sâmbătă, 10 mai 2008

the w(hole) pie I

this one goes off in English...

it's about why I am so pessimistic as to what lays ahead at the end of the tunnel for the international financial crisis and about this recession. I reckon I might have been influenced by the works of Nouriel Roubini, the "uber bear" and father of all doomsayers but it also comes from what my common sense tells me. and yes I know that this looks like a complex (and it is) situation where common sense might yield the wrong conclusions but hell, I'll stick to my guns and go with my gut above any other fancy explanation an economics Nobel Prize might come with...

what does the main stream media tell you? there is an "issue" with the mortgage crisis that has spread to the financial sectors, caused problems on Wall Street & to the banks. consumers hesitate in spending but don't worry we'll just throw in some more debt, some fiscal stimulus packages and people will (need to) start borrowing some more and come back spending these dollars. everything will be great again, just wait a little...

ok, let's take a step back...

first of all I'll have to warn you, this one tends to be holistic (wow!) :) oh yeah, I do believe things are interconnected... and amongst the many factors leading to a set of potential outcomes, several issues came to my attention:

- consumerism as an economic engine;
- the fractional reserve system
- the role of the financial system (even as a Ponzi scheme)
- the central banks
- pure greed

those of you that know it already just bear with me while I give a bit of background to what I am about to say. those of you that haven't yet might want to have a look at some materials on consumerism and the role of the banks

so...consumerism appeared in the early 20th century and was boosted by the necessity of using the over sized post war production capacities and as a means to control the masses. simply put, make them believe that this or that product makes them feel good , special and gives them a social status. invent new needs, manipulate their desires to sell them more products, always more. cater for their needs (real and invented) and they'll be gullible sheep easy to herd. oh! I forgot to mention, more products sold = more profit for the few.

but how do we sell them more and more products when they don't earn the money (and God forbidden, we don't want them to earn more money - they might start thinking about what to do with it - so bring on that inflation and rig the statistics) to afford them ? well there's always the banks...

and you know how they work don't you? to put it plainly, they create money out of thin air and by that I mean they can lend more than their deposit base (fractional reserve system) which is to say for the 100$ deposited by you with the bank, they can create $400 new out of thin air... I am oversimplifying now but that's pretty much the name of the game.

there are several tricks to the game though:

1. You pay interest on the loans you take from a bank. Let me spell this out to you, you pay something on the money that was given to you, created by magic out of nothing (most of the times it's just an electronic entry on your current account that goes electronically to other people's accounts when you use that card of yours...); and the interest is not that small of an amount...take that mortgage loan over 25 year and you'll end up reimbursing significantly more than you initially paid on that house. And some more bad news to you, when the bubble deflates (did I hear something?) your house may be worth a lot less than what you initially paid for with the money taken from the bank.

2. To pay that interest you have to work for the money.Real work that involves time and real effort. And guess what, as you are an employee you only receive a fraction of the value you created through your work (though some of us manage not to create much:)) through your salary. That means a heck of effort goes into that monthly installment...

3. Banks are institutions based on trust. You trust them with your money (that is the fraction left after you buy all the nice stuff you don't need and pay the interest on the loans). But banks are also (and more than others) into the "all for profit mantra". And they'll do anything for more of that juicy stuff including all sorts of reckless things such as betting your money (oh that's called investing) on worthless instruments (call them CDOs, RMBS, CLOs, Alt A, CDO square, CDS and the likes of them) with the hope on selling them with a profit. And, guess what, they've added layers upon layers of these worthless instruments and invested irrespective of the fact that they had no real clue about the risks they were taking.

All is well that ends well but what if not? Then there come the losses that wipe out the capital (writedown/writeoff sounds familiar recently doesn't it). Don't worry, there's that "too big to fail"... or was that "too many to fail" ?

That's when they can change the rules of the game to get away with it, modify the regulations to report worthless collateral as solid stuff, avoid rating downgrades, use the FED's money (or FHLB, Fanny & Freddy for that matter) to plug the holes in their balance sheets.

4. There are guarantees to the loan. Sometimes real. So if you don't pay that money back they're gonna take real things from you . That's how funny money gets translated into real things...


so in a nutshell you have to work more in order to pay the interest on the money you borrowed to buy the things you don't need. In the meantime the economy produces more than is needed because one knows that the consumer will buy and the banks will give him/her the money. All the while the banks will do their utmost to make crazy bets with your hard earned dollars and rig the game to get away with the blame if the cards come crumbling down.

Oh almost forgot, there's also inflation, that phenomenon that makes your 100$ worth 50$ in several years :) More about it later

but let's take a look at the broad figures for 2007:
I believe this alone is sufficient evidence as to there is enough debt already.

It's simple, why borrow more when you're already over indebted, pay more interest while earning less and all of this just to buy things you don't really need ? What does your common sense tell you to do?

And there's another catch to consumerism, it can't just be consumption for the sake of consumption(not to mention on your own money) as if we were in a world with infinite resources. We're not. We're on a planet with very finite and rapidly dwindling resources that we have to share with an exponentially growing population. Economists will have to realize that they're not living in a theoretical world and cope with the real resource consumption rate.

There's always an equilibrium tendency in every system and certainly not such a thing as a free lunch in real world. Somebody always pays that bill and I see the waiter coming...

(more to come on the FED, the shadow financial system and inflation)

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