Daily Comment – 3rd November 2009: Greenspan Prostituted Economic HIV

Macro

Greenspan Prostituted Economic HIV

I’ve recently commented on how Fed (and the BoE) is desperately trying to stoke inflation and why inflation is imperative in a bloated debt-burdened society. Let’s be clear: practical, sensible, regulated extension of credit in a modern sophisticated society like ours is a good thing. But when prostituted to excess, debt is like HIV, a deadly virus which compromises the immune system. It’s important to understand that debt may not be the direct cause of a “deflationary death” per se. Rather, it is the excessive accumulation of debt in society which causes any subsequent inevitable infection (like, say, deflationary recession) to be a much bigger problem than it ought to be. Most notably, it constrains and restricts the conventional remedies available to weather a cyclical downturn. By suppressing the natural immune system of an economic organism, a debt-virus leaves it fatally vulnerable to any number of common diseases and infection. The next important question is: how did we all get so far in debt?

Back in the old days, things used to be simple: when our parents were young, it used to be quite difficult to get a loan. One had to be able to convince any creditor, usually a local entity/person, that one was “good for the money”. For good reason, that was not always an easy thing to do. Mortgages were only given to those who could convincingly pay off the total debt (not just the monthly interest payments) and only to those who could give substantial down-payments from day one. Years of saving by first-time buyers for a deposit or down-payment was regarded as a measure of their determination and tenacity to see the loan through – it bred a different attitude towards indebtedness. Upon repayment of the mortgage loan, people used to hold “mortgage parties” and invite their neighbours around for a glass of wine to celebrate the extermination of their debt-burden.

Not any more. Today we brag about the latest financing deal we got on a car, TV, house or the credit cards we hold. As young, wide-eyed, embryonic contributors to national economic output, debt culture is thrust upon us before we even have chance to experience income, let alone savings: the average student debt is now 20,000 pounds and rocketing at far greater speeds than inflation. Somewhere between Then and Now, attitudes towards debt skidded from prudent to complacent to downright comical. It is still hard (and at times almost impossible) to resist “interest-free” credit cards, student overdrafts and graduate loans, liar-loans and so-called “cheap” low-doc/piggyback/interest-only/adjustable-rate mortgages because they were practically being forced down our throats at every opportunity. But we should first be introspective: as individuals who find ourselves mired in debt, we must first have the good dignity to step up and take accountability for our own mistakes. There is no such thing as a free lunch, we should have read the small print, we should have considered the consequences, we should have known better.

But there were many at fault. The consumers, after all, had to borrow from somewhere: banks, loan companies, credit cards and consumer loan companies were all too happy to tout great “financing deals”. It got to the stage where salesmen were knocking on poor people’s doors offering to replace all their windows for “free”, knowing full well the deceitfulness of this pitch. At times it felt as though you could not purchase anything over 100 quid without it being on credit with “no payment or interest-free for 6 months”.  The banks and consumer-credit companies (note, CIT Bankruptcy proceedings may be quite interesting) themselves were leveraged at higher levels than they had ever been; they were clearly a big part of the problem. So too were all businesses and companies which accumulated debt beyond their capacity to pay it back. So too were the political and financial regulatory bodies, which were supposedly designed to protect the public.

Interestingly, unlike Japan during the “lost decade”, this time many public companies were in remarkably good shape, after legislation introduced post-Enron, required them to clean up their balance sheets. Thank goodness they were! Never-the-less, we still have a continuation of a balance sheet-led moderation on our hands, just like Japan had – except the balance sheet repair is occurring at the banking and consumer level (rather than on the balance sheets of corporations, as was the case in Japan). However, the principle is still the same. As I’ve mentioned, it actually makes the situation in economies like the UK and US a little more convoluted (and, perhaps, a little more interesting), as there is a political element to this when it directly concerns the financial health of Joe Public – i.e. The Electorate!

So the people are partly to blame, but they borrowed from the financiers who were overseen by the regulators and, of course, politicians all of whom are also partly to blame, but where did the financiers get their ability to lend at such incomprehensibly low rates, with such little regard for the systemic consequences?

This is something I wrote as far back as 2005 in my piece, Looks like Deflation but Feels like Inflation:

I cannot go without highlighting this quote I got from Daily Reckoning. They are quoting Frank Notdaft, sorry, Frank Nothaft chief economist for Freddie Mac, so I guess he must be a clever guy and very influential…

 Daily Reckoning:

“for the typical family, home equity accounts for the bulk of their wealth,” said Frank Nothaft, chief economist for Freddie Mac.

And here is where the CNN report becomes amusing. People believe what they need to believe when then need to believe it, we keep saying. Freddie Mac’s chief economist believes that debt posed no problem, as long as it is backed by house price increases:

“The average loan-to-value ratio after refinancing is still 70 percent,” Nothaft said, “which means homeowners are being pretty conservative”.

He also points out that the number one use the money is being put to is home improvement, ‘which enhances the home’s value’

AAAAGGGHH!!!

Does this sound familiar? Here is an excerpt from the end of my last email:

Merv “the Swerve” (BoE Governor, Mervin King) told us not to worry because…

“the increase in indebtedness was equally offset by an increase  in asset prices”…

…highly irresponsible in my opinion… asset prices can fall far quicker than debts can be eroded, by inflation or otherwise… that’s not the risk we’re worried about, Merv… it’s like saying: “don’t worry about the flood, eventually the water drains away and water recedes to it’s natural level”…

You see Mr King, Mr Nothaft, for men in positions of your responsibility it is distinctly irregular to suggest that comfort can be drawn from the fact that increases in debt are “offset” by rising asset values… so when my house depreciates by 30% can you guarantee that my debt will decrease by 30% too, y’ know, to “offset” the shortfall in my house price? You see, I can sell my house anytime I wish, tomorrow if need be, but my debt I carry indefinitely until I am able to pay it down, this is where the risk lies. Surely men of this stature can understand this!?

As custodians of our financial system, the Central Banks, and the individual central bankers within them, are ultimately responsible for the root-causes the imbalances built during our Era of Excess. For years, governor of the BoE, Mervin King, was himself encouraging debt accumulation, not only through the institution’s excessively easy monetary policy but also in his incredibly irresponsible rhetoric.

But nobody flaunted unrestrained recklessness with the future of our economic well-being like the Original Sinner: Alan Greenspan. With excessively easy monetary policy for the best part of a decade, “The Great Maestro” even over-looked the disbandment of the public reporting of money supply data and endorsed the use of dubious inflation calibration techniques and biased measures such as Core CPI – which consistently underestimate inflation hazards (or what I like to call “inflation without the inflationary bits”). This enabled unhindered, unregulated, unbridled Greenspan Banking to continue with his real interest-free lending stance to the banks and institutions who, in turn, exposed the entire economy to easy debt and laissez-faire risk management and lax credit oversight. Of course, we have ourselves to blame, but let’s be clear: this mess started at the top.

This over-dependence on Paper Wealth Capitalism, debt-ubiquity and Anglo-American consumerism were the founding blocks to the global imbalances we find today – including the Trade Deficits and the so-called, Western-politically-contrived, phrase: “the savings glut” in China. To be fair Greenspan recently conceded that there was a flaw to his economic ideology… after he’d resigned and after we’d had the biggest financial meltdown in living memory …yeah, thanks for that.

This is not the end of cyclicality, but with higher taxes, higher default rates, larger deficits and potentially dangerous inflation down the road, it’ll take more than 18 months for the consumer to recover from 2 decades of neglectful central banking and their promiscuous prostitution of debt.

The sadly ironic part is that, so gargantuan is the hangover from our 20 year orgy of easy-lending, the least excruciatingly painful exit we have from this is just more of the same: Hair-of-the Dog Monetary Policy.

Macro Data to Watch:

• Japanese Bank Holiday today

Markets

A limp recovery from the US markets – I’m getting used to 3% moves now! It was Ford that grabbed the headlines, beating analyst predictions comprehensively and trading up on good volume.

Currencies have been relatively stable recently. I think when the rest of global GDP data comes out we may have some more movement – for now though, we’re range trading.

Interestingly, despite the sell off in equities, credit spreads remained little changed, globally.

Global Stocks to Watch:

Earnings:

• KT Corp
• UBS
• Danske
• Kraft
• Swiss Re
• BMW
• MasterCard

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