What will happen to interest rates?

Jim in San Marcos envisages eventual interest rate rises worldwide, to 10-15%. Commenting on the preceding post, Nikolay disagrees and James asks the question. I'm trying to understand the situation, like everyone else, so I'll have a go at thinking aloud:

Nikolay makes the point that people are becoming more concerned about the return OF their money, than the interest ON their money. So money-holders will limit demand for their cash by being picky about who they'll lend it to; control by quality screening, not by price.

Also, if people who habitually live on credit become frightened - and I think they are - then they will start trying to live within their means.

And discretionary expenditure could be reduced and/or redirected, not necessarily towards the cheapest end. I was listening to someone in the UK fashion industry on R4 yesterday, and they said far from everyone turning to Primark, the trend was to buy better quality, less of it, and make it last longer. Note that it's budget airlines like XL (competing on price) that are in danger of going down - they don't have much "fat to survive the winter".

From another angle, as the supply of cash and credit is dwindling, so are prices of houses and many other big-ticket items - look at the deals on cars and computers.

So it's possible to imagine that the contraction in credit may be approximately matched by a contraction in demand for credit, at least for a time. Bankruptcies and house repossessions will burn off a lot of debt, so we'll see a lot of ordinary people cleaned out and possibly more bank failures, especially as (in response to reduced expenditure) unemployment grows.

Thus we could see a recession in which the government tries to stimulate consumer demand by cutting interest rates - and this may not work, because many won't want (or be able to afford) to take on debt at any price; and those who do have cash and are watching prices fall, will hang off, waiting for further falls - as happened in Japan.

But Jim himself has acknowledged that rates may be cut in the short term. What about the longer term?

More unemployment, lower profits etc will shrink the tax base and increase the benefit burden. The budget won't balance without cuts in the public pay sector (= even less tax, even more benefits) or more government borrowing - I don't see how we in the UK could be taxed much more. So there's a danger that while consumer debt leads the way into recession, increased government demand for debt (and increased concern about government creditworthiness) may then lead the way to higher interest rates on State bonds.

When the State has more dependents, it will also find that not everything is going down in price. Food and fuel are must-haves, so benefits will have to be increased to cover the cost of such items. There will be more poor, and they will each need more. And the government will have to borrow more.

Or start devaluing the currency. Then all bets are off.

So here's a scenario: interest rates kept low, or cut; then government borrowing rises, while the economy burrows into a slump; then the real "credit crunch": the moment when the government, like an ad-man under pressure, needs a feelgood episode and, despite having sworn off it for life, reaches for the booze or the white powder, in this case inflation.

More and more, Michael Panzer's dire financial drama seems plausible.

Time for the stockmarket to smell the coffee?

Michael Panzner reproduces a graph that implies a possible 25% fall on the Dow, factoring-in a little overshoot.

Your money - no hiding place in the Crash

I've spent some time trying to find out where's a safe place for any little wealth you and I might have. Looking at the Great Depression for a precedent, Jesse suggests it's more a game of cat-and-mouse, or fox-and-geese. No "fire-and-forget," then: we will have to keep looking, thinking and acting. (htp: Michael Panzner)

Check your bank deposit security

A cautionary story from Michael Panzner here. An American nearly lost most/all of $400,000 deposited with his bank, despite taking great care to set up the account in a way that brought it under the FDIC deposit protection scheme.

An intriguing detail is the reluctance of the bank to let the account be titled appropriately - failure to do which could have cancelled the FDIC protection. Another, is the bank's reluctant and misleading response when the depositor tried to exercise his right to withdraw his cash.

And the $15,000 interest was lost, anyway.

Where is your account? Make sure it's not dead money.

Unbelievable, unimaginable

The problem with looming economic disaster is that you look out the window and since what you see is normal, you wonder what that mad Cassandra is wailing about.

Michael Panzner reproduces an article by Paul Farrell in MarketWatch about the absolutely enormous international derivative market, currently estimated at $516 trillion. Those numbers are beyond imagining, but if 2% goes bad, that's equivalent to 20% of the world's annual GDP up the chimney.

Why safe investments aren't

Michael Panzner's latest explains a point I've learned and repeated here before: "refuge" investments like gold are not as safe and predictable as you might assume. Borrowing money to invest boosts prices, and then when credit becomes tight, forced sales can deflate prices just as rapidly. We're all in a bouncy castle, like it or not.

Why equities should go down

I'm breaking radio silence because of a brilliantly lucid article (from the subscription-only Barron's site) found for us by Michael Panzner.

Vitaliy Katsenelson explains that the current average price-earnings ratio may seem cheap, but that's because recent profit margins have been well above the 8.5% trend. Even allowing for a shift since 1980 away from industry towards the higher-margin service sector, the present 11.9% profit margin should be seen against a longer-term background figure of around 8.9 - 9.2%, which if current p/e ratios continue would imply a downward stock price correction of 22 -25%.

This chimes with Robert McHugh's "Dow 9,000" prediction from last July. And in many fields it's usual for overshoot to occur in the process of regression to a mean, so if it holds true in this case we could see even deeper temporary lows.

Day traders, be warned: this piste is a Black Run.

Meow boing splat

Both Karl Denninger and Michael Panzner interpret yesterday's rise on the Dow as a bear market rally. There are already references to "dead cat bounce", but we haven't anywhere nearly touched the bottom, I think.

People speak of the crash of 1929, but it took much longer for the crisis to work through and there were lots of opportunities for investors to step off with smaller losses. There were also plenty of traps for those who thought it was time to buy back in.

Here's a chart (source) of the process:

As they say, history doesn't repeat itself, but it rhymes. Today's central banks are acutely aware of this past history and do not wish to be remembered for making the same mistake, i.e. worsening the situation by deliberately contracting the money supply.

However, Denninger and others think we can't stop this contraction anyway, once the credit bubble has been pricked, and attempts to reflate will merely devalue the currency while failing to stimulate the real economy.

Panzner votes DE (flation)

Michael Panzner is in the DE camp, because the bubble was caused by credit creation: "The way up is the way down" (a maxim of both Taoism and Heraclitus, apparently; but then the Greeks have always been great travellers and interested in ideas).

In his excellent book (reviewed here last May), he suggests that inflation will come afterwards (actually, not just IN- but HYPER-).

Debt and slavery

Doug Noland sees the debt crisis spreading to the corporate sector; David Jensen writes a letter to the Governor of the Bank of Canada, including very telling graphs of mounting debt and the bubble in the financial markets; Michael Panzner discusses a piece from the Financial Times on the threat of a downgrade of America's historic AAA credit rating, and refers to the weakening of the USA's military pre-eminence; Sol Palha worries about the acquisition of Western assets by sovereign wealth funds ("Slowly but surely America and Europe are going to be owned by foreigners. The irony is that Congress is trying to keep immigrants out of this country but right in front of their eyes foreigners are slowly gobbling up huge chunks of this country.").

All this leads me to Jeffrey Nyquist's grim, but compelling latest piece. He despairs of the irrelevance of mainstream political discussion, especially as the polling process rattles on, and paints a far greater picture. I think you should read it all, but here are a few extracts:

What is happening in the news today, what is happening in the markets and in the banking system, has profound strategic implications... There are no invulnerable countries... If a government does not see ahead, make defensive preparations, establish a dialogue with citizens, lead the way to awareness and responsibility, then the nation stumbles into the next world war unarmed and psychologically unprepared.

Even worse, today's politics has become a politics of "divide and conquer" in which one constituency is played off against another: poor against rich, non-white against white, the secular against the religious. Before a positive outcome is possible, we must have unity and we must have reality.

It's more comfortable to ignore the crying of Cassandra, but maybe Nyquist is like Churchill in the pre-WWII political wilderness, trying to prepare us for the next conflict. We in Britain only just made it, and how we have paid for that struggle ever since.

But it was a price worth paying. History would have been very different, and very horrible I am sure, if Churchill had listened to some in his Cabinet in 1940 who advised him to make a deal with the Nazis. He said, “If this long island story of ours is to end at last, let it end only when each one of us lies choking in his own blood upon the ground.” It's a line that even now has tears pricking my eyes. The appeasers were silenced by the sound of deeply-moved men banging their fists on the Cabinet table in agreement and applause.

My worry is that I don't see men of that calibre now. As Lord Acton said in a letter to a bishop, "Power corrupts, and absolute power corrupts absolutely". Commenting on the House of Commons after the Great War, Stanley Baldwin remarked on the presence of "A lot of hard-faced men who look as if they had done very well out of the war". Today, the faces are softer, the hair expensively dressed, the manner relaxed and affable, but behind it all one senses cold-hearted, selfish betrayal. To be charitable, it may be that our leaders and ex-leaders don't fully realize the negative consequences of all their deals, compromises and consultancies.

As our reckless debt is progessively converted into ownership, we may find out how much we took our freedom for granted. It's a lot harder to get back.

The Bible has something to say on this, too (and no, I'm not a preacher, this is to show that the issues endure throughout history): Leviticus, Chapter 25 deals with debt, buying and redeeming slaves, and how the chosen people should be treated differently from the heathens - for the latter, enslavement is perpetual.

Stuffed

Michael Panzner hands on a piece from Naked Capitalism: expert, inside opinion is that the banks are so gorged with bad debt that America will mimic the "melancholy, long withdrawing roar" of Japan's ebb tide.

Twang money, encore

The Contrarian Investor is also struck by the elasticity of fiat money, and how this vitiates attempts to make fair comparisons and store wealth. Gold for the long term, he thinks.

In the short term, we have this contest between credit contraction and currency expansion. I'm getting the feeling it'll be the first followed by the second, which is what Michael Panzner predicts in "Financial Armageddon".

Little boxes, revisited

I've previously suggested that you don't need to be too technical, as long as you focus on the reward systems (the cui bono?). Here, Michael Panzner quotes and discusses an article by Nat Worden on the failure of ratings agencies in the subprime debacle.

I think it's in "Jane Eyre": a teacher who wishes to instil piety into a little boy, asks him whether he'd rather have a biscuit or a blessing. When he answers, a blessing, he gets two biscuits.

When recession empties the the biscuit barrel, maybe we'll get authentic leadership.

UPDATE

My beloved recalled it better, and so I've found the quote on the Net:

...I have a little boy, younger than you, who knows six Psalms by heart; and when you ask him which he would rather have, a ginger-bread nut to eat, or a verse of a Psalm to learn, he says: "Oh, the verse of a Psalm! Angels sing Psalms," says he. "I wish to be an angel here below." He then gets two nuts in recompense for his infant piety.’

Defensive investing

Michael Panzner's latest is lucidly entitled "Today's Lesson: Bad Economy = Bad Stock Market". At last, financial analysis I can understand.

I've never understood why the stockmarket seems serenely unrelated to the dire state of the economy. Supposedly the market "looks ahead" around a year, but it can't be seeing what I'm looking at.

Anyhow, Panzner reproduces Dan Dorfman's article in the New York Sun, which reviews what's happened to the market in past recessions and gives tips on strong defensive areas - booze, cigs and "household products". I can understand that, too - or the first two, at least.

The Fed and King Canute

Michael Panzner directs us to John Hussman, who explains that the Federal Reserve's power to manage the financial system is very limited - the funds it provides are dwarfed by the amount out in the economy.

... the problem with the U.S. financial system ... is not liquidity, but the solvency of mortgage loans and securitized debt. The Fed's actions are not likely to have material impact on this.

This, plus Larry Lindsey's comments noted in my previous post, adds weight to Karl Denninger's continuing theme of inevitable deflation.

Michael Panzner on Michael Panzner

Michael Panzner quotes USA Today quoting him, and I'll quote Michael too, since the advice seems sensible...

Predicting tough times ahead, Michael Panzner, author of Financial Armageddon, recommends that investors buy shares of companies that sell stuff that people need to buy no matter what's going on with the economy. Companies that sell soft drinks, tobacco, prescription drugs and toilet paper, for example.

Investors, he says, should play it safe, loading up on defensive stocks, socking away more cash and moving toward the safety of U.S. Treasury notes and bonds.

Long or short crisis? Inflation or deflation?

Terry Gilliam's take on the old tale

An interesting post from Michael Panzner, commenting on the views of derivatives expert Satyajit Das. The latter thinks we're in for a 70s-style inflationary grind, whereas Mr Panzner leans towards a 30s-style deflation.

I am reminded of Borges' short story, "Pierre Menard, Author of the Quixote". In this, a modern author attempts to re-produce the 16th century novel "Don Quixote" by Cervantes: not copying - writing it again exactly, but as though for the first time ever. Since Menard is writing in a different period of history, the same words have quite different meanings, implications and associations. To pen the identical lines today, spontaneously, would involve a monstrous effort. So Borges' tale is a wonderful parable about the near-impossibility of our truly understanding the mindset of the past, and how history can never be quite repeated, because the present includes a knowledge of the past that it takes for its model.

For those reasons, we'll never have the Thirties again, or the Seventies; but we might have a retro revival. And the differences may be as significant as the similarities.

Ken Kesey's bus (named "Furthur"), and part of the commercialised modern follow-up

Gambling with more than you've got

The world's economy is now like a huge gambling table, and the players collectively are betting several times the value of their assets.

FT Alphaville (thanks to Michael Panzner for the alert) gives the above graphs to show how much is at stake in the business of mutual guarantees known as "over the counter" (OTC) derivatives: over $500 trillion. That's not all: Wikipedia's article (last link shown) explains that there is also a separate class of Exchange-Traded derivatives.

These sums are quite unimaginable. But we can compare them with other figures: according to FT.com, the total value of the US and European stockmarkets in March this year was a mere $31 trillion. Wikipedia estimates that the total value of all stocks and bonds in the world is less than $100 trillion.

Our daily lives stand on a thin crust over this boiling financial melange. We'd sure better hope that the experts haven't bitten off more than they can chew.

(Picture source)

Financial experts

Commenting on Michael Panzner's scorn for the authoritative pronouncements of some financial experts, I was thinking of a "wizard" story which I've now tracked down. It's been circulating since 1995, but it's worth retelling. Mark Oswald of The New Mexican newspaper reported:

During discussion by the Senate of a serious piece of legislationconcerning the psychology profession last week, Sen. Duncan Scott,R-Albuquerque, proposed an amendment. It says:

"When a psychologist or psychiatrist testifies during a defendant's competency hearing, the psychologist or psychiatrist shall wear a cone-shaped hat that is not less than 2 feet tall. The surface of the hat shall be imprinted with stars and lightning bolts.

"Additionally, a psychologist or psychiatrist shall be required to don a white beard that is not less than 18 inches in length, and shall punctuate crucial elements of his testimony by stabbing the air with a wand. Whenever a psychologist or psychiatrist provides expert testimony regarding the defendant's competency, the bailiff shall contemporaneously dim the courtroom lights and administer two strikes to a Chinese gong."

Usually, anything proposed by Scott - whose hard-core conservatism is like cod liver oil for the Senate's Democratic majority - goes nowhere. But his wizard-hat amendment was warmly received and passed by a voice vote. It is now part of Sen. Richard Romero's psychologist bill, as the measure moves to the House.

Jokes this good usually come with a rider. It was subsequently reported:

The bill, with the wizard amendment, passed the Senate by voice vote and cleared the house by 46-14. Unfortunately, Gov. Gary Johnson vetoed the legislation.

It's extra fun when the authorities play along for a while.

That reminds me... Back in the 1970s, a couple of Oxford undergraduates proposed the building of a full-sized pyramid in one of the University's parks, as a monument to themselves. It went to the University's Hebdomadal Council and the proposal was narrowly defeated (5-4, they say).

Musical chairs and funny hats

Michael Panzner looks closer to being vindicated as the weeks roll by. Here he quotes Nouriel Roubini on the continuing musical-chairs-type credit tightening - we're getting well beyond sub-prime territory - and castigates the financial astrologers who failed to foretell the oncoming disasters. I think many of them should be made to wear star-bedecked hats, and wave wands.