How long, oh China, will you defer reality?
How long, oh China, will you defy gravity?
How long, oh China, will you run roughshod over the laws of economics?
How long, oh China, will you continue to mock us who doubt?
How long?
Maybe not all that much longer.
http://www.macrobusiness.com.au/2014/03/morgan-stanley-chinas-minksy-moment-is-here/
Showing posts with label financial crisis. Show all posts
Showing posts with label financial crisis. Show all posts
Thursday, March 20, 2014
Friday, February 7, 2014
What is a bubble? aka A Con Game
The global financial crisis of 2007-09 is often described as a bubble bursting. A bubble implies highly inflated prices.
There were highly inflated asset prices, eg. a variety of housing related leveraged debt instruments, but the general equity markets were not overly inflated on either a trailing twelve month or a forward earnings basis. The bursting of the housing bubble (and I would suggest it was also a localized/regional event) was predicated upon a mountain of easy money which in turn led to a run on the financial system and a consequent financial market panic. The real world came to a stop, earnings consequently collapsed and equity valuations in hindsight looked grotesque. What it really highlighted was that the financial system (and the economy) are based substantially upon confidence. The confidence of bankers to lend, investors to invest and business men to make investment decisions. When that confidence disappears in a tightly coupled, complex system all bets are off. That is what we call systematic risk, where one action begets another and feeds upon itself.
There was no one singular cause to the global financial crisis. There were myriad factors and contributors. However, when confidence in the whole system evaporated, it led to panic and an exit from all asset positions.
There were highly inflated asset prices, eg. a variety of housing related leveraged debt instruments, but the general equity markets were not overly inflated on either a trailing twelve month or a forward earnings basis. The bursting of the housing bubble (and I would suggest it was also a localized/regional event) was predicated upon a mountain of easy money which in turn led to a run on the financial system and a consequent financial market panic. The real world came to a stop, earnings consequently collapsed and equity valuations in hindsight looked grotesque. What it really highlighted was that the financial system (and the economy) are based substantially upon confidence. The confidence of bankers to lend, investors to invest and business men to make investment decisions. When that confidence disappears in a tightly coupled, complex system all bets are off. That is what we call systematic risk, where one action begets another and feeds upon itself.
There was no one singular cause to the global financial crisis. There were myriad factors and contributors. However, when confidence in the whole system evaporated, it led to panic and an exit from all asset positions.
Friday, December 23, 2011
There Is A Price To Be Paid
No economic law is more immutable than, "there is no such thing as a free lunch!" Actually, a more immutable law (at least in my mind) is you can't spend more than you make (at least not for very long). Not surprisingly, the two laws are related. And the truth be told, there are such things as free lunches, but they usually come with strings attached (which is the usual application of the idiom). But in the economic realm, there is a simple reason why there is no such thing as a free lunch and relatedly why you can't keep spending more than you make. It is because the production of a lunch costs something. Whoever is handing out free lunches is limited by how much capital they have. Ergo, there are limits to free lunches (and deficits), and the economic law holds true.
And so it seems with the massive government and monetary interventions we have experienced in the post-GFC world. We have become desensitized to the scale and the scope of the operations, and don't think twice anymore about new initiatives or new "solutions," largely because we have not seen too many deleterious effects. It seems that because none of these actions have led to immediate calamity, then maybe they are alright (perhaps even a free lunch). People who would traditionally and historically have been aghast at the actions proposed and undertaken, are now much less squeamish about each new initiative. We are becoming more comfortable with and more complacent about government interventions. And if that doesn't sound familiar, you may like to remind yourself of the pre-conditions to a bubble* (comfort and complacency are important ingredients).
There is a cost to artifice, and there is a price to be paid for attempts at muting the laws of economics. You can't simply wish new liquidity into existence, or make interest rates whatever level you want, without some cost. We have yet to see or feel the full effects of those costs, and therein lies the danger. The bigger the cause, the greater the effect. Ultimately it will be the encroachment of the previously contingent liabilities that sink us (unless we make the necessary painful changes). Rather than smoothing over the effects, the passage of time may in fact accelerate our day of reckoning.
*Bubble is being used here in the sense of something that is isn't sustainable, and for which there is a rude awakening.
And so it seems with the massive government and monetary interventions we have experienced in the post-GFC world. We have become desensitized to the scale and the scope of the operations, and don't think twice anymore about new initiatives or new "solutions," largely because we have not seen too many deleterious effects. It seems that because none of these actions have led to immediate calamity, then maybe they are alright (perhaps even a free lunch). People who would traditionally and historically have been aghast at the actions proposed and undertaken, are now much less squeamish about each new initiative. We are becoming more comfortable with and more complacent about government interventions. And if that doesn't sound familiar, you may like to remind yourself of the pre-conditions to a bubble* (comfort and complacency are important ingredients).
There is a cost to artifice, and there is a price to be paid for attempts at muting the laws of economics. You can't simply wish new liquidity into existence, or make interest rates whatever level you want, without some cost. We have yet to see or feel the full effects of those costs, and therein lies the danger. The bigger the cause, the greater the effect. Ultimately it will be the encroachment of the previously contingent liabilities that sink us (unless we make the necessary painful changes). Rather than smoothing over the effects, the passage of time may in fact accelerate our day of reckoning.
*Bubble is being used here in the sense of something that is isn't sustainable, and for which there is a rude awakening.
Tuesday, June 23, 2009
Thinking the Unthinkable
What if all the monetary and fiscal stimulus fails?
What do we do then?
Talk about staring into the abyss.
What do we do then?
Talk about staring into the abyss.
Thursday, May 28, 2009
Worst Case Scenario
How is this for a worst case scenario.
Rising prices among the food, energy and commodity groups underpinned by a collapse in the dollar and rising interest rates.
Declining prices for labor, consumer goods and anything discretionary (predicated on falling incomes, rising savings and increasing unemployment).
Greater govt dead-weight cost associated with weak stimulus multipliers, major policy mistakes, rising tax burdens, increasing regulation, crowded out private investment, clueless monetary authorities, and the reintroduction of trade warfare.
Instead of global stagflation, global flat-lining.
Rising prices among the food, energy and commodity groups underpinned by a collapse in the dollar and rising interest rates.
Declining prices for labor, consumer goods and anything discretionary (predicated on falling incomes, rising savings and increasing unemployment).
Greater govt dead-weight cost associated with weak stimulus multipliers, major policy mistakes, rising tax burdens, increasing regulation, crowded out private investment, clueless monetary authorities, and the reintroduction of trade warfare.
Instead of global stagflation, global flat-lining.
Friday, May 8, 2009
Summer - The Quiet Before the Storm
The damage is done. The financial sector is irrecoverably impaired.
Financial companies are holding on in quiet desperation.
The dam could well burst during the summer, when all those who can't make it anymore, "spit the dummy."
The same is true of retailers, energy services, and small industrials.
Financial companies are holding on in quiet desperation.
The dam could well burst during the summer, when all those who can't make it anymore, "spit the dummy."
The same is true of retailers, energy services, and small industrials.
The Ball's In Your Court
The ball's in your court, Mr Europe.
The US has passed the stress test (at least for the time being), now the ball is in the Europeans court. Are they going to address their problems, or are they going to continue hoping against hope?
If European financials break, then we could go back to square one (or awfully close to it).
The US has passed the stress test (at least for the time being), now the ball is in the Europeans court. Are they going to address their problems, or are they going to continue hoping against hope?
If European financials break, then we could go back to square one (or awfully close to it).
Saturday, May 2, 2009
A Quick Few Thoughts On Deflation
These are superficial musings.
(1) We've seen substantial asset deflation thusfar in this crisis, but very little consumer price deflation (we have seen a substantial deceleration in consumer price inflation, but not consumer price deflation).
(2) There is a chance we may enter into consumer price deflation. There is substantial productive overcapacity in the US and overseas, which could lead to a second wave of flow-on effects (more firings and competitive price declines...to cover fixed costs), all of which could feed upon itself in a self-reinforcing downward spiral, accentuated by global competition (pseudo protectionism).
(3) I think we have seen the first wave of this crisis, and we are now at a juncture where we are waiting and seeing if there are second order flow-on effects coming through the system. We could be in a period of the "lull before the storm."
(4) If a second wave arrives and we enter into a period of consumer price deflation, then the market is going to take a bath again.
(5) The market is currently rallying on the premise that we will avoid consumer price deflation and the consequent debt deflation of Irving Fisher fame.
Holding my breath! You should hold yours also.
(1) We've seen substantial asset deflation thusfar in this crisis, but very little consumer price deflation (we have seen a substantial deceleration in consumer price inflation, but not consumer price deflation).
(2) There is a chance we may enter into consumer price deflation. There is substantial productive overcapacity in the US and overseas, which could lead to a second wave of flow-on effects (more firings and competitive price declines...to cover fixed costs), all of which could feed upon itself in a self-reinforcing downward spiral, accentuated by global competition (pseudo protectionism).
(3) I think we have seen the first wave of this crisis, and we are now at a juncture where we are waiting and seeing if there are second order flow-on effects coming through the system. We could be in a period of the "lull before the storm."
(4) If a second wave arrives and we enter into a period of consumer price deflation, then the market is going to take a bath again.
(5) The market is currently rallying on the premise that we will avoid consumer price deflation and the consequent debt deflation of Irving Fisher fame.
Holding my breath! You should hold yours also.
Friday, May 1, 2009
What Happens Next
What happens after the banking crisis is averted. There is so much stress over the stress tests. Not sure why. The stress tests are a total sham and the results have been telegraphed far in advance.
My sense is that the effects of this crisis and the consequent deleveraging will be with us for some time. We've got to go through the consequent regulatory hearings, legislation, lawsuits, and lingering solvency concerns. The end result will hopefully be a de-fanged financial sector, with more limited ability to take risk and leverage, but where basic banking functions will flow.
Time will tell. Here's hoping.
My sense is that the effects of this crisis and the consequent deleveraging will be with us for some time. We've got to go through the consequent regulatory hearings, legislation, lawsuits, and lingering solvency concerns. The end result will hopefully be a de-fanged financial sector, with more limited ability to take risk and leverage, but where basic banking functions will flow.
Time will tell. Here's hoping.
Thursday, April 30, 2009
Risk is Back
The VIX is trending down, investors are looking at their cash yielding 0%, and the world looks as though it might emerge later this year. What is a good investor to do? Buy, of course!
So says the market. My concern is that the financial crisis and related recession have scared the consumer witless (not withstanding having also destroyed his wealth and taken his job), and convinced the patient they need to live their lives a little differently (which incidentally is a good thing).
Recovery may be taking shoot, but it is going to be subdued as it faces a cavalcade of transitional headwinds (deleveraging US consumer, more cautious attitude toward risk, higher taxes, a moribund financial sector, govt funding issues). Look to the lost decade for guidance.
So says the market. My concern is that the financial crisis and related recession have scared the consumer witless (not withstanding having also destroyed his wealth and taken his job), and convinced the patient they need to live their lives a little differently (which incidentally is a good thing).
Recovery may be taking shoot, but it is going to be subdued as it faces a cavalcade of transitional headwinds (deleveraging US consumer, more cautious attitude toward risk, higher taxes, a moribund financial sector, govt funding issues). Look to the lost decade for guidance.
Monday, April 27, 2009
One of many dilemmas
One dilemma I have been wrestling with is to what extent is the future economic performance of the economy factored into current equity/asset valuations. With equity prices off over 58% at their lows, an awful lot of future bad news was being factored in. This largest decline since the Depression made sense to me because we were dealing with the largest economic decline since the Depression (in addition to a financial crisis of global proportions). But the question is did we overshoot on the downside and what is a reasonable level for equities given interest rates, growth prospects and a greater appreciation for risk. I do a lot of back of the envelope calculations in order to gauge perspective and am a great believer in normalizing things, especially in the midst of an extreme event. As such back in January when I put pen to paper and tried calculating a ballpark fair value number for the Standard & Poors 500, I came up with normalized EPS of $65 and a normalized PE multiple of about 15 to arrive at a ballpark fair value of somewhere between 900-975 [Note: this calculation was done in the midst of downward earnings revisions taking S&P 500 earnings to $40 and multiples of 8 being thrown around as reasonable - pointing to levels of 320-500 on the Standard & Poors].
P.S. The divergence between all the positive information coming out of China and the performance of the FXI recently may be telling of something. Keep an eye on that.
Disclaimer: I have a personal position in the FXI.
Liquidity v Solvency
Bronte Capital brought this home to me the other day with an excellent post (http://brontecapital.blogspot.com/2009/04/liquidity-and-banks-primer.html). My takeaway is that the banks (that are likely insolvent technically - Citigroup and probably Bank of America of the big boys) will continue in a zombie state fending off runs with a hydrant of liquidity (care of the Fed) and slowly recapitalize over time. This to me looks somewhat reminiscent of the Japanese experience. Solvency and liquidity are interrelated, but the dynamic surrounding a bank (or company) plays out differently in each circumstance. What struck me though was the fact that a technically insolvent bank (or company) can continue operations so long as it maintains the confidence (forebearance) of its creditors and has sufficient liquidity to meet any concerns.
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