2009-03-05

China: The Hope of the World Economy?

Sweden to GM/Saab: Drop Dead!

Finally, a nation with a little backbone...a little integrity...a little good sense. And guess what, it's that dreary socialist refrigerator - Sweden. Asked to bailout its GM-owned automaker, Saab, the country's Prime Minister just said 'no.' Good for him...

"Voters did not pick me to buy loss-making car factories," he explained.

But it's a time of contradictions, paradoxes and oxymorons. Up is down. Right is left. In is out. Good is bad.

The socialists are the only ones protecting the free market, now. Americans are scuttling it with every chance they get. The stocks of capitalist companies are going up in communist China...but in America, they're going down. Since November, the Shanghai index has outperformed the S&P by 75%.

And back in the United States, projects that were considered too marginal to justify spending money a year ago are now thought to be indispensable. And the IOUs of the biggest spendthrift on the planet are the hottest item on the market. Ten-year Treasury notes are now priced to yield only 2.99% - just as the Obama administration announces a $1.75 trillion budget deficit.

Even crooks and criminals are flummoxed. A guy walks into a big downtown bank. He points a gun at the teller and says: "Give me all your money."

The teller replies calmly: "You don't understand. This is a bank. We don't have any money."

The only people with money now are the people who never earned any...the people who print the stuff.

But back to China:

All the things that used to convince pundits that China was hopeless now persuade them that it's the hope of the entire world. "China's autocrats can announce a stimulus - and get on with it," writes John Authers, admiringly, in the Financial Times. They don't have to beg and bicker with the dunderheads in Congress. They can just do it.

And China's banks are more solid, too. "China's are in good health, with both loans and deposits rising. American counterparts are not."

But our irony cup runneth over when we read Auther's next comparison:

"Finally, there is confidence in officialdom." The markets have lost confidence in Tim Geithner and the rest of the feds, he says. "Meanwhile, hope...is pinned on the audacity of Chinese officialdom and is ability somehow to keep their economy on course."

Everything is so topsy-turvy, dear reader, we think we're going to throw up.

The whole world now turns its weary eyes...not to that bastion of free- market leadership, the United States of America, but to a country that has only had a quasi-free-market in goods and services for less than a quarter century...a country still run by Maoists. It is to them that we supposedly look to save the world economy!

What a great time to be alive! Practically every headline makes us want to reach for a drink. And we're finally getting to see something that we only read about in the history books...yes, we're going to find out what makes a depression so great.

Bankruptcy filings in the United States were up 37% in February, over the year before. House sales plunge, say the papers. Auto sales plunge, say the websites. Joblessness soars, says this morning's news. Corporate America laid off 158% more workers this February, as compared to a year ago. Since the beginning of the year, layoffs are running 191% ahead of the same period in 2008. Almost a half a million people have lost their jobs so far this year...and there are 10 months left to go.

The Dow gained 149 points yesterday. Our "Crash Alert" flag is still flying...but the Dow is probably going to rally for the next few days.

Gold, meanwhile, continues its correction. It fell to $906 yesterday. Goldbugs, don't despair. Have faith. The commies aren't going to pull the world economy out of its tailspin. The bailouts and boondoggles in the West aren't going to do it either. Buying gold is still the smartest long-term decision that you can make for your portfolio...and we suggest you take advantage of this correction. Buy some while the price is low - and even better, you can get the yellow metal for just a penny per ounce. Get yours now.

Remember, this is a depression, not a recession. Both America and Chinese economies have lived in a grand, symbiotic delusion for the last 10 years. America believed it could let the Chinese do all the sweating and saving. China believed it could make money by selling to people who couldn't afford to buy. Now, both economies need perestroika. Both need to be refocused. China will turn its economy towards domestic consumption...and military spending, no doubt. America will have to accept a lower standard of living with fewer imports.

These adjustments take time. The last time the world went through a depression was in the '30s. Every major economy - except Britain - fell backwards...all of them losing more than 20% of GDP. It took three years before they hit the bottom. Then, some bounced back quickly - Germany and Japan - thanks to military spending. Others - the United States and France - barely bounced at all.

*** More bubbles ready to burst. In the United States, public pension systems are under-funded by about $1 trillion. Firemen, teachers, policemen, municipal workers...state bureaucrats. Every one of them is looking to the feds for a bailout.

Oh...and AIG is getting its FOURTH go-round of rescue money. The fifth one will come around soon enough. And there's Detroit...California...student loans...commercial loans...the banks...the homeowners...the unemployed...the sick...the halt...the lame...the blind...the plain stupid.

Where will the feds get the money?

They'll continue to borrow it. Then, when lenders get tired of lending, they'll print it. That's when gold will really fly...but that might not be for another few years.

For the moment, lenders like buying U.S. government IOUs. It's the only thing they feel they can trust. One way or another, they're sure Uncle Sam will make his payments.

But, as we've been saying, we live in an upside down world. If and when the fear subsides, investors are going to look elsewhere for yield. Prices will begin to rise again. So will yields. So, the U.S. government will have to pay more to borrow. Thus, as things get better for the economy...they will get worse for the U.S. Treasury. It will find itself with higher and higher interest costs...and no way to pay them.

What will they do? Throw up their hands and admit they can't make their payments? Or print money? We've already made our guess; they will do the wrong thing.

*** What is the right thing to do?

"Leave it to time to affect a permanent cure by the slow process of adapting the structure of production..." said Friedrich Hayek.

"Depressions are not simply evils, which we might attempt to suppress," added Schumpeter, "but forms of something which has to be done, namely, adjustment to change."

The economy needs to be restructured. The dead wood needs to be burnt off. But the feds are trying to stop the fire.

Alas, said Schumpeter, "most of what would be effective in remedying a depression would be equally effective in preventing this adjustment."

Bradford Delong explains:

"...certain investments should not have been made. The best that can be done in such circumstances is to shut down those production processes that turned out to have been based on assumptions about future demands that did not come to pass. The liquidation of such investments and businesses releases factors of production from unprofitable uses; they can then be redeployed in other sectors of the technologically dynamic economy. Without the initial liquidation the redeployment cannot take place. And, said Hayek, depressions are this process of liquidation and preparation for the redeployment of resources.

"As Schumpeter put it, policy does not allow a choice between depression and no depression, but between depression now and a worse depression later: 'inflation pushed far enough [would] undoubtedly turn depression into the sham prosperity so familiar from European postwar experience, [and]... would, in the end, lead to a collapse worse than the one it was called in to remedy.' For 'recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead.'

*** We got on the Paris metro this morning. In the car, there were two fellows...bums...in worn-out jackets...scuffed-out shoes, without socks. They didn't seem drunk or drugged, just very tired. One bent over with is his head on his knees. The other was bent over too but uncomfortable...swaying, as if he was about to be sick. Both had an eastern European ...or Turkish look. Maybe they were gypsies...dark complexions, but European features...rough, course...with thick hands and dirty fingernails. Occasionally, they exchanged words in a language we didn't understand. The older one seemed less well than the younger man, who was probably in his 40s. As they tried to sleep, the younger one fell off his seat. Catching himself...he put his head back on his knees...and then, a minute later, he fell off again...this time right onto his head. Then, he picked himself up and sat down...and dozed off again.

Isn't that a question, though...

The Peak Oil story was never about running out of oil. It was about the collapse of complex systems in a world economy faced by the prospect of no further oil-fueled growth. It was something of a shock to many that the first complex system to fail would be banking, but the process is obvious: no more growth means no more ability to pay interest on credit... end of story, as Tony Soprano used to say.

There was a popular theory among Peak Oilers the last decade that the world would enter a "bumpy plateau" period when the global economy would get beaten down by Peak Oil, would then revive as "demand destruction" drove down oil prices, and would be beaten down again as oil prices shot up in response - with serial repetitions of the cycle, each beat-down taking economies lower - the only imaginable outcome being some sort of quiet homeostasis. This scenario did not play out as expected. It was predicated on a mistaken assumption that all systems would retain some kind of operational resilience while ratcheting down. Anyway, the banking system was mortally wounded in the first go-round and the behemoth is dying hard.

The last desperate act of the banking system in the face of Peak Oil's no-more-growth equation was to engineer species of tradable securities that could produce wealth out of thin air rather than productive activity. This was the alphabet soup of algorithm-derived frauds with vague and confounding names such as credit default swaps (CDSs), collateralized debt obligations (CDOs), structured investment vehicles (SIVs), and, of course, the basic filler, mortgage backed securities. The banking system is now choking to death on these delicacies.

The trouble is that the EMT squad brought in to rescue the banking system - that is, governments - can't remove these obstructions from the patient's craw. They don't want to drown in a mighty upchuck of the alphabet soup.

The collapse of complex systems is actually predicated on the idea that the systems would mutually reinforce each other's failures. This is now plain to see as the collapse of banking (that is, of both lending and debt service), has led to the collapse of commerce and manufacturing. The next systems to go will probably be farming, transportation, and the oil markets themselves (which constitute the system for allocating and distributing world energy resources). As these things seize up, the final system to go will be governance, at least at the highest levels.

If we're really lucky, human affairs will eventually reorganize at a lower scale of activity, governance, civility, and economy. Every week, the failure to recognize the nature of our predicament thrusts us further into the uncharted territory of hardship. The task of government right now is not to prop up doomed systems at their current scales of failure, but to prepare the public to rebuild our systems at smaller scales.

The net effect of the failures in banking is that a lot of people have less money than they expected they would have a year ago. This is bad enough, given our habits and practices of modern life. But what happens when farming collapses? The prospect for that is closer than most of us might realize. The way we produce our food has been organized at a scale that has ruinous consequences, not least its addiction to capital. Now that banking is in collapse, capital will be extremely scarce. Nobody in the cities reads farm news, or listens to farm reports on the radio. Guess what, though: we are entering the planting season. It will be interesting to learn how many farmers "out there" in the Cheeze Doodle belt are not able to secure loans for this year's crop.

My guess is that the disorder in agriculture will be pretty severe this year, especially since some of the world's most productive places - California, northern China, Argentina, the Australian grain belt - are caught in extremes of drought on top of capital shortages. If the U.S. government is going to try to make remedial policy for anything, it better start with agriculture, to promote local, smaller-scaled farming using methods that are much less dependent on oil byproducts and capital injections.

This will, of course, require a re-allocation of lands suitable for growing food. Our real estate market mechanisms could conceivably enable this to happen, but not without a coherent consensus that it is imperative to do so. If agribusiness as currently practiced doesn't founder on capital shortages, it will surely collapse on disruptions in the oil markets. President Obama at least made a start in the right direction by proposing to eliminate further subsidies to farmers above the $250,000 level. But the situation is really more acute. Surely the US Department of Agriculture already knows about it, but the public may not be interested until the shelves in the Piggly-Wiggly are bare - and then, of course, they'll go crazy.

The recent huge drop in oil prices has left the public once again convinced that the world is drowning in oil - if only the scoundrelly oil companies were forced to deliver it at reasonable prices. The public has been consistently deluded about this for decades. What's missing so far is for the president of the United States to lay out the reality of the situation in a dedicated TV address. I know a lot of you think that Jimmy Carter already tried this and failed to make an impression (and ruined his presidency in the process). I guarantee you that Mr. Obama will have to do this sometime in the next few years whether he likes or not, and he'd be well-advised to get it done sooner rather than later. And by this I don't mean just vague allusions to "energy independence" or "renewables" in speeches devoted to many other issues. I mean telling the public the plain truth that we'll never offset oil depletion and the intelligent response is to do everything possible to transition to walkable towns and public transit, not to sustain the unsustainable.

The alternatives - i.e. what we're trying now - is to further delude ourselves into thinking that we can run Wal-Mart and the suburbs by some other means than oil. Despite all our investments in these things, we won't be able to run them by other means, and the news about this had better get out before enormous disappointment turns into titanic rage. If Americans think they've been grifted by Goldman Sachs and Bernie Madoff, wait until they find out what a swindle the so-called "American Dream" of suburban life turns out to be.

This week, in the power centers of America, attention is fixed on the never-ending fiasco of AIG - a company whose main product turned out to be credit default swaps, and is now choking on them. Kibitzers on the sidelines of finance are forecasting a king-hell bear market suckers' rally in the stock markets followed by a belly flop to Dow 4000 or lower. I myself called for Dow 4000 two years ago - and was obviously a bit off on my timing. All this is surely trouble enough. But while your attention is focused on Rick Santelli in the Chicago trader's pit, or Larry Kudlow desperately seeking "mustard seeds" of new growth in financials, try to let one eye stray to the horizon where these other complex systems are working out their next moves. Farming. The oil markets. These are the coming theaters of alarm and distress.

 

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