Wednesday, August 12, 2009

Green shoots, turkeys, and endless deleveraging

Back to the talk of “green shoots” in the economy – this is getting talked up a bit both in the US and Europe at the moment, and it’s worth taking a look at how valid it might be.

Counterpunch and many of the writers on it have really been hitting the nail on the head the last couple weeks – start with Dave Lindorff, who explains that the collapse in house prices in the US has destroyed the equity that consumers were able to borrow against. In effect, much of the economic activity in the US in the last decade was spending done with borrowed money – money borrowed against houses on the understanding that the price rises would stick, and money borrowed on credit cards on the understanding that jobs could be used to pay off the balance down the road. Now that jobs are being shed indiscriminately, and the real estate market is shelled, how can real spending-driven economic activity recover?
Where is the consumer spending supposed to come from that used to represent a whopping 70% of economic activity in a United States that long ago stopped making things? The answer is: nowhere.
Lindorff also refers to the fact that consumers simply could not borrow if they wanted to – the banks are not lending. Do they know something they don’t want to tell us? Lindorff again (my bold):
That’s why card companies like American Express and many Visa and MasterCard issuers, instead of just charging a late charge when card-holders miss a monthly payment deadline as in the past, are now just jacking up the interest rate they charge, --in American Express’s case to 28% or over 2% a month! That’s not the action of a bank that is expecting to get repaid by a valued customer—it’s the extortionate action of a usurer that wants to extract as much money as possible from a borrower that it expects to have go bust.
The ever reliable Mike Whitney also talks eloquently about the Federal Reserve in the US pumping money in to banks with the full knowledge that this will likely result in stock market speculation, driving the recent rally in the States. This means that the run up in the stockmarket stateside is not based on any fundamentals (employment, housing market, spending by joe public) whatsoever, but is simply the government funnelling money to financial institutions knowing that it will likely end up in the stockmarket, inflating values against the fundamentals – a game that can have only one conclusion. To add to that, Whitney highlights another problem that has been bubbling under for some time now – that is the trouble that the US is starting to experience in getting foreign governments and central banks to participate in the auctions of US dollar bonds. This (auctioning off US government bonds) is how the US has been funding its astonishing national debt for some time now, but unfortunately it does require confidence on the part of foreign governments and investors that the dollar won’t collapse, rendering the bonds they have purchased near-worthless.

As the fundamentals of the US economy get in to worse and worse shape, the likelihood of a dollar collapse gets closer and closer. Foreign governments would prefer not to have a sudden dollar collapse – they (China particularly) have so much money tied up in the US that a sudden collapse would be catastrophic for them also, so there is an element of chicken and egg. However, while nobody wants to be the one to cause the panic and run for the exits first, people (similar to the end of a large sporting event) are starting to put their things in their pockets and silently slip on their coats, hoping that nobody notices and they can be out of the door before they get trampled in the stampede and lose everything. The day of reckoning comes ever closer.

Finally, Whitney talks here about the roots of the destruction of the US economy – something that should have resonance in every other economy with over-extended consumers, rising unemployment and a housing market crash (here’s looking at you Iceland, Ireland, the UK, Spain, Eastern Europe, who knows where else):
A careful reading of the FRBSF's Economic Letter shows why the economy will not bounce back. It's mathematically impossible. We've reached peak credit; consumers have to deleverage and patch their balance sheets. Household wealth has slipped $14 trillion since the crisis began. Home equity has dropped to 41 per cent (a new low) and joblessness is on the rise. By 2011, Deutsche Bank AG predicts that 48 per cent of all homeowners with a mortgage will be underwater. As the equity position of homeowners deteriorates, banks will further tighten credit and foreclosures will mushroom.
In other words, the borrow-to-spend game relied upon the public having confidence that they would have the money from a job to pay back the borrowings, and that they would remain in a position of strength to pay back their mortgage in a house rising in value. There is now no confidence, for many people there are no jobs, and for many there is nothing but a vast collapse in house prices.

It’s going to take a very long time for the public to start to pay off the debts that they have personally accumulated, and until that time, it seems unlikely that they will be willing to stimulate the economy by spending unnecessarily. The game is up.

On a related tip, there’s a slightly heavy but quite interesting article here by hotshot of the month Nassim Nicholas Taleb, exploring the limits of statistics as a tool and parts of life where statistics are used with disastrous results. It’s particularly interesting because he talks at length about banks using statistics methods to analyse risk, without really understanding the statistics or the risks.

Here’s his somewhat hilarious metaphor for a turkey using statistical methods incorrectly to analyse it’s own risk:
A Turkey is fed for a 1000 days—every days confirms to its statistical department that the human race cares about its welfare "with increased statistical significance".

On the 1001st day, the turkey has a surprise.
Which begs the question - if we are the turkeys, is day 1001 in our past - or is it still to come?


Anonymous said...

I agree with the overall tone of the article, with one exception. For the 5th straight month, US consumers have been deleveraging consumer debt and increasing their savings to record levels in response to current times. Revolving consumer debt has declined from $987b to $917b and will continue this trend imo.

divot said...

I hear you, and I don't subscribe to the "world coming to end" theories that many doom-merchants like to engage in, so some balance is needed! :)

[I will say that the overriding principle here is that nobody knows what is going to happen. What you can make are reasonable presumptions, based on overwhelming evidence and particularly using common sense with regards to the fundamentals. That's not to say that you can't make very feasible assumptions that are quickly proven completely wrong - these are vast, complex issues, and anything could happen at any time to change the script dramatically for better or worse. All I can say at the moment is that on balance of current evidence, my money would be on a long and protracted period of social and financial uglyness]

To take your example - if you're saying that the US consumer has cleared $70b of a $987b debt in 5 months, then what you are also saying is that if consumers maintain their current levels of debt clearance and savings, it will take at least 5 1/2 years to clear the debts that have been accumulated before there can possibly be any turnaround in spending patterns. That's if jobs and wages stabilise immediately at current levels to allow this debt deleveraging to continue, if interest levels stay at their history lows, if inflation doesn't happen in a significant way, if the economic situation does not deteriorate further, if the dollar does not suffer a run or a collapse, and if no other unforseen problems (a Taleb "black swan") come out of the blue to make things worse. This is before you start looking at the financial system itself and the problems it might still cause, and it's before you consider the negative equity issue and the restrictive effect it may have on people's spending patterns even if the other debt is cleared.

In other words even looking at the few encouraging elements in the crisis, you still have to factor in a huge number of "ifs" regarding a lot of things that are reasonably likely to go wrong, in order to see any way out of this in the remotely near future.

Add to this a generation that are going to grow up with their formative experience of the economy and money management being saving and debt payment, rather than spending - the effects of this crisis will be felt long after its immediate symptoms and effects have died down.