John Robb's Weblog

If deflation in 2009, does pay from....

bureaucratic employment (particularly government employment) that has automatic cost of living increases go down? ;->

Another Record

Consumer confidence dropped to the lowest level EVER recorded.

One thing we need to distinguish between is a drop in confidence supported by actual conditions (INSOLVENCY, debt too high, stagnant incomes, a lack of opportunity, etc.) and one derived from a shift sentiment (divorced from conditions, a fad). We are accustomed to assuming the latter. This is the former.

70% of the US economy is consumer driven and by extension, most of the rest of the world's economy (particularly in the developing world) is based on the economic activity of same group of people.

From the perspective of someone analyzing decision making, the fact that the US gov't can't see that the crux of this crisis is consumer insolvency is a fairly cool example of institutional failure.

A Historian's Perspective

Niall Ferguson (who is trying his hand at economic history now), points out the obvious trends that don't seem to gain traction in much of what we regard as economic analysis. Much of this sounds familiar to trends I've been pointing to:

Systems thinking:

From the 1980s until 2007, the world economy had enjoyed higher, more widespread growth and fewer, less severe crises – hence Federal Reserve chairman Ben Bernanke’s hubristic celebration of a “great moderation” in 2004. On the other hand, the more the world came to resemble an intricate, multi-nodal network operating at maximum efficiency – with minimal inventories and just-in-time delivery – the more vulnerable it became to a massive systemic crash.

On the potential failure of outdated theory:

“We assumed that we economists had learned how to combat this kind of crisis,” admitted one of President Barack Obama’s “dream team” of economic advisers, shortly after his return to academic life in September 2009. “We thought that if the Fed injected enough liquidity into the financial system, we could avoid deflation. We thought if the government ran a big enough deficit, we could end a recession. It turned out we were wrong. So much for [John Maynard] Keynes. So much for [Milton] Friedman.”

A nod to the solvency crisis and the paradox of debt/thrift:

With total debt above 350 per cent of US gross domestic product, the excesses of the age of leverage proved difficult to purge. Households reined in their consumption. Banks sought to restrict new lending. The recession deepened. Unemployment rose towards 10 per cent, and then higher. The economic downward spiral seemed unstoppable. No matter how hard they saved, Americans simply could not stabilise the ratio of their debts to their disposable incomes. The paradox of thrift meant that rising savings translated into falling consumer demand, which led to rising unemployment, falling incomes and so on, ever downwards.

Hiding loses (preventing markets from working):

The crux of the problem was the fundamental insolvency of the major banks, another reality that policymakers sought to repress. In 2008, the Bank of England had estimated total losses on toxic assets at about $2.8 trillion. Yet total bank writedowns by the end of 2008 were little more than $583bn, while total capital raised was just $435bn. Losses, in other words, were either being massively understated, or they had been incurred outside the banking system.

The rest of article is an interesting prediction (with a EOY 2009 time horizon) of American resurgence. Fairly sure it's not supported by the trends (cited above), but hey, it is a good read regardless.

Peter Schiff

is right on with his analytical conclusion that you don't get yourself out of a solvency crisis by adding more debt.

The real way to work out this current crisis is to find a way to unwind debt at the banking, corporate, small business, and individual levels and increase savings.

That's exactly opposite of what we have been doing. First, we are actively avoiding addressing this bubble of debt, by showering money on firms to prevent them from marking those toxic assets to market (this enables a culture of looting and avoidance of any responsibility for failure). Second, the government is ramping up it's debt at a scintillating rate (crowding out everyone else). Lastly, and worst of all, the government isn't doing anything to help small businesses and individuals unwind debt.

One of the big problems is that we are gearing up to fight the last war (the last great depression). This war is entirely different. This depression is being driven not by a precipitous fall in our exports but rather a solvency crisis. We are a (mostly) insolvent debtor (although we don't seem to acknowledge that fact). Debtors in denial typically inflate to avoid repayment of their obligations.

Inflationary depression anyone?

Small Business Bloodbath

Small businesses are in free-fall. It's always tough running a small business, even in good times. However, the systemic factors now in place -- from the horrific bankruptcy reform of 2006 to financial firms/banks inexorably hiking interest rates even as their costs fall to a failure to find financing from firms that are hoarding massive public bailouts -- have created a fatal brew. Great stories from the WSJ.

The alternative is to wipe the decks clear with the global economy and go informal (the entrepreneurial plan B) with more modest goals.

Yet again....

Financially broken American households shun retail. This is what happens when you turn a rising tide into a lock system.

The Great Moderation Assumption Error

One of the reasons that so many strategist are perpetually stuck in a mode of starry eyed optimism is that they matured during "The Great Moderation." Essentially, "The Great Moderation" is a twenty five year period of economic growth that has suffered relatively shallow recessions, low inflation, and a boom in asset prices.

________________

The problem is that this "moderation" was really due to the destruction of the link between productivity and incomes (which kept wages stagnant). Here's the economist Thomas Palley on this:

One reason for the changed business cycle is retreat from policy commitment to full employment. The great Polish economist Michal Kalecki observed that full employment would likely cause inflation because job security would prompt workers to demand higher wages. That is what happened in the 1960s and 1970s. However, rather than solving this political problem, economic policy retreated from full employment and assisted in the evisceration of unions. That lowered inflation, but it came at the high cost of two decades of wage stagnation and a rupturing of the link between wage and productivity growth.

Another reason is the use of "financial innovation" to produce inexpensive debt which in turn led to a rapid accumulation of debt and asset price inflation:

With regard to lengthened economic expansions, the great moderation has been driven by asset price inflation and financial innovation, which have financed consumer spending. Higher asset prices have provided collateral to borrow against, while financial innovation has increased the volume and ease of access to credit. Together, that created a dynamic in which rising asset prices have supported increased debt-financed spending, thereby making for longer expansions. This dynamic is exemplified by the housing bubble of the last eight years.

A better way to look at the "the Great Moderation" is that it was accomplished through the systematic financial and economic debasement of the American family (those at the top of American corporations and on Wall Street gained incredible wealth by participating in this process). All we have left now are low wages, massive debt, and a crappy "service economy."
_________________

So, this assumption error means that most strategists are still developing product based on a return to "normal." The problem is that there will not be a return to normal and those strategies are merely castles in the sky.

A Very Lean XMas

If you and your family aren't circling the financial wagons right now, cutting to the extent possible your exposure to global financial undertow (which is reaching tidal wave proportions), then you are exposing yourself unduly. Have a happy non-commercial xmas everyone.

Defacto Unionization in China

Spreading virally.

Going South

"For every one of mine that you kill, I will kill 10." This was on a note attached to 12 decapitated corpses, initially IDed as Mexican Army conscripts, that were found along a major road in southern Mexico.

Calderón's promise not to strike deals with the drug cartels followed comments from Rubén Aguilar, who served as chief spokesman for former president Vicente Fox, in which he suggested that the Calderón government ought to seek a de facto truce with traffickers to end the bloodshed. "The only way to win the war is negotiating," Aguilar told the Frontera newspaper in Tijuana.

Sounds familiar.