Accepting the New Yuan Reality?

It's hard to say what dynamic really going to take hold in China, but it looks like the bust is well underway. Inflation in that country is spiraling out of control even as money authorities 'ramp' up a fake inflation- fighting campaign. China raises interest rates by piddling amounts.

According to Bloomberg there is a yuan cash crunch taking place right now:

PBOC Extending Biggest Cash Crunch Since Lehman: China Credit

Borrowing costs for China’s banks will rise to the highest in more than two years in the first quarter as policy makers curb supplies of cash to fight inflation, according to a survey of bond analysts.

The seven-day repurchase rate, which measures interbank funding availability, may average 2.9 percent in the first quarter, compared with 2.75 percent in the previous three months, according to the median estimate in a Bloomberg survey of eight analysts. Both levels were the highest since the third quarter of 2008, when Lehman Brothers Holdings Inc.’s bankruptcy caused global credit markets to seize up.

Central bank Governor Zhou Xiaochuan’s tolerance of the funding shortage shows his determination to curb the fastest inflation in two years in a country where 150 million people live on less than $1 a day. The seven-day repo rate has doubled in the past year to 3.14 percent, as the one-week U.S. dollar Libor remained little changed at around 0.25 percent.

“The pool of liquidity is getting smaller, but corporate demand for funds hasn’t dropped as China is still an investment- driven economy,” said Sheng Nan, an analyst in Shanghai at UOB Kayhian Investment Co., a unit of Singapore’s United Overseas Bank Ltd. “That means higher borrowing costs for some companies, and for others there could be no funding available at all. That’s certainly not conducive to economic growth, but the government’s priority now is fighting inflation.”

The People’s Bank of China ordered lenders on Dec. 10 to set aside more deposits as reserves for a third time in five weeks. Governor Zhou pledged Dec. 31 to keep prices “basically stable” this year, after a second interest-rate increase in three months on Christmas Day. He said inflation pressures are rising, partly as a result of monetary easing in the U.S., according to an article posted on the website of the China Finance magazine on Jan. 4.

The issue is how much control Zhou Xiaochuan has over China's money supply along with whether he is willing to stare a systemic real estate- and accompanying debt deflation in the eye. Zhou is in a dangerous box. China needs inflation the same way Bernanke does. Without a constant flow of new money the structure of bad debts becomes a cascade of defaults.

Clamping down on inflation means crimping cash flows: this results in unserviceable debts and lenders falling insolvent. Credit destruction ruins borrowers who must find instantly scarce and increasingly valuable funds to repay loans. When they cannot, collateral is forfeited and capital annihilated in currency traps. Deflation rewards the cautious, who hold cash. Among the ruined by deflation are the elites who used their connections to massively overleverage themselves and cannot meet margin calls.

The costs of inflation are balanced against the cost of having to bail the banking system, or, not bailing it out and letting the excesses self- liquidate. The lesson Lehman's failure teaches is that the road that leads from economic growth and 'good times' to systemic collapse is very short.

At the same time, ramping hyperinflation ruins savers and liquidates investment capital while putting food prices out of the reach of the average Chinese citizen. Riots and worse follow when food is unavailable. Zhou is damned if the does and damned if he doesn't.

When countries are experiencing very high rates of inflation, one effect is an apparent 'shortage' of cash, which ultimately compels money authorities to add more and more to the money supply. Right now, industries are clamoring for cash. These companies will turn to loan sharks to gain the funds they need if the authorities cannot satisfy them.

Zhou's problem is that China's money supply does not flow entirely through banks but also through a gigantic, informal black market of local government entities, developers, overseas traders and lending pools. China is increasingly tolerant of this informal economy because it is 'backup liquidity' @ no questions asked and because this shadow economy provides 'services' for the elites. No black market will survive only to provide goods for the proletariat, there simply isn't enough margin.

Since these markets cannot create a money supply (Seigniorage) they trade whatever currencies can be had on any and all markets, which would includes the currencies found within the China banking sector. Buying dollars or euros from the back door is putatively illegal in China but certainly happens if the yuan 'offer' is high enough. This currency/yuan 'spread' is the inflation basis. Ironically, the increased demand for yuan also increases the yuan price for dollars and other currencies. It's the gross demand for a sufficient supply of money that matters.

At any given time, there may be proportionately more dollars or euros and less yuan circulating on the street but the total value of the money supply as a whole will tend to increase. This is because the opportunity is far greater to profit on the street trading money with fewer barriers to entry than exist in the official economy. As with all other currency regimes, funds in circulation will tend to remain in circulation with increasing velocity which becomes self- reinforcing. Since one currency or another is in greater demand relative to another there is always incentive to sell whatever is in hand for an instant gain or to avoid an instant loss.

Within this constellation of currencies a preference for one or another takes hold which enforces an unofficial exchange rate that is never favorable to the local currency which is of course created by seigniorage in ever- expanding amounts. This preference rate is added to the 'back door' rate or yuan cost of buying the preferred currency. The two costs added together become the real rate of inflation which can be many times more than the official rate.

Like the OECD's 'shadow banking' little is sure about the size of the Chinese currency black market. Increasing inflation @ the 'Trans-China scale' indicates it is massive and will be extraordinarily hard to throttle. Entire Chinese cities have sprung up empty: how much of this is the product of 'informal finance' run amok?

Arbitrage opportunities expand along with inflation which changes the relative values of 'official' and 'street' monies: interbank lending rates are creeping upward as the black markets seek cash regardless of the cost. Unlike rocketing LIBOR rates during the '08 credit squeeze which was the result of liquidity collapse in the dollar- denominated shadow banking system, China's rise is caused by a voracious black market demand for currency. The central bank must bid against the yuan black market for dollars. At the same time, it must add yuan so as to compete with China's savers as liquidity providers.


We simply have the dude @ the Fed with the nose ring and Metallica tattoo sitting in a cubicle next to the loading dock who punches a few trillion into existence on his laptop between tokes.


Renting the cheaper 'official' funds to sell short to loan shark operations causes the cash drought at the bank level. You can read between the lines.

China is allowing companies to hold dollars. This is from a Chinese news source Caing. Where are the dollars held, again?:

China Allows Exporters to Keep Foreign Earnings Overseas

The new measure signals loosening controls on foreign exchange

China said December 31 that exporters will be allowed to keep their foreign revenues overseas from January 1, in a move to expand a trial program effective since October 1.

The new measure signals loosening controls on foreign exchange and will help slow down the growing pace of China's already massive foreign exchange reserves.

Under the new rule, it is up to qualified Chinese exporters to decide how long they park their revenues in foreign currencies in a foreign country and when to transfer the funds to China, according to the State Administration of Foreign Exchange.

In the past, exporters were required to convert their revenues in foreign currencies into Chinese yuan with commercial banks. Commercial banks in China sell the foreign currency to the central government. The People's Bank of China has been forced to increase the monetary base in order to purchase foreign currency from commercial banks, which has increased the liquidity of the yuan in China.

Oops! it seems the black market cat is already out of the bag! By making this announcement, the money authorities are accepting a fact on the ground, that exporters are already holding dollars. The next step is for the Chinese to 'allow' dollars to circulate freely on the streets. The fact of the announcement itself reflects the new reality.

Of course, there is nothing authorities can do to keep the companies from putting their dollars into informal circulation within China if, as the articles suggest, exporters are reluctant to swap them at low 'official' rates for yuan. Chinese businesses appear to be already spurning the bank- level dollar- exchange and getting better yuan rates by peddling dollars in the black market. The higher the 'street' rate of exchange, the more yuan escape from savings and flow toward the loan sharks.

The more savings that escape into circulation, the higher the rate of hyperinflation.

This is why the Chinese money authorities are quietly adding to the supply of yuan. They do this while keeping rate rises very small and pimping 'inflation fighting' noise on television. This also takes F/X pressure off the yuan, which would otherwise fall in value against the dollar. How would it do otherwise? America's yuan complaints are far away. The exchange of dollars/yuan that matters takes place on the sidewalk next to the Forbidden City. China can only offer more yuan for dollars at the banks to attract dollars away from the loan sharks.

Again, the central bank is in a box. If they could somehow push the yuan's value upward, dollar- investments already made in China @ the lower rate would be claimed in more valuable yuan. This would represent a value loss to China and a gain for 'evil' dollar speculators. Avoiding this outcome was the reason for the dollar/yuan peg and increase in dollar surplus in the first place.

Conventional macroeconomics insists the yuan appreciate because of the current account surplus held by the Chinese in debtor countries' currencies. The informal currency arbitrage within the Chinese local economy is pulling in the opposite direction. Rather than a cheap yuan stimulating Chinese exports, the Chinese cost advantage has allowed a cheap yuan. Now that costs are rising the cheap yuan advantage has morphed into hyperinflation. This in turn has created a vicious cycle where the informal dollar/yuan arbitrage is driving the yuan lower which next puts more and more yuan into circulation which sets off successive rounds of arbitrage. Each of these takes different forms such as food price hikes, wage hikes and changes in F/X policy.

That these forms have manifested themselves indicates the arbitrage is taking place. No other indicators are necessary.

Meanwhile, China also faces the dilemma of using dollars, euros and yen to buy petroleum and other commodities. China does not trade its currency freely. America can 'manufacture' dollars at the cost of a few pennies. America essentially pays for petroleum with 'nothing in particular'. China's fuel inputs are paid for with real output that has been shipped 'paid for': in other words goods that have been made out of real materials and labor then traded to America, also for ... 'nothing in particular'! The US's dollars have more worth to China as they have been earned with work than the same dollars are worth to America. We simply have the dude @ the Fed with the nose ring and Metallica tattoo sitting in a cubicle next to the loading dock who punches a few trillion into existence on his laptop between tokes.

The term 'lending into existence' does not do the process justice; 'peeing dollars into existence' makes more sense.

China buys oil with dollars and sells the oil and products within the country for yuan. These are presumably earned with sweaty brows. Buying @ increasing volumes pushes up the input cost in dollars. The dollars must be 'bought' with yuan/labor in the first place. Then the yuan spent by fuel users must be 'bought' with labor and more yuan. The yuan themselves are priced by yuan/currency arbitrage on the streets in the Chinese black market. The foreign exchange costs are paid thrice by China in yuan. As she buys more fuel overseas -- including coal -- with foreign exchange the yuan costs multiply at every point of the transactions.

The foreign exchange costs of the dollars spent of fuel are added to the yuan value of wages and to the foreign exchange costs of yuan again in China. Add bid- offer spreads at every level and it is easy to see how fuel and other commodity consumption rapidly amplifies hyperinflation.

Pundits suggest that China and other developing countries can afford to pay higher dollar costs for fuel. This does not take into account the internal costs associated with F/X and black market pricing of currencies used to pay for the fuel.

Keep in mind that any dollar devaluation for whatever reason also adds to China's F/X costs in yuan. Any fuel subsidies are also strictly zero- sum; given to one sector and taken from another.

Inflation is a wage- price spiral. Increased costs without increased wages to pay them is simply bankruptcy deferred. Wages are increasing dramatically in China: sez Financial Times:

Beijing city to raise minimum wage 21%

Jamil Anderlini and Rahul Jacob

Beijing city is to raise its minimum wage 21 per cent next year, the second such rise in barely six months, amid rising inflationary pressure and growing concern over China’s widening wealth gap.

The increase, which will come into effect on New Year's day, raises the statutory minimum monthly wage in the Chinese capital to Rmb1,160 ($175) and the hourly rate to Rmb6.7. It follows a 20 per cent rise in June.

China cash purchases are effecting markets as seen from these chartz by estimable TFC Charts. Here's the NYMEX front month crude:

Here's the July contract:

Nymex crude is back into contango with open interest starting to increase in distant contracts.

Here's the COMEX gold contracts for Feb, 2011:

Here's the December contract:

Gold has also slipped back into contango which means less intense demand for gold -- and crude -- in hand.

My personal opinion is that China will continue with more stimulus and ignore inflation while it engages in an inflation- fighting PR campaign. China's elites -- which own the Chinese government and Communist party -- need hyperinflation so that they may repay massive (gambling) debts with worthless yuan.

What about an anti- deflationary bailout of private interests as was attempted in the US?

The bailout which started in 2008 is the reason for the hyperinflation in the first place. That bolt is shot.

The danger is that China will find herself unable to control hyperinflation with any interest rate tools. The endgame from this vantage point is a completely dollarized Chinese economy, like Zimbabwe's or Ecuador's. Should China shift to a gold standard, the most likely outcome would be trading inflationary collapse for massive deflationary contraction with one crisis following hard on the heels of the other.

China embodies steve's 'First Law of Economics': that the costs of managing any surplus increase along with the surplus until the costs are greater than the value of the thing itself. Here, the cost of managing China's F/X surplus is hyperinflation that destroys the Chinese economy. What China MUST do is cut the dollar/euro surplus down to size and do so immediately.

Of course, doing so will make it more difficult for Chinese cash flow to service its yuan- denominated debts or to buy fuel. It may indeed be too late for China. Its bad choices are those given by the waste- based economic model it imported from the US. It can continue to accept hyperinflation or gamble with debt deflation ... or a combination of both.

Wow! Happy fricking new year ...

The Revenge of the Real Economy ...

Butterfly

Happy New Year everyone!

There is a lot of talk about inflation since energy costs have risen dramatically since early last summer, taking along prices for food and other goods. Whatever is for sale includes petroleum either in the manufacture, processing, packaging and transport. Basically all goods are forms of petroleum, all services require petroleum to enable them.

"They aren't making any more people with money!"

Rising prices of goods in and of themselves are not indicative of inflation which is a change in the value relationship between money and the business that money leverages. Valuable business means less valuable money: when money is given a 'negative' value by trade in the markets that is inflation. Business lends into existence what funds it needs to insure success. More money in circulation and more credit means a greater money supply and an equivalent decline in unit purchasing power. It also means an equivalent increase in debt. Both of these are benign which is what Fed Chairman Bernanke acknowledges when he proclaims his desire for a 'modest' 2% rate of inflation.

Only business expansion creates more credit/money in this way along with the benign inflation. Attempting to add more funds into bank reserves cannot increase business activity, neither can pitching horseshoes. Only the possibility of returns on time, skill and hard work can increase business activity. Because or in spite of Bernanke's efforts, the returns on increased reserves and added debt have vanished. High input prices make fuel- using enterprises unacceptably risky. This being so, what remains is finance and other Ponzi forms of outright gambling/speculation.

Finance as a consequence has found itself in grave difficulty. Finance cannot create value so it is an absolute dependency upon the real economy which is relied upon to produce useful, valuable goods and services. The productive economy fell alongside finance. Ironically, finance was rescued. What story can this tell other than to acknowledge that the real economy cannot produce any more and saving it is useless.

Too bad the Establishment cannot imagine a 'Plan B' economy that isn't machine/fuel dependent.

Sovereign bailouts of finance allocate resources away from the returns from work in exactly the same manner as do increasing fuel prices. The analog is government- sponsored 'War on Work' very much like the failed but destructive Wars on Drugs and Terror.

At some point debt increases to a point where it cannot be serviced by business cash flow. Debt then must either be repaid or liquidated. This process is integral to the business cycle. Instead of restructuring, the Establishment has been making an all- out effort to hold- harmless lenders while refusing to allow credit from being wiped out. It is doing this by replacing questionable private credit with the public version. Doing so does two things. One is to degrade sovereign credit is the one becomes the proxy of the other. Swapping bad private loans for 'better' public versions strip mines the sovereigns' creditworthiness which effects their ability to borrow cheaply. Not only is the endeavor futile, the effort cannot create the desired (hyper)inflation: credit destruction is irresistible. Even when the sovereign can keep up with credit destruction for a short period it commits itself to doing so endlessly. At some point the sovereign runs out of resources, its creditworthiness is dissolved. Debt becomes too great for the 'virtual cash flow' or monetization efforts of the central banks to service adequately. The failed establishment becomes irrelevant and useless. Debt destruction commences as before until debts fall to a level that is serviceable by the new (and far lower) cash flows of those businesses which remain. The cycle of money/credit expansion begins again.

Inflation is not to be confused with hyperinflation which is the purposeful expansion of the supply of money and credit into circulation by banking authorities. This effect is taking place right now in China where the authorities are bent on stealing what value remains to the country's bank depositors and working classes.

In both inflation and the hyper version price increases are accompanied by an increase in demand or in wages and worker earnings. Analysts in the US suggest many important goods such as food, medical care, education, staples and fuel are becoming more costly. They ignore declining wages and house prices. Wages enable workers to pay the high prices. Without wage increases or employment it is hard to see how any company raising prices will be able to stay in business.

This was the end of the real estate bubble; pundits said, "there are more people all the time and they aren't making any more land!"

"They aren't making any more people with money!" This has been the shortage since oil prices went barometric in 2004: nobody is making any more people with money. People cannot earn, they cannot find a place where such earning is possible It costs too much to pay workers and also pay for more expensive inputs at the same time. This is the point the 'high prices' people miss. High prices of primary goods are not inflationary. The allocation effect of the high prices is highly deflationary.

High prices force choices between one good at the expense of another. A company will buy fuel to transport imports from China rather than paying higher wages to local workers. Consequently, local demand erodes. Exporting jobs also exports customers. At some point the funds available to purchase goods vanishes and all the businesses fail. This is the dynamic of the early 1930's. Even low prices are to the unemployed and impoverished unaffordably high. High real prices -- either for goods or labor -- are simply a form of business suicide.

Right now petro prices are going bananas! How long before the rising prices gut the real economy? Will this effect the finance economy at all?

This is the weekly Brent Crude chart by TFC Charts:

Notice that the open interest currently is much less than during the 2008- 09 period of the Great Oil Price Spike. The institutional long index speculators are so far out of the oil markets. It is likely that China and other large customers are buying crude on the spot markets and avoiding futures altogether. The futures markets follow the spot markets since those 'paper' markets must discount risk.

The same thing is taking place in the precious metals markets. A premium is paid to take the good rather than wait so the future price is discounted as a consequence. This is self- reinforcing. Demand for physical either crude or metals is intense. At the same time it is very hard to obtain physical by purchasing the forward contracts and standing for delivery. Rising prices create an incentive to hoard. Commodities are held off markets which creates uncertainty. The markets are becoming untrustworthy as a consequence. This in turn puts more purchasers into the spot markets driving the price higher. This is the reverse of what happened in the fall of '07 and the spring of '08 where funds were piling into futures contracts some eight years out. Longs are biting the bullet and paying the spot premium knowing that the 'cheaper' futures contracts provide less of a guarantee of obtaining delivery.

How the exchanges expect to deal with this situation is hard to say but at some point they will suspend delivery altogether. The markets are completely distorted, both by purchaser preference and risk but also blatant manipulation. Only incompetents insist that the markets reflect a top- line improvement in the real economy.

The prices of commodities will rocket upward along with prices for stocks and many currencies. This is all part of the Planet Bernanke strategy to devalue the dollar and make the US economy 'competitive' in a more or less traditional, Keynesian sort of way. I acknowledge Mr Bernanke's brilliance but his efforts are self- defeating.

Americans are saturated with debt. Customers are unwilling or unable to borrow any more. Only the government is borrowing while standing in the place of private borrowers. Since the government cannot create wealth or value, it can only recycle funds that already exist and shift them from one place or custody to another. Fiscal policy is a shell game. It only works if people suspend disbelief. Traders are cynically doing so on this day but for how much longer?

Being debt saturated means large 'spending' produces diminished or negative returns. Trillion$ have been borrowed and spent to what end? To support + 16% unemployment and a piddling 2% increase in US GDP. Pumping in more trillion$ will likely to have even less effect.

As for creating hyperinflation in the US, this is practically impossible. The idea is to repay lenders with funds that are worth much less than the original amount borrowed.

Most US debt is of short duration or indexed to inflation. Short duration debt must be refinanced repeatedly as it matures. In the face of inflation lenders command higher yields which defeats the hyperinflation tactic. Indexing of yields has the same effect: the loan has a mechanism that adjusts the rate of interest to reflect higher inflation. In debt markets with short durations or 'interest indexes' there is no shortcut to keeping yields from adjusting themselves to protect lenders' capital.

At some point the rising yields become too expensive for the borrower to support: debt deflation follows.

Currency devaluation cannot work when Americans consume more fuel per capita than all the other countries' citizens. Any dollar gains in output resulting from currency devaluation are more than canceled out by increases in the fuel price 'tax' paid to oil companies and OPEC. Instead of increasing competitiveness, the price rise puts the oil- soaked US economy in a bear trap.

$95 crude is a real problem hitman for an economy that is structured around $20 crude. To pay the fuel bill other goods and services are stiffed. Since 2004 this stiffing process has wreaked havoc on the US and Eurozone economies, this ruin has trickled up toward finance. Since 2004 the $30 fuel- dependent cohort has been eliminated as prices have risen, as prices rise further the businesses that can afford moderately high crude prices are pushed to the edge of the cost abyss.

Fuel price rises are squeezing a balloon: clench on one end and the balloon expands elsewhere. High fuel prices make servicing municipalities more expensive. Unlike private companies, states, counties and 'metro areas' cannot ship fire- fighting or police jobs to low- wage countries like Vietnam. High wages, high benefits and leaping fuel/goods' costs are becoming ruinous to the municipalities. Just as these were to US businesses before China bailed them out and took all those unaffordable US manufacturing jobs.

Meanwhile, the urge to buy and drive more cars becomes the epitaph for our expiring gestalt. Our policy makers do not have the inner resources to confront the failure of our personal transportation 'choices'. This looks to be a fatal error as auto and other industrial uses of petroleum drive prices higher, bankrupt more individuals and businesses and make a general oil- driven economic crash more likely.

Somehow high oil prices and high energy company profits are painted in the business media as an unadulterated good thing: sez Bloomberg:

Stocks Rally, Treasuries Tumble on Economic Outlook

Stephen Kirkland and Nikolaj Gammeltoft


Stocks rallied, sending the Standard & Poor’s 500 Index to its best gain in a month, and oil rose as growth in U.S. and European manufacturing bolstered speculation the economic recovery will strengthen. Treasuries slid.

The S&P 500 increased 1.4 percent to 1,274.62 at 11:22 a.m. in New York and the Stoxx Europe 600 Index gained 0.7 percent for its largest advance since Dec. 21. Oil rose to a 27-month high, copper reached a record near $4.50 a pound and silver topped $31 an ounce. The 10-year Treasury note fell, sending the yield seven basis points higher. Markets in London, Shanghai, Tokyo and Sydney were closed for holidays.

All 10 industry groups in the S&P 500 advanced today after U.S. manufacturing expanded at the fastest pace in seven months in December, while data later this week is forecast to indicate growth in services and employment. European manufacturing expanded more than initially estimated in December, London-based Markit Economics said.

“It’s a happy start for the market to the new year,” said Tom Mangan, who helps oversee $2.4 billion as a money manager at James Investment Research Inc. in Xenia, Ohio. “The stronger manufacturing numbers complete the pattern from the end of last year with strong economic data, reflecting greater confidence in the economy.”

Obviously the finance economy is doing just fine, to hell with the real economy. So far, the Federal Reserve has been successful inflating assets with moral hazard and the dollar carry trade. How long can this game be kept up?

The money managers must know that higher oil prices will soon effect demand. This is basic business, 101.

Meanwhile, squeezing the balloon causes distortion in the housing markets which are beginning to resume their long decline.

Real estate during the bubble years was bizarre in many ways. As 'homebuilders' excreted millions more ugly boxes @ ever higher prices the demand became insatiable. Were houses 'Giffen goods'? These are items that are more sought after even as the prices rise, defying the laws of supply and demand. How about precious metals, now?

Is crude oil a Giffen good? At what price level do the high- priced versions become ordinary good? Seems that a lot of what is taking place in the greater world orbits around opportunity costs and time factors, both of which are fuel/machine doppelgangers. The outcome is a crisis of valuation: what is anything worth if there isn't enough fuel to run things?

Conventional analysis obscures the real picture. There are few words about the energy/infrastructure imbalances that 'back' our currencies/debt loads and stands as collateral for everything including our 'money'. Our consumption infrastructure which includes housing, shopping, transport and support and 'moderne' agriculture is unprofitable with higher priced fuels. No profits = no economy. Inputs are too pricey to allow profits.

This is our crisis in seven words.

We cling to the fuels and jettison everything else: jobs, benefits, senior care, police and other civic services, rational government, and much of our national character. This process is taking place in other countries as well ...

What is 'preserved' is the cartoon version of modernity with 'just in time' convenience at a cost that strip mines everything else.

It would be nice to see this aspect of our 'policy' appear in the public discussion along side banker care and debt remediation. In fact, economic circumstances will deteriorate until stringent energy conservation becomes the center of the public policy.

It's that or conservation will be imposed by events which is what is taking place right now. We must start taking steps to ready ourselves for the new world that is coming for us whether we are prepared for it or not.

Oops ...

Sorry about the slow- no posting gang. I have really been laid up and pretty much unable to think more than ten sentences at a time.

Hopefully some good stuff next week!

steve

Predictions and More Predictions ...

The smart analysts refuse to make predictions which is the strategy Economic Undertow will follow. I will instead focus on what is happening in the present that the rest are ignoring.

For those who are prediction- deprived, the following is a smörgåsbord of 'Brand X' predictions from other analysts.

Phil's Stock World looks for a crash that may or may not happen, he's predicting, not me:

We are still trying to stay on top of things with our $10K to $50K Portfolio but we are stuck dead at $26,000 (virtual net) with 4 bearish positions remaining open. Our deadline for $50K was Jan 21st and it’s not looking good at the moment as this market simply goes up and up every day but I still have the nagging feeling that, the minute we capitulate, we’ll miss a beeline to $50K so it looks like we’ll stick it out over the weekend, although it’s only Tuesday so it may be too early to put on a brave face on bearish bets that clearly are not working at the moment.

It does seem to me that what’s going on with copper is a microcosm for what’s going on in the markets. The trading is very thin, the Chinese markets are selling off with the Shanghai down another 1.7% this morning and the Hang Seng off 1% as well. Nonetheless, with London closed and no real price check on the market, copper shot up a nickel to touch $4.31 overnight as the Dollar was knocked down from 80.7 to 78.9 – which used to be considered a major move in a currency but is now considered "Tuesday morning." It is truly amazing what you can get used to…

Somali Pirates (aka "Rent-A-Rebel") have seized an fuel tanker, also aiming to drive up oil prices during a thinly traded week (are you seeing a theme here?). Already the return of $3 gas prices has knocked 20% off the value of used SUVs in just one month, but I sure don’t feel sorry for the people who still have them – I was dumbfounded at how many SUVs were selling this year as truly my 6 month-old niece has more of an attention span than the American consumer, who can be burned over and over and over again by the same bad decisions, it seems. "It’s a challenge," says Adam Lee, president of the family-run Lee Auto Malls dealerships in Maine. "How do you tell a good customer, ‘You paid $32,000, and now it’s only worth $17,000?’" ROFL!!!

Indeed. Here is Doug Kass via Minyanville:

1. In line with consensus, the domestic economy experiences a strong first half, but several factors conspire to produce a weakening second half, which jeopardizes corporate profit growth forecasts.

2. Partisan politics cuts into business and consumer confidence and economic growth in the last half of 2011.

3. Rising commodities prices becomes the single greatest concern for the US stock market and economy. Scarcity of water boosts agricultural prices and causes a military confrontation between China and India. The continued effect of global warming, the resumption of swifter worldwide economic growth in 2011, normal population increases and an accelerated industrialization in emerging markets (and the associated water contamination and pollution that follows) contribute importantly to more droughts and the growing scarcity of water, forcing a continued and almost geometric rise in the price of agricultural commodities (which becomes one of the most important economic and stock market themes in 2011). Increased scarcity of water and higher agricultural commodity prices (corn, wheat, beans, etc) not only have broad economic consequences, but they become a destabilizing factor and serve as the basis for a developing powder keg in the relations between China and India.

4. The (stock) market moves sideways during 2011.

While the general consensus forecast is for a rise of about 10% to 15% for the S&P 500 in 2011, the index ends up exactly where it closes the year in 2010. A flat year is a fairly rare occurrence. Since 1900, there have only been six times when the averages recorded a year-over-year price change of less than 3% (plus or minus); 2011 will mark the seventh time.
5. Food and restaurant companies are among the worst performers in the S&P 500. (This surprise is an extension of surprise No. 3.) Several well-known multinational food companies and a host of domestic restaurant chains face margin and earnings pressures as they are unable to pass the violent rise in agricultural costs on to the consumer.

6. The shares of asset managers suffer. I expect a series of populist initiatives by the current administration beginning by a frontal assault on mutual fund 12b-1 fees.

7. Vice President Joe Biden and Secretary of State Hillary Clinton switch jobs by midyear 2011, 18 months before the 2012 Presidential election.


8. Speaker of the House John Boehner is replaced by Congressman Paul Ryan during the summer. A tearful Boehner proves too dogmatic.

9. A new political party emerges. Screwflation becomes a theme that has broadening economic social and political implications. Similar to its first cousin stagflation, screwflation is an expression of a period of slow and uneven economic growth, but, in addition, it holds the existence of inflationary consequences that have an outsized impact on a specific group.

10. The price of gold plummets by more than $250 an ounce in a four-week period in 2011 and is among the worst asset classes of the new year. The commodity experiences wild volatility in price (on five to 10 occasions, the price has a daily price change of at least $75), briefly trading under $1,050 an ounce during the year and ending the year between $1,100 and $1,200 an ounce.

11. Among the most notable takeover deals in 2011, Microsoft launches a tender offer for Yahoo at $21.50 a share. With the company in play, News Corporation (NWS) follows with a competing and higher bid. The private equity community joins the fray. Microsoft (MSFT) ultimately prevails and pays $24 a share for Yahoo (YHOO).

12. The Internet becomes the tactical nuke of the digital age. Cybercrime likely explodes exponentially as the Web is invaded by hackers. A specific target next year will be the NYSE, and I predict an attack that causes a week-long hiatus in trading and an abrupt slowdown in domestic business activity.

13. The SEC's insider trading case expands dramatically, reaching much further into the canyons of some of the largest hedge funds and mutual funds, and to several West Coast-based technology companies.

14. There is a peaceful regime change in Iran.

15. China overplays it's economic hand by implementing multiple tightening and by its unwillingness to allow its currency to appreciate. The region's GDP climbs by only 5% in 2011.


Doug Kass writes daily for RealMoney Silver, a premium bundle service from TheStreet.com.

Meanwhile, not to forget Motley Fool's Morgan Housel who thinks things will go from pillar to post around these particular areas of interest:

1. Municipal bonds; States are facing a $180 billion fiscal hole in 2011, and an additional $120 billion in 2012, according to the Center on Budget and Policy Priorities. States and localities face a long-term pension deficit of between $1.2 trillion and $3 trillion, depending on what discount rates you use. Property taxes -- a main source of revenue for local governments -- are falling and will continue to fall as property values are reassessed and real estate prices sag.

2. Rising interest rates; As grisly as the past three years have been on housing and employment, they've occurred against a backdrop of record-low interest rates -- a spectacular boon that's blunted the blow.

3. Oil: It was simple math: Gasoline prices rose from $2.29 to $4.05 between early 2007 and mid-2008. The U.S. consumed about 210 billion gallons of the stuff during that period. That's a $370 billion added tax on consumers.

With oil prices now breaching $90 a barrel -- almost 30% higher than a year ago -- a similar headwind is gaining momentum.

Should oil break above $100 a barrel, you get a two-for-one sting: Consumers are whacked by higher gas prices, and $100 breaks the psychological threshold of proving this country's energy policy is abysmal at best.

4. Mad man at the helm; Fed chairman Ben Bernanke has made it clear: He will keep interest rates ungodly low until the economy is out of the woods.

... the Fed is strictly concerned with price inflation, not asset inflation. Price inflation is when the price of goods like food goes up. Asset inflation is when there's a stock bubble. With the focus on the price of goods, assets can spin wildly out of control as the Fed looks the other way, insisting there's no inflation while bubbles form and inevitably burst. This is essentially what happened last decade with the housing bubble. Many think it's a story we're replaying line for line today.

5. Valuations; When the Fed prints money with abandon, there's a good chance the valuation of every financial asset will go nuts. Stocks. Bonds. Gold. Houses. Used cars. Everything gets distorted and becomes subject to bubblehood.

On one end, you have investors plowing into bonds, happy to buy the debt of governments, municipalities, and companies for returns that often round to zero. These investors won't be happy with the outcome. Just wait. At the other end, my colleague Alex Dumortier recently showed a few examples of irrational exuberance creeping back into the stock market, including what he found were high historical valuations, smart investors heading to the sidelines, and good ol' complacency.

The iron rule of investing is that there's a perfect negative correlation between returns and excitement. And there's a lot of excitement in almost every asset class these days.

Matthew Lynn @ Bloomberg:

No. 1. The bull market returns. Actually we’ve already been in a bull market for more than a year. Just take a look at the figures. But in the early stages of a rising equity cycle, no one says it’s a bull market. First they call it a dead-cat bounce. Then they call it a bear-market rally. By the end of 2011, the penny will have dropped. We’ll be officially back in bull territory.

No. 2. The alternative-investment industry crashes. The main driver of hedge funds and private-equity funds was the search for yield. With stock markets in the doldrums, interest rates cut to almost nothing, and bond yields at record lows, investors were desperate for any kind of meaningful return on their money. They were willing to listen to slick hedge-fund managers who promised to make 30 percent a year on high velocity yak-hide arbitrage. Next year, interest rates will be rising, and so will bond yield and equity returns.

No. 3. Venture capital returns. The start-up industry took a terrible beating from the dot-com crash. But as a rough rule, a decade is long enough for the financial markets to forget everything. .

No. 4. France gets smoked out in the euro crisis. Somehow France has managed to get itself grouped along with Germany as one of the strong euro nations. But it runs a bigger budget deficit than Italy. It has chronic unemployment and little growth. Crucially, it has the greatest resistance to reform.

No. 5. The Apple Inc. backlash starts. We used to think International Business Machines Corp. was sort of sinister. Then it was Microsoft Corp. But which business today has far too much power, is run by control freaks and puts profits before principles? That’s right. The world’s third-biggest company, measured by market value, is about to discover that the line between cool upstart and ugly monopolist is a very thin one.

No. 6. The German model is back in fashion. The words German and fashion go together about as well as Greece and solvent. But in a world trying to figure out how you get out of a debt crisis, the Rhineland model of capitalism is suddenly going to seem very appealing. Lots of mid-size companies, with huge technical expertise, low debt and skilled workforces exporting niche products to the whole world -- that sounds like a pretty good formula for success in the 2010s.

No. 7. Lloyds Banking Group Plc gets broken up.

No. 8. Iceland teaches the world a lesson. Two years ago, every government in the world bought into the idea that you had to bail out your banks. If they collapsed, you would go straight back to the Stone Age. One country defied the consensus. Iceland couldn’t afford to keep its banks going. What happened? There’s been pain, sure, but from next year on the economy should be growing again, inflation is under control and interest rates are coming down. If Iceland keeps recovering, only one conclusion is possible: You don’t need to bail out banks after all.

No. 9. Russia puts the R back in BRIC. We’ve heard a lot about the rising economic power of Brazil, India and China. A lot less has been heard about the R in the BRICs - - Russia. It tends to get dismissed as a raw materials supplier with an authoritarian government. But it’s trying to recreate itself as a technology powerhouse -- look at the plans to create a new Silicon Valley in the Moscow suburb of Skolkovo. Crazy? Remember, this was the first country to put a man into space.

No. 10. A backlash against Christmas e-cards.

(Matthew Lynn is a Bloomberg News columnist and the author of “Bust,” a book on the Greek debt crisis. The opinions expressed are his own.)

Estimable Dave Rosenberg opines by way of Automatic Earth:

1. In Barron’s look-ahead piece, not one strategist sees the prospect for a market decline. This is called group-think. Moreover, the percentage of brokerage house analysts and economists to raise their 2011 GDP forecasts has risen substantially. Out of 49 economists surveyed, 35 say the U.S. economy will outperform the already upwardly revised GDP forecasts, only 14 say we will underperform. This is capitulation of historical proportions.

2. The weekly fund flow data from the ICI showed not only massive outflows, but in aggregate, retail investors withdrew a RECORD net $8.6 billion from bond funds during the week ended December 15 (on top of the $1.7 billion of outflows in the prior week).

3. Investors Intelligence now shows the bull share heading up to 58.8% from 55.8% a week ago, and the bear share is up to 20.6% from 20.5%. So bullish sentiment has now reached a new high for the year and is now the highest since 2007 ? just ahead of the market slide.

4. It may pay to have a look at Dow 1929-1949 analog lined up with January 2000. We are getting very close to the May 1940 sell-off when Germany invaded France.

5. What about the S&P 500 dividend yield, and this comes courtesy of an old pal from Merrill Lynch who is currently an investment advisor. Over the course of 2010, numerous analysts were saying that people must own stocks because the dividend yields will be more than that of the 10-year Treasury. But alas, here we are today with the S&P 500 dividend yield at 2% and the 10-year T-note yield at 3.3%.

6. The equity market in gold terms has been plummeting for about a decade and will continue to do so. When measured in Federal Reserve Notes, the Dow has done great.

7. As Bob Farrell is clearly indicating in his work, momentum and market breadth have been lacking. The number of stocks in the S&P 500 that are making 52-week highs is declining even though the index continues to make new 52-week highs.

8. Stocks are overvalued at the present levels. For December, the Shiller P/E ratio says stocks are now trading at a whopping 22.7 times earnings! .

9. The potential for a significant down-leg in home prices is being underestimated. The unsold existing inventory is still 80% above the historical norm, at 3.7 million. And that does not include the ‘shadow’ foreclosed inventory. According to some superb research conducted by the Dallas Fed, completing the mean-reversion process would entail a further 23% decline in real home prices from here.

10. Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities.

The estimable Bruce Krasting sticks his neck waaaaaaaaay out there and avoids predictions while writing an alternative narrative:

Oh boy is 2011 going to be an exciting year! Some things that I think might happen:

-Volatility is going up across the board. If you have the stomach for the swings that are coming across all markets there is a ton of money to be made; balls and timing are all that are necessary. The markets will create dozens of opportunities to make and lose.

-There will be 50 days with a swing in the S&P greater than 1%. There will be 10 days where gold swings $50. There will be two days with a drop greater than 100 bucks. Most of the big moves will be down moves. Bonds will not be spared the volatility.

-Gold will be higher a year from now but off its peak. At some time in the fall, gold will be near 1,800 and the New York Times will do a front-page story that gold is on its way to 2,000. That will be the high point of the year.

-Copper will continue to rise. This metal will benefit as the poor man’s gold. Why buy an ounce of something for $1,600 when you can have a whole pound of something else for only $5?

-The US bond market is in for a heck of a year. The 30-year will trade at BOTH 3% and 5%. Higher rates will come early in the year, then the deflation trade will come back into vogue.

-Spain will be the next sovereign debtor that falls prey to the market. This will happen before the end of the 1st Q. The package to bail them out will exceed $500b. This will exhaust the EU resources.

-The IMF will contribute $125b to the Spanish bailout. The US portion of this will be $25b. Republican Senators and Congressman go nuts. The American people will side with them.

-The ECB will be forced to issue bonds that are joint and several debt of the EU members. This development will stabilize the EU temporarily, but it will be hated in Germany. The amount of the new issuance of these bonds will be small. The program will be terminated in 2012.

-The dollar versus the Euro will be all over the lot. The low for EURUSD will be ~1.17. The really big surprise is that toward the end of the year the Euro will be pushing 1.50.

-The CHF (Swiss franc) will be like copper. It will attract investors as there is no good alternative. Before June EURCHF will trade below 90.

-The market will finally wake up to the fact that the YEN is not a good store of wealth. The continuing argument will be, “Yeah the Yen stinks, but everything is worse so it should be okay”. Wrong. The Yen is a short.

-The US will have a full year deficit of 1.4 trillion dollars. This depressing reality will hang on the US economy/markets.

-QE2 will be the last QE we see. The program will end (on schedule) on 6/30. Perversely, long-term interest rates will rise as long as QE continues. When the program is finished rates will begin a rapid decline. .

-The high for the S&P will occur before June. The S&P will fall short of 1,500. The low will be 1,100.

-Oil will rise to $130 in the next six months. It will be above $100 at the end of the year.

-China’s inflation rate will continue to rise. Food will be the primary driver. The central government will respond with monetary tightening and an acceleration of the Yuan appreciation. It will not work. Inflation will push 7%.

-Brazil will continue to shine as a resource rich country that runs a trade surplus and has low budget deficits. The surprise of the year will be Argentina. Food will be the reason.

-The US will wind down its presence in Iraq. With every step we take out the door domestic violence will rise. Iran will assume a larger roll in the south (Basra). This will not go over well with the US.

-Kim Jong-Il will die. His son will take over. The heir is a nut, there will be more military exercises that results in shells landing on S. Korea soil. China will make public statements that it is trying to bring order; behind the scenes they will be applauding the chaos.

-Obama’s popularity will continue to fall. The legislative “successes” at the end of 2010 will convert to a series of failures. There will be no new stimulus. Portions of the health care legislation will be dialed back.

-Obama will propose a means test for Social Security in his State of the Union Address. Retirees who are living the high-life (Warren Buffet types) are going to have their SS checks cut to the bone.

-The 2% reduction on worker contributions to Social Security will be extended and expanded to 3% for 2012. Rates will not go up in future years. Social Security will have to be gutted as a result.

-2011 will be a stock pickers market. Index investing will see a bad year. Some of the darlings of 2011 like AAPL and NFLX will not fare so well.

-There will be at least three more 'Flash Crashes'. The SEC will launch another investigation into how this could happen. The conclusion will be that ETF's and how dealers manage them are responsible for the liquidity problems in individual stock names. There is no solution to this problem. The market will be on edge looking for the next mini crash.

-Meredith Whitney will be proven wrong in her forecast that 50-100 munis go chapter 9 this year. The process to insolvency takes much longer than she has anticipated. Only 11 munis will make a chapter filing. The rest will be pushed to the brink in 2012.

-The center of attention will move away from California as the most bankrupt state. In his State of the State address in January, New York’s new Governor Andrew Cuomo will fess up to the fact that for the past year of so NY has been burying its problems.

-Unemployment will not go down. The average for the year will be above 10%. The number of workers who leave the system will rise to 20mm. These workers will find part-time jobs that pay cash. The new day-workers will compete will illegals for employment. Social tensions will be the result.

-The Chevy volt will not sell well. Boeing will be unable to complete a single Dreamliner. GM will trade below $30, Boeing will hit the low $50’s.

-The Singapore dollar will be the strongest currency on the globe in 2011.

-Apple will not come up with a new product this coming year. The rest of the consumer tech manufacturers will gain some market share.

-Headline inflation will rise a bit. It will push through 2%. Those numbers are meaningless.

-Much to my chagrin and surprise Tim Geithner will not be replaced as Treasury Secretary. He will continue to do a very mediocre job for us. He will be replaced in January of 2012.

-Comcast will complete the acquisition of NBC/CNBC. One of the first acts will be to fire Mark Haines. Nothing will help.

There will be violent weather episodes all over the globe. The La Nina condition that is now dominating global weather is the strongest in 50 years.

-Fannie and Freddie will be merged. Out of the ashes will come a good bank and a bad bank. The bad bank will hold 2.5 trillion of questionable mortgages.

-Washington's other mortgage lender FHA will run into troubles.

-There will not be a failure of a government bond auction. But the coverage for each issuance will grow smaller. China, Russia and Brazil will reduce their holdings of US reserves.

-Mortgage Gate will die as a headline story.

-The narco violence in Mexico will expand to many more cities. Tourism will be hurt as a result. Some of the violence will pass over our border. Anti immigration attitudes will expand. Because the low-end economy will remain in the dumpster the actual number of illegal aliens will decline by more than 1mm. This will add to the RE woes in some US areas. It will stress the countries that they originated from as $ remittances decline.

-Interest rates will be higher throughout the year for corporate bonds and Munis. This will bring a reversal of the mania to buy dividend stocks. Those who thought that this investment strategy would work for them will be disappointed.

-Jon Hilsenrath will write an article for the Wall Street Journal that is actually critical of the Fed. The unpopularity of the Fed will rise to such a level that Jon will have no choice but to follow suit.

-The Fed will come under attack from all sides. They are truly in a no-win situation. Unemployment will continue to rise while inflation rises and the dollar declines.

-ZIRP will be with us for yet another year. Bernanke will not let go of this loser policy.

-Social unrest will become visible in America in 2011. There will be demonstrations in many major cities. Some will turn violent.

Have a great year!!


Sez Nouriel Roubini:


The US:

Roubini Global Economics expects gross domestic economic growth of 2.7pc, down from its estimate of 2.8pc for this year. Inflation will remain muted at 1.4pc compared with 1.6pc for this year. The growth, a sharp contrast to the 2.4pc contraction of 2009, won't be enough to bring down unemployment, though. Roubini is forecasting it stays around 9.5pc. Even if the US economy could deliver growth of 4pc, it would still need half a decade of that to cut unemployment closer to 5pc, his firm reckons. Roubini is also not optimistic that there will be any agreement in Congress over the next two years on how to tackle the country's deficit. Unless bond investors force the issue, that will be a job for whoever wins the next presidential election, he says.

The Eurozone:

It's in the eurozone that the greatest risks to global growth lie, according to Roubini. What he characterises as a "muddle-through" approach is not sustainable and more countries will eventually have to restructure their debts, he reckons. Despite a forecast that the German economy will slow to growth of 2.2pc in 2011 from an estimated 3.5pc this year, the pressure will grow on Europe's largest economy to adopt a very stimulative fiscal policy to compensate for the weakness of many of its eurozone neighbours. Europe's second-tier of heavyweights - France and Italy - will grow just 1.3pc and 0.8pc respectively, according to Roubini.

Asia:

Tensions between the region and the US will remain over currency policy. Roubini doesn't expect any significant devaluation of the yuan by China. That, in turn, will encourage other Asian exporters, such as South Korea, to keep their currencies weak because no one wants to lose market share. Roubini expects Chinese gross domestic product to slow to 8.7pc next year from the 10pc he has pencilled in this year. At 8.8pc India's growth will almost match the 9pc enjoyed this year. However, all the major emerging economies face a tough battle against inflation as a combination of their own internal growth and the liquidity unleashed by the Federal Reserve's quantitative easing drives up prices.

Here's some tidbits from Jim Hansen of Ravenna Capital Management. You have to sign up for this:

More brave souls willing to predict the price of oil.

In an article last week titled “Chart Watchers See a Crude Reawakening” the Wall Street Journal had these brave calls on the price of oil for next year.

“Mr. Ross said he wouldn't be surprised to see $100 oil in 2011. The $103 level will face significant resistance, he said, because it represents a 61.8% Fibonnaci retracement from the 2008 peak to trough. Fibonacci followers note that until a market retraces more than 61.8% of the previous decline, it is still governed by that downtrend. But shooting higher than $103 would imply that oil has entered a new primary uptrend.

Other technicians are even more bullish. Mary Ann Bartels, technical research analyst at Bank of America Merrill Lynch, said in a note to clients earlier this week that crude oil could surge to $118 to $120 a barrel in 2011.” WSJ 2010-12-22

“Fibonacci followers…”? Sounds like a new religion and given how most people invest it probably is. The $118 to $120 a barrel range in 2011 is a little more gutsy call than $103/barrel.

If that $120 level is reached hold on to your investing hats because that is well above the 4-5% of GDP level that experts like Steven Kopits have said historically induces recessions.

Now you would think the former president of a major oil company would know better than to predict price but it appears not. “The former president of Shell Oil, John Hofmeister, says Americans could be paying $5 for a gallon of gasoline by 2012.” Since that would add another $2/gallon to the current price it would take approximately $750 million (3/4 of a billion) more out of the U.S. economy per day than the current $3/gallon average price. That can best be described as an anti stimulus program.

“The price of fuel is up 13.6% from last December and 76% higher from December 2008, according to a new study from the Oil Price Information Service.” The report also indicated that households in Montana and Mississippi will be paying more than 12% of income for gasoline in December. It is a long drive to the nearest Wal-Mart so that will hurt.

But even more important is that if gasoline does climb to $5/gallon diesel fuel (remember diesel sells at premium to gasoline), heating oil and importantly for the airline industry jet fuel will have also climbed to equivalent levels. The resulting economic pain will run much deeper than just the $750 million in additional gasoline costs. It will easily be a $1 billion per day tax on the U.S. economy and this is a tax increase neither the President nor Congress can repeal.

Send an email to: jim.hansen-at-kmsfinancial.com and put 'subscribe' on the subject line. You won't regret it!

This collection is from ASPO USA:

–Arthur Berman, petroleum geologist and board member of ASPO-USA predicts:

I believe that oil prices in the US will average $88-92 a barrel in 2011 but may climb toward $100 by the end of the year, while natural gas prices in the US will average $4.00-4.25 in 2011 but may climb toward $5.00 by the end of the year. I believe that much of the “shale gale” euphoria will begin to unravel in 2011 and there may be some important distress situations or even bankruptcies that will underscore the risk of these ventures. I suspect that the rush to “liquids-rich” gas plays in the US will be exposed as low-resource potential ventures rather than another Saudi Arabia of crude oil. I imagine that the miracle of Chinese growth will begin to show some weakness in 2011 as state-directed economics becomes unstable. The PBC has been artificially keeping inflation low by buying dollars and creating bonds to keep the money supply low. The loans for big infrastructure projects will not uniformly perform. This cannot last. True inflation is higher than revealed and, when it is known, will show the vulnerability of the economy because the rural sector is not sharing prosperity with the urban sector. Sovereign debt problems in Europe will continue to create instability in the global economy. The EU concept is flawed because a single currency does not allow weak economies to devalue their currency.

– Gail Tverberg, actuary and writer, is editor of The Oil Drum sez:

I expect 2011 will be a year of recession and increasing layoffs. It may start off reasonably well, but then an attempted price rise of oil to, say, $120 barrel, will prove to be too much for most economies. There will be countries and smaller political subdivisions (state, city) that take steps to restructure their debt with longer maturities. All of this will drive interest rates up, and make credit harder to find. The recession will worsen as credit contraction ensues. Governments will scramble to try to keep each other and banks from failing. In some cases they will be successful; in other cases they will not be.

– Lindsay Curren is editor of Transition Voice, the magazine covering peak oil, climate change, economic crisis and the Transition movement response. She sez:

The US will fail to produce a meaningful energy policy even as energy is increasingly understood by the people as a key input, the cost of which threatens to cripple family economies. As federal and political solutions fail further, the economy continues to limp along, with more and more folks out of work, causing severe local and state cutbacks and even state and municipal bankruptcies. And this gets to the crux of the cultural shift that I see. Increasingly unemployed people will hobble social services, exposing a culture in clear decline with no plan to address it. The federal government and centralized business will have less and less relevance. In response, the unemployed and underemployed “underclass” will either take re-localization to the next level, getting very creative and energized as they craft compelling and imaginative yet practical local solutions including bartering, more local currencies, more mass transit and carpooling usage, organic community building, more food production, and simpler local living. But the will has to be there even as we feel exhausted and unsure and resources are limited.

– Ilargi, The Automatic Earth (and Nicole Foss at a remove) say:

I’ll now venture to name 2011 The Year of the Stone that Grinds the Family Jewels. Well, either that, or, as my writing partner Stoneleigh phrases it: The Year of The Margin Call. We can extend and pretend only so long. We can hand over only so many years of the people’s future earnings to the banks. That is, before someone becomes suspicious of what we do. The realization that there is simply no way we can pay down our debts, whether we’re in Ireland, California or Japan, will dawn in 2011, no matter what stories are spun in capital cities and TV studios. It’s high time to get out of the way of the wave that’s-a-gonna-be-a-comin’, and no, timing the market is NOT the main concern, even as finance types would have you believe it is. It’s getting out of the way of the wave that should be your main concern.

– Charles A. Hall and David J. Murphy. Professor Hall is a systems ecologist at SUNY-ESF, an affiliate of Syracuse University. Murphy is a graduate student in environmental science and a contributor to The Oil Drum.

We predict (with relatively little certainty assigned to it) that there will continue to be (for a while) a mild economic recovery, which will increase the demand for oil, and thus require the increased use of higher-priced oil. This will eventually require that 10 percent or so of the US GDP will go to the price of energy, which, as in the past, will lead to an economic downturn which will lead, in time, into the same cycle again. While we are not sure of the details of timing or prices we think that Jean Laherrere’s and Colin Campbell’s concept of the “undulating plateau” will continue to describe the US (and European) economies for the forseeable future - at least until serious peak oil and declining EROI kicks in.

– Tom Whipple is editor of Peak Oil Review.

It looks to me as if the coal/power shortage in China is continuing to spread and will get much worse in the next two months. Beijing’s only possible short-term response is to import as much more energy in the form of oil, coal, and natural gas as they can, thus driving the oil prices above $100 a barrel in the next few months. The Wall Street consensus that China’s oil imports will fall to a 6 percent increase this year seems much too low when you factor in the need to grow at 8-10 percent, replenish stocks, build a strategic reserve, and cope with the growing coal shortage. The likelihood that we will see another 2008 type oil price spike in the next six months seems to be growing every day.

– Christine Patton is co-chair of Transition OKC and author of the Peak Oil Hausfrau Blog.

Not only have American social networks become sadly deteriorated, but so have the skills needed to support them: the fundamental ability to build and maintain the healthy long-term relationships that are critical for community success. Just like planting a garden or cooking from scratch, these skills have to be learned and practiced, and they have to work well in order for coalescing community groups to stay together rather than fall apart. In 2011, community facilitators will increase their focus on helping groups of people simply learn how to get along.

– Ron Swenson, ASPO-USA Board of Directors has this prediction:

Solar: Solar manufacturer shipments more than doubled from 2009 to 2010. I predict that world production of solar energy systems will double again this coming year. A quarter of the growth will come from PV (photovoltaics) and the balance of growth will come from large solar thermal electric projects being installed in the US southwest and other parts of the world. Oil: As a consequence of the drilling moratorium imposed by the Gulf of Mexico Deepwater Horizon disaster, the USA will experience oil shortages in 2011 or 2012. (A steady supply from the Gulf has been dependent on new wells filling in as production from older wells declines.) Thoughts of seeking satisfaction of market demand from sources more remote than the Gulf must take into account the longer trip time that would be required for oil tankers. Lacking excess capacity, the global tanker fleet is unlikely to be able to respond, even if other oil suppliers (Africa, Middle East) could be imagined to increase their production.

– Bart Anderson, teacher, journalist and technical writer, is co-editor of Energy Bulletin and active in Transition Palo Alto sez:

I’m looking at two things for 2011. 1) If the WikiLeaks phenomenon grows, we will see the release of documents that confirm what we have been saying about energy shortfalls, corporate domination of governments, and foreign policies aimed at control of resources. 2) There will be continued government cutbacks in pensions and social services in industrialized countries, such as the US, UK, Ireland, Spain and Greece. In France this year, millions demonstrated and went on strike. Popular protests such as these could change the political landscape.

– Richard Heinberg, author of The Party’s Over, Blackout and Peak Everything sez:

I hate making predictions. The world situation is so complex now with demand and supply factors going all directions short-term, so that even if we know the long-term trend (depletion and decline) it’s really hard to make a meaningful one-year forecast. Okay, so, that said, here’s a shot in the dark: Asia-Pacific coal prices will rise at least 20 percent from their current level during 2011.

– Estimable Jeffrey J. Brown, independent petroleum geologist sez:

No matter what specific years that one picks as the starting and ending points, the period from the late Nineties to the end of this decade was characterized by a double-digit average long-term rate of increase in average annual oil prices. For example, from 1998 to 2008 the average rate of increase in US spot crude oil prices was about 20 percent per year. However, what I find interesting is the progression in three year-over-year annual price declines in the 1997 to 2009 time period: down to $14 in 1998, down to $26 in 2001 and down to $62 in 2009. Note that each successive year-over-year price decline was to a level that was about twice the level reached during the prior decline. If this pattern holds, the next year-over-year price decline would bring us down to an average annual oil price of about $120, in the context of a long-term average double-digit rate of increase in annual oil prices, which is what we are seeing in 2010, versus 2009.

– Raymond De Young, associate professor of environmental psychology and planning, University of Michigan sez:

Rob Hopkins’s application of Alexander’s -A Pattern Language‖ to Transition Town initiatives will be accepted as a coherent way to organize and disseminate the emerging insights from the many small experiments being conducted. As an -open source‖ framework, this language will grow organically. Far-reaching ideas (e.g., sacredness as an essential and central feature of all community transitions, Brownlee, 7 Nov 2010), once tested and found true and useful, become new patterns for practitioners to consider for adoption in their community.

– John Michael Greer, author of The Long Descent and The Ecotechnic Future sez:

Washington DC, 15 December 2011: The blue-ribbon panel of economists tasked by the White House with finding the cause of this spring’s record-breaking spike in oil prices has just released its preliminary report. The panel, chaired by former Fed chairman Alan Greenspan, dismissed the suggestion that “peak oil” was responsible for the runup in prices, which briefly saw petroleum at $233 a barrel. The report states instead that speculation was to blame, and credited prompt action by the administration for the subsequent plunge in prices that brought prices back down to today’s price of $68 a barrel, a new low for the year. In other news, a White House spokesman angrily rejected claims that this summer’s stock market crash had anything to do with the price of oil, and insisted that it would have only a minor impact on the nation’s economy…

– Debbie Cook is president of the board of Post-Carbon Institute and former mayor of Huntington Beach, CA. sez:

When the witches of Delaware attempt to cast their spell on big-ag ethanol subsidies, the wizards of ADM will exorcise the Tea Party from energy politics. Put another way, corporate America will turn momma grizzlies into teddy bears.

– Sharon Astyk, ASPO-USA Board of Directors, author of Depletion and Abundance and Independence Days

There is every reason to believe that we will see a food-price run-up similar to the one in 2008 in the coming year, making absolutely clear exactly how tightly food and energy prices are intertwined. Although the number of the world’s malnourished briefly fell below 1 billion this year, the number will rise again above it.

– Tad Patzek, chair of the Department of Petroleum and Geosystems Engineering, The University of Texas at Austin sez:

To arrive at my most important predictions for 2011, I have attempted to be insanely optimistic and skip the usual peak-everything stuff. The Happy New Year of 2011 will see a thorough public discussion of what needs to be done to make the US a more resilient society and economy. The federal government and Congress will start working together on the development of a massive national electrified railroad system to transport goods and people. We will come off our high horse and stop hallucinating about building bullet-train tracks in a railroad system that is decidedly mid-twentieth century or earlier. Many cities across the US will embark on the crash investment in light rail and other alternatives to cars.

Subsidies for corn, soybean, wheat and rice will be repealed and replaced with a thoughtful program of developing a robust, distributed system to produce a wide variety of healthy whole foods for all. The administration and Congress will wake up to the fact that an unhealthy, obese and generally uneducated population will require an insanely expensive healthcare system that will fail if the root causes of poor health are not eliminated.

Our schools will hire science teachers who live the practice and theory of science, not merely the theory of teaching. Many families across the US will dump game stations, idiotic TV, and iPhones in exchange for conversations and books. Neighborhoods will again become centers of civic activity and common thinking. We will occasionally stop and talk to the homeless, instead of giving them a dollar or a dirty look. Economists will discover that the Earth is spherical and finite, not an infinite mathematical plane with infinitely substitutable resources. Those of us who have animals and children will pet both and smile. Republicans will occasionally talk to the rest of us, and we will respond with kindness.

Right!

What is happening under our noses is the emergence of the idea of 'resources' in an economic gestalt that has not felt a need to recognize it before. This itself has a cost that has not been budgeted that must be added to the cost emerging of the resources themselves. We now become 'hardware' rather than software people. This is an idea that doesn't currently exist in 21st century America with its scaffolds of entitlements. What is desired above all other things is a paradigm that can put a value on resources that the establishment can profitably live with, which is an impossible contradiction to resolve.

Another 'meme of the now' is the collapse of the post- Andy Warhol fashion universe of 'fab' and 'trend' that goes nowhere and provides nothing but a useless distraction. It has heretofore written the roles that all must play. Unfortunately, the unattractive 'unemployed' and 'foreclosed upon' and the 'living in despair' roles are becoming corrosive to all the rest: the 'fab' roles that basically pimp more and more waste. We cannot waste anymore and must figure out a way to be serious rather than flippant. The upshot is a new kind of politics that is more serious, which is turning from the Warhol model of empty- suit fronts for business interests.

Things matter now.

The new trend is ruin and poverty. How does one make that anything other than what it is, something deadly serious as a heart attack. Accompanying ruin is creeping repudiation of obligations. This may or may not gain traction in 2011 but the gravitational attraction that walking away exerts will pull in all directions, perhaps in Ireland first but what happens next?

Along with the ghost of Warhol goes the shades of Ayn Rand and the self- rationalizing neo- liberals. If any group deserves its onrushing discredit, it is this one. The denouement is all that is lacking but their doom is linked to the flippancy behind which they can pose. Whether this year or another is the end for them the outcome is inevitable. Bernanke is their champion; everything done in his name for the benefit of his neo- lib, wiseguy friends has been lost to the run- up in crude prices and decline in bonds.

After Bernanke comes who ... or what, exactly? This is where finance creeps right at the lip of the abyss, talking the 'recovery' talk but shitting in their pants.

Nothing lasts forever and the shock of mondernist 'new' has grown old and moldy. Modernity reeks of failure, whether it is hyperinflating China, the rotting Phoenix and Las Vegas suburbs or in the canyons of lower Manhattan. The surprise is that modernistas are still hanging around but one can almost feel the nervous sweat that accumulates around the collective collar as the noose tightens.

Krugman Makes Mistake, Refers To 'Peak Oil' in the Times ...

Paul Krugman, the Keynesian economist everyone loves to hate because he advocates giving away money nobody has dropped the 'PO bomb and done so in the august pages of the New York Times'. You're fired, Krugman:

In particular, today, as in 2007-2008, the primary driving force behind rising commodity prices isn’t demand from the United States. It’s demand from China and other emerging economies. As more and more people in formerly poor nations are entering the global middle class, they’re beginning to drive cars and eat meat, placing growing pressure on world oil and food supplies.

And those supplies aren’t keeping pace. Conventional oil production has been flat for four years; in that sense, at least, peak oil has arrived. True, alternative sources, like oil from Canada’s tar sands, have continued to grow. But these alternative sources come at relatively high cost, both monetary and environmental.

Also, over the past year, extreme weather — especially severe heat and drought in some important agricultural regions — played an important role in driving up food prices. And, yes, there’s every reason to believe that climate change is making such weather episodes more common.

So what are the implications of the recent rise in commodity prices? It is, as I said, a sign that we’re living in a finite world, one in which resource constraints are becoming increasingly binding. This won’t bring an end to economic growth, let alone a descent into Mad Max-style collapse. It will require that we gradually change the way we live, adapting our economy and our lifestyles to the reality of more expensive resources.

More expensive resources means what, exactly? Resources that are expensive enough to keep them in the ground and out of the grasp of 'industry' means a Mad Max collapse. Expensive to the point of some trifling inconvenience to anyone other than economic 'losers' such as the Welfare Queenish unemployed is clearly not expensive enough. What is needed is the destruction of demand! Anything less is pointless, right Professor Krugman?

This is the dilemma that the establishment has created for itself by wasting its irreplaceable natural capital and calling the outcome 'progress'. Our dilemma strands us. We require the comforting illusions that modernity provides of our 'dominance' of the natural world even as the exercise of that dominance undermines the modernity itself. The 'change' Krugman refers to is a parade of rear guard actions designed to keep catastrophe at bay.

High oil prices spill over into other goods and services that embed fuel or require it to get to a market of some kind. High prices reduce the supply of customers, which manifests as declines in the amount of business which in turn means less funds to service debts or keep governments solvent.

Grasping for the 'more' alternative is not confidence building. Also not confidence building is the Establishment denial of the Peak Oil subject. This suggests the Establishment is impotent or cowardly or both. Sez Rick Munroe @ The Energy Bulletin:

Liquid Fuel Emergency (LFE) planning is not a priority

As the Leotta team points out, “preparedness for oil/fuel disruptions isn’t one of those [most pressing] issues” for local and state government agencies. Furthermore, it’s not a priority at the federal level, either. Examination of the priority lists at Public Safety Canada and DHS give no indication of concern over future oil supply, nor of any attention to LFE planning. To their credit, both agencies have a clear focus on the protection of critical infrastructure, but there is no comparable concern over what’s inside the pipelines: the supply of oil and gas itself.

Another reason why LFE planning is not on the radar of emergency planners is the widespread unawareness of the evidence regarding oil supply. It is still rare to encounter an emergency planner (at any level) who is already familiar with the term, “peak oil” or the literature on oil supply security (eg. the Hirsch Report, warnings regarding export capacity and a near-term supply crunch, the Oil Shockwave exercise, military analyses of peak oil, recent statements from the International Energy Agency, etc.).

“All hands on deck”

Both Alan Smart in Australia and Kathy Leotta in her earlier study have stressed the importance of pre-planning for an LFE, as did the GAO in its analyses. The Leotta team is correct in stating, “It will be ‘all hands on deck’ when a crisis occurs or is imminent” and in warning that “some period of confusion and scrambling” appears likely. The supply of affordable fuel is so essential to our economy and our security that a major LFE could present emergency planners and civic leaders with a problem of unprecedented complexity, scale and risk to social order. The Oil Shockwave exercise (June, 2005) concluded that a 4% reduction in global oil supply could lead to a near-tripling of oil prices, and that effective government responses were very limited. Shockwave participant (and current Department of Defense chief) Robert Gates warned, “The threat is real and urgent, requiring immediate and sustained attention at the highest levels of government.”

Half a decade later, Gates’ warning remains largely unobserved despite the mounting evidence of impending oil supply difficulties. Here in North America, we have instead sustained inattention at all levels of government, a situation which in turn is sustained by the unwillingness of mainstream media to examine the evidence and present it to citizens.

I'll leave it up to the reader to come to his or her own conclusions about 'Mad Max'. Real progress will only begin with embracing the concept of 'Less'. What happens after supply disruptions begin escapes analysis. The supply- side obsession of American- style policy makers would suggest a no- holds- barred drilling regime with the vegetable garden @ the White House ripped out and replaced with an oil- drilling rig. Then what? More leaning on Canadians and military aggression around the world to feed the SUVs! This would have the White House drilling rig on one side and a missile aimed @ Caracas on the other.

Meanwhile there are a raft of 2011 prognoses @ Energy Bulletin of which this one by Ron Swenson from ASPO catches the eye:

Solar: Solar manufacturer shipments more than doubled from 2009 to 2010. I predict that world production of solar energy systems will double again this coming year. A quarter of the growth will come from PV (photovoltaics) and the balance of growth will come from large solar thermal electric projects being installed in the US southwest and other parts of the world. Oil: As a consequence of the drilling moratorium imposed by the Gulf of Mexico Deepwater Horizon disaster, the USA will experience oil shortages in 2011 or 2012. (A steady supply from the Gulf has been dependent on new wells filling in as production from older wells declines.) Thoughts of seeking satisfaction of market demand from sources more remote than the Gulf must take into account the longer trip time that would be required for oil tankers. Lacking excess capacity, the global tanker fleet is unlikely to be able to respond, even if other oil suppliers (Africa, Middle East) could be imagined to increase their production.

– Ron Swenson, ASPO-USA Board of Directors

It's been a theme here @ Economic Undertow that shortages would be the consequence of unaffordable rather than unobtainable fuels. Our booming 'poverty' industry makes it likely that shortages that appear will be persistent. This creates the worst of all worlds as modernity- driven resource consumption continues unabated in the face of shortages while alternative approaches to employing workers and creating output is starved of capital. I don't know right this minute how our fabulous so- called policy making apparatus is going to escape this particular trap- slash- vicious cycle.

As for 2011 predictions: the hardest thing is not so much making predictions but accurately noting what is taking place at the moment right under our feet. It is amazing how much is missed!

For instance, we are already in the post- peak world of less and less oil available AT AN AFFORDABLE PRICE. The price matters! Dollar- for- dollar, peak oil took place in 1998 when the yearly average barrel price was $14! We have been pricing our fuel waste 'system' into receivership for over ten years. No wonder our economies are having the bends!

Price a rationing tool which measures credit at the same time. @ + $90 the world has credit that it can free up so that fuel can be rationed to those who can borrow and bid.

The trend is shifting away from credit availability. The price that will matter is the 'cash price' not just of fuel but everything else. It is this ongoing destruction/repudiation of credit toward a preference for cash that is the large trend that carries from 2010 to 2011 and beyond.

This is what makes Swenson's prediction/observation so troubling. When rationing by credit/price ends the rationing will be by physical availability. In given areas, there will be no fuel available regardless of price or how much money or credit customers have in their pockets.

You can have a thousand dollars in cash in your jeans but if there is no gas in the gas stations in your state you won't go anywhere unless you walk. The next step may be no food in the supermarkets which is the troubling part, the part that Munroe tasks the establishment with ignoring.

Right now is the peak of 'emergency credit': bailout funds from central banks, super- sovereigns, from foreign exchange and interest rate derivatives directed toward the lending/credit market that becomes more impaired by the minute. The Federal Reserve has according to some source or other been able to replace the credit evaporated in the shadow banking system since the failure of Lehman Brothers. What of it? What can the Fed do next? Can it create new customers who will take on new good loans? Can the Fed 'print' new products or good collateral to borrow against? What of the 'assets' that fall worthless tomorrow? The Fed has accepted a stupid and pointless task. More emergency credit solves nothing, the economic system built on endless waste of a finite good is now obviously insolvent. This insolvency will become more and more visible during the upcoming year.

Unaffordable fuel means all the depend on it is also unaffordable. This fact will be denied for as long as possible guaranteeing the insolvencies that emerge will be intractable, that final ruin will be total.

That ruin will be total, what a legacy we supposed wisest of apes leave to our children!

Waiting for the Other Shoe To Drop ...

Merry Christmas! Here is John Hussman:

4) We did not avoid a second Great Depression because we bailed out financial institutions. Rather, the collapse in the economy and the surge in unemployment were the direct result of a gaping hole in the U.S. regulatory structure that prevented the rapid restructuring of insolvent non-bank financials. Policy makers then inappropriately extended the "too big to fail" doctrine to ordinary banks. Following a striking loss of public confidence that resulted from arbitrary policy responses, coupled with fear-mongering by exactly those who stood to benefit from public handouts, the self-fulfilling crisis was contained by a change in accounting rules that effectively disabled capital requirements for all financial companies. We are now left with a Ponzi scheme. 

While it's clear that the four-second tape in Ben Bernanke's head is an endless loop saying "We let the banks fail in the Great Depression, and look what happened," any disruption caused by the "failure" of a financial institution is not due to financial losses to bondholders, but is instead due to the necessity of liquidating the assets in a disorganized, piecemeal way, as was the case with Lehman Brothers. Large, sometimes major banks fail every year without a material effect on the economy. The key is to have regulations that allow these failures to occur with the minimal amount of disruptive liquidation.

It is important to recognize that nearly every financial institution has enough debt to its own bondholders on the balance sheet to absorb all of its losses without any damage to depositors or customers. These bondholders lend at a spread, and they knowingly take a risk.

Bank regulations intelligently allow the FDIC to cut away the "operating" portion of a financial institution from the obligations to its bondholders and stockholders. Consider a bank with $100 billion of assets, against which it owes $60 billion of customer deposits, $30 billion of debt to its own bondholders, and $10 billion in shareholder equity. Now suppose those assets decline in value to just $80 billion, creating an insolvent institution ($80 billion in assets, $60 billion in deposit liabilities, $30 billion in debt to bondholders, and -$10 billion in equity). The "operating portion" is the $80 billion in assets, along with the $60 billion of customer deposits, which can be sold as a "whole bank" transaction for $20 billion to another institution. The stockholders are wiped out, while the bondholders get the $20 billion residual and take a loss on the rest. Depositors and customers now get statements with a different logo at the top. The seamless "failure" of Washington Mutual is a good example of this in action (the emphasis in mine). 

The problem with Bear Stearns and Lehman was that no equivalent set of regulations was in place to allow "cutting away" the operating portion of a non-bank institution. Instead, the Fed illegally expanded the definition of the word "discount" in Section 13(3) of the Federal Reserve Act and created a shell company to buy $30 billion of Bear Stearns' questionable long-term assets without recourse. The remaining entity was sold to JP Morgan, where Bear Stearns bondholders still stand to get 100 cents on the dollar plus interest. Lehman was allowed to "fail," but because there was still no set of regulations that allowed cutting away the operating entity, it had to be liquidated piecemeal.

Importantly, and even urgently, it was not this "failure" that produced the economic downturn. If you carefully observe what happened in 2008, the large-scale collapse of the financial markets and the U.S. economy started literally sixty seconds after TARP was passed by Congress on October 3, 2008. At that moment, the world was told not that the smooth operation of the global financial system would be ensured by taking receivership of failing financial institutions; not that the focus of policy would be the protection of depositors, customers, and U.S. fiscal stability; but instead that insolvent private balance sheets would now be defended, subject to the arbitrary decisions of policy makers in which nobody had confidence. Lehman's failure simply told investors that these decisions could be completely arbitrary, since there was really no operative distinction between Bear Stearns, which was saved, and Lehman, which was not. Moreover, in order to pass TARP, the public had to be convinced that a global meltdown would result if financial institutions weren't preserved in their existing form. In this way, policy makers created a crisis of confidence.

Skip forward and carefully observe what happened in 2009, and you'll see that the crisis was suspended once the FASB threw out rules requiring financial companies to report their assets at market value, while at the same time, the Federal Reserve illegally broadened the definition of "government agency" in Section 14(b) of the Federal Reserve Act in order to purchase $1.5 trillion of Fannie Mae and Freddie Mac obligations. These actions replaced the arbitrary discretion of policy makers with confidence that no major institution would be at risk of failing because, in effect, meaningful capital standards would no longer apply.

Thus, our policy makers first created a crisis of confidence, and then resolved it by legalizing a global Ponzi scheme.

Or rather, the Bernanke Money Laundry which allows finance 'friends' of the Chairman to swap their used toilet paper for cash. The friends use Fed liquidity to pump up markets allowing the same friends to sell into these rising markets on an ongoing basis. Sez Hussman:

As David Einhorn at Greenlight Capital has noted, "We learned the wrong lesson." We should have learned that existing capital standards were insufficient and that there was a large, gaping hole in our regulatory structure that failed to provide "resolution authority" for non-bank financial companies. Instead, we've learned the dangerously misguided notion that some institutions are simply too big to fail. This inevitably creates a situation where reckless misallocation of capital continues to be subsidized at increasing public cost, while bondholders go unscathed and insiders take bonuses with the same alacrity as Bernie Madoff's early investors.

In short, the downturn in the real economy occurred because regulators refused to take receivership of insolvent institutions, while pushing a story line that the entire global economy would crumble if bondholders had to take losses. This created a fear among depositors and consumers that the entire system was arbitrary and unstable, fueled periodic runs on various financial institutions, tightened the availability of credit to companies having nothing to do with real estate, and created a self-fulfilling prophecy of global economic weakness. Had our policy makers said "depositors and customers will be protected, we will immediately exercise resolution authority over insolvent institutions, and bondholders will not be spared" we could have simply had a "writeoff recession" in paper assets, rather than an implosion of the real economy and an explosion in public debt.

The facts simply do not support the idea that taking receivership of insolvent financials leads to economic distress. Rather, it properly rests losses on the bondholders, and preserves the operation of the financial system by bolstering its solvency. One might argue that we could not possibly let bondholders take the trillions of dollars of losses that would have been required in order to restructure debt and get the bad obligations off the books. This is absurd. A 20% stock market decline wipes out about $3 trillion in market value. Indeed, given the size and average maturity of the U.S. bond market, just the increase in interest rates that we've observed over the past 6 weeks has knocked off trillions in market value.

The financial markets are perfectly capable of taking losses. They don't do well with disorganized piecemeal liquidation - where perfectly good loans are called in and countless positions have to be unwound - but that isn't required if your regulatory structure allows receivership/conservatorship that can cut away and gradually transfer the operating portion of an institution. What the global economy is not capable of taking is the uncertainty that results when policy makers apply arbitrary rules, leaving all other decision makers in the economy frozen at the edge of their seats to discover what the results of those arbitrary decisions will be. We have learned the wrong lesson, and we continue to pay for it.

Here's part 3 of Hussman's analysis. Sue me, I'm backwards:

3) Downside risk tends to be elevated precisely when risk premiums and volatility indices reflect the most complacency

I could go on, but nobody cares.

"I could go on, but nobody cares!"  


Let's look @ Hussman's $100 billion bank. It had $100b in assets (loans), $60b in deposits, $30b in bondholder (senior) debt and $10b in shareholder equity. Losses in the real estate market took assets to $80 rendering the bank insolvent: ($80 billion in assets, $60 billion in deposit liabilities, $30 billion in debt to bondholders, and -$10 billion in equity). The "operating portion" is the $80 billion in assets, along with the $60 billion of customer deposits, was sold as a "whole bank" transaction for $20 billion to another institution. The stockholders were wiped out, with the bondholders' stake converted to $20 billion in shares in the buying bank. What happens next?

Real estate continues to lose value keelhauling the new institution's assets the same way falling real estate undermined Hussman's original bank. Bank insolvency becomes self- sustaining as no new good loans (assets) are made to offset the rapidly devaluing existing loans. Net credit declines leaving values unsupported which effects assets system- wide. The only business that keeps the 'institutions' afloat is arbitraging the difference between short and long term lending rates and by trading credit derivatives: indirect forms of debt subsidy, courtesy of central bank manipulation of bond markets.

As the process gains internal momentum, asset devaluation outstrips the amounts bondholders have at risk, ruining all of them and the banks as well. Bondholders- turned stockholders are fed into the liquidation furnace. This is the mechanism behind Nicole Foss' suggestion that the likely final price level for (debt- free) real estate: that is, the cash value with all credit stripped out will be 90% below cycle highs. Absent a significant restructuring plan and resolution of property values relative to worker incomes there will simply be no credit available to anyone to buy anything. Prices will be set by whatever cash currency folks have in their pockets. Asset values will be meaningless as there will be no 'assets' per se.

This is no new invention but the sequence that destroyed banking and credit in the US and elsewhere in the early 1930's.

What John Hussman illuminates is a process dependent upon a return to bubble values: finance markets can sustain SOME losses not a total, self- amplified collapse of value. Losses cannot be confined to real estate. Price stability is insufficient to pay returns to the banks' assets, only liquidity- driven (bubble) growth. This is not any criticism of Hussman's analysis which is a classic model of restructuring. The problem is the need for exogenous support for values ... so that constantly declining assets do not continue to bleed balance sheets. Where do these supporting funds come from, an invasion of Bankers from Outer Space with spaceships full of money?

Right now the only support is more sovereign debt and the continuation of extend- pretend. Both of these are illusory as sovereigns can only recycle not create value nor can E/P conjure value when it has evaporated. The constant debt/subsidy requires the pristine appearance of 'integrity of debt'. This must be maintained at all cost which requires still more subsidy. This is the circular Ponzi Scheme Hussman paints.

Outside of the Ponzi lurks Irving Fisher's debt deflation. Anchored to fuel prices set in dollars and the self- destructive propensity of finance to serve itself at the expense of the rest, deflation cannot be outmaneuvered.

Take away the willingness of creditors to lend and galloping insolvency freezes the credit system. This is indeed what is taking place right now in the Eurozone. Borrowing is becoming more difficult, lending more risky and the loans less effective. Bondholders hold the euro hostage. At the same time, the hostage is already a corpse. Talk of 'haircuts' once started cannot be contained. Greece's suggestion a few days ago that it will quietly default sometime in the future triggered a mad panic in Credit Default Swaps written against Greek bonds.

Ambrose Evans- Pritchard:

The Greek newspaper Ta Nea said Athens was examining plans to impose a cut in interest rates on its debt and to extend maturities once the €110bn (£94bn) rescue deal from the EU and the International Monetary Fund expires in mid 2013.

The proposals stop short of "haircuts" on the principle of the debt and would be done in a co-operative fashion with bondholders. While this would qualify as an orderly restructuring of debt, it is tantamount to default.  Ta Nea said Brussels had given a "green light" to the idea, provided that Greece complies with the terms of its fiscal austerity package and carries out deep structural reforms.

The European Commission denied that it had given its blessing for "any restructuring of government bonds by Greece or anywhere else".

The claims caused a wild spike in credit default swaps for Greek debt, with ripple effects across the EMU periphery. Markit's iTraxx SovX Western Europe index measuring risk on sovereign debt in the region surged to a record 208 basis points in intra-day trading, though the moves may have been distorted by a lack of liquidity in the run-up to Christmas.

If Greece becomes the first country in developed Europe to restructure sovereign debt since the Second World War, it breaks a powerful taboo and risks opening the floodgates to serial defaults in southern Europe and Ireland.

"This is going to worry the markets a lot: if it is true, it changes the whole politics of the eurozone debt crisis," said Elizabeth Afseth, a bond expert at Evolution Securities.

The fantasy is that the hundreds of trillions of dollars/euros/yen/renmimbi in claims will all be repaid one way or another while keeping depositors whole and doing so on the backs of retirees and schoolchildren with growth constrained by $100 crude oil. The absurdity is self- evident and yet this is where the world places itself as a first prescription for 'recovery'..

Adults cannot even discuss the idea of an orderly restructuring because the creditors hold the world's finance structures by the heels from the ledge of very high window. Absent is the acknowledgement that any regime that can be held by the heels at all has nothing left to contribute to society.

Complacency belongs to those whistling past the graveyard. Where are the risks lurking? The Bernanke Money Laundry can be brought to an end by actions in Congress by way of Bernanke nemesis Ron Paul. Reining in the laundry would cause the stock market to decline, perhaps sharply. Congress can fail to extend the national debt ceiling for political (posturing) reasons triggering a government shutdown. A US state can default or an important city declare bankruptcy leading to a run out of municipal issues. Chinese hyperinflation can reach Hungarian or Weimar proportions: 100% or more per week. A run could be made against the banks of a large European country such as France or Italy. This would mean the end of the euro as the whole lacks the resources and -- more importantly -- the will to support the unpayable debt such a run would reveal.

The risk begins when Ireland's government- to- come tells the EU what it can do with its bailout of German and French banks on the backs of Irish working people.

Adults cannot speak about debt restructuring until it is forced on them, the same adults refuse to discuss energy conservation. Instead of creating an artificial fuel shortage with large 'incentives' to cut fuel use/waste we subsidize more waste! Instead of allocating fuel in a way that sets humane priorities and allows nature to recover from our all- out assault on it with our machines, the chosen path is to allow 'the market' to create real shortages. When these appear they will be distressing because there will be no way short of physical rationing to allocate what remains. Our fuel supply's affordability is determined by economic profitability.

Profitability declines because the credit system is insolvent. This reduces the funds available to extract harder to reach fuels. It also constrains the ability of customers to bid for it. Peak oil effects are amplified by the inability of society to afford the fuel as well as afford new means to 'use' it.

Here is Chris Skrebowski's observation from October's ASPO Convention: 



What are our options? What policies might work?

• 
  
  Leave it to the market and hope high prices will improve supply and reduce demand. This popular policy led to the 2008 crash.
• Hope Opec sees our welfare as their priority. Hmmn ...
• Keep activity at low levels and accept little growth and high unemployment
   Or we could:
• Maximise efficiency in use
• Maximise use of economic alternatives (The economic bit is the rub)
• Maximise the use of alternative fuels (Shale gas is exciting but realistic?)
• Start taking the oil out of transport (Not easy but probably the best policy)
• Reduce the energy needed in our economies (Note -moving production overseas only moves the location of demand)
• All these can and to some extent are being done but will it be fast enough to avoid the next price spike and its economic consequences?
   

ASPO-USA Washington
7-9 October 2010



I agree with Skrebowski to a point: our culture- wide energy bank is insolvent alongside our credit/money versions and for the same reason. Our assets -- workers output translated into aggregate demand -- is declining relative to liabilities which includes our massive fuel- wasting infrastructure. One cannot support the other. Absent conservation the only alternative is for an invasion of fuel tankers from Mars.