Economic Musings I: The State of “the” Economy
It’s always amazed CrisisMaven how little a trained economist could know of the world going on around him or her, so as to not spot a bubble for example. Obviously it has to do with the indicators they use which are only remotely related to reality. Those who can only calculate a model with maybe two enterprises and “a” state are probably not able to fathom a newspaper article talking about how the fashion in clothes affects shoe manufacturers. Or that there is an association of dye manufacturers and the fashion industry that today knows which shades of green, blue or pink will be en vogue in, say 2014.
(Find more statistics and indicators etc. in our References section!)
Well they do, because that’s not left to chance – the chemical manufacturers of dyes have to know today in order to develop the necessary chemicals or mixtures. So one can know many economic developments in advance unless one stubbornly ignores the writing on the wall, er, rather the newspaper. One could have spotted a bubble in property prices by relating the rent (or return in general) with the house price to find out that houses were by and large much overpriced a while ago.
When you want to find out where and when a housing market is going to slow down, you don’t look at building permits, loan applications or inventory, they’re all quite lagging indicators, no, you ask the lady in the classified section of your local newspaper if and how many realtors are late on their ad payments and if there’s a trend – that’s a forecasting indicator instead of a lagging one. But in a central bank you don’t venture down to the local ads section in the Spokane Advertiser, no, no, you have brilliant rocket scientists who make figures up and then interpret them. Well, CrisisMaven would rather read the newspaper used to wrap fish than these “reports”.
Let’s begin with what could well be the death knell for all sovereign debt in the near future – the Greek sovereign default debacle. Sovereign default? CrisisMaven, are you kidding? No, I’m afraid, I’m not. Let’s assume you “owned” a house, i.e. you bought it on credit from Bank A and there is a mortgage on it to that amount. Now, what that bank, any bank, expects you to do in normal times is that from now on you begin to pay back that money plus interest. When the house is “underwater” due to the miserable fact that both you and the bank financed at a time where everything seemed to go nowhere but up, but you kept paying, that bank might still stand by you, in good times as well as in bad. However, let’s assume that after the Bank A had agreed on the initial mortgage at price A you had used the since rising house price to put more loans on top of the old one, never told your first bank plus spent all that second, third … etc. money on consumption, while now it has turned out, adding insult to injury, that your house never actually was worth what the bank thought at the time – would they still love you? Would they cushion you with even more money so that you could pay interest on other loans just to keep you from formally defaulting? Surely not, to them your default lies already in the breach of trust you committed when you embarked on your former borrowing spree!
That’s exactly how owners of longer term Greek debt may feel. Greece, by cooking the books and obtaining credit on false pretenses has squandered its credit and markets now have begun to watch out for similar behaviour in other circles. Why would that be? Well, let’s say, that treacherous homeowner was a member of the “Savings and Financial Probity Union” of Suburbia and after Bank A had arranged his mortgage so successfully he recommended his bank to other members, while equally the bank extended their credit to the other members of the Probity Union because member A was thought to be such a good debtor at the time. All of a sudden Bank A realises that was maybe not so, in fact, other members also used this society as a front to more easily obtain credit without actually having a notion of how ever to repay it. Now the bank would take a look at all the other members and probe their financial status. And so on. Later it would wonder if members of the sister society in Connurbia might not equally be cheats and so on and on. This is what we currently see in the sovereign debt markets. Only the Suburbia Society is called the European (Currency) Union, the Connurbia Society is an unaudited Fed together with a state debtor that swipes multiples of its acknowledged unsustainable debt in unfunded pensions, Medicare and Medicaid plus Fannie, Freddie, FDIC etc. under the carpet.
For decades everyone, hope against hope, was ready to believe that if a state sold bonds it would repay. That belief held despite the fact that each year that debt grew larger, often even at a stronger pace than the underlying economies, no in fact, true to Keynesian principles, sovereign debt was meant to rise especially when the economy “tanked” to make up for the “slack” etc.
But that always only was a dream. Now creditors around the world are beginning to wake up. They begin to wonder, if one state is close to default (or, as CrisisMaven argues, has technically defaulted already), if the overall contraction of the world economy that entails might not affect even “healthy” economies and their sovereign’s debt. After all, when homeowner A begins to default, he buys less at the supermarket so the supermarket surely can’t hope to get another mortgage for an extension they want to build etc.
This process of reflection has only just begun. It is offset currently by the corruptive effect that sovereign debt is still the “prescribed” collateral in many transactions and that central banks are extending (short term) credit at near zero interest while banks can get that credit against sovereign bonds as collateral at a multiple of that interest rate. That is a business proposition no bank’s CEO can afford to ignore. They have to use this instrument to line the pockets of their shareholders (and rack up bonuses in the process) but it is not a business. A business is where you create value, pawning worthless sovereign debt to get more interest than you pay for it is not what qualifies for being called a “business”.
There are many people now in this crisis who frequent pawn shops and who only months before would never have thought they’d ever in their life see the inside of one. They know that when pawning stuff they don’t get more out of that transaction than they put in, quite contrarily, they pay interest! And their collateral is accepted only at a steep discount.
The Federal Reserve and the European Central Bank are the only pawn shops CrisisMaven knows of that pay you to pawn worthless paper and get rich in the process! It’s time to wake up and the current sovereign debt crisis shows creditors have begun to awake from a once pleasant dream only to face the dire reality: states are bankrupt, their risk premiums will rise ever faster, with small hiccups and bumps in the road like current shifts towards dollar-denominated bonds etc. (because the Euro is felt to be even worse) that will show false flags, but by and large, sovereign debt will soon be seen for what it’s worth: nothing. That comes at a time where tax revenue cannot be increased, quite the contrary. So how do states then “pay” their obligations? Either officially default after the technical default that has already taken place or by printing money. There is no other way.