Round table economics discussion - 2009-11-17

In this episode of the Optimistic Bear round-table economics discussion our panelists (Elliott & Jeremy) talk about how the fact the US does not have much debt denominated in foreign currencies sets it apart from other nations which have had gret economic stresses. They also talk about how a deeper recession may not mean a break-down in civil society, but that it could lead to greater inneficiences as businesses and consumers start to keep greater supplies of goods to make up for a less predictable supply chain.

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Optimistic Bear Round table discussion podcast series

Welcome to the Optimistic Bear round-table discussion podcasts. Check out the latest conversations about economic news, and issues, with my friends and guest speakers.

• (2009-11-10) Kevan & Jeremy discuss the definitions of inflation and deflation, and whether government policy makers actually understand economics or are willfully driving the economy into a deeper hole. The Optimistic Bear's attempts at finding hope from economic trauma, with the belief that the depression will cure the mal-investments, are tempered by Jeremy's comparison to the rise of Fascism in 1930s Germany, and Kevan's concerns that the lack of US savings, and massive unfunded liabilities cannot possible lead to a happy ending.
• (2009-11-05) In this episode of the Optimistic Bear round-table economics discussion our regular panel (Kevan, Elliot & Jeremy) discuss the Federal Reserve's decision to keep interest rates unchanged, and whether their hands are tied by the direction of the Treasury Bill markets. We also ponder the morality of "walking away" from properties that are worth substantially less than the mortgage, even when a home-owner is able to continue making payments.
• (2009-10-30) In this episode of the Optimistic Bear round-table economics discussion Matt Stiles joins us as a guest, filling in for our regular participants who are unavailable this week. We talk about the paradox of a declining stock market at the same time that the economic news was so positive this week and the financial stresses that local governments are experiencing with pension obligations.
• (2009-10-22) Kevan, Jeremy, and Elliott discuss whether rosy earnings reports indiciate that tech industry has turned the corner, and whether innovation thrives during recessions. Kevan takes on the deflationists, suggesting that the worst might only be starting for the dollar.
• (2009-10-16) Elliott and Jeremy talk about the significance (or lack thereof) of the Dow hitting 10,000 and societal attitudes when markets hit bottoms. Hear about how stocks are not a panacea for long term investors, and that bonds usually perform better in the long haul. Also, the Optimistic Bear points out that bearish investors need to tread carefully since the cards are stacked against bearish investors.
• (2009-10-08) In this episode of the Optimistic Bear round-table discussion podcast, we talk with Jeremy about growing problems with reverse mortgages, and how to make head or tails of the inflation/deflation debate when each side claims the Federal Reserve is doing different things with the money supply. We also talk discuss about the societal, and career, pressures to just "play along" that many people faced during the bubble years.
• (2009-10-01) Welcome to the inaugural Optimistic Bear round-table discussion podcast. The Optimistic Bear chats with Kevan, Elliott & Jeremy about Economics, inflation/deflation, bond prices, with a smattering of politics thrown in for good measure.

NOTE: You can view the complete list of Economics Unveiled podcasts to hear more conversations with the experts.

Introducing the Optimistic Bear Weekly Economics and Finance

Tune in to the Optimistic Bear live internet radio show every Tuesday night at 9:00pm (Pacific Time).

The Optimistic Bear discusses the latest economics and financial news with both guests and listeners. Has the global economy turned the corner? Is deflation or inflation ahead? What will happen to stocks, bonds, real-estate, commodities and gold? Is there anything that can be done about it? Tune in to find out. The Optimistic Bear has his own opinions, but his guests offer different views to give listeners a broad perspective.

http://www.blogtalkradio.com/optimisticbear

Note: You can check out the full directory of past episodes from the Optimistic Bear weekly economics discussions.

The world's best financial & economics analyst

I would like to announce that www.surkan.com has just joined the affiliate program of Elliott Wave International. This is the financial newsletter service that I have come to view as indispensable. I have been a subscriber for years, and find that their analysts are the closest to my own views of anything there is.

The EWI view that society, and the economy, moves in cycles (or waves, in their parlance), has had a profound impact on my view of economics and the world. It’s not the “news” that drives the big changes in society, rather it is changes in society that create the news.

I have never fully bought into the complex wave theory that EWI uses, with which they will plot (and predict) trends in the stock market, but their general technical analyses has been dead on the money as to where the economy was headed, even if their timing hasn’t always been the best. EWI is one of the only authorities to call for deflation (which they still maintain is ahead), and they were way ahead in seeing the growing financial storm that was brewing. Astonishingly, EWI has held these bearish views without falling into the trap of conspiracy theories, blaming everything on nefarious cabals and manipulators.

I whole-heartedly recommend EWI to all of my readers. They have a free membership service (Club EWI), which allows you to access some basic articles, and they have various levels of paid subscriptions to the different newsletters they offer.

Right now EWI is offering a free series of courses based on Bob Prechter’s book “Conquer the Crash”, which offers very useful advice on protecting yourself from the growing depression.

Incidentally, I had the great privilege of going to lunch with Bob Prechter (the EWI founder) when he was visiting Seattle earlier this year.

In the interests of full disclosure, as an EWI affiliate member I do gain a commission for all subscribers (even the ones using the free Club EWI service) that come from Surkan.com. If you do decide to sign up to EWI (which I highly recommend), please use the links on Surkan.com (in the advertisement banners, or this post) so that I will get some credit.

Re-defining terms: forget inflation and deflation

In this episode of Practical Economics Matt Stiles talks about how the recession is far from over, and that the entire inflation/deflation debate may be irrelevant since the very definitions used for these terms don’t describe the phenomena we are seeing in the global economy. Matt goes on to say that the recession may be part of a generation cycle, and that it is inevitable that boom and bust cycles will persist forever. Check out Matt’s blog at http://futronomics.blogspot.com/.

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NOTE: You can view the complete list of Practical Economics podcasts to hear more conversations with the experts. Tune in to the weekly economics round-table discussions to hear the latest from the Optimistic Bear.

Profiting from the recovery

In this episode of Economics Unveiled Bill Conerly explains that the economic recovery is going to be a lasting (albeit slow) one, and that businesses should start positioning themselves to profit from it. He also explains that business plans should be robust enough to succeed regardless of what happens to the economy. Don't over-extend yourself when times are good, and don't cut out muscle when things get tough.

Bill tells the Optimistic Bear that he has been around the economics block enough to have learned the humility to know that the future is hard to predict, and that outcome of debates such as the inflation/deflation argument are just unknowable. You can check out Bill's blog here: http://businomics.typepad.com/.

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NOTE: You can view the complete list of Practical Economics podcasts to hear more conversations with the experts. Tune in to the weekly economics round-table discussions to hear the latest from the Optimistic Bear.

Talking about FinancialArmaggedon

Michael Panzner (of http://www.financialarmageddon.com/) discusses his views of the global economic roadmap, and the “end of the American era”. He describes an inflationary future for America as policy makers cave into the pitchfork wielding masses, unwilling to accept deflation. Unfortunately, Panzner doesn’t believe there is necessarily any particular nation for investors to park their money that will remain unscathed from the coming turmoil. Panzner’s view is an expansive one, covering the history of empires and societal trends.

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NOTE: You can view the complete list of Practical Economics podcasts to hear more conversations with the experts. Tune in to the weekly economics round-table discussions to hear the latest from the Optimistic Bear.

Mish is right on deflation, but wrong on the cause

Mike Shedlock has posted another interesting article on the likelihood that severe deflation lies just ahead for the economy. Over-all, I agree with his points.

Travakoli makes six points about deflation. I concur with all of them. Here
are three of them.

• Our fundamental financial and economic problems, i.e. overleveraging, lack of transparency, have not been solved.
• Since 2008, capacity utilization has plummeted; businesses have no pricing power; U.S. lost 6.7 million jobs but numbers are underreported; personal income tax receipts are down 21%; corporate tax receipts are down 58%; U.S. deficit will exceed $1.8 trillion; govt. spending is now 185% of tax receipts; 13% of mortgages are seriously delinquent and/or in foreclosure; huge decrease in personal net worth; 15 million mortgages exceed the home value. We’re on a massive debt spending spree.
• Income on all levels is not sufficient to make debt payments.

However, I disagree with the explanations for the cause of the current crisis. Mike agrees with Travakoli’s condemnation of bankers and regulators for imprudent, and immoral, behaviour.

At its core," Tavakoli observes, "the mortgage crisis is no more sophisticated
than a schoolyard swindle, and the SEC is the principal."

The debt bubble was a broad societal phenomena, in which everyone played a role. Bankers took on imprudent risks, and regulators let them. At the same time, however, investors were willing to turn their heads to obviously questionable dealings of the firms they put their money into, and consumers were also willing to gorge at the debt troughs, taking on mortgages that they knew they couldn’t pay, in the hope of getting rich with asset appreciation. It is so eye-opening to read about how many of the investors in Bernie Madoff's investors knew he was up to something since the returns were too good to make sense, but they kept their money with him because they simply figured he was breaking the law by getting access to insider information or such like.

The old adage of con-men, about how you can only cheat a crooked person, is very apt. The crazy schemes of the bubble era only worked because there were SO many people willing to knowingly participate in scams. Even if individuals didn’t understand the full depth of the malfeasance that was taking place, they knew full well that something was up. The janitor who got a million dollar loan to purchase homes with 100% financing knew full well that there was no rational reason for the people giving him the loan to do so unless they had some sort of scheme up their sleeves.

My disagreement as to the cause of the debt bubble, and resulting crash, is critical. If my belief is true (that the bubble was a result of a societal wide psychological delusion), then there really isn't anything wrong in the structure of the economy, or regulatory bodies, per-se. We may simply be dealing with nothing more than the ebb and flow of long-term cyclical swings in societal attitudes.

Optimistic Bear Round table discussion podcast - 2009-10-01

Welcome to the inaugural Optimistic Bear round-table discussion podcast. The Optimistic Bear chats with Kevan, Elliott & Jeremy about Economics, inflation/deflation, bond prices, with a smattering of politics thrown in for good measure.

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UK banks bail-out Irish subsidiaries

Lest anyone think that the asset bubble (and concomitant crisis) is confined to America, Ireland continues to reel from the bust. Banks in the United Kingdom continue to pump billions of pounds into their Irish subsidiaries, which are struggling from collapsing real-estate prices.

Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, rescued by
British taxpayers last year, injected 3.03 billion euros ($4.4 billion) into
their Irish units during the past 10 months amid rising real estate losses.

“The scale of that figure is quite shocking,” Brian Lucey, associate professor of finance at Trinity College Dublin, said in an interview. “They weren’t leaders in the Irish market. The figure just shows the level of clean-up needed.”

British banks invested in Irish real-estate developers at the height of the “Celtic Tiger” boom and are now writing down investments amid the worst property slump in western Europe.

Refiners struggle as fuel demand slows

Declining demand is continuing to hurt all commodity sectors. Even oil refiners are now hurting as demand for gasoline remains low. Who knows, maybe once the speculators who have been stock-piling crude during the past year begin unloading their inventories the resulting drop in oil prices could lift refinery profits.

U.S. refiners may fail to meet financial requirements of their credit agreements later this year as slumping fuel demand erodes the profitability of making gasoline and diesel.

When banks can’t afford to foreclose

Evidence of bank tardiness in foreclosing on delinquent borrowers is continuing to mount. The author of a recent blog posting on the growing “shadow” inventory of foreclosures is getting very close to identifying the real reason lenders are reluctant to actually take possession of homes with delinquent mortgages.

Banks make more money by NOT foreclosing on homes. Banks are dragging out the
foreclosure process for their own selfish reasons. Until the day they foreclose, the amount of money owed to them is an asset…sure, it’s an asset that isn’t paying interest payments…but it is still an asset. The day they foreclose, a $400,000 asset
could become a $150,000 asset and a $250,000 loss.

All this is true, but the bigger point may be that lenders simply can’t afford to take the financial hit to their books that a foreclosure requires. My suspicion is that many lenders are in such dire financial straits as it is, that taking even more write-downs will force them into insolvency. This seems to be the pattern of dealing with the entire financial crisis: delay taking necessary actions, and pray that somehow asset prices will recover.

During my trip to Florida I heard about families who have lived in their homes as long as two years without paying, because the banks haven’t gotten around to foreclosing. And that’s a problem. Until the real estate market recognizes all its losses — including accounting for all foreclosures — it won’t be able to regain real stability and move on. Of course, that has implications for the broader economy as
well.

As of July, mortgage companies hadn’t begun the foreclosure process on 1.2 million loans that were at least 90 days past due, according to estimates prepared for The Wall Street Journal by LPS Applied Analytics, which collects and analyzes mortgage data. An additional 1.5 million seriously delinquent loans were somewhere in the foreclosure process, though the lender hadn’t yet acquired the property. The figures don’t include home-equity loans and other second mortgages

Moreover, there were 217,000 loans in July where the borrower hadn’t made a payment in at least a year but the lender hadn’t begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue aren’t in foreclosure, up from 8% a year earlier.

With each passing day it is looking more and more like the US is following Japan down the path of deflation. Just as Japan’s decision to avoid taking the sharp pain of letting banks fail, and write-off bad loans, led to 20 years of zombie banks and corporations, America is doing precisely the same thing, but on a grander scale.

Contraction of credit and money supply continue to break records

Credit, and the broader money supply, are contracting at unprecedented rates. This sure doesn’t smell like inflation to me.

Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).

"There has been nothing like this in the USA since the 1930s," he said. "The rapid destruction of money balances is madness."

Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an "epic" 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.

"For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew," he said.

Who says house prices always go up?

Anyone hoping that the real-estate market will see a swift rebound, let alone any kind of recovery, should take note of what’s happened in previous bubbles. The bubble in Texas property that burst in the early ‘80s still hasn’t seen a return to pre-bubble values nearly 30 years later.

Now that the myth of ever-rising house prices has been shattered, it may be time to
embrace another inconvenient truth: that prices can take decades to recover, at least when adjusted for inflation. A study in June by the Federal Housing Finance Agency, a regulator, pointed out that in parts of Texas house prices still languish some 30% below their 1982 peaks in real terms.

FHA leads the way towards sub-prime meltdown 2.0

The anemic economic recovery that is being talked about so much is resting on very week foundations. An astonishing 90% of all new American mortgages are now guaranteed by the US government, in one way or another. It’s as if the private economy has vanished.

Worse, the extraordinary growth of Ginnie Mae (which handles FHA loan guarantees) shows that risky lending continues to thrive, but now it is being handled by the government rather than private mortgage brokers, and investment bankers, driving luxury cars. Instead of taking a tip from the private sector, which tightens it’s lending criteria during recessions, the government is lowering its standards as fast as it can. The rising default rates on new FHA insured loans bears this out.

Prepare yourself for sub-prime implosion 2.0 in the years ahead, when masses of FHA insured borrowers default, and the government is forced to bail-out Ginnie Mae.

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory.

Deflation strikes Doritos

The deflationary forces keep sneaking up on us. Here is an example of how some super-market items are finally starting to see deflation. It’s telling, however, that prices for these items haven’t changed. Instead, producers are simply offering more goods for the same amount of money.

Your eyes are not deceiving you in the grocery store. Yes, your bag of Doritos just got
bigger. No, the price didn't change.

Last year, food packages
shrank as food-makers, dealing with record high ingredient costs, struggled to
maintain their profits. But the weakened economy has caused a slump in demand
for ingredients such as corn and oil, pushing those prices back down. With lower
ingredient costs -- and higher consumer demand for more value -- some brands
such as Frito-Lay are shifting back to bigger packages, and doing it without
raising prices.

This fits a pattern I’ve been seeing lately. Deflation is indeed rearing its, head, but it doesn’t always show up in the list prices. For example, many private schools are offering far more generous financial aid packages (to a much greater portion of students) rather than reducing their official tuition rates. We see a similar phenomenon in other areas where list prices remain high, but increasing numbers of add-ons are offered at no extra cost. A five year warranty? No problem it’s built into the price. You can get almost anything upgraded these days without paying a “premium” price.

At some point overt deflation will break out in even these laggard areas of the economy. House builders tried to stave off price reductions for years by offering ever more expensive inducements (including outright cash kick-backs), but eventually there was no alternative but to just drop the prices. Everyone else is just catching up.

Rosenberg says the bear market is here to stay

This is one of the best overviews of where there economy is, and will be headed in the coming years, I have heard anywhere. David isn't alarmist, and he uses rational arguments (with facts and historical comparisons) to explain how we are in the midst of a long term cyclical bear market that will experience a lot of volatility in the coming years. This is no prophet of the apocalypse. Life will go on, we will eventually get through this, but things will be rough for many years.

It's very sobering to hear how there have been lengthy periods where bear markets prevailed, despite large rallies along the way. I laughed when I heard the warning to bond bears, pointing out that US treasury yields fell in the '30s DESPITE massive government stimulus and spending.

Of course, it only stands to reason that such a level-headed perspective on the economy would come from the mouth of a Canadian.

The Never-Ending Bear Market

Before we get too excited about the possible end of the recession, and an economic recovery, it is important to get a bit of perspective. Deflationary depressions (which is what we are experiencing) can be long-drawn out affairs. The 1930s was one of the most volatile periods for the Dow Industrials on record. More recently, Japan has been experiencing one massive bear market since 1989.

The chart below says it all. There has been at least 5 major rallies in the Nikkei since 1989 (depending how you count), only to have the market tank even lower lows. Some of those rallies even lasted for a good period of time. The rally in the 2000s lasted over 5 years (rising some 140% from the 2003 bottom) , before new 20 year lows were reached in 2008.

If the US in entering a lengthy period of credit deflation (which is a theory I subscribe to), then there is a good chance the rally of 2009 will fail, and the markets will reach new lows. Unfortunately, I don’t think we will have the luxury of years before this rally peters out.

If anything meteoric rallies are sure-fire sell signals. Swift rallies (that cover a lot of ground in a short period of time) almost always occur during bear markets. The great rally of 2009 isn't any different.

I come to praise Ben Bernanke

With all the opprobrium being dumped on the hapless Federal Reserve chairman, a little balance is in order. Ben Bernanke is not some evil spirited monster, salivating at ways to nationalize the economy, or enable world domination. I fully believe he is honestly trying to prevent economic catastrophe by the best means he knows of.

Neither do I believe that Ben is a mental midget. Not only does he have PhDs, but many of the studies he has written show a deep intellect and sharp mental processes.

I don’t even blame the Fed chairman for the financial crisis and recession. For that matter, I don’t really blame Alan Greenspan either. I think a quote from the CalculatedRisk blog sums it up nicely.

It is one thing to have different views from those of the Fed Chair on particular decisions that have been made-- I certainly have plenty of areas of disagreement of my own. But it is another matter to question Bernanke's intellect or personal integrity. As someone who's known him for 25 years, I would place him above 99.9% of those recently in power in Washington on the integrity dimension, not to mention IQ. His actions over the past two years have been guided by one and only one motive, that being to minimize the harm caused to ordinary people by the financial turmoil. Whether you agree or disagree with all the steps he's taken, let's start with an understanding that that's been his overriding goal.

Of course, this doesn’t mean I am in agreement with the chief US central banker on much (although his suggestions that congress reign in spending are welcome). To a great extent I see the leaders of the Federal Reserve in much the same light as the technocrats who tried to steer the Soviet economy. I am sure that many Soviet officials were true believers, and many of them were highly educated, but that still didn’t make their belief in communism as the solution to economic problems correct.

Likewise, US central bankers (and treasury officials) may well believe that stimulus and loose credit are good for the economy, but that doesn’t negate the fact that they are only succeeding in making the recession worse, and saddling future generations with even larger debt loads. The solution to the economic mess requires a purging of bad debt, and a return to savings. Unfortunately, these are the very things that policy makers are trying their level best to avoid. It’s akin to a heroin addict taking more narcotics when the start to feel the pangs of withdrawal. It may help you feel a bit better in the short term, but it is no solution the underlying problem.


That said, the vilification of Ben Bernanke, or other economic officials, is counter-productive in the larger debates over policy. Casting aspersions on the motives, or integrity, of the people you disagree with merely serves to undermine your own arguments. Let’s just admit that it’s possible Ben Bernanke really is a nice person, trying to do good for his countrymen. Then we can engage in a real debate over the efficacy of the policy measures being taken (or the very existence of the Federal Reserve itself).

Iron Ore Producer Drops Prices 28.2%

Here is yet another example of the budding deflationary process at work. And yet there are people still scared of inflation? From where I'm sitting, prices just keep dropping. Sure, we've had a bit of a bounce with the summer bear market rally, but the signs that prices will just keep falling when this rally fades just keep growing.

Vale SA, the world’s largest iron- ore producer, said it agreed to cut
prices for the steelmaking raw material for ArcelorMittal by 28.2 percent

Of course, don't forget to check out my classic in-depth podcast on the case for deflation.