From David Goldman @ Asia Times:
The financing of the US deficit by foreign banks through the carry trade is a remarkable phenomenon, reminiscent of Japan during the 1990s. As long as the Fed can keep this going an actual economic downturn is unlikely (I have never predicted one) but it suggests an anemic economy as far as the eye can see.
The magic of the carry trade, which can be kept going as long as the Fed and finance can thus justify short interest rates near the zero point, which means as long as the Treasury can issue debt which means as long as the Fed and finance can thus justify interest rates near the zero point, which means as long as foreign banks borrow through intermediaries at the low rates, which means as long as they can use the funds to buy Treasury securities … well, you know!
The finance perpetual motion machine is the US’s substitute for real output and commerce. Our paper is good because it is. Therefor our economy is ‘in recovery’. Hallelujah!
This has been taking place in Japan since 1990. The national balance sheet expands with little/nothing to show for it. People get old then die. Hallelujah!
The world’s Number Two economy is encased in amber, now the Number One is caught in the same ZIRP trap. China’s economy is poised at the edge of the default abyss. Can they also transition into a self- sustaining zombie economy like Japan and the US? Is there sufficient capitalization available to support three gigantic economies with no real net output?
That’s right, China has no real net output, only phony- baloney figures and inflation. Their US costomers have funds to buy their goods because they are repudiating their ‘senior’ debts. Perhaps someone can explain how that’s bullish for China output.
Ditto, Japan!
The Number Three Eurozone economy is also ready to puke. The E- zone has faults within its borrowing/interest rate mechanism that allows speculators to attack individual country’s borrowing. Greece today, Portugal tomorrow, ‘???’ the day after. Can the Eurozone get to ZIRP and raise enough ‘mechanical liquidity’ to find a zombi-esque sweet spot for itself?
At which level does the credit formation machine and its product become irrelevant? Both success and failure at this endeavor risk decoupling what remains of productive commerce from the dead hand of finance. What David Goldman describes is both the usurpation and institutionalization of uneconomic commerce.
If commerce was able to provide an economic return it would compete with zombie finance and bid up short rates which would end the carry trade. Zombie institutions would fail but would be replaced by going concerns with products to sell … and customers would materialize with money in their pockets to buy!
It’s always tough to sell the ‘hope’ talk when the base institutions and central Establishments of nations are surrendering as a matter of fact. I guess a media ‘recovery’ is better than the real thing if the real thing is (hopelessly) out of reach. Right?
The trend du jour which has been sneaking up on the establishment is one of system wide debt repudiation. The outcome of this trend is uncertain. Here’s George Washington:
Walking away from home mortgages has actually become mainstream, being trumpeted by:
- The New York Times (and New York Times Magazine)
- Many others
In addition, as I pointed out in February:
There is an established legal principle that people should not have to repay their government’s debt to the extent that it is incurred to launch aggressive wars or to oppress the people.
Matt Taibbi wrote Monday:
As powerful as these Wall Street banks may seem, they are also exquisitely vulnerable. Right now virtually all of them are dependent upon the government keeping accounting standards lax enough for all of them to claim to be functional businesses. It is generally accepted that if the major banks on Wall Street were forced to mark all of their assets to market tomorrow, they would all be either insolvent or close to it.
Thus their “healthy” financial status is already illusory. So imagine what would happen if large numbers of those dubious loans on their balance sheets that they have marked down as “performing” were suddenly pushed ahead of time into the default column. What if Greece, and the Pennsylvania school system, and Jefferson County, Alabama, and the countless other municipalities and states that are wrapped up in these corrupt deals just decided to declare their debts illegitimate and back out?
An argument that has circulated along with Greece’s finance woes suggests that loans arranged under dubious pretenses are not enforceable. Here’s more from George Washington:
Former Managing Director and board member of Wall Street investment bank Dillon Read, president of Hamilton Securities Group, Inc., an investment bank, and former government servant Catherin Austin Fitts wrote Tuesday:
Look up “fraudulent inducement.” My position as the former Assistant Secretary of Housing-Federal Housing Commissioner and then as lead financial advisor to the U.S. Department of Housing and Urban Development is that the majority of the mortgages originated in the United States after 1996 were fraudulently induced.
The way to deal with criminals is to treat our contracts with them in a manner reciprocal to how they have treated their contracts with us.
Will a growing movement to abrogate contracts with institutions who have broken the law be disruptive? Yes. Will that require painful adjustments? Yes. That is the price we pay to deal with the challenges we face. This includes the fact that the banks have sold criminally originated debts to our pension funds and retirement accounts as well as to allies and institutions around the world.
It is much less painful, however, than the price we will pay if we continue to operate by a double standard whereby large institutions and a small group of people are permitted to live and operate above the law. So let’s address the lawlessness in the financial sector, face the national security issues involved in using our financial markets for economic warfare and begin the transformation.
Austrian economist Murray Rothbard wrote in 1992:
I propose … out-right debt repudiation. Consider this question: why should the poor, battered citizens of Russia or Poland or the other ex-Communist countries be bound by the debts contracted by their former Communist masters? In the Communist situation, the injustice is clear: that citizens struggling for freedom and for a free-market economy should be taxed to pay for debts contracted by the monstrous former ruling class. But this injustice only differs by degree from “normal” public debt. For, conversely, why should the Communist government of the Soviet Union have been bound by debts contracted by the Czarist government they hated and overthrew? And why should we, struggling American citizens of today, be bound by debts created by a … ruling elite who contracted these debts at our expense?
Ed Harrison at Naked Capitalism had a long article earlier today discussing repudiation:
Strategic defaults increase consumer spending
At the end of last month I proffered three potential explanations for the continued fall in the US savings rate. The first explanation was that the economy was in a cyclical recovery predicated on asset price inflation and this gave enough troubled debtors breathing space to spend more freely. The second explanation was the opposite, that distress amongst those troubled debtors was leading them to spend a larger percentage of income. The third explanation was that strategic defaults were giving a lot of people money in their pockets that would have otherwise gone to servicing debt and this had increased consumption.
As long as an incentive exists to default other than top- line cost reductions there will be more defaults. Harrison suggests vacations:
Another hedgie in San Francisco, responded with this after seeing these anecdotes:
From the West Coast I have at least that many stories. They come in clusters. One brave party takes the first step and “wins” then relatives or co-workers follow the successful example. The persons are still employed – default on debt – they rarely get contacted by lenders and then negotiate hard (the debtors that is). After some settlement they keep spending lavishly. In every case a vacation is part of the program. Every case!
Please read the entire article, it’s well worth the time.
Harrison uses the term default, which is not the same and the distinction is important: default is the inability to service a loan suggesting that a restructuring of terms will allow repayment in the future. Repudiation is a counterclaim against the original claim the loan itself represents. Repudiation does not allow the loan to be repaid at all. The counterclaim made is that the original loan is fraudulent or illegal or impossible to service under any and all circumstances.
Add together the increase of loans that cannot be repaid or will not and collateral that is rendered worth less by the process and there are significant losses. The process described by Goldman is the work of the Establishments’ prevention of the marking or acceptance of loan losses by the originators. This process is by itself a form or repudiation.
That no nation on Earth during this crisis has seen fit to write down bad loans and taken the accompanying losses suggests that doing so is fatal. The loss- avoidance strategy of extend- pretend and carry trades ultimately precipitates the large losses that the strategy seeks to avoid.
The systemic outcome is the viral spread of moral hazard from institutional levels to all forms of credit taking aim at the enforceability of contracts.
Thus the two poles are well defined; the cynical debt creation machine is the chosen device for preventing the accounting of losses. This ends up with a parallel cynicism of borrowers across the country who see the process in operation and find no reason not to emulate their betters!
It’s not simply mortgage debt that is being repudiated to an increasing degree. Commercial mortgage debt is repudiated in New York and San Francisco. Greek debt is at the threshhold of default and repudiation is possilbe. Already sovereigns’ derivatives are repudiated.
This is moral hazard trickle down. People are learning they can repudiate their debts without adverse consequences. Unseen in this performance piece is the undermining of the ‘money concept’ which grows into substantial systemic risk. The consequence of non- stop bailouts and forebearance is the widespread assumption of future bailouts and forebearance. Money is a debt marker for a promise to repay upon demand. What happens when people decide to stop paying? At issue is the relative economic value of the reason to not pay measured against the value of the repudiated loan. Marginal utility functions but the outcomes is bizarre: utility auto- immolation.
The stock markets grind upward, pricing in bailouts at all levels without consequence or cost. Is the current price increase the outcome of institutionalized moral hazard or part of a longer process that knocks the pricing structure apart?
What level of repudiation triggers revulsion, where the cynicism at issuance levels poisons the trust that supports the entire debt/money system. While it is not particularly clear from my own perspective what the implications are for ‘money’ or its derivatives, the feeling is that the nascent trend toward walking away bears great dangers. Take away the perceived need (imperative) to repay and what instrument is left to trade with? Force?
Peak oil has made the pursuit of money more profitable than the pursuit of commerce- derived profits. The expanding overhang of pointless debts which poisons public attitudes toward repayment complicates the values that society assigns to money. What is deflation without the cash preference? It seems we are all destined to find out.