Thursday, August 21, 2008

Peak Oil!! Peak Inflation ?!? Peak Credit??

Does Peak Credit inevitably follow piqued credit? Well if you're my age, and you thought so and positioned accordingly, you'd have been bankrupted a very long time ago - possibly as early as the late 1980s. And if you were a glutton for punishment, you'd have been toasted again in 1994, another time in 1998, yet again in 2002, and rubbing one's nose in it, perhaps every year after that until midsummer two-thousand-and-seven. Dog days indeed for those bearish on the ability of the financial system to manufacture, distribute, and service debt, whether in real or nominal terms, or in relation to any measure of the economy or change in the growth thereof.

Yet as pessimistic on its sustainability (and wrong!!) as one would have been in the past, one should now be as optimistic one's assessment that this is The Big One, that we've smacked head-first into the boundary of the maximum amount of debt that can be assumed by households, corporates and governments in our economy and be reasonably sustained with the fruits of our labour, and investment. Actually, I would posit that we long-ago pierced any reasonably sustainable threshold, and only through sheer inertia and the fortuitiousness of pulling of rabbits-out-of-hats have we lasted this long. But it is the anchoring of popular belief in faith and absent solvency from days long passed combined with the extrapolation a series of non-extrapolatable macro income streams which could cause any sensible human being believe or have believed that the boundary lay somewhere in front of us and not far behind us.

Culpability is not singular. Stern-Stewart, investor short-termism and systemic mono-focus, along with greedy managers replete with agent/principal dilemmas must assume blame on the corporate side. Selfish American Voters repeatedly demanding representatives requite incongruous financial goals with cynically lame and unsustainable fiscal policies, along with a near complete detachment from reality in regards to present consumptive desires in relation to both incomes and longer-term savings requirements are just as at fault as the monetary wrecktitude resulting from an unwillingness to accept mild deflation and cyclical recessions where required for reasons that - to this day remain inexplicable given that Continental Europeans seemingly had little difficulty distinguishing a bubble or accepting that both taxes and economic brush-fires are not inherently bad in The Big Picture.

So IF what we are currently witnessing, commonly termed as The Credit Crunch, is in fact, an expression of what I will term Hubbert's financial equivalent - "Peak Credit" phenomena , and IF as I posit, we long ago untethered the financial wagon from the real economic train, what does this mean?

Many things, but first and foremost, that we are at a major and painful inflection that will impose a real Kunstleresque austerity upon Americans converging their desires with their means. In a word, this means "revulsion", a somewhat arcane and long-forgotten term for large-scale write-downs and/or economy-wide elimination of outstanding debt(s). For this reflects the implausibility of servicing, let alone paying off obligations, and the consequences to those whose capital and assets were/are/will be vaporized. It will, undoubtedly, be fought by authorities, with certain costs borne by the state and socialized upon unwitting voters. Japan wallowed in their own debt-shite for more than decade, and in the US it is (in present political climate of denial) even more natural that attempts to band-aid and stave off the inevitable reality will likewise be tried. In another time and another place, natural growth and demographics might have met inflation somewhere in the middle and the cycle would resume again without massive dislocation. But this time it is different. This time, the encumbrances are too large. This time, there is competition for markets, and their value propositions are surpassing Americas. This time the patient is too soft, obese, relatively uneducated, faux-faithful, weak, politically compromised, and cronily corrupt. This time, the business cycle is turning dramatically for the worse, wealth effects are only beginning to bite, oil has peaked with a generation of adjustment between any remotely plausibly cost-effective replacement. And competition is even heating up in the emerging world for the remaining high-margin business. This does not sound like an environment that will assist households or government to rebuild balance sheets and make good on obligations without great sacrifice from ordinary people and even greater sacrifices from the monied class. This sounds like an environment where creditors and debtors will be required to sit down and negotiate what can and might plausibly be paid, or converted into equity, or stretch maturity with lower rates - anything to keep it as an "asset" and a performing one.

"Peak Credit", like Peak Oil, thus forlornly reflects the necessity of increasing demand for credit from borrowers to sustain the unsustainable, at precisely the time when supply is constrained and shrinking, for suppliers are squarely confronting the reality that new sources are limited, and in any event, the demanders (even if supplied) have diminishing hope in the current environment of returning what was lent.

Some will think that these ruminations border on the insane. And I will admit that when I walk out of my office door to the local trendy coffee bar, there is scant evidence where I live that Peak Credit is anything but a financial phenomena - limited to the flippers in Vegas or the spec developers in Fla. or CA. But perhaps that's because the most insidious aspect of Peak Credit is its disruption to the chain of dependencies that bore its hallmark over the past two-and-one-half decades. So inexorable and complete has the rise of credit been in its permeation of every crevice of life that no one blinks when multi-trillion dollar GSE balance sheets are supported by but the thinnest veneer of equity - even AFTER large potentially (no, probably) impermanent increases in underlying asset values; when dogs receive pre-approved credit cards by mail; that its sheer ubiquity produces persistently negative rates of saving; when corporates use leverage in lieu of a margin of balance-sheet safety on the enterprises they are meant to steward in order to conform and placate the markets' twisted short-sighted ideal of optimal capital structure leaving them woefully exposed to cyclical fluctuations; where data-mined models themselves based on limited data replace good common sense; where leaders defer to unsustainable plebeian notions of what constitutes prudent fiscal policy producing errors in judgment that make the trench warfare of the first world war appear sane. If this is what God's country resembles, imagine the financial horror in hell...

"Peak Credit" will wreak as monumental changes upon American consumptive life as Peak Oil, and these cannot help but exert a massive deflationary pull - at least until such time as the parties agree to squarely face reality that confronts them, and in an interconnected world, everyone else.

16 comments:

vlade said...

Cassie,
while I fundamentally agree, I'm still not sure whether the govts won't attempt to run the printing presses at full speed and damn the torpedoes. I know that Japan's experience suggests it may not work, but it doesn't mean they won't try it.
In fact, I'm pretty sure Gordon here in the UK will throw away his golden rule and borrow to the hilt in the next year (it being pre-election year).

normal being said...

Hmh, that was a lot...

I really respect, what you're saying, both here and on the macro man blog, so please forgive me if I want to add a few points.

Globally:
There's enough money in the world and that money is backed by real stuff. Oil production may stagnate, but it is not yet declining and it won't for quite a while.
In most of the world, there is not a lack of money, but of banking. Whereas in the US and UK there seems to be only banking and no (real) money at all.
So it was natural for many countries, who simply couldn't handle their own savings, to give them to the people, who claimed they could. Ok, turns out they couldn't either.
In terms of money lost - on a global scale - it hurts, but it is not the end of the world.
So what is needed now? More banking. In China, in India, in the GCC, in Africa (microbanking), in Russia. Someone has to connect the financial ressources with the opportunities. Who will be that someone? Maybe Lehman (owned and financed by the Koreans).

How will that happen? It's either traditional holding credit/debt to maturity (once called banking) or refinancing the stuff over managed credit portfolios as an asset class. No leverage, total transparency and fundamental research instead of quant models.

What does that mean for the US? Well, the tap of dumb money dried out. Cold turkey is inevitable, but smart money will be there for reasonable business models at a reasonable price (which will be beyond control of the FED).
When there's any doubt on Agency debt or - worse - Treasuries it will be REAL bad.
But for the banks, there is an opportunity, if they learn their lesson. They have to think globally from now on and they need a backbone of real deposits. Ultimately they will have to go where the money is, either by aquiring or by getting aquired.

Knute K Knutson said...

Most astute. Thx

el pollo said...

Yeah, I agree. As Red Foxx used to yell, clutching his chest, “Elizabeth – I’m coming. This is the big one.” Of course even your average Wall Street lemming doesn’t really have a clue, though there is fear in the air. Actually, it was proven only this year that rats have a special receptor in their olfactory bulbs that can only detect fear pheromones emitted by other rats. But one may ask, “What do Wall Street lemmings and rats have in common?”

But even among the astute who understand the enormity of this impending financial and economic catastrophe, some see a deflationary outcome; some see hyper-inflation. Of course, its “natural” course is extreme deflation – right back to the stone age. But will the central banksters panic and start to roll the presses? At what point in the development? Do they really want to? Deflation can be nice if you have no conscience and own all the marbles. And this pretty much describes the uber rich.

But if Helicopter Ben starts his drop, how is he going to get this money into circulation? It’s sort of illegal to just give it to his friends and puppet masters, at least doing so when it’s not so complicated that j6p can’t understand it. Things have progressed past negative real interest rates. So I guess he will have to print the money, and pass it to Bazooka Hank at Treasury at the 6% profit, and then we can start a couple of more wars and buy Hummers with it from General Motors, assuming they can survive long enough. Or we can print $2T to bail out Fanny and Freddy when housing prices reach 25% of peak, but that’s just treading water, compensating for debt destruction.

So help me out. Other than my scenario of huge deficit spending, preferably on things that are totally destructive to humans in general, how does Helicopter Ben get his freshly printed money into the economy?

"Cassandra" said...

el pollo,

I agree insofar as amongst many light-weight inflationists (and Moldbug & DAvid Pearson certainly are exlcluded here), there is a misunderstanding of what is actually in the realm of possibility. As I see it, with housing, retail, and commercial real estate with their large shares of economic activity already built out, there will be little to no take-up there. Moreover, with the massive transfer of mfging to lower-cost asia, it takes a ballsy capitalist (unless playing with OPM ) to invest in substantial domestic plant and equipment given the macro & micro backdrop.

Of course there is (in answer to your question) expenditure upon universal healthcare, public transport, retoooling the vehcile fleet to uber-efficiency, primary and higher education, alternative energy, traditional energy E&P, and agriculture, which could place a floor on economic activity, but this involves some policymaking consensus , and inevitably substantially higher taxes on the monied class, and upon energy & consumption. While still deflationary, such reorientation towards social democracy would/could transition am excessively consumptive economy living beyond its means to more balanced economy in-line with other industrial and post-industrial peers.

Will it happen? Not IMHO until the "Team America" vomit scene inflicts its technicolor pain upon those still in denial.

Rufus Willy said...

"Will it happen? Not IMHO until the "Team America" vomit scene inflicts its technicolor pain upon those still in denial."


I think I just wet myself

zanon said...

Cassie: Glad you think that additional government taxing and spending will help the US live within its means.

Tell me, how is that working out for Medicare? Or the state of California?

Look, I'm all for the US living within it's means, but the notion that somehow, a system that accounts on a cash basis, make multi-generation long entitlement commitments, and operates via a fickle public/power hungry politicians/and Agencies who operate with the determination of continental drift is going to somehow make a long term commitment to fiscal discipline is very funny. The society is simply not geared, in any way, to under-promising.

To date, the ability of its engineers to create manna from heaven has increased wealth fast enough for everyone to be paid, but counting on miracles is a strategy with some rather obvious problems.

If austerity comes to the US, and who knows if it ever will, it will not be via a politician having a sit-down, grown-up conversation with the electorate.

-zanon

"Cassandra" said...

Zanon,

With due respect, neither California nor medicare are robust examples of social democracy in action.

I've lived the majority of my life and most my adult life outside the USA. I would love nothing more than for the American people to live within their means. Yet for whatever reasons (mostly US military spend and absurdly inefficient healthcare system, stigma of public administration as a profession) the USA has been unable to accomplish what many many other nations seem to be able to deiiver in terms of setting tax rates that while forcibly throttling consumption, still manage to redistributiuvely deliver reasonable quality services that remain reasonable value propositions in the main. As importantly, these tax systems (despite regressive VATs and systematically high energy taxes) are viewed as promoting general fairness - an important aspect that encourages the un-monied class to be sufficiently enfranchised to choose to progress through work rather than through crime.

Perhaps you, Zanon, can speak for why American public administration, like American automobiles, are so pathetically inferior to those of America's peers. But, anyone who's lived abroad in the world's advanced social democracies can tell you it's primarily an American problem - NOT a fundamental constraint of social democracy.

As I suggest, I am not optimistic about another fireside malaise chat causing radical change to the tax system. But someone has to break it to them, else the Vomit Scene moment is inevitable.

zanon said...

Cassie: Like you, I have also lived most of my life outside the US, but unlike you, have been stateside for most of my adult life.

Why is American public administration so inferior? Good question -- although I will add that the best public administrations I know of do not exist under social democracies, I'd have to give that prize to city states like Singapore and Dubai.

I would also add that, for such a bunch of incompetents, the US Govt sure wields a great deal of influence in the world, so they have to be doing *something* right.

As we work on teasing out what the secret ingredients are, I assume by true social democracies you mean Old Europe -- the UK, France, Germany (not Italy)? Let me ask you, do you think these countries have better, more competent public administration today than they did in 1958? Or 1908? I don't know much about France or Germany, but the UK's ability to govern competently (as well as the land mass it has available for governance) has clearly declined dramatically over the past 100 years.

Why is US governance so bad? I fear they may simply be ahead of the curve.

-zanon

"Cassandra" said...

Zanon,

i would suggest that in a large nation-state the european experience of doing something in the name of public interest vs. the great american experiment of doing nothing in the name of the public interest or more recently doing something unsustainably divisive and divergent in the name of the public interest while still championing the philosophy of doing nothing, is superior. Not perfect, maybe not even desirable in the extreme, merely superior. And governing a reasonably-sized nation state that is not a benign dictatorship is precisely a matter of better practical outcomes rather than ideals. And yankee laisssez-faire-ism has proved itself a rather unworthy model.

zanon said...

Cassie: I must confess, I find it difficult to understand quite what you are saying. You have quite defeated me.

Originally, I thought your question was on why the Quality of government was worse in the US than in Large Nation State Europe. By "Large Nation State Europe" I assume you mean UK, Germany France (not Italy, Spain, Portugal). But when talking about quality of governance, thinking about countries run like responsible family businesses (Dubai, Singapore) is worth considering as Large Nation State Europe *was* a family business not three generations ago. If "family business" is a useful model for producing quality governance (sometimes, not always, I do not idealize family) then this is one explanation why the US is run worse than Europe. It also suggests that the decline we see in Europe will continue until it reaches US levels of degradation.

Also, from a scale perspective, please note that the US is equivalent to the EU, and a better comparison for France is California. If there are diseconomies to scale in governance, and I think they are, the Europe is governed better than the US because the EU has not had time to fully integrate the continent politically.

If your question is why the *size* of government in the US is smaller than that of Europe, along with lower taxes, then I suggest you just give it time. As we both know, spending=taxes, and the US is spending at a robust rate. Taxes will fall in line. Government programs are eternal, and have been growing monotonically since the US was founded, while tax rates follow Brownian Motion with pronounced upward drift. The US government consumes 30%-40% of production today, this is set to rise to 50%-60% as the boomers retire in the next 10-15 years. The US and Large Nation State Europe will converge.

Finally, I'm afraid I cannot recognize the America you describe -- this nation with its great experiment of "doing nothing in the name of the public interest". There is a great deal of Government activity in the US and it is all, all done in the name of the "American people". Listen to a speech by any american president or presidential contender in the past 60 years and you will hear the term "American people" invoked a thousand thousand times. There is activity. It is in the name of the American People. There is a nauseating quantity of it. Does any of it work? We are now back to the question of quality. But I think any blue collar factory worker in Detroit, or 18 year old African American in Baltimore might have an opinion to share.

When you talk of "yankee laissez-faire-ism" do you mean in the sphere of Governance, or in Industry, or in Finance? "Laissez-faire" ceased to be a governing model with the Civil war. US industry remains fairly Laissez-faire, in that it can open shops on Sundays, but compare it to a real economic wild west (China) or to itself 50 years ago, and we can see that it has diminished there as well.

In the financial sphere -- now here is something different. We shall have to see if Bernake & Co. can somehow cobble together a path that 1) maintains current consumption (to capitalize a financial sector that is, technically, bankrupt) and 2) reduce consumption, since current levels of consumption are unsustainable. The fact that leveraging up in the US is so easy, while de-leveraging is impossible, is frankly a travesty and very very dangerous failure. A Fed that completely abdicates keeping an eye on money supply should be fired (before being blindfolded and given a last cigarette).

We may very well be seeing the end to the dollar as the world's reserve currency, and the end of Bretton Woods 2, and when this tide goes out I don't think "yankee lassiez-faire" will be the only naked swimmer revealed.

The fact that you have seen no public official being canned, or better yet sent to prison, may also suggest why US governance is so poor. Being thicker skinned, they need more than just a stern talking to for the message to sink home.

-zanon

"Cassandra" said...

I violently agree with much of what you suggest. You are quite correct in that there is little defense of parochial pork-barrel politics. Yet, I do not view that the more or less central tenets of social democracy - universal healthcare, equal access to education, reasonable & affordable public transport infrastructure, minimum stipends for the indigent, elderly and unemployed - have anything to American style rent-seeking and Menckian abuse of the Federal milk-teat. You and I could go line-by-line through the Federal budget over a very large beer, and would probably agree in regards to what is worthy and what is not, though this is hardly the place for such an exercise.

I am quite aware (and agree) that America, for all the laissez-faire free-market rhetoric, is hardly such And where it is, it is hypocritically so typically by corporate or interest-group design rather than in the name of the public interest. And yes, when the tide goes out, the US will not be alone in making societal choices about what it can and cannot afford. Yet, that said, the sum of her choices and policies makes the US far closer to a Sao Paulo-outcome than the more egalitarian, less coarse, and less brittle social outcomes likely to evolve in Europe when the shit hits the fan. Which is fine if you're in the 0.05% of folk that has a private helicopter, and private security force, but stressful hell for the vast majority of ordinary good-hearted folk that are not.

zanon said...

Given the size and foolishness of the Federal budget, we'd better get a keg ; )

-zanon

Etz said...

Cas: I thought you'd enjoy this,

Breaking News: Lehman To Be Acquired by Tooth Fairy

The market responded with enthusiasm to reports that the Tooth Fairy has agreed to acquire Lehman. The purchase price has not yet been determined and will be set by Dick Fuld wishing upon a star, clicking his heels three times, and being transported back to that magical place where Lehman still sells for over $70 per share.

In related news, Lehman has agreed to sell all of its level III capital, including CDOs, ABSs, pet rocks, baseball cards, slightly used condoms, and credit default swaps written by MBIA and Ambac. Lehman’s level III capital will be acquired for 150% of its face value by Tinkerbell, who will carry it off to Neverland to be fed to a crocodile. Lehman is financing 90% of the acquisition at an interest rate that has not been announced; Tinkerbell’s up-front payment consists of a handful of pixie dust, three crickets, and a bullfrog. Analyst Dick Bove estimates that the bullfrog could eventually be transformed into three princes and a pumpkin coach. The deal gives Lehman no recourse to any of Tinkerbell’s assets other than the Level III capital. If Tinkerbell defaults, Lehman’s successor entity will stick its hand down the crocodile’s throat and attempt to get it to regurgitate. The firm’s historical value-at-risk analysis shows that sticking your hand down a crocodile’s throat is completely safe.

Treasury Secretary Hank Paulson issued a statement: “I am delighted that SWFs (Sovereign Wealth Fairies) continue to express confidence in the terrific values represented by American financial institutions. As I have been saying since August of 2007, this shows that the crisis is now over.”

Meanwhile, the SEC has announced an investigation of mean, evil, bad short-seller David Einhorn. While out for a beer with a friend, Einhorn reportedly suggested that the Tooth Fairy does not exist and that wishing upon a star is not a wholly reliable price discovery mechanism. Christopher Cox, chairman of the SEC, said, “Vicious rumors attacking the Tooth Fairy will not be tolerated. Our entire financial system and indeed the American way of life depend on the Tooth Fairy and wishing upon a star. How else could one value level III capital appropriately?” The SEC is reportedly planning to set up re-education camps for short-sellers.

said...

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