-- Posted Friday, 10 August 2007 | Digg This Article
| Source: GoldSeek.com
Rick's Picks
Friday, August 10, 2007
"Phenomenally accurate forecasts"
We've harped on the theme of debt deflation many times in the past, but not recently because I had despaired of finding someone who could score any points taking the other side of the argument. Alas, now my best hope for a good debate, Fred Hapgood, has let me down. Briefly a teacher at Atlantic City High School when I was a student there in the mid-1960s, Fred has one of the most fascinating sites on the Web, and the essays he has posted there and freelances to magazines make for great reading. Unfortunately, he has not brought his considerable intellectual gifts to our years-long discussion of deflation. More to the point, our most recent series of exchanges has led me to conclude that his intention all along was not to debate the issue, but to wheedle me in countless trivial ways. You can judge for yourself, since I've reprinted below key excerpts from our most recent series of e-mails. He started things rolling this time by quoting a letter I'd written him in September, 2006. I had concluded at the time that the housing downturn had already set in motion deflationary forces from which the U.S. economy will not recover. I still believe that is so, as most of you will already know. Here is the latest point-and-counterpoint:
Not in Kansas
Rick: (writing in September, 2006): "We're not in Kansas anymore, Fred. However, if this housing downturn proves to be anything less than The Big One, I'll have a lot of shutting up to do.
Fred: (July 2007: It's been two (sic) years now. Long enough to make the point?
Rick: For sure, Fred -- and I'm glad you've finally come around. We are in fact in the very maw of deflation. The problem, simply stated, is that we have a $460Tr financial economy feeding off global GDP amounting to no more than $60Tr. That first number has nearly tripled since we began corresponding and is continuing to rise (per BIS data) by several trillion dollars per month. Also, whereas it took something like $3 of borrowing back then to create a single dollar of GDP growth, it now takes closer to $9. How long can that go on?
Bad Timing, Fred
Rick (in postscript): I hope you'll pardon my sarcasm, Fred. It's just that your question of "long enough?" has come at a time when even the idiots who run the banking system are starting to concede they can see no end to the subprime-mortgage debacle. They seem, finally, to understand, as you evidently do not, that the problem is about to spread into Alt-A mortgages, whence middle-class America's ten-year consumption binge originated.
Have you not read a newspaper in the last six months? Or do you perhaps have friends in Cambridge who have assured you that the toxins from the mortgage meltdown can somehow be contained? These would likely be some of the same guys who, like Helicopter Ben Bernanke, think inflation is the problem, even as they contrive to ignore the fact that real estate is a $23 trillion item on household balance sheets, food a mere $1.3 trillion item. Inflation a threat? Rubbish!
I mean, really, Fred: This is IT! How can you of all people not understand that?
Dow Turning Cartwheels
Fred: But Rick. What you said two (sic) years ago was, and I quote "...if this housing downturn proves to be anything less than The Big One, I'll have a lot of shutting up to do." That was two years ago and today the Dow is turning cartwheels, setting records practically every day. Unemployment is down around 4.5 or so. If you don't have a lot of shutting up to do now, then when?
Rick: What does the Dow's turning cartwheels have to do with reality, much less with the health of the economy? The Dow was turning cartwheels in the summer of 1929. It will ALWAYS be turning cartwheels before the bottom drops out. What do you think dot-com stocks were doing before they collapsed in 2001?
Fred: Fine. Forget about the Dow. My question remains: is two years a fair test of your prediction? Do you have a lot of shutting up to do now? If not, when? Is there anything at all that could happen that you would accept as a disconfirmation of your perspective?
Rick: I do not have any shutting up to do, Fred, not with the real estate market in a deepening crisis that is about to spread into Alt-A paper and which has already cause a quite significant decline in property values across 70% of America's regional markets.
Real Burden of Debt
Question: What is the effective real-rate burden of a person with a 6% mortgage whose home has declined in value by a "mere" 3%. Answer: 9%. That is much more, on average, than hedge funds are returning to investors these days. Just try to imagine Joe Sixpack on the supply side of 9% yields. We are there, Fred.
But then, when have you ever addressed a single point that I've made, much less stretched your mind to ponder my arguments? What about that $500 trillion of leveraged financial instruments sitting on top of a $60 trillion GDP? And the $9 of borrowing now needed to engender a dollar's worth of GDP growth? Don't such facts matter? And, do you think that the near-tripling of public/private debt since we began our discussion is inconsequential?
Where do you come off thinking I owe YOU answers? You have yet to refute a single thing I've said. Why don't you bring some rigor and intellectual honesty to the discussion by responding to a specific point that I've made?
Fred: "This is IT!" Uh-huh. Suppose nothing significant happens to the economy for the next two years. Will you have a lot of shutting up to do then?
A Lot of Ruin…
Rick: There's a lot of ruin in a once-omnipotent nation's economy, Fred.
Fred: Suppose you knew a guy who thought he had the power to predict the weather but had been wrong -- 180 degrees wrong, not just wrong in the sense of not right, but wrong in the sense of predicting the exact opposite of everything that happened, without exception, for 25 years!
Now he comes around again, selling the same prediction. What would you do? What would you ask of him? Wouldn't it be something like, Why isn't the last 25 years an effective argument that you really can't predict the weather? What is the difference between the predictions you are making now and those you have in the past? Have you learned anything from your record of unbroken failure? And so on. I honestly don't see anything inappropriate in such questions.
No Recovery Possible
Rick: What's your hurry? Let it suffice to say that forces leading to an epochal de-leveraging of financial assets have recently reached critical mass. What that implies is that we will not see ANY significant periods of economic recovery ( i.e., GDP growth exceeding 3% in a given quarter) between now and the predicted K-wave deflationary trough around 2015. Is that a prediction you can live with? For my part, and unfortunately for us all, I feel quite confident in making it.
Now, what about my question: Why do we need $500 trillion worth of leveraged financial instruments (aka "derivatives") to conduct global business in goods and services amounting to $60 trillion?
Fred: What's wrong with those numbers? Looks like a good investment to me. You'd turn up your nose at 8.3%?
8.3% Yields a Killer
Rick: I don't follow your point. Regardless, any investment yielding 8.3% right now is a bad bet, since the supplier of those yields is headed for bankruptcy. That's a prediction you can chisel in stone, Fred. And, yes, I know: Not a single one of your "smart guys" would agree with me. But let them try to service an 8% loan on top of assets and paychecks that are falling by as little as 3.5%. Come to think of it, 80 million American consumers are already in that boat, with 6.5% mortgages and homes that on average have decreased in value by more like 5%. (We won't even count such statistical out-liers as Tampa and Las Vegas, since none of your smart guys will have properties in such places.)
Fred: My point is that you give no reason for believing that $500 T in debt is in way out of line for a $60 T economy. It's certainly not obvious. If you look at the world economy in aggregate, as a single entity, then these numbers look like that entity is paying $500 T for an annual return of $60 T. That looks like a good deal, or at least certainly not a bad one. (Not that it matters, since there is no alternative anyway. It's not like capital could escape to Mars.)
Your point about 8.3 being a "bad bet" right now is irrelevant, even if true, since the scenario behind your "bad bet" is only bad from the point of view of the creditor. His misfortune is the debtor's fortune, since the debtor has got access to the creditor's money for free. And we are not playing favorites here -- we are looking at the global economy as a whole, and from the global point of view, it doesn't matter whose pocket the dollar is in or who is spending that dollar. The reason you haven't ever seen, and never will see, a debt- led depression, is that national economies don't care whose pocket the dollar is in either.
World No 'Growth Stock'
Rick: The world is not a growth stock, Fred -- more like a utility that is being run to maximize losses and drive shareholders to despair. So your PE multiple would be way out of line. Concerning your explanation of why we will "never" see a debt-led depression, your logic is so far beyond the pale that it verges on delusional. Are you aware of the draconian changes in the U.S. bankruptcy code?
You say it doesn't matter who gets socked with the loss. Trust me, we all lose. Even your smart guys could tell you that. The "dollars" do not transfer from Peter to Paul, either -- they simply disappear from the world's store of imagined wealth as the value of the collateral falls toward zero.
It is very puzzling to me that you are able to write so lucidly about very complex subjects but unable to bring much common sense to your economic analysis. Nothing against optimism, as I've told you before, but yours has blinded you to the obvious. I would guess that, paradoxically, your investment portfolio has done very well, since you will likely have bought shares in companies whose business you, more than the rest of us, fully understand.
***
Information and commentary contained herein comes from sources believed to be reliable, but this cannot be guaranteed. Past performance should not be construed as an indicator of future results, so let the buyer beware. Rick's Picks does not provide investment advice to individuals, nor act as an investment advisor, nor individually advocate the purchase or sale of any security or investment. From time to time, its editor may hold positions in i ssues referred to in this service, and he may alter or augment them at any time. Investments recommended herein should be made only after consulting with your investment advisor, and only after reviewing the prospectus or financial statements of the company. Rick's Picks reserves the right to use e-mail endorsements and/or profit claims from its subscribers for marketing purposes. All names will be kept anonymous and only subscribers' initials will be used unless expre ss written permission has been granted to the contrary. All Contents © 2007, Rick Ackerman. All Rights Reserved. www.rickackerman.com
-- Posted Friday, 10 August 2007 | Digg This Article | Source: GoldSeek.com
