Posted At : April 23, 2009 10:52 AM
I was gardening over the weekend (Yes, I do that and subscribe to the “Hun” version of gardening) and I was taken aback by my neighbors comment to me that “here comes Dr. Doom.” “Hey” I said, it’s been a while since I’ve been Dr. Doom. In fact I’ve been pretty positive of late and very right on”. It had been a while since Jennifer and Kelly over at News10 dubbed me that. It got me thinking, I want to tell it like it is, and I have been very accurate, but I want to make sure folks aren’t tuning me out for being too negative. So, do me a favor if you will: reply back and let me know if you enjoy reading these updates and if they’ve helped. Something short or long, whatever. I put a lot of time into these and I just want to make sure you are reading and benefitting from these updates. Thanks in advance.
Economic Update – Inflation? Really?
The market and the media is comforted by the fact that the long duration of this economic crises and the enormous government stimulus will bring an end to this long and painful recession. In the short term, I don’t disagree. It would be hard to believe that all the money being thrown around will not help and as important, psychology has shifted to being sick and tired of being sick and tired. Unfortunately however, the many long term obstacles still exist. Demographics are still pointing to continued slow consumer spending, the fuel for the economy’s engine: the banks have made a mess that will take years to rectify, not to mention a mockery of the system: The system is still grossly over-leveraged: and commercial real estate is just starting to fall (off a cliff), like we needed something else.
I’ve covered the demographics extensively, we know about the banks woes, and I covered commercial real estate last week, so let’s touch a bit on the leverage, which is a bit confusing to most. Up until 2004, banks were allowed to lever up to 12 to 1. That means for every 1 dollar in their pocket, they were allowed to spend 12. That sounds crazy in itself, but wait. In 2004, they petitioned the SEC and were granted the ability to lever 40:1. WOW. I wish I could get those terms. Nice when it goes up which probably explains the huge profits. But, that means if you lose 2 ½%…you lose 100%! See what happened? Today the problems persist and we still have a problem. Right now there is roughly $2 trillion of cash in our economy and $50 trillion in credit. Because what do the banks do? They take deposits in and then they borrow money to leverage them up. I take my credit card and I spend with it. I borrow against a house. I have an asset that rises, and I borrow against it.
So, we have two trillion dollars of actual cash propping up $50 trillion in credit. If we all decided to settle and pay off everything, we couldn’t do it because there is not enough cash. There would be massive asset deflation. We, as a nation, are levered 25 to 1. Now, that $50 trillion is in a real sense the money supply because that is what we are all pretending is real money. I lend you money and you pretend you are going to pay me back. Then you pretend he is not going to call your debt for cash, and we are all going to keep the system going. Because if we all try to pay each other back at once, we are all collectively — and this is a technical economic term — screwed.
So we keep the system going. Now, where are we today? We are at the Great Deleveraging. We are seeing massive losses and destruction of assets, on a scale that is unprecedented. There was massive destruction of assets during the Great Depression, which caused a lot of problems, and we are seeing the same thing today. We are watching trillions simply being evaporated. We are watching people pay down their credit lines, which is one way of saying the supply of money and credit is shrinking. Not just in the US, but all over the world. Because when you start adding European cash-to-credit, and Japanese cash-to-credit, and Indonesian and Chinese cash-to-credit, it becomes multiple tens of trillions, and we are watching a goodly portion of that credit be vaporized. So we — individuals and businesses — are trying to find that $2 trillion in real cash and get some of it to pay down our debts. We are reducing that massive leveraged money supply down to some smaller number. The “Home” piggy banks are dry, the credit cards maxed and savings and retirement accounts crippled. Quarter 1 06 we had $223 billion in mortgage equity withdrawals. Quarter 2-2008 it was $9.5 billion. Is it any wonder we were in recession by 2008? By the third and fourth quarters there was no money to keep the treadmill going. That $50 trillion in credit was shrinking fast. We were imploding it. Further — just as a little throwaway slide — if you look at 2010 and 2011, we are getting ready for another huge wave of mortgage resets.
Now, we’ve gone through the last wave and we saw what happened; it created a lot of foreclosures. We are not out of the woods yet. It is going to be 2012 before we sell enough houses to really get back to reasonable levels, because we had 3.5 million excess homes at the top. We absorb about a million a year, it takes 3 years, that’s kind of the math.