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by Brian Butler

There’s a hole in the bucket…

2009/02/12 in credit crisis, macro trends

This morning, I watched congress grilling US banking exec’s about the need to get money flowing again.  Watching this session run in circles, it reminded me of a simple song my mother used to sing about a “hole in a bucket”, and the cascading flow of suggested fixes, with each leading to another, but none of them fixing the original problem (see song here)

BANK CEOS HEARING

While it may seem important to pressure banks to lend more (and it may look good on camera to appear tough on bankers)… pressuring the “traditional” banks to lend more won’t fix the problem of “deleveraging” of global financial system.

The problem with contraction of credit lies outside of the traditional commercial banking realm, and instead can be found in the (forced) contraction of the “shadow banking market“  (comprising hedge funds, broker-dealers, private equity funds, structured investment vehicles and conduits and money market funds, etc..).

Shadow Market troubles…

The traditional banks may be lending, but even if the traditional commercial banks were to open up the gates, and let their capital flow,  they can’t make up for the massive-gaping-hole that is missing from the “shadow banking” market that has gone “missing in action” (or, off the cliff)…

Securitization has for several years exceeded bank loans as a percentage of private credit market debt.

shadow-b2

In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered.

Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them…

…while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist

source: PIMCO

How big could the “hole” be?

Estimates are all over the board, so rather than try to make my own guess as to the size of the liability, Im going to share with you some of the more educated guesses Ive seen recently, and let you draw your own conclusions:

in January 2008 the International Monetary Fund published its $1tn estimate for the losses (that number has been revised upwards).  Newer estimates look much worse…..according to Martin Wolf: “The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Derivatives Market size…

If you look at global derivatives markets, according to the BIS, you see that there was

  • Notional amounts outstanding:  June’08 = $683,725 billion
  • Gross market values =   $20,353 billion   (approx $20 Trillion USD!!)
Notional  vs  Gross
  • “Notional” value is the “maximum losses in case of a meltdown” ….and gives an idicator of the market’s size
  • “gross market values” tells you the scale of financial risk transfer taking place in derivatives markets.”

Lets use the smaller number in this discussion.  If you round down to $20 trillion, thats an incredible amount of money.   The size of this mountain of “side-bets” (or “weapons of mass distruction, as Warren Buffet called them) is difficult to really put in personal terms.  I found a great description of the magnitude of the mountain here:

  • U.S. annual gross domestic product is about $15 trillion
  • U.S. money supply is also about $15 trillion
  • Current proposed U.S. federal budget is $3 trillion
  • U.S. government’s maximum legal debt is $9 trillion
  • U.S. mutual fund companies manage about $12 trillion
  • World’s GDPs for all nations is approximately $50 trillion
  • Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
  • Total value of the world’s real estate is estimated at about $75 trillion
  • Total value of world’s stock and bond markets is more than $100 trillion
  • BIS valuation of world’s derivatives back in 2002 was about $100 trillion
  • BIS 2007 valuation of the world’s derivatives was a whopping $516 trillion
  • June ’08…it grew to $683,000,000,000,000  (yes, thats Trillion, with a “T”)
  • source:  PIMCO

A massive “hole in the bucket”

You see, there’s a “hole in the bucket, deal Liza” (see video below here, if you dont know this one).  And, no quantity of extra lending from traditional banks will fill that hole.

Links for more (from GloboTrends):

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by Brian Butler

Fiscal stimulus too small…

2009/01/27 in credit crisis, macro trends

The proposed fiscal stimulus package of $825 billion is probably  (a) too small, and (b) not directed at the right part of our economy (the financial sector).  Let me share with you a recent quote that I read from the IMF:

“If there’s not a restructuring of the banking system, then all the money that you can put into [monetary and fiscal] stimulus will just go into a black hole,” Strauss-Kahn, director IMF

On the surface of it all, a massive spending binge of $800bn USD sounds impressive ….but is it?  If you think in personal terms, then hundreds of billions sounds like alot of money. And, maybe it is when compared to the budgets of most countries on the planet.   But not when its compared to the size of the international finance market, in which there are approximately $140 trillion in financial assets, and hundreds of trillions of dollars traded every year in the currency markets.

Why look at the financial markets size?

When looking at a fix to the financial problem, it is important to compare the size of the proposed fix to the size of the financial system.  You need to compare “apples to apples”, if you will.  And, since the root of the problem lies in the financial sector, it makes sense to compare the size of the stimulus to the size of the problem.   It doesn’t make sense to compare the bailout to the size of a countries GDP (or reserve), when the root of the problem lies not in the real economy (although that is clearly suffering right now), but with the heart of the financial system.

The size of the financial market

Lets look at the numbers…and take a look at how big the fiscal stimulus plan really is  in comparison to the estimated size of the global financial system…

see data below…or, here in our GloboTrends wiki

The overall size of the world financial assets (promises outstanding) was approx $140 trillion in 2005.  That incredible number was the total quantity of financial assets, or seen another way…there were $140,000 billion promises outstanding for future payments.   That unbelievable quantity of promises was only possible because people believed that the underlying assets upon which those promises were made were actually worth what people said they were.

Shrinking the financial market

But when houses started losing value, the mountain of assets stacked on top of them needed to shrink.   The underlying assets suddenly couldn’t support this incredible (massive) amount of promises stacked on top of them.  And the mountain of finance began to fall…not all the way down, but to a new, lower level of promises.  This is what analysts often called “deleveraging“, which meant that we were shifting from an economy with lots of credit…to one with less credit.  Less lending, less leveraging, less total financial assets for you and me.    Note that this $140 trillion of financial assets was equal to about 3.16 time total world GDP in 2005….up from 2.18 times in 1995,  and from 1.09x in 1980.  This means that we were living on nearly 3 times as much financial credit in 2005 as we were back in 1980, just 25 years before.  This massive boom in finance just happened to correspond to the longest and most prosperous boom in US history…a coincidence?  I think not.

Complexity of modern finance…

So, what is happening now is we are moving back to a world with less financial leveraging.  It wasnt our choice, but a requirement once investors lost confidence in the underlying value of the property upon which the mountain of promises was heaped.

But because of the complexity of modern finance, once uncertainty entered into the picture, it because extremely difficult to know which assets were worth what. With mountains of derivatives stacked on top of other derivatives, spliced, diced and repackaged every which way…it became extremely difficult for counter-parties to judge the risk of lending to each other.

The result?  Banks stopped lending to each other for fear that the assets may not be worth as much as they thought.  With bad assets mixed in with good assets, a confusion set in.   As a result, all banks sought to shore up their balance sheets and reduced lending.   Uncertainty led to a forced deleveraging of the entire financial system…

The pain we feel in the real economy (with job losses, companies losing money, etc) is a direct result of the deleveraging process.   We start at one level of activity, and are forced down to a lower one.

The stimulus package is too small

We cant seem to spend enough money.  But thats because we are fighting the problems that result from the original problem rather than dealing with the original problem itself.  Trying to stop the water from a broken dam is much more difficult than plugging the holes in the dam!

If you add up all the money we have already spend, its clear that throwing money at the problem will not work.   Around the globe, country after country is spending money like crazy (cutting interest rates, proposing fiscal stimulus).  This latest round of $825 billion is just the latest round.  Remember, we previously spent a hundred billion plus in February of 2007,

“After the economy slowed in late 2007, Congress passed a $168 billion stimulus package in February 2008 consisting primarily of tax rebates. The package was later judged by many economists to have been ineffective, since surveys showed that much of the extra money was saved or used to pay debts, neither of which generates direct economic activity.”

And then there was the $700 billion of money in the TARP plan (Paulson Plan) that also wasnt enough to stop this deleveraging monster…

“$700 billion to use to buy up mortgage-backed securities whose value had dropped sharply or had become impossible to sell. While Congress eventually gave him most of the authority he sought, Mr. Paulson ended up switching gears and using the money to make direct investments in troubled financial institutions instead.  source NYTimes

I previously wrote an article arguing that the fall in oil prices was a big fiscal stimulus  (see link here).  But, all of this stimulus has done very little to fix the problem…because none of it went to the root of the financial deleveraging…the trouble is that the financial system is just too MASSIVE in comparison to all of these efforts..

In comparison…the financial Market is MUCH bigger!

  • $140 trillion in financial assets…compared to $0.8 trillion in fiscal stimulus.
  • On any given day, approximately $1 trillion US dollars worth of currency is traded in just the UK alone….with another $600 bn in the US (each day).  Add them up, and you have hundreds and hundreds of trillions of dollars traded each year in the international money markets.
  • in the face of such a MASSIVE market…one has to ask….

Will a stimulus of just $0.8 trillion make a difference?

If you accept that the root of the problem is in the financial markets, and not in the real economy…then you need to compare the size of the proposed fiscal stimulus plan not to the size of the real economy, but instead to the size of the financial one. Once you do this, you begin to see why economists such as Martin Wolf are saying that this stimulus package is too small to be effective.  (his argument was slightly different than mine, but with the same conclusion that the stimulus package is too small).

My thought is that spending $0.8 trillion in the face of $140 trillion in assets … is like spending half of one percent of the total assets in the hopes of propping up the market.  Not only is it way too small, but it goes after the real economy, and not the financial one.

So, what is the solution?

Do we all just need to accept financial system deleveraging?  Do we just need to learn to live with less (credit, goods, finance)?  No.  But we need to accept that this problem is not going to be solved by throwing $825 billion at the real economy.  Instead, what we need to do is to find a way to get all of the bad assets out of the larger pool of assets in the financial system.   Separate them, write them down, and isolate them from the majority of good -quality assets still in the financial system.

Here are my thoughts for a practical solution.

  1. Create a “bad bank” which would purchase assets from financial institutions in exchange for cash and equity.
  2. Look to Sweden, not to Japan (for the answers).  My recommendation is to spend some time studying the Swedish model for recovery
  3. Give the TARP another go.  Although Paulson later switched course and tried the European model of direct bank recapitalizations, I think he was originally on to a good idea…buy up bad assets, and find a way to strip them out of the financial system

If those steps fail…then the only other alternative may be to reluctantly nationalize the banks.  But, this WILL NOT SOLVE the root problem of forced deleveraging due uncertainty of what assets are worth.  It will only lead to forced lending and bad debts, and a potentially huge bill for tax payers.

Final recommendation…go ahead with the stimulus package

Yes, thats right.   After arguing that it wont work, Im still arguing that it should be done.   The point of my article is that this particular plan will not solve the underlying problem that is causing the financial crisis, but that doesnt mean that the fiscal stimulus shouldn’t be done.

There is a feedback-loop that exists between the “real economy” and the financial markets.  While the trouble may have started in finance (and ultimately needs to be solved there), the real economy plays a vital role.  Anything that can be done to get people working, and the economy moving ….will give our policy makers time to fix the real problem in the financial sector.

But the risk is that politicians will pat themselves on the back for “solving the problem”, when they should be realizing that the stimulus package is just a (much needed) bandaid.  It will cover up the trouble for a little while, but hopefully we dont all forget that this is just a temporary fix, and that further action is needed.

Hopefully, whatever fix comes next will be directed at the financial markets themselves….hopefully we wont open the newspapers 6 month from now to read news reports like this:

” USA faces extended downturn Despite Stimulus“

The data:  our financial mountain of promises:

* here is a sample of the data we are collecting in our GloboTrends Wiki…

Size of the Financial sector:

What is amazing is that the financial sector ballooned to the size that it has…with a worldwide total of $140 trillion in promises outstanding in 2005 (surely more in 2008/9).  Of that total, the US was the prime holder of promises (assets).  The US household sector held about $39 trillion (28% of world total), and with the US as a whole holding nearly $52 trillion (37% of all world financial assets, or promises).

USA:

  • household & non profit:
    • total assets = $64.4 trillion assets owned  (5x USA GDP)
    • total debts =  $11.9 trillion
    • total balance:  $52.5 trillion
      • of this $52.5 trillion…the breakdown was as follows:
        • $25.6 trillion = tangible, mostly property
        • $38.7 trillion = financial assets
          • $6.1 trillion in deposits
          • $3.1 trillion in credit market instruments
          • $5.7 trillion in direct corporate equity
          • $8.9 trillion in indirect corporate equity, of which…
            • $1.1 trillion in life insurance
            • $3.0 trillion claims on pension funds
            • $1.9 trillion claims on gov’t retirement funds
            • $2.9 trillion mutual funds

So, total US financial assets in 2005 was as follows…

  • Household & non profit sector (data from above):
    • financial assets:  $38.7 trillion
  • Business sector -  Non-farm, non-financial corporate sector
    • financial assets:  $10.9 trillion
  • Business sector -  Non-farm, non-corporate sector
    • financial assets:  $2.3 trillion
  • TOTAL US private sector Financial Assets:
    • $52 trillion USD (approx. in 2005)….obviously it grew more till 2008 (especially housing bubble), before falling…

Financial assets globally…

Compare this with world (in 2005):  source : McKinsey report 2005, “Mapping the global capital market”

  • USA (private sector only):  $52 trillion  =  37%  (rounded)
  • Eurozone (all):  $30 trillion                  =  21%
  • Japan  (all):  $19.5 trillion                    =  14%
  • UK (all):  $8 trillion                             =   5.7%
  • Top 4 total $109.5 trillion / 140           =  almost 80% world total !!
  • World total (all, including private + govt + business):  $140 trillion….owned of financial assets

How this $140 trillion breaks down…

  • $44 trillion was equities      =  31.4%
  • $35 trillion was private debt securities   =  25%
  • $23 trillion was government debt securities   =  16.4%
  • $38 trillion was bank deposits                        =  27.2%…….down from 42% in 1980 (shift away from simple deposits to more indirect banking)
  • $140 total

How has it grown? As a % of GDP…

  • $140 trillion was = 3.16 x total world GDP in 2005….up from 2.18 times in 1995,  and from 1.09x in 1980
  • Regional trends from 1995 to 2005
    • UK: rose from 2.78x to 3.59x GDP
    • USA  from 3.03x to 4.05x GDP
    • Eurozone: from 1.80x to 3.03x GDP

Sources:

* data from McKinsey report 2005, “Mapping the global capital market“  and http://www.federalreserve.gov/releases/

Should we More money for banks?  

“Politically difficult”…but worth it…

Strauss-Kahn recognized that putting more public money into the banking sector to restructure it can be unpopular politically. “But the reality is that one dollar spent in restructuring the banking sector today is much more useful to achieve recovery than the same dollar spent on bridges, hospitals etc.”

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by Brian Butler

Top macro-economic trends for 2009

2008/12/14 in macro trends

On our GloboTrends wiki homepage, we host an ongoing discussion of global “macro” economic trends that we think are the most important to keep an eye on.  Some trends we are watching in the GloboTrends wiki are currently ongoing right now (such as our coverage of the USA credit crisis, deleveraging,  margin calls, etc), and we will talk about how they happened, and predict their likely outcome.

Some of these potential macro economic trends may seem statistically unlikely to occur in the short term (if at all), but if they were to happen, they could cause massive global disruption to the financial and economic systems, so they are worth discussing, and taking a closer look at.  These unlikely events were dubbed Black Swan’s in a   book by Nassim Nicholas Taleb , or “fat tail” probability in statistics.  These are the financial equivalents of 9/11, or the chance that a housing bubble could cause global economic meltdown.  In a world where the un-thinkable seems to happen with a greater frequency, it makes sense to start looking at the “worst case” scenario, and figure out how to (a) protect yourself, and (b) position your portfolio to profit from ongoing trends.

The links are to the GloboTrends wiki, where the document is dynamic, so any of our community is welcome to contribute, and to help shape our views of these important developments.  Please log in to our wiki, and feel free to comment…

Top Trends for 2009:

In no particular order, here are the global macro trends that we think will be most significant in the coming year (2009):

  1. Credit crisis of 2007/08 will continue on into 2009…this one is clear…but, how long will it last? how will it fundamentally change international finance?  Add your comments to our wiki…
  2. Deleveraging of Financial markets will continue.  In my opinion, this is the most destructive of all the trends.
  3. Risk of deflation in the US as Fed Funds target rate approaches zero (other analysts see the opposite risk of potential hyper inflation).  Add your comments..
  4. Changes are happening in China.  We are especially concerned about the relations/ dependency between China & USA
  5. Protectionism rises: free trade movement slows down in 2008
  6. Fiscal stimulus expected in massive doses…but will it have any effect at counteracting the deleveraging process?
  7. Monetary / Fiscal policy seen as ineffective…so expect un-conventional action from the Fed, such as quantitative easing
  8. Rise in risk aversion – investors and companies are paying for safety (as negative Treasury yields have indicated)
  9. Increased regulations: Philosophical move away from “free markets” toward “bigger government”.  How far will the pendulum swing?
  10. nationalizations will increase as companies go bankrupt, and look for protection.  privatizations will increase as governments sell off assets to raise cash….which will be the more important force?
  11. IMF will become more important,  WTO might be sidelined
  12. USA is losing stature (military seen as less strong, economy less of a model)
  13. US dollar:  will it continue recent trend of strengthening during the crisis?  Or, will the weak dollar trend resume after the height of the crisis passes, and investors become concerned about excessive debt levels (which no doubt will be increased as we pay for fiscal stimulus packages proposed with the new administration)

In addition to these global trends listed above, we are also interested in discussing how these trends will effect other areas.  For example, we are discussing…how will the credit crisis affect the…

  1. Rise of purchasing power in emerging markets (will this continue post “great deleveraging”?)
  2. inflation (was a big problem going into 2007…now is deflation more of a concern?)
  3. Asian countries fight to keep their currencies undervalued vs the dollar (will this intensify? lead to trade wars?)
  4. Clean-tech and environmentally conscious investing (will this movement continue in the face of economic crisis & lower oil prices?)
  5. immigration (with US & Europe stumbling, how will that affect relations with immigrants?  will there be resentment?)
  6. philanthropy &  Investing in socially good projects (will giving suffer as a result of the crash?)
  7. tech trends to watch (will innovation jump in response to the recession?  or, will lack of funding lead to less?)

Are we missing something?

We are looking for help… this is a community page for open discussion about global trends.

My goal with the site is to create a community where investors and global business leaders can learn, collaborate, gain reputation by contributing content, and lead discussions.   The reputation of leading a discussion on a particular topic should help to find financing, find new jobs, or find new business partners,etc…  Contribute to GloboTrends wiki:


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by Brian Butler

Investing advice: need to focus on global macro trends AND current valuations

2008/11/20 in Tumblr blog imports

If you focus too heavily on long-term trends for investing, you might loose a mountain of money in the short-term as market volatility makes your fundamental bets irrelevant.

I recently watched a series of interviews that Jim Rogers gave with FT.com, and I was troubled by what I heard.  I’m afraid he’s focused too heavily on the long term trends, and too little on the dangers of short term volatility.   Yes, it’s important to look at global (macro) trends, but in times of high volatility as we have seen in the past few months, its useful to take a pragmatic and flexible approach.

Interviews with Jim Rogers can be found here:

Summary of Jim Rogers investing position:  a “Bull on China” & Commodities

Earlier this year, Jim Rogers was still recommending investors to look to China & to commodities for investments.   While this may be good advice in the long-run, its terrible advice in the short run (especially over the past 6 months).  see chart below, and click on 5yr button to see the long-run trend.

Read the rest of this entry →

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by Brian Butler

Does “Decoupling” in the global economy mean that Latin America is safe from a US recession?

2008/05/08 in Tumblr blog imports

No, I dont think so: “A third of the collateralised debt obligations (CDOs) and other financial instruments based on US residential mortgage-backed securities (RMBS) that are tied to sub-prime markets have moved offshore, mainly to Europe, the OECD said.”

In early 2008, it became fashionable to claim that a recession in the USA would not cause emerging markets such as Brazil to slow down. The theory of decoupling states that these emerging markets are no longer directly correlated with the US economy: they have been “decoupled”, and now depend more on China, and on Europe, and on their own internal growth.

My take on this:

The reason that the emerging markets such as Brazil, and China have not yet been adversely effected by the US bursting of the credit bubble is because our connections with those countries is not related as much with credit. Our connections with China is that we buy their products. Consumer demand of products is more important to the Chinese economy that a collapse of banking credit in the USA. We were never “coupled” in the credit markets, so the idea that we have been “decoupled” is ridiculous. In fact, the countries are still very much tied through trade and through globalization, we are more tied together than ever before. Its just that the connections are through consumer purchases of goods and services, and not on the availability of credit.

But, what is going to happen? My predictions:

Credit contraction in the US, if it causes the consumers to cut back spending (buying of Chinese made goods), then that could cause a slowdown in China. With a slowdown in China, there would be less demand for commodities, and countries in Latin America (and other big raw material suppliers) would feel the hurt. The key is the consumer consumption….that is where the correlation (coupling exists).

What you should do?

Pay very close attention to the health of the US consumer….does he keep spending? If not, then be careful, and take defensive positions out of commodities, and emerging markets. …because the idea of “decoupling” will come undone.

Read more: http://kookyplan.pbwiki.com/decoupling

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by admin

Three factors that are driving up food prices worldwide

2008/05/08 in Tumblr blog imports

three key factors:

  1. rapid demand for more energy-intensive food in Asia (as people get richer, they want to eat more meat, beef. But raising beef takes more energy, and more grain than if people just ate the plain grains themselves. This increases overall demand on the grains markets.
  2. the competition that new biofuels are posing for land; As farmers of food have to now compete for land with farmers for fuel, there is a lower supply of good land available for food production.
  3. the effect of drought on global agriculture; droughts, hurricanes, cyclones, etc…they all reduce the supply of crops in any particular year. Countries such as Bangladesh, and Myanmar have been particularly badly hit recently.


Key question: will the inflation level in the food sector come back down? how soon? is this inflation that we are seeing now = to just a one-time readjustment of the prices higher? (caused by less land available due to biofuels incentives). Or, should we expect the prices to continue to rise year after year into the future?

My guess is that the effects of the corn-ethanol subsidies on world food prices is a “one-time” effect. After prices move higher the first year due to lower supply, then they should find equilibrium. That is, unless either (a) the expectation of future inflation causes actual rates to rise further (psychological effect), or (b) the prices will actually come down because more farmers will be attracted to the market in the future due to the higher prices, and due to the higher-supply in the future, and the prices will come down.

The trouble is that food price inflation can lead to all-sorts of other inflationary pressures. As workers are faced to pay more for food, they may demand higher salaries, which can make products more expensive, and thus creating a vicious cycle. The fed is right to be concerned, and to fight inflation before it becomes expected and anticipated. Because as long as inflationary expectations are low, there is little chance that the cycle can become vicious.

What needs to be done, now.

1. Countries need to avoid the temptation to hoard food.

Countries such as Vietnam that are afraid that rice supplies will not be enough (or that future prices will rise) are hoarding (collecting) vast collections of rice. By not exporting the full production, they are only increasing the pressure upward on price. By holding back supply, country after country is only making the situation worse. What needs to happen is that the agriculture producing nations need to remove export limitations (as Argentina has done by heavily taxing exports) and allow market forces to help boost agriculture supply.

read more “Corn ethanol subsidies have to go”

KookyPlan Wiki

http://www.blogcatalog.com/directory/economicblogs

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