Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘deflation’

• Severe Debt Scarcity Coming to US

Posted by Ron Robins on December 30, 2010

By Ron Robins. First published December 26, 2010, in his weekly economics and finance column at alrroya.com

If US consumers believe it difficult to borrow now, just wait! In the next few years credit conditions are likely to go back seventy years when private debt was difficult to obtain. Most Americans intuitively believe there is too much debt at every level of society. But the economic and political vested interests do not want them worried about that. They want to give them credit to infinity to keep this economic mess from imploding. The US Federal Reserve’s new round of quantitative easing (QE2) is clear evidence of that. However, Americans are right about their inordinate debt load, and future economic conditions are likely to create a severe debt scarcity.

The principal reasons for the coming debt scarcity are that ‘debt saturation’—where total income cannot support total debt—has arrived, say some analysts; also, the growing understanding that adding new debt may not increase GDP—it could decrease it; and that the banks and financial system are a train wreck in waiting, eventually being forced to mark their assets to market, thus creating for them massive asset write-downs and strangling their lending ability.

The realization that debt saturation has arrived will not surprise many people. But understanding that new debt can decrease economic activity might surprise them. And the numbers illustrate this possibility. In Nathan’s Economic Edge, Nathan states, “in the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!”

In fact Nathan also shows that for decades, each new dollar of debt produces less and less in return, from a return of close to $0.90 in the mid 1960s to about $0.20 by 2007. One explanation for this is that as societal debt increased it focused disproportionately on consumption rather than productive enterprise, whose return appears greater.

On the subject of consumption, the renowned economist David Rosenberg in The Globe & Mail on August 16 stated that “U.S. household debt-income ratio peaked in the first quarter of 2008 at 136 per cent. The ratio currently sits at 126 per cent, but the pre-2001 norm was 70 per cent. To get down to this normalized ratio again, debt would have to be reduced by about $6-trillion. So far, nearly $600-billion of bad household debt has been destroyed.” This data reaffirms Americans growing aversion to debt, that debt has become too onerous, and is suggestive of debt saturation.

Replacing declining consumer debt is the exponential growth of US government debt. For 2009 and 2010, the combined US government’s fiscal deficits required or require borrowing an extra $2.7 trillion or so. Yet with all that spending—combined with about $2 trillion of ‘money printing’ from the US Federal Reserve (the Fed)—it created only around $1 trillion in increased economic growth!

One may argue that the phenomenal US government borrowings will provide returns far into the future and that the present low economic returns are due to not funding areas with potentially better returns. Some economists say that spending on infrastructure and education provides the best returns. However, with economists such as Nobel Laureate Paul Krugman and numerous others predicting huge continuing deficits for years ahead, and with a Japan-like slump in economic activity, the odds are likely that any new borrowed dollar will continue to provide only poor returns for years to come.

A further, major reason for the coming debt scarcity will be the tremendously impaired financial condition of the banks. The values assigned to many bank assets are fictional according to numerous experts. QE2 is about many things but one of them is aimed at delaying the potential for implosion of the banking system. In 2009, the Financial Accounting Standards Board (FASB) caved in to government and banking industry lobbyists to allow many bank assets to be ‘marked to fantasy’ and not ‘marked to market.’

This viewpoint is best expressed by highly respected Associate Professor William Black (and formerly a senior regulator who nailed the banks during the savings and loan debacle) and Professor L. Randall Wray, who wrote an article on October 22 in The Huffington Post, entitled, “Foreclose on the Foreclosure Fraudsters, Part 1: Put Bank of America in Receivership.” They wrote that, “FASB’s new rules allowed the banks (and the Fed, which has taken over a trillion dollars in toxic mortgages as wholly inadequate collateral) to refuse to recognize hundreds of billions of dollars of losses. This accounting scam produces enormous fictional ‘income’ and ‘capital’ at the banks.”

However, the Federal Reserve may be realizing that it might not have been such a good idea to buy some of these ‘toxic’ securities. Bloomberg reported on October 19 that, “citing alleged failures by Countrywide to service loans properly… Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit, people familiar with the matter said.”

Also, on November 2, CNBC reported that Citigroup could be liable for huge amounts of toxic security buy-backs as well. “If all four mortgage acquisition channels turn out to be equally as defective… Citi’s liability for repurchases could soar to about $100 billion dollars at a 60 per cent defect rate – and to around $133 billion dollars at an 80 per cent defect rate.”

Clearly, such numbers are staggering. These, as well as many other banks and financial entities, could collapse. Politically, in the present circumstances, it would be difficult for the US government to provide massive new funds to support the financial system. Therefore, it will be up to the Fed to decide what to do.

If the Fed prints ever increasing amounts of new money to try to moderate the financial collapse, hyperinflation could be the result. If it does not print massive amounts of new money, a deflationary depression could be born.

In high inflationary or hyperinflationary conditions, few will want to lend as they get paid back in dollars that are declining very rapidly in value. In a deflationary episode, lending is reduced due to huge loan losses. Therefore, during either, and/or after such events, debt scarcity will be in full force.

Data indicates that American consumers do not want to increase their debt. Debt saturation is occurring, and with it a declining return on each borrowed dollar—even for the US government. Most significantly, the banks and the financial system will probably soon experience a new round of massive real estate related losses and subsequent financial institutions’ bankruptcies. Thus, a new major financial crisis will likely soon engulf America, greatly impairing its lending facilities and creating a severe scarcity of debt.

Copyright alrroya.com

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Posted in Banking, Economics, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a Comment »

• New Bank Regulations Likely to Fail

Posted by Ron Robins on December 22, 2010

By Ron Robins. First published December 15, 2010, in his weekly economics and finance column at alrroya.com

New banking and financial industry regulations in the US and the Basle III rules for banks globally—might fail on key issues. The newly enacted US Dodd-Frank Wall Street Reform and Consumer Protection Act, despite its noble purpose to prevent further financial chaos, is unlikely to do that. And the Basle III requirements for higher and better quality bank reserves are good on paper, but full implementation is improbable amidst likely future hefty bank losses.

At the heart of the financial crises were derivatives, and as Warren Buffett the famed investor has warned, “derivatives are financial weapons of mass destruction.” Yet, after about two years of Congressional wrangling, the Dodd-Frank bill incorporates a rough future structure for derivatives but authorizes yet another committee to report back in the spring of 2011 with detailed regulations governing them. And the old expression, ‘the devil is in the details,’ is never more apt than in this instance.

Already, US Banks are calling for derivatives called ‘foreign exchange swaps’—a $42 trillion market—to be exempt from the rules.

Derivatives are major profit centres for the too-big-to-fail US banks. These banks have repeatedly told US lawmakers—who receive considerable campaign funding from them—not to restrict those profits. Because of the influence of Wall Street on the Obama Administration and the US Congress, it is difficult to be hopeful that when it comes to the detailed regulations, and especially their enforcement, that much will really change concerning US banks’ derivatives’ activities.

Two particular varieties of derivatives are at the centre of our financial debacle. They are mortgage backed securities (MBS) and credit default swaps (CDS). The latter, though originally considered ‘insurance policies’ against debt default, are now frequently gambling vehicles that incentivize the taking-down of struggling companies (AIG)—and now, governments (Ireland?).

The size of the derivative problem for US banks cannot be overstated. As Alasdair Macleod, a British banker and economist remarked on October 28, “according to the FDIC [the US Federal Deposit Insurance Corporation], outstanding derivatives held by US banks increased from $155 trn to $225 trn between mid-2007 and mid-2010. In other words, since the credit-crunch the derivative bubble in the US has grown a further 45 per cent and is now fifteen times total US GDP, literally dwarfing the banks’ total equity, which is only $1.35 trn. Consider this fact: derivative exposure is 189 times total bank equity.”

Aside from the derivatives issue, and also not addressed in the Dodd-Frank bill, are the two massive US mortgage progenitors now on US government life-support, Fannie Mae and Freddie Mac.

Fannie Mae and Freddie Mac were formerly somewhat private institutions and own or guarantee about half of all US residential mortgages. But as the real estate crises exploded and due to their potential for vast losses that could paralyse the housing markets, the US government commandeered them in September 2008.

The principle offering in the Dodd-Frank bill concerning Fannie Mae and Freddie Mac is that by January 2011 President Obama offers a proposal to Congress to bring them out of government receivership.

Thus, on the two vital issues of derivatives and real estate, the Dodd-Frank bill seems queasy and deficient. These inadequacies allow for a re-ignition of the financial meltdown at almost any time.

Acknowledging the severe problems in the banking industry, banking regulators have introduced new global banking rules. In September, the Bank for International Settlements (BIS) in Geneva, Switzerland—which sets the regulations that banks everywhere generally adhere to—issued its Basel III regulations, which are due to come into effect for all banks between 2013 and 2019.

Basel III’s most important requirement will be that banks hold higher and better quality reserves.

But the BIS may be too optimistic about the ability of many banks, particularly the too-big-to-fail banks, to reach the new reserve requirements. For instance, a Reuters report on November 21 said, “the new Basel III banking rules will leave the biggest US banks short of between $100 billion and $150bn in equity capital, with 90 per cent of the shortfall concentrated in the top six banks, the Financial Times said, citing research from Barclays Capital.”

However, these equity shortfalls may well err on the low side. In the next few years, US and European banks especially, are likely to be hit with big waves of new losses related to real-estate, derivatives, and sovereign debt.

Real estate losses because US and European banks have still not written-off their full potential losses concerning toxic MBS that they may have to buy back due to newfound paperwork improprieties related to the emerging foreclosure fraud, as well as mortgage losses generally, on foreclosed and other properties.

Additionally, banks may suffer further huge derivative losses as they are eventually forced to price certain derivative and other asset classes at more realistic appraisal values instead of the ‘mark to fantasy’ that often now exists.

And recently, an even greater potential hit to banks’ capital has arisen: the possibility of gargantuan losses on bad sovereign debt in the EU and elsewhere.

On September 13, The Economist magazine had this to say on the MBS and derivatives issue relating to Basle III. “The most serious failure in Basel III is that it doesn’t address the principal contribution of Basel II to the last financial crisis, namely, the calculation of risk-weights [for instance, risks associated with MBS]… What brought banks like Citigroup and Bank of America to their knees wasn’t direct exposure to sub-prime loans, but exposure to triple-A-rated debt backed by pools of such loans, debt which turned out not to be risk-free at all.”

The US Dodd-Frank bill either passes the buck or overlooks the very problems that led to the financial meltdown, and the Basel III regulations may be rendered impotent due to massive future bank losses. Thus, these new bank regulations are likely to fail.

As Henry Ford, the founder of the Ford car company once said about banking, “it is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”

Copyright alrroya.com

Posted in Banking, Economics | Tagged: , , , , , , , , , , , , , , , , , , , , , , | 1 Comment »

• Gold Lust Re-Emerges

Posted by Ron Robins on December 9, 2010

By Ron Robins. First published May 22, 2010, in his weekly economics and finance column at alrroya.com

Why the emerging lust for gold? Concerns of excessive debt and potential inflation are mostly influencing gold’s rise. But other factors are in play too. These include ancient and new cultural and spiritual attitudes towards the metal, as well as apparently failing manipulation schemes.

Cultural and spiritual reasons for gold’s rise
In China, which is fast becoming the world’s largest gold market, gold historically and culturally stands for good luck. The very symbol of Chinese culture, the golden dragon, represents happiness, procreation, and immortality. In India, which likely still has the world’s biggest private hoards of gold, the Vedic tradition associates the metal with purity of life, immortality, truth, magnificence—and has long been revered as money and the store of wealth. In ancient Persia, Egypt, and throughout the Middle East, gold is often referred to in divine terms and considered the only true money.

In recent years, a possibly rapidly growing (though of unknown magnitude) new source of gold buying has arisen. Respected sociologist Paul Ray has identified a group he labels ‘Cultural Creatives’ (CCs). These CCs form the backbone of most New Age movements and other spiritual groups, many of whom buy gold for purported spiritual benefits. According to Dr. Ray, CCs probably number around 25-30 per cent of adults in most developed countries and are likely to form majorities in those countries in the next ten to twenty years.

Alleged failing gold market manipulation increases gold price
A major factor influencing the gold market is alleged gold market manipulation. Gold market manipulation has existed since the earliest of times. Its deep cultural and historical significance has been the bane of kings, emperors and modern day central bankers. Monetary systems based on gold tended to be restrictive, therefore inhibiting the ability of kings and governments to finance wars, etc. By contrast, paper (fiat) currency systems are able to create credit and debt at will, hence all modern societies have chosen paper-based currencies and attempted to reduce and suppress the role of gold.

The attempt to control the role of gold in the modern world has, according to the Gold Anti Trust Action Committee (GATA), been onerous. GATA claims the U.S. Treasury, The Federal Reserve and other governments and central banks have collaborated to suppress its price. GATA has extraordinary documentary evidence of this. One instance of how gold suppression has been working is a quote from the former head of the U.S. Federal reserve, Alan Greenspan. In testimony to the Committee on Banking and Financial Services, U.S. House of Representatives, on July 24, 1998, he said that “… central banks stand ready to lease gold in increasing quantities should the price rise.” Evidence by James Turk, Dimitri Speck, Eric deCarbonnel, and others suggests that they have done that and more over the past decade.

Also, backing up GATA’s claim, Michael Gray wrote in the New York Post, May 9, 2010, ”Federal agents have launched parallel criminal and civil probes of JPMorgan Chase and its trading activity in the precious metals market.” JPMorgan Chase has very close ties with the U.S. Treasury and Federal Reserve. Considering the fact that a major New York daily has published this story, it has received remarkably little attention. Why the media silence? I believe it exhibits an ingrained cultural bias to keep a lid on gold suppression so as to minimize the increasing loss of confidence in major currencies.

However, as is obvious from the rising gold price, if price suppression had been working it does not seem to be functioning too well at present. Central banks may have lost too much gold in loaning and selling into the gold markets to keep its price down. Also, they are now realizing it may well be the best asset to hold. Incidentally, nobody knows for sure how much gold the U.S. government has as the last public audit of its gold reserves was in 1971.

Gold as currency
In the time of the Prophet Muhammad the gold dinar was the currency of exchange. In Europe, the Greeks, Romans, Venetians, Dutch, Spanish and British, all found gold to be the ideal currency. As a currency, gold has the advantage of having a value in and of itself. It is also durable, divisible, convenient, relatively rare, and cannot be ‘manufactured.’

In recent years, the Gulf Cooperation Council proposed a common currency, which some key supporters want backed by gold. Throughout the Muslim world a cultural monetary renaissance is occurring as a return to the ancient gold dinar as a principle form of currency is debated. The Emirates Palace, Abu Dhabi’s top hotel, has even introduced an ATM offering gold bars. Internationally, the proposed revised Special Drawing Rights of the International Monetary Fund may also have a commodity component that includes gold.

The re-emergence of gold as the alternative currency is gaining momentum. This appears to be not only because of the current monetary debacle affecting paper currencies, but also due to purchasing of the metal by those re-discovering its cultural underpinnings, by those valuing its purported spiritual properties, and the increasing failure of central banks in suppressing its price. As the lust for gold gains momentum, it again reveals itself as the ancient metal of kings.

Copyright alrroya.com

Posted in Finance & Investing, Gold & Precious Metals, Monetary Policy, Personal Finance | Tagged: , , , , , , , , , , | Leave a Comment »

 
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