 | | The Daily Reckoning | Monday, July 11, 2011 |
- An ominous tale of post-consumption detox...and the lesson therein,
- Death by debt: A closer look at the ECB's rotten balance sheet,
- Plus, Bill Bonner on three things the unemployment figures are telling us and more...
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| Urgent: Offer Closes Tonight at Midnight! |
Israel Gives Money-Grubbing OPEC the Middle Finger
Israel just discovered what could be the 2nd largest oil basin in the world today. This could spell the beginning of the end for OPEC – and huge gains for you. Details here.
|  | | | | Chocolate Covered Debt Crisis | | Examining the Sweet and Sometimes Deadly Nature of Debt Financing | | |  | | Eric Fry | Reporting from Laguna Beach, California...
"Mint Poison Cookie" is not the name of a Ben & Jerry's ice cream flavor. But it might as well be...if you happen to be a Chihuahua with a sweet tooth.
Last Saturday night, your editor's Chihuahua, Tango, consumed a near-fatal quantity of chocolate, which got your editor to thinking that debt is a lot like chocolate: Sweet and delicious in some circumstances; fatal in others.
Ben & Jerry's "Mint Chocolate Cookie" ice cream is the favorite flavor of your editor's youngest son, Ethan. He loves chocolate. So does Tango. When Ethan eats chocolate nothing much happens. When Tango eats chocolate he spends the night in "Animal Urgent Care," undergoing emergency chocolate de-toxification. No kidding.
Sometime on Saturday, Tango chowed down a few brownies while no one was looking. The poor little guy's heartbeat raced up to 240 beats- per-minute, necessitating a battery of emergency de-tox procedures at the Urgent Care Center.
One sleepless night and $1,600 later, Tango came trotting out of the doggy ER as if nothing had happened. But something had happened. The 5-pound pooch nearly overdosed on chocolate.
Greece is that 5-pound pooch. The US is a St. Bernard, relatively speaking. But while Greece eats a few too many brownies, the US is busy inhaling the entire inventory of a See's candy store. From the Mediterranean to the Pacific, the nations of the West are gulping down life-threatening quantities of debt.
But remember, debt is like chocolate – sometimes sweet and sometimes fatal. Debt-financed investment, for example, is often sweet. Capitalistic initiative frequently requires debt-financing to succeed. And even after achieving some measure of success, capitalistic enterprises can magnify their profitability by taking on additional debt.
Debt-financed consumption is entirely different. It does not facilitate capitalistic initiative or leverage success; it merely advances demand from the future to the present. At the outset, debt- financed consumption often seems as sweet as chocolate to a Chihuahua. But the resulting consequences can be nearly as dire.
Over-indulging in debt-financed consumption produces a kind of financial tachycardia, in which debt-service obligations race ahead of cash-flow, and the debtor struggles merely to maintain his vital signs. Sometimes the debtor treats his affliction in time to recover. But sadly, many debtors respond too late to save themselves...and succumb to their over- indulgence.
Despite the hazards of debt-financed consumption, very few of us modify our behavior. As long as someone will provide the financing to buy a car, or a La-Z-Boy or a collector's set of Obama-Biden china dishes, we will avail ourselves of it. At the individual level, this behavior may not be a big deal. But at the national level, it is a very big deal indeed.
Increasingly, the credit that used to fund private enterprise in the West is funding mere consumption. Decreasingly, therefore, the nations of the West possess the wherewithal to "grow themselves out" of difficulty.
"In 1957, 54 cents of national income resulted for each dollar of debt," according to the Grandfather Economic Reports, "But, today only 20 cents of national income results per dollar of debt. That's a 63% drop in national income per added dollar of debt."
Expressing the identical data in terms of debt per unit of GDP, the Grandfather Economic Report observes, "In 1957 there was $1.86 of outstanding debt for each dollar of national income. But, today's economy needs $4.91 in outstanding debt for each dollar of national income... If we look just at the period 2000 to 2010 total debt increased $30 trillion, while US GDP increased [only] $4.6 trillion. In that period it took $7.50 in new debt to produce one extra $1 of added national income."
The remedy to this lamentable trend lies on the expense side of national income statements, not on the revenue side. If an overly indebted Western nation hopes to emerge from its extreme indebtedness it must reduce the cost, size and intrusiveness of its public sector in order to liberate financing and other resources for the private sector.
In Chihuahua terms, the governments of the West must stop eating chocolate. But that's rarely the inclination of elected officials...or of the constituents they represent. Neither the elected nor the electorate is eager to correct its self-destructive behavior. They'd rather find mechanisms to absorb or conceal the consequences of it. (I.e. "No" to spending cuts; "Yes" to raising the debt ceiling).
The solution, they argue, is not to avoid eating chocolate; it is to hire more veterinarians for the Urgent Care Center. So don't expect the West to stop eating chocolate until its national treasuries suffer cardiac arrests.
The Greek treasury may be the first; it won't be the last.
| | | | | Is this America's Last Gasp? |
A terrible question. But it must be asked – and answered.
This urgent broadcast will do just that.
Tune in now for urgent news on our banks, agencies, retirement accounts – and even our trash collection!
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| | The Daily Reckoning Presents | | The Euro and You | | |  | | Frederick J. Sheehan | "Global regulators...have no real sense of what type of contagion effect would occur if Greece were to default," observes Michael Lewitt in the June 16, 2011, edition of The Credit Strategist. "No doubt they believe it is significant enough that they are willing to do virtually anything humanly possible to prevent this scenario from unfolding."
Lewitt is demonstrably correct. Since 2007, global bureaucrats have broken any law that has hindered their attempts to ward off our inevitable reckoning. Attempts to prevent a euro eruption have become preposterous. The European Central Bank (ECB) is clearly in extremis.
A week does not go by without the ECB reducing its standards of collateral. The cost is not only its credibility as a central bank, but in the composition of its deteriorating balance sheet.
To make matters worse, Greece is the smallest economy among the impoverished PIIGS: Portugal, Ireland, Italy, Greece, and Spain. Since others will probably follow Greece, the current impasse is all the more discouraging. The Greek government cannot meet its July interest payment obligations to banks, central and commercial. It can no longer borrow from banks or in the bond markets. (This is also true for Ireland and Portugal, and possibly others.)
The Greek government has bills and salaries to pay. The ECB is doing its all to avoid default. This presents a dilemma: the further it goes in preventing (in fact: forestalling) a default by the Greek government, the more it compromises its legitimacy by breaking its own rules and ruining its balance sheet. A credit-sensitive bystander would say the ECB's legitimacy and balance sheet are cases of the emperor wearing no clothes but conventional opinion being afraid to state the obvious.
Remembering that the euro is an experiment – a currency that is only 13-year-old and not issued by a sovereign government – the European Central Bank should, above all, adhere to the highest standards of integrity.
Let's go back a year. After a meeting at the European Central Bank on May 6, 2010, the ECB confirmed its commitment to never buy sovereign (government) and corporate debt. On May 10, 2010, The ECB announced an unlimited program of buying sovereign (government) and corporate debt. On the same day (May 10), the ECB and IMF announced a $957 billion "shock-and-awe" loan program to calm markets. Said one European Union official: "We shall defend the euro whatever it takes." The double-talk from European Union and ECB officials still pours forth. As St. Augustine or Bernie Madoff said: "Once you go down that road, you can't stop." And it is a frightening road for all the folks who calculate their wealth in euros.
"As the citizens of the economically strong countries (and citizens with wealth to lose across the entire Eurozone) reflected on their personal financial conditions," writes Donald Coxe (Coxe Advisors LLP) in his May 26, 2011 edition of Basic Points, "they recognized a new fundamental risk: Their pay-checks, pensions, life insurance, bank deposits, bond investments, and cash were euro-denominated."
The ECB's balance sheet stands behind the euro. To generalize, as long as this balance sheet commands widespread trust, the euro will maintain its strength. But this balance sheet is not very trustworthy.
On the left side of the ledger, the ECB holds €1.9 trillion (about $2.6 trillion) of assets. On December 31, 2010, it posted €82 billion in capital and reserves. The leverage ratio is 23:1. If the value of ECB assets falls by 4.3%, it will be insolvent.
What do those assets consist of? The ECB holds €480 billion of asset-backed securities (ABS) and €360 billion of "non-marketable financial instruments." That comes to 44% of total assets. These asset-backed securities are not the old reliables. No, these are vintage 2010 securitizations, in which year the ECB permitted European commercial banks to bundle their bad mortgages and mortgage securities, sell them at par value to the ECB.
As for "non-marketable financial instruments," these presumably include the Portuguese government bonds issued in 1943 and due for repayment in the year 9999. The bankers in Lisbon surely broke out a vintage port when they unloaded the 1943's that settle 8,000 years from now.
Another peculiar "non-marketable financial instrument" is called the "own-use" bond, sold by Irish banks to the ECB. These are bonds that Irish banks issue to themselves and then sell to the ECB in return for euros. This arrangement may be difficult to grasp at first since it is both new and bizarre. An example: Allied Irish Bank (AIB) issued a €2.87 billion "own use" bond on April 26, 2011. By issuing this bond, AIB owes itself €2.87. The €2.87 was used as collateral for cash – euros – wired from the ECB. The Irish government provides the collateral by guaranteeing these bonds.
But the Irish government has no money and it cannot print euros. Only the ECB can authorize money-printing. In what must be quite an understatement, the Irish Independent observed: "'Own-use' bonds are popular with banks because they can continue to access funding at the ECB's one percent interest rate even when they have run out of the high-quality collateral typically demanded in Frankfurt."
For its part, the ECB insists all of these loans are properly collateralized. One understatement follows another: "This makes some eurozone states uncomfortable, since any losses on the money advanced by the ECB would have to be funded by all 17 states." This remark refers to the ECB relationship with the central banks of the countries feeding at the euro banquet. The national central banks must pony up for any losses incurred by the ECB.
The other 56% of the assets on the balance sheet (there may be some double-counting here) includes loans of €106 billion to the Irish central bank. On its December 31, 2010 balance sheet, the Irish central bank showed €70 billion in an "Emergency Liquidity Assistance" account, funds forwarded from the ECB.
At the end of 2010, the ECB also held outstanding loans of €92 billion to the Portuguese and Spanish central banks (€48 billion and €44 billion, respectively). More collateral (the Colossus of Rhodes?) stood behind the €90 billion in Greek assets held by the ECB.
The list of unconscionable deceits by the euro authorities is long, but that may be enough to indicate the euro is heading south. That is before looking at the European banking system, which has already suffered from bank runs. Depositors have withdrawn money and caution builds in the interbank lending market (one reason US Treasury yields remain so low.)
Here, specific and vulnerable bank exposures will be ignored and attention directed to one term: credit-default swaps. Nobody knows who owes whom what. This is 2008, again. Since then, United States politicians passed a financial reform bill that is taller than the Washington Monument, but credit-default swaps remain unregulated, uncollateralized, unmonitored, and requiring no capital. They may be bought, sold, and traded by, between, and among banks, insurance companies, pension funds, endowments, and hedge funds.
Credit-default swaps are the reason various parties want the negotiation of Greek debt to avoid a "credit event." If a credit event is triggered, the insurer pays the owner of the CDS. Leaving European banks aside, US banks have written $34.1 billion of credit- default insurance on Greece, $54 billion on Ireland, and $41.2 billion Portugal sovereign debt.
Europe has an additional problem, not of prominence in 2008. Once triggered, the vintage 2011 CDS need to be settled in euros, not dollars, as was generally true when Lehman and AIG were on the front page. Federal Reserve Chairman Ben S. Bernanke has magnanimously announced the Fed has opened unlimited swap lines should Europe need them. (On our behalf: there is no recourse by the Fed if another central bank fails to pay us back. Thank you, Marshall Auerbach, for explaining this and other peculiarities.) However, Simple Ben cannot advance euros. Only the ECB can do that (through the national central banks).
To sum up, if an agreement cannot be reached to resuscitate Greece, the ECB will print billions of euros so that banks can settle CDS claims. To prevent this hypothetical Greek failure – really, to avoid a CDS credit event – the ECB may need to buy up the Greek debt. (Unintended consequences for doing so may spring to mind. The list is longer than that of scorned securities currently accepted by the ECB.) In either case, the world will be plastered with a new batch of euros. Ben Bernanke will not let the opportunity of international panic pass without matching new euros with new dollars.
This is why gold and silver were invented.
Regards,
Frederick J. Sheehan,
for The Daily Reckoning
Joel's Note: Mr. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009) and The Coming Collapse of the Municipal Bond Market (Aucontrarian.com, 2009)
| | | | | | | | | Bill Bonner | | Giving Up on the Economic Recovery | | |  | | Bill Bonner | Reckoning from Paris, France...
The fight for recovery is over. The feds have waved the white flag. Maybe...
The Labor Department came out with the latest employment numbers last week. They were atrocious. Only about a fifth as many new jobs as economists expected. Which shows you three things.
First, economists can't really predict levels of employment, growth, prices, or anything else. And they are especially bad at it when they have the wrong idea of how things work.
Second, the feds have failed. They have been completely unable to make any progress against the downturn.
Third, this is not a recovery. Widely reported in the media was the opinion that the employment numbers were 'disappointing for the second year of a recovery.' Well...yes. Because it's not a recovery. It's a Great Correction. And this is just what you'd expect.
For the last 4 years – since the beginning of the financial crisis in '07 to today – economists, analysts, investors and policymakers have had the wrong idea. They thought they were dealing with an ordinary (though perhaps severe) recession, which they thought would be followed by an ordinary (though perhaps weak) recovery.
Not at all! It was not an ordinary post-war recession. So, the ordinary counter-cyclical policy measure – more credit! – didn't work. This time, the economy already had too much credit. Which is to say, too much debt. It didn't do any good to add more debt. Households were already drenched in it.
They couldn't absorb any more. They couldn't increase their spending by borrowing more money. So, spending couldn't go up...
Instead, households are struggling to maintain their standards of living in the face of rising consumer prices and flat...or falling...incomes.
And now, the mainstream financial press is finally catching on. Heck, even the US Secretary of the Treasury, Tim Geithner, may be opening his eyes.
Yes, dear reader, Mr. Geithner appeared on Meet the Press over the weekend and surrendered. He told the world that Americans faced a tough economy and that it would "feel very hard, harder than anything they've experienced in their lifetime."
He's probably right about that. But we can't help but wonder: how does he know? Until now, he has not had a clue. What happened? Did he see a burning bush on the road to Damascus? Did he get hit in the head by a rock? Has he come around to The Daily Reckoning point of view? Or is it a set-up?
After telling the world that he and his colleagues saved the world in the crisis of '07-'09...and then, that their bailouts and subsidies would bring a recovery...Geithner seems to be admitting defeat.
Surely, if there were something he could do, he would do it, right? So, this must mean that Geithner and company have come to the same conclusion we have...that there is really nothing that can be done. They should back off and let nature take her course, right?
Don't count on it, dear reader. Instead of learning something...that is, instead of admitting defeat, we suspect the feds are up to something. They're preparing the public for the next election. They will tell voters that they face tough times; they will spend more money trying to turn the situation around. Then, any improvement, no matter how slight, will be regarded as a major triumph.
Here is the report on the latest unemployment numbers in The New York Times:
Fourteen million, in round numbers – that is how many Americans are now officially out of work.
Word came Friday from the Labor Department that, despite all the optimistic talk of an economic recovery, unemployment is going up, not down. The jobless rate rose to 9.2 percent in June.
What gives? And where, if anywhere, is the outrage?
The United States is in the grips of its gravest jobs crisis since Franklin D. Roosevelt was in the White House. Lose your job, and it will take roughly nine months to find a new one. That is off the charts. Many Americans have simply given up.
But unless you're one of those unhappy 14 million, you might not even notice the problem. The budget deficit, not jobs, has been dominating the conversation in Washington. Unlike the hard-pressed in, say, Greece or Spain, the jobless in America seem, well, subdued. The old fire has gone out.
In some ways, this boils down to math, both economic and political. Yes, 9.2 percent of the American work force is unemployed – but 90.8 percent of it is working. To elected officials, the unemployed are a relatively small constituency. And with apologies to Karl Marx, the workers of the world, particularly the unemployed, are also no longer uniting. The article goes on to cite – with apparent approval – the efforts of labor unions and President Roosevelt at combating unemployment during the '30s.
And more thoughts...
Here's further evidence that the mainstream financial media is catching on. Here is a remarkably thoughtful article from The Wall Street Journal's 'MarketWatch:'
Commentary: Sluggish growth is no mystery: No one has any money
By Rex Nutting, MarketWatch
WASHINGTON – ...Where is the boom that inevitably follows a deep bust, such as we experienced in 2008 and 2009?
But there is no mystery. What other result would you expect from the financial ruin of the once-great American middle class?
And make no mistake, the middle class has been ruined: Its wealth has been decimated, its income isn't even keeping pace with inflation, and its faith in the American economy has been shattered. Once, the middle class grew richer each year, grew more comfortable, enjoyed a higher living standard. It was real progress in material terms.
But that progress has been halted and even reversed. In some respects, the middle class has made no progress in a generation, or two.
This isn't just a sad story about a few losers. The prosperity of the middle class has been the chief engine of growth in the economy for a century or more. But now our mass market is no longer growing. How could it? The middle class doesn't have any money.
There are a hundred different ways of looking at the economy, and a million different statistics. But if you wanted to focus on just one number that explains why the economy can't really recover, this is the one: $7.38 trillion.
That's the amount of wealth that's been lost from the bursting of housing bubble, according to the Federal Reserve's comprehensive Flow of Funds report. It's how much homeowners lost when housing prices plunged 30% nationwide. The loss for these homeowners was much greater than 30%, however, because they were heavily leveraged.
Leverage is an amazing thing: When prices go up, the borrower gets all the gains. And when prices go down, the borrower takes all the losses. Some families lost everything when the bubble collapsed, others lost very little. But, on average, American homeowners lost 55% of the wealth in their home.
Most middle-class families didn't have much wealth to begin with – about $100,000. For the 22 million families right in the middle of the income distribution (those making between $39,000 and $62,000 before taxes), about 90% of their assets was in the house. Now half of their wealth is gone and it will never come back as long as they live.
Of course, rich folk lost lots of wealth during the panic as well. Their wealth is mostly in paper not bricks – stocks, bonds, mutual funds, life insurance. The market value of those assets fell further than home prices did during the crash, but they've mostly recovered their value now. The S&P 500 (SNC:SPX) lost 56% of its value when it crashed, but it's doubled since then. Stocks are down about 13% from peak.
The rich recovered; the rest of us didn't. Regards,
Bill Bonner,
for The Daily Reckoning
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Readers who are interested in exactly what Bill is doing to protect and grow his own family wealth will do well to take a look at his Bonner & Partners Family Office project. In it, Bill and his team of international analysts, contrarian thinkers and specialists work to devise creative, though low-risk investments to build long-term financial security. Feel free to take a look at a personal invitation, from Bill's son, Will, right here.
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Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
| | |  |  |  | Imperial Suicide
What's "imperial suicide?" It's what empires do. If no other empire arises to kill them...they kill themselves. China will probably eventually crush the US militarily. But that is far in the future. The US can't wait. It lets the zombies run wild. At home, Congress debates a "debt ceiling" measure, as if it made any difference.
The IMF: Leading the Way to Financial Ruin
Debt Is a Bummer | China: Where Money Is Treated Best
I am sure that Mr. Pento is right because every country on the Face Of The Planet (FOTP) is desperately creating more and more money, and the money will eventually find its way to the place where it is treated best and/or has the best prospects, which is, in this case, Bob. Oops! I meant "China."
Buying Gold on the Price Inflation Guarantee
Awaiting the "Zero Hour" of Available Credit | US Dollar Reverses Losses After Jobs Report
Well... Friday was quite interesting with the Jobs Jamboree falling flat on its face, and watching the dollar get sold...and then bought again as the day went on... The dollar holds the hammer again this morning, as now the media and market observers are going after Italy...
Nation About to Take a Bath
The True US Unemployment Picture | |
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