Debt forgiveness, inflation and welching

Thus Jesse, discussing Michael Hodges' visionary "Grandfather Economic Report" and US indebtedness:

In a simple handwave estimate, one might say that the debt will have to be discounted by at least half. That includes inflation and selective defaults...

... something has got to give. The givers will most likely be all holders of US financial assets, responsible middle class savers, and a disproportionate share of foreign holders of US debt.

While the debtors hold the means of payment in dollars and the power to decide who gets paid, where do you think the most likely impact will be felt?

I give below the US Treasury's data on foreign holdings of their government securities as at October 2008, but I also reinterpret it in the light of each country's GDP, to show relative potential impact (please click on image to enlarge).

Mind you, even a complete repudiation would only take care of $3 trillion. Funny how not so long ago, $1 trillion seemed a high-end estimate of the damage, and now it's something like seven times that. And that still leaves a long haul to get to Hodges' $53 tn - equivalent to, what, one year's global GDP?

Ed Rates of the Caribbean

Vorsprung durch Technik

Is gold a hedge against inflation?

There are problems with using gold as an insurance against inflation.

1. Governments interfere with it - from making it the legal base of their currency, as in the US Constitution, to making it illegal to have any, as in the US in 1933; from guaranteeing the exchange rate of gold against the dollar (post WWII) to the Nixon Shock of 1971, when the gold window was closed.

2. Central banks claim to hold it, then (it is widely suspected) lend or sell it surreptitiously.

3. There is so little of it, that speculators can have a significant effect on the price, especially if (as appears to have happened in recent years), the speculation has been powered by vast amounts of borrowed money.

Below, I give three graphs, all comparing the price of gold per ounce in US dollars with inflation as measured by the Consumer Price Index (and that's another can of worms). It's clear that gold has a very volatile relationship with inflation and can spend a very long time above or below trend.

In the fourth graph I divide the Dow by the price of gold. It seems obvious that gold is a contrarian position for equity investors, rather than a simple hedge against inflation.

Currently, the Dow has come back to something like a normal ratio to gold, but past history suggests there will be an overshoot. And gold itself seems above trend over all three periods chosen; which suggests that both still have a way to fall in nominal terms, but the Dow more so.

(N.B. gold prices to the end of 1967 are annual averages, then monthly averages to the end of 1974, then the price is as on the first trading day of the month; all gold price figures from Kitco).

Nominal and real

Marc Faber's latest interviews on Bloomberg and CNBC show him estimating the recession to last "2, 5, 10 years". He also says that Asia is better placed to recover, because after the panic of 1998 they deleveraged, i.e. reduced borrowings.

So it's time for me to review my guesses about when the recovery will come for us. A key consideration is inflation, which Faber says is being stoked up for the long term by all the "stimulus" currently put in by panicky Western governments.

I've suggested that we might compare the present, not to the 1929-32 collapse, but the period 1966-1982, when inflation sometimes growled and sometimes roared. The result was that the nominal and inflation-adjusted low points are very far apart: the start-of-month level for the Dow hit bottom in September 1974, but adjusted for CPI, the real bottom was in July 1982.

So when the upturn comes, depends on your definition. I am still guessing that there will be a nominal recovery in 2010, but inflation will erode gains over time and the real turning point may not come until, say, 2016.

"Efficiency" vs. survival

"...we have to build back into the system Resiliency. This means that each region has to work to become largely energy, food and financially self sustaining and that each region needs to network into the others. In effect we shift from an efficient machine to a resilient network."

Robert Paterson, as quoted by London Banker.

Like I keep saying, it's about diversity, dispersion and disconnection - please click on the label below for my posts on this subject.

It's not about dinosaurs

Would you rather explain away the following, or share in it?

1. The death of William Blake, 12 August 1827:

“Just before he died His Countenance became fair. His eyes Brighten'd and he burst out Singing of the things he saw in Heaven”

2. The experience of St Thomas Aquinas, 6 December 1273:

LXXIX: The witness went on to recall that while brother Thomas was saying his Mass one morning, in the chapel of St. Nicholas at Naples, something happened which profoundly affected and altered him. After Mass he refused to write or dictate; indeed he put away his writing materials. He was in the third part of the Summa, at the questions on Penance. And brother Reginald, seeing that he was not writing, said to him: 'Father, are you going to give up this great work, undertaken for the glory of God and to enlighten the world?' But Thomas replied: 'Reginald, I cannot go on.' Then Reginald, who began to fear that much study might have affected his master's brain, urged and insisted that he should continue his writing; but Thomas only answered in the same way: 'Reginald, I cannot - because all that I have written seems to me so much straw.' Then Reginald, astonished that ... brother Thomas should go to see his sister, the countess of San Severino, whom he loved in all charity; and hastening there with great difficulty, when he arrived and the countess came out to meet him, he could scarcely speak. The countess, very much alarmed, said to Reginald: 'What has happened to brother Thomas? He seems quite dazed and hardly spoke to me!' And Reginald answered: 'He has been like this since about the feast of St. Nicholas - since when he has written nothing at all.' Then again brother Reginald began to beseech Thomas to tell him why he refused to write and why he was so stupefied; and after much of this urgent questioning and insisting, Thomas at last said to Reginald: 'Promise me, by the living God almighty and by your loyalty to our Order and by the love you bear to me, that you will never reveal, as long as I live, what I shall tell you.' Then he added: 'All that I have written seems to me like straw compared with what has now been revealed to me.'

Relativism

It's hard to measure what's going on, because currencies have turned out to be rulers made out of very stretchy elastic - especially for us Brits, recently.

In this article, Kurt Kasun reproduces a chart from Marc Faber's latest newsletter, showing an estimated drop of c. 50% on the world's stockmarkets - a loss of some $30 trillion.

So I've looked at the Dow and the FTSE, as priced in Euros, since the Euro appears to be more stable than either the dollar or the pound sterling (until we discover the supermassive black hole at the centre of the European financial galaxy, no doubt).

Fasten your seatbelts

I've relayed rumours of these things here earlier: a dollar crash and US bond default. Now a respected Japanese ratings agency is preparing us for the reality. (htp: Karl Denninger)

Democratic deficit

How come I can vote several times a week at Waitrose, but only once every five years or so in national elections (and with a result that's a foregone conclusion)?

Vengeance is mine

Following comments on the last post, I see the feeling that scores should be settled is spreading - see Denninger and a threatening post to which he's linked.

UPDATE

And Jim Kunstler, too.

Every little thing's gonna be all right

From what I read, some people are becoming survivalist: storing food, water, medicines, cash, even weapons.

Perhaps it's no coincidence that BBC is currently screening a remake of Terry Nation's gripping 1975 post-catastrophe series, "Survivors". But that series assumes that most people have died suddenly because of a virus, so the ecosystem has not been destroyed by desparate, starving victims. I don't think Survivors is the model we should use. If we are to survive, it'll be together, in our populous societies, because if society breaks down, you and I are unlikely to emerge as the last people standing. Lone heroes don't win; this is a fantasy.

I think spare supplies are a good idea, because there could be some disruption, which could affect the very young and elderly; so we need ways to keep warm, eat and have clean water in an emergency. And it's important to make your home secure against a rise in burglary, which is associated with economic downturns; and not to go out after dark without at least one or two companions. Weapons are another matter: "guns in the home are far more likely to be used against members of the household than against intruders."

Pace the doomsters, the UK and the USA will feed itself. We may end up eating more veg and less meat; and we may be using public transport instead of cars; personally, that would simply take me back to the 70s, when I was slimmer and fitter. Globally and locally, there is enough to feed the world, although not enough to overfeed it or encourage unproductive men to sire children.

Two aspects of the current crisis worry me:

1. The present method of organising resources may be replaced, not by one dreamed of by well-fed Western socialists, but by a cruel, remote, commanding elite as in North Korea or East Germany, who far from minimising scarcity will use it to get and maintain power.

2. The transition from this system to whatever replaces it, may be disorderly and involve suffering for many people.

This is why I think the underlying issue for us is to preserve and strengthen democracy, to increase the chances that both the journey and the journey's end are acceptable.

Why banks?

Banks require re-capitalisation. The capital is required to cover losses. Capital is also needed for assets returning onto their balance sheet (as the vehicles of the “shadow banking system” are unwound). This capital is required to restore bank balance sheets. Additional capital will be needed to support future growth. Availability of capital, high cost of new capital and dilution of earnings will impinge upon future performance.

Satyajit Das (htp: Jesse)

Nope. Banks need destroying, as does all this bank-created debt. The mistake is to try to keep things as they are. How did we come to buy houses "on tick", then cars, and now our clothes and groceries? Why is there any lending for consumption, seeing how it only means reduced future consumption? Why should banks be kept going, requiring a significant proportion of our earnings, so that wages have to be high for us to live on what's left, making us uncompetitive with the developing world?

I am reminded of the pitiless response of the Comte d'Argenson to the satirist, Desfontaines:

Desfontaines: I must live.
D'Argenson : I do not see the necessity.

The lesser of two weevils

In an apocalyptic - but carefully-reasoned - post, Karl Denninger says that when the deficit expansion stops, US government spending will have to be cut by 50 - 60%, unless there is to be a "general default" on debts.

I have no idea what a general default would look like, but in a closely-interwoven and distant-from-nature modern industrial society I can only fear it might prove utterly destructive. So we're back to contemplating the lesser, but still vast disaster.

I also have no idea how much worse it might be in the UK.

Someone else please read this unberobed OT prophet and tell me where he's wrong.

PS

Jesse:

While the Obama Administration cannot take a 'weak dollar' policy it is the only practical way to correct the imbalances brought about by the last 20 years of systemic manipulation. It is either that, or the selective default on sovereign debt, most likely through conflict, a hot or cold war.

Christmas viewing

Hilarious new animation in which the daring but accident-prone duo attempt to undo the damage caused by an idiot who sold off half of Britain's gold and let the bankers blow up the economy. From the makers of "The Wrong Assets" and the full-length "The Curse Of The Weird Scotsman".

How will the future look?

Thanks to the glacial catchup by the mainstream media, the public is finally worrying about economic depression, and consoling itself with the thought that we've messed it up for everyone, so at least the Chinese won't prosper and come over here as tourists, overdressed, overpaid and taking too many pictures for their digital photoframes at home.

Short-sighted, I think. On the CapitalistsatWork blog, I comment:

I think we should turn our eyes, not on the Depression, but how things will look afterwards. The East will generate demand as it aspires to the lifestyle we used to enjoy, and meantime we have been allowing them to transfer the means of production to their co-prosperity sphere. So the Chinese factories will re-open, perhaps after some of the light industry has relocated to Thailand, the poorer parts of India, and other neighbouring regions?

And I shouldn't discount India as potentially the real industrial powerhouse of the 21st Century, while China scrabbles about annexing territory for extra lebensraum, water and wood.

I think, by the way, that econinvestguru Marc Faber took up residence in Chiang Mai, northern Thailand, not to pursue a monastic existence (hardly characteristic of the formerly ponytailed playboy), but because he's close to "where it's at", or even better (and typical of this farsighted man), where it will be.

Europe is keeping China (and America) going

A very interesting piece by Brad Setser, where he shows that the EU's currency strength and growing imports from China have offset the levelling in demand from America. His bottom line is that China's making money from us and lending it to the US.

Default

I relayed Jesse's comments on Ecuador's moves to default here on November 28th, and now it's happened. Any big ones coming, do you think?

The seventh seal

Denninger's question:

With the $7 trillion dollars we have committed we could have literally given every homeowner with a mortgage a fifty percent reduction in the principal outstanding.

This would have instantaneously stopped all of the foreclosures by putting all (essentially) homes into positive equity - overnight!

So why wasn't this done?

His answer: the government is trying to cover the staggering bets of the derivatives market. With borrowed money. The Treasury has swallowed the grenade and put its fingers in its ears.

This is the fourth horseman of the financial apocalypse that Michael Panzner predicted, as summarized here on Bearwatch on May 10, 2007.

UPDATE: Jesse comments on another fresh sum - tens of billions - needed to cover AIG's losses. As he says, there is an air of expectancy; but also of unreality, like the announcement of a major war.

Inappropriate gloat

I came to the US fresh out of university, and went to graduate school. Consequently, I was mostly oblivious to the details of 'real life', like taxes, bills and repairs.

Working my way into the system, it all seemed that it couldn't possibly work: too many people with no discernible talent were earning too much, and prices were lower than I thought they should be, particularly fuel prices. I thought the problem was that I wasn't intelligent enough, and just didn't understand.

The one personal satisfaction that I can get from the current mess is that I was right - it doesn't make sense.