Trade Grinds to a Halt

Over the last 6-9 months, we have seen many indicators of weakening demand and the impact on trade. For example, the collapse of the Baltic Dry Index - down more than 90%. This reflected lease rates for freighters and indirectly demand for bulk cargo capacity. The initial drops in shipping volume were modest but had a severe impact on commodity prices and shipping rates as the global economy swung from a sellers market to a buyers market. Now we are starting to see the full impact of credit withdrawal. Our thesis has long been that excessive and EZ credit (TM) were the root cause of massive false demand that radically distorted the consumer economies, those who manufactured and exported to them and the raw material suppliers to the manufacturers. The chain of causation has proven out and now we will see just how large that distortion was.

Domestic Strife
Our back of the envelope calculation is that first-order effects in the US will be 10% of GDP, with further ripple effects from there. Our assumptions are fairly simple. Net additions to household debt ranged between $800 billion to $1.2 trillion from 2002 to 2007. That number fell to $77 billion in Q2 and negative $117 billion in Q3. All data come from the Fed Z.1 Flow of Funds release. We merely assume that net consumer credit will go to zero, whereas it could go severely negative as defaults and debt repayment have already caused outstanding credit to fall. We further assume that household savings will rebound from approximately zero to halfway back to the historic 10% range. The cumulative impact would be to reduce personal consumption by $1.3-1.6 trillion or between 9% and 12% of GDP.

Granted not all of this will hit US production. Much of the damage will occur in the export economies as we stop buying from them. We have repeatedly argued as much. Outsourcing which destroyed jobs in the US and made the target nations prosperous is now going in reverse and this should provide a partial circuit-breaker to the US economy which MAY prevent a consumption-employment-income-consumption death spiral like the 1930s. On the other hand, business spending is also falling and that swing is far more difficult to estimate. For modeling purposes, the hit to US output from lower capital spending should be roughly equal in size to the reduced demand for imports so US GDP probably declines 9-12% - straddling the 10% line of the textbook definition of depression.

Unless people dig themselves even deeper into a debt hole, households will not take on further debt - either out of prudence or inability. It would have been extraordinarily difficult to stop this a year and virtually impossible now. Once the (misplaced) confidence evaporated, the conclusion became inevitable.


Globo Stop
I'd like to thank Karl Denninger of Ticker Forum for his inimitable description of the current crisis. The PG version of which runs:

We're screwed, but they're screwed worse.

We are indeed seeing just how bad the rest of the world has it right now. The NY Times did an excellent piece over the weekend that described the rapid decline of world trade. Here's the money quote:

Over all, the total reported exports from those 43 countries peaked in July, at $1.03 trillion. By November, the figure was down 26 percent, to $766 billion. Since the figures are seasonally adjusted, the monthly figures should be comparable.

This is not just a problem for Asia but a global one. German exports fell 21%. Over a quarter of all world trade went away in only FOUR MONTHS. I think this is a pretty good example of just how much credit distorted the US and world economy. At some point, credit goes from a useful organ to a cancer. We have often spoken of the Universal Debt bubble and the breathtaking size and scope of it. It was "fun" while it lasted but the bill for the UDB is about to come due. The check is on its way to the table and we're going to spend a lot of time arguing over who gets to pay for it. George Washington spoke of government but it applies to credit as well and the distinction between the government and the banks grows ever smaller:

... a troublesome servant and a fearful master. Never for a moment should it be left to irresponsible action.

Global Reversal

It's been a few weeks and there's been a bit of excitement surrounding the Fed. But from an economic and credit standpoint, it's largely "sound and fury, signifying nothing." Risk spreads are still wide, lots of high-grade and few low-grade bonds are being issued, market rates (all but the shortest maturities) are higher not lower. Sure, stock markets are rallying on the promise of inflation but the Fed may not be able to deliver, especially since only the Bank of Japan is using the same playbook.

If you look closely, the recent past is very similar to the 1970s. We have rising inflation everywhere, though masked this time using statistical manipulation in the First World. Inflationary credit excess driving unsustainable demand for all kinds of stuff. This benefits rising industrial exporters (Japan then, China now) and commodities producers (OPEC, Chile, Brazil, Canada, Australia, Texas, Alberta and various African nations). We experienced a co-ordinated global boom then, just as now and for the same reasons. In fact, we are currently experiencing the highest sustained rate of global GDP growth since the early 1970s - not a terribly auspicious precedent.

Even with cuts in the Fed funds target rates, the US economy seems to be well along the road to a severe recession. Housing can only be described as collapsing. To those who argue that prices haven't come down much, you are correct - that comes later. Prices are sticky in housing since the average market participant is poorly informed. Price declines often continue well after a bottom in sales and construction. Just given what's happened already, we can look forward to 18-24 months of falling prices.

Predictably, lending against depreciating collateral isn't terribly popular and the initial effects of less EZ credit are being seen in the first small drops for consumer spending and retail sales. The declines would have been worse without rapid growth of credit card balances.

The Federal Reserve reported that consumer credit rose at an annual rate of 5.9 percent in August, the biggest increase since a 7.9 percent jump in May.

The increase was led by an 8.1 percent leap in revolving credit, the category that includes credit card loans.

This will get much worse for at least a year. With consumer spending now accounting for an unprecedented 72% of the economy, the vulnerability to a consumer spending slowdown is obvious. Of course American consumers have been spending money they don't have for the last 5 years and the engine for excess spending - the housing bubble has been sputtering and has now shut down.

What's fascinating is that similar dynamics are now being seen overseas. Many nations have experienced simultaneous housing bubbles and their associated wealth effects. A number of them are now rolling over in credible imitations of the US housing market of 2006. What ties them all together is credit. Live by the (credit) sword, die by the sword. It hasn't hit the inflation boom economies yet but it very likely will.

UK Builders
UK Lenders
Australia
New Zealand
Ireland
Spain

There's evidence of housing rolling over in such diverse locations as Sri Lanka, the Baltic States and Thailand. Once again, the only common thread is a deflating global credit bubble.