Market Review: Deflation?

The fact is ... the market is schizoid right now.

On one hand, we're facing deflation, on the other gold is spiking. In the EU they're talking austerity but in the US they're talking about renewed stimulus. Gold is jumping, but so are Bond prices - that's very weird.

As global liquidity flooded the China market, it meant China's economy has gained even more momentum but at the same time has taken on more risk of the threat of the influx of liquidity reversing. Also, instead of the widely anticipated inflation, we have ourselves deflation.

The spring of 2009 was also the period of the great inflation scare, in which everyone from Glenn Beck to US Federal Reserve presidents was warning that an awful surge in prices was just around the corner. That obviously didn’t happen.

At the heart of the inflation/deflation debate was and is a debate between two visions of the economy. One vision is basically an updated Keynesian view: sticky prices revised gradually based on unemployment and excess capacity, the possibility of persistent economic malfunction because people are trying to hoard cash rather than buying real goods. And this view also said that we were and are in a liquidity trap, in which things that might have been inflationary under other conditions — like a large expansion of the monetary base — weren’t at all inflationary under current conditions. In fact, the likely outlook was for falling inflation, and possibly deflation.

The other vision was basically a crude quantity theory of money view: the Fed is printing money, the government is running deficits, one plus one equals high inflation, maybe even hyperinflation.

Now consider that the expansion in the monetary base served largely to fill the void left when structured finance fell apart and a staggering amount of liquidity went up in smoke. The Keynesian model -- as I understand it -- does not incorporate this particular fact set. The lack of inflation over the past year or so does not vindicate the Keynesian model.

When the new financial regulatory regime is established and some level of structured finance is allowed to be rebuilt, THEN in the absence of a monetary contraction, serious inflation will occur.

There are no "scare tactics" here: just solid economic science. The Obama administration has destroyed American jobs. The Bush and Obama administrations have imposed on every American a debt, including unfunded liabilities, in excess of $200,000. This debt will never be paid back and you will never get the "free quality health care" you dream about or the government keeps promising. Facts, people. Not scare tactics, but cold hard FACTS.

Obama has already repeatedly broken his pledge not to raise taxes on anyone earning less than $250,000. Obama's health care is already causing insurance premiums to rise and jobs to be lost. Here, the outcome will be Japanese zombism.

Or perhaps the US will simply default on its obligations. It is happening in Europe (no, there will be no one big enough to bail us out). People want hope, be it denial of how bailouts have simply converted private debt to public debt.

It is true that interest rates and inflation have not yet taken wing, but this is no guarantee that these things are not 'just around the corner', for example. To wit, the government's injection of 'liquidity' has been largely targeted to keep interest rates low. If it were true that interest rates "do not" rise in an environment of low consumer demand, one has to ask why the government has so heavily mortgaged the future to serve the present.

My belief is that we need to reduce government spending dramatically, cut taxes to the bone, and push rates to under 0 so as to force banks to pay interest for any money they haven't lent out and in so doing facilitate credit flow.

History has spoken enough, are we ready to listen?

Canadian banks: Bastion of Stability

7 reasons Canada is rated as a 'bastion of stability'

Despite what is common propaganda, there are many clues to why Canadian banks were not in as suggested good shape. For one, why did we need transparent regulations deregulated in secret in 2008.

Canada Banks' Relief Toxic Assets

Oct 17, 2008

Under a ruling expected on Friday, the country's biggest banks and insurers will be able to postpone recording losses on assets that have become hard to sell and hard to value amid the global credit crunch

CMHC: Canada's very own ticking economic time bomb!

CMHC: Canada's very own ticking economic time bomb!

May 30 2010
The Star

Stanley Taube

For the past few years, Canada has been basking in the glow of international economic praise.

Our banking system is the best in the world. There has been no need for government bailouts. True, we have recently been running large deficits. But they are manageable in terms of the size of our economy. Our dollar is strong. Investors want to invest in Canada. Best of all, our real estate market, with a short hiccup in late 2008 and early 2009, has been moving steadily upward. Historically low mortgage rates have made housing affordable to practically anyone wishing to purchase.

Not for us the housing disasters that have occurred practically everywhere in the world. No toxic investment paper, as was created in the U.S., by bundling mortgages into investment vehicles that had very poor underlying security. Not for us the “ninja” borrowers (no income, no job, no assets).

We look smugly at states like Nevada and Florida, where real estate values have fallen by up to 50 per cent from their highs in 2006 and 2007. And this gloomy scenario has been repeated in Ireland, Spain, France, Italy. You name it, and real estate has dropped dramatically. Even Manhattan in New York and Kensington in London have not escaped.

So is Canada really the nirvana of the world? We are part of the Planet Earth. Our economy is very much interwoven with many other countries. Are we that much smarter then practically everyone else? Maybe luckier?

Or is there a potential financial disaster lurking just over the horizon, waiting to put us into the real world of true financial crisis? I believe there is. And that disaster is the Canada Mortgage and Housing Corporation (CMHC).

CMHC is a federally owned crown corporation that insures mortgage lenders against losses on their mortgage investments. It charges insurance premiums for this service. These premiums are higher for those mortgages where the borrower has little equity in his home. For example, the premium for a mortgage that amounted to 95 per cent of the home's value would be 2.75 per cent. The premium is generally added onto the mortgage balance. Accordingly, a borrower who takes out a 95 per cent mortgage could owe 97.75 per cent of the value of the home. Until recently, mortgages could be insured for 100 per cent of a home's value!

This all works very nicely if real estate values stay steady or keep rising. The CMHC program encourages people to buy homes by making mortgage loans available that private lenders would not give. But here are the problems:

Mortgage lenders invariably shift the riskiest assets into the CMHC program. You have 5 per cent down payment? Off you go to CMHC! You have 25 per cent down payment? You're our kind of client! We will retain your mortgage for our own account.

At the end of 2009, CMHC had $473 billion in outstanding guarantees. This is up from $408 billion at the end of 2008. With the frantic pace of real estate activity in the past few months, that figure is surely over $500 billion today.

And what is backstopping this huge obligation? CMHC had $9.3 billion in equity at the end of 2009. There is also a very paltry $1.3 billion for loan loss reserves. So there is approximately $10.6 billion available before CMHC runs out of money. After that? Well, CHMC obligations are direct obligations of the Government of Canada. We taxpayers are on the hook for the rest.

Let's assume that real estate in Canada falls a very reasonable 20 per cent in value. Given the recent run-up in prices, rising interest rates, ever increasing listings and fewer buyers who qualify for mortgages, a decline in values is virtually inevitable. Tens of thousands of borrowers will be unable, or unwilling, to make their payments.

The 20 per cent hit that CMHC could take would be more like 25 to 30 per cent. There are significant expenses in disposing of repossessed property — taxes, utilities, insurance, real estate commissions, legal fees, and so on. I would estimate that CMHC (which, in effect, is the federal government) could wind up $125 billion in the red.

This would blast an enormous hole in our government's finances. Canada would be put into the same category as the other prolific spenders. Which is where we should be. We are merely postponing the inevitable.

Stanley Taube is a lawyer and author. He has taught political science at the University of Toronto.

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My personal take on this, CMHC can convince people to buy, with whatever incentives they can think up, the losers will always be aplenty. Assuming this fairy tale of a strong real estate market continues, then we will be seeing people being priced out. But on the contrary, when the market adjusts as it usually does, each successive buyers will lose money. Speculators, suckers or whoever the niche, everyone eventually loses if they own a home whether or not the mortgage is payed off. Those who bought near the top just lose more.

The fall of the Euro

If volcanic ashes were not enough, how about an economic crisis? Greece proved to be a spark for what would be an overhaul of the Euro system which has seen the Euro dollar take a plummeting since the start of the month. The immediate impact of the euro crisis has been (a) a fall in oil prices (b) a fall in long-term interest rates, both of which have transnational implications, which means this would be a good time to examine what exactly is wrong with the Euro and where is it headed.

Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue. With a unified currency, adjustment to differential shocks requires adjustments in relative wages - and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany. Of course this would set off wide-spread discontent.

The Greek budget crisis has made it clear that something must be done to limit fiscal deficits in eurozone countries. The attempt to do so with the group's Stability and Growth Pact has failed and there is now political consensus in Europe that new rules are needed to prevent large deficits.

There have been no agreement on what should be done and none expected soon. The European Commission proposed last week that the national budgets of each country be examined by the others before they are approved. It would clearly be anathema to the German government to have its spending and tax policies approved by France, let alone by Greece and Portugal. The problem therefore to find a way to prevent excessive deficits while leaving member states free to shape their own spending and tax policies.

Here something may be learnt from United States. Although the 50 states share a currency and each sets its own spending and tax policies, state deficits remain very low. Even California has a deficit of only about 1 percent of the state's GDP and total general obligation debt of less than 4 percent of state GDP. The basic reason for these small deficits is that each state's constitution prohibits borrowing for operating purposes. In some states, these self-imposed restrictions go back to the 19th century, a time when excessive borrowing led to state defaults. Those states wanted to assure potential lenders that such excess borrowing would not happen again. Over time, all states adopted such rules to help make the bonds they issued for capital expenditures attractive to investors.

If the EMU governments were to adopt similar constitutional rules, the interest rates on their bonds would fall. Of course, important differences exist between EMU members and the U.S. states. Because Europe lacks a central fiscal authority, some provision must be made for temporary deficits when economic conditions warrant. European nations also have national security responsibilities that may require surges in defense spending. But if the budget rules are well articulated, the effectiveness of the fiscal discipline will remain.

Germany recently adopted such a constitutional amendment. Germany's central government must reduce its deficit to 0.35 percent of GDP by 2016 unless a decline in GDP causes a larger deficit. Other EMU nations could follow Germany's example because doing so would bring down their interest rates. The European Central Bank could accelerate this process by restricting collateral to bonds issued by governments with satisfactory constitutional limits on their deficits. The combination of national self-interest in achieving lower interest rates and an ECB rule on allowable collateral would create a powerful restriction on deficits. It would also leave member governments free to determine the structure and levels of their taxes and spending, as long as their decisions did not violate their self-imposed constitutional limits.

Meanwhile, Gold and the US Dollar have been great beneficiaries from the Euro crisis as people seek alternative to the Euro for real value.

Health Care Reform & A Stronger Canadian $

In a 219-212 vote late yesterday, the House of Representatives approved the largest healthcare overhaul in four decades. The bill, which failed to garner a single Republican vote, will be signed into law by Obama, who called it "a victory for the American people."

The healthcare measures will cost $940B over ten years and cover 32M uninsured Americans. The bill is a mixed bag for insurers, who stand to gain over 20M new customers but are unhappy the bill doesn't substantially address the problem of rising healthcare costs and further reduces government subsidies to the industry. Pharmaceutical companies, on the other hand, emerge as clear winners from the bill, while large businesses are worried about higher costs and stricter coverage rules.

Meanwhile, the Canadian dollar is charging towards par with its U.S. counterpart. Canada's currency has risen about 7 percent since early February, peaking on Friday at 99.38 U.S. cents, its highest since July, 2008. Many analysts expect it to return to parity with the U.S. dollar, and stay strong through 2010 or longer.

What this means is that cross-border acquisitions have become more attractive. There are also greater availability of debt and equity financing. What does this means for local businesses if consumers are heading south for cheaper products or looking to acquire U.S. assets by Canadian companies looking to grow?

Canada's economic recovery has outpaced the U.S. and corporate balance sheets are stronger. Debt and equity markets have been willing to finance deals, and may be even more enthusiastic about a U.S. purchase that could be financed in both U.S. and Canadian dollars. In short, Canadian companies are better positioned than many of their international peers to purchase foreign assets, having better weathered the financial crisis than most, and emerged from the recession with stronger balance sheets -- relatively high levels of cash and low levels of debt.

But staying true to “No Risk, No Gain” belief, while there is no doubt with the U.S. being a significant market, if you buy a strategic asset which has a great fit with your business, you can achieve synergies, but at the same time, you have to be ready to take some volatility along the way.

The U.S. economy is still unhealthy with high levels of national debt that has to raise concerns and lead to the question, “How far can the U.S. currency fall?”. Of course, there would be less incentive to purchase an asset when it will be worth less in the future. Agreeing on a price is fraught in an economy where no one is sure if the biggest risks are still ahead.

The soaring Canadian dollar does help Canadian companies in another way, allowing them to import at lower costs, especially inventory and equipment upgrades.

Overall, Canada’s economy is heavily reliant on immigrants with new money and the commodities market. Then there are other causes for concern with local businesses struggling to keep up with increasing competition and most fresh graduates are victims of structural unemployment (stuck in a job well under their qualifications).

Toyota Customer Confidence Crisis

Any crisis starts with containment, and that is what Toyota is working on now with its crisis in customer trust. After death and injuries spurred three global recalls that covered over 8 million vehicles, what was once a exemplary engineering and manufacturing mega-corporation has its integrity being questioned.

The problems as follows: an aftermarket floor mat that, if not clipped down properly, can interfere with the gas pedal; a pedal from one supplier that can get "sticky " because a composite material interacts with moisture over time as it wears; and a software glitch on the 2010 Prius that can cause less-than-a-second's hesitation in braking when the antilock braking system is applied.

For each of these problems a specific cause has to be determined—when it occurred, where, and how. There is no evidence that floor mats were assembled incorrectly because they are put on by dealers. There is no evidence that the sticky pedals were assembled wrongly; that issue rather concerns the specific composite material selected for one part. And in the Prius case, the issue lies in the software code, not in how the module was assembled at the plant. So revamping production does not appear to be in order. It seems remarkable that all the recalls occurred within a six-month period. But in fact the cause was at least six months old in each case—five or more years in the case of the pedal design.

Thus, the real principle violated here is that the quality control process did not uncover the problems before distribution, and resolve them completely before launching upon the public. And from here forth, merely repairing the defected units upon recall and issuing new warranties will not help repair its damaged public image. To do so, you would need to show a renewed commitment to quality, safety and customers.

Financial Reform To Come

An Obama Plan That Just May Make Sense


Quite an interesting article breaking down Obama's new plans for Wall Street. Just yesterday, Obama proposed freezing non-security accounts' budgets. It does indicate that Obama is taking prompt actions behind his words.


Some ask "Why now?". Maybe it is because his support is dwindling. But I am compelled to think that the economy is only now barely stable for him to push for the financial reforms that he claim is needed.

Anyways the next few weeks could be interesting as we play audience to a political and financial battlefield.

Vancouver: Fundamentals don't apply

The UDI (Urban Development Institute) had member lunch, some 1,100 attendees yesterday. The captains of the real estate industry gave speeches. The general consensus is that prices will be up sharply this year, as they have already surpassed pre-crisis levels.

The real estate market in any city does not stay down for ever. However Vancouver has shown itself to be quite resilient. The Vancouver real estate market corrected in September 2008 but had the shortest stagnation period of any city in North America. In fact, Vancouver has had the quickest recovery of any city in the World.

Its recovery can be attributed to several reasons.

1. Strong immigration to B.C. (Led by Chinese, the strongest growing economy in the world.)
2. Recovering U.S. economy. (Highly doubtful as explored in my previous post)
3. Recovering B.C. economy. (Supported by new immigrants but jobs and overall consumer spending continues to suffer.)
4. Inter migration to B.C. (Driven by favourable market conditions in B.C. and deteriorating market conditions at home)
5. The HOT money from Asia wants to be here. (Stable banking system, world’s best place for living, safe haven for refugees/criminals because of human rights laws)
6. Shortage of inventory for sale. (More buyers than sellers. Sellers market.)
7. Shortage of land. (Properties in prime location are limited.)

When it comes to Vancouver, fundamentals do not apply. After all, this is a market supported by people several times richer than locals. As long as the rich continue buying, it justifies the argument that this city is just that special and good times last.

Proposal For Financial Reform

While everybody agreed that the health care system was broken with prices too high and coverage too low, nobody likes the proposed solution that came from nearly a year of debating how to fix it. No wonder. Without offering a single answer to the issue of runaway costs, Congress decided to make participation in the broken system compulsory. Ridiculous and Obama took the fall.

Today, Obama spoke of his proposal of an overhaul of regulations prohibiting banks from running proprietary trading operations solely for their own profit and sponsoring hedge funds and private equity funds. He also proposed expanding a 10 percent market-share cap on deposits to include other liabilities such as non-deposit funding to restrict growth and consolidation.

“Never again will the American taxpayer be held hostage by a bank that is too big to fail.”

This proposal will affect trading at major banks such as JPMorgan Chase & Co, Morgan Stanley and Goldman Sachs. Goldman Sachs, which today announced over $13 billion profit for 2009, a record year, voiced doubts on the proposal.

Ending Federal Reserve oversight of Goldman Sachs “has virtually no chance of ever happening, it’s just not something we spend time on,” Goldman Sach’s CFO Viniar, 54, said in a conference call with journalists today. “We’re now regulated by the Fed and I expect we will be on a continuing basis.” “You have global institutions around the world who are set up in a certain way and to put rules in place that roll back the financial system by 10 years I think is going to be a very, very hard thing to do,”

Goldman Sachs and Morgan Stanley, both based in New York, were the two largest security firms before converting to banks in September 2008 during the global financial crisis to gain access to Federal Reserve lending facilities. Today’s proposals raised questions about whether they would opt to revert to securities firms so they could avoid the new rules.

Critics claim that if this proposal freezes or reduces the banks’ ability or willingness to invest, other investors will pull back until other asset managers step in to take up the slack.

On the other hand, how do you justify the struggling economy, taxpayer bailouts and growing bank profits at a time of 10 percent unemployment, as well as a federal deficit that rose to $1.4 trillion last year if no financial reform is being made to prevent history from repeating?

Obama can’t get everything right, but in this case, he has my vote.

Wall Street? You can't handle the truth!!

The world is in depression? Maybe so, but bankers are enjoying a large and controversial deluge of annual bonuses. The economy may be in the dumps, but Wall Street enjoyed record profits of $50 billion in the first nine months of last year—"nearly two and a half times the previous annual peak in 2000."

Why? Indeed a good question. "Profitability," adds the state of New York, "has soared because revenues rose while the costs of doing business—particularly interest costs—declined" (in other words, thank you Federal Reserve). As most countries cut their interest rates, this runs true across the board.

Personally the bankers and related are heavily spoiled, and the industry is providing them with reason to be. Those in the financial industry are indeed highly mobile, can and will simply seek work for someone else if they are denied some ridiculous compensation. As such, they argue that record profits should equate to record compensation.

Laughable argument but let us evaluate what this really means.

Exactly where are these alternative job opportunities that warrant leverage for "outsized compensation"?

In case you haven't been paying attention, the "official" unemployment rate for the U.S. is 10% but the actual percentage of working-age people that have a job has fallen to levels last seen in the early 1980s. Of those who are of working age and not in prison (that is, available to work) only a smudge over 58% are employed - a six percent drop, roughly, since the hayday in 2006. Since numbers if interpreted corrected do not lie, that's roughly 98 million people who could be working but aren't. Beyond the "structurally unemployed", some 25 million people were added to the workforce from 2000-2009 yet not one of them actually became employed, while in the last 18 months some 9 million were fired. A very large percentage of those fired, along with many who entered the workforce, are highly-skilled individuals.

So exactly where are these alternative jobs for the "mobile" workforce?

Answer: Nowhere. A job is better than no job, whether you get a $5 million bonus or not. But that is no reason not to feed the greed by making up lame excuses for making 50,000 times what the average low-end worker makes per month.

As for the "record profits", despite what the quarterly report claims, they are simply a grand-scheme fraud to protect the public from mass hysteria and anger at the system.

Simple math. We'll call it "subtraction."

During the bubble years, hundreds of billions of dollars in Home Equity lines were written. A good number of these were securitized and sold off, but not all - there is a huge percentage of them sitting on these bank balance sheets. If the property is worth less than the first mortgage that they are behind, they have zero recovery value in a foreclosure.

This is one of the schemes that was promulgated by "mark to fantasy" accounting adopted in early 2009. These loans were worth nothing, being carried at dramatically above their actual market value, the homes collaterals would go into foreclosure and receive a fat zero recovery. This means that virtually every large bank is still insolvent, as none of these loans can be refinanced if the property is underwater and as a consequence the "recast date" is a hard wall that will force them to default.

Now let's ask the seminal question: What has factually changed about the character of these "assets" on bank balance sheets since March?

Here's the scorecard on the fundamentals behind the valuation of these "assets":

1. Home prices have continued to decline. That is, more homes today are worth less than their first mortgage than were in March of 2009.
2. The "skew", that is, where those declines have happened continues to be centered in Arizona, Nevada, California and Florida, just as it was.
3. Mortgage performance, that is, the percentage of loans that are current has continued to deteriorate. Indeed, it has deteriorated a lot since March of 2009.
4. The so-called "HAMP" program is a dismal failure, having led to fewer than 10% of the so-called "qualified trial mortgages" turning into permanent modifications. While everyone makes excuses nobody pays attention to the elephant in the room - the 2004, 2006 and 2007 warnings from the FBI, HUD and private credit analytics firms that about one in ten of these exotic loans were made to people who actually provided an accurate income. That is, nine in ten HAMP "modifications" are failing not because the program is defective in its design but because the person in the house could not ever and still cannot afford it.
5. The recast wall for OptionARMs is closer today than it was in March of 2009. A disproportionate percentage of HELOCs are behind these sort of tricky loans.
6. The labor rate (percent of employment-age people actually employed) has fallen 1.5% since March of 2009. That is, 3.6 million fewer Americans are working today than were in March - half of them by coming into the workforce anew, the other half as a consequence of losing jobs and dropping out of the workforce.

How is it possible for you to make "record profits" while your asset quality continues to deteriorate, payment performance continues to deteriorate, the ability of people to pay loans you gave them continues to deteriorate and the recovery value of the assets behind those loans continues to deteriorate?

You get to define "record profits" by intentionally understating both fair value and reasonably-expected losses. Major institutions are paying out "compensation" with what amounts to fake money that was in fact not earned (due to all the hidden losses) is almost precisely what Madoff did with his clients – albeit a much larger scale. Can someone spell ponzi? Maybe that word is too hard to learn.

Unfortunately, such a strategy is purely temporary as the underlying quality (or lack thereof) of the assets will eventually break light, forcing recognition. By then, these "earnings" will have evaporated, leading questions “Where have my money gone?”.

What really ticks me is bogus valuations that continue to be claimed by institutions and their refusal to come clean about the false profits being made. The fact that these institutions could escape such a levy by breaking themselves up and thus not being subject to it offers a positive. Broken up they would lose their seminal argument for why they should be "too big to fail".

We are past the point when we argue that allowing all of these institutions to go bankrupt would have destroyed the economy or lending generally. If any, it would have destroyed those who bought fraudulent securities and those who issued them, which is actually the only right thing to do.

When the FASB decided to (temporarily) suspend mark-to-market and replace it with mark-to-whatever-you need-to-make-your-quarterly-bonus, it ripped out one of the last pillars of true accountability.

The most common rationale for the move was the idea that banks shouldn't be penalized by short-term movements in the asset price, if their intention is to hold the loan until maturity. Sounds legitimate, until you look under the hood: no rational accountant would have allowed marking bonds at par, simply because of the plan to hold them until maturity. There's another issue at work, namely, the creditworthiness of borrower. Nobody believes these crummy loans are worth a hundred cents on the dollar, including the guy who just sold them for 35 cents.

Similarly, according to The Canadian Press, President Barack Obama said with reference to his proposed plans to impose a $90 billion tax levy on big financial institutions to recoup some of the costs of the financial crisis:

If the big financial firms can afford massive bonuses, they can afford to pay back the American people.

The $90 billion Obama will extract from Wall Street won’t even begin to shrink the monster deficit the Fed has run up. But that is a problem for the next administration (probably Republicans). Who said politics isn’t fun? As Obama’s assistant Rahm Emanuel put it, ‘Its a shame to let a good crisis go to waste.’

Now, do we live in a world of fools that none actually realize when market conditions are characterized by unfavorable valuations, overbought conditions, over-bullish sentiment, and upward yield pressures, the market’s tendency is exactly that - to make continued marginal new highs for some period of time, followed by abrupt and often steep losses virtually out of nowhere? I think not. Many simply live in denial, hoping to postpone the problems to such time in the future when they would not be around to suffer the consequence.

Private vs. Public

As the Copenhagen talks are set to wind down today, it is worth pointing out that 2009 is a year in which government investment in renewable energy and energy efficiency programs increased due to green stimulus projects. Linking public and private funds and providing a clearer regulatory environment in the sector will be key though consensus and consistent effort are difficult.

Linking the private with public seems to be the next great obstacle or crisis. This is all the more obvious since the ongoing massive swap from (almost) worthless private debt to (almost) guaranteed public debt will be the lasting bequest of the current financial crisis. Latest forecasts say that the average debt/GDP ratio of OECD countries will soar from less than 70% to more than 100% in the next few years. It is interesting to see what and how fiscal stabilization interventions affect real economy in response.

Meanwhile bubbles are popping up all over the place, from commodities like gold to real estate. Fueling these bubbles is unprecedented confidence levels that seemed to be more hopeful rather than rational. Some would make the argument that major players are simply playing the game of market manipulation and creating a smokescreen to lure the public. Others speculate that all bad things must come to an end (oblivious that by same reasoning, good must turn bad). Can we imagine that we are standing in a volcano ready to erupt at any time?

Bank of Canada warns of debt peril

CBC News

At this point, we should all be realistically weary of the same old doom and gloom news and thus I have cut down on my part to report such. So it turns out that some industries are hit heavy while others are still getting by. For example, second-hand automobile business which was booming due to its affordability is now completely dead with new cars coming out at huge discounts.

While I am out doing Christmas window shopping, it is barely the same festive mood that was so infective. Smiles were still plentiful though mostly on younger faces.

Hang in there, guys.

Behaviour Finance in Property Market

News Link

May be dry for some, but may help you understand your cognitive dissonance and optimism.

Enjoy.

American Decay

While witnessing the expected rapid decline of the Greenback, I am confronted with all that are wrong with the ideologies of the Americans.

First and foremost, let me give you a hint – Land of the Free. Did you get freedom? I can argue that freedom is the fundamental and critical flaw in the American ideology. From top down, democracy is the only choice for freedom seekers and it bogs down the system with inefficiency. Simply too many cooks spoil the soup and not to mention, majority of the people are incapable of differentiating propagandas and rationale. Most people are plain, bluntly put, dumb and ignorant. So the obvious problem is you have a country run by idiots chosen by idiots representing idiots. Now, if that is not a recipe for catastrophe, I don’t know what is.

Freedom accentuates differences in individual opinions creating controversies. The good news is the United States have found a way to resolve such. The bad news is, deny it all they can, the Godfather of terrorism is the one and only United States. Terrorism was created to rule. Being the leader of the developed world, whether by means of brute force, economic sanctions or political influence, the most powerful country in the world will do what it takes to keep its power. The difference is they can do it under the pretence of the protector of the greater good of mankind (ironic that they can make decisions for everyone) and they can sugarcoat their lies with lame reasons (yet no one dares to defy even though defiance will be futile as in Bush’s era). No other country is as nosy as the US which seems to think they can run every country better than they can themselves. One has to wonder how they get the time when their own homeland issues are unresolved.

For example, there is the creation of debt to buy what really can’t be afforded so every American can have a home and live the life they want. For some reason, they seem to believe that they can enjoy eternal economic growth at a greater rate than the interest of debt. In other words, they do not think they need to pay in the end (marked by the ridiculously trillions of national debt US owed). The question is who is paying for the hundreds of billions of dollars spent on space exploration, weapon enhancements and keeping Wall Street happy.

But somehow they have survived while other countries have not with the level of debt. Why and how? It’s really quite simple. The trigger-happy United States can conjure up any whack excuse to exercise their dominance. I might add, whoever came up with the idea to sell on fear is a genius. Selling arms of war to those in need is not only highly profitable, it also reinforces the need for US to be more totalitarian and to build more deadly weaponry which leads to even more need to sell arms of war. It’s a beautiful money making and power building cycle.

Wake up and smell the flowers, America. There are people living with less than a dollar a day, eating less than one meal a day, no home, no job and no future. They were born to live a slow and agonizing death. They are the results of the exploitation. There are other pressing issues of pollution and global warming, overpopulation, diseases and scarcity of resources which conditions are deteriorating by the second. You can preach freedom, equality and prosperity all you want, but at the end of the day, you better get your priorities straight because times are different and you are no longer the all almighty you once were.

Obama wins the Nobel Peace Prize

Yes, this is quite funny. April's Fool!!! Wait! It's not a joke?

Obama has been awarded the Nobel Peace Prize. This is a somewhat surprising move by the Nobel Committee, since Barack Obama simply hasn’t had enough time as president to do all that he had set out to accomplish. Still, Thorbjorn Jagland, the chairman of the Norwegian Nobel Committee, claims that the prize was awarded based on Obama’s work so far. “We are not awarding the prize for what may happen in the future but for what he has done in the previous year. We would hope this will enhance what he is trying to do,” he said.

For his part, President Obama’s initial comments in reaction were indeed eloquent as he declared the conferral a “call to action” for him as well as the nation. Obama expounded on his surprise, wondering if the honor was somehow misplaced but stopped short of spurning reception, wondering aloud if the committee overlooked more deserving candidates. If anything, he lathered on the humility but apparently not enough for the likes of Fox News commentators. Fox trotted out a parade of conservative spokespersons none of whom had the slightest congratulatory comment for the President.

To my mind, Obama’s efforts at diplomacy have transformed the dialogue internationally and if only for this reason, he is surely deserving of the prize. His efforts at diplomatic solutions for seeming intractable problems, too, make him a judicious candidate. Given the unilateralism of the previous eight years, this predilection for all things Obama by the international community should come as no surprise.

Or perhaps, the nobel committee is trying to uplift the dampened spirits of a tired world by creating humorous controversy. Ha ha.

Real Estate Trends Could Impact Future Path Of Canadian Monetary Policy

TD ECONOMICS REPORT

Released today. It contains some interesting thoughts about monetary policy and the real estate market across Canada.

The truth of debt and depression

When debt is the real issue underlying an economic downturn, the result is a period of stagnation and short business cycles as we have seen in Japan over the last two decades. This is what a modern-day depression looks like – a series of W’s where uneven economic growth is punctuated by fits of recession. A recession is merely a period of recalibration after businesses get ahead of themselves by overestimating consumption demand and are then forced to cut back by making staff redundant, paring back inventories and cutting capacity. Recessions can be overcome with the help of automatic stabilizers like unemployment insurance to cushion the blow. Depression is another event entirely.

Focusing in the US, in the end, there can only be one direction the government is headed: increase asset prices (or, at least keep them from falling). Despite the remaining problems in credit cards, commercial real estate or high yield loans, limiting credit growth, the asset-increasing changes instituted by government definitely have meant that banks will earn a shed load of money and that house price declines have stalled, underpinning the asset base of lenders. This equates to an end to massive write downs, a firming of banks’ capital base, and a reduction in private sector deleveraging. As write downs cancel out capital, only when the massive write downs end will the downturn bottom.

What we are seeing today is that while toxic assets are still impaired and the banks are still under-capitalized, the feedback loop has spiraled beyond comprehension creating a false sense of recovery. As long as the balance sheets are still filled with problems, companies will not increase consumption. Banks are not lending because no one is borrowing and also because they too are rebuilding their own balance sheets. Despite what the government claims, the U.S. economy cannot possibly work itself out of the greatest financial crisis in some 70-odd years in a mere 4 years and then expect to raise taxes on the middle class without a major recessionary relapse.

So where does that leave us? The effects of this depression have been lessened by economic stimulus and government support. Government intervention has led to a reduction in asset price declines, which led to stock market increases, which led to asset price stabilization and more stock market increases and eventually to asset price increases. There is still no sustainable recovery at hand as the fundamental problems are delayed but not solved.

So the government has made some improvements, should the government continue to spend? The private sector (particularly households) is overly indebted. The level of debt households now carry cannot be supported by income at the present levels of consumption. The natural tendency, therefore, is toward more saving and less spending in the private sector. That necessarily means the public sector must run a deficit or the import-export sector must run a surplus.

The fact is, when faced with a serious debt problem (denominated in its own currency), there are only a few ways for a government to tackle the issue, namely:

1. Pay down the debt (via spending cuts / tax increases)
2. Monetize the debt (print your way out)
3. Default (you didn't really think we'd pay you back, did you?)
4. Positive Balance of Trade (More CDOs?)
5. Economic Growth (Only real growth)

Obviously 5 is the most palatable option, with 4 being a reasonably good alternative. But as the economic crisis at hand is a global one, most countries are in a state of economic weakness. That means consumption demand is constrained globally, leaving no chance for the U.S. to export its way out of recession without a collapse in the value of the U.S. dollar. Printing equates to money devaluation and inflation. Spending cuts and tax increases will stall the economy. Obviously, default would be catastrophic, leaving the government with the bill and the heavy task of pursuing option 5.

Meanwhile, all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, unemployment will rise and stock prices will fall as the global economy will relapse into recession.

To really recuperate, the government must allow market forces to restructure the economy. The government and individuals must rein in their spending; stock of savings must be replenished, interest rates must be allowed to rise, asset prices must to adjust to economic reality, insolvent businesses must be allowed to fail, and wages must reflect productivity. To accomplish these goals, subsidies that distort market forces must be removed and regulations that undermine our competitiveness must be repealed.

None of this can be accomplished without a degree of short-term economic pain and some consequences. At the end of it all, the middle class will probably be wiped out, leaving the uber-rich and uber-poor, which is a recipe for social revolution. Geopolitical pressures mount as every country tries to deal with a difficult time. Wars always seemed to be the perfect solution in desperation.

You can only hope we come out of it all a little smarter than before.

The New Gold

With increasing talks of deflation instead of inflation, some people are questioning the rationality of investing in Gold. Gold has a wicked history of being an unreliable inflation hedge. It has, though, at times been a haven against sudden currency depreciation. On one side, the Treasury is printing so much money leading to inflation. The other, the Treasury may not print enough and thus reasons to deflation.

For the longest time, the US is considered the world’s safe haven. The US dollar is the world’s leading reserve currency, dominating in global politics, economy and military. Most importantly, its status allows US to borrow abroad in securities denominated in its own currency. After Wall Street’s financial crisis, US’s real estate meltdown and credit crunch, it has become obvious that the US is no longer the untouchable rock of superiority.

There has to be a limit to the lending elasticity or overconsumption it has enjoyed through the years. So long as people and capital are unemployed, cost-push inflation is not seen as a threat thus stimulus is believed to be cost-free. The risk, of course, is if the obligations continue to exceed the levels justifiable by assets, the bubble cycles will persist and sooner or later, a ‘sudden stop’ (the cessation of capital inflows to both the private and public sectors) is unavoidable.

Some would argue that if borrowing is to improve such assets as infrastructures that would provide jobs, services and other benefits, it would be a win-win situation for all. In my humble opinion, they are right but the key question is really the pace for return versus interest due. If the pace of return is slower, then do we have enough time for the results to show before the bank is dried out?

For the reasons above, I have stayed away from stock markets (overvalued medium of exchange). Stock values will not fall to zero. They have option values (beautiful invention of the numbers game). Nonetheless, if stock value fell 90% in the Great Depression, in today’s even more leveraged environment, what do you perceive as a realistic market correction?

The world we live in is an arbitrager’s dream, with each of them running around thinking they can predict better than others. The fact is the ones with the chips make and change the rules.

When the government (the ones who make the chips) operates at a deficit, what it is doing by definition is spending money without having taxed it out of anybody first. It is printing money into existence and spending it. Because it is spending it in various ways it makes the receiving classes (owners and selected welfare groups) happy. It is actively and thoroughly redistributing income, but doing so in a way which very few people understand. The result is a naturally increasing tendency to inflate and spend. A side effect is a skewed economy open to exploitation.

It should be no surprise that all currencies that have gone into this inflationary spiral unchecked have perished, with dramatically negative consequences for the people and countries who possessed the currency. Because the United States has begun this process, a spirit of self-preservation strongly suggests reducing your holdings of fiat currency and increasing your holdings of commodity currency.

Gold is the primary form of commodity currency in the world and will soon no longer be seen as a placeholder for value, but as an investment for an uncertain future.

Mark my words.

Canada shielded from recession? A new reliance on government?

While global recession recovery is anticipated, the pace of expansion beyond next year will be constrained by the need to rein in government deficits, by lingering excess capacity in many sectors and by changes to financial regulations that will boost capital requirements, restrict leverage and raise funding costs for higher-risk activities. Yet Canada almost looked impervious to all the economic and financial concerns. Almost.

What makes Canada different?

Canada was initially insulated from the deepening retrenchment in the U.S. and other developed nations by the resilience of its banking system, the relative financial strength of our government and household sectors, and by a huge revenue infusion from booming commodity markets. We could no longer deny recession only when faltering demand from emerging nations triggered a collapse in resource prices and export earnings in the final months of 2008 and even then, the erosion in employment, housing activity and car sales has been far less severe than south of the border.

Home sales and prices have already begun to climb and residential construction is beginning to revive. Firmer employment prospects in 2010 should reinforce the improving trend in housing activity.

Also, as employment and housing income stabilizes, Canadian domestic activity will revive in coming months evidenced with consumers returning to the malls in greater numbers. Meanwhile a myriad of government-funded shovel ready projects will finally get into the ground. As promised, the Bank of Canada will not nudge up interest rates till next year which then should see a speedy spike back to pre-crisis levels once the economy recovers. However, by then, borrowing costs will not be an impediment to the revival of domestic demand.

Since, foreign sales make up one-third of Canadian GDP, the strength of Canada’s rebound will be tied to commodity markets and reversing the recent slide in U.S. sales (easier said than done). Canada is already benefitting from higher commodity prices in response to demand from China and other nations. Prices for oil and most minerals are expected to move higher as global growth gets into gear, although sales of natural gas and forest products to the U.S. will be constrained both by that country’s slow pace of expansion and competition from alternative sources.

Will there be hyper-inflation or even inflation? I am still confident that as demonetization of the money markets occurs, inflation is imminent and will continue to boost the Canadian economy.

While the Loonie is moving towards parity vis-á-vis the U.S. dollar suggesting economic growth, we must remain wary of a double-dip or double recession as credit conditions and balance sheets improve at a slower pace. Bottom line is, Canada is looking better than most countries, but we must continue to strive to be cautious.

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REST OF THE WORLD

A glance at share prices or short-term growth forecasts reveals shrinkage of output has stalled in all of the world’s big economies, global stock markets have rallied by 64% since their trough and corporate finance, once frozen, is thawing fast. Yet closer inspection suggests caution.

Unemployment is still rising and much manufacturing capacity remains idle. Many of the sources of today’s growth are temporary and precarious. What we are seeing is a rebuilding of inventories global spending driven by massive fiscal and monetary stimulus which cushions the damage to households’ and banks’ balance-sheets without tackling the underlying problems. Debts are accumulating with no improvements to debt servicing capabilities. New bubbles are being utilized to pull out of recession. Banks still need to bolster their capital. All these suggest consumer spending will be lower and the cost of capital higher than before the crunch.

Does all these so-called analysts not come to these realization? All eyes on the policy makers to pull off several tricky maneuvers: shoring up demand now without wrecking the public finances; containing unemployment without inhibiting the shift of workers from old industries to new ones; and, more than anything else, fostering innovation and trade, the ultimate engines of growth. It is no secret that global spending must be rebalanced: indebted consumers must cut back, while thrifty countries should spend more and save less.

In China this means a stronger currency, bigger social safety-nets and an overhaul of subsidies to increase the share of national income going to workers. Other Asian currencies will also need to appreciate and take over U.S. role for consumption so global recovery can sustain. Germany and Japan need structural reforms to boost spending, especially in services. What has long been lacking is the political will—and here the G20 seemed to make progress and will need to continue. The Pittsburgh communiqué promised to subject members’ economic policies to “peer review”. These reviews may prove toothless, but the commitment to them is a step forward.

Out of this crisis, there is a growing reliance on governments, reflecting the damage done to free markets. This strikes another warning bell as basic fundamental assumptions of economic and financial analysis are violated.

Global issues require global effort

Friday evening, the heads of the world's 20 biggest economies encompassing 85% of global economic activity, will have dined, met, lunched, met again, and made their pronouncements. If history is any judge, this will end up being a 24-hour series of photo ops producing little if none at all immediate or lasting results.

Certainly, weighty issues are on the table: rebalancing world commerce, reforming the global financial system, reining in executive pay, fending off protectionism, and plotting out how to extricate national governments from deep involvement in the financial markets. However, the most successful events have been those bringing together technocrats and finance ministers over extended periods. Only during times of crisis, such as last fall’s financial crisis, having a forum like the G-20 will be invaluable as a speedy communication and cooperation forum.

It is hard to imagine that world leaders would reach consensus to coordinate stimulus spending, monetary policy, and other moves to stabilize the economy in normal times. Desperation eliminates many of the unnecessary options and leaves you with the bare necessities. No more redundant procedure or idealistic differences.

Surely, pressing issues of the summit would be to ensure the US continues to save more and spend less while China steps up its nascent shift toward a more consumer-driven economy and away from exports. Such would counter the slowdown of worldwide growth as we strive for economic balance and stability.

On trade, the World Bank, the World Trade Organization reports more than 100 protectionist measures, which include a U.S. ban on certain Mexican trucks from operating in the U.S. and a "Buy American" provision in the Administration's $787 billion stimulus package.

Another issue that is likely to arise again is efforts by China, Russia, and other countries to create some other form of reserve global currency in addition to the dollar.

While the G20 is not structured to examine the scarcity of resources or the effects of global warming, I feel it is time for a cooperative effort to rectify the situation.

Since the Chinese, Indians and Russians have entered the market economy, the number of employed people worldwide has doubled, to about 3 billion. Vast new markets and low-wage production countries have developed, with serious consequences for the consumption of energy and water.

Oil consumption has increased by more than 25 percent since 1990, while the consumption of natural gas has grown by more than 50 percent. Fossil fuel production is becoming more and more difficult and costly.

The scarcity of water is even more serious. Global water use has doubled since 1950, and even as large segments of the world population lack adequate access to clean water, more and more water is being used in food production. For example, more than 1,000 liters of water are consumed to produce one kilogram (2.2 lbs.) of bread, while producing a kilo of beef uses up almost 16,000 liters of water.

We have reached the point at which the Earth's regeneration capacity is being stretched too thin. Theoretically, humanity today already needs 1.3 planets to maintain its lifestyle. If everyone were as wasteful as the Americans, five planets would not be enough. Not to mention that by 2050 the world's population will have increased by 2 billion needing food, clothing and shelter.

Given the Earth's limited system, the economy clearly cannot grow indefinitely. From an ecological perspective, this is the fundamental contradiction within the logic of growth. As economies mature, it automatically becomes more difficult for them to sustain their rates of growth. The principle is clear: Resource consumption must be decoupled from growth.

This is effectively what representatives of the world's governments will be discussing when they meet in Copenhagen for the United Nations Climate Change Conference in December. But, I remain reserved as to how effective the meeting will be. The UNO (A.K.A “Organization of the Useless Nations”) continues to be nothing more than a rubber stamp or a high-profile excuse for the America’s dominance.

We need change and perhaps, the world is changing, but we are far from our goal.