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The Daily Reckoning | Tuesday, April 5, 2011
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Springtime for Bailouts Revisiting the Government Rescue of the Financial World
Reckoning today from Delray Beach, Florida...
Bill Bonner
Yesterday was a nothing, no-account, waste-of-time kind of day in the markets. The Dow rose a bit. Gold did too.
So, let's take this opportunity to raise our heads and have a look around. When you watch something too closely you can miss the bigger story, like studying an unfolding bud and without realizing it is springtime.
But first, a chance to meet Dear Readers...
We're planning a trip to China next month. We'll be there with colleague Addison Wiggin and three of our children, visiting Beijing and Shanghai. If you live in China, we'd like to meet you. We'll host a cocktail reception in both cities. It might be a small party; but it will be fun. Drop a line to our assistant: darius.m.fisher@gmail.com
Now, back to springtime...
In April, 2007, the US, British, Irish...and many other economies...were saturated with debt. It had to be squeezed out. And so began a Great Correction. Everything under heaven serves some purposes. And the purpose of a correction is to correct mistakes. In this case, the Great Correction was meant to purge the errors of a credit expansion that was already more than half-a-century old.
The de-leveraging began in US subprime mortgages. Then, it spread, calling into question the value of just about everything. It resulted in the biggest losses in history - mostly in stocks, real estate, and derivative assets. From memory, those losses were estimated at between $20 and $30 trillion dollars, worldwide.
The rescuers were on the scene in force by the fall of '08, after Lehman Bros. went belly up. They effectively stopped the process - partially - by refusing to allow major borrowers to go broke. If a large institution couldn't pay its debts, they lent it more money.
In Ireland, for example, lenders had put far too much money into real estate. When borrowers couldn't pay, the government stepped in, grandly announcing that it would cover all the loans.
Whew! What were they thinking? The bad debts turned out to be a lot more than the Irish government could handle. Pretty soon, not only were the bankers in trouble, but so was the government itself. Ireland was going broke. And the more private lenders raised their lending rates, the more broke Ireland became. The government was desperate for a bailout; it turned to the IMF and Brussels. Now, the hole is deeper...and the Irish are looking for another bailout.
In the US, the story is similar. It bailed out the banks, Fannie, Freddie, AIG, General Motors and so forth. But since the US can print its own money, it could bail without sinking its own barque. In the short run at least, its own credit was unimpaired. The Fed bought up the bad loans and mortgage derivatives - to the tune of $1.2 trillion - printing the money to do so. Unlike the Europeans, whose central bank is run by Germans with a residue of financial integrity, the Fed followed the Bank of Japan. It reduced lending rates to zero. It monetized debt - first the $1.2 trillion of private sector debt from all over the world...and then $600 billion (still underway) of public sector loans.
And let's not forget the $700 billion TARP program. Or the tax cuts.
Add it all together and you a total bailout bill that may exceed $20 trillion.
What has been the result of all this expense and effort? Well, if you think the Great Correction needed to be arrested - at any cost - it was a marginal success. US GDP shrank...but only by about 4% maximum. Unemployment got no higher than 10% - thanks largely to the way the number is put together.
Unemployment seems to be yielding grudgingly to the feds' assault. At least, that's the way the papers tell the story. By our math, job creation is just barely keeping up with the population increase.
Meanwhile, housing fell about 20%...and is still going down.
From all that we can tell, the Great Correction has not been turned around...it has merely been slowed down, delayed, and magnified by public sector borrowing, and money-printing, on a huge scale.
In short, the feds have made the situation worse, just as we predicted. They've frozen the process of correction. Which leaves the zombies still preying upon the productive economy.
And that brings us to Japan...The book the US Congress never wanted you to see...
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by Bill BonnerEven before the Richter needle began to quiver and the pots began to fall, Japan's finances were already shaky. The country began running huge budget deficits following the stock market sell-off of 1990. Economists called this "fiscal stimulus" back then. Two decades later, the deficits are bigger than ever - 7.5% of GDP this year - and they stimulate nothing.
Japan has gotten in the habit of living beyond its means. The country has an accumulated debt equal to twice national output and 20 times tax revenues.
Japan has become a "zombie state." Its people are getting old. Net of private and public borrowing, its savings rate is now hugely negative.
Japan is "fiscally and demographically doomed," as Dennis Gartman puts it.
The zombie state survives only by feeding off the next generation. The government borrows, spends the money, and then counts on the next generation to make good on the loans. But the next generation is disappearing.
CNN carried an interview with an emergency worker in Japan. He noted that there were very few children among the dead. The interviewer speculated that the young were faster and better able to scramble to safety. Another reason may be that young people in Japan barely exist. There are no immigrants. Women do not get married. They do not have children - at least not enough to replenish the population anyway.
Obviously, a change of direction is in order. But what's the hurry? One of the remarkable features of our financial world is the low yields on US and Japanese sovereign debt. Japanese investors - who own 94% of Japanese government bonds - lend money to the central government for 10 years at only 1.2% yield. At that rate, the carrying cost of debt is so low borrowers are under no pressure to reduce their debt load or to change their habits. It is easier to add more debt than it is to face up to the challenge of a major political and economic restructuring.
No wonder the debt increases. Adding debt is the path of least resistance. And this is the path politicians tend to follow. As we mentioned here two weeks ago, the Bank of International Settlements estimates that Japan's debt will reach three times national output by the end of this decade.
This was the status of things when the teacups began to rattle and fall. Zero interest rates, money-printing and large fiscal deficits were already regular, every-day, business-as-usual components of the Japanese economy. Take them away, and all the unhappiness that the Japanese authorities had tried to avoid for so long would suddenly fall upon them.
As it turned out, the teacups fell upon them first. And then the sea rose up and threatened to swallow them whole. And if that weren't enough, their power plants turned against them too. Their recent quake was the most expensive natural disaster in history - likely to cost $200 billion to repair, according to an estimate from Goldman Sachs. The Tokyo stock exchange saw its biggest sell-off in 24 years - a loss in market value of $610 billion.
Under these circumstances, austerity was not only out of the question, it was no longer even part of the conversation. Reprising almost the exact words used by Ben Bernanke, Larry Summers and Tim Geithner in the autumn of 2008, the Japanese announced they would deal with the emergency at hand and worry about the long-term integrity of their national finances later.
In came the Bank of Japan with ¥15 trillion ($189 billion) of QE on Monday and another ¥21 trillion ($264 billion) on Tuesday. By Wednesday, almost $700 billion of new funds had been made available. On Tuesday, the price of gold also sank $30, prompting observers to speculate that Japan was selling gold in order to raise cash.
Japan hardly needed to sell gold. Like the US, Japan uses debt monetization (now politely called "quantitative easing" but more accurately described as money-printing) to fill in the gaps in its budgets. But as the Japanese age, they save less and less. And the window on "borrowing from ourselves" closes. QE is surely destined to play a larger role in financing both the Japanese reconstruction...and Japanese self-destruction, too.
As to the reconstruction, no one is going to complain if the Bank of Japan buys a few more government bonds. The country is repatriating capital from all over the world. In anticipation of this the yen has spiked to record highs versus the dollar. This makes QE seem not only like a sensible way to make funds available for reconstruction, but a way to help the economy too. It will help push the yen back down, helping Japan's export industry.
In the long run, no program of unbridled money printing goes unpunished. Sooner or later, Japan will add hyperinflation to its long list of torments.
Regards,
Bill Bonner,
for The Daily Reckoning
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Of course, a little "banking" is necessary. Capital must be allocated. But a lot of it is just a pest. A leech. A blood-sucking, flesh eating zombie!
Well, guess what? Profits in the zombie sector are back to where they were before 2007. Which just shows you where that $20 trillion went - into the pockets of the same people whose recklessness and greed caused the meltdown.
Not that we're complaining about bankers. That's the way the system is supposed to work. It goes from boom to bust...from euphoria to desolation...from expansion to contraction... The whole system is meant to separate fools from their money; the bankers merely help!
But when the feds step in to try to eliminate the down-stroke of the cycle they make a total mess of the situation. The system goes into a correction...and gets stuck. Progress is halted. Companies that should have died are kept on zombie life-support. Bankers that should be parking cars are kept at their jobs earning million-dollar bonuses. Investors who should have lost all their money, get a chance to lose even more.
That's what happened in Japan. Along with Addison Wiggin, we predicted that it would happen here too. Of course, we were nearly 10 years too early. But what's a decade? Sometimes, even marriages last longer.
*** But wait. Now, the news reports tell us that the feds' anti- correction program is working.
Probably the most widely read and most highly appraised financial newspaper is The Financial Times. It's the journal of the financial elite...where policymakers all over the world get their bent news and their misshapen opinions.
Last week, Clive Crook, writing in the FT, told us that "the Fed was right" to launch QE2. He said he was looking for QE3.
And then, just yesterday...in the FT's "Lex" column. Another headline:
"QE2 won. What next?"
Stock market prices are up. Inflation expectations are up. Unemployment is down to 8.8%. QE2 "clearly had the advertised effects."
Then, on page 9, there's Clive Crook again telling us what he thinks we should have next.
"The economy needs a third phase of quantitative easing," he writes.
Regards,
Bill Bonner,
for The Daily Reckoning
Tuesday, 5 April 2011
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