Are we headed for the Red Pond?

Recycled from my post of April 1st, 2008.

How do we get out of this?

I'm trying to understand the situation, and it's worrying that many experts freely admit they don't understand, either. Here is the simplified picture I'm building up:

Democratically-elected governments wanted their voters to get back the feelgood factor after the tech bubble burst and the stockmarket pretty much halved. So they undid the belts round the banks' waists and said, go eat.

The banks went at it like labradors at a full plate of Gravy Train, and got very fat on lending far too much money, with very few questions asked. Houses doubled in value and became the new stockmarket.

Then the bust, because whatever you treat like an investment will behave like one. Except houses are unlike shares: if you lose all your money on them you have nowhere to live, and this will make the losers very angry and vengeful. Also, housing is illiquid, which is bad news for banks, who can't put bricks and fridges in their vaults. And if the banks go bust their richer depositors (some of them Party contributors?) will get very upset, also the businesses that hold their balances in cash. This last is very important: a small fraction of bank accounts holds the majority of uninsured cash.

So now the "rescue". Billions - hundreds of billions - poured into the system. Who will pay the bill?

• Not the shareholders, since (in most cases) we didn't let the banks collapse.


• Not the majority of retail depositors - they have votes, and enough education to make trouble.


• Not the poor - they have nothing, and are more likely to vote for whoever keeps paying their benefits. That's if they vote at all, but non-voters will become very interested in democracy if their money runs out.


• Not the seriously rich - they have most of their personal wealth safely outside this thieving country and if annoyed, will not only move out but close businesses that employ many voters, which will dump smelly stuff on the heads of the Government and leave a big tax hole to boot.

I can see only two classes of juicy victims: taxpayers, and people who have saved up money.

Very few people understand that the combination of income tax plus National Insurance and employer's NI, is effectively a marginal tax rate on income of over 40% on all but the worst-paid. Raising direct taxation much more will only increase the incentive to give up work altogether, or to lay off employees. And there's only so much benefit to be gained by shipping-in zillions of low-paid foreign immigrants to replace them - that dodge is getting to be a public embarrassment, politically as well as economically.

Indirect taxation tends to be regressive, hitting the poorer worse (as a proportion of their income) - which implies a need to increase their benefits. Not impossible - there's a plan afoot for an extra levy on power bills, to finance heating costs for the poor. Doing it in this roundabout way preserves the illusion that we are a lower-tax economy, and appeals to the sneaky, surreptitious personality of the man currently running the country. There will be other subtle and economically suspect ways to raise tax, and Gordon Brown thought up many during his incumbency as Chancellor of the Exchequer - which, I think, has not yet ended.

And then there's the attack on savers. Means-testing is a good one, yielding a very high effective tax rate. Last time I looked, the combination of minimum income guarantee and savings credit for pensioners worked out to a 40% tax on poor pensioners who'd increased their pension income by voluntary savings.

Inflation is a fruity possibility. The government is going to have to borrow staggering amounts in coming years, to pay for the current bailout and future mass unemployment, so if the returns on its bonds can be lower than inflation it'll help the public finances a bit.

But who's got the money to sub our kleptomaniac Government? Maybe they won't bother to ask the people to trust them any more; maybe they'll just ask the Developing World to buy-in with their sovereign wealth funds. In other words, sell the country, piecemeal.

Isn't that what's happening? The younger generation will be taxed and worked half to death, the older ones will find they're not as wealthy as the illusory boom led them to believe, and meanwhile the New Pan-European Bureau-Aristocracy is selling us all to foreign powers and foreign businessmen, who do not have to answer to the electorate?

I must study the Highland Clearances, and the Flight of the Earls.

Stating the obvious

Recession is here, warns Item Club

UPDATE: Britain surrounded by water. More on the main news bulletin, next.

Goldman Suchs

Read, and hang your head.

Are trade deficits a good thing?

This is from a professional academic economist in America. Is he correct? Should we cheer up?

Here's a letter that I sent recently to the Washington Times:

In "Other economic numbers need attention" (Oct. 16), William Hawkins assumes that every dollar increase in America's trade deficit is a dollar increase in Americans’ debt. Not so. If Mr. Hawkins pays for a new car with $20,000 cash and then observes the car dealer stuffing that cash into a mattress, Mr. Hawkins's trade deficit with that dealer rises by $20,000 while his debt to that dealer rises by exactly $0.

More fundamentally, the trade deficit means that foreigners invest in the U.S. rather than spend all of their dollars on U.S. exports. If Mr. Hawkins mistakenly thinks such investments to be undesirable, I have good news for him: as Uncle Sam meddles much more aggressively in capital markets, foreign investors will be scared away. America will then be much more likely to run trade surpluses - just as it did for nine out of ten years of the greatly depressed 1930s.

Sincerely,

Donald J. Boudreaux

Dow 4,000?

We think we will see 10-12% unemployment, a 4-5% decline in GDP, and the equity markets could drop at least 70% from peak to trough.

J. Kyle Bass of Hayman Advisors, 14 October 2008. (htp: "Dearieme")

This source reckons LIBOR is out of sight, not because of counterparty worries, but because banks simply haven't got the money to lend.

Less pessimistically - just - George Slezak (quoted on Jesse) thinks the Dow could possibly go as low as 6,000.

Financial self-education

Watch Paul Grignon's "Money as Debt" video:

... and see here for Chris Martenson's online "Crash Course" (a condensed version of his "end of Money" seminar).

(htp: Yoyomo)

If these teach you anything, please pass them on!

The importance of correctly predicting liquidity movements

A hedge fund manager (Andrew Lahde) says farewell to the industry (extracts):

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? ... Throw the Blackberry away and enjoy life.

...I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle. I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life – where I had to compete for spaces in universities and graduate schools, jobs and assets under management – with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.

On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunctinstitutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government. Capitalism worked for two hundred years, but times change, and systems become corrupt. George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher. My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles. This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft’s near monopoly. I believe there is an answer, but for now the system is clearly broken...

(htp: Michael Panzner)

All the Earth's water and air (by Adam Nieman)

We're back to last Thursday

The Dow has closed at 8,577.91, 733.08 off its start today. My amateur trend-drawing suggests that it's now back into its midstream; but then there's often an overshoot.

However, for those who do have money and also a long view, maybe it's not a bad price.

Deflation hasn't happened yet; interest rates to rise, eventually

Jesse argues that we're not yet in a deflation, technically speaking; it's "the transfer of wealth from one asset class to another". So the money is merely changing pockets.

But after that, he expects (as I suggested yesterday) gold to rise sharply: "the move in gold will obtain explosive momentum from which a major rally leg will occur as the banks lose control." The euro, too, he thinks; and oil will stay high. So he concludes that when the pent-up liquidity starts to flow in the system, the US will have to raise interest rates to prevent a relative decline in the dollar.

A future case for impeachment?

The threats:

htp: Karl Denninger

The result:

At least $125bn is to go to nine of America's largest banks, including Citigroup, JPMorgan Chase and Bank of America, in exchange for capital under the rescue plan.

The power:

(9) TROUBLED ASSETS-

The term `troubled assets' means--

(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes financial market stability; and

(B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.

...not "prior approval", you'll note. For those that think they understand law, here is the full text of the genetically-modified bill as enacted on 3rd October 2008.

And here's an intriguing clause in Section 119:

(2) LIMITATIONS ON EQUITABLE RELIEF.—

(A) INJUNCTION.—No injunction or other form of equitable relief shall be issued against the Secretary for actions pursuant to section 101, 102, 106, and 109, other than to remedy a violation of the Constitution.

Excuse my ignorance, but is this a watered-down version of the infamous "non-reviewable" Paulosn proposal ("Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.")?

A lesson from 1721

The South Sea Bubble ended in the imprisonment of the Chancellor of the Exchequer, John Aislabie:

The South Sea Company had been built on high expectations which it could never fulfil, and it collapsed in August 1720. An investigation by Parliament found that Aislabie had been given £20,000 of company stock in exchange for his promotion of the scheme. He resigned the Exchequer in January 1721, and in March was found guilty by the Commons of the "most notorious, dangerous and infamous corruption". He was expelled from the House, removed from the Privy Council, and imprisoned in the Tower of London.

Aislabie was replaced by Robert Walpole, who became in effect Britain's first modern-style Prime Minister - who earlier had spent six months in the Tower in 1712, as a result of unjust impeachment by his political enemies.

Now, who will be properly prosecuted and properly punished for a man-made disaster that has undermined the world's banking system?

More dire warnings

Karl Denninger is predicting a bond and currency crash in the US if banks aren't forced to disclose exactly what they do and don't have, so we can let the insolvent go down and release the liquidity into the right channels.

I hope the right path is taken, because my brother lives there.

By the way, in body language terms I read Hank Paulson as a hell of a bully. He looks like a totalitarian danger to me.

Rally? The smart money's been moving out for a long time

Read Michael Panzner here. Reminds me of when Jimmy Goldsmith sold all his holdings on the Paris Bourse in the Summer of 1987, and recently how Warren Buffett was reported to be holding massive amounts of cash.

Now Buffett has bought $5 billion of Goldman - but as preferred stock with a 10% dividend (and with warrants representing an instant capital gain from day one); and Philip Green is buying £2 billion of Baugur's debt. Note that these wise men are NOT buying stock market ordinary shares: they are betting on a sure thing, pretty much.

I think bear market rallies are when the pros sell to the amateurs. When the amateurs realise the pros have gone, and there are no more bigger fools, the panic proper starts. And then the pros are there, waiting for the bottom prices. I think this is what is behind legs 4 and 5 of the Elliott Wave.

A note on gold

Some commentators on the gold market predicted that the price would come down, or at least be restrained, because leveraged speculators would have to sell assets to raise money to clear some of their borrowing.

As the credit market continues to remain tight and the prospects of quick killings made on the back of increasingly-expensive borrowed money become less plausible, watch for the gold price to bottom-out (I read one claim yesterday that this has already happened). Then when continued liquidity injections from governments start to work their way into prices, my guess is that gold will make a steeper and steadier rise, as it becomes not a find-a-bigger-fool speculation but a flight to security, away from devaluing currency.

I may soon get back in myself, with some of my small savings.

And yes, I did indeed start drawing my "cash stash" yesterday, and plan to take more out today. Can anyone believe the blanket guarantees for deposits at banks, especially under the present economic and monetary conditions? You think disasters can't happen, but as a young woman my mother suddenly found herself fleeing the country alone, with two horses. Hope for the best, plan for the worst.

Cassandra couldn't run Troy

Thanks to Michael Panzner at Financial Armageddon, we can read for free an interview with 70-year-old money manager Jeremy Grantham. Grantham points out that business is run by managers, not by Old Testament prophets, and so he philosophises that crises will recur.

He also believes that this one isn't over yet:

The terrible thing -- after all this pain -- is that the U.S. equity market is not even cheap... it started from such a high level in 2000 that it still has not yet worked its way down to trend, although it is getting close. But the really bad news is that great bubbles in history always overcorrected. So although the fair value of the S&P today may be about 1025, typically bubbles overcorrect by quite a bit, possibly by 20%. That is very discouraging.

My 26 June guess at the trend for the Dow was c. 7,000 - 10,000:

If that means a midpoint of 8,500 and the overcorrection is 20%, then the momentary low point could be around 6,800, which at least suggests that the gap between my two red lines is approximately correct.

Friday's lowest point during the day was 7,773.71, still 10% away from the theorised minimum; and the Dow closed at 8,451.19. Yesterday it remained above the latter figure throughout, and rose to 9,387.61.

In short, Grantham must be reading this as a bear market rally, and it's not very silly to think that the Dow could come back to 7,000 at some point.

Good luck to the day traders, I haven't the nerve and speed to try to make a fortune on the bucking-bronco stage of the market.

All clear

Dow up 936, FTSE up 324: so it's all okay again. Isn't it?

Except here in the UK, the Prime Minister wants banks to carry on lending like they did last year. Is there a touch of madness in this?

Surreal. That's the feeling.

I see Mish has the same feeling.

Dow falls are only at interim stage

Jesse relays a couple of charts from Steve Williams at CyclePro, and adds one of his own. As I read it, the implication of the CyclePro charting is that the end-point for the Dow at the bottom of the bear market could be around half its present value, in a process that might take 8-10 years.

Jesse's chart relates the Dow to the price of gold, and the implication of his is a drop of some 60% - but that could be achieved by a rise in gold, as well as a fall in the Dow.

Perhaps it is time for us to be making quiet, regular withdrawals from the cashpoint and building up a stash of truly instant-access cash. I shall start today.

And when inflation hits?

Derivatives blowup may hit insurance and car makers

This blog looks at the implications of failed investment bank Lehman's call on their "insurance" in the form of derivatives contracts. If everyone can handle the the cash call when it comes, good; if not, maybe a domino effect - one failure unbalancing another in a chain reaction. In particular, will hedge funds , who tend to play with borrowed money, be able to honour their contracts, or will they be the weak link in the chain?

Next up, says "George Washington", are the insurance and auto companies. It seems Standard & Poor's fear these could be the last days for GM and Ford.

I'm given to understand that players in derivatives usually balance their position with bets both ways; but they tend to be big bets. It's like a seesaw with an elephant at each end: if one elephant steps off, or turns out to be a baby compared to the other... What's the chances of $55 trillion of derivatives being well-balanced at all points?

So there are good reasons to think that next week is going to be more exciting than most of us would wish. Friday's Dow volatility may be repeated.