Economic Amnesia

Today is Remembrance Day. Lest we forget.

The Great War was a disaster for Europe and the rest of the world. Following decades of relative peace and economic stability, fighting broke out in August 1914 and didn’t cease until 11am on 11 November 1918…93 years ago today.

The continent is still feeling the aftershocks of the Great War. The peace was badly managed. The allies gave Germany a huge reparations bill but took away her ability to pay.

Germany printed the money instead. This resulted in a hyperinflation that tore its society apart. Farmers had plenty of food but they wouldn’t take the worthless paper currency as payment…so the townspeople half-starved.

The proclamation of September 19 (1923) threatening a month in goal and unlimited fines to anyone who hoarded food or money, or prevented the paying of taxes, or impeded the distribution of food or fodder, though signed by the Chancellor, the minister of the Interior and the President himself, was a useless act of desperation: everyone, ministers included, was hoarding all he could; no one made any effort to pay taxes; and the only impediment to the distribution of food was the lack of a negotiable currency to pay for it.

Adam Ferguson – When Money Dies

Just a few weeks later a British diplomat, Joseph Addison, wrote home to a friend: ‘The population is ripe to accept any system of firmness or for any man who appears to know what he wants and issues commands in a loud, bold voice’

In Munich at the time little Adolf Hitler was speaking in a very loud and bold voice. The hyperinflation changed Germany’s history irrevocably.

World War II was just a continuation – albeit a much larger and more destructive one – of The Great War.

The Eurozone and its currency, the euro, were conceived to tie European nations together economically so they would no longer be tempted to tear each other apart.

Good idea. Poor design.

The eurozone is now breaking up. Instead of converging like the designers thought they would, each country has continued on its historical path. The theory and hope of convergence masked the fact that each eurozone member continued to go about their business.

Perhaps if there were more remembering, not just on this day but every day, the world wouldn’t be lurching from one crisis to the next.

Unfortunately, China – and seemingly all who analyse the country’s economic fortunes – have developed amnesia about how economics actually works.

If they cast their mind back just a few years, they would remember the US’s experience following their credit bubble bust – the subprime crisis and its aftermath.

Data out this week has reassured China watchers. House prices are beginning to fall and inflation is coming down. That’s good news because it shows China’s central planners are cooling the economy as expected.

And it’s good news because authorities will soon be able to ease monetary policy and stimulate the economy again. Apparently that’s how an economy works. A bit of tinkering here and there and voila, you get the outcome you were after.

But as much as we try, we can’t remember a country that had lasting success with the fine-tuning tool. Something – usually human behaviour – occurred to upset the bureaucrats plans.

Given today is all about remembering, consider the US experience of 2007 as a template for what is happening in China now. Remember how the subprime crisis was ‘contained’. Remember how the Fed would sort it out by cutting interest rates? Remember how none of this came to pass?

Earlier this week we wrote to subscribers of Sound Money. Sound Investments telling them the market’s sanguine attitude was very reminiscent of 2007. We quoted from Gary Shilling’s recent book, The Age of Deleveraging, detailing the denial:

It’s incredible that after the subprime residential mortgage market started to collapse in earnest in February 2007, even as the woes spread rapidly to the rest of housing, and even as the crisis spread to Wall Street with the Bear Stearns bust in June of that year and threatened to sink the domestic and global economies, most forecasters remained in denial. In August 2008, eight months after the recession had actually started, the Wall Street Journal’s poll of 53 economists, including me found that only about half believed the US economy was in recession and that most expected real GDP to rise from the fourth quarter of 2008 (it actually dropped 1.9 per cent).

Meanwhile, investors, policy makers, regulators and Wall Street leaders did not appear to understand the depth and breadth of the financial crisis. Every step of the way, they felt sure that the latest problem would be the last problem, that the latest bailout would solve all difficulties and no more would be required. They weren’t really aware that it was a financial crisis driven by deleveraging. And the stock market, although a good measure of sentiment, was only a sideshow.

The air is just starting to come out of China’s bubble. If you don’t think it’s a bubble, check out the photo below. Only an out-of-control credit boom could produce apartments under an unfinished railway line.

China's bubble

Source: The Epoch Times

According to Bloomberg, new residential housing starts dropped 1.3 per cent in October from a year earlier, while ‘housing transactions’ dropped 25 per cent on the previous month.

Meanwhile, the Wall Street Journal tells us year-on-year car sales fell 1.1 per cent last month, the third drop in sales this year. Data out yesterday showed China’s export machine is slowing, as Europe’s austerity starts to impact its largest trading partner.

This is just the early stage of China’s bust. Next year things will get much more interesting.

Greg Canavan,
for Markets and Money

And now over to Bill Bonner from Paris, France:

Security was unusually heavy at the Eurostar terminal in Paris yesterday. Police roamed the halls and corridors. Long lines formed as baggage and passports were inspected. In the executive lounge, plain-clothed cops eyed packages…and studied travelers.

Then, in London…on our way to the office we passed a melee of striking cab drivers and electricians. A scuffle had broken out. A man was on the ground, surrounded by Bobbies in phosphorescent green jackets.

Europe is on edge.

“While Rome burns the eurozone fiddles” says the headline in today’s Daily Telegraph.

At least, things are starting to go in the right direction; the Dow fell 389 points yesterday.

What’s that? The right direction is down. And apart. It’s the way to wash out years of built-up debt that can’t be repaid…and cleanse the system of zombie loans, zombie businesses, and zombie spending.

The right direction is to let the accumulated wisdom of willing buyers and sellers figure out what things are worth…let them destroy those that are worthless…and raise up those that have real value.

The right direction is to let Mr. Market do it. God knows he causes enough trouble. Let him sort out the mess he makes.

But the right way is not the only way. Obviously, it’s not the way the zombies want to do it. They want to fiddle…to meddle…to manipulate the system so that the rewards go to them and the costs are put on someone else. They want to sweep problems under the carpet…and continue spending!

But yesterday, investors began to realize that there was no carpet in the world big enough to hide Europe’s government debt.

Not that the debts are particularly huge. Some are bigger than the US. Some are smaller. Generally, European governments tried to provide more and more services by going deeper and deeper into debt. Generally, the US government enticed its own households into debt — with EZ credit, low rates and government-subsidized loans for students and housing. And they’re both still at it…see below…

In other words, in both Europe and America, government used centrally-planned, bureaucrat-direct zombie capital investment to make up for real growth. And you know how that goes, dear reader.

Today, again, the world’s attention is focused on Italy. “Doomed by corruption, bloated by bureaucracy and poor productivity,” says the Telegraph. But hey…it could be describing any number of places.

The unemployment rate for people between 15 and 24 in Italy is 30%. Hospitals are overcrowded. Roads have potholes. And the “country has been spending more than it earns for years….” Italy’s national debt is 120% of GDP. US debt is 100%.

But at least the Italians are civilized. They have some of the highest tax rates in Europe. They just don’t pay them.

Poor Berlusconi. He’s being forced to resign. After so many years of public service. So many years of doing his level best on behalf of the Italian people…to create a better government…a better nation…and a better world. And now they cast him out like an empty cereal box. And the popolo minuto look on…gawk…and gloat.

But at least he has a tender shoulder to cry on…and a warm smile to greet him after a hard day’s work. The Telegraph reports that the aging politician spent the night with Francesca Pascale, 26. The woman is an angel, for sure…descending from the heavens to succor the embattled Italian prime minister in his hour of need.

But let’s not get distracted by Berlusconi’s trials and tribulations. We’ve got a financial crisis on our hands. The Italian 10-year note yield jumped over 7% yesterday. It was at 7.25% when we looked this morning. At that rate, say the experts, it’s too expensive for the Italians to borrow. And if they can’t borrow, they can’t pay their bills — including about 300 billion euros-worth of debt that they’re supposed to roll over in the next 12 months.

Naturally, the holders of the debt are a bit nervous. And who holds it? Banks. That’s right. The same banks that bought housing derivatives and brought the whole world’s financial system to the brink of collapse. Now, they’ve got government debt up the kazoo. And once again, the world’s financial system edges towards a fall.

The New York Times is on the story:

Europe’s efforts to stem financial contagion foundered on Wednesday as investors dumped their holdings of Italian government bonds, prompting a global stock market sell-off.

Investors drove up the cost of borrowing for Italy beyond 7 percent, a critical level that many economists see as unsustainable and that last year precipitated bailouts for the financially troubled nations of Greece, Ireland and Portugal.

“Wednesday’s surge in Italian government bond yields has catapulted the euro zone crisis into a dangerous new phase,” said John Higgins, a senior markets economist with Capital Economics, in a research note.

Italy faces important tests of investor confidence at an auction on Thursday of one-year bills to raise 5 billion euros, and an auction next week of five-year bonds when it hopes to raise up to 3 billion euros. About 48 percent of Italian debt is held by Italian investors; the rest, 52 percent, is held by investors outside Italy, mostly in Europe.

It is unclear who beyond the central bank will be providing demand for Italian debt in the coming weeks.

Who, beyond the central bank? Our guess is that, soon or late, they will not look much further. Hold onto your gold, dear reader. Sell stocks on rallies. Buy more gold on dips.

And more thoughts…

The feds continue to lure American households into debt with subsidized mortgage rates. Bloomberg reports:

So far this year, Ginnie Mae, a corporation wholly owned by the government that packages mortgages backed by the Federal Housing Administration and other agencies, has issued more mortgage bonds than Freddie Mac, making it the second-biggest funder of home loans.

Ginnie Mae today reported record earnings, with net income of almost $1.2 billion for the fiscal year ending Sept. 30. The profit surpasses the company’s previous high of $906 million in 2008. Ginnie Mae said it financed nearly 60 percent of all US home purchases during the year, reflecting the increasing role FHA has been playing in the market.

“We’ve done a really incredible job supporting the housing market,” Ginnie Mae President Ted Tozer said in an interview. “And the taxpayer makes a ton of money on it.”

Congress created Ginnie Mae in 1968 to generate capital for government mortgage programs. The company developed the first mortgage-backed security in 1970. Today, its bonds are populated with loans insured by the FHA, the Department of Agriculture, the Office of Public and Indian Housing and the Department of Veterans Affairs.

“Our model is something people don’t really understand,” Tozer said. “It’s the government having its cake and eating it, too.”

What do you think, dear reader? Do you think Ginnie Mae — inventor of the mortgage-backed derivative — has also invented a model that allows the government to have its cake and eat it too? Can the feds sell debt to American consumers…make a profit out of it…and also render a good service to the public?

Or is this just another zombie racket, run by an overpaid hack, that shifts resources to favored industries and leaves American households even deeper in debt?


Bill Bonner
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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2 Comments on "Economic Amnesia"

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tony james

World economy on track for one world govt, and one leader, maybe the antichrist?


US collective amnesia on their track record on property rights traced :

The long march of Progressivist and Fabian blue blood ticket clippers was accompanied by appropriation and little miss muffet conservatives that wanted to sit on that land appropriation. Appropriation has run out of sustainable currency in the far flung fields of the empire and in collateral valuations at home.

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