Friday, July 17, 2009

The Price of Ponzi

Faking Bank
First let's be clear that prices for the majority of asset classes around the world are unsustainably high. This is an obvious corollary to the very inflated state of the global financial system and economy due to the excessive leverage that we have commented upon many times. It bears repeating that central banks (CBs) have little actual power, they merely serve as rallying points and fetish-totems for optimistic, true-believing speculators. The evidence is quite clear that CBs often fail to accomplish their goals, in recent cases despite extraordinary actions to "inspire confidence" - i.e. reignite speculation.

If the CBs were as powerful as most think, they could not possibly fail to accomplish their goals. Like voodoo, it is the BELIEF of the victim that causes the damage - a negative application of the well-documented placebo effect. While they have succeeded in restarting speculation to some extent in equities and commodities, they have utterly failed to do so in most of the securitization and especially the re-securitization markets. Other than the Fed itself, there is very little demand for MBS and ABS. CDOs have fallen flat on their face and can't get up. The investment bankers' efforts to re-securitize garbage and get it rated as AAA again have largely met with derision. Assets in the real economy are seeing no increase in demand at all to this point. Housing, commercial RE, private businesses, capital equipment and others are all in the doldrums with hardly any positives even in the second derivative.

Flee(t)ing Confidence
Take note of which asset classes are seeing speculation and which are not. It is only those that can be sold instantly with a mouse click that are getting any action - equities and commodities which trade as futures on an exchange. The exceptions are revealing. Iron ore, which requires long-term contracts instead of futures isn't going up and in fact is going down, with users essentially buying at spot by refusing to commit to L-T deals. Assets that are theoretically liquid but actually trade by appointment only are seeing little help. This would include the aforementioned MBS and ABS. Those that require a real commitment and have payback periods measured in years continue to crater. Basically, the only confidence at this time is the confidence of the daytrader.

Yet we now see speculation among economists that there could be a return to growth in the next four quarters and actually, it's hard to disagree that such a thing is technically possible. The key here is the massive amount of deficit spending by governments around the world. Official US Treasury estimates place the FY 2009 deficit at $1.8 trillion but $2 trillion is more likely. The DEFICIT will likely represent 14% of GDP this year. China is in a similar situation, with a "stimulus" package of nearly $600 billion in a $4.4 trillion dollar economy - which works out to just under 14% of GDP. Hmm, that number sounds familiar.

Large segments of both economies are ponzi schemes, though China's most vulnerable sectors are both larger and more leveraged relatively speaking. In the US, the most affected sector is finance; in China, construction and fixed investment. Consider for a moment that both governments are spending enormous sums of money they don't have - effectively borrowing it from the future to spend now. Once again hoping to ignite a chain reaction of speculation and a new bubble.

We actually expect a slight positive print in US GDP in early 2010, with a larger collapse to follow as soon as the government can no longer borrow cheaply. This is the inevitable result of spending twice your income (tax revenue) just to keep the current illusion alive. When the bond market cuts off this foolishness, the portion of the economy that is unsustainable without a bubble dies and all of the capital spent to keep it alive dies with it - a complete waste. Instead of a mere depression, we have a depression compounded with the destruction of capital that should have been preserved to start rebuilding afterwards.

Pricing Ponzi
If you think about it, both the US and China are expending one-seventh of their respective GDPs to support a lie. Another way to think of it is the rate of return the market (in the form of speculators) demands to continue to invest in the ponzi schemes. In effect, the government's best guess at the required RoR is 14%. Antal Fekete has written about the falling marginal productivity of debt. In other words, the debt-based ponzi scheme is becoming less and less effective. As a result the sponsor of the scheme (governments) are having to increase the amount pumped into the bubble to keep the speculators in and prevent a UNIVERSAL recognition of the failure that has already occurred. This is typical of late-stage ponzi schemes where a critical mass of investors become suspicious and demand their money. The sponsor has to come up with it somewhere and in this case they can conveniently pledge their citizens' future income (taxes) as collateral for more loans.

It is impossible to calculate the precise cost but we can look at deficit and "stimulus" spending as a good first approximation of the price to keep the ponzi scheme rolling. If 14% of GDP can be spent and not even produce a single quarter of positive numbers then the decay is even larger and more advanced than we have previously postulated. As an example, the latest Personal Income Report from the BEA showed the scale of government attempts to manipulate the economy. Wages dropped sharply but personal income rose 1.4%. The money quotes:

Private wage and salary disbursements decreased $12.4 billion in May, compared with a decrease of $0.7 billion in April.

Personal current transfer receipts increased $162.6 billion in May, compared with an increase of $59.1 billion in April. The American Recovery and Reinvestment Act of 2009 provides for one-time payments of $250 to eligible individuals receiving social security, supplemental security income, veterans benefits, and railroad retirement benefits. These benefits boosted the level of personal current transfer receipts by $157.6 billions at an annual rate in May.

Once the long-end of the Treasury yield curve resumes its upward march, the financing will get more difficult. If short-term money ever becomes expensive for the US government then the deception is over. But for right now we may get further upticks in optimism as long as the government can continue to create doubt and obscure the real state of the economy. In the near term, it's all in the hands of the speculators and their mood swings and isn't that a sad commentary on the state of the world.

No comments: