The difficult task of damage control

Douglas A. McIntyre writes:

When the Bank for International Settlements annual report came off the presses today, there was no good news in it. One section summarized the agency's view: "While difficult to predict, their interaction does appear to point to a deeper and more protracted global downturn than the consensus view seems to expect."
BIS should be considered a dispassionate observer. It does not make money in the financial sector. It is third party observer with the ability to watch the global economy from above the fray.
The fray is looking worse.

Remember the Bank of International Settlements? The one that, this time last year, warned that the global economy could be on the brink of a major depression similar to the one that happened in the 1930s? The “central banks’ bank” has now released its 78th Annual Report for the year ended 30 June 2008. Below is the overview of the Report. Not pleasant reading at all.

BIS 78th Annual Report 2007/08: an overview

Chapter I: Introduction: the unsustainable has run its course

After a number of years of strong global growth, low inflation and stable financial markets, the situation deteriorated rapidly in the period under review. Most notable was the onset of turmoil in the US market for subprime mortgages, which rapidly affected many other financial markets and eventually called into question the adequacy of capital at a number of large US and European banks. At the same time, US growth slowed markedly, reflecting setbacks in the housing market, while global inflation rose significantly under the particular influence of higher commodity prices.

This sudden change in financial conditions was blamed by some on shortcomings in the extension of the long-standing originate-to-distribute model to new mortgage products in recent years. Others, however, noted that the sudden deterioration in both financial and macroeconomic conditions looked more like a typical “bust” after a credit “boom”. Indeed, several factors seem to support this second hypothesis: the previous rapid growth of global monetary and credit aggregates; an extended period of low real interest rates; the unusually high price of many assets (both financial and real); and the way in which spending patterns in different countries (the United States and China in particular) reflected their different stages of financial development (encouraging consumption and investment respectively).

While central banks in all the major financial centres took action to reliquefy financial markets, the setting of policy rates diverged markedly in light of domestic macroeconomic circumstances. Some central banks were more concerned about actual inflation and raised policy rates, whereas others focused on the disinflationary pressures likely to emerge as growth slowed, and lowered policy rates instead.

Chapter II: The global economy

The global economy has slowed since the second half of 2007 against the backdrop of the financial turmoil and a deepening US downturn. At the same time, global inflation has risen, led by rapid increases in prices of energy and key food items. The current consensus view is still that the global economy will slow only modestly further in 2008. Developments up to the first quarter have been broadly consistent with this view as growth in the euro area, Japan and major emerging market economies continued to be strong.

Unfolding developments at the core of the global financial system have, however, also created great uncertainty about future economic prospects. Banks in several advanced industrial economies have been tightening lending standards, and thus a generalised squeeze in the availability of credit remains a distinct possibility, with potentially more severe implications for demand than are reflected in consensus forecasts. These developments have been compounded by the recent rapid rise in oil prices and increased inflation expectations in a number of major economies.

The extent to which households with overstretched balance sheets in the United States and some other advanced industrial economies will have to retrench in the face of these negative shocks is hard to predict. While a substantial rise in US household saving could bring about a further sizeable reduction in the US current account deficit, it would do so at the price of weakening demand in the rest of the world. At the same time, inflation risks are greater than they have been for many years.

Chapter III: Emerging market economies

Growth in emerging market economies (EMEs) last year once again significantly exceeded that in the rest of the world. Foreign currency inflows were large, reflecting continued growth in current account surpluses and capital inflows in 2007. Nevertheless, the potential knock on effects of financial market turmoil in the major centres increased the risk of a slowdown in EMEs. At the same time, recent increases in headline inflation have caused inflation targets to be breached in many EMEs, reflecting the impact of steep increases in oil and food prices. As in the advanced industrial economies, these conflicting forces have created a major dilemma for monetary policy. Efforts to resist currency appreciation have introduced additional complications, having been associated with a sharp increase in foreign reserves and in credit growth in a number of EMEs.

Developments in the advanced industrial economies could also pose major challenges. First, a pronounced slowdown in the United States would hurt the EMEs which, although remarkably resilient so far, still depend significantly on external demand. Second, tighter conditions in global financial markets could constrain EMEs with large current account deficits, particularly those relying on more volatile portfolio financing. Countries heavily dependent on cross-border bank borrowing could also be especially vulnerable.

Chapter IV: Monetary policy in the advanced industrial economies

Monetary policy in the advanced industrial economies faced two conflicting challenges during the period under review. On the one hand, tensions in financial markets threatened to spill over into the real economy by way of tighter credit conditions and a loss in confidence. On the other hand, inflationary pressures that stemmed from rising commodity prices, together with high capacity utilisation and tight labour markets in many economies, threatened to feed into longer-term inflation expectations. Differences in the manifestation of these challenges across countries and regions can explain, at least in part, why central banks dealt with them in different ways. For example, the Federal Reserve reacted forcefully by cutting its policy rate from 5.25% to 2%, whereas the ECB and the Bank of Japan kept their policy rates unchanged.

Changes in interest rates were only one measure through which central banks responded to the dislocation in financial markets. Even before the turbulence led to any changes in policy targets, central banks in several countries had adjusted their operations in a number of extraordinary and unprecedented ways to keep reference rates near targets and to provide financing in markets where liquidity had evaporated. The various types of operations and the reasoning behind them are discussed in the final section of the chapter.

Chapter V: Foreign exchange markets

Foreign exchange market volatility picked up sharply in the latter half of 2007 and has remained at elevated levels since. This was associated with a faster rate of decline of the US dollar as well as a substantial appreciation of the euro, yen and Swiss franc. As carry trades became less attractive, expected growth differentials became more of a focal point for market sentiment than prevailing levels of interest rates. While exchange rate policies continued to shape the behaviour of some emerging market currencies, developments in commodity prices and specific trends in capital flows also exerted a considerable influence on exchange rates.

Notwithstanding some significant exchange rate movements and tensions in certain foreign exchange swap and cross-currency swap markets, foreign exchange spot markets generally continued to function smoothly throughout the period of higher volatility. From a longer-term perspective, there have been a number of notable developments that could potentially have a bearing on the resilience of foreign exchange markets. These include higher turnover, greater diversity in foreign exchange market activity and improvements in the risk management infrastructure. While generally positive, it is possible that the full implications of these developments for market dynamics at times of stress have not yet become apparent. It is important, therefore, to sustain the impetus for better risk management practices in foreign exchange markets going forward.

Chapter VI: Financial markets

During the period from June 2007 to mid-May 2008, concerns over losses on US subprime mortgage loans escalated into widespread financial stress. What initially appeared to be a contained problem quickly spread across other credit segments and broader financial markets to the point where sizeable parts of the financial system became largely dysfunctional. Surging demand for liquidity, coupled with growing concerns about counterparty risk, led to unprecedented pressures in major interbank markets, while bond yields in advanced industrial economies tumbled as investors sought safe havens amid fears that economic growth would weaken. Equity markets in advanced industrial countries were also weak, with financial shares selling off particularly sharply. A brighter spot was emerging financial markets, which in contrast to previous episodes of broad-based asset market weakness proved to be more resilient than those in the advanced industrial economies.

The financial market turmoil unfolded in six stages, starting in mid-June 2007: (i) a dramatic widening of spreads on subprime mortgage products following large-scale rating downgrades on mortgage-backed securities and the closure of a number of hedge funds with subprime exposure; (ii) the extension of the sell-off to a wide variety of credit and other markets from mid-July, including structured products more generally; (iii) the expansion of the turmoil into short-term credit and, particularly, interbank money markets from end-July; (iv) broader problems for the financial sector from mid-October, including for companies acting as financial guarantors; (v) increasingly dysfunctional markets, against the backdrop of a marked worsening of the US macroeconomic outlook from early 2008, accompanied by rising fears about systemic risks which caused spreads of even the highest-quality assets to move out to unusually wide levels; (vi) recovery, except in the interbank term market, in the wake of the Federal Reserve-facilitated takeover of a troubled US investment bank in March 2008.

Chapter VII: The financial sector in the advanced industrialised economies

Several years of growth and enhanced profitability for financial firms came to an abrupt halt during the period under review as strains stemming primarily from exposures to residential real estate spread throughout the financial system. What had started as a problem specific to the US subprime mortgage market became a source of outsize losses for financial firms worldwide on their holdings of related securities. Uncertainty about the size and distribution of losses was exacerbated by the complexity of the new structures used in the securitisation process. Retrenchment from risk-taking led to illiquidity, exposing weaknesses in the funding arrangements of many financial firms. Indeed, the situation was punctuated by the near failure of sizeable financial firms, prompting intervention by the public sector to avert potential systemic repercussions from a disorderly collapse.

With many financial institutions nursing weakened balance sheets, even as the macroeconomic environment continues to worsen, a turn in the credit cycle seems likely to imply persistent headwinds for economic activity. How the situation will evolve depends critically on the dynamic interactions between the financial sector and the macroeconomy. Reduced credit availability, due to efforts by the financial sector to preserve its capital base, could prolong the period of weak profitability by affecting aggregate spending, economic activity and asset quality. These effects could also be transmitted across borders if weakened banking systems tend to cut back on their international exposures. Beyond the cyclical implications, this period of intense stress also heralds some structural shifts. Financial firms are revisiting assumptions that supported a move towards a business model focused on origination and distribution of loans through securitisation. At the same time, policymakers are reviewing aspects of the prudential framework that failed to perform as intended.

Chapter VIII: Conclusion: the difficult task of damage control

In the aftermath of a long credit-driven boom, it would not be surprising to see turmoil in financial markets, slowing real growth and temporarily rising inflation. The crucial questions at the present juncture have to do with the severity of these individual trends as they now appear and how they might interact. While difficult to predict, their interaction does appear to point to a deeper and more protracted global downturn than the consensus view seems to expect. At the same time, inflationary forces, particularly in emerging market economies, could also prove unexpectedly strong and persistent. A major factor in inflation prospects everywhere is likely to be the behaviour of wages, but in some countries the effect of a depreciating exchange rate on domestic prices could also play an unwelcome role.

With inflation a clear and present threat, and with real policy rates in most countries very low by historical standards, a global bias towards monetary tightening would seem appropriate. That said, the circumstances of different countries, both actual and prospective, currently rule out a "one size fits all" response. Moreover, should the global economy slow sharply and inflationary pressures recede, the bias to tightening would evidently also be reduced.

In the current and prospective environment, it should nonetheless be borne in mind that the effectiveness of a lowering of policy rates might be significantly reduced in the aftermath of a credit-induced spending boom. In view of the potential negative side effects of such a policy, not least the risk of encouraging further financial imbalances and misallocations of real resources, complementary policies might be envisaged to avoid overburdening monetary easing. Expansionary fiscal policy could have some merit, but in many countries current debt levels mean there is little room for manoeuvre. Steps to recognise and deal with losses and debt overhang problems, in a timely and orderly way, and subject to conditionality, must then be a high priority.

Perhaps the principal conclusion to be drawn from today's policy challenges is that it would have been better to avoid the build-up of credit excesses in the first place. In future, this could be done through the establishment of a new macrofinancial stability framework, which would call for both monetary and macroprudential policies to "lean against the wind" of the credit cycle. Recognising that cycles can be attenuated but not eliminated, a number of preparatory steps are also suggested that would allow periods of financial turmoil or crisis to be more effectively managed.

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entree

Submitted by Michael Samuelson on August 4, 2008 - 5:50pm.

If I were a cynic, I would think that these two announcements were but the entree before the main course. The exposure of US banks to CDO's is expected to be at least 1 trillion dollars and maybe as high as 2 trillion dollars. Isn't it fortunate our banks aren't as greedy as their US counterparts.

This article is quite interesting.

And this one too should be of some interest.

A few failures

Submitted by peter hindrup on August 4, 2008 - 6:21pm.

Recently on News Hour: SBS; the woman who heads up the US bank insurance scheme was interviewed.

She said that they had 900 banks on their list that they were ‘watching’, and that normally 13 percent of those that made the list went under.

She added that most of those that had gone under recently were not on the list.

Expecting another 100 odd banks to fail? So much for the mighty US economy!

carpe diem

Submitted by F Kendall on July 29, 2008 - 12:11pm.

There will be blips and bounces, though Jenny: I would jump at one of them if I were you. It will be a long time before they are back to $27 or whatever, I think.

It's hard to sell a sinking stock: I recall Pacific Dunlop. Oh dear. $7+ to threepence or thereabouts.

Unsettled, Fiona?

Submitted by F Kendall on July 29, 2008 - 9:57am.

I wonder whether you read the interesting (Kohler, Gottliebsen, Batholemeuzs et al) commentary at http://www.businessspectator.com.au/ although it seems to me that Australian commentary is a little alarmist; Guardian pessimistic, and I would have thought the NYT to be reassuring until recently, when they have written such as: "Even (treasury secretary) Mr Paulson, for all his experience and market savvy, occasionally appears flummoxed by the scale and complexity of the crisis."

A good time to tolerate uncertainty.

NAB nabbed to the tune of ... $830 million

Submitted by Fiona Reynolds on July 25, 2008 - 6:20pm.

The National Australia Bank has just announced a massive $830 million provision for exposure to collateralised debt obligations (CDOs). In an article about the announcement just published in the SMH, Michael West writes:

CDOs are collateralised debt obligations, or thousands of loans bundled together and split into millions of securities so no one can quite value them by splitting them all apart.
They were supposed to be a nice robust security - having gained the ratings blessing of S&P and Moody's in return for a fee - which you could sell because the diversity of many debts supposedly offset the risk of holding specific debts.
Wrong, now no one wants to buy them and because they are not trading, few have seen fit to write them off yet.
…
The critical question is, what else is out there?
When subprime first bit, the estimated losses for the global banking system were put at $US400 billion. By the end of last year it was touted at $US800 billion and by last month a US research firm Bridgewater Associates was saying $US1.6 trillion.
Pinning the tail on this subprime donkey is an exercise in high speculation but also, it seems, is picking even the exposures of the local banks. One, they don't want to tell us in one go. Two, they might not know what is good and bad themselves.

(my emphasis)

Citigroup banking research reckons ANZ and NAB are the leading candidates. ANZ heads the list with a $23 billion exposure to credit default swaps (CDS) and NAB with its conduits (off-balance-sheet dumping grounds for things you can't sell).
Not strictly subprime, CDS (as opposed to CDOs) are corporate debt insurance derivatives. There is a large amorphous market for these things, believed by some to be an accident waiting to happen as no one seems to have bothered making specific reserves for CDS unlike regular insurance markets.
According to Citigroup, Westpac and CBA are ''well down the risk'' curve on this fancy derivative risk. While neither has disclosed adequately on its credit issues, both have a ''smaller CDS counterparty risk'' estimated at $3 billion for CBA and $9 billion for Westpac. Their conduit lines are also smaller at an estimated $3 billion and $7 billion.
Watch out for other acronyms such as SIV (structured investment vehicles) and ABS (asset-backed securities). They are also dangerous.

What else, indeed, is lurking out there? Don’t know about others, but I feel a bit unsettled.

Footnote

Submitted by Dr Jack Woodfor... on July 29, 2008 - 1:46pm.

FR The National Australia Bank has just announced a massive $830 million provision for exposure to collateralised debt obligations

What's a lazy $830mil when the big bods are backing their utes up to the back door?

And aren't the NABs the red-hot crew who rather exultantly decorated the plate glass windows of their emporia with huge cardboard cheques made out by the then Treasurer Peter Costello for a surge of "First Home Buyers",

Huge dud cheques, as it turned out, because the hapless first home buyers were up against an inflated market fed by another surge, of tax avoiders exploiting Costello's capital gains tax holidays.

And who in turn fed off the precipitating boom and population growth from immigration, with a government simultaneously exploiting xenophobia.

What was that, Peter Garrett, about "The time has come to pay the rent"?

Dr Jack Woodforde, OAM etc

All done with crystals

Submitted by Malcolm B Duncan on July 25, 2008 - 7:47pm.

Dr Reynolds, you may remember that immediately before it collapsed, Pyramid Building Society bundled all its securities and sold them off. Haven't got a link to the Royal Commission Report but I was in a case that involved a finance deal they had done. That was a long time ago. It is reported as Gilmour v Pyramid Building Society in the NSW Court of Appeal (about 1991 if I remember correctly off the top of my head). As usual, I didn't get paid. Roddy Meagher thought I was right, though.

Plus ca change, m'dear. Just get ready to watch it all again but this time in spades right across the entire banking sector.

Glad I'm broke, really - nothing to lose.

Too late

Submitted by Jenny Hume on July 29, 2008 - 11:29am.

Fiona: Why when I knew ANZ was going to do this at least a week ago did I not bother to dump our shares. Same with AWB. I'll blame WD.

Extracts from an article

Submitted by Michael Samuelson on July 16, 2008 - 1:51am.

Extracts from an article in market watch:

"You can count on us" was their slogan. Not quite. IndyMac Bancorp Inc. had $1 billion of uninsured, unsecured, and unprotected consumer deposits at stake. The 10,000 uninsured depositors will get 50 cents on the dollar now and wait for the rest.

IndyMac is a much bigger version of last September's failure of Alpharetta, Ga.-based NetBank, which had $109 million of uninsured deposits at the time of its failure. Uninsured NetBank depositors got 50 cents on the dollar and a conservator's certificate for the rest. Four other banks failed this year and uninsured depositors have received no immediate reimbursement.

This time the stakes are much higher. IndyMac's uninsured depositors' balances are about 10 times that of NetBank's -- 10,000 uninsured depositors with a total of $1 billion in deposits. The average payoff over the past 12 years has been 72 cents on the dollar. It can take years to collect whatever is left for the uninsured depositors.

Now check out some overall stats from the FDIC

There is $6.84 Trillion in bank deposits.
$2.60 Trillion of that is uninsured.
Total cash on hand at banks is $273.7 Billion.

Can anyone else see a run on American banks coming?

I only hope that Australia is sufficiently insulated from the American economy to weather the coming storms, and there are more coming, but truthfully I doubt it.

Reality

Submitted by Paul Walter on July 15, 2008 - 11:04pm.

Realised with a jolt this thread exists – h ave been pondering these issues since last weekend news and Fannie/Freddie Bubble crise.

Prof. Jeffrey Sachs, whose views have often found their way into WD threads, reckons on teev news serious recession.

Not a depression, but no soft landing.

John Pratt, let me thank you for keeping this going, I think as interest in more peripheral issues wanes, more will turn their attentions to this thread. Also nod to others already contributed here, including ol' sparring partner Paul Morrella.

Richard: Bet you PM's off on a summer vacation. Hey Paul, check your email, I've left you something!

"Panic of 2008" an end to capital rules era.

Submitted by John Pratt on July 15, 2008 - 8:38am.

This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early '80s undermined New Deal ideas and called forth a rebirth of radical free-market notions. What's becoming the "Panic of 2008" will mean an end to the latest capital rules era.
What's striking is that conservatives who revere capitalism are offering their own criticisms of the way the system is working. Irwin Stelzer, director of the Centre for Economic Policy Studies at the Hudson Institute, says the subprime crisis arose in part because lenders quickly sold their mortgages to others and bore no risk if the loans went bad.

Where do we go from here? It is obvious that global financial systems are failing and we need a new economic order. Where are the political leaders who will take us into this brave new world? Ideas of continuous growth are pushing us into a global disaster. We need an economic system based on ethical rules, a system that will be sustainable.

We need a new global economy that will give everyone access to the treasures of the planet while not destroying the planet in the process.

No nation too big to fail

Submitted by John Pratt on July 14, 2008 - 4:12pm.

During much of Japan’s lost decade of the 1990s, Americans called for an end to its coddling of weak banks. Better to let them keel over, along with the paper tiger companies they sustained. No company was “too big to fail,” Washington said.
Yet here, in the aftermath of a financial crisis brought on by what were once called American virtues — financial engineering and risk management — Washington may bail out Fannie and Freddie for the simple reason that they are too big to fail. If they go down, so do whole neighborhoods. So, perhaps, does the global financial system.

No company is too big to fail and no nation is too big to fail. US debt is at around $53 trillion.

These debts are overwhelming by any measure, but here’s one way to put them into perspective. We can compare them to debts carried by General Motors, which we all know is financially strapped because of its huge debt load.
GM’s 2006 audited accounts indicate that its debts totaled $190.4 billion, which is a daunting 91.8% of the $207.4 billion of revenue GM generated that year. In contrast, not only is the $53 trillion US government debt greater than its annual revenue, it is in fact 20-times greater than the $2.6 trillion of revenue it received last year. The US government’s debt load by comparison makes GM look like a paragon of financial prudence.
What about all the US government’s assets? Good question. The report values them at $1.6 trillion, but this total excludes the value of so-called StewardshipLand, which equals about 650 million acres, most of which is barren Alaska tundra and desert in Nevada and other Western states. What is this land worth? Yellowstone National Park is worth more than frozen tundra, but let’s say that the land is worth $10,000 per acre on average, which is probably a generous valuation. The total therefore is $6.5 trillion, which when added together with the $1.6 trillion of assets in the financial report, totals $8.1 trillion, which is just 15% of the US governments total debt obligations. Any way one looks at it, the US government has a huge negative net worth, and owes far more than it can possibly repay.

The US government is bankrupt. The wars in Iraq and Afghanistan cannot be won because the US doesn't have the money to keep spending like it has since 9/11. The sooner the world realises that the free market system has failed the sooner we will be able to sort out this global catastrophe.

We paid $2.4 billion to lose 5 percent of our super

Submitted by John Pratt on July 14, 2008 - 10:20am.

With superannuation losses expected to be the worst in 20 years, Australians are being urged to take a close look at the hefty commissions paid to financial advisers.
A new report out today shows retail superannuation funds paid advisers a staggering $2.4 billion during 2007 as retirement investments peaked and then sank as the share market correction hit.
The market volatility will deliver negative returns for many super funds, with most down by an average 5 per cent.
The Industry Super Network, which represents industry super funds, says the fees and commissions are "indefensible" given the negative returns most Australians are about to receive.

We really need to be careful with our super. $2.4 billion went to advisers who then went and lost an average of five percent.

With compulsory super being pumped into the share and property markets in record amounts, the price of shares are already hyper inflated. Does anyone see any prospect of shares rising in the next few years? In fact, the most likely scenario is a further crash as fuel prices and carbon taxes bite.

But don't worry - the so called financial advisers will still make billions.

My tip: pull your super out while you can. If you're locked in make sure you check the fees you pay.

We pay ten percent to borrow our own money

Submitted by John Pratt on July 14, 2008 - 9:04am.

THE Federal Government's Future Fund and the Reserve Bank have quietly propped up the banks through the global financial turmoil of the past year, ABN-Amro economists have revealed.
They say the two institutions provided a quarter of the massive growth in bank funding to fight off the global credit crunch.
As the standard mortgage rates charged by the banks approach 10%, their analysis implies that, without that support from Government, the banks would have been forced to lift mortgage rates even higher to attract money in the markets, or else cut their lending. The National Australia Bank and Westpac are tipped to raise their mortgage rates this week in line with those just announced by St George, the Commonwealth and the ANZ.
Rates charged by the Commonwealth and the ANZ will rise by 14 basis points today, to 9.58% and 9.62% respectively.

This is an accountant's dream. The government takes our money in taxes, puts the money into future funds, then gives the money to the banks so we can pay ten percent interest on our own money. In the meanwhile the banks make record profits.

THE Commonwealth Bank has announced a super half-year profit of $2.37 billion, a record for the bank as it gouges home loan borrowers with interest-rate rises.

CBA, the nation's biggest home lender, drew the ire of the Federal Government and homeowners last week after it raised rates on standard variable loans by 30 basis points to 8.97 per cent.

Why don't we give the money back to taxpayers to help pay off their home loans? Instead of squeezing us for every cent they can get.

US mortgage market in turmoil. US government debt $14 trillion.

Submitted by John Pratt on July 11, 2008 - 6:59pm.

Fannie Mae and Freddie Mac are so big — they own or guarantee roughly half of the nation’s $12 trillion mortgage market — that the thought that they might falter once seemed unimaginable. But now a trickle of worries about the companies, which has been slowly building for years, has suddenly become a torrent.

US government debt could go to $14 trillion.

Finally, for taxpayers and the United States government, the risks posed by Fannie’s and Freddie’s declining share prices are potentially overwhelming.
As government officials discuss various rescue plans — including taking over either or both companies in a conservatorship, others are pushing for more immediate action.
“We are potentially looking a crisis in the face, and we must not allow this to happen,” said William Poole, who retired in March as president of the St. Louis Federal Reserve. “The government must intervene.”
If a bailout were to occur, it would most likely make it more expensive for the United States government to borrow money in the future, since the government’s potential obligations, which currently stand at about $9 trillion, would rise by an additional $5 trillion.

As the US mortgage market plummets the outlook for a recovery in the US looks very bleak indeed.

“This is the last thing we need right now,” said Brett Barry, an agent at Realty Executives in Phoenix. “The market is like an elevator with the cable cut lose. It is accelerating downward.”

CBA raised their interest rates today because of the global cost of credit.

The Commonwealth Bank is increasing its standard variable home loan rate by 0.14 of a per cent from 9.44 to 9.58 per cent.
The bank says it has had to pass on to customers some of the cost oof funding its loans.
Analyst Mark Topy from Patersons Securities says the other banks are under the same sort of pressure.

As the cost of money soars many will be unable to pay their mortgage. This will flood the market with houses no one can afford to buy. It looks like housing prices are going to tumble.

Still looks like deflation

Submitted by Michael Samuelson on July 13, 2008 - 7:51pm.

Precisely, John. As real estate values tumble, not just domestic, but commercial also, unemployment will rise, firstly in the real estate and construction industries, then in the service industries, putting downward pressure on wages. The only price rises you are likely to see will be directly tied to rising oil prices, caused by an increased demand from developing nations. Take this factor out, and real prices would be falling along with wages. Still looks like deflation.

I stick with deflation

Submitted by Michael Samuelson on July 3, 2008 - 6:14pm.

I stick with deflation. The rising price of most goods can be put down to the rising price of oil, which in turn can be put down to to dwindiling supplies, greater demand, or both. Price rises aren't associated with spiralling wages. In fact, wages worldwide are falling due to rising unemployment. Prices of assets, including housing are crumbling.

Deflation has several definitions, most of which are suspect, but the one that seems the most likely is the reduction in money supply and/or credit. As banks create money by supplying credit, their unwillingness to lend to each other points to deflation, a period where people horde rather than spend or invest.

Two rams butting

Submitted by Paul Morrella on July 3, 2008 - 4:55pm.

Scott Dunmore, deflation was a big part of the Great Depression. What we are seeing at the moment is a huge risk of something loosely termed "stagflation". Shock spiing headline inflation (food, commodities etc), in conjunction with lagging growth, business profits, employment etc.

reality check

Submitted by Paul Walter on July 3, 2008 - 6:22pm.

As Paul and Scott more or less say, the world is undergoing a sort of reality check. As in previous cycles there has been a lulling into a false sense of security. Cornucopia and plenitude reign. Onward and upward. Onward ever upward...

Ho hum.

It's just that humanity has ever so slightly wrongly estimated the ratio of materials and energy available against technology and innovativeness. Thus, we find ourselves up a creek without a paddle, but this is by no means for the first time in recorded history.

Yes, a few hundred million more people than expected will suffer malnutrition, disease, war or other species of hardship, but those of us in the west who have been prudent will get by, to further remark at a later date as yet unclear, on the teleology of the onwards march of humanity toward a projected, if yet again somewhat inexplicably delayed Elysium, arranged for a yet (slightly disturbingly) unconfirmed contingent later date.

Best of all possible worlds...

I don't doubt you in the slightest

Submitted by Scott Dunmore on July 3, 2008 - 4:11pm.

David, you have caught me unaware of the situation in Japan circa 1990 but do you have other examples? (This from genuine interest.) I'm not talking about short term liquidity situations.

The goat track

Submitted by Scott Dunmore on July 3, 2008 - 10:25am.

Michael, I don't think we are seeing deflation as such, in fact I think it's almost impossible. Correct me if I'm wrong but I cannot recall it ever happening in the economic history of the industrial age. By deflation, we mean money growing in value, ie it buys more stuff than before. Bearing in mind that money is ever only a medium and has no intrinsic value of itself (despite the fact that having it in the bank is a bloody good thing); what we're left with is real wealth as defined by Adam Smith. We've already seen the disappearance of a lot of phony money and expect a lot more of it to go.

[David R: deflation is, as you say, when money buys more - or to put it another way, when prices are going down ... not likely now, but has happened many times in recent history eg Japan in early 90s]

At this point I'd like to invite my old mate Geoff into the debate. We don't share the same reality in many areas but he has expertise in this.

Just why we had to be subjected to a discourse in econospeak I don't know. If anybody knew where to look, we've been discussing this here for some time.

I don't want to come across like a broken record but the fundamentals continue to be ignored. Growing population (tripled in my lifetime), finite resources, inevitable decrease in living standards and ultimately, increased warfare.

Hence my weldschmertz.

The indicators of global economic depression have been in place for some time, most notably the imbalance of international trade. If nations start defaulting the last piece is in place and the world's largest economy, the USA, carrying a bluff all too easily read is most vulnerable. With our levels of foreign debt I'd suggest our position is none too healthy either.

Economic fundamentals have been ignored, the consequences of "globalisation" wherein disparities of lifestyles and artificial rates of exchange are not factored, have destroyed our real wealth. Napoleon would describe us as a nation of hotel owners.

The "Bottom Line", never was, only about three quarters down.

The farmers around my way are squealing like stuck pigs about mining companies drilling for gas and coal on or near their properties, not realising that the scale of productivity of their land is entirely dependant on what's underneath. (Oh, and guess what, now they're talking about liquefying coal to produce diesel for power stations but if anyone thinks we'll buy it for the reported cost of $32-40 a barrel, I suggest they're more than a little naive.)

A goat track indeed.

Completely off topic, I leave you with a thought for today. Where does this leave us bloggers?

Deflation

Submitted by Michael Samuelson on July 2, 2008 - 2:04am.

If I'm not mistaken we are actually seeing deflation, not inflation. The rising cost of oil and food represent legitimate market corrections. These commodities are not being hoarded above ground. However, the credit tightening, rising unemployment and lack of wage growth, as well as general pessimism, seem to be classic symptoms of deflation.

The road ahead is about to turn into a goat track.

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