...

Have a quick question for any to respond to,or not

Do you think the run up of fuel
now is a possible signal that a attack on Iran is more than a possibility?

Stoneleigh said...

I think an attack on Iran is a distinct possibility, but I don't think a run up in fuel prices is a signal one way or the other. Huge amounts of money are flowing into commodities and bidding up the price. Eventually, the near-vertical spike will reverse, probably sharply. Commodity tops, like equity bottoms, are driven by fear, hence both tend to be sharp spikes. See the recent spike and reversal in silver for example.

Anonymous said...

It's not a deflationary world.

The USA is deflating due to the collapse of credit. So too is Europe.

China is inflating. The Gulf States are inflating. South America is inflating. Africa is inflating. Russia is inflating.
In fact these countries have a serious problem with inflation and are trying to rein it in.

The mechanism for this is incoming US dollars, which have to be sterilised by the creation of corresponding amounts of Chinese currency. Hence China's foreign reserves are now up to $2 trillion.
This fountain of money creation then affects the commodity producing countries like Brazil. Of course Russia and the Gulf have their own stream of oil money.

Stoneleigh figures China is a bubble, because it depends on the US. I figure China is milking the US for all it is worth but has a plan B for when the cow runs dry.

Saying that "overall" the world will experience deflation is like saying that a bucket of freezing water and a bucket of boiling water are "on average" lukewarm. It misses the point.

One part of the world is being destroyed by deflation. Another is being destroyed by inflation. Do we split the difference and call it moderation?

Stoneleigh might think I am being naive - on the contrary, I think she is being OVEROPTIMISTIC. Because in saying that Chinese demand will just quietly collapse once the US tanks, she's missing half of the nutcracker that will squeeze the life out of the western middle class - the ever-increasing demand from China, Russia and the Middle East for every necessity of life that allows survival.

My vision of China spending their $2 trillion to pump up their local economy when the US falls, thus keeping demand strong in the midst of a terrible depression, is by far the scarier one.

If they can print up yuan at the rate of several hundred million per year to buy up incoming US dollars (for stabilisation purposes), can't they just keep printing yuan when the dollar flow dries up? Given the size of their dollar hoard, it's not as if people will lose confidence in their currency.

Anonymous said...

Table 8: China's Top Export Destinations 2007 ($ billion)
*Percent change over 2006
Source: PRC General Administration of Customs, China's Customs Statistics
Rank Country/Region Volume % Change*
1 United States 232.7 14.4
2 Hong Kong 184.4 18.8
3 Japan 102.1 11.4
4 South Korea 56.1 26.1
5 Germany 48.7 20.8
6 The Netherlands 41.4 34.2
7 United Kingdom 31.7 31.0
8 Singapore 29.6 27.8
9 Russia 28.5 79.9
10 India 24.0 64.7
* from 2006

scandia said...

Stoneleigh, I am sure I would have read your August/07 posting on The Oil Drum on The Resurgence of Risk...I expect I would have skimmed it as I wouldn't have understood it.
Do I need to remind all of my entry level question to TAE, " what is a counterparty?" I've come a long way since then. Iunderstand that August/07 posting now thanks to the learning curve provided by TAE!
Good time to ask another "dumb question" What is " the real economy?' and if the financial news isn't talking about " the real economy" what other kind is there?

cj said...


Tenthousandmilemargin makes a case for deflation in the west and inflation in much of the rest of the world. If that is the fact, would there not be increasing demand for all manner of commodities from those economies which are inflating. The price that drives commodities surely isn't dictated by the US market only. As the US slides into deflation I would think that the other rapidly expanding markets would still drive the price of commodities higher as they compete for what remains. Maybe, maybe not. The one thing that I feel will accelerate this unfolding drama is of course, oil. As the US slips into a depression we will have a tremendous crash in purchasing power. As we bid against other countries for available supply the US will be the loser. This would of course rapidly drag the US down further into the depths, and rapidly accelerate inflation elsewhere. This whole dynamic could happen a lot faster than many might think. Of course there is always the US military. You never know what wars they might prosecute in the name of "our way of life is non negotiable" I hope not, but from where I stand the people in this country live in a grand disconnect from reality, and would most likely cheer on a war that gets us what we want. Lets just steal from someone else. Isn't it grand being an American!


Anonymous said...

I agree Chris. I recall a point made about the historical transfer of power on the world stage and how rarely it occurs peacefully. I don't expect us to pass the torch voluntarily (though it seems that would be a solid option for us to choose).

Bigelow said...

“Real economy”, is also known as main street, where stuff is made and consumed.

scandia said...

Bigelow, I can assume that the " real economy" does not include the financial sector?
I don't see anything being" made" there. Other than paper debt and paper fortunes of course, which have an impact on the " real economy"?

Anonymous said...

Scandia, 'counter party' is basically just the other guy I think they stopped using the term 'other guy ' and started using that hoity toity 'counter party' as 'other guy' was becoming too often used honestly in the phrase 'screw the other guy'

About China and it's counter party (us)

During the 30's I heard that there were 5 million applications to emigrate to the USSR. China for all the western lipstick is still underneath a socialist state. I have often had the thought in the back of my head that China is using the west in order to garner the wealth necessary put it's population in order, that is get through the population bulge that will leave an every decreasing number of the young and the fertile. Here is a graph for that Chinese population snake . digesting.

Maybe China will shut it's doors, close the blinds and just curl up next to the new nuclear reactors it is building and digest till it wakes as a slender vigorous and revitalized Chinese dragon?

Just a thought though:)

Anonymous said...

Outtacontrol said:

Anyway, I'm still looking for a better idea than CSBs if anyone has any.

Probably not for what you seem to want but for anyone who has different needs the following might be of interest: .

These are Canadian high interest savings accounts that are fdic insured: The Citizens Inhance Cash Multiplier fund is paying 3.25%, , Dundee is paying 3.2%, as is Altamira. Manulife and Coastal Community (a Vancouver island credit union) are paying 3%.

When I last looked CSB's are paying 2.45% (2.90% if you want to hold the premium bonds for a full 3 years and unless I read it wrong can not be cashed out for that term).

scandia said...

Crystaradio, that is a very good suggestion- Hibernation. It is an evolutionary tactic other species use to conserve energy. Probably for other reasons as well. Those who remain, for awhile at least, may only manage to be active for certain seasons on earth. Again to conserve energy or climate change may provide a season or two that would be intolerable for human beings. Voila! Hibernation provides a solution. Better than dead.

Stoneleigh said...


It's not often I'm called over-optimistic :)

China has been inflating because it's in a massive bubble. Yes they have money, but so did Japan on the brink of its long deflation and that didn't prevent their bubble from imploding. There is a huge amount of bad debt set to cripple the Chinese banking system, as there was in Japan.

China's problem is the enormous misallocation of capital that the global credit bubble has engendered. It has invested staggering sums of money in plastic-tat factories for export markets that are about to dry up. Much of that capital will be reduced to waste very quickly, leaving a very large number of people destitute and angry.

Far from being optimistic, I am expecting China to look for someone to blame, since that appears to be a universal human trait. They have a large surplus of single young men who would probably be relatively easy to inflame against a perceived enemy.

They also have a country that is environmentally ruined in many places, including the next dust bowl in the north. Why would they stay where they are and suffer when they could colonize many other places, as we did when we were the empire in the ascendancy?

I don't expect China to suck in resources the way it has during the bubble years by any stretch of the imagination, but I do expect them to seek control over strategic resources economically and/or militarily.

Essentially, I see the coming period as an interregnem leading to a shift of hegemonic power. I suspect we won't like being colonized, but when did we ever give other people any choice in the matter?

Stoneleigh said...


You said; "But foreign governments (Chinese, Saudis, etc.) have several trillion dollars in sovereign wealth funds. How does this impact deflation? If cash is then king will that make them the kings?"

Basically, yes, although they'll have their own serious problems to deal with. China is the rising power, but India and the Gulf states are very vulnerable. Much of resource-poor India is likely to become uninhabitable as the water tables continue to fall by feet per year and the glaciers that provide river water melt. For a population growing as quickly as India, this is a disaster. Parts of China will have similar problems of course, but other parts will do much better. I expect a great deal of outward migration from both huge centres of population.

The prosperity of the Gulf states is essentially a desert mirage. As a resource-rich part of the world, they are very unlikely to experience peace in a world prone to resource grabs. Such regions are regularly flooded with weapons, while great powers stoke up old hatreds that they can then exploit. The octogenarian Saudi regime is particularly likely to be overthrown in what I expect to be a veritable orgy of destruction in the region.