Detroit Publishing Co. Curb Market 1905 "New York City, Broad Street exchange and curb brokers"
Ilargi: In a nice coincidence, while Nicole Foss (Stoneleigh) wrote about decentralization a few days ago in The Storm Surge of Decentralization, today Ashvin Pandurangi, independently from Nicole, also focuses on that theme, albeit from a completely different angle.
Perhaps even from the 180 degree opposite angle: it's precisely because the 1% push so hard for centralization that it's crucial for the 99% to push back and decentralize. And it's precisely becauseour economic models exist only by the grace of growth unchecked that we need to get out and take a step back, or that growth will surely eat us alive.
It's exactly like Arthur Miller's Willy Loman, as quoted by Ashvin, says: "After all the highways, and the trains, and the appointments, and the years, you end up worth more dead than alive".
That's what societies founded on perpetual growth and its inevitable companion, centralization, end up doing to 99% of their citizens: they degrade and pervert their dignity, their lives, and their value. In that sense, decentralization marks the beginning of a return to our true human potential, since it restores the values and dignity that make our lives worth living.
Unfortunately, today most of the 99% will not recognize this, and if they did it would scare them senseless, so they help push the growth paradigm forward even as it's gnawing at their bones. Life as a cog in a machine is the only life they've ever known. What else could there be? When you're told a hundred times a day that you live in the land of the free, what's not to believe?
It's high time we begin to understand to what extent the interests of the politicians and bankers and CEOs that we allow to make our decisions for us (read: against us), differ from our own. But since our education systems and media have denied the very existence of any such difference all of our lives, this understanding will be very hard to come by for 99% of the 99%.
"After all the highways, and the trains, and the appointments, and the years, you end up worth more dead than alive." -Arthur Miller, Death of a Salesman
Ashvin Pandurangi: The word of the last few centuries is centralize. That's what "institutions" do, whether they are technically financial, political, educational, "corrective", religious or medical; private or public. Those labels are largely irrelevant when you want to understand the fundamental nature of an institution. They are simply structured hierarchies of distributed power that strive to grow larger and more influential with each passing day.
Perhaps they are trying to influence the outcome of an election, the direction of foreign policy, the prices of a market, the focus of scientific research or the psychology of society's youth, but, rest assured, they are trying very hard to influence something. Some institutions are much more influential than others, and typically these are the most self-serving.
These institutions are also inherently self-limiting structures; fractal constructs that are self-similar and limiting at every scale, right up to that of our global economy and civilization. They never freely compete with each other to reach some generally productive equilibrium, but rather coerce their respective sectors to become more and more dependent on their functions over time.
By exercising more power and influence in a given field, they crowd out both their own opportunities for further expansion and the opportunity of other institutions to enter the sector and grow. The world's "too big to fail" financial institutions have clearly demonstrated how a few giant players can grow so large to threaten the collapse of the entire global economy when they can no longer grow.
The current crises of capitalism also demonstrate a rapidly progressing, yet age old trend which reveals the strategy of almost all of society's "industries" and their respective institutions - boundless aggregation. One of the major pieces of propaganda in today's financial world is that increasing mergers & acquisitions ("M&A") activity is a sign of growth and health in the economy.
It is, in reality, a sign of desperation and a harbinger of decreased resilience (a.k.a. "impending doom"), and that becomes quite clear when we consider the type of M&A activity that has been occurring over the last few years. Relatively large companies are suddenly finding themselves in a position of pure desperation, where they must either combine with other companies through some legal process or die.
I recently met a guy who was finishing his second year in Wharton Business School at the University of Pennsylvania, and had an internship position with an unnamed investment banking firm. He told me that his responsibilities at the firm were related to conducting "fairness opinions" for corporate clients that were involved in merger deals and wanted to insulate themselves from shareholder liability (if the bankersays it’s a fair deal, then it must be).
He also told me that M&A activity had unsurprisingly slowed down immensely since the onset of the "recession", in terms of total valuation of deals, but that it was markedly off its lows in 2009 and there were still many companies pursuing deals because they simply have no other options to remain viable. Many of these deals are increasingly conducted at the international scale, since domestic markets have already been picked clean to the bone.
These are mid-sized companies in manufacturing, IT, telecommunications, retail or services with a depressed consumer base, relatively high debt to equity ratios and very little ability to access the credit markets and obtain affordable financing; the institutions that have struggled for years to become "successful" business operations, but are now nothing more than basement bargains for much larger institutions.
They are the last remaining dust particles of competition within those industries, waiting to be vacuumed up as soon as the slightest window of opportunity presents itself. These opportunities are pervasive in the current volatile environment, where share prices of public companies are frequently pummeled down in tandem and the markets remain in an indefinite state of uncertainty due to opaque asset valuations and government policy.
As a targeted company's share price continuously comes under pressure, it becomes more vulnerable to "hostile takeovers", since it is cheaper and the larger acquiring company holds significantly more leverage, literally and figuratively, with the company's shareholders (which typically include its executives and directors). The latter must hastily decide whether to remain independent and hope for a miraculous recovery, or give in to a proposed merger.
As soon as the deal is announced and before it is even finalized, share prices could stabilize and increase on expectations of "synergies" from centralization (a.k.a. "a temporary bailout"), but only afterthe small-time, passive investors have already jumped ship. Indeed, it is no coincidence that U.S. M&A activity picked up in 2009-10, right in time for the Fed's QE asset purchases and the stock market rally. Companies who have remained off of public exchanges are by no means immune to this scourge of centralization, either.
That fact has become especially true in recent years, when "private equity groups" re-surged as a popular and relatively discreet vehicle for institutional investors (such as pension funds) and extremely wealthy individuals to conduct leveraged buyouts of various companies around the world. Ironically, the private "equity" group typically uses substantially less than 50% of investor equity in the buyout, and finances most of the deal through debt.
Dan Primack for CNNMoney reported on M&A trends in early 2011.Report: 2011 M&A gaining on 2007 record-breaker "The 2011 total represents a 58% increase over the same period in 2008, inclusive of a 52% increase in private equity-sponsored transactions. About half of the deal volume is for U.S. targets (up 36%) and around one-quarter is for European targets (up more than 100%), while both emerging market and cross-border deals experienced declines.
Energy and financials were the leading sectors, although materials experienced the largest year-over-year growth (see chart). Financials were sparked by the $59 billion restructuring for AIG -- a deal whose inclusion here is questionable -- while energy got a boost from Duke Energy agreeing to buy Progress Energy for $26 billion. Those are the first and third-largest so far in 2011, sandwiched around AT&T buying T-Mobile for $39 billion.Graph: Fortune; Source: Thomson Reuters On the private equity side, the largest deal is Blackstone Group's (BX) agreement to acquire the U.S. shopping mall assets of Australia's CentroProperties for $9.4 billion. It's followed by Apax Partners buying Smiths Medical for nearly $3.9 billion and Clayton Dubilier & Rice taking Emergency Medical Services private for $2.9 billion.
In a separate report, S&P Leveraged Commentary & Data reports that leverage multiples for large deals have climbed half a turn to 5.2x -- lower than the heights of 2007, but besting 2008, 2009 or 2010.
Since private equity funds are illiquid investment vehicles that require long-term commitments, much of the capital invested during the boom of the mid-2000s is still in the process of being deployed, despite the horrendous macro-economic situation. Small to mid-sized companies can neither run nor hide from the slithering tentacles of leveraged capital seeking returns, which have only increased in length since 2010.
It should be pointed out, though, that the massive $39 billion deal between AT&T and T-Mobile has recently fallen apart, costing the former $4 billion simply to walk away from the deal. Even the highly-conflicted Federal Communications Commission and Department of Justice couldn’t ignore how damaging this monopolistic merger activity would be to the telecommunications industry, and therefore they decided to block the deal. . That’s the official story, anyway.
Now that we have reached the end of 2011 and the European sovereign debt crisis has reached a crescendo from which there is no turning back, M&A volumes are once again being pummeled down as they were in 2008. Once again, though, we are talking about total valuation of deals and not necessarily the number of mergers and acquisitions that will be taking place in 2012.
Helen Thomas and Anousha Sakoui of the Financial Times report on the opportunities for further centralization of corporate assets:Collapse in M&A Amid Debt Turbulence "Fourth-quarter M&A volumes fell 32 percent to $375.3 billion from the previous three months, led by a 41 per cent decline in Europe. The drop, combined with a pullback in equity issuance amid turbulent markets, contributed to an 8 per cent fall in investment banking fees to $72.6bn for 2011, against 2010.
In Europe, fees totalled only $2.57 billion across all products, the worst quarter since records began at data-provider Thomson Reuters in 2000. "Volumes in equity and debt capital markets and M&A in 2012 are likely to be challenged, but with a crisis comes opportunity," said Manuel Falco, co-head of European investment banking at Citigroup.
"There will be huge opportunities in the public sector to acquire state-owned assets, and companies will need to issue equity [for] defensive [purposes]. The crisis presents the best buying opportunity for acquiring a company in Europe."
Should we be surprised that the wholesale destruction of European economies is described as presenting the "best buying opportunities" in history? Perhaps we should call them the "best opportunities for institutional cannibalism in all of history". This centralization process does not only take the form of "voluntary" mergers, especially in present times, but more often results from bankruptcy filings that force companies to liquidate or restructure their assets.
There have been quite a few examples of this dynamic in the world of high-stakes international finance over recent years, and there are many more to come. While the number of actual US "bank failures" in 2011 reached a 3-year low of 90, perhaps due in part to the pickup in financial merger activity noted above, the number of "problem banks" listed by the FDIC has remained pretty much constant over this same time period.
The largest, most recent victim of the global debt crisis was MF Global, a large broker-dealer, which was bankrupted and is in the process of being liquidated. Many of MF Global’s European sovereign debt assets were already sold off to investors such as George Soros and JP Morgan at huge discounts (5%) to fair market value. . There are also claims that MF Global fraudulently filed Chapter 7 as a securities broker, rather than a commodities broker, to give major creditors access to the company’s cash before its clients.
So as the lower and upper "middle class" citizenry of the developed world are being rapidly digested in the acidic bowels of financial capitalism, the "big, yet not quite big enough" institutions are systematically having their "assets" aggregated on the books of a few supranationalgiants at not only cheap prices, but through illegal transfers and illegally discounted prices. As the weak wither and die, the strong draw lots to see who among them will be devoured first (JPM and Goldman always draw the biggest straw).
Whether it's Bear Stearns and Lehman handed over to Barclays and JP Morgan for a pittance, a large telecommunications provider targeted by AT&T, a few executive agencies rolled up into the Federal Reserve via Dodd-Frank or MF Global’s assets auctioned off at discounts to Soros and JPM, there is very little choice in the matter for either side of the deal. Either you submit to the "mercy" of centralization, or you are shoved out of the "market" and lose every speck of institutional value you had left.
Make no mistake, these are not rational economic actors acting in the best interests of their stakeholders and maximizing long-term institutional value, but desperate, irrational and short-sighted actors coerced into deals for a quick payoff. The low-level employees and mid-level managers of the acquired institutions usually find themselves joining a line in the local unemployment office or perhaps attending a "networking seminar", designed to create the illusion that they remain important to the system.
Meanwhile, there are millions of new, starry-eyed faces that have been spewed out of various "educational" institutions, wading tens of thousands deep in debt, who are now "willing" to work longer hours for much less salary and fewer benefits. Your degree, work experience and interpersonal skills mean next to nothing, because there is simply no more room for your specialized "credentials" in the institutional system.
As the unsurprisingly misleading chart from the BLS shows below, "mass layoff events" (at least 50 initial claims for UI filed against an institution in a 5-week period) have hovered around 1500/month for the last two years. . Initial unemployment claims are generally revised upwards after initial publication and still remain well above what is necessary to actually improve the unemployment situation. Expect these mass layoffs to only get worse in 2012.
As noted above, much of this shake-up is occurring in the financial industry right now, where large banks are shedding assets like skin cells to raise capital, and of course this process starts with the only asset that can’t afford to be shed, their low to mid-level employees. The graph constructed below only captures those banks which have announced mass layoffs over the next year or so, and both the number of banks and number of planned layoffs are sure to increase as the year progresses. It is also important to remember many of these banks already conducted mass layoffs in the shake-ups and restructurings of 2008-09.
The only thing that matters now is how much of an institutional slave you can force yourself to be, which means lower wages for more hours and no benefits; unless, of course, you can count yourself among the entrenched class of the top 1-5%. These corporate directors, high-level officers and government officials, who bled their respective institutions dry, will typically secure positions in an acquiring institution. That, or they will secure a similar position at another large institution somewhere in our global society, only a private jet ride and a gated complex away.
At the very least, they can retire with a healthy severance package and/or pension, start up a "non-profit" organization and invariably use it as a front for a corporate interest lobby. Most of the small and mid-sized clients/customers in these industries are also squeezed like the small-fry employees, because they are not benefiting from "economies of scale", but instead are paying for the privilege to access the centralized market. Nowhere is this fact more evident than in the financial industry, where individual and small business debtors are charged ever-more interest and have to put up ever-more collateral to obtain credit and/or rollover obligations.
While the effect of the institutional squeeze is to generally depress wages and asset/consumer prices, the effect of that depression is to eliminate choices and make everything much less affordable. Meanwhile, the unfortunate (and relatively large) clients of failing institutions such as MF Global have their funds outright stolen from them and transferred to large institutional creditors who were engaged in "repo" lending and derivative trades with the now bankrupt entity.
Welcome to the world of exponential centralization, where 99% of the population reeks of desperation and the other 1% personifies destruction in the form of "synergistic" acquisitions. The latter will inject a few more drops of lifeblood into the heart of ponzi-aggregation capitalism, but it too is rapidly losing its ability to create the illusion of economic stability and growth. That driving force of capitalism, capital, has become much too scarce for the centralization ponzi to continue outside of direct totalitarian force.
The largest institutions are clearly the least flexible to "new and unexpected" conditions that will arise, and therefore are the most acutely vulnerable to "black swans" and systemic shocks in the near-term. When, not if, some politician, bureaucrat or banker takes one wrong step on the tightropes stretching across every line of latitude from the North to South Pole, look out below. Despite what we are told, nothing material of man is immortal and we only get one chance to survive this world. Our global institutions already blew theirs many years ago, and most are now worth much more dead than alive.
WPA Federal Art Project poster from New York, 1936
At the start of a week that has been dubbed "historical" and "one of the most important moments in Europe's history", I can't seem to forget the statements by Merkel and Sarkozy sometime mid-October, when both solemnly pledged that by the end of that month the euro crisis would be resolved. We know where that went. And we also know that establishing stronger fiscal ties across the continent, the somewhat vague "plan" that seems to be worked out in all haste, even if it can be accomplished, which is by no means guaranteed, will take a lot of time. Time that Europe almost certainly won't be allowed. Merkel, Sarkozy, Monti, Draghi, they've lost all credibility in the eyes of the markets. The only thing they still trust them to do is throw more of their people's funds and future funds as free money at the fire, which the markets can then lap up. At some point, though, the free money will run out.Satyajit Das has some nice quotes:The Sovereign Debt Train Wreck The US is in serious, perhaps irretrievable, financial trouble. Peter Schiff, president of Euro Pacific Capital, identified the state of the Union with characteristic bluntness:"Our government doesn’t have enough spare cash to bail out a lemonade stand. Our standard of living must decline to reflect years of reckless consumption and the disintegration of our industrial base. Only by swallowing this tough medicine now will our sick economy ever recover."There is a lack of political or popular will to take the action necessary to even stabilise the position. The role of US dollars and US government bonds in the financial system mean that the problems are likely to spread rapidly to engulf other nations. As John Connally, US Treasury Secretary under President Nixon, beligerently observed: "Our dollar, but your problem."
Connally's observation is about to be thrown right back into the face of America: "Our euro, but your problem." Europe doesn't have the means to save itself. It will look to the rest of the world, especially the US, to do it instead. The same US that "... doesn’t have enough spare cash to bail out a lemonade stand. Nice dilemma.As former broker Ann Barnhardt observes: Europe is mathematically impossible. It cannot be saved. [..] You even want to make a start at trying to bail out Europe we are talking $25 trillion just to start. [..] if you were going to bail out the entirety of Europe - you would now be talking about hundreds of trillions of dollars. Whatever concocted statements or plans come out of the EU summit on Friday, December 9, it doesn't really matter anymore. The best the Europeans can do is extend and pretend the can down the road for a few more days or weeks. So how about it, America?Here's Stoneleigh with our 1000th post on TAE:
Stoneleigh:Look Back, Look Forward, Look Down. Way Down.
This is the 1000th post at The Automatic Earth, so it seems appropriate to review our message and update our projections - to look back and then look forward. Since the beginning of TAE in January 2008, and before that at The Oil Drum Canada, our purpose has consistently been to warn people that a decades-long credit expansion is ending, and that, as a consequence, we are in the grip of a very serious financial crisis. The first leg down (October 2007- March 2009) was just a foretaste of what credit crunch really means, and the long sucker rally of March 2009-May 2011 was enough to put people back to sleep again, secure in the mistaken belief that supposedly omnipotent central bankers could postpone any kind of reckoning indefinitely. Now in early December 2011, we are seven months into the next phase of contraction, but most have yet to recognize that the trend has once again turned down.Financial bubbles are not a new phenomenon, but are in fact quite common in the historical record. Every few decades, a new generation rediscovers the magic of leverage, igniting a rapid expansion of credit, and therefore debt. Every time humanity experiences a bubble, it fails to recognize the pattern. The lessons of the past are sadly never learned. Each time the optimism is highly contagious. In the larger episodes, it crescendos into euphoria, leading societies into a period of collective madness where risk is embraced and caution is thrown to the wind. Sky-high valuations are readily rationalized - it's different here, it's different this time. We come to believe that just this once there might be a free lunch, that we can have something for nothing. We throw ourselves into ponzi finance, chasing the mirage of speculative gains, often through highly questionable and outright fraudulent practices. Enron, Lehman Brothers, and recently MF Global, are but a few egregious examples of what has become an endemic phenomenon.The increasing focus on chasing speculative profits parasitizes the real economy to a greater and greater extent over time. After all, why work hard for small profits in the real world, when profits on money chasing its own tail are so much greater for so little effort? Who even notices the hollowing out of the real economy, or the conversion of large amounts of capital into waste, or the often pointless depletion of non-renewable resources, or the growing structural dependency trap, when there is so much short term material prosperity to pursue? In such times, the expansionary impulse drives the development of multiple engines of credit expansion. The reserve requirements for fractional reserve banking (already a ponzi scheme) are whittled away to almost nothing. Since the reserve requirement effectively determines the money supply multiplier effect, that multiplier becomes almost infinite. The extension of credit through the shadow banking system removes the semblance of central bank control over monetary expansion. Securitization and financial innovation also create putative wealth from thin air, using underlying collateral to derive layers of additional illusory value. In this way, excess claims to underlying real wealth are created. The connection between the rapidly expanding virtual worth of the derivative instruments and the real value of the underlying collateral becomes ever more tenuous.In 2007, Bill Bonner of Agora Financial produced a descriptive example of this process.Imagine a man who makes his living digging ditches. He may hire himself out at a daily rate of, say, $25. The old capitalists would have paid no attention to him – he is just one of millions of small entrepreneurs getting by in life.But today’s financial hustlers will spot the opportunity. Let’s take him public, they will say. We’ll raise his daily rate to $30…pay him his $25…and the rest will be our "profit." We’ll sell shares to the public at a P/E of 20…let’s see, 20 x $5 x 250 days per year = $25,000. All of a sudden, the ditch digger has a capital value of $25,000. Then, they borrow $20,000 from a hedge fund…and pay it to themselves for structuring the deal. Now, the hustler has $20,000 in his pocket; the hedge fund has a high-yield bond worth $20,000; the shareholders have $25,000 worth of stock; and the poor man is still digging his ditches.Then, an even more ambitious wheeler-dealer will come along and decide to "roll up" the whole industry – bringing the ditch diggers together into a multi-national consortium. Now they can all do cross-border transactions…including derivatives. And now ditch-digging is a major business, suitable for large investors…with more investment coverage and a higher P/E ratio. Soon all the world’s banks, pension funds, insurance companies, and hedge funds have some of the ditch digging paper – debt or equity – and billions in fees and commissions have been squeezed out of ditches by the financial industry.That, patient reader, is the way (the world-over) that industries and assets are now being bought, sold, refinanced, leveraged, re-jigged and resold. In the old days, companies went to investors or to banks for capital and cultivated a relationship with them that was long and fruitful. Now, it’s all wham-bam-thank-you-ma’am capitalism. Inquiring capitalists now only want to know one thing – how fast can we do this deal? How many points can we get out of it and how much leverage can we get? And whom can we dump it on, when we’re done?
This is - the proper definition of - inflation : an increase in the supply of money plus credit relative to available goods and services. In times of speculative mania, when people no longer care what they pay for something on the grounds that someone else will always pay more, and money is being created with abandon in order to satisfy the acquisitive impulse, credit hyper-expansion constitutes inflation on a massive scale. Expansion is the only reality many of us have known, hence it is no wonder we imagine it can be a permanent condition.As John Rubino wrote, credit gains 'moneyness' as during periods of ponzi finance, creating excess claims to underlying real wealth:As the global economy expanded without a hic-up, more and more instruments came to be used as a store of value or medium of exchange or even a standard against which to value other things—in other words, as money. Thus mortgage-backed bonds and even more exotic things came to be seen as nearly risk-free and infinitely liquid....credit gained "moneyness," which sent the effective global money supply through the roof. This in turn allowed the U.S. and its trading partners to keep adding jobs and appearing to grow, despite debt levels that were rising into the stratosphere. For a while there, borrowing actually made the world richer, because both the cash received and the debt created functioned as money.
In the process of credit expansion, we borrow from the future through the creation of debt. Our focus on virtual wealth has very significant real world effects, as it distorts our decision-making in ways that guarantee bust will follow boom. We bring forward tomorrow's demand to over-consume today, frantically building out productive capacity in order to satisfy that seemingly insatiable demand. As money supply increase leads the development of productive capacity during this manic phase, increasing purchasing power chases limited supply and consumer prices rise. Increasing virtual wealth also drives up asset prices across the board, strengthening speculative feedback loops that inevitably strain the fabric of our societies, all too easily to the breaking point. However, concern about the inflationary trend continuing into the future is misplaced. That is where we have come from, but it is not where we are going. Simply extrapolating past trends forward is tempting, but does not constitute meaningful analysis and has no genuine predictive value. It is far more important to be able to identify coming trend changes and to understand where these will lead. Decades of inflation lie behind us. It is deflation - the contraction of the supply of money plus credit relative to available goods and services - that lies ahead. The threat we are facing is the rapid and chaotic extinguishing of the myriad excess claims to underlying real wealth created during our thirty years of credit hyper-expansion.Here is another illustrative parable of financialization run amok, looking this time at the real world consequences that follow. Whereas credit expansion pushed up both demand and prices, creating the perception of great wealth in the process, the inevitable bust crashes prices and ruins businesses. The artificial demand boost disappears, but rather than return to its previous level, demand crashes and remains depressed for a long period of time. The greater the scale of the credit expansion, the greater the effect of bringing demand forward during the boom years, and the greater the crash thereafter. With little demand, there is no price support at anything like previous levels, so prices also fall and remain low, potentially for years, as we saw in the depression of the 1930s.Helga is the proprietor of a bar.She realises that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronise her bar. To solve this problem, she comes up with a new marketing plan that allows her customers to drink now, but pay later. Helga keeps track of the drinks consumed on a ledger (thereby granting the customers' loans).Word gets around about Helga's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Helga's bar. Soon she has the largest sales volume for any bar in town. By providing her customers freedom from immediate payment demands, Helga gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Helga's gross sales volume increases massively. A young and dynamic vice-president at the local bank recognises that these customer debts constitute valuable future assets and increases Helga's borrowing limit. He sees no reason for any undue concern, since he has the debts of the drinkers in Helga's bar as collateral. Helga, flush with borrowed money, gives in to the increasing demands from her employees and dramatically increases their rates of pay and installs what are the community's best working conditions.At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS. These "securities" then are bundled and traded on international securities markets. Naive investors don't really understand that the securities being sold to them as "AA" "Secured Bonds" really are debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by Helga's bar. He so informs Helga. Helga then demands payment from her alcoholic patrons, but being unemployed they cannot pay back their drinking debts. Since Helga cannot fulfil her loan obligations she is forced into bankruptcy. The bar closes and Helga's 11 employees lose their jobs and all their accumulated entitlements.Overnight, DRINKBOND prices drop by 90%. The collapsed bond asset value destroys the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Helga's bar had granted her generous payment extensions and had invested their firms' pension funds in DRINKBOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds.Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers. Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multibillion dollar no-strings attached cash infusion from the government.The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Helga's bar.
When a credit expansion reaches the point where the debt created can no longer be serviced by a hollowed-out real economy, and the marginal productivity of debt becomes negative, continued growth is no longer possible. Ponzi schemes which can no longer grow implode. The first stage of this process began in 2008, with the first reversal of M3 plus total credit market debt since WWII.The process of monetary contraction following a ponzi expansion is implosive because it involves the destruction of virtual value - the fairly abrupt realization that the emperor has no clothes. A pertinent analogy is that of a giant game of musical chairs where there is only one chair for every hundred people playing the game. Imagine what happens when the music stops. A few will be lucky and secure a chair. The rest represent excess claims, and those claims are then extinguished.Credit only functions as a money equivalent during times when the suspension of disbelief can be maintained. Once confidence is lost and a toxic combination of fear and suspicion takes hold, a pile of human promises that obviously cannot be kept ceases to hold the illusion of substance. At that point one can expect is significant contraction in the scope of what constitutes money.As John Rubino wrote of the 2008 crisis,When the U.S. housing market—the source of all that mortgage-backed pseudo money—began to tank, hedge funds found out that an asset-backed bond wasn't exactly the same thing as a stack of hundred dollar bills. The global economy then started taking inventory of what it was using as money. And it began crossing things off the list. Subprime ABS? Nope, that's not money. BBB corporate bonds? Nope. High-grade corporates? Alas, no. Credit default swaps? Are you kidding me?........No longer able to function as money, these instruments are being "repriced" (a slick little euphemism for "dumped for whatever anyone will pay"), which is causing a cascade failure of the many business models that depend on infinite liquidity.
No market moves only in one direction. The tug of war between greed and fear, and consequent ebb and flow of confidence, mean that the scope of what constitutes money can demonstrate periods of reflation as suspension of disbelief temporarily reasserts itself. The two year sucker rally from March 2009 saw the monetary contraction process reverse temporarily, and a number of factors resumed trajectories characteristic of the expansion years.As we have said many times, rallies are kind to central authorities, because the supportive psychology of a rally, complete with suspension of disbelief, allows their actions to appear effective, temporarily. Stimulus packages seemed to achieve the desired ends, at least in terms of elevating the markets, suggesting that we were facing a relatively simple problem with a straightforward solution. A dangerous perception has developed that central bankers are so much wiser and better informed than their predecessors in other times and places, that the lessons of the past have been learned and the pitfalls of the past avoided. This is of course the height of hubris. If a predicament such as this could be so easily resolved, then there would be no similar crises in the historical record. We cannot simply assume that previous central authorities were blind, ignorant, unimaginative or disinterested in self-preservation.Now that the downtrend has reasserted itself with a vengeance, the supportive psychology of a rally no longer exists. Confidence is ebbing again, and fear is sharply in the ascendancy. We can already see how ineffectual the actions of central authorities are under such circumstances. Everything they do is too little, too late, and every failed attempt to stem staunch the financial hemorrhage only makes them look more desperate, which undermines confidence further in a vicious circle.Europe is leading the contraction this time, providing a telling example of the powerlessness of central authorities in the face of a collapsing credit ponzi. The stability fund (EFSF) was originally to be €220 billion, but it was obvious long before that was agreed that €220 billion would be grossly insufficient. Agreement , at the expense of the Slovakian government, was obtained to increase the fund to €440 billion, but by this time there were already public discussions of the need to leverage the fund by a factor of five. A further agreement to extend the facility to a trillion euros was already behind the curve, as it was common knowledge that at least €2 trillion would be needed, and that would cover only Greece. Clearly, several other members of the eurozone would require the same treatment, and there is no provision for their difficulties. At the heart of the problem lies the loss of money equivalence of credit instruments previously seen as risk free. As 'moneyness' is lost, the effective money supply contracts, and does so very rapidly. This is deflation by definition.CNBC's John Carney explains:It’s easy to miss the contraction of the money supply because it involves a destruction of financial assets that we do not usually think of as "money" but that, in fact, operate as money — or did until relatively recently. The fundamental characteristic of modern fiat money — as opposed to commodity-based money under a gold standard — is that it serves as a medium of exchange. This means dollars or euros, for example. Basically, the local currency.Within the banking system, however, other financial assets also serve as money. These assets can be used to meet margin calls, collateralize obligations, and make payments. U.S. Treasury bonds are the most obvious example of this kind of money-equivalent financial asset. The U.S. government recognizes the equivalence of Treasury bonds and dollars within the banking system by not requiring banks to hold any reserves against the bonds. They are counted as "cash or cash equivalents" on balance sheets of U.S. public companies.Over in Europe, sovereign debt issued by euro zone nations also served as a money-equivalent inside the banking system. Banks were not required to hold reserves against sovereign debt. They used them as collateral for obligations, and made inter-bank payments with sovereign bonds. The bonds were, in short, as good as euros.When the markets turned against nations like Greece and Italy, the cash-equivalency of their bonds came into doubt. It was obvious that they could lose value, and quite rapidly. The debt could no longer be used as collateral, except at extreme discounts.The discounting of sovereign debt, then, meant that there was less money in the European banking system. If a one million euro bond previously held as a money-equivalent is now worth just 600,000 euros, the holder has lost 400,000 euros. Multiply that across the banking system, and you have millions of euros of money-equivalents simply vanishing.It is exactly as if some paper-eating plague just started rotting physical euros. The money supply of Europe is vanishing.
The attempt to ring-fence Greece, allowing a one-off 50% haircut for them alone, is also clearly insufficient, given the obvious predicament of Portugal, Ireland, Spain and Italy, and the mounting problems of Belgium, France and Austria. The contagion is rapidly reaching the core of the eurozone, the actions of governments being overtaken by events at every step. In addition, a decision to declare a 50% haircut not to represent a credit event, thereby triggering credit default swap payouts, is very dangerous. If a 50% haircut is not a credit event, then what protection is afforded by a CDS contract, and what therefore is its monetary value? On the other hand, allowing CDS contracts to be triggered would reveal the huge extent of counter-party risk in the CDS market, similarly demonstrating the worthlessness of this supposed form of insurance. The CDS market has a built-in meltdown mechanism, and is destined to be a significant factor in credit implosion. The authorities were damned if they did and damned if they didn't. The price of being in a position of perceived power at such as time is to see one's reputation go down in flames for being unable to solve the insoluble.The scale of the European debacle is not yet generally understood. While it is agreed that current stability funding is woefully inadequate, there are few people taking a realistic look at the scale of the potential losses across countries and asset classes. Ann Barnhardt, who ran a brokerage until recently (when the MF Global collapse led her close it on the grounds of no longer being confident of the safety of her clients' funds) is one individual who pulls no punches in her assessment of the losses Europe is facing, and the impossibility of repayment. In an interview with Jim Puplava she looks at the scale of the problem as a whole:Well, if anybody out there understands fourth grade arithmetic you know from metaphysical certitude that Europe is done. Europe is mathematically impossible. It cannot be saved. You want to make a start. You even want to make a start at trying to bail out Europe we are talking $25 trillion just to start. And it would then - if you were going to bail out the entirety of Europe - you would now be talking about hundreds of trillions of dollars. Okay, people, there isn’t that much wealth or money on the surface of the earth. The total gross domestic product of the entire planet earth is I think just under $70 trillion. And we are talking about in excess of $100 trillion to bail out Europe? This is now mathematically impossible.It's not a matter of if the global financial system is going to collapse. Oh, it's going to collapse. You better trust and understand that. It's just a matter of when. And these piddling little maneuvers that these people are making, that the Fed is doing. Oh, we are going to give Europe some money. Okay. What I saw this morning, what the Fed is getting ready to do in terms of Europe, is keep Europe going for another seven days. Well, fantastic. Thanks for that. That is literally the brain dead mindset of these politicians. All they are doing is looking to kick the can down the road. At first it was kick the can down another 10, 12 years. Then it is kick the can down the road for another year. And then it was well, let’s kick the can down the road for another few months. Now we're literally to the point where all we can do is kick the can down the road for a matter of a few days. It's not going to make it. I will be very surprised if we make it until Christmas.
Over the next year and beyond, we will discover what credit crunch really means. It is an economic seizure, and its effect is devastating. Credit in its myriad forms represents the vast majority of the money supply, and it is about to lose its money equivalency. This will leave only cash, and that cash will be extremely scarce. Aggravating the effect of crashing the money supply will be a substantial fall in the velocity of money, meaning that money will largely cease to circulate in the economy as people hang on to every penny they can get their hands on. Money is the lubricant in the engine of the economy in the way that motor oil is the lubricant in a vehicle engine. Attempting to run any kind of engine with insufficient lubricant will result in that engine seizing up.Without the monetary exchange that we have built into our system at every level, it will not be possible to connect buyers and sellers, producers and consumers. Nothing moves in an economic depression. This is the polar opposite of the frenetic activity of the inflationary boom years. Instead of the orgy of consumption to which we have become accustomed, we will experience austerity on a scale we cannot yet imagine. Demand will evaporate, not because people do not have wants, but because they will lack the purchasing power to turn those wants and needs into consumption. Demand is not what we want, but what we can pay for. We will be looking at falling prices as lack of demand undercuts price support, but because purchasing power will be falling much more quickly than prices, everything will become far less affordable, even as prices fall. As a much larger percentage of the much smaller money supply begins to chase essentials, those will receive relative price support, and will be the least affordable of all.We must prepare right now for the onset of a long period of deflation and depression. Many people are reluctant to make preparations until they see the roof on fire, but by then it will be too late to take action. To reiterate the advice TAE has been offering since its inception - hold no debt, hold liquidity in order to maintain freedom of action, gain some control over the essentials of your own existence, and build social capital in your own communities. There is no time to waste in securing what you have, under your own control to the greatest extent you can manage. The future is at our doorstep, and it does not look like the past as we have known it.
National Photo Co. Bond Vault 1914 "Treasury Department, Office of Comptroller of Currency -- bond vault. Contains bonds to the value of $900 million securing government deposits and postal savings fund"
I’m not a technical analyst or a fundamental analyst or any other type of equity market analyst. What I am is just a guy who likes to think he can spot completely nonsensical propaganda when he reads or hears it. You know, the type of non-stop propaganda that attempts to manage perceptions/expectations and convince "investors" that, while things are obviously very bad in the real economy, everything is still just hunky dory in the wonderful world of equities. Case In Point Some mainstream market analysts chimed in after the serial S&P ratings downgrades of nine Eurozone countries, and specifically the one-notch downgrade of France from AAA to AA+ (ratings outlook still negative), to say that the market had already "priced them in" and therefore they are really no big deal. S&P had put all of these countries on negative watch back in December before the latest and unsurprisingly innocuous EU Summit, so the downgrades were no surprise. Here are just two examples of a very pervasive and perverse logic, presented by The Telegraph:S&P cuts ratings of nine eurozone countries: reaction Fabrice Seiman, head of Lutetia Capital, said: "S&P is absolutely right. France is paying the price of 30 years of irresponsibility in public finances. French politicians on the right and on the left fell short of the job by not taking measures to reduce spending." I think this is already priced in. There should not be any sizable reaction, but there could be a technical reaction on the Franco-German spread. It should be limited to the long-term and if there is a reduction in spending." Bill O'Grady, chief market strategist at Confluence Investment Management, said: "If France had been downgraded more than one level it would have precipitated a crisis. This is not good but it was anticipated, baked in. For oil it is probably a neutral event. If it raises concerns about a worsening economic environment it would be bearish."
Ashvin: That logic does sound appealing on the surface and many others like to parrot it, but the first question to pop into my mind was this – how can the market "price in" very significant developments in Euro sovereign credit markets by steadily increasing in valuation since they became aware those developments would occur?? Since the S&P put a bunch of EZ countries on negative watch on December 5, 2011 and the EU Summit on December 9, the S&P500 has risen almost 6%.
That’s a boat load of downgrades the market appears to have priced in over the last month while very little "positive" news has come out of Europe. Now I’m confident that the initial reaction to my question above would be, "that’s a really simple and stupid question to ask!". Fortunately, there are several great analysts out there who have reached similar conclusions about these equity markets, which have allegedly "priced in" everything under the Sun, and have provided us with slightly more nuanced arguments than my own. The U.S. Dollar (and Treasuries) has been increasing in value alongside U.S. equities, so the pundits should find it very difficult to explain the upwards "pricing in" market action of the last month by saying it is a nominal increase of shares priced in dollars. What we have is a very significant divergence between the dollar index and equities, as Charles Hugh Smith outlines in his piece, A Useful Fiction: Everybody Loves a Melt-Up Stock Market, and one that must close in the near future. The following charts of the dollar index ($DXY) and 5-year Treasuries are from M3 Financial Analysis:
The truth is that the very notion of the market "pricing in" events as the investor collective becomes aware of them is flawed. In the comprehensive TAE classic of 2010, Fractal Adaptive Cycles in Natural and Human Systems, Nicole Foss delves into Robert Prechter's theory of "Socionomics" (among other things) and how it can explain market valuations as a function of endogenous factors, such as the collective mood of investors, rather than exogenous events relayed by "the news".Bob Prechter's socionomics model combines Elliott's observed fractal patterns with an understanding of human herding behaviour, comprising a comprehensive challenge to prevailing notions such as the Efficient Market Hypothesis by reversing causation and recognizing the role of emotional/irrational behaviour as the prime market driver. While the real economy demonstrates negative feedback loops, finance is thoroughly grounded in positive feedback.
Ashvin: Mish Shedlock also touched on this concept in a post earlier this week. He illustrated that, at best, the market should be viewed as a contrarian indicator for future economic trends due to its function as a gauge of extreme sentiments, and, at worst, it shouldn't be viewed as an indicator of anything at all.Cherry Picking Timeframes on Alleged Leading Indicators; Big Change In LEI on January 26 "The stock market is not a leading indicator of the economy. Rather, the stock market is a coincident indicator of sentiment towards equities. ... Far from being a leading indicator, on an absolute basis the S&P has a perfect track record of peaking right before or just as a recession starts. This is just as one might expect from a gauge of equity sentiment which tends to peak right before a downturn in the economy (with everyone extrapolating good times forever into the future). ... On a percentage change basis, the S&P 500 is not leading, not lagging, and not coincident. Instead it is completely useless mush."
Ashvin: It's not just the "fringe bloggers" drawing these conclusions about the market, but also such "reputable" financial institutions as UBS. Granted, the well-intentioned bankers over there also point out that the French downgrade, among others, was expected and shouldn't affect near-term credit spreads too much. Instead, they choose to focus on the effects it will have on the state of realpolitik in Europe’s core, and how that is certainly not something which is "priced in" at all. Indeed, only market shills and fools can even pretend to separate the two (finance and politics).
Ashvin: So if the equity markets are "pricing in" anything, it's the pure hope that all of these downgrades of countries, banks and corporations will continue to be glossed over by bond markets, that political/economic imbalances in Europe haven't been exacerbated, that the Greek government and its creditors aren't helplessly struggling to reach a "voluntary" debt reduction deal before a technical default in March becomes inevitable, that China/India aren't facing "hard landings" and that the U.S./U.K. economies will not be dragged down by their own housing markets, corporate [lack of] earnings, unemployment trends or any of the above. Some people will tell you that the only thing the markets need to keep their manic phase intact is the inevitable QE money printing that the Fed will officially announce, which has conveniently been "just around the corner" for almost a year now. Despite those consistent predictions of QE3, I made clear that I didn’t expect the Fed to relent in 2011, and many of the same financial and political reasons underlying that expectation still stand. The primary reasons being the conundrum reflected by the fact that the S&P is still hovering around 1300 (and oil around $100/bbl), which makes the marginal benefits of QE very slim, and the politically volatile situation in the run-up to November’s elections. On the other hand, the financial threats from the Euro crisis and a strong dollar (weak euro) have clearly intensified over the last few months, and the ECB is even more constricted from printing than it has ever been (at least for anything other than sub 3-year sovereign paper through its indirect LTRO, which still doesn’t reflect net cash entering EZ bond markets). Perhaps these developments will finally convince the Fed to "pull the trigger" on QE3, but then many questions still remain – how many trillions are needed to boost "risk appetite" for more than a few weeks and what happens when those trillions are perceived as "not enough"? Like I said at the beginning, I'm not any sort of market analyst, but there do seem to be a whole slew of developments starting to weigh on collective investor sentiment right now, which will only get heavier in the upcoming weeks and months. No one can tell you that any of these negative and ongoing developments herald an imminent market crash or how exactly they will impact shares. What I can say with confidence, though, is that none of them are insignificant bumps in the road. They certainly did not "remove any uncertainty" from the markets and they have in no meaningful way been "priced in" by these markets either.