Tuesday, June 28, 2011

Lies, dammed lies and debts.

Prag Cap

The Bellwether thesis is that the whole US/UK debt problem/insolvency/inflation issue is now the mainstream and mostly wrong. That does not mean it is not starting to get a grip as per the attached re the debt ceiling in the US. There seem to be 2 threads to this. Continued at post 1.

Posted by bellwether @ 12:56 PM (1954 views)
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16 thoughts on “Lies, dammed lies and debts.

  • One is the global insolvency argument which is as nonsensical as it sounds. Insolvency is obviously a relative rather than absolute phenomenon, as in if everyone is insolvent then by definition no-one is.

    The other is the western insolvency argument where the wealth of the West is illusory and once the debt scenario is unpicked only countries such as China will be left standing. This world view seems to be shaped by various fallacious concepts such as thinking that the US needs to fund itself via debt, or thinking of money and debt as wealth, rather than merely an accounting method for measuring wealth that can be manipulated and changed.

    True wealth is of course know how, resources, people, infrastructure, rule of law, culture, allegiances and weapons – departments in which West continues to outdo the rest of the world.

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  • general congreve says:

    Believe it or not Bellwether, I am 100% with you on this one.

    All that needs to be done to resolve this problem is wipe the slate clean, just like Iceland did. The wealth itself will not disappear, just the ownership or the ‘claim on wealth’ will change.

    In Iceland before they defaulted and wiped the debt slate clean those with large reserves of Icelandic Krona and Shares in Iceland’s stock market were relatively wealthy. They had a decent claim on ownership of wealth via their solvency. However, in the process of default they lost a large amount of their ‘claim on wealth’, that claim shifted to others holding other financial reserves that became more valuable as a result of Icelandic default.

    For example, this is what happened to your ‘claim on wealth’ if you were invested in the Icelandic stockmarket:

    Image and video hosting by TinyPic

    And this is what happened if you held you wealth in Krona and wanted to purchase anything made in Europe or that was a piece of European wealth (property in Europe for example):

    Image and video hosting by TinyPic

    The blue line is the official Icelandic rate, as lied to everyone by the Icelandic central bank, the red line is the real rate as quoted by the European Central Bank. At it’s worse, before bouncing back a little, the Krona lost 69% against the Euro. Meaning that claims on Icelandic wealth (assets and exports) rose by 69% for holders of Euros (for example).

    And god forbid what happened if you had your Krona in a bank that went bust, your claim on wealth went from whatever it was to ZERO.

    Iceland then experienced 18% inflation in the year following their default, which further eroded the ‘claims on wealth’ that holders on Krona and Krona denominated assets formerly held.

    During the same time the price of gold in Krona rose 259%, but because the Krona fell 69% against the Euro (we shall use that as a benchmark), the value of gold actually fell 23.5% in Iceland, post crash. So, gold holders didn’t get rich, but they maintained a far greater proportion of their share of wealth than those in Krona and Krona denominated assets. In fact due to the relative price movements of Icelandic property, Icelandic gold holders actually found houses to be 8% cheaper for them, post crash.

    So, as we can see, no real wealth was destroyed in the Icelandic default. Houses still stood, fish still swam in the sea and livestock still grazed. It was just the claim on that wealth that changed hands. So, although real wealth and resources are maintained in a default, you need to make sure you are holding the winning hand when the slate is wiped clean, or you will suffer the consequences.

    Footnote: Iceland is a tiny country of 300,000 or so people. At the time of their collapse their was a general world panic and a dip in markets caused by the failure of Lehman Brothers. This sparked a ‘flight to safety’, with many asset holders rushing to buy the Dollar and Euro, seen as traditional safe havens, thereby pushing down the value of gold in these currencies. Further depression of the gold price took place as investors liquidated gold positions to get cash to cover losses in the stock market. These concurrent factors outside Iceland obviously contributed to the fact gold had a -23.5% return during their crash.

    Of course, the situation is different now. The unresolvable debt problems (without default) in the Eurozone, the realisation that US debts are onerous and realisation that there is no real recovery to speak of are weighing heavily on the idea that the dollar or Euro are safe havens. What happens if the US or Eurozone default and wipe the slate clean? The dollar, Euro or pound certainly won’t be the safe place to be. This is why when the big boys decide it’s time to wipe the slate, the dollar and euro will be the last place you want your money. The real claims of wealth will be shifting elsewhere when that happens.

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  • One of the problems with our commentators is their desire to explain everything in terms of history. Maybe looking at what might happen would be more productive.

    Maybe our speculation would lead others to charge us with being stupid, doom-watchers, bears or bulls. We need to get past this to develop as individuals or as a nation. How do you think this will pan out, Bellwether?

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  • @1 – the other dichotomy is between those who argue that:

    With trillions (quadrillions?) of derivatives in a highly leveraged financial system any major default leads to contagion and a cascade of cross-defaults: CDS settlements are triggered by the first default, protection sellers, dependent on day-to-day credit lines, cannot meet their obligations, so their creditors pull in those credit lines, leaving those sellers with illiquid “assets” and a situation in which banks cannot meet their obligations, triggering more CDS “events”. Credit markets and interbank lending ceases, stockmarkets tumble and catastrophe ensues. To prevent this bailouts are necessary even if they reward speculators, who will carry on as before (“earning their way out of debt”) knowing that governments daren’t refuse the next bailout.

    And those who argue that:

    The above is a cat’s cradle of cross-bets between a small number of financial players, that it’s just an accountancy exercise to net them off and that they should be set adrift to argue among themselves while the new money created to enrich those gamblers could just as easily have been employed to stoke up the ‘real economy’ and utilise those “resources, people, infrastructure” etc.

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  • “One of the problems with our commentators is their desire to explain everything in terms of history. Maybe looking at what might happen would be more productive.”

    it was not looking at history that got us into this mess. if you take this 1960s modernist blairite way of looking at the world you will always come undone. everything that happens has already happened in some similar form in history.

    as you get older and wiser in life you realise that there is nothing new, and if you havent realised that yet, then you are still young or have gained no wisdom.

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  • general congreve says:

    @4 – If the first case is true and bailout after bailout is forced on the world, then we suffer a shift on ‘claims on wealth’ via inflation/devaluation devaluing certain ‘claims on wealth’ and revaluing others. If the second is more true and they let the chips fall, or if the first case is true but they just lose control and the chips end up falling involuntarily, then we get an Iceland scenario, but more or less global.

    Same, same, slightly different time frames.

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  • letthemfall says:

    The wealth may not disappear as such, but the deserving may lose it, and the undeserving gain it, which is what we have seen happen periodically during periods of financial “difficulties”. And as icarus points out, the effect of the instability is to paralyse economies, preventing the realisation of the wealth inherent in the productive workforce. Govts in theory should be able to act to prevent the worst problems; in practice they don’t seem to do much.

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  • mark wadsworth says:

    “True wealth is of course know how, resources, people, infrastructure, rule of law, culture, allegiances and weapons – departments in which West continues to outdo the rest of the world.”

    Yup.

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  • general congreve says:

    @6 – So the BTLers and Banks that lent them the money – thereby making housing unaffordable for the productive members of society – who will lose their shirts in an outright collapse, are deserving? And those that didn’t partake of the credit swill trough, thereby increasing speculative rise in house prices, but wisely put their money in safe assets are undeserving?

    Or are you saying that if the banks keep getting bailouts they will be profiting from stealing wealth via inflation and tax payer theft, while everyone else suffers?

    A default like Iceland quickly gets things back on track, the paralysis doesn’t last long, as the paralysing grip of debt over society and the economy is broken. Not without some fallout and wealth realignment of course (as illustrated above), but the deadlock is broken for the better, on balance.

    Let’s hope Greece puts a bomb under the banksters tracks, so they get what is coming to them and we can get this dog and pony show over with.

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  • general congreve says:

    @7 – True and hopefully these words will provide some small crumbs of comfort to anyone who loses most of what they thought they had in the coming default, when they lose their savings, pension, stock values and the value of their house tanks.

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  • I would concede in all of this that gold (or relevant commodities) are some kind of truth drug. So if it turns out the $ is trash because the US is stuffed, then come the melt down holding gold (or RC) will mean you don’t just preserve your position but end up wealthier.

    My problem is that I just don’t see a melt down of this order, and actually think that as the world sits is pretty much as the world is, and if anything people are too buoyant on the east and too negative on the west. I see gold up only 50% in $ terms over a 3 year time frame (a time frame of huge financial panic) frame as kind of indicative of this. The percentage increases are slowing significantly meaning no doubt we are reaching some kind of accurate value. I’m sure too that as the rise tires we will get some kind of parabolic spike when everyone will get greedy. Huge amounts will be lost when it pops. Bugs will be crushed because it is very difficult to detach from an investment that is also a world view. I see no return to the gold standard, and see no use for it.

    If I was to spend a great deal of time asset allocating (which I don’t because), then I’d see the whole monetary demise/hyper inflationary story as passe, overdone and probably priced in. You can move on financial blogs for this sort of stuff, with, I’m sorry (and no dig at GC who is thoughtful on the topic), some real morons on the band wagon, and the story is now becoming pretty mainstream.

    Of course it’s impossible to be right at present, there are too many variable, but that’s my guess and the more alarm bells I hear going off the more convinced I become. We will know in a few years I guess.

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  • letthemfall says:

    GC
    It’s not quite as simple as that. BTLers lose: HPCers gain. If only …
    No, as we’ve seen, the taxpayers pay, the bankers reap the gains. Now Greece is in that position. But if it were to default we would have to see the result. But as a rule, the worst off suffer the most.

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  • general congreve says:

    @10 – Blimey, fair play Bellwether!

    I’m sure we will see a spike in gold, whether that is more or less a permanent revaluation of gold as money, with gold finding a new higher value (relative to where it is now in terms of purchasing power) as we move back onto a new gold standard (one possibility from this), or whether it is a temporary phenomenon that is seen in typical bull markets, remains to be seen. Obviously any investor in gold will do well to watch the markets and the actions of central banks, governments, the IMF etc. very closely so as to see where we go on this one, rather than just assume blind faith.

    Personally, as regards not seeing a meltdown. The governments of the world threw everything they had at this to prevent an immediate meltdown, but they only kicked the can down the road and are now running low on ammunition for further kickings. We are currently in the eye of the storm, so despite the relatively sluggish appreciation of gold (less so silver) over the past 3 years, this is not over by any stretch.

    There were rumblings about Iceland for a long time, I was still getting 6% on my savings until I pulled them out of Icesave two days before the collapse ensued. Getting that 6% rate of return with no problems in the build up to the collapse certainly didn’t mean collapse wasn’t on the cards. When collapse come it comes suddenly and without warning, then things happen in a flash in a disorderly manner. Everything seems fine, until it isn’t. In the Icelandic crash that meant a near 90% drop in the stock market, a 69% drop in the Krona versus Euro and a 259% appreciation in the Krona gold price, all in short order.

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  • GC,
    In your first graph, if I’m not mistaken the Iceland all-share index is quoted in Icelandic Krona! That means the collapse was far worse than that one graph alone would imply.

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  • general congreve says:

    @13 – A very valid point. Similar to these two points when looking at a UK housing market that is seemingly more or less static for the last few years…

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  • general congreve says:

    @11 – You’re right, it won’t be that simple, because in the case of an Iceland like collapse, or a continued ZIRP/QE inflationary path, the HPCer is eventually going to see the value of his hard earned savings for his deposit go up in smoke. That is why it is important to understand the dynamics of the situation and the potential outcomes, so one can take the best action to protect oneself from the machinations of the banks, the politicians and the markets in the future.

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