Bear Market


Why The Debt-Dependent Status Quo Is Doomed in One Chart

June 29, 2012 by · Leave a Comment 

By Charles Hugh Smith, OFTWOMINDS


The global economy is now addicted to debt. Once debt stops expanding, the economy shrivels. But expanding debt forever is unsustainable. Welcome to the endgame.


Regardless of whether you call it debt saturation or diminishing return on new debt, the notion that taking on more debt will magically enable us to “grow our way out of debt” is not supported by data. Correspondent David P. recently shared this chart of Total Credit Market Debt Owed and GDP and this explanation:

The purpose of this chart is to examine the relationship of total debt to GDP. Since Debt is not factored into GDP, just exactly how much debt is being used to create growth, and over what time periods. But absolute numbers don’t work so well, since they don’t let you examine particular years, seeing what the 1950s look like vs the 2000s, for example.

Red Line: Annual Change in TCMDO (Total Credit Market Debt Owed) * 100/ That year’s total GDP, showing that year’s % increase in TCMDO/GDP.
Blue line: % change in GDP over last year.

Any gap between the red line and the blue line is what I would call the creation of debt in excess of income. And that gap is the ANNUAL gap, not a cumulative gap. As an example, in 2008 TCMDO grew by an average of 30% of that year’s GDP, while GDP itself grew by around 5%. Ouch. 

So projecting forward, how much debt growth do you think we’d need to get back to business as usual? 50s was 8%, 60s about 12%, 70s 15%, 80s maybe 20%, 90s back down to 15%, and 00s probably 25-30% per year. We’d probably need a surge of 35% or more, per year, to bring back those exciting bubble years. But who could possibly have the income to support that? To quote the parable of the Little Red Hen: “Not I”, said the goose.

Thank you, David. Note what happened to GDP the moment debt ceased expanding in 2008: it tanked. This is the chart of debt addiction: the moment the expansion of debt is withdrawn, the economy implodes. Here is a chart which shows debt has outrun income for decades:
Debt can be expanded at a rate that exceeds the rise in real income in only one way: by lowering interest rates so the same income can support a larger debt.
This is of course the reason the Federal Reserve has lowered interest rates to near-zero with the ZIRP (zero-interest rate policy).
Eventually the buyers of newly issued debt at near-zero (or even negative) yields start to fear they will never get their capital back or they will be paid back in depreciated currency, and so they demand a higher yield. Since income has already been stretched to the limit to support a towering mountain of debt, this rise in yield catapults the borrower into insolvency.
That is Greece, Spain, Italy, and eventually, the entire debt-dependent global Status Quo. 

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We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.We cannot know when the Central State and financial system will destabilize, we only know they will destabilize. We cannot know which of the State’s fast-rising debts and obligations will be renounced; we only know they will be renounced in one fashion or another.
The process of the unsustainable collapsing and a new, more sustainable model emerging is called revolution, and it combines cultural, technological, financial and political elements in a dynamic flux.
History is not fixed; it is in our hands. We cannot await a remote future transition to transform our lives. Revolution begins with our internal understanding and reaches fruition in our coherently directed daily actions in the lived-in world.

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Go to my main site at www.oftwominds.com/blog.html
for the full posts and archives.

More articles from Charles Hugh Smith….

Why Australian Banks Will No Longer Be a Defensive Play

June 29, 2012 by · Leave a Comment 

The Daily Reckoning

According to Slipstream Trader Murray Dawes, the technical stars have aligned. They’re warning of an imminent market plunge. Murray reckons it could happen within weeks. (Read his latest research here).

We thought the big sell-off that Murray is looking for was underway last night. Stocks opened down in Europe and the US. Until late in the day indices were in the red by more than 1%. But then, out of nowhere, a huge late-day rally gave some respectability to the numbers.

What caused the rally? There was no particular news to move the market that sharply. We have no idea. Like most things in the markets these days, it smells a bit dodgy.

Perhaps the late rally was simply intended to make us all think the Europeans were doing something productive at their latest summit in Rome…apart from watching Italy beat Germany in the Euro 2012 football semi-finals.

But, just like every other summit and emergency meeting in this whole sorry debacle, whatever they come up with will just be more of the same. Because in a fiat currency system that runs on debt, the only solution is to create more debt. We’re not trying to be pessimistic about the situation. It’s just reality.

A debt-based fiat money system is a giant and elaborate Ponzi scheme. Individual Ponzi schemes die a very quick death upon discovery. But the global Ponzi has a considerable life span. That’s because its perpetrators write the rules of the system. But this just ensures that, when the end finally arrives, it will be spectacular.

The Safety of Australian Banks?

As Murray mentioned yesterday, the market is on a precipice at the moment. The longer the tug-of-war continues, the more violent the eventual break will be. But for the market to plunge from here the Australian banks will have to come under pressure. That’s because they make up such a large proportion of the overall market.

Below is a chart showing the ASX200 plotted against Australia’s biggest bank, the Commonwealth (ASX: CBA). As you can see, the performance between the ASX200 and CBA diverged in March. And since the beginning of June, the outperformance has only increased. As a result, over the past 12 months the ASX200 fell just over 10% while the CBA advanced around 2.5%.

It appears as though money is running scared from most other sectors in the market and heading to the safety of the Aussie banks. Let’s call it relative safety. Australian banks only look good because everything else looks so bad…Australian resources especially.

Australian investors revere the banks. Throughout the long credit boom they were the solid, safe, growth stock. During the bust they revealed their true colours by plunging in price. But they recapitalised and now, in the post-boom environment, they are back to their most favoured trading status.

Even the Bank for International Settlements (BIS), the central banks’ central bank, reckons the Australian banks are amongst the best and most profitable in the world.

Commonwealth Bank Outperforming the Market

Commonwealth Bank Outperforming the Market

Source: BigCharts


But with credit growth anaemic and residential property prices at the beginning of a long and epic slide, how will Australian banks maintain their darling status?

Our guess is they won’t. But we’ve been saying that for a while now so take it with a grain a salt. The reality is that the Australian banks remain highly profitable thanks to good management and good fortune. And while management will probably remain sound, their fortunes are slowly turning.

As this credit crisis rolls on, we think the property market downturn will damage bank balance sheets (Australian banks have around 70% balance sheet exposure to residential property) and drag down their profitability (measured by return on equity). In time, Australian banks won’t be seen as a defensive play…rather they’ll be viewed as the highly leveraged and risky institutions that they are.

That’s a longer term view. In the short term, we’re interested to see whether these ‘defensive’ plays will re-join the broader market as they did in the latter half of 2011 (see chart). If they do, then Murray’s prognosis will prove correct, and you can expect much lower prices in the weeks ahead.

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

The US Deficit of Deceit
2012-06-22 – Greg Canavan

How Nice to Have Friends At the Fed
2012-06-21 – Bill Bonner

Deep in the Stock Market Trenches
2012-06-20 – Murray Dawes

In Praise of the Eureka Rebellion
2012-06-19 – Dan Denning

What Could Possibly Go Wrong With Infrastructure Investment Bonds?
2012-06-18 – Dan Denning

Similar Posts:

More articles from The Daily Reckoning….

Australian Resources Sector: Caught in the Inflationary Vice

June 29, 2012 by · Leave a Comment 

The Daily Reckoning

While the Australian resource sector has already endured nasty selling, perhaps there’s more to come. It’s no secret that investors don’t like the sector at the moment. It’s not quite reminiscent of 2008, but it’s not far off either. A few years ago, it was the bursting of the global credit bubble that caused the carnage. This time, it’s China’s credit bust.

Capital intensive industries with long life assets always take the brunt of credit busts. That’s why resource stocks are so volatile. Plentiful credit causes a momentary boom. Long term demand, along with prices, look robust, so producers plan big investments to satisfy that future demand.

But when things turn pear-shaped, investors run for the hills. Weaker credit growth lowers demand and commodity prices. Previously robust resource projects now look marginal and can’t obtain further funding. Share prices collapse.

Some resource projects turn bad in other, sneakier ways. Take Santos’ Gladstone LNG project. It’s suffering from cost blowouts. Yesterday the company upped its total cost estimate for the project from $16 billion to $18.5 billion.

This is a feature of all major resources projects, especially in Australia. To explain why, have a think about this Ludwig Von Mises’ quote from Human Action:

‘…changes in the structure of prices brought about by changes in the supply of money available in the economic system never affect the prices of the various commodities and services to the same extent and at the same date.’

China’s deflating credit boom first held out the carrot of higher prices and greater demand. Then, as the credit boom dissipated throughout the Aussie economy (via the terms of trade link), came the stick that led to higher prices of wages, materials and services.

So inflation lures you in…and then it bites you on the arse. Call it the inflationary vice. That wasn’t precisely Santos’ issue. It needed to find more gas for its project and so had to increase its budget. But looking for more gas costs money and uses more resources. These types of hiccups lower return on capital and lead to lower share prices.

The big gas, coal and iron ore projects in WA and QLD have pumped up wages and prices in those areas. Some mates of ours recently headed to QLD to work on a new coal project. They’re getting paid stupidly good money. They know it too. They also know it won’t last for long.

That makes us wonder…does everyone else know it, too?

Regards,

Greg Canavan
for The Daily Reckoning Australia

From the Archives…

The US Deficit of Deceit
2012-06-22 – Greg Canavan

How Nice to Have Friends At the Fed
2012-06-21 – Bill Bonner

Deep in the Stock Market Trenches
2012-06-20 – Murray Dawes

In Praise of the Eureka Rebellion
2012-06-19 – Dan Denning

What Could Possibly Go Wrong With Infrastructure Investment Bonds?
2012-06-18 – Dan Denning

Similar Posts:

More articles from The Daily Reckoning….

The Biggest Fraud in Economics

June 29, 2012 by · Leave a Comment 

The Daily Reckoning

Forget ‘peak oil.’ Or so they say. It has fracked its way to energy self-sufficiency.

Porter Stansberry:

… there are roughly 20 major shale oil plays in the US. The largest five of these new reservoirs have more than 20 billion barrels of recoverable oil… meaning that each of these new fields is not only the largest in US history (by a wide margin), but that each of them, individually, would more than double the proven reserves of domestic oil…

That is why America is on track to be the world’s leading producer of oil within the next five or six years… and why the most knowledgeable oil analysts are predicting a new all-time high of American oil production by 2017. In fact, we’ve already become a net energy exporter for the first time since 1949.

The Wall Street Journal tells us that the US will not import a single barrel of oil from the Middle East by 2035.

Hey, wait a minute. Wasn’t that supposed to be why we’re spending trillions on wars in Middle East…to keep vital supplies of black goo headed our way?

Of course, the numbers never really made any sense. Neither did the logic of it. It would have been a whole lot cheaper just to buy the oil on the open market. Trillions cheaper.

But money isn’t everything. The US needs to guarantee access to oil…or its whole economy might be brought to its knees.

Which is probably a good place to introduce a new idea:

The biggest fraud in economics is economics itself.

What’s the point of having an economy? It is so that people will get the stuff they need and want. The more efficient the economy, the more stuff people get with the least effort and expense of resources.

It makes no sense to waste trillions of dollars’ worth of resources just to “protect the economy.” The whole point of an economy is to create more stuff…not to waste it. You might just as well try to protect your health by committing suicide.

Most economists are fools or knaves. The knaves want to get prestigious jobs and Nobel prizes by offering crackpot advice. The fools think it will work.

A few months ago, they were concerned with peaks. There was a peak in oil production. There was a peak in food production. There was a peak in available water coming. Then, a peak in peaks must have been hit.

Now there is a peak in valleys. All of a sudden, the peaks are far away. Commodity prices are falling, not rising. Deflation is economists’ worry, not inflation. Deflation is an impediment to growth; everyone believes it.

The European debate is largely a dispute over which fraudulent solution will cause ‘growth.’ The austerity crowd believes it has to clamp down on government spending. This will give investors’ confidence in government bonds. The feds will be able to borrow again. The economy will grow. All will be well.

The economic stimulus crowd targets growth directly. It wants the feds to spend…creating jobs, incomes, spending and so forth.

Paul Krugman is in The Financial Times:

“At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending.”

Krugman says the real problem is a lack of demand. People just don’t want to spend their money. This is something that needs to be fixed!

Why? Why not let people decide for themselves when they want to spend and when they want to save? Why let the government do for them what they do not want done? Krugman doesn’t bother to think about it.

He is worried only about growth. He is afraid that the economy will collapse completely before austerity measures lead to growth. The austerity group worries that government-led ‘growth’ will blow up the economy before it has a chance to turn into real, private sector growth.

Neither side doubts that growth is the key. Almost everybody agrees: we have to pursue growth. “The Hero,” Ben Bernanke, does it by printing money. Congress and the administration do it by running trillion-dollar deficits.

Nobody doubts that ‘growth’ is the key to progress, happiness, and maybe even Heaven. But there’s the foundation of the great flim-flam right there.

Why do economists think ‘growth’ is such hot stuff? Because they can measure it…

Economists can measure GDP. They can tell when it goes up…or when it goes down. Generally, more is better…because it means the economy is creating more stuff. So, economists tailor their policy recommendations…their theories…and their editorial page blah- blahs to the goal of stimulating growth.

But is growth a good thing? Is it the same as progress and prosperity? Is more stuff what the world really needs?

Just 5 years ago, TIME magazine thought the US needed more stuff…in the form of houses. Seventy years ago, the US needed more stuff…in the form of tanks and fighter planes.

Forty years ago, US economists – notably Samuelson – were convinced that the Soviet economy would soon be larger than the US economy. Why? It could produce more stuff. They had charts to show how stuff production in the Soviet Union was increasing…and how it would surpass the US in just a few years.

And what happened? It didn’t matter. The stuff was worthless.

Regards,

Bill Bonner
for The Daily Reckoning Australia

From the Archives…

The US Deficit of Deceit
2012-06-22 – Greg Canavan

How Nice to Have Friends At the Fed
2012-06-21 – Bill Bonner

Deep in the Stock Market Trenches
2012-06-20 – Murray Dawes

In Praise of the Eureka Rebellion
2012-06-19 – Dan Denning

What Could Possibly Go Wrong With Infrastructure Investment Bonds?
2012-06-18 – Dan Denning

Similar Posts:

More articles from The Daily Reckoning….

Italy’s Revenge: VAFFANMERKEL

June 29, 2012 by · Leave a Comment 

Zero Hedge


In this bizarro world, in which beggars have practically convinced themselves, and certainly the S&P500, they are now choosers, the latest escalation is actually biting the hand that feeds you. Below is today’s front page of Italian Libero. It is self-explanatory.

Just a thought (and one which so many people forget): every action has a bigger (sorry Newton) and opposite reaction. Italy may enjoy its day in the sun, but one day soon the surreal Stockholm syndrome will end. Then it will be the turn of all those 82 million very angry Germans, as we described last year, to have a word or two about their broke neighbors.

More articles from Zero Hedge….

Greek Bank Deposits Have Biggest One Month Outflow Ever In May

June 29, 2012 by · Leave a Comment 

Zero Hedge


It’s official: all those rumors of unprecedented deposit withdrawals in May as Greece was heading into one then another parliamentary election were true. According to just released NBG data, May deposit outflows were €8.5 billion, or the highest on record, bringing the local banks’ total private sector deposit base to just €157 billion, the lowest since January 2006, and represents a massive 5% outflow of the entire deposit base as of the end of April. And keep in mind rumors of epic bank jogs and trots did not really pick up until weeks into the second Greek election two weeks ago. At this rate of outflows the entire Greek banking system will have zero deposit cash left in under two years. So aside from the ‘details’, Europe is all fixed and stuff.

More articles from Zero Hedge….

Biderman’s Disbelief In The Market’s Unending Belief In ‘Something For Nothing’

June 29, 2012 by · Leave a Comment 

Zero Hedge


Epic Rant. Everyone’s favorite Bay Area truthsayer is back and this time he is taking on the general ignorance of an indoctrinated mainstream media and the brainwashed investing public. Dismissing the nonsense of one media blogger’s belief that the ‘Euro would be better off without the meddling Germans’ – implying that once the ECB was left to follow the path of stupidest resistance of printing and spending that all will be well with the region, Biderman conjures Lewis Black (spit and all) in the incessant belief that more debt can solve a problem of too much debt. Furthermore, the expectation that a European QE can bring rates down for Europe (without a German pillar of sanity) is ludicrous: “Unreal, what sane person would by short-term zero-interest rate debt instruments issued by a combination of broke debtor nations?” Reading the media or watching nitwits opine on CNBC and Bloomberg that everything is #winning: ‘just because the Federal reserve or ECB prints money’ is clearly frustrating as the TrimTabs CEO concludes “You just cannot print money and solve the world’s problems”.

More articles from Zero Hedge….

EUR Soars Most Since October 2011 Greek "Bailout" Announcement: Here Is What Happened Next

June 29, 2012 by · Leave a Comment 

Zero Hedge


Today’s 4-sigma short-squeeze ramp in EURUSD (up over 220pips from pre-Summit-statement) is very reminiscent of the 10/26/11 reaction to the Greek debt deal. EURUSD rallied magnificently, squeezing a dominating short-crowd over 400 pips higher that time. But it is the impulse reaction that we note – within two days, the entire rally had faded and indeed went on to sell off for a few more months as reality struck. One month after that previous last 4-sigma jump in EURUSD (late November 2011) we saw the global co-ordinated central bank liftathon that started the five-month epic idiocy of the equity exuberance that was the decoupling self-sustaining short-squeezing ‘cleanest dirty shirt’ first quarter of 2012. Trade accordingly.

EURUSD testing up to its 50DMA here as the 4-sigma move brings back hopeful memories from last October and November (and fearful squeeze nightmares)…

and here is how the EUR reacted to the Greek debt deal (a 400 pip rally) and then the hangover fade as all those shorts were burnt and the fundamental reality kicked back in…

 

and today’s exuberance as shorts scramble…

 

Charts: Bloomberg

More articles from Zero Hedge….

The Market Ticker – Europe: Squirrel!

June 29, 2012 by · Leave a Comment 

By Karl Denninger, The Market Ticker

Ever see “Up” where the dog has the “talking” collar on and every second word is “squirrel!”

Well, that’s pretty much what you have here in Europe today, and along with it, the market.

“We agreed on short-term measures that should apply to Spain and Italy,” said Luxembourg Prime Minister Jean-Claude Juncker, who heads the group of euro finance ministers. “We will keep all options open to do the interventions that need to be done to calm the situation. There is a whole array of possible interventions and measures.”

Yeah, right.

Let’s see…. subordination will come with that.  I know, I know, they say it won’t.  Yes it will as it must.  You can’t take $20 from one pocket and put it in the other, then claim to have an additional $20.  But this is what the EFSF/ESM proposes; a huge part of their funding comes from Italy and Spain so the claim that there is no subordination is per-se false; it’s indirect, but it’s still there!

What will this do for the proper price of money in the market for these nations?

It will drive it to the moon, that’s what.

What’s worse is that the EFSF and ESM simply don’t have enough capital to matter.  All they can do is buy at the margin, but in doing so they tamper with seniority, turning what is effectively “most-senior” debt into subordinated debt for those who already held the notes!

This is bad, not good.

And there’s not enough firepower.

And subordination will ultimately drive funding costs up, not down.

And there was nothing — at all — about actually fixing the underlying problem, which is that they’re still spending more than they take in over there.

Never mind here.

 

More articles from the Market Ticker….

The Market Ticker – Personal Income and Spend: Recession Incoming?

June 29, 2012 by · Leave a Comment 

By Karl Denninger, The Market Ticker

Income and outlays eh?

Personal income increased $25.4 billion, or 0.2 percent, and disposable personal income (DPI) increased $18.5 billion, or 0.2 percent, in May, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) decreased $4.7 billion, or less than 0.1 percent.  In April, personal income increased $29.4 billion, or 0.2 percent, DPI increased $19.5 billion, or 0.2 percent, and PCE increased $16.2 billion, or 0.1 percent, based on revised estimates.

So we have basically no growth in income (and it’s no real growth) and no growth in expenditures eh?

But they claim that “real” PCI and PCE were both up?  Bah — that’s all gasoline, or so we’re supposed to believe.

Let’s look inside.

Personal outlays — PCE, personal interest payments, and personal current transfer payments — decreased $7.0 billion in May, in contrast to an increase of $13.9 billion in April.  PCE decreased $4.7 billion, in contrast to an increase of $16.2 billion.

That is not good.

I wouldn’t call this “recession now”, but it is not a strong report at all.

What’s going on today in the market is all about the EU “summit”, wihch is rather funny in and of itself.  The PCE report didn’t move anything, really, and the internals show why — there was deterioration internally, but realistically it’s not a disaster.

Yet.

More articles from the Market Ticker….

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