Deepening Depression Navin Doshi (June 10, 2009)

As the currency carry trades swept away Iceland in 2007, and later bankers tried minimizing the effect of sub-prime toxins in 2008, there is no light at the end of the tunnel based upon the most recent data received in the first week of June 2009. The contradiction is that the stock market is singing a different, more optimistic tune. This might be because institutions like Goldman-Government Sachs (GGS) predict a brighter future by investing in BRIC (Brazil, Russia, India, and China) countries and energy. The word “Government” was introduced in the middle because they seem to be providing Treasury Secretaries and economic advisors to U.S. Presidents for a couple of decades. GGS believes that the world economy will roar back on a tidal wave of liquidity and is forecasting that oil will rise to over $85 per barrel. Government seems to give an impression that the worst is behind us.

Contradicting that forecast, the executives of big oil companies state that the oil markets are awash with so much crude that about 100 million barrels are stored on tankers at sea. John Williams, who runs Shadow Government Statistics (www.shadowstats.com) thinks that we are experiencing Pollyanna Creep- Pollyanna being the orphan lead character of the 1913 children book, who learns to find cheery perspective on life’s misery. Williams debunks government data and claims that the unemployment is over 20 %, GDP is shrinking by 8 % and CPI is up by 7 %. He believes that the tidal wave of liquidity created by the government will result in a massive stagflation, much bigger than the one in 1970s. One does hear whispers from former government officers stating that there is always political pressure to manipulating data to their advantage.

Optimists think that the developing economies will pull us out of global recession. However, China, the main driver of the new economy, is using about 10 % less electricity from a year earlier, in spite of the strong fiscal boost given by the Chinese Government. Scholars of the depression era economy conclude that the global rupture over the last ten months has been more violent than during the earlier slumps because global debt leverage was much greater this time. The fall in world industrial output on average is worse compared to what happened during the 1929-1930 period of depression. The manufacturing capacity utilization is running at an historic low of about 50 to 60 %. The danger is that companies will have to fire a lot of workers, deepening deflation. Here in Los Angeles, corporations and institutions like UCLA are cutting costs and salaries of employees.

Stephen Roach of Morgan Stanley fears an Asian relapse because of Asia’s fatal dependence on the exports to the West. China’s incipient economic rebound is based upon infrastructure spending. Apparently that alone can not be sufficient to pull the global economy out of the slump. The global economy that got used to American spending is getting very little help from Americans, as nearly 80 million baby boomers ferociously retrench their spending. Their saving rate has jumped from almost nothing to over five % and may test 15 %, the post war peak. The Obama Administration is hoping to bring back the old paradigm of Americans shopping till they drop. That may never come back as Americans are concerned about an uncertain future and their needs during retirement.

After 9/11, his first doctrine was based upon his statement, “either you are with us to fight terrorism, or you are against us supporting terrorism”. This was one of the reasons to declare war on Saddam, a supporter of terror, and preemptive strike. His second doctrine was about spreading democracy. His words, “the survival of liberty in our land increasingly depends on the success of liberty in other lands,” resonates with John Kennedy’s words, “we shall pay any price, bear any burden, meet any hardship, and support any friend to assure the survival and success of liberty.”

“It is difficult to deal with terrorism through non-violence,” the Tibetan spiritual leader, the Dalai Lama, said delivering the Madhavrao Scindia Memorial Lecture in Delhi in January 2009. He termed terrorism as the worst kind of violence which is not carried by a few mad people but by those who are brilliant and educated. “They (terrorists) are brilliant and educated…but a strong ill feeling is bred in them. Their minds are closed. Only way to tackle terrorism is through prevention.” The head of the Tibetan government-in-exile left the audience stunned when he said “I love President George W Bush.” He went on to add how he and the US President instantly struck a chord in their first meeting unlike politicians who take a while to develop close ties. “I told him ‘I love you but some of your policies I oppose’,”

The stock bull market of last three months has driven down the bond market with rising interest rates and the cost of energy. The bond revolt alone in the past has brought the economic recovery to a halt. Rising interest rates are bad for all businesses, particularly for the real estate market.

Standards for underwriting real estate loans have been tightened after going through the experience of the sub- prime loan fiasco. The five year interest only loans and balloon loans which were originated over the 2004-07 periods will face strong barriers as they will be due for refinancing up to the end of 2012. The combination of required additional cash due to the lower market value and higher interest rates will lead to an increase in defaults. In this scenario the apartment market should be least affected, while the buildings used for retail should fare the worst, followed by hotel and office buildings. Rising unemployment takes a toll on consumer spending and the decline in the level of business and travel reduces hotel occupancies. The poor economic conditions, cost cutting, and lay-offs take a toll on office leases.

If the borrower has maintained the monthly payments and is able to continue to do so, banks may negotiate loan extensions in an effort to forestall foreclosures. Banks do not have an interest in repossessing properties, and trying to sell in a depressed market. Currently there is leverage all the way across the system and there is no way to extract capital from depressed value properties as it was possible in the previous cycle. The rise in defaults should continue unless by some miracle, the market finds a bottom and stabilizes.

Navin Doshi

P.S.

Argument to keeping stronger $ by M. R. Venkatesh: (NOV 2008)

Obviously, what aids and sustains the US dollar is a “suspended sense of disbelief” amongst countries about the value of US dollar. Yet, common sense tells us that the excess supply will obviously result in a fall in the value of any product. The US dollar is no exception.

Late Iraqi leader Saddam Hussein was fully aware of this paradigm. Seeking to exploit the inherent weakness of the US dollar, Saddam wanted to trade his crude in Euros, which would have lead to a lower demand for the US Dollar and thereby triggered a dollar collapse. And those were his “weapons of mass destruction — WMD.”

And if some analysts are to be believed, Venezuela and Iran too possess the very same WMD. Naturally, it requires some specious arguments and military intervention to protect the US dollar. Never in the history of mankind has a national army protected the national currency so vigorously as the US Army has done is the past decade or so.

Navin Doshi (June 10, 2009)
(Mr. Doshi is a financial market trader, writer, and a philanthropist)

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