The Permanent Bailout

Milton Friedman once said that "Nothing is so permanent as a temporary government program." The central banks, as rogue private bodies exercising governmental powers a proving that axiom true yet again. The Federal Reserve claimed yesterday that we are in a recovery but none of their emergency programs can be rolled back.

... the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.

Meanwhile, over in Europe, there is growing recognition that the bailouts have failed and that the money isn't going to be paid back. Instead of actually admitting anything of the sort, the ECB is now talking about effectively making the loans permanent. Sure, they SAY it's going to be a 30 year loan instead of 3 years but if Ireland and Greece can't pay the money back now and continue to run deficits, what makes anyone think they'll be in a better position to pay it back later?

The question sort of answers itself. The bailouts are throwing good money after bad as every one of these banks is so far underwater they can't even see the surface from here. Without honest accounting, we have no idea just how deep that hole is but it certainly looks like a bottomless pit from here. It's been stunningly clear for a while now that so much bad debt needed to be purged from the system but the central and TBTF banks have made every effort to PREVENT such a purge.

(Wall) Street Corner Hustle
The latest brainstorm from the ECB is exactly the same sort of shell game. Greece and Ireland can't pay the money back and they know it. Instead of acknowledging reality, we'll just convert it into a long-term "loan" so they don't have to pay it back within the term and maybe even the lifetime of the people making the decisions. It can't be paid back and it won't be paid back but maybe they can keep up the lies for a little while longer.

This is simply more Extend and Pretend so that they can keep trying to fool people into impoverishing themselves by overspending and taking on too much debt to keep up the illusion. That is the meaning of "prosperity" in a keynesian ponzi economy. You use inflation to convince people to eat their seed corn, making them feel better - for a little while. This is why central bankers place so much emphasis on "confidence" - in practical terms that measures the willingness of the population to deplete their capital and eat their seed corn due to the inflationary deception of the central banks.

The UDB gave us the biggest illusion of false prosperity the world has ever seen. The bankers are now trying to cover their tracks and delay the inevitable hoping you'll forget their complicity. But the best simple summation can be found from the creators of South Park:

The Visible Fist

The Visible Fist of government that is. The Visible Fist is about to crush the property market in China, exploding one of the most egregious bubbles on the face of the planet. The specific blow will take the form of imposing a property tax nationwide - in guidelines recently approved by the State Council. It was reported earlier this week in China Daily.

Although the measures have been considered for some time, the recent push has been given urgency by the dangerous levels that China's property bubble has reached. One of the key contributing factors has been the number of speculators buying property and then holding it off the market to profit from the price run up. Morgan Stanley's Andy Xie estimates that such properties number in the 10-20 million unit range.

Some of his other comments portray a China going through the same stages of economic madness that the US has over the last 20 years. But China is passing through each stage much faster as the (well-deserved) lack of trust in their financial system causes people to only chase really big potential profits. Look at this paragraph and tell me you don't see the parallels:

China's policies have travelled the path of least immediate resistance - monetary expansion and asset inflation. The main purpose behind asset inflation is that the government can tax it. It provides a place for people to chase their get-rich-quick dreams and is popular as long as the market goes up. It also offers insiders who have disproportionate influence to play the game at the expense of little people. It is no coincidence that China's policies have been so pro-asset-inflation in the past few years.

His comments seem to suggest that the lack of a property tax was a deliberate strategy to encourage land speculation and bid up prices in a frenzy. This would make sense as the state was by far the biggest landowner and wanted to extract the maximum price for it. With a large amount of land now in private hands, it can be taxed as the taxable base can now replace diminished land sales as a source of government revenue.

Increasing the carrying cost of speculative assets is one of the surest ways to burst a bubble. That is why rising interest rates nearly always do the trick. Rising ownership taxes have the same impact. China is doing both. The government is both instituting a property tax and requiring higher interest rates on properties other than a primary residence. The impact has been dramatic and nearly immediate and so far, it's just the new financial rules and property restrictions. The tax will aggravate the impact. Here is a report from two weeks ago in China Daily:

The Shanghai market has already felt the chill of the tightening housing policies with new apartment sales falling in April. Over 13,185 units of newly built apartments were traded in April, down 43.7 percent from the same period in 2009, according to data from China Real Estate Index System Shanghai.

Trading in the secondary market in Shanghai also saw a dramatic slump since April 16.

A total of 13,865 housing units changed hands between April 1 to 16, but only 7,974 units were traded from April 17 to 30, said Ma Ji, consulting manager at property consultancy Shanghai Centaline China.

Local media also reported that a property tax might be imposed in the next few months. Houses that fall into the definition for charging property tax will be levied an annual fee of as much as 8 percent of the apartment's total value, the Shanghai Securities News reported on Wednesday.

While I applaud the Chinese government's belated return to sanity, they are now being forced to take action to rein in the monster they created. Recall that we criticized the massive push to force credit through the system last year in Command and Control and The Price of Ponzi. The Sinophiles bragged about how smart the Chinese government was and how the money was going into useful projects. They completely forgot (or never learned) that money is fungible and much of it was bound to end up wasted in financial speculation in stocks and real estate.


Implications
China is trapped in a massive inflationary spiral of its own making. Wages are rising rapidly - undermining their major competitive advantage. But the average worker is still falling behind in terms of housing and other necessities. Just as in the US during the 1970s, inflation's initial effect is seen a purely positive - a feeling of rising prosperity that seems costless. China went through that over the last 18 months and it's time to pay the piper. It is going to be impossible to tame short of crashing their economy to subdue the fundamental labor supply picture, crash the RE market to increase purchasing power in terms of land or crash the stock market through contraction of the overall money supply. I expect more than one will be needed and likely all three will happen when they try to trigger any one readjustment.

One final comment. The divergence between Chinese consumer inflation and US CPI dis-inflation is strong supporting evidence for the Austrian and Monetarist schools view of the matter. Both consider inflation to be a matter of increasing amounts of money (really credit). Private credit is tanking in the US and has been for some time while China forced their banks to lend massively more.

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.