So to admit upfront, this is all parasitic on some neat reporting from Bloomberg out on the Analytic Journalism frontier.  They have acquired and made available to the public (which means they want us to use it right?) data as they describe “Once secret ” from the Federal Reserve on its lending to major banks during during the peak of the financial crisis.

As they describe it in detail the data:

The data reflect lending from the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, the Term Auction Facility, the Term Securities Lending Facility, the discount window and single-tranche open market operations, or ST OMO.

Got that?  I have pulled the files for PNC and National City which now are one of course.  Some may recall there was a certain bit of angst up the Turnpike that for some reason National City was denied TARP funding that might have kept it around a bit longer.  The PNC takeover followed immediately on the heels of the government’s denial of TARP dollars.  Some thought it a bit less than fair since along the way PNC used some of the same money to implement the takeover.

Well.. if there is any doubt over the flawed logic of a straight one on one comparison of the financial situation of the two banks at the time, here is what the Bloomberg data has for Fed lending to the two institutions as a percentage of their market capitalizations day by day.

So, what to believe?

I don’t know, but it is interesting that Reuters are now reporting France and Germany to be in an agreement on a fast track move towards fiscal union as well as allowing the ECB to aid sovereigns more forcefully (i.e. unsterilised intervention).

I want to see this before I believe it. Germany is certainly sending conflicting signals. Yet, this may be because they are truly unsure how long they can play this game of chicken with the rest of Europe. Clearly, Merkel has a point in refusing to issue euro bonds and/or letting the ECB step in since the periphery needs to put their house in order or at least show a credible plan to balance the budget. This is essentially quid pro quo as Merkel knows that Germany needs to pay in the end.

But there is a rub. One issue is surely the fact that public finances across the eurozone are unsustainable but another is how these economies are going to achieve anything near the growth needed not to collapse (default) anyway.

We keep on coming back to two main points.

1) It was clear for all that pain was coming in the periphery already in 07/08 and that this would be a substantial period of negative growth/deleveraging consolidation.

2) But the question was always whether such pain could be administered from within the euro zone. We are steadily coming to the conclusion that this is not possible and Germany knows this. But the solution is not clear since jettisoning the euro would have grave implications for the EU too and therefore there is a very strong lock-in mechanism here which it is difficult to get out of.

Finally, there is always the risk that one or many of the Southern European economies will simply “get” enough and make some quick and devastating decisions. It is important to understand my point on this.

I am sure it would be catastrophic for Greece or another country to leave by their own accord and do a messy default, but at some point the rest of Europe and the market will simply corner whatever government that might be in place and they will start taking their own independent decisions.

I note that there are calls for the new government in Spain to play “hardball” with Germany. In this situation, Germany has a distinct interest in just letting the market squeeze the periphery, but of course the rest of the “core” is getting dragged down too and the whole banking system is now at risk of a major liquidity/solvency crisis. In this sense, I only agree conditionally with Felix Salmon:

El-Erian is very good at explaining the problem which needs solving:

“Europe must still stabilize its sovereign debt situation. But this is now far from sufficient. Policymakers must also move quickly to contain banking sector frailties, and do so using a more coherent approach to the trio of capital, asset quality and liquidity.”

It seems to me, though, that sequencing matters here. Liquidity is — always — more important than capital/solvency. Give an insolvent bank enough liquidity, and it can live indefinitely. Remove liquidity from a bank, and it dies immediately, no matter how solvent it might be or how high its capital ratios are. And as for asset quality, we’re pretty much talking a zero-sum game here: when the banks’ dubious assets are the sovereign’s liabilities, the real solution is inflation, not nationalization.

I agree that liquidity is a key issue at the moment in the euro zone banking system, but let us not kid ourselves. Europe has not had a functioning interbank market since 2008 and we are just now seeing the accumulated effect of this.

I just read a big and very detailed BC report on deleveraging among EZ banks and I am extremely concerned. It is clear to me that not only sovereigns are battling with solvency issues but so are many banks and the extent to which they are fighting it means that they will have to cut lending and asset growth substantially. As such, I am afraid that the problems in the euro zone are beginning to resemble a widespread solvency problem both amongst banks and sovereigns, a combination which, to boot, will feed off each other. Especially Eastern Europe are going to have big problems in 2012. They are going to see an almost complete stop of credit flows through the banking system due to parents cutting cross border lending.

I think  that we will see a wholesale and government driven process of bank nationalisations and restructuring in the next 6 months in the euro zone. I also think that most southern european economies are ultimately facing both public and private insolvency issues which will need balance sheet write-offs to get solved. It seems to me that, as so many times before, euro zone politicians are once again getting caught out by reality.

Scientists define volatile organic compounds as naturally occurring or man-made chemicals with low boiling points, a condition that allows these molecules to easily evaporate into the air, potentially causing irritation and creating an explosive environment. As Global Resource Investments Founder and Chairman Rick Rule predicted last March, man-made volatility has clouded the economic environment for the last month and could continue to do so for the next 12 months, according to his analysis. But volatility doesn’t have to be painful, he says, if you prepare yourself with plenty of cash and courage. “Volatility is like cyclicality. It is really a series of opportunities to buy low and sell high. And, if you understand volatility for what it is and accept it, it could be a tool as opposed to a threat. ”

The Un-Recovery
First, he outlines the reasons for the volatility. Rule doesn’t see a recovery in the United States. “I see government-induced liquidity in the market and I see some recovery in equities prices as a consequence of very, very, very low—make that negative—real interest rates as well as hope on Wall Street and in Washington,” he says. The problem with this paper recovery is that liquidity wasn’t what caused the recession. The issue is that individual and government balance sheets are unbalanced. Many of the assets are ephemeral. Unfortunately, liabilities are almost always real. “As a society, we owe an amount that is unserviceable relative to what we produce,” he says.

By encouraging people to spend more money they don’t have, the government is making the problem worse. Instead, he thinks people should rebalance their balance sheets and invest more in this country. “The idea that we can fix the fact that we owe too much money by encouraging borrowing and spending is an example of the idiocy that comes out of Pennsylvania Avenue and will continue to weigh down the recovery.” He says, “Until we deal with the problems that confront us in society, we are not going to have a U.S. economic recovery.”

Rule points to a war against savers. “The Fed has declared war on productive elements of society in order to distribute the benefits to the less productive elements of society. This is not the key to prosperity.” Drilling down interest rates punishes savers and rewards spenders. “This is perverse, truly perverse,” he says. He equates “quantitative easing” to a fancy way of saying “counterfeiting.” Increasing the nation’s money supply without increasing society’s ability to create utility through the provision of goods and services is simply fraud. You can’t maintain the value of a currency unit if you create it out of thin air far in advance of the society’s ability to generate value. That is true in the U.S. and abroad. “I have always said that the U.S. dollar is the worst in the world except perhaps for all the others,” he jokes. Rule is not alone in his low opinion of paper currency. Casey Research Chairman Doug Casey famously noted that the U.S. dollar is an I.O.U. nothing. The euro is a “who owes you” nothing. “It’s an artificial construct,” Rule says. “Europe truly is the triumph of politics over economics.”

One example of the irrational European economic policy now in fashion is the decision to “bail” Greece out of the trouble it was having servicing debt that was 150% of GDP by requiring the struggling country to service debt that is 165% of GDP. “I defy the European Union to explain to me how by adding a big column of negative numbers they end up with a positive number; very, very, very problematic,” Rule says. And, problems get deeper. “Because of the extremely close ties between the big banks on both sides of the Atlantic with large amounts of primary capital represented by sovereign debt, many of the large private sector banks have multiples of shareholder equity invested in securities by issuers like Italy, Spain, Portugal, Ireland and Greece that are insolvent. This means by real accounting standards most of the big banks in Europe are broke.”

This economic reality doesn’t mean that banks are going to fail any time soon, Rule explains. It simply means that the shareholder’s equity in the bank—the value of assets minus the value of the liabilities—is probably negative if the securities that these banks have in sovereign—as opposed to solvent—issuers were removed. “The test going forward will be the test between those two words,” Rule says. “Sovereign does not make solvent.” He takes issue with the words of the famous CEO of Citicorp, Walter Wriston, who said countries don’t go broke. “That was wrong. Countries do go broke. Countries will go broke. The question in Europe now is whether the savers—Finland, Austria and Germany—will decide that they and their children are going to carry the lifestyle of the rest of the Europe.”

The discussion going on in Europe right now is the same as the one going on in the United States, he says. “Who should benefit from production—the producer or the non-producer?” He points to a war worldwide between these two factions. “Sadly, non-producers outnumber producers and, in a democracy, the war is often won by the non-producer.” He likens democracy to a vote by five coyotes and a lamb over what to have for lunch. “That’s really the nature of the debate that’s taking place in the United States and Europe today.”

Free-ish China
“The good news about China,” Rule says, “is that over the last 30 years the place has become more, as opposed to completely, free. More than 30 years ago, Deng Xiaoping, then leader of the Chinese Communist Party, said ‘to become rich is glorious’ and China has become very glorious as a consequence of that.” Ironically, in this allegedly Communist country, there is no social safety net, meaning that people are on their own in China, Rule says. “As a consequence, savings are extraordinarily high, as much as 40% of a household income. So, China is generating enormous, enormous, enormous savings in direct contradiction to us, of course.”

Rule also points to more capital investment-friendly tax laws in the East. “In the United States if a big producer builds a big piece of manufacturing equipment, it may be required to amortize that equipment for tax purposes over 30 years. In China, that same producer is allowed to expense the equipment, meaning that there is a huge incentive to add the capital necessary to raise the utility of the workers operating that machinery. China is much, much, much friendlier to capital formation. The United States is much, much, much friendlier to consumption.” For these reasons and many more, Rule says “China, India and the frontier markets appear legitimately to be on the road to progress—a very different road than their European and North American cousins appear to have chosen.”

But, all is not bright in China. “Some 10,000 people rule 1.3 billion people and official sector misallocation is always a threat. The government decides what sectors should succeed, what sectors should fail. Expect the road to progress in China to be bumpy,” Rule warns.

The combination of domestic and international challenges on the horizon set the stage for more volatility, Rule concludes. “So many black swan events are looming that they resemble a flock of black swans. The idea that one of those black swans could precipitate an event like the ‘07–’08 liquidity crisis appears to me to be a very, very, very good possibility.” He goes so far as to suggest that in the next 18 months to 2 years, we could see a shut down for some period of time in interbank lending and frozen debt market liquidity. “In that set of circumstances you would want to have some cash,” he warns.

Golden (and Platinum) Opportunities
All of this darkness could shine a light on the metals—gold, silver, platinum and palladium, Rule says. “The most important part of the pricing of these metals is the continued debasement of fiat currencies. Metals prices worldwide are denominated in U.S. dollars. If the value of the denominator itself continues to decline, which I think it will, the nominal price for precious metals should continue to increase.” The increase may not be steady. “I suspect that these prices both up and down will be volatile for a few reasons,” Rule says. “Gold markets in particular, maybe silver markets as well, are determined by both of the primary economic motivators in the world—greed and fear. A raging bull market, which I think we might get into, compels people to buy gold bullion because they are afraid of the depreciation in dollars. This, in turn, stimulates the greed buyer who buys simply because the price went up and he or she understands the thesis. The price escalation in bullion that was driven by the greed buyer reinforces the fears of the fear buyer. And, the prices reverberate higher and higher as fear buyers and greed buyers compete with each other. That’s the market that we saw in 1979–1981—the single strangest bull market that I have experienced in my career. I suspect that we are likely in the early stages of a market that resembles that.”

The second set of circumstances Rule identifies as pushing gold prices up over the next year is supply-based. “In classical economics you are taught that higher product prices lead to increased supply. Because mining is a capital-intensive business, the response of the producers to increased commodity prices is not direct or immediate, particularly if interbank lending dries up debt financing needed for the large capital-intensive projects. There will be supply constraints that are, in some fashion, artificial.”

For supply-side reasons, Rule is increasingly attracted to the platinum business. More than 80% of platinum and palladium—PGM metals—come from three countries: South Africa, Zimbabwe and Russia. He cites local political turmoil as a limiting factor in the continued production in these areas. “Increasingly, South African governments are calling for more social rent—higher taxes, government participation in wage negotiations and, in some cases, outright nationalization. This will absolutely constrain the industry from making the investments in increasing production and sustaining their existing production over the five to seven years. Given that South Africa is the most important platinum producer in the world and it’s highly likely that the South African platinum producers will continue to constrain working capital investments, I would suspect that on a five-year going forward basis platinum production will falter.”

Moving north to Zimbabwe, Rule is no more optimistic. “President Robert Mugabe and his associates stole everything in the country that had any value. Now they have decided that about 150 people should control 51% ownership of the platinum mines in Zimbabwe. If you look at the track record of the black political elite in Zimbabwe managing the assets they have stolen over the last 20 years, you will see that the potential impact on platinum supplies as a consequence of their stealing productive capacity will be catastrophic.”

Rule sees Russia as a bright spot. “Russia gets slowly better over time. Yes, there are problems. The place is corrupt. They tend to attempt to mediate commercial disputes by shooting each other. There are problems with alcoholism. But, gradually things are improving in Russia. The difficulty isn’t Russian politics, but the fact that the big platinum and palladium producer there is running into lower and lower grades and having to go farther and farther down in the mines. Its production problems are organic as opposed to political.”

The bottom line for Rule is that there are going to be supply-side challenges in the platinum business at the same time that demand for platinum both as a precious metal for investment purposes and as an industrial metal for auto catalysts continues to increase. Rule acknowledges that a slowdown in the economy in Western Europe and North America will constrain vehicle demand there, but cites exploding vehicle demand in emerging markets, particularly China and India. Western air quality standards being imposed in both of these countries means that auto catalysts using platinum and palladium have kept pace with vehicle sales in those markets. “Strong demand and declining supplies point to very, very, very interesting opportunities in platinum markets,” he concludes.

Disconnected Equities
Good news for commodity prices has not always translated to rising junior mining stock prices. Rule sees four reasons for this disconnect. The first is historical. He credits the dramatic rise in precious metal stocks five years ago to an anticipation of the increase in bullion prices. “Some of the reaction that you might have expected in the equities prices might have occurred before the event took place,” he explains.

The second reason is what he calls “dismal corporate performance” over the last 10 years. “One would expect with the gold price increasing from $260 an ounce (oz.) to $1,800/oz. and silver increasing from $4/oz. to $40/oz. would result in absolutely skyrocketing free cash flows generated from the companies, but that didn’t happen. The operating response relative to the increase in product prices was, to be charitable, anemic.” The financial services industry, which had spectacular cash-generating expectations based on the returns of the 1970s, has been particularly disappointed. “There has been widespread disgust among gold share investors to the cash-generating performance of the companies relative to the escalation in their product prices,” Rule says.

The third factor is sector market-cap explosion. “Issuers—the mining companies and their cohorts in the financial services community—were engaged in inflation in the same way that governments around the world have issued lots of paper. Mining companies have issued billions of shares so that although the share price escalation has not been dramatic, the combined market capitalization of the precious metal sector producer, developer and explorer has grown at an extraordinary pace. There are many more issuers now than there were 10 years ago and every one of those issuers has many, many, more shares outstanding. You have to be very careful when you buy these things.”

The fourth point Rule makes is another cautionary one. “In the junior exploration sector, as many as 90% of market participants have absolutely no value. They are worth nothing. So, the sector as a whole can’t experience dramatic price appreciation when 90% of the paper in the sector is counterfeit or valueless. In fact, the gold shares are suffering from the same type of value depreciation as the U.S. dollar. You need to pay particular attention to defending yourself and your portfolios from these valueless, zombie security issuers.”

Rule stresses the importance of carefully evaluating a portfolio now, before the precious metals equity markets start experiencing price appreciation in the next three to six months. Why now? “Any price appreciation anticipation is over,” he says. “There is no premium built into the metals prices relative to the commodity anymore. In fact, this disparity has been noted. We think for the first time in some time the precious metals equities are reasonably priced relative to the metal itself,” Rule says.

Rule is also more positive on the issue of executive competence. “Corporate performance, which has lagged terribly over the last five years has begun to increase,” he says. For the last two or three years, the industry as a whole has generated about $2 billion (B)–$2.5B a year in surplus cash. This year, he expects the industry to generate between $4.5B–$5B, a clean double in 12 months. “The performance that hasn’t occurred hitherto is beginning to occur now,” he says. This cash on company balance sheets will enable them to do many things—greenfield and brownfield developments in their own portfolios along with mergers and acquisitions.

These are all positives for company prospects, Rule says. “We are now truly in a discovery cycle. For the last nine years the exploration industry has been well funded and well staffed. That spending cycle is beginning to yield discoveries. There is nothing, nothing that adds both liquidity and courage to junior equities markets like discovery.” Rule points to the last discovery cycle in ‘95 and ‘96 when some stocks went from $0.30 to $30.00 in 19 months. “My suspicion is that the underperformance of select precious metals equities for the next three to six months is over. Will it be volatile? It will absolutely be volatile. But, the fact is anticipation is no longer in the market; there isn’t a bullish outlook, which perversely is good. There is liquidity in the system. There is the will and the urge to merge so consolidation will take place. And, all of this will be punctuated by discovery.”

Rule also advises balance when it comes to choosing between seniors and juniors. “For those of you who are investors, for those of you who look at a return on capital employed rather than praying for a return of capital employed, you would go to the senior producers and the senior producers would do well. We particularly favor acquisition strategies that involve buying select seniors and your global broker can help you in that selection. And, then selling puts and calls against core positions. That is, allowing the market to pay you to buy low and sell high or acquiring the position simply by selling a put. We think the seniors are uniquely priced. We don’t think, by the way, that you pile in and build 100% position right now. We think you take a third position or a half position relative to where you want to end up because we are going to experience incredible volatility. But, we think this is the time to begin to establish positions.”

Rule cautions that investors need to be willing to take more risk with juniors. “The volatility will be more pronounced the farther out the quality scale you become. But the potential for reward is outsized too.” He anticipates a lot of mergers with juniors acquiring each other and juniors being acquired by the intermediates and intermediates and juniors being acquired by the seniors. “Given the relative underperformance of the juniors this year to last year, in November and December of this year—during tax-loss selling seasons—could be a once-in-a-decade acquisition opportunity.”

Rule ends by reiterating his words of warning about the volatility in the air. “This will not be stair steps to heaven. This market will not go straight up. The buzz word and I’m going to say it again and again and again in this broadcast is going to be volatility.” Again, he looks to the past to illustrate what could happen in the coming year. “Some of you will remember the 1970s bull market in precious metals when the price advanced from $35/oz. to $850/oz., a truly breathtaking ascent. You need to bear in mind that in 1975, in the middle of that ascent, the gold price fell from $210/oz. to $104/oz., a 50% decline. And the share price decline in the mining shares was even more dramatic. Did it matter over the course of a decade? No. Did it matter to people who suffered through the decline personally? Absolutely. So, while we think the sector is a good place to be don’t think of it as a place without risk.”

Founder and CEO of Global Resource Investments (GRI), Rick Rule began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. Rule’s company has built a sterling reputation for its specialist expertise in taking advantage of global opportunities in the resources industries. Last month, Rule closed a landmark deal with Eric Sprott, another famous powerhouse in the arena. With GRI now a wholly owned subsidiary, Sprott, Inc. manages a portfolio of small-cap resource investments worth more than $8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S. This article is based on Rule’s August 31Global Resource Investments webcast. Listen to the entire webcast.

Starting a new job and settling in a new city/flat has proved a little more unsettling for my blogging efforts than I had expected. Anyway, what better time to return to the fray when the SP500 completes its worst run in a long time returning to levels not last seen since March where we thought we had to write off the entire Japanese economy as a nuclear wasteland. So, is it all back to square one for the already weak recovery?

Arguably though the catalyst this time is more sinister in that it cannot really be pinned on any single event. Surely, the debt ceiling charade and the prospects of Spain and Italy spiralling further into the arms of what ever bailout that might be on offer are catalysts in themselves, but the underlying economic data is getting increasingly sour.

All the leading data we are looking at, both in terms of the global breadth of economic momentum and specifically on the US economy have rolled over in a dangerous fashion and a recession in the US cannot be entirely ruled out. Indeed, on some measures we would even be calling one. Elsewhere, the slump in the July Australian PMI also suggests that one of the hitherto strongest economies in the global recovery may be about to embark on its own homegrown downturn.

It was also interesting to see the SNB finally cave in (yet again) to the relentless rise of the CHF despite the bank’s efforts both communicative and with hard money to starve off the beast. As I have remarked before, safe haven flows hurts and can be akin to holding Old Maid. Indeed, it may turn interest rate decisions on their head as rates will be lowered going into a melt up of economic activity to attempt to deter speculative inflows.

Generally, one of the most obvious consequences of the recent bout of weakness will be that more stimulus is in the pipeline, at least in the US economy whereas the ECB will probably need a little time before the reality dawns on them. However, the underlying inflection point between an economic recovery that is clearly turning out much weaker than expected and the reality of too much debt is starting to hurt. In that vein, it is difficult to see a viable way out of the obvious need to cut spending and reign in excessive public spending with the simple fact that what has largely driven GDP in the recovery has been government consumption and investment.

We can consequently expect that the Krugmans of the world to get another big chunk of the discourse as the call for further and bolder stimulus packages increases. In this respect, the Squid had nice note out on Monday on the possible avenues a new round of QE would take where the main message seems to be that the Fed will try to further cement its position of low rates for an extended period. But more interestingly is the widespread expectation that if the Fed engages in further asset purchases it will be on the long end of treasury curve and thus to flatten the curve on the long end. Surely, this makes sense in so far as goes the idea that the housing market remains in an extremely poor condition. Mortgage rates are thus likely to be driven more by long term rates than rates on the short end or at the middle. Coupled with outright targeted asset purchases of MBS using the proceeds from its securities portfolio the Fed would be signalling that the size of its balance sheet will remain inact.

Sufficient on to the day and all that but with the current sinister backdrop of market currents and poor economic data we can expect Bernanke to step up any time now.

It has occured to me here that what we might be facing in the developed world is a mirror image of the situation in the emerging world and that the combination is not the best of mixtures for the global economy.

Consider then the situation e.g. in India where the RBI is trying frantically to weigh against excessive government spending not to mention China where you get the distinct feeling that at least some part of the inflation problem comes from the central authorities’ credit policies (or lack of tight standards). Conversely, in the developed world austerity is the name of the game quite simply out of necessity and faced with extremely fragile economies it is largely up to the central banks to attempt giving the economy some tailwind. On a personal note, this is also why I consider the ECB’s recent hiking campaign as the biggest policy failure since, well, they raised just before a recession the last time. The very best we can hope for in Europe is then not a recovery but simply that we might end up back at square one. ]]> http://www.citizeneconomists.com/blogs/2011/08/04/random-shots-all-back-to-square-one/feed/ 0 http://www.citizeneconomists.com/blogs/2011/06/02/corporate-fascist-economic-system/ http://www.citizeneconomists.com/blogs/2011/06/02/corporate-fascist-economic-system/#comments Thu, 02 Jun 2011 14:15:38 +0000 Bron Suchecki http://www.citizeneconomists.com/blogs/?p=7905

Without Federal Reserve intervention in the financial markets since September 2008, the biggest banks in the world would have entered bankruptcy liquidation. The U.S. economy would have experienced a 10% to 20% fall in GDP. The unemployment rate would have soared above 15%. The stock market would have fallen 70%. . . . → Read More: Corporate Fascist Economic System]]> A Fistful Of Dollars:

Without Federal Reserve intervention in the financial markets since September 2008, the biggest banks in the world would have entered bankruptcy liquidation. The U.S. economy would have experienced a 10% to 20% fall in GDP. The unemployment rate would have soared above 15%. The stock market would have fallen 70%. Wealthy bondholders and stockholders would have seen their wealth cut in half. Incumbent politicians would have all been thrown out of office. The richest Americans, constituting the ruling class, would have borne the brunt of the pain.

In a true capitalist system, organizations and people who assumed too much risk and made poor decisions would have failed. But the United States does not have a capitalist system. We have a corporate fascist economic system where a small cartel of bankers, military weapons suppliers, and mega-corporations set the agenda for the country through their complete capture of politicians and the mainstream corporate media.

The Global Economy’s Corporate Crime Wave:

Corporate corruption is out of control for two main reasons. First, big companies are now multinational, while governments remain national. Big companies are so financially powerful that governments are afraid to take them on.

Second, companies are the major funders of political campaigns in places like the US, while politicians themselves are often part owners, or at least the silent beneficiaries of corporate profits. Roughly one-half of US Congressmen are millionaires, and many have close ties to companies even before they arrive in Congress.

As a result, politicians often look the other way when corporate behavior crosses the line. Even if governments try to enforce the law, companies have armies of lawyers to run circles around them. The result is a culture of impunity, based on the well-proven expectation that corporate crime pays.

As you would expect this dampens the negative price spiral that can occur in countries where walk away is an option. However, consequence of this is that in the face of financial difficulties people will tend to restrict other spending and divert money to paying off the mortgage to avoid the stigma of bankruptcy (although this doesn’t seem to have bothered “former tennis ace” Mark Philippoussi) This contraction in discretionary spending acts like the “Paradox of Thrift” Terry mentions in his article.

I think Terry makes a good case that “house prices could simply slide down gently over a long period, with inflation doing most of the work of price adjustment” but he does identify four risks/shocks which could bust prices.

He notes that the RBA is between a rock and a very hard place in trying to de-bubble housing but having to increase interest rates too much to control inflation, or having to cut interests rates too much if housing tanks which will weaken the Aussie dollar and stocks as foreign investors pull out.

My view is that push come to shove RBA will cut rates and damn the exchange rate as an imploding housing market is not good for banks and the political pressure will be too intense. This will be an extend and pretend that will work for a few years as there is plenty of room to move with interest rates at the 6% level. A weak exchange rate is good for AUD precious metals prices, by the way, a sort of hedge against house price drop in a way.

I would also not discount politicians doing something stupid to “help” housing. With debt to GDP of 20% a populist call to “do something” could be made when other countries are at 100% ratios (”we have the capacity”). It will all be wasted of course but could drag the game on a bit longer.

However, as the US shows us, once you get to zero interest rates you’ve got nowhere to go and QE doesn’t help housing. Once we reach that point then we will really see a housing price crash as the boomer demographics, China slowdown and “income levels [don't] hold up relative to interest rates” factors all kick in together.

To sum up my view on house prices, “It Won’t Happen Overnight … But It Will Happen” (explanatory link for non-Aussies)

So, the butcher’s bill on Ireland is in and stands at 85 billion Euro jointly financed by the EU (the European Financial Stability Fund (EFSF) and the European Financial Stability Mechanism), the IMF and bilateral loans from a number of countries including Sweden, Denmark and the UK. Of course, it only worked a couple of hours and today markets are reeling again in the face of the Eurozone crisis which seem to have no end. Worryingly, markets seem to be contend on going for all together larger game this time around with Spanish bonds bearing the brunt of the attention.

In principle and fact I agree with RBS’ Harvinder Singh (via FT Alphaville’s Neil Hume) that the only possible end game at this point is that things get so bad that some form of fiscal unity and/or a joint Eurozone pooling of risk through the issuance of an EMU bond. Illuminati’s Jim O’Neill is a little more sanguine although he ultimately also invokes the point that the core and especially Germany must go all in, in its effort and comittment to keep the Eurozone in one piece.

I know that all this may come of as scaremongerings, but the farther we move forward into this mess, the more it is beginning to look like calm and calculated analysis rather than prophecies of doom.

So, Can Germany Pay?

On that note, I thought that I would highlight an issue which has not yet been debated much in the context of the Eurozone debt crisis. In this sense, we always hear about CDS or yield spreads to Germany and still; to the extent that we are talking “EU money” we know that  it is the German taxpayer who must foot the majority of the bill.

So, can Germany really pay all this?

The recent economic narrative on Germany suggests that it can. In fact, Germany has been hailed as the rock onto which all other shipwrecked European economies must turn to in the hour of need with GDP growth rates in Q2 and Q3 (2010) exceeding expectations. And with the German export machine back in full swing, there seems to be nothing standing in the way of Germany saving the world, let alone Europe.

Now, this is not entirely true of course and one major part of the difficulties encountered in the course of the past months has been the obvious (and natural) resistance of the German taxpayer in simply accepting to pay for the mistakes and overspending of others. And one would assume that the reluctance to do so stems not only from a feeling of unfairness, but also from a genuine fear that Germany simply won’t be able to pay even if the good intentions can be mustered in the first place. As such the following point emphasized today by a friend of mine is important;

Spain’s external debts, have exploded without a significant offset of external assets. On net, Spain owes the world about 80% (closer to 90% today) of GDP more than it has external assets. As a frame of reference, the degree of net external debt Spain has piled up in a currency it cannot print has few historical precedents among significant countries and is akin to the level of reparations imposed on Germany after World War I. We don’t know of precedents for these types of external imbalances being paid back in real terms.

So, when Merkel notes that bondholders must also share the losses she is naturally referring to the fact that Germany cannot be expected to bailout all the Eurozone’s periphery’s international investors. However, what she is perhaps forgetting is that Germany itself holds a non-neglieble amount of those very same net external assets that Spain, Greece, Ireland and Portugal have built up.

However, even considering this point, the reality is still that as the economic conditions of the periphery has deteriorated and morphed into a calamity so it seems that the well known structural problems of the so-called core have been forgotten. Beauty, wealth and economic travails are as most other things a relative entity it seems.

On that note, allow me turn the tables on the discourse a little. Consequently,  the Economist recently ran a special report on Japan essentially focusing almost entirely on the fact that Japan is the most rapidly ageing economy in the world and this represents the main challenge for Japan as an economy and as a society. I am a demographic fan boy, I know, but still the analysis in the Economist makes sense. Deal with the demographic challenge or else …

So, which economy might then be the second most rapidly ageing economy in the world? Right, you guessed it; Germany.

(click on pictures for better viewing)

I should think that these charts are rather self-explanatory and note in this context that the German debt/GDP has gone from about 63% of GDP in 2007 to 84% in 2010. Further, according to the IMF this will increase to just hy of 90% in 2014. Naturally, none of these calculations factor in any extra liabilities Germany will have to assume to keep the Eurozone together in that period, so your guess is as good as mine as to the final figure in 2015.

The question which seems to whisper in the wind (and which may sooner rather than later turn into a roar) is then just how Germany is going to be able to shoulder all those bailouts when the real bailout it needs to think is the one of its own welfare state as the weight of population ageing sets in. Of course, Germany could in principle sacrifice any build up of assets in Asia, Latin America and the rest of the emerging world and devote its entire surplus powers to financing excess investment and consumption in the Eurozone periphery and Eastern Europe ad infinitum. But somehow, this does not strike me as a viable long term solution since this has already been tried and well, it got us into this mess in the first place.

I guess, the contrarian Masters of the Universe might immediately see this as a case for buying German CDS in a punt on the event that the benchmark itself came under pressure. I think this would be premature, but there is definitely a narrative and discourse missing in the current Eurozone debacle not about whether Germany is willing to pay, but indeed, whether she will be able too.