Commodity Complex Crash Commences

 Deflation-problemgc2reddit-logoOff the keyboard of Michael Snyder

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Published on the The Economic Collapse on December 8, 2015

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The Global Commodity Crash Tells Us That A Major Deflationary Financial Crisis Is Imminent

If we really are plunging into a deflationary global financial crisis, we would expect to see commodity prices crash hard.  That happened just before the great stock market crash of 2008, and that is precisely what is happening once again right now.  On Thursday, the Bloomberg Commodity Index closed at 79.1544.  The last time that it closed this low was 16 years ago.  Not even during the worst moments of the last recession did it ever get so low.  Overall, the Bloomberg Commodity Index is down more than 28 percent over the past 12 months, and it has plummeted by more than half since mid-2011.  As a result of this stunning commodity collapse, extremely large mining companies such as Anglo American are imploding, giant commodity trading firms such as Glencore and Trafigura are in full-blown crisis mode, and huge portions of the global financial system are in danger of utterly collapsing.

In recent days, I have been trying to stress that many of the exact same patterns that we witnessed just prior to the great stock market crash of 2008 are happening once again.  This includes the staggering crash of commodity prices that we are currently witnessing, and even CNN acknowledges that there are parallels to what we experienced seven years ago…

The last time raw materials like copper and oil were this cheap, an economic depression loomed just around the corner.

It’s no secret that commodities in general have had a horrendous 2015. A nasty combination of overflowing supply and soft demand has wreaked havoc on the industry.

But prices for everything from crude oil to industrial metals like aluminum, steel, copper, platinum, and palladium have collapsed even further in recent days.

As I mentioned above, this crash in prices is hitting mining companies really hard.  Just this week, the fifth largest mining company in the entire world announced a massive restructuring and will be laying off tens of thousands of workers…

In the latest example of just how bad things have gotten, Anglo American–the world’s fifth largest miner–just kitchen sink-ed it, announcing a sweeping restructuring, a massive round of layoffs, and a dividend cut. The company will reduce its assets by some 60% while headcount will be cut by a whopping 85,000 or, nearly two-thirds. 

Overall, the U.S. has lost approximately 123,000 good paying jobs from the mining sector since the end of 2014.  And if commodity prices stay low, this sector is going to continue to bleed good paying jobs.

Meanwhile, investors have been dumping the debt of any companies that have anything to do with commodities.  This has significantly contributed to the emerging junk bond crisis that I discussed in my last article.  As I write this, a high yield bond ETF known as JNK has fallen all the way down to 34.31, which is the lowest that it has been since the last recession.  For much more on the junk bond implosion, I would encourage you to read an article that Wolf Richter just put out entitled “Bond King Gets Antsy as Junk Bonds, Which Lead Stocks, Spiral to Heck“.

So why are commodity prices falling so rapidly?

Many analysts are pointing to the economic slowdown in China as the primary reason.  For years, the Chinese economy voraciously gobbled up commodities from sources all over the planet, but now things are changing.  The Chinese economy is really, really slowing down, and some recently released numbers give us some clues as to the true extent of that slowdown…

-Chinese exports fell 6.8 percent in November on a year over year basis after being down 6.9 percent on a year over year basis in October.

-Chinese imports were down 8.7 percent in November on a year over year basis.

-Chinese manufacturing activity has been contracting for nine months in a row.

-Last week, the China Containerized Freight Index plummeted to 718.58 – the lowest level ever recorded.

And of course it isn’t just China.  Goldman Sachs says that the seventh largest economy on the entire planet, Brazil, has plunged into a “depression“.  And as I pointed out the other day, of the 93 largest stock market indexes in the entire world, an astonishing 47 of them (more than half) are down at least 10 percent year to date.

Even though stocks slid in the U.S. this week, the major indexes still seem somewhat stable.  But this is a bit of an illusion.  Yes, the biggest names on Wall Street are still flying high for the moment, but shares of a multitude of smaller and mid-size firms have been plummeting.  At this point, nearly 70 percent of all U.S. stocks are already below their 200 day moving averages.  This is yet another thing that we would expect to see just before the bottom falls out for stocks.

Everything that I have been writing about this week (see here and here) is perfectly consistent with all of my warnings from earlier this year.

We are plunging into a deflationary financial crisis in textbook fashion.  And if the Federal Reserve actually does decide to go ahead with an interest rate hike next week that is just going to make things even worse.

But most people are not patient enough to watch a process play out.  Most people that write about “the coming economic collapse” hype it up like it is going to be some sort of big Hollywood blockbuster that is going to happen over a week or a month and then be over.  That is definitely not the way that I see things.

To me, “the economic collapse” is something that has been happening for decades, that is still in the process of happening right now, and that will continue to happen as we move forward into the future.  The long-term trends that are ripping our economy to shreds continue to intensify, and our leaders are not doing anything to fix our underlying fundamental problems.

And the financial crisis that I warned would start during 2015 and accelerate in 2016 has already begun.  More than half of all major global stock market indexes are down by at least 10 percent year to date, and some of them have plummeted by more than 30 or 40 percent.  Trillions of dollars of wealth has been wiped out around the globe, and this is just the beginning.

All of the numbers tell us the same thing.

Big trouble is ahead.

My job is to inform you of these things.  What you choose to do with this information is up to you.

Oops! Low oil prices are related to a debt bubble

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Published on the Our Finite World on November 3, 2015

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Why is the price of oil so low now? In fact, why are all commodity prices so low? I see the problem as being an affordability issue that has been hidden by a growing debt bubble. As this debt bubble has expanded, it has kept the sales prices of commodities up with the cost of extraction (Figure 1), even though wages have not been rising as fast as commodity prices since about the year 2000. Now many countries are cutting back on the rate of debt growth because debt/GDP ratios are becoming unreasonably high, and because the productivity of additional debt is falling.

If wages are stagnating, and debt is not growing very rapidly, the price of commodities tends to fall back to what is affordable by consumers. This is the problem we are experiencing now (Figure 1). 

Figure 1. Author's illustration of problem we are now encountering.




Figure 1. Author’s illustration of problem we are now encountering.

I will explain the situation more fully in the form of a presentation. It can be downloaded in PDF form: Oops! The world economy depends on an energy-related debt bubble. Let’s start with the first slide, after the title slide.

Slide 2




Slide 2

Growth is incredibly important to the economy (Slide 2). If the economy is growing, we keep needing to build more buildings, vehicles, and roads, leading to more jobs. Existing businesses find demand for their products rising. Because of this rising demand, profits of many businesses can be expected to rise over time, thanks to economies of scale.

Something that is not as obvious is that a growing economy enables much greater use of debt than would otherwise be the case. When an economy is growing, as illustrated by the ever-increasing sizes of circles, it is possible to “borrow from the future.” This act of borrowing gives consumers the ability to buy more things now than they would otherwise would be able to afford–more “demand” in the language of economists. Customers can thus afford cars and homes, and businesses can afford factories. Companies issuing stock can expect that price of shares will most likely rise in the future.

Without economic growth, it would be very hard to have the financial system that we have today, with its stable banks, insurance companies, and pension plans. The pattern of economic growth makes interest and dividend payments easier to make, and reduces the likelihood of debt default. It allows financial planners to set up savings plans for retirement, and gives people confidence that the system will “be there” when it is needed. Without economic growth, debt is more of a last resort–something that might land a person in debtors’ prison if things go wrong.

Slide 3




Slide 3

It should be obvious that the economic growth story cannot be true indefinitely. We would run short of resources, and population would grow too dense. Pollution, including CO2 pollution, would become an increasing problem.

Slide 4




Slide 4

The question without an obvious answer is “When does the endless economic growth story become untrue?” If we listen to the television, the answer would seem to be somewhere in the distant future, if a slowdown in economic growth happens at all.

Most of us who read financial newspapers are aware that more debt and lower interest rates are the types of stimulus provided to the economy, to try to help it grow faster. Our current “run up” in debt seems to have started about the time of World War II. This growing debt allows “demand” for goods like houses, cars, and factories to be higher. Because of this higher demand, commodity prices can be higher than they otherwise would be.

Thus, if debt is growing quickly enough, it allows the sales price of energy products and other commodities to stay as high as their cost of extraction. The problem is that debt/GDP ratios can’t rise endlessly. Once debt/GDP ratios stop rising quickly enough, commodity prices are likely to fall. In fact, the run-up in debt is a bubble, which is itself in danger of collapsing, because of too many debt defaults.

Slide 5




Slide 5

The economy is made up of many parts, including businesses and consumers. The consumers have a second role as well–many of them are workers, and thus get their wages from the system. Governments have many roles, including providing financial systems, building roads, and providing laws and regulations. The economy gradually grows and changes over time, as new businesses are added, and others leave, and as laws change. Consumers make their decisions based on available products in the marketplace and they amount they have to spend. Thus, the economy is a self-organized networked system–see my post Why Standard Economic Models Don’t Work–Our Economy is a Network.

One key feature of a self-organized networked system is that it tends to grow over time, as more energy becomes available. As its grows, it changes in ways that make it difficult to shrink back. For example, once cars became the predominant method of transportation, cities changed in ways that made it difficult to go back to using horses for transportation. There are now not enough horses available for this purpose, and there are no facilities for “parking” horses in cities when they are not needed. And, of course, we don’t have services in place for cleaning up the messes that horses leave.

Slide 6




Slide 6

When businesses start, they need capital. Very often they sell shares of stock, and they may get loans from banks. As companies grow and expand, they typically need to buy more land, buildings and equipment. Very often loans are used for this purpose.

As the economy grows, the amount of loans outstanding and the number of shares of stock outstanding tends to grow.

Slide 7




Slide 7

Businesses compete by trying to make goods and services more efficiently than the competition. Human labor tends to be expensive. For example, a sweater knit by hand by someone earning $10 per hour will be very expensive; a sweater knit on a machine will be much less expensive. If a company can add machines to leverage human labor, the workers using those machines become more productive. Wages rise, to reflect the greater productivity of workers, using the machines.

We often think of the technology behind the machines as being important, but technology is only part of the story. Machines reflecting the latest in technology are made using energy products (such as coal, diesel and electricity) and operated using energy products. Without the availability of affordable energy products, ideas for inventions would remain just that–simply ideas.

The other thing that is needed to make technology widely available is some form of financing–debt or equity financing. So a three-way partnership is needed for economic growth: (1) ideas for inventions, (2) inexpensive energy products and other resources to make them happen, and (3) some sort of financing (debt/equity) for the undertaking. 

Workers play two roles in the economy; besides making products and services, they are also consumers. If their wages are rising fast enough, thanks to growing efficiency feeding back as higher wages, they can buy increasing amounts of goods and services. The whole system tends to grow. I think of this as the normal “growth pump” in the economy.

If the “worker” growth pump isn’t working well enough, it can be supplemented for a time by a “more debt” growth pump. This is why debt-based stimulus tends to work, at least for a while.

Slide 8




Slide 8

There are really two keys to economic growth–besides technology, which many people assume is primary. One key is the rising availability of cheap energy. When cheap energy is available, businesses find it affordable to add machines and equipment such as trucks to allow workers to be more productive, and thus start the economic growth cycle.

The other key is availability of debt, to finance the operation. Businesses use debt, in combination with equity financing, to add new plants and equipment. Customers find long-term debt helpful in financing big-ticket items such as homes and cars. Governments use debt for many purposes, including “stimulating the economy”–trying to get economic growth to speed up.

Slide 9




Slide 9

Slide 9 illustrates how workers play a key role in the economy. If businesses can create jobs with rising wages for workers, these workers can in turn use these rising wages to buy an increasing quantity of goods and services.

It is the ability of workers to afford goods like homes, cars, motorcycles, and boats that helps the economy to grow. It also helps to keep the price of commodities up, because making these goods uses commodities like iron, steel, copper, oil, and coal.

Slide 10




Slide 10

In the 1900 to 1998 period, the price of electricity production fell (shown by the falling purple, red, and green lines) as the production of electricity became more efficient. At the same time, the economy used an increasing quantity of electricity (shown by the rising black line). The reason that electricity use could grow was because electricity became more affordable. This allowed businesses to use more of it to leverage human labor. Consumers could use more electricity as well, so that they could finish tasks at home more quickly, such as washing clothes, leaving more time to work outside the home.

Slide 11




Slide 11

If we compare (1) the amount of energy consumed worldwide (all types added together) with (2) the world GDP in inflation-adjusted dollars, we find a very high correlation.

Slide 12




Slide 12

In Slide 12, GDP (represented by the top line on the chart–the sum of the red and the blue areas) was growing very slowly back in the 1820 to 1870 period, at less than 1% per year. This growth rate increased to a little under 2% a year in the 1870 to 1900 and 1900 to 1950 periods. The big spurt in growth of nearly 5% per year came in the 1950 to 1965 period. After that, the GDP growth rate has gradually slowed.

On Slide 12, the blue area represents the growth rate in energy products. We can calculate this, based on the amount of energy products used. Growth in energy usage (blue) tends to be close to the total GDP growth rate (sum of red and blue), suggesting that most economic growth comes from increased energy use. The red area, which corresponds to “efficiency/technology,” is calculated by subtraction. The period of time when the efficiency/technology portion was greatest was between 1975 and 1995. This was the period when we were making major changes in the automobile fleet to make cars more fuel efficient, and we were converting home heating to more fuel-efficient heating, not using oil.

Slide 13




Slide 13

If we look at economic growth rates and the growth in energy use over shorter periods, we see a similar pattern. The growth in GDP is a little higher than the growth in energy consumption, similar to the pattern we saw on Slide 12.

If we look carefully at Slide 13, we see that changes in the growth rate for energy (blue line) tends to happen first and is followed by changes in the GDP growth rate (red line). This pattern of energy changes occurring first suggests that growth in the use of energy is a cause of economic growth. It also suggests that lack of growth in the use of energy is a reason for world recessions. Recently, the rate of growth in the world’s consumption of energy has dropped (Slide 13), suggesting that the world economy is heading into a new recession.

Slide 14




Slide 14

There is nearly always an investment of time and resources, in order to make something happen–anything from the growing of food to the mining of coal. Very often, it takes more than one person to undertake the initial steps; there needs to be a way to pay the other investors. Another issue is the guarantee of payment for resources gathered from a distance.

Slide 15




Slide 15

We rarely think about how all-pervasive promises are. Many customs of early tribes seem to reflect informal rules regarding the sharing of goods and services, and penalties if these rules are not followed.

Now, financial promises have to some extent replaced informal customs. The thing that we sometimes forget is that the bonds companies offer for sale, and the stock that companies issue, have no value unless the company issuing the stock or bonds is actually successful.  As a result, the many promises that are made are, in a sense, contingent promises: the bond will be repaid, if the company is still in business (or if the company is dissolved, if the amount received from the sale of assets is great enough). The future value of a company’s stock also depends on the success of the company.

Slide 16




Slide 16

Governments become an important part of the web of promises. Governments collect their assessments through taxes. As an economy grows, the amount of government services tends to increase, and taxes tend to increase.

The roles of governments and businesses vary somewhat depending on the type of economy of a country. In a sense, this type of variation is not important. It is the functioning of the overall networked system that is important.

Slide 17




Slide 17

There was a very large run up in US debt about the time of World War II, not just in the US, but also in the other countries involved in World War II.

Adding the debt for World War II helped pull the US out of the lingering effects of the Depression. Many women started working outside the home for the first time. There was a ramp-up of production, aimed especially at the war effort.

Slide 18 - From The United States' 65-Year Debt Bubble




Slide 18 – From The United States’ 65-Year Debt Bubble

What does a country do when a war is over? Send the soldiers back home again, without jobs, and the women who had been working to support the war effort back home again, also without jobs? This was a time period when non-government debt ramped up in the US. In fact, it seems to have ramped up elsewhere around the world as well. The new debt helped support many growing industries at the time–helping rebuild Europe, and helping build homes and cars for citizens in the US. As noted previously, both energy use and GDP soared during this time period.

Slide 19




Slide 19

I haven’t found very good records of debt going back very far, but what I can piece together suggests that the rate of debt growth (total debt, including both government and private debt) was similar to the rate of growth of GDP, up until about 1975. Then, debt began growing much more rapidly than GDP.

Slide 20




Slide 20

The big issue that led to a big increase in the need for debt in the early 1970s was an increase in the price of oil. Oil is the single largest source of energy. It is used in many important ways, including making food, transporting coal, and extracting metals. Thus, when the price of oil rises, so does the price of many other goods.

As we noted on Slides 11, 12, and 13, it is the growing quantity of energy consumption that is important in providing economic growth. The natural tendency with high energy prices is to cut back on energy-related consumption. Increasing debt, if it is at a sufficiently low interest rate, helps counteract this natural tendency toward less energy usage. For example, the availability of debt at a low interest makes it possible for more consumers to purchase big-ticket items like houses, cars, and motorcycles. These products indirectly lead to the growing consumption of energy products, because energy is used in making these big-ticket items and because they use energy in their continuing operation.

Slide 21




Slide 21

Many people have been concerned about what they call “peak oil”–the idea that oil supply would suddenly drop because we reach geological limits. I think that this is a backward analysis regarding how the system works. There is plenty of oil available, if only the price would rise high enough and stay high for long enough.

Much of this oil is non-conventional oil–oil that cannot be extracted using the inexpensive approaches we used in the early days of oil production. In some cases, non-conventional oil is so viscous it needs to be melted with steam, before it will flow freely. Some of the unconventional oil can only be extracted by “fracking.” Some of the unconventional oil is very deep under the ocean. Near Brazil, this oil is under a layer of salt. If prices would remain high enough, for long enough, we could get this oil out.

The problem is that in order to get this unconventional oil out, costs are higher. These higher costs are sometimes described as reflecting diminishing returns–more capital goods are needed, as are more resources and human labor, to produce additional barrels of oil. The situation is equivalent to the system of oil extraction becoming less and less efficient, because we need to add more steps to the operation, raising the cost of producing finished oil products. The higher price of oil products spills over to a higher cost for producing food, because oil is used in operating farm equipment and transporting food to market. The higher cost of oil also spills over to the cost of almost anything that is shipped long distance, because oil is used as a transportation fuel.

You will remember that increased efficiency is what makes an economy grow faster (Slide 7, also Slide 37). Diminishing returns is the opposite of increased efficiency, so it tends to push the economy toward contraction. We are running into many other forms of increased inefficiency. One such type of inefficiency involves adding devices to reduce pollution, for example in electricity production. Another type of inefficiency involves switching to higher-cost methods of generation, such as solar panels and offshore wind, to reduce pollution. No matter how beneficial these techniques may be from some perspectives, from the perspective of economic growth, they are a problem. They tend to make the economy grow more slowly, rather than faster.

The standard workaround for slow economic growth is more debt. If the interest rate is low enough and the length of the loan is long enough, consumers can “sort of” afford increasingly expensive cars and homes. Young people with barely adequate high school grades can “sort of” afford higher education. With cheap debt, businesses can afford to buy back company stock, making reported earnings per share rise–even though after the buy-back, the actual investment used to generate future earnings is lower. With sufficient cheap debt, shale companies can create models showing that even if their cash flow is negative at $100 per barrel oil prices ($2 out for $1 in) and even more negative at $50 per barrel ($4 out for $1 in), somehow, the companies will be profitable in the very long run.

The technique of adding more debt doesn’t fix the underlying problem of growing inefficiency, instead of growing efficiency. Instead, as more debt is added, the additional debt becomes increasingly unproductive. It mostly provides a temporary cover-up for economic growth problems, rather than fixing them.

Slide 22




Slide 22

A common belief has been that as we reach limits of a finite world, oil prices and perhaps other prices will spike. In my view, this is a wrong understanding of how things work.

What we have is a combination of rising costs of production for many kinds of goods at the same time that wages are not rising very quickly.  This problem can be temporarily hidden by a rising amount of debt at ever-lower interest rates, but this is not a long-term solution.

We end up with a conflict between the prices businesses need and the prices that workers can afford. For a while, this conflict can be resolved by a spike in prices, as we experienced in the 2005-2008 period. These spikes tend to lead to recession, for reasons shown on the next slide. Recession tends to lead to lower prices again.

Slide 26




Slide 26

The image on Slide 26 shows an exaggeration to make clear the shift that takes place, if the price of oil spikes. When the price of one necessary part of consumers’ budgets increases–namely the food and gasoline segment–there is a problem. Debt payments already committed to, such as those on homes and automobiles, remain constant. Consumers find that they must cut back on discretionary spending–in other words, “Everything else,” shown in green. This tends to lead to recession.

Slide 27




Slide 27

If we look at oil prices since 2000, we see that the period is marked by steep rises and falls in oil prices. In Slides 27 – 29, we will see that changes in the price of oil tend to correspond to changes in debt availability and cost.

In 2008, oil prices rose to a peak in July, and then dropped precipitously to under $40 per barrel in December of the same year. Slide 27 shows that the United States began its program of Quantitative Easing (QE) in late 2008. This helped to lower interest rates, especially longer-term interest rates. China and a number of other countries also raised their debt levels during this period. We would expect greater debt and lower interest rates to increase demand for commodities, and thus raise their prices, and in fact, this is what happened between December 2008 and 2011.

The drop in prices in 2014 corresponds to the time that the US phased out its program of QE, and China cut back on debt availability. Here, the economy is encountering less cheap debt availability, and the impact is in the direction expected–a drop in prices.

Slide 28 - From The United States' 65-Year Debt Bubble




Slide 28 – From The United States’ 65-Year Debt Bubble

If we go back to the steep drop in oil prices in July 2008, we find that the timing of the drop in prices matches the timing when US non-governmental debt started falling. In my academic article, Oil Supply Limits and the Continuing Financial Crisis, I show that this drop in debt outstanding takes place for both mortgages and credit card debt.

Slide 29




Slide 29

The US government, as well as other governments around the world, responded by sharply increasing their debt levels. This increase in governmental debt (known as sovereign debt) is part of what helped oil and other commodity prices to rise again after 2008.

Slide 30




Slide 30

We often hear about the drop in oil prices, but the drop in prices is far more widespread. Nearly all commodities have dropped in price since 2011. Today’s commodity price levels are below the cost of production for many producers, for all of these types of commodities. In fact, for oil, there is hardly any country that can produce at today’s price level, even Saudi Arabia and Iraq, when needed tax levels by governments are considered as well.

Producers don’t go out of business immediately. Instead, they tend to “hold on” as best they can, deferring new investment and trying to generate as much cash flow as possible. Because most of them have no alternative way of making a living, they often continue producing, as best they can, even with low prices, deferring the day of bankruptcy as long as possible. Thus, the glut of supply doesn’t go away quickly. Instead, low prices tend to get worse, and low prices tend to persist for a very long period.

Slide 31




Slide 31

In 2008, we had an illustration of what can go wrong when the economy runs into too many headwinds. In that situation, the price of oil and other commodities dropped dramatically.

Now we have a somewhat different set of headwinds, but the impact is the same–the price of commodities has dropped dramatically. Wages are not rising much, so they are not providing the necessary uplift to the economy. Without wage growth, the only other approach to growing the economy is debt, but this reaches limits as well. See my post, Why We Have an Oversupply of Almost Everything (Oil, labor, capital, etc.)

There is some evidence that the Great Depression in the 1930s involved the collapse of a debt bubble. It seems to me that it may very well have also involved wages that were falling in inflation-adjusted terms for a significant number of wage-earners. I say this, because farmers were moving to the city in the early 1900s, as mechanization led to lower prices for food and less need for farmers. I haven’t seen figures on incomes of farmers, but I wouldn’t be surprised if they were dropping as well, especially for the many farmers who couldn’t afford mechanization. Wages for those who wanted to work as laborers on farms were likely also dropping, since they now needed to compete with mechanization.

In many ways, the situation that led up to the Great Depression appears to be not too different from our situation today. In the early 1900s, many farmers were being displaced by changes to agriculture. Now, wages for many are depressed, as workers in developed economies increasingly compete with workers in historically low-wage countries. Additional mechanization of manufacturing also plays a role in reducing job opportunities.

If my conjecture is right, the Great Depression may have been caused by problems similar to what we are seeing today–wages that were too low for a large segment of the economy, thus reducing economic growth, and a temporary debt bubble that tended to cover up the wage problem. Once the debt bubble collapsed, demand for commodities of all types collapsed, and prices collapsed. This problem was very difficult to fix.

Slide 32




Slide 32

When we add more debt to the economy, users of debt-financing find that more of their future income goes toward repaying that debt, cutting off the ability to buy other goods. For example, a young person with a large balance of student loans is unlikely to be able to afford buying a house as well.

A way of somewhat mitigating the problem of too much income going toward debt repayment is lowering interest rates. In fact, in quite a few countries, the interest rates governments pay on debt are now negative.

Slide 33




Slide 33

If the cost of producing commodities continues to rise, but the price that consumers can afford to pay does not rise sufficiently, at some point there is a problem. Instead of continuing to rise, prices start to fall below their cost of production. This drop can be very sharp, as it was in 2008.

The falling price of commodities is the same situation we encountered in 2008 (Slide 27); it is the same situation we reached at the beginning of the Great Depression back in 1929. It seems to happen when wage growth is inadequate, and the debt level is not growing fast enough to hide the inadequate wage growth. This time around, we are also challenged by the cost of producing commodities rising, something that was not a problem at the time of the Great Depression.

Slide 34




Slide 34

If we think about the situation, having prices fall behind the cost of production is a disaster. We can’t get oil out of the ground, if prices are too low. Farmers can’t afford to grow food commercially, if prices remain too low.

Prices of assets such as the value of farmland, the value of oil held by leases, and the value of metal ores in mines will fall. Assets such as these secure many loans. If an oil company has a loan secured by the value of oil held by lease, and this value falls permanently, there is a significant chance that the oil company will default on the loan.

The usual belief is, “The cure for low prices is low prices.” In other words, the situation will fix itself. What really happens, though, is that everyone is so afraid of a big crash that all parties make extreme efforts to avoid a crash. In fact, there is evidence today that banks are “looking the other way,” rather than taking steps to cut off lending to shale drillers, when current operations are clearly unprofitable.

By the time the crash does come around, it is likely to be a huge one, affecting many segments of the economy at once. Oil exporters and exporters of other commodities will be especially affected. Some of them, such as Venezuela, Yemen, and even Iraq may collapse. Financial institutions are likely to find themselves burdened with many “underwater loans.” The usual technique of lowering interest rates to try to aid the economy doesn’t look like it would work this time, because rates are already so low. Governments are not in sufficiently good financial condition to be able to bail out all of the banks and others needing assistance. In fact, governments may fail. The fall of the former Soviet Union occurred when oil prices were low.

Once there are major debt defaults, lenders will want to wait to see that prices will stay consistently high for a period (say, two or three years) before extending credit again. Thus, even if commodity prices should bounce back in 2017, it is doubtful that producers will be able to find financing at a reasonable interest rate until, say, 2020. By that time, depletion will have taken its toll. It will be impossible to make up for the many years of low investment at that time. Production is likely to continue falling, even if prices do rise.

The indirect impact of low oil and other commodity prices is likely to be a collapse in our current debt bubble. This collapsing bubble may lead to the failures of banks and even governments. It seems quite possible that these indirect impacts will affect us most, even more than the direct loss of commodities. These impacts could come quite quickly–in the next few months, in some cases.

Slide 35




Slide 35

Stocks, bonds, pension programs, insurance programs, bank accounts, and many other things of a financial nature seem to be very “solid” things–things that we can expect to be here and grow, for many years to come. Yet these things, directly and indirectly, depend on the ability of our system to produce goods and services. If something goes terribly wrong, we may find that financial assets have little more value than the pieces of paper that represent them.

Slide 36




Slide 36

I won’t try to explain Slide 36 further.

Slide 37




Slide 37

Slide 37 illustrates the principle of increased efficiency. If a smaller amount of resources and human labor can be used to create a larger amount of end product, this is growing efficiency. If more and more resources and labor are used to produce a smaller amount of end product, this is growing inefficiency.

The other part of the story is that simply automating processes is not enough. Instead, the economy must also produce a sufficiently large number of jobs, and these jobs must pay high enough wages that the workers can afford to buy the output of the economy. It is really the health of the whole interconnected system that is important.

Slide 38




Slide 38

Our low price problems are here now. That is why we need very cheap non-polluting energy products now, in large quantity, if there is any chance of fixing the system. These energy products must work in today’s devices, so we aren’t faced with the cost and delay involved with changing to new devices, such as cars and trucks that use a different fuel than petroleum.

Slide 39




Slide 39

Regarding Slides 39 and 40, we are sitting on the edge, waiting to see what will happen next.

The US economy temporarily seems to be in somewhat of a bubble, now that it does not have QE, while several other countries still do. This bubble is related to a “flight to quality,” and leads to a higher dollar, relative to other currencies. It also leads to high stock market valuations. As a result, the US economy seems to be doing better than much of the rest of the world.

Regardless of how well the US economy seems to be doing, the underlying problems of rising costs of producing commodities and prices that lag below the cost of production are still present, making the situation unstable. Wages continue to lag behind as well. We should not be too surprised if the economy starts taking major downward steps in the next few months.

Slide 40




Slide 40

Financial Doomsday Clock “One Minute to Midnight”

Off the keyboard of Thomas Lewis

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Published on the Daily Impact on August 19, 2015

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The hair-on-fire headline reads, in full: “Doomsday clock for global market crash strikes one minute to midnight as central banks lose control.” But here’s the thing — the headline does not appear in a hair-on-fire, Chicken-Little website such as (one might slanderously call) Zero Hedge, David Stockman’s Contra Corner, Wolf Street or (dare I append this name to the list of Titans?) The Daily Impact. It appears on the website of  one of the world’s top mainstream newspapers, Britain’s  The Daily Telegraph. And here’s the subhead: “China currency devaluation signals endgame leaving equity markets free to collapse under the weight of impossible expectations.”

Worried yet? Don’t be. It’s way too late.

One of the hair-on-fire websites (first clue: it’s name is The Economic Collapse Blog) lists 23 — count them, 23 — countries whose stock markets are crashing right now. The largest of them, of course, is China, whose markets have been imploding for two months. For most of that time the mainstream media has been murmuring assurances to the rest of us — it’s over, it’s stable now, it’s contained, it won’t affect us — while things got worse, faster, over a wider area.

As the Telegraph article points out, it was China that saved the world after the 2008-9 crash, by expanding its economy ruthlessly, with borrowed and imaginary money (that is, money imagined into existence by the central bank). They built high-rise apartment buildings, whole cities of them, in which no one lives. They built freeways on which no one drives — they poured more concrete in three years than the United States has poured in its entire history. Now, mired in debt that is coming due, its currency devalued, its stock market crashing, China teeters on the brink of unimaginable catastrophe.

The seizures afflicting China’s economy are a major reason why the prices of virtually every industrial commodity have crashed this year, with dramatic effects on the economies and the currencies of the countries whose welfare depends on the sale of the assets nature deposited under their territory. The fairy tale has been that these “emerging” nations, which of course will never deplete their deposits of whatever, will take over the engine of endless global growth as the mantle falls from the shoulders of the exhausted roosters — the United States, China, etc. Instead, each of these countries is in turmoil, its currency fraying, its markets roiled, its economy seizing up.

Money, real and imaginary, is rampaging out of China, out of Greece, out of the emerging markets, out of the bond market, and. yes, out of the American stock market. According to staid and optimistic CNBC, it’s a “stampede,” with domestic equity funds losing $20 billion in investor funding in July, nearly $160 billion in 12 months. The outflows are far worse than they were in the 2009 crisis. Ask not for whom the Chinese gong tolls; it tolls for three.

As the markets, including the US markets, continue to stagger along the edge of the cliff like the proverbial drunken sailors, the Dipsticks (a.k.a. the Masters of the Universe) continue to buy the dip, praying fervently to the great god Mammon that each reverse is a temporary hiccup and not the manifestation of the immutable law of gravity.

Never mind what your smartphone thinks the time is. It’s a minute to midnight, all over the world.


Thomas Lewis is a nationally recognized and reviewed author of six books, a broadcaster, public speaker and advocate of sustainable living. He also is Editor of The Daily Impact website, and former artist-in-residence at Frostburg State University. He has written several books about collapse issues, including Brace for Impact and Tribulation. Learn more about them here.

Oil Market Unravels

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on January 5, 2015


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Oil Falls Below 50 As Global Financial Markets Begin To Unravel

Crisis Silhouette - Public DomainOn Monday, the price of oil fell below $50 for the first time since April 2009, and the Dow dropped 331 points.  Meanwhile, the stock market declines over in Europe were even larger on a percentage basis, and the euro sank to a fresh nine year low on concerns that the anti-austerity Syriza party will be victorious in the upcoming election in Greece.  These are precisely the kinds of things that we would expect to see happen if a global financial crash was coming in 2015.  Just prior to the financial crisis of 2008, the price of oil collapsed, prices for industrial commodities got crushed and the U.S. dollar soared relative to other currencies.  All of those things are happening again.  And yet somehow many analysts are still convinced that things will be different this time.  And I agree that things will indeed be “different” this time.  When this crisis fully erupts, it will make 2008 look like a Sunday picnic.

Another thing that usually happens when financial markets begin to unravel is that they get really choppy.  There are big ups and big downs, and that is exactly what we have witnessed since October.

So don’t expect the markets just to go in one direction.  In fact, it would not be a surprise if the Dow went up by 300 or 400 points tomorrow.  During the initial stages of a financial crash, there are always certain days when the markets absolutely soar.

For example, did you know that the three largest single day stock market advances in history were right in the middle of the financial crash of 2008?  Here are the dates and the amount the Dow rose each of those days…

October 13th, 2008: +936 points

October 28th, 2008: +889 points

November 13th, 2008: +552 points

Just looking at those three days, you would assume that the fall of 2008 was the greatest time ever for stocks.  But instead, it was the worst financial crash that we have seen since the days of the Great Depression.

So don’t get fooled by the volatility.  Choppy markets are almost always a sign of big trouble ahead.  Calm waters usually mean that the markets are going up.

In order to avoid a major financial crisis in the near future, we desperately need the price of oil to rebound in a substantial way.

Unfortunately, it does not look like that is going to happen any time soon.  There is just way too much oil being produced right now.  The following is an excerpt from a recent CNBC article

The Morgan Stanley strategists say there are new reports of unsold West and North African cargoes, with much of the oil moving into storage. They also note that new supply has entered the global market with additional exports coming from Russia and Iraq, which is reportedly seeing production rising to new highs.

Since June, the price of oil has plummeted close to 55 percent.  If the price of oil stays where it is right now, we are going to see large numbers of small producers go out of business, the U.S. economy will lose millions of jobs, billions of dollars of junk bonds will go bad and trillions of dollars of derivatives will be in jeopardy.

And the lower the price of oil goes, the worse our problems are going to get.  That is why it is so alarming that some analysts are now predicting that the price of oil could hit $40 later this month

Some traders appeared certain that U.S. crude will hit the $40 region later in the week if weekly oil inventory numbers for the United States on Wednesday show another supply build.

‘We’re headed for a four-handle,’ said Tariq Zahir, managing member at Tyche Capital Advisors in Laurel Hollow in New York. ‘Maybe not today, but I’m sure when you get the inventory numbers that come out this week, we definitely will.’

Open interest for $40-$50 strike puts in U.S. crude have risen several fold since the start of December, while $20-$30 puts for June 2015 have traded, said Stephen Schork, editor of Pennsylvania-based The Schork Report.

The only way that the price of oil has a chance to move back up significantly is if global production slows down.  But instead, production just continues to increase in the short-term thanks to projects that were already in the works.  As a result, analysts from Morgan Stanley say that the oil glut is only going to intensify

Morgan Stanley analysts said new production will continue to ramp up at a number of fields in Brazil, West Africa, Canada and in the U.S. Gulf of Mexico as well as U.S. shale production. Also, the potential framework agreement with Iran could mean more Iranian oil on the market.

Yes, lower oil prices mean that we get to pay less for gasoline when we fill up our vehicles.

But as I have written about previously, anyone that believes that lower oil prices are good for the U.S. economy or for the global economy as a whole is crazy.  And these sentiments were echoed recently by Jeff Gundlach

Oil is incredibly important right now. If oil falls to around $40 a barrel then I think the yield on ten year treasury note is going to 1%. I hope it does not go to $40 because then something is very, very wrong with the world, not just the economy. The geopolitical consequences could be – to put it bluntly – terrifying.

If the price of oil does not recover, we are going to see massive financial problems all over the planet and the geopolitical stress that this will create will be unbelievable.

To expand on this point, I want to share an excerpt from a recent Zero Hedge article.  As you can see, a rapid rise or fall in the price of oil almost always correlates with a major global crisis of some sort…

Large and rapid rises and falls in the price of crude oil have correlated oddly strongly with major geopolitical and economic crisis across the globe. Whether driven by problems for oil exporters or oil importers, the ‘difference this time’ is that, thanks to central bank largesse, money flows faster than ever and everything is more tightly coupled with that flow.

Oil Crisis Chart - Zero Hedge

So is the 45% YoY drop in oil prices about to ’cause’ contagion risk concerns for the world?

And without a doubt, we are overdue for another stock market crisis.

Between December 31st, 1996 and March 24th, 2000 the S&P 500 rose 106 percent.

Then the dotcom bubble burst and it fell by 49 percent.

Between October 9th, 2002 and October 9th, 2007 the S&P 500 rose 101 percent.

But then that bubble burst and it fell by 57 percent.

Between March 9th, 2009 and December 31st, 2014 the S&P 500 rose an astounding 204 percent.

When this bubble bursts, how far will it fall this time?

Not Just Oil…

Off the keyboard of Michael Snyder

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Published on The Economic Collapse on December 9, 2014

This is where stock and gas prices are going. To see the panic index, read from right to left.

This is where stock and gas prices are going. To see the panic index, read from left to right

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Not Just Oil: Guess What Happened The Last Time Commodity Prices Crashed Like This?…

Financial Crisis - Public DomainIt isn’t just the price of oil that is collapsing.  The last time commodity prices were this low was during the immediate aftermath of the last financial crisis.  The Bloomberg Commodity Index fell to 110.4571 on Monday – the lowest that it has been since April 2009.  Just like junk bonds, industrial commodities are a very reliable leading indicator.  In other words, prices for industrial commodities usually start to move in a particular direction before the overall economy does.  We witnessed this in the summer of 2008 when a crash in commodity prices preceded the financial crisis in the fall by a couple of months.  And right now, we are witnessing what may be another major collapse in commodity prices.  In recent weeks, the price of copper has declined substantially.  So has the price of iron ore.  So has the price of nickel.  So has the price of aluminum.  You get the idea.  So this isn’t just about oil.  This is a broad-based commodity decline, and if it continues it is really bad news for the U.S. economy.

Of course most Americans would much rather read news stories about Kim Kardashian, but what is happening to the prices of these industrial metals at the moment is actually far more important to their daily lives.  For example, when the price of iron ore goes down that is a strong indication that economic activity is slowing down.  And that is why it is so troubling that the price of iron ore has almost sunk to a five year low.  The following comes from an Australian news source

The price of iron ore has held below $US70 a tonne in overnight trade, leaving its five-year low within reach.

At the end of the latest offshore session, benchmark iron ore for immediate delivery to the port of Tianjin in China was trading at $US69.40 a tonne, down 0.4 per cent from its previous close of $US69.70 a tonne and only 2 per cent above the five-year low of $US68 reached a fortnight ago.

This week’s dip back under $US70 a tonne has followed revised forecasts from JPMorgan that suggest the commodity will average just $US67 a tonne next year, about $US20 below the investment bank’s previous expectation.

Copper is probably an even better economic indicator than iron ore is.  Economists commonly refer to it as “Dr. Copper”, and there is a really good reason for that.  Looking back over history, the price of copper often makes a significant move in one direction or the other before the economy does.  And now that the price of copper just hit the lowest level that we have seen since the last financial crash, alarm bells are going off.  The following comes from an article by CNBC contributor Ron Insana

Copper prices are now below $3 a pound and there’s an expression that “the economy is topped with a copper roof.” More simply put, copper tends to top out in price, before it becomes obvious that, in this case, the global economy is about to weaken.

So is the global economy heading for rough waters?

Could 2015 be a very rough year economically?

According to Insana, the signs are all around us…

We already have evidence that the commodity crash has ominous portents for the rest of the world:

* Japan’s recession is deeper than previously thought.

* China’s demand for basic materials, amid a glut of uneconomic construction projects, appears to be plummeting.

* Russia’s ruble has collapsed and the country is on the brink, if not already in, a recession.

* India’s economic recovery is beginning to look shaky.

* Europe’s growth rate and inflation rate, for the next two years, were just revised downward by the European Central Bank, suggesting that Europe’s economic crisis is far from over. In fact, at least one former European leader with whom I recently spoke, believes the crisis in Europe may just be in its early stages.

* Brazil and other emerging market nations are struggling with a variety of issues, from recessions at home, to the rising value of the dollar, which is complicating how emerging markets conduct economic policies at home, given how closely their currencies are tied to the greenback.

In addition, the Baltic Dry Index is now at the lowest point that we have seen at this time of the year since 2008

Simply put, with collapsing commodity prices (iron ore for instance) and massive fleets of credit-driven mal-investment-based vessels, it should surprise no one that the shipping index just plunged back below 1000, now at its lowest for this time of year since 2008. Furthermore, the seasonal bounce always seen in Q3 was among the weakest ever.

What does all of this mean?

It is commonly said that those that do not learn from history are doomed to repeat it.

So many of the exact same patterns that we witnessed leading up to the financial crash of 2008 are happening again.

Unfortunately, very few people saw the last crash coming, and this next crash will take most Americans by surprise as well.

I have written more than 1,200 articles about the economy on my website since 2009, and right now our financial system is more primed for a crash than at any other time since I started The Economic Collapse Blog.

Hopefully we have at least a couple more months of relative stability, but without a doubt 2015 is shaping up to be the most “interesting” year that we have seen in the financial world in a very long time.

All of the signs are there.  But most people choose to believe that everything is going to be okay somehow.  When the next crash comes, those people are going to be absolutely blindsided by it.

When you see storm clouds on the horizon, the logical thing to do is to prepare.  And the number one thing that most people should be working on is an emergency fund.  So don’t be frittering your money away on frivolous things.  In the early stages of this next crisis, you are going to need money to pay the mortgage, to put food on the table and to take care of your family.

Just remember what happened back in 2008.  A lot of middle class families were living on the financial edge every month, and because they didn’t have any cushion to fall back on, millions of those families ended up losing their homes when their jobs disappeared.

You need to have an emergency fund that can cover at least six months of expenses.  You don’t want a job loss or a major emergency to put you into a situation where your family could be put out into the street.

And for those that still have lots of money invested in the stock market – I really hope that you know what you are doing.

The market giveth, and the market taketh away.

And when the market taketh away, the consequences can often be exceedingly cruel.

Competitive Currency Devaluation & Deflation

logopodcastOff the microphone of RE

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Aired on the Doomstead Diner on November 18, 2014


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Speedy Gonzalo Lira sez, “OOPS! I guess I made a MEEESTAKE!”


…Remember back to 2008-2009 when Hank Paulson pulled out the Bazooka to bail out the TBTF Banks, and then Helicopter Ben Bernake launched the first of his QE ships? Pundits in the Econ Blogosphere went berserk, predicting imminent Hyperinflation of the Dollar. John Williams, Speedy Gonzalo Lira, Mish, you name it they all predicted rampant HI which somehow never arrived here.

Meanwhile in the dark secluded corners of the internet, a few people like Nicole Foss of The Automatic Earth, Steve Ludlum from Economic Undertow and myself all predicted a deflationary event coming down the pipe, at least for the Dollar.

What is the situation today? Deflation is now the word of the day spoken fearfully by Central Bank chieftains, and even notorious Hyperinflation predicting sites like Zero Hedge are on the Deflation Bandwagon…

For the rest, LISTEN TO THE RANT!!!

Ukraine Frenzy and Trapezoid of Doom

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on March 7, 2014

Ukraine hiccups, Russians double down on ‘blunder’, Pot meets Kettle.

Triangle of Doom 030114 copy

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Figure 1; Cost vs. credit using WTI price from Commodity, (click on for big). The premise of the Triangle of Doom is that fuel supply remains both plentiful and affordable until trends collide at the end of this year or beginning of 2015. This is a best-case scenario, with policy makers avoiding errors that damage credit or interfere with world petroleum extraction. Abenomics and the ongoing Russian fiasco in Ukraine look to be fatal errors, the best-case scenario has to be reconsidered, with the triangle morphing into a Trapezoid of Doom with a rapidly-approaching dead end.

Credit and fuel cannot be considered separately, one affects the other. Economic problems tend to be blamed on monetary misadventures, yet our economies run on petroleum … which has become both scarce and increasingly expensive since 2000. Credit is offered as a both a palliative and as a abstract substitute for fuel but it carries its own ballooning costs. Strains ricochet through credit system and emerge unpredictably, panic takes many forms. The obvious strategy is resource conservation yet the establishment holds it in the same regard as child pornography; the conservationist is never invited to the dinner party, doing without is never part of any discussion. Conservation is no fun, it isn’t trendy or chic, it means no shopping which is bad for business … which requires endless streams of capital to annihilate and more tycoons to worship.

The outcome is conservation by other means. The status quo is rotting away in real time right under everyone’s noses, Russian intervention in Ukraine is a small component of a very large and malignant whole. Wasteful business as usual is kaput, it has exhausted itself: capitalistic niceties — its fare-thee-wells and discrete robberies — are swept off the table; in place there is the sending in of the tanks with the refugees clogging the roads cheering.

As the world burns through its affordable fuel supply the credit regime falls apart undone by diminished returns. Our surplus-cost-management economy cannot allocate resources that don’t exist, when confronted by scarcity managers punt. The command economy replaces credit with brute force. This is the process that has slithered out of the shadows in Ukraine; it is also why the West is frantic to put the Russian genie back in the bottle, to cobble together a credit/finance solution to the Ukraine problem.

It is hard to know what to make out of what is underway in Ukraine. Putin has decided to rock the boat and is doing so with vigor. In a tightly coupled world with brittle-fragile credit markets and the Russian dependency on Western credit, it is possible Mr Putin does not understand the risks. On the other hand, being in the energy business, and absent the need to soothe an sugar saturated- over stimulated population of television watchers and cell-phone fingerers, he might realize that the jig is up. He certainly is aware that the West will sacrifice just about anything and anyone to preserve their precious lifestyles, creature comforts, automobiles and the fuel needed to run them.

Then, again, what can Putin win? Russia cannot conquer Ukraine or control it, that is obvious; its first best chance with Yanukovych failed. Putin’s second best chance is to offer Ukrainians a security detail that will not hesitate to shoot Ukrainians. Russian ascendency in Ukraine is a vanishing asset. Aside from its rapidly depleting mineral resources Russia is bankrupt, it cannot afford Ukraine as an imperial bauble any more than could the Soviet Union which could deploy much more massive force, structured around popular ideology … and much more massive natural resources.

Ukraine is the latest American intelligence fiasco; hundreds of billions of dollars have been squandered by agencies that have no clue. The same agencies certainly know in minute, personal detail what animal rights- and anti-fracking activists are up to but are caught out by Ukrainians first and then by the Russians. The US president and the rest of the US establishment are embarrassed even as they refuse to acknowledge it.

The media is a frenzy of conflicting information and inflamed nonsense. There are suggestions on how to torment the Russians as if this is something the US has been specifically entitled by Our Creator to do. What passes of leadership in the US is made up of banker- and auto industry lackeys; it drowns in hypocrisy. Our military has meddled at stupendous cost in the affairs of other countries since the end of World War Two for the benefit of these same industries; the Russians are imitating the US. Perhaps just once the United States should do nothing, not even discuss Russia or Ukraine. The Canadians are doing nothing, the Swiss and the Chinese are doing nothing, not a word comes from Japan. Why not sit back quietly and let Russian ambition dig its own grave?

Some of the intimations of meddling are just dumb; that US funding caused the popular revolution that unstrung Yanukovych, or hired neo-Nazis bent on reviving the Third Reich. Agitators and extremists have had their part, but the ground was- and is fertile for removing Yanukovych who is both a common thief and a pro-Moscow partisan. Neither the US nor the EU paid hundreds of thousands of demonstrators to crowd into Kiev and other Ukrainian cities. Popular revolutions have been underway around the globe since 2008, this has everything to do with the governments’ dwindling ability to provide luxury lifestyles including jobs for their teeming multitudes of educated- and thwarted children. Revolutionary skills require time, practice and opportunity to acquire, the young are learning; now, success. Ukraine’s children have managed at least for a brief interval to free their country from some of its odious tycoons. The youths do not understand at this moment that both the car-waste Western lifestyle and tycoons are unaffordable extravagances but they are learning and as such the children are dangerous. Part of Putin’s violent reaction is the push-back by tycoons and the status quo that supports- and rationalizes them. In this sense, the US- and EU bosses should be supporting Putin and encouraging him to crush Ukraine’s young people! This is class war, as Warren Buffett has insisted, and up to a few weeks ago the Buffett class was winning, now … not so sure!

The neo-Nazis are ascendent across Europe, in the US and elsewhere, certainly in Russia as well. The Nazis are willing to confront the corroded establishment where the rest are content to entertain themselves. Cartoonish and fearsome at the same time; the Nazis have no magic solutions to resource problems, they can no more deliver the American way of (wasteful) life than anyone else. All they can do is preside over decline then absorb their portion of the blame.

Ukraine’s problems are for their own citizens to solve, their first job is to form a new government, one that does not include US- and EU stooges or Goldman-Sachs alumni. Ukraine has been the place where both European and Russian empires have gone to die; no outside help is needed. The US has plenty of its own problems that are desperate for attention and investment including overdue preparations for hard times. Multi-billion dollar loan-slash-aid packages for Ukraine should be directed toward Detroit; it is long past time to make investments in our own for once.

Russia Sector Credit Flows

Figure 2: The Russian economy and finance is basically a money-laundering scheme that directs the returns from energy sales to tycoons. Funds flow from EU and UK banks by way of fuel customers to Gazprom and the Bank of Russia. Some funds are held as currency reserves, the rest flow to tycoons’ overseas accounts where they are used to purchase luxury real estate, yachts, artworks, gold and other easily exchangeable goods … The Bank of Russia uses overseas currency-in hand as collateral to refund roubles to commercial banks; these are distributed into the Russian economy. See ‘Debtonomics; Currency Crisis’ for an explanation of how the process works.

Russia lacks the ability to produce needed organic credit, it lacks infrastructure including strong banks, a freely tradeable currency, goodwill and the rule of law; instead there are weak banks, a rouble that circulates little outside of Russia, absence of trust and arbitrary rule by Putin. Because Russian credit is no good it requires external credit. Russia relies on the provision of European lenders acting indirectly through Russia’s overseas energy customers. Russia cannot support its own industry, which like industry everywhere, requires constant credit subsidy to function. A constant flow of new funds from overseas is necessary as the leakage to tycoon safe-havens is a collateral drain with an accompanying reduction in rouble purchasing power. If Russia holds onto its collateral the tycoons are starved of funds. The alternative is for the Bank of Russia to make unsecured loans in an attempt to ‘make good its purchasing power losses with volume’. The outcome is the vanishing lender of last resort and bank runs.

Unsecured rouble lending by Bank of Russia is indicated by red-outlined arrow. Russian banks are unable to distribute their own losses into the Russian economy, attempts to force such losses results is a vicious cycle- black market currency arbitrage and hyperinflation as in Argentina, Venezuela, Belarus, Iran and previously in Russia, itself. Citizens and speculators use whatever local currency they can get their hands on to ‘purchase’ the desired hard currency heedless of the affect on the exchange/inflation rate as indicated by the black-outlined arrow.

It is possible Russian foolishness will by itself trigger the exact crisis the Russians are desperate to avoid. Events that signal major economic turning points can be hard to identify as they occur, the background accompaniment tends to be rising interest rates:

On September 20, one day after a new high in the New York market (1929) — one which proved to be the interwar peak on the New York Times Index — the occasion presented itself. The Hatry empire collapsed in London. This was a series of companies, investment trusts and operating units with interests in photographic supplies, cameras, slot machines and small-loan companies, controlled by one Clarence Hatry. Caught up in the speculative fever, Hatry was having difficulty borrowing £8 million to buy United Steel and use it as a base for a wider coup in British steel. He tried to use fraudulent collateral from his various companies, was caught out and went into bankruptcy. Stock exchange dealings in the Hatry securities were suspended and the financier and several of his associates arrested. In the un-settlement, the bank of England rate was raised from 5.5- to 6.5 percent on September 26.

Apart from the Frankfurt Insurance Company in August and unlike other crashes, it was the only warning …

— Charles P Kindleberger, “The World in Depression, 1929-1939″

Putin looks to be the 21st century’s Clarence Hatry, whether the world or Russia can cope or not remains to be seen. Like Hatry, Putin has built a creaky empire out of a series of companies, investment trusts and operating units with interests in energy resources, pipelines, military hardware and ankle-breaking loan companies. Right now finance markets are pretending that nothing untoward has occurred. Then again:

It’s nerve-wracking to live in the historical moment of an epic turning point, especially when the great groaning garbage barge of late industrial civilization doesn’t turn quickly where you know it must, and you are left feeling naked and ashamed with your dark worldview, your careful preparations for a difficult future, and your scornful or tittering relatives reminding you each day what a ninny you are to worry about the tendings of events.

Persevere. There are worse things in this life than not being right exactly on schedule.

James Howard Kunstler

Ukraine looks to reduce its dependency on Russia by signing an agreement with Chevron to develop its oil and gas. The company will likely sell any Ukrainian gas it produces as quickly as possible leaving the country with the empty bag. There may also be gas reserves offshore but Ukraine needs a real government and Russia needs to grow up and act like adult. If Ukrainians used gas for heating and domestic, it would last a long time. Selling to Japan or UK for electric generation; not more than a couple of years..

Ukraine needs a plan how to make the fuel supply last: they need an ‘energy policy’. It is difficult to imagine anyone in charge in any country has heard of such a thing. They also need time and breathing space to implement it. Ukraine has been able to survive since the fall of the USSR by playing European and Russian insecurities against each other, by threatening the one side with political and economic alignment with the other so as to gain funds from both. It was the latest such maneuver that blew up so spectacularly in Yanukovych’s face. Poor Ukraine, it is too far from God and too close to Russia, too close to the European Union, the IMF and the European Central Bank. Any funds from the West will arrive with strings like spiders’ threads that the Ukrainians will find difficult- or impossible to unravel. Ukraine’s interim prime minister is the country’s ex-central banker. It relies on the handful of tycoons remaining in the country for political leverage. Every Ukrainian knows the proceeds of every Russian loan ends up in the pockets of oligarchs, the country’s assets are held as collateral, they ultimately fall to Gazprom and Russia or to European companies. In the meantime the world holds its breath …


Off the keyboard of John Ward

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Published on The Slog on January 13, 2014


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econcartCROPThe distance from now to the inevitable is, by definition, finite

Tell me, have you ever read 2000-2013 The Corporate Issuance Global Frenzy: what role for US Quantitative Easing? by Marco LoDuca of the European Central Bank et al?

G’wan…bet you haven’t. I have, and now my brain hurts. Simplistic is bad, but simple is good. Impenetrable is worthy, but clarity and vision are worth more.

Four years ago, I asked two questions about the arrival of QE and Zirp into our linguistic lexicon. One, what will you do if QE doesn’t work? And two, why will Zirp help recovery, when the biggest single demographic group with the lowest overheads needs Zirp + 4% to keep spending?

They were both naive questions – I know that now. When the first two bouts of QE didn’t work, I took out Bear Notes, on the wild and crazy assumption that Ben and Merv must change tack. They didn’t, and I saw a third of my investment capital  wiped out. And of course, without Zirp most of Wall Street would’ve gone bankrupt, followed in fairly short order by the US Government and the United Kingdom. I did a quick sum and worked out that if rates were at 4% for 3 years, for example, by 2015 $2.30 in every $5 would be going on just managing US Sovereign interest.

Anyway, 2014 has dawned, and here we are with the same crazy people saying “one more heave” for both stimulation and austerity at the same time. Here we are with Greece, Spain and Italy on the edge of default – and debt bonds from these countries flying off the shelf. Here we are with Zirp having saved nobody really, and the tapering of QE about to start a little bit and if anything goes wrong well, it won’t hahahahaha. And above all, here we are talking about interest rates as if these Masters of the Universe could forbid them to rise, ever.

In that context, 2000-2013 The Corporate Issuance Global Frenzy: what role for US Quantitative Easing? by Marco LoDuca of the European Central Bank et al doesn’t exactly hum with relevance. There are many who will be glad about this, but my point is based on reality rather than long equations: there is no point in doing learned studies based on the logic of madness unless you are a CBT counsellor or psychiatrist.

This is where we are, actually, now, on Planet Earth:

1. The Americans, Brits, Eurozoners. Japanese and Chinese are all emitting drivel, spin and desperately clutched, atypical statistics to tell us the recovery is under way. It isn’t. QE has failed, and the response of the authorities is now that of managing crack addict withdrawal rather than getting a better policy.

2. Printing money to purchase poo simply gives the central banks a very big and wide poo-based balance sheet, while starting out on the fast lane to inflation.

3. Interest rates must and will rise, because market pressures on gold, commodities, bonds and a hundred other formerly good investment areas have gone, and the smart money knows that the Bourses have had their day in the sun: it’s about to start drizzling.

4. When they rise, money will have to be printed to manage debt owed by the debtor countries. This will result in the fast-lane inflation vehicle sprouting James Bond wings and zooming up into hyperinflation. Don’t even think about what that will do to the markets.

5. Neoliberal economics demands consumption 24/7/365. Sadly, they also demand a 30% reduction in mass consumer spending power. And guess what – inflation will merely exacerbate that. This is a circle that simply cannot be squared. It’s the flaw in the theory, the ghost in the machine, the Mammoth in the downstairs lavatory.

Those five factors demand a crash. They don’t point to it, or suggest it, or even persuasively propose it: they demand it. Flatlining consumption will meet tentatively tapered easing, skid into a bond balloon, and bounce over the central reservation where it will hit rising debt costs towing hyperinflation. In the raging inferno that follows, the stock market will be burned to a crisp.

I have no idea any more how long the boys in the the bubble can keep up the denial. Japan’s road looks pretty short to me, and Germany’s austerity shtick will hit the buffers once the directionalising debt money pulls out of ClubMed. The bank bailin surrealism will not get past the first French bank that tries it on, and that in turn will make France’s real situation obvious. Britain’s Chancellor George Osborne has a carpet-bag like a tardis: I’m constantly amazed by the consistently superficial credibility of the cons he pulls off. And in theory, until the tipping point, the States could keep pumping smoke into the Hall of Mirrors almost indefinitely.

But in time, “almost” will be passed, and then Janet Yellen will be heading like Speedy Gonzales for the downstairs loo. In there she’ll find a hairy mammoth saying “I was here first”.

Enjoy the week.

Paradox of Grift

Off the keyboard of Steve from Virginia

Published on Economic Undertow on August 24, 2013


Discuss this article at the Economics Table inside the Diner

Labor Force Participation 081813


The hissing sound being heard in the background in countries such as India and Indonesia is the air leaking out of the latest in the long line of speculative gambling ventures cooked up by Wall Street buccaneers and their public-sector valets … ventures that make up what remains of our economy these days. Since the Great Finance Collapse in 2008, billions in cheap dollar loans have been flowing overseas looking for quick killings to be made by creating — then selling — ‘assets’ to greater fools. As long as there is a generalized increase in the flows of credit, there are more- and greater fools to be had. Once credit flows diminish, the fool supply is exhausted; there is nothing to support the inflated asset prices. Soon enough, ‘hot’ dollars exit and the first tier fools cash out; this is the dreaded Minsky Moment, when the credit scaffold that supports the speculation empire collapses under its own weight.

Panic is being felt right now by those within emerging markets that heretofore have felt themselves immune to such things. Like Americans and Europeans before them, the hopeful moderns in Asia, Africa and Latin America believe ‘It’s different this time’ … that the winds of history are at their backs because once-upon-a-time the winds were at the Americans’ backs; that progress is a certainty, that it can be conjured or brought forth by way of modernist fetishes … stock-and bond casinos; gigantic ‘glitzy’ concrete high rises and shopping malls, jet vacations and luxury performance sedans; five-star resorts and 18-hole PGA Championship golf courses … the Las Vegas-style excrescences that decorate modernity like pigeon feces. When it becomes clear to the marginal market participant that the fetishes are just that … empty and possessing of no virtue or anything else in and of themselves … there are runs!

The runs are reflexive and pointless; ultimately self-defeating … there is nowhere to run to. There is no alternate universe of functioning modernist symbols; there is even less functioning that is non-modern! There is only universal ‘worth-iness’; like truthiness, a hollowed out version of the real thing. We are living the ‘Paradox of Grift’: as the impulse to steal increases … the worth of what is stolen or steal-able evaporates … (FT);


Emerging markets endure wild roller coaster rideThursday was another day of turmoil for emerging markets.

Unimpressed by the Turkish central bank’s recent efforts to support its currency, investors sent the lira down to a record low against the US dollar; India’s rupee fell to its lowest-ever level; Indonesia’s rupiah dropped to the weakest since 2009.

As if that were not enough, Malaysia’s ringgit and Thailand’s baht ended the day in a three-year trough.


‘Unimpressed by central banks’ efforts’? The central banks enable the background conditions for the runs in the first place! Their ‘no questions asked’ loans are a form of limitless moral hazard: no lender will be allowed to lose money regardless how how stupid, venal or corrupt their business. Central banks misprice risk by over-paying for bonds which are lenders’ IOUs. By doing so they bid others out of the marketplace. The result is repressed interest rates. Risk is a product of the false-pricing process itself … particularly that relating to the business of the stupid, venal and corrupt.

Put another way, the recent rise in interest rates and decline in many currencies is commonly held to be the result of Federal Reserve ‘taper’ or promised future reduction of monetary stimulus. This is backwards: interest rates are rising and currencies depreciated as the consequence of five years of ‘temporary’ easing; tapering is not an alternative but the conclusion of the short-term lending cycle that began in 2008.

Central bank lending will decrease if for no other reason than the ongoing exhaustion of the supply of good collateral. The central bankers have been strip-mining good collateral from the private sector. When it is gone what remains is bad collateral and grave danger for central banks which risk becoming indistinguishable from their commercial lender clients … insolvent.

Reality is revealed as is the sun from behind a cloud; revelation is underway right now within emerging markets. At some point the central banks’ actions are measured against outcomes. Easing has been underway for five years. Where is the beef? This sort of examination is fatal to speculation which requires increasing hordes of credulous fools eager to borrow and lose, returning to borrow again and again. Reality emerges => fools are unmasked => central bankers ‘lose control’ of the processes they have been entrusted to properly manage, (WSJ);


Ten-Year Treasury Yield Nears 3%Treasury bonds took a beating for a second consecutive session, sending the benchmark 10-year note’s yield to a two-year high.


Most of this movement in price has occurred since May … this is another run!


The yield is nearing the 3% mark, a level the market last traded at back in July 2011. Bond prices fall when their yields rise.Better-than-forecast manufacturing reports from China and the euro zone drove cash out of safe-haven bonds and into stocks. Persistent anxiety over a shift in the Federal Reserve’s easy-money stimulus continued to push investors to lighten up on bond holdings.


When a central bank loses control, there is nothing that can be done on the monetary front when the need arises other than to wring hands and weep; there is effectively no lender of last resort. This might seem to be a small matter in abstract … but imagine the outcome in 2008 if the Federal Reserve and the European- and UK central banks had been ineffective or their programs ignored by the market participants. Stock markets would have collapsed entirely and the banks shuttered … as occurred in the United States during 1932- and 1933.

Because the central banks cannot create ‘new money’ (they are collateral constrained), because the central banks cannot create natural resources or real capital, because central banks cannot determine by command the money-cost-of-money … which is set at gas stations around the world by motorists buying fuel with money millions of times per day … the banks’ reach is limited. At the same time, they are integral to the operation of the credit system itself and the stability of all the different kinds of credit-derivatives markets: they are ‘Schrödinger’s banks’; important and useless at the same time.

Both industrial firms and sovereigns are credit dependencies. Industrial economies monetize resource capital destruction; commercial banks finance finance the process. Central banks stand behind commercial lenders with reserves. This position within the credit system is what makes central banks vital. At the same time, the banks overreach. The credit system is more than a few central banks propping up commercial lending zombies and lending back and forth to each other plus their governments. Central banks are designed to be lenders of last resort. When they become lenders of first resort and sole credit providers, there is effectively no credit at all. This is the point that is approaching right now.

The central banks are painted into a corner of their own making. If they offer unsecured loans hoping to generate waste-based ‘growth’ they become insolvent which kills what they attempt to create. Not making the loans removes fuel required by speculators, which also kills growth! Making loans that distort interest rate mechanism ‘poisons the well’ and interest rates increase … which kills growth. Likewise, not making the loans results in exactly the same thing. Over the longer-term, the banks cannot win: all roads lead not to Rome but toward rising interest rates, non-growth, insolvency and credit collapse.

According to the analysts, the bottom is dropping out of the Treasury market because of ‘good news’ in China and the eurozone. The fool supply diminution is made out to be something other than what it is; a bit like fracking: tens of thousands of holes are drilled into the ground so that the fools might dribble out …

A very bad man, indeed. There is in fact no end to them. The world is submerged under their mountainous claims. The costs associated with this ‘claims-surplus’ are far greater than any possible gain from it … indeed, more than what the claims are worth:
TCMDO 122612
Here is the ‘Paradox of Grift’ in a chart: total US credit market debt in billions of dollars. This debt = assets of the rich, their intent is to compel the non-rich to repay the debts with their labor. The ambition to steal everything outruns itself as debts in question are unmanageably enormous. They cannot be retired by anyone or anything and are therefore worthless.

A large percentage of this total is compounded debt service costs which by themselves increase exponentially. If the mean rate of interest on this debt is 4%, annual debt service costs for our credit market debt is greater than US$2 trillion. This is the bankers’ ‘cut’, no wonder they are well-dressed.

Meanwhile, a look at commodities’ prices suggests — as does interest rate panic — that $110 crude is the ‘new $147 crude’, (Bloomberg):


Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 106.42 +1.39 +1.32% Oct 13
Crude Oil (Brent) USD/bbl. 111.04 +1.14 +1.04% Oct 13
RBOB Gasoline USd/gal. 300.72 +4.24 +1.43% Sep 13
NYMEX Natural Gas USD/MMBtu 3.49 -0.06 -1.69% Sep 13


Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,395.80 +25.00 +1.82% Dec 13
Gold Spot USD/t oz. 1,397.73 +21.59 +1.57% N/A
COMEX Silver USD/t oz. 23.78 +0.70 +3.04% Dec 13
COMEX Copper USd/lb. 335.60 +2.15 +0.64% Dec 13
Platinum Spot USD/t oz. 1,541.13 +0.88 +0.06% N/A


Graph by Bloomberg. Relentlessly rising fuel prices tax funds away from consumption economies toward oil drillers even as the flow of funds to drillers returns diminished increments of crude. Each dollar spent to gain crude today returns less crude than yesterday … just as every dollar spent by drillers tomorrow will return less crude than today. The waste of 90+ million barrels of crude- and crude like substances every single day year after year has consequences: none of those barrels will ever be retrieved except in forms toxic to our grandchildren.

Underway around the world right now … is the very predictable outcome of conventional monetary- and economic policies. Governments and central banks succeeded in stimulating resource waste-capital destruction for a few short years under circumstances that did not — and will not in the future — favor it. In a sense, policy in the present has been the extension of Reaganism and reaction against the message borne by the oil shortages of the early 1970s: ‘pedal to the metal’ unrestrained exploitation of all resources including credit … and hoping for the happy ending because we’re Americans and we deserve it!

The result is a witches’ cauldron of misanthropic so-called ‘policies’: the liberalized bourgeois world with Adolph Hitler’s Boy’s Town fashion sensibilities, Sarah Palin’s “Drill, Baby, drill” energy policy, Joseph Stalin’s and Joe McCarthy’s reactionary paranoia … General Motors’ ‘Good for America’ waste and Madison Avenue ‘Mad Men’ rationalizing all of the above. Soon enough we are set to learn in real time that all of the above is a hoax; an empty bag. In the end nobody can fool Mother Nature, that claims against the human race are not found within the credit ledger but instead within the solar budget that we balance or else.

… or else … (Finger cutting gesture across throat.)

Tapir Talk

Off the keyboard of Steve from Virginia

Published on Economic Undertow on June 20, 2013


Discuss this article at the Epicurean Delights Smorgasbord inside the Diner

Take away moral hazard courtesy of the central bank and what do you have?

Reality bludgeoning the markets, that’s what, (Bloomberg):


Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 95.45 -2.79 -2.84% Jul 13
Crude Oil (Brent) USD/bbl. 102.88 -3.24 -3.05% Aug 13
RBOB Gasoline USd/gal. 279.98 -7.92 -2.75% Jul 13
NYMEX Natural Gas USD/MMBtu 3.88 -0.08 -2.07% Jul 13
NYMEX Heating Oil USd/gal. 288.63 -8.62 -2.90% Jul 13


Precious and Industrial Metals

Commodity Units Price Change % Change Contract
COMEX Gold USD/t oz. 1,288.80 -85.20 -6.20% Aug 13
Gold Spot USD/t oz. 1,290.24 -61.07 -4.52% N/A
COMEX Silver USD/t oz. 19.75 -1.88 -8.69% Jul 13
COMEX Copper USd/lb. 306.70 -8.45 -2.68% Sep 13
Platinum Spot USD/t oz. 1,367.68 -47.43 -3.36% N/A


Crude oil, gold, silver … are crushed. So are stocks on all the major indices around the world. Wall Street banks and players can finance their own positions needing no help from the central bank; they do require reassurance that the Fed will direct public funds — borrowed from the same banks at interest — toward them if any of their bets go wrong.


Stocks Slammed, Bond Yields Surge After Bernanke’s Taper Talk Wall Street was a sea of red Thursday morning, on the heels of Federal Reserve Chairman Ben Bernanke’s signal that the central bank’s asset purchase program will slow down as soon as late 2013.

Bernanke was sure to qualify his remarks at Wednesday’s press conference, comparing a tapering of asset purchases to taking his foot off the accelerator, but the initial market reaction indicates traders view the Fed chief’s remarks as a warning that the brakes are coming.

The selloff, which began in the U.S. Wednesday afternoon before racing around the world, produced heavy losses in every asset class. Equities took a beating .Japan’s Nikkei dropped nearly 2% and the major European indexes fell even further, while the S&P 500 began the day with losses worse than 1%, falling 18 points to 1,611 in the first hour of trading.

Commodities took a beating, as crude oil dropped almost 3% to $95.75 a barrel and gold prices plunged nearly 5.5% to less than $1,300 an ounce.

The dollar was one of the few assets in positive territory, rising about 1% the euro and even more than that versus the Japanese yen.


Notice that the dollar worth increases relative to that of other assets. Notice also that Treasury bond yields have increased, this suggests there is more to the ‘crisis du jour’ than fiddling with interest rates. There is the dawning realization that central banks have exhausted themselves, that they have little in the way of policy instruments that would effect a major decline, that there are diminished returns to their reflation efforts.

Realization = decline. The markets are like a magical airplane that stays in the air only because all the passengers believe at once that the plane can fly. As soon as the marginal passenger doubts … the airplane falls … so do the markets.

Be sure that higher interest rates are on their way. The feedback loop that effects rates is within the foreign exchange or currency markets, NOT the bond markets. The currency markets are gigantic and outside the reach of central bankers … and their nonstop efforts at manipulation. There is a sorting out- or consolidation of currencies underway, particularly the euro and the Japanese yen: these are currencies that are overpriced leaving holders with massive risks that must somehow be offloaded onto hapless third parties; pensioners, school-children, farmers in third-world countries and the middle classes everywhere.

The euro is effectively worthless because of associated political and management failures within the European Union. Seeing the effects of currency policy on Spain, Greece, Cyprus and others, the euro is revealed as a poisonous liability for its holders, a derivative instrument for a cruel and unaccountable non-country. In a world guided by reason, the euro would be done away with, it would be worth exactly zero, yet it is not. The euro is exchangeable on demand for petroleum, this gives the euro worth.

The Japanese yen is also worth less as it is nothing but a proxy for Japan’s now-stranded automobile waste, both in- and outside that country. The currency exchanges cannot accurately measure the worth of these two currencies; at the same time holders have little choice but to shed their positions, to do otherwise is to caught out when the markets reset. Exiting a position is the repricing mechanism, the process feeds on itself. What is underway in the various sub- and derivative markets is the outcome of large currency position unwinds and the hunt for market fools large enough to relieve the Chinese’ and others’ currency risks.

Currency markets drive the national bond markets as holders of currencies do not hold paper money in vaults but debt instruments or IOUs of sovereign governments. Bonds must be swapped or sold first to gain the currency which is then swapped for the desired dollars. Mercantile exporters such as Japan have massive, illiquid holdings of their customers’ bonds; there is consequently a shortage of currency in circulation which is why the Shanghai Interbank Overnight Rate(s) are massively volatile as is the Japanese bond market.
Tapir 1
Figure 1: Tapir or Tapirus Indicus, hard to see how this harmless, pig-like creature could do so much damage to the finance industry. As mentioned previously, conventional analysis such as Forbes’ beating on the Tapir is misplaced. The focus should be on Japan’s trade deficit, China’s real estate- and debt excesses, Europe’s failed supra-national experiment and America’s creeping totalitarianism. Market repression has been able to keep the related costs from being priced into these countries’ securities but such efforts cannot succeed forever.

Hedge fund boss Kyle Bass does a good impersonation of Nicole Foss, leaving out her bits about farming and Peak Oil. Because Bass manages billions of dollars of other peoples’ money, he is free to speak by the necessities of his business regardless of consequences … and his argument is taken seriously.

In early-21st century America, as in other periods and other places, the content of an argument doesn’t matter so much as the size of the arguer’s bank account and whether the topic can hold the hope for some free money for suckers.

All the crises are interconnected and basically all about the same thing: fuel has become scarce, it has become costly, too costly for ‘others’ to subsidize, the managers desperately try to cheat and then fail, the failure is now becoming apparent and now the speculators are stumbling toward the exits so that they might keep what they can.

Foss offers suggestions to the non-investor on how to withdraw outside the line of financial fire, to exit the Titanic before it hits the ice. Bass looks to profit by the misery of others, to rent seats in the lifeboat; the seats gained from bankers and other finance riff-raff, in reality pensioners and institutional stand-ins for ordinary citizens — widows and orphans — will be the victims suckers as they have since the beginning of time.

Bass is trapped in his own paradigm: when Japan’s calamity occurs, one of the casualties will be Bass, himself. His firm is dependent upon counterparties being willing or able to make good losing wagers, for there to be anything left of the market fools … from which to collect.

It is hard to see those counterparties staying alive with fortunes intact when they themselves must collect from their own failed counterparties. Bass runs a hedge, his hedge is dependent upon all the hedges, all others are hedged against each other; in the very real sense nobody is hedged at all. Here is the reason for the frantic effort over the past five years to prop up every single ‘systemically significant’ finance player on Planet Earth: every one is a counterparty to all the others. The casino which makes up finance is nothing other than trillions of stupid bets, every one made for their own sake, none of which was ever intended to be collected. Because this is so, there is naught but fees demanded by the brokers putting the gamblers — like Bass and his counterparties — together.

The institutional bias fails Bass, what he does not- and cannot understand. The correct strategy is Nicole’s; to stand aside as far as possible from the fracas which is enveloping the entire developed world, to not bet on particular sides because all sides will fail. Bass succeeded in 2008 by taking the opposite side of clearly stupid trades by large banks. The banks sustained losses — which were gains for Bass and his clients — because they were backstopped by the taxpayers’ ability to borrow from the very same banks. The crisis in 2008 illuminated the incestuous circularity of both the lending process and the dependence of each borrower on all the others. When the system Bass depends upon falters, there is no other (ex-planetary) system to bail Bass out!

… or any of the rest of us.

Japan depends its non-Japanese overseas trading partners to subsidize the country’s resource waste by way of its trade surplus. That is, Japan gains more from the goods it sells overseas than what the customer gains from the use of the goods. At some point the customer is exhausted by its ‘Made in Japan’ goods and cannot afford to buy any more. Put another way, Japan has borrowed as much as it possibly can against the accounts of its customers by way of foreign exchange. The customers refuse or are unable to borrow, that strands Japan, (Bloomberg):


L.A. Breaks Driving Addiction as Bike-Train Commutes GrowJames Nash

Bikes, Buses Replacing Car Addiction in L.A.

Los Angeles embodied America’s love affair with the automobile in the last century. In this one it’s trying to kick the car to the curb.

The city that put drive-thru restaurants on the map has doubled its network of bike lanes to 292 miles (470 kilometers) and expanded light rail by 26 percent in the past eight years, with another 18 miles of track coming by 2015. Bus and train ridership is on the rise, while the total number of passenger cars registered has declined in Los Angeles County — evidence more commuters are breaking their dependence.

Shrinking Allegiance

“The next 10 years will be as important to the auto industry and transportation literally as the invention of the Model T,” Scott Griffith, former chief executive officer of Zipcar and a strategic adviser to the company, said at the Bloomberg Link Next Big Thing Summit in Half Moon Bay, California, on June 17. “We’re now on the edge of all these new business models coming along and the intersection of information and the car and transportation. If you look out 10 years, I think we’re going to see a huge change, particularly in cities.”

While the new-car market has rebounded from the recession, Los Angeles County had 28,000 fewer passenger cars registered in 2012 than five years earlier, according to California Department of Motor Vehicles data. Boardings on the Los Angeles County Metropolitan Transportation Authority’s buses and trains increased 4.7 percent to 41.3 million in May 2013, compared with May 2011.


It isn’t just California, car sales are declining along with stocks and commodities. Taking away the cars punishes Japan while adding more makes matters worse as the fuel burned in the new cars is lost forever. At the same time, the economies of the world are dependent upon more car sales. This is the dilemma that is being resolved right now, to car or not to car …

that is indeed the question.

Buy the Rumour…

Off the keyboard of Steve from Virginia

Published on Economic Undertow on June 3, 2013


Discuss this article at the Epicurean Delights Smorgasbord inside the Diner

Old Wall Street proverb says, “Buy the rumor, sell the fact”. Once upon a time, Wall Street was a real market, the idea back then was for traders to get a jump on the crowd. Smart money anticipates moves, the rest of the market reacts after moves occur. Smart money wins, the dumb money winds up with less, they are the lewzers …

It looks like the smart crude oil money is heading for the exits:

Energy Commodity Futures

Commodity Units Price Change % Change Contract
Crude Oil (WTI) USD/bbl. 91.97 -1.64 -1.75% Jul 13
Crude Oil (Brent) USD/bbl. 100.39 -1.80 -1.76% Jul 13
RBOB Gasoline USd/gal. 277.89 -3.36 -1.19% Jul 13
NYMEX Natural Gas USD/MMBtu 3.98 -0.04 -0.97% Jul 13

Keep in mind, futures’ prices are benchmarks that do not reflect prices in cash- or over the counter markets.

World crude prices @ $100 per barrel or below are dangerous because so much of the revolutionary new forms of ‘crude oil’ are costly to bring to market.
Marginal Oil Cost 060113

Figure 1: Marginal cost of a barrel of crude oil from David Murphy (The Oil Drum) in late 2010. Marginal production costs relentlessly increase, they are much higher now. US conventional crude returns a profit to the producers at current WTI price but profits shrink with price declines. Enough declines and there are no profits — and less crude.

The marginal price is one where the customer decides that extra barrel is not worth it. Customer choice being what it is, the price of the sainted marginal barrel becomes the price for all the other barrels. What is magic about the entire process is that any garden-variety barrel of oil in any part of the world can become the marginal barrel. If marginal barrel is low-cost, the high-cost varieties are left out in the cold.

This is okay if there are a bazillion barrels of low cost crude ready to sell, not okay when low cost supplies are being continually depleted and are largely gone. When the $100 dollar crude is out of reach, there is nothing cheaper to replace it.

When the little man in the TV talks about frakking and ‘revolutions’ he’s lying. What he leaves out is that the customers are flat broke and cannot afford to buy fuel, nor can they afford to borrow. ‘Broke’ is why oil prices are declining, not an excess of supply.

As with most other aspects of our ‘Economy of Stupid’ we have painted ourselves into a corner of our own making. We need continual monetary easing from central banks to bail out finance, yet the costs of easing to everyone besides finance are unbearable. We need finance because the precious industries we have invested so much in the way of resources and prestige over the past decades cannot pay their own way; without finance, there is no industry. We need government borrowing to service finance’s debts even as the borrowing itself increases the dead-weight burden of those same debts. We need high crude prices to meet the costs providing new energy sources but the required prices are bankrupting us.

We’re stuck … everything we try to keep the status quo intact makes everything worse. We need to back out of the box(es) we’ve wedged ourselves into but we refuse to even consider it. We keep believing that tomorrow Santa Claus will arrive with the elf-magic needed to rescue us from our own follies. We cram ourselves more tightly into the corners, inch further into the rat holes, creep closer to the abysses … we are at the point where we have run out of room …

Rumor has it, the smart money has shorted Santa Claus …

Note the inflated returns to many of the low-cost producers. The high marginal cost is a perverse incentive for the low-cost producers to exhaust their petroleum capital as rapidly as possible, to trade it for empty promises of future ‘prosperity’. The greater returns allow producers to load up on luxury autos, strip malls, high-rises, fashionable-but-money-losing ‘development’ projects, military hardware and other forms of resource waste. This in turn adds more incentives for the producers to exhaust their capital even faster and more completely.

The conventional economic assumption has been that crude oil customers products are unaffected by price increases; that the economy will run in the background as usual regardless of input cost. Taken a step further, this ‘price signal’ is offered as a component of the economy’s ordinary function; the higher price is incentive to increase supply. This assumption is false for two reasons:

The first is that using more costly fuel does not produce any more goods or services than using the cheap stuff. Goods and services matter; our economies are much more than pumping oil. When crude prices increase, there is demand for additional credit. Because there is no increase in real goods to swap for fuel, customers can only meet the higher price by borrowing more. The outcome is rationing fuel by borrowing until credit itself becomes too costly, after which point there are physical shortages of fuel.

The second is that cost- or money-return does not effect geology. High-priced technology cannot magically produce oil or any other resource where it does not exist. The roughly 10x increase in crude market price from $11 per barrel in 1998 to $104 now has not resulted in 10x increase in crude production. The rate of crude extraction has remained at more or less the same level since 2005.
Marginal Oil Cost 041813

Figure 2: Oil company costs from Goldman-Sachs, (click on for big): today’s crude producers are tomorrow’s gold miners, trapped by high costs. When the marginal drillers fail, the failure effects all the other actors within the space … who require credit to meet their own costs. Major international companies and national producers have greater borrowing capacity than the marginal producers but such capacity is not infinite. Worst case scenario is that drillers become wholly-subsidized wards of the various sovereigns within command economies but that lasts only as long as the sovereigns themselves are credible borrowers. When the sovereign is borrowing from itself it cannot subsidize anything.

With depletion, the fuel price continues to increase relative to all other prices: this is the ‘real’ fuel price. Fuel is embedded in all goods and services; energy costs across the product spectrum are cumulative. When nominal fuel prices increase customers cannot keep up, when the nominal fuel price declines, the ability of customers to meet that price declines faster. The process feeds on itself as energy deflation, similar to Irving Fisher’s debt deflation. There is no possible way to win.
Triangle of Doom 060213
Figure 3: The crude oil dilemma in one chart: Continuously increasing nominal prices are needed by drillers to bring new crude to the marketplace. (Click on for big): Chris Nelder:


The advent of tight oil in the U.S. has been hailed as the beginning of our incipient energy independence, although I have found no basis for such optimism in the data. In fact, this is the third or fourth time we have been treated to such cornucopian stories. A few years ago it was biofuels that would save us from peak oil, and before that it was natural gas liquids, deepwater oil, heavy oil, tar sands and coal-to-liquids. One need look back no farther than 2005 to find plenty of pollyannish projections in reports from the EIA and IEA, and in op-eds in the Wall Street Journal. None of those projections panned out.The argument was that high oil prices would make these previously-uneconomic resources viable, and to a limited extent that has been true. What we didn’t know then, however, was the pain tolerance limit of consumers. In 2008 we found that limit as we approached $120 a barrel for oil and $4 a gallon for gasoline. Prices are once again beginning to kill demand in the U.S., but under a slightly lower ceiling, because the economy isn’t nearly as strong as it was in the first half of 2008. Now the ceiling is closer to $100 a barrel.


The pain tolerance was assumed, anyone with basic observational skills could see the massive investment in consumption infrastructure would never provide any return at all with crude priced above $20 per barrel. At the higher current price, the burdens on credit providers — and borrowers — are crushing.

From $147, crude at the current price is expensive enough to destroy economies. Soon enough, $90 crude will be doing the dirty deeds: China’s economy slinks off to die in agony as per to its own PMI report. Overseas customers enduring depressions cannot afford to buy Chinese exports which in turn effects Chinese consumption, (Radio Free Asia):


After years of great gains, the slowdown of the country’s economic expansion has taken a toll on oil demand growth. In March, China’s apparent oil demand rose only 1.9 percent from a year earlier and fell 4.2 percent from February to 9.7 million barrels per day, Platts energy news service said. Oil imports in the first quarter dropped 2.3 percent to 5.6 million barrels per day, according to General Administration of Customs data.The oil figures are the latest in a string of energy results that reflect economic cooling with official growth for the first quarter of 7.7 percent. Herberg said weakness in demand for oil, coal and power is a sign that heavy industry has been hit by the economic slowdown.


Like the rest, the China establishment lies about its economy, the fact of the lie speaks for itself. Meanwhile, Japan is blowing up …
Japan Trade Balance 060313
Figure 4: From Kyle Bass & above by way of Mauldin-Grant Williams: Japan’s trade surplus is gone; the swan song of Japanese exporters and the end of overseas’ subsidies for Japan’s own wasteful consumption. Mercantilism is nothing more than beggaring one’s neighbors by offering junk in exchange for value. Japan’s trading partners are broke, they cannot support themselves, they certainly cannot subsidize Japan any longer. The partners are broke because Japan never offered products that preserved the trading partners’ capital, only products that destroyed it.

Japan prolongs the agony by attempting to borrow from itself hoping nobody notices.

Robert Rapier, (The Oil Drum):


A question I frequently encounter is, “How high could gasoline prices ultimately rise in the U.S.?” Because the oil markets are global, the answer to that question is, “It depends on how much value people in developing countries place on increasing their oil consumption to two or three barrels of oil per year.” Or, an alternative way to think about it is, “If you were only allocated 3 barrels of oil per person per year, how much would you be willing to pay for those barrels?” The 20th barrel the average person in the U.S. consumes each year might allow us to drive that 12,000th mile. But the first barrel that someone in a developing country consumes might allow them to drive that very first mile and have heat in their home for the first time. They will be willing to pay a lot more for those initial barrels than we are for our excess barrels, and this explains why their consumption has increased even as oil prices have risen.

And if future oil prices are dictated by how much developing countries are willing to pay for their second or third barrel of oil per capita, this number may ultimately be much higher than $100 per barrel. This is a major reason that I don’t ever foresee a sustained return to cheap oil. There are many who have placed most of the blame for increased oil prices on speculation, but the thirst for oil in developing reasons means that there are fundamental issues of supply and demand at work as well.


A variation on this theme is that the people in developing countries buy more efficient products that use less fuel which allows them to bid more for each barrel of oil.

It is most likely that these countries are subsidized like the Japanese by the US current account- and trade deficits. As US customers go broke and money becomes tighter, fewer dollars will flow overseas, there will be less collateral for loans offered in local currencies, fewer dollars will be offered in exchange for crude oil. The result will be more of the same: less consumption, lower crude prices, more supply taken off-line and recessions.

Our Investment Sinkhole Problem

Off the keyboard of Gail Tverberg

Published on Our Finite World on February 8, 2013

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We are used to expecting that more investment will yield more output, but in the real world, things don’t always work out that way.

Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World bank, oil consumption from BP's 2012 Statistical Review of World Energy.Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy.)

In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.

The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1), and in fact in total energy consumption (Figure 2, below), does not seem to result in a corresponding rise in GDP.

Figure 2. Total primary energy consumed per capita, based on BP's 2012 Statistical Review of World Energy data and population data from EIA.Figure 2. Total primary energy consumed per capita, based on BP’s 2012 Statistical Review of World Energy data and population data from EIA.

At least part of problem is that Saudi Arabia is reaching limits of various types. One of them is inadequate water for a rising population. Adding desalination plants adds huge costs and huge energy usage, but does not increase the standards of living of citizens. Instead, adding desalination plants simply allows the country to pump less water from its depleting aquifers.

To some extent, the same situation occurs in oil and gas fields. Expensive investment is required, but it is doubtful that there is an increase in capacity that is proportional to its cost. To a significant extent, new investment simply offsets a decline in production elsewhere, so maintains the status quo. It is expensive, but adds little to what gets measured as GDP.

The world outside of Saudi Arabia is now running into an investment sinkhole issue as well. This takes several forms: water limits that require deeper wells or desalination plants; oil and gas limits that require more expensive forms of extraction; and pollution limits requiring expensive adjustments to automobiles or to power plants.

These higher investment costs lead to higher end product costs of goods using these resources. These higher costs eventually transfer to other products that most of us consider essential: food because it uses much oil in growing and transport; electricity because it is associated with pollution controls; and metals for basic manufacturing, because they also use oil in extraction and transport.

Ultimately, these investment sinkholes seem likely to cause huge problems. In some sense, they mean the economy is becoming less efficient, rather than more efficient. From an investment point of view, they can expect to crowd out other types of investment. From a consumer’s point of view, they lead to a rising cost of essential products that can be expected to squeeze out other purchases.

Why Investment Sinkholes Go Unrecognized

From the point of view of an individual investor, all that matters is whether he will get an adequate return on the investment he makes. If a city government decides to install a desalination plant, the investor’s primary concern is that someone (the government or those buying water) will pay enough money that he can make an adequate return on his investment over time. Citizens clearly need water. The only question is whether citizens can afford the desalinated water from their discretionary income. Obviously, if citizens spend more on desalinated water, the amount of discretionary income available for other goods will be reduced.

The same issue arises with pollution control equipment installed by a utility, or by an auto maker. The need for pollution control equipment arises because of limits we are reaching–too many people in too small a space, and too many waste products for the environment to handle. The utility or auto makers adds what is mandated, since clearly, buyers of electricity or of an automobile will recognize the need for clean air, and will be willing to use some of their discretionary income for pollution control equipment. Mandated renewable energy requirements are another way that governments attempt to compensate for limits we are reaching. These, too, tend to impose higher costs, and indirectly reduce consumers’ discretionary income.

All types of mineral extraction, but particularly oil, eventually reach the situation where it takes an increasing amount of investment (money, energy products, and often water) to extract a given amount of resource. This situation arises because companies extract the cheapest to extract resources first, and move on to the more expensive to extract resources later. As consumers, we recognize the situation through rising commodity prices. There is generally a real issue behind the rising prices–not enough resource available in readily accessible locations, so we need to dig deeper, or apply more “high tech” solutions. These high tech solutions indirectly require more investment and more energy, as well.

While we don’t stop to think about what is happening, the reality is that increasingly less oil (or other product such as natural gas, coal, gold, or copper) is being produced, for the same investment dollar. As long as the price of the product keeps rising sufficiently to cover the higher cost of extraction, the investor is happy, even if the cost of the resource is becoming unbearably high for consumers.

The catch with energy products is that consumers really need the products extracted–the oil to grow the food they eat and for commuting, for example. We also know that in general, energy of some sort is required to manufacture every kind of product that is made, and is needed to enable nearly every kind of service. Oil is the most portable of the world’s energy sources, and because of this, is used in powering most types of vehicles and much portable equipment. It is also used as a raw material in many products. As a result, limits on oil supply are likely to have an adverse impact on the economy as a whole, and on economic growth.

The Oil and Gas Part of the Problem

A major issue today is that oil supply is already constrained–it is not rising very quickly on a world basis, no matter how much investment is made (Figure 3).

Figure 3. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.Figure 3. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.

As noted above, the easy-to-extract oil and gas was extracted first. New development is increasingly occurring in expensive-to-extract locations, such as deep water, Canadian oil sands, arctic oil, and “tight oil” that requires fracking to extract. This oil requires more energy to produce, and more inputs of other sorts, such as water for fracking. Because of rising costs, the price of oil has tripled in the last 10 years.

Investment costs also continue to soar because of rising costs associated with exploration and production. Worldwide, oil and gas exploration and production spending increased by 19% in 2011 and 11% in 2012, according to Barclays Capital. Such spending produced only a modest increase in output–about 0.1% increase in crude oil production in 2011, and 2.2% increase in the first 10 months of 2012, based on EIA data. Natural gas production increased by 3.1% in 2011, according to BP. Estimates for 2012 are not yet available.

If we want to “grow” oil and gas production at all, businesses will need to keep investing increasing amounts of money (and energy) into oil and gas extraction. For this to happen, prices paid by consumers for oil and gas will need to continue to rise. In the US, there is a particular problem, because the selling price of natural gas is now far below what it costs shale gas producers to produce it–a price estimated to be $8 by Steve Kopits of Douglas Westwood. The Henry Hub spot natural gas price is now only $3.38.

The question now is whether oil and gas investment will keep rising fast enough to keep production rising. Barclays is forecasting only a 7% increase in worldwide oil and gas investment in 2013. According to the forecast, virtually none of the investment growth will come from North America, apparently because oil and gas prices are not currently high enough to justify the high-priced projects needed. The flat investment forecast by Barclays suggests a major disconnect between what the IEA is saying–that North America is on its way to becoming an energy exporter–and the actual actions of oil and gas companies based on current price levels. Of course, if oil and gas prices would go higher, more investment might be made–a point I made when writing about the IEA analysis.

What will the ultimate impact be on the economy?

I would argue that for most of the developed (OECD) countries, the ultimate impact will be a long-term contraction of the economy, similar to that illustrated in Scenario 2 of Figure 4.

What happens if economy stops growingFigure 4. Two views of future economic growth.

What happens is that as we increasingly reach limits, more and more investment capital (and physical use of oil) is allocated toward the investment sinkholes. This has a double effect:

(1) The prices paid for resources that are subject in investment sinkholes need to continue to rise, in order to continue to attract enough investment capital. This is true both for goods that directly come from investment sinkholes (oil, gas and water) and from products that have a less direct connection, but depend on rising-cost inputs (such as food and electricity).

(2) Products outside of essential goods and services will increasingly be starved of investment capital and physical resources. This happens partly because of the greater investment needs in the sinkhole areas. Also, as consumers pay increasing amounts for essential goods and service because of (1), they cut back on the purchase of discretionary items, reducing demand for non-essentials.

In some real sense, because of the sinkhole investment phenomenon, we are getting less and less back for every dollar invested (and every barrel of oil invested). This phenomenon as applied to energy resources is sometimes referred to as declining Energy Return on Energy Invested.

As discussed above, world oil supply in recent years is quite close to flat (Figure 3). The flat supply of oil is further reduced by the additional oil investment required by sinkhole projects, such as the ones Saudi Arabia is undertaking. Also, there is a tendency for the developing world to attract a disproportionate share of the oil supply that is available, because they can leverage its use to a greater extent. Both of these phenomena lead to a shrinking oil supply for OECD countries.

The combination of shrinking OECD oil supply, together with the need for oil for many functions necessary for economic growth, leads to a tendency for the economies of OECD nations to shrink. It is hard to see an end to this shrinkage, because there really is no end to the limits we are reaching. No one has invented a substitute for water, or for unpolluted air. People talk about inventing a substitute for oil, but biofuels and intermittent electricity are very poor substitutes. Often substitutes have even higher costs, adding to the investment sinkhole problem, rather than solving it.

Where we are now

When resource prices rise, the impact is felt almost immediately. Salaries don’t rise at the same time oil prices rise, so consumers have to cut back on some purchases of discretionary goods and services. The initial impact is layoffs in discretionary sectors of the economy. Within a few years, however, the layoff problems are transformed into central government debt problems. This happens because governments need to pay benefits to laid-off workers at the same time they are collecting less in taxes.

The most recent time we experienced the full impact of rising commodity prices was in 2008-2009, but we are not yet over these problems. The US government now has a severe debt problem. As the government attempts to extricate itself from the high level of debt it has gotten itself into, citizens are again likely to see their budgets squeezed because of higher taxes, lay-offs of government workers, and reduced government benefits. As a result, consumers will have less to spend on discretionary goods and service. Layoffs will occur in discretionary sectors of the economy, eventually leading to more recession.

Over time, we can expect the investment sinkhole problem to get worse. In time, the impact is likely to look like long-term contraction, as illustrated in Scenario 2 of Figure 4.

Is there an End to the Contraction?

It is hard to see a favorable outcome to the continued contraction. Our current financial system depends on long-term growth. The impact on it is likely to be huge stress on the financial system and a large number of debt defaults. It is even possible we will see a collapse of the financial system, or of some governments.

In a way, what we are talking about is the Limits to Growth problem modeled in the 1972 book by that name. It is the fact that we are reaching limits in many ways simultaneously that is causing our problem. There are theoretical ways around individual limits, but putting them together makes the cost impossibly high for the consumer, and places huge financial stress on governments.

QE3 Ship Sails

Off the keyboard of RE

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Its all over the Blogosphere and the MSM, Helicopter Ben has once again loaded up the Chinook Choppers and is going to drop anywhere from $40B to $125B worth of Funny Money on the TBTF Banksters EVERY MONTH from now to Kingdom Come.

Graham Summers of Phoenix Capital on Zero Hedge is busy eating CROW after months of predicting that the Bernank would NOT  run another QE Gambit.  After 2 Epic Fails with QE1 & QE2 & “Operation Twist”, yet ANOTHER one of these Helicopter Drops you would think a Normally Smart Academic like Helicopter Ben would not undertake.  There are however extenuating circumstances here you have to consider in the situation as it stands.

The primary consideration you have to grasp is what is going on over in Eurotrashland.  The Krauts and the Bundesbank basically Caved to Super Mario Dragon and have agreed to fund the ESM and look the other way while the ECB does back door buying of Sovereign Debt of Spain and Italy.  IOW, Super Mario is going to Print to Fund these economies, at least for a while.  This will require a LOT of Ink and Paper to print those colorful Euros.

What happens if Super Mario is Printing non-stop to fund those economies and Helicopter Ben does NOT print in tandem?  Answer: the Exchange Rate goes to hell in a handbasket in short order.  The Euro would drop in value rapidly, the Dollar would rise in value and all the trade based on the current relative valuations being held stable would fall apart.  In order to Validate the Value of the Euro, Helicopter Ben HAS to print just as fast as Super Mario does.

As Steve on Economic Undertow often points out though, CBs like Da Fed and the ECB don’t really Print Naked, they Print to match “Collateral” that is thrown at them and Buy this Collateral with the New Money.  The issue here is that just about anything these days serves as Collateral on completely Fictitious Marking of Value.

Not quite Baseball Cards here as Collateral, but Close.  For the ECB, they are “buying” Sovereign Debt that is Irredeemable Debt, it cannot and never will be repaid.  In the case of Da Fed, they are Buying MBS that basically amounts to non-performing loans.  Stop and THINK about that.  Even if it is JUST $40B a month, are people REALLY taking $40B/month out in Mortgages anywhere now?

The $40B DaFed CAN buy each month is the Trash on the books of Fannie and Freddie and the TBTF Banks.  In return for the worthless securities, they hand over new worthless Toilet Paper money.  This is LIMITED though, because really the TBTF banks and Fannie and Freddie have only a limited number of these securities to SELL to Da Fed.  At this point ALREADY after 2 rounds of QE, I suspect these Banks hold few MBS, Da Fed ALREADY “owns” most of the Trash.  For the Banks to get MORE Cash for Trash, they would have to issue out more Mortgages.  To WHOM will they issue such mortgages?

THAT is the problem here.  You see, Da Fed can Buy infinite Debt, but only if infinite Debt is issued out and somebody SIGNS for that debt.  Dead BROKE J6P is not signing for new Debt, nor are TBTF Banks OFFERING him debt to sign for either.  You have this HUGE ZIRP Credit Line, but unless you can get somebody at the bottom end you define as a “Good Credit Risk” to sign, you cannot distribute out the money this way.  THAT IS THE PROBLEM.

Helicopter Ben can make the money cheap to free with ZIRP to the TBTF Banks, but if those Banks do not push that money out into new loans, it just exists as Digibits on a ledger in a Super Computer.  It is NOT real MONEY!

Now, with the few MBS that some of the TBTF still have, they can Sell it to Da Fed and get back more funny Money to “Invest” elsewhere.  Which of course generally amounts to Pumping and Dumping the Stock Market and Bidding up Commodities these days.

Far as the Stock market is concerned, this produces the “Wealth Effect: where Stock Holders THINK they are getting Richer because the Stock Market goes inexorably upward.  Similarly, the Commodities markets get driven upwards as those who now have GOBS of new Free Money can bet it in those markets also!  So UP go the Oil futures contracts, UP go the Soybean Futures also.

Problem here of course is that at the OTHER end of the line, Konsumers have no access to Money Drops from Helicopter Ben’s Chinook Chopper.  The Money problem here is a DISTRIBUTION PROBLEM, not a  CREATION  problem.  HB can create INFINITE Money, what he CANNOT do is move that money outward any further than the TBTF Banks responsible for pitching it out in more LOANS.

In prior incarnations of this cycle, as long as CBs pushed out more money at low interest rates,those with access to that money used it to “invest” in industries that might employ some people, so the money got distributed out that way. NOW these Banksters are NOT pushing the money out that way, what they are doing instead is blowing bigger bubbles in the Stock and Commodity Markets, and MANY economistas see this as a precursor to Hyperinflation.  Which it could be, but ONLY once complete FAITH is lost in the system as whole, and we are not there yet.

QE3 will NOT get a Huge number of people taking on new Mortgages, because they are not Credit Worthy people!  Even if you HAVE a Minimum Wage Job Flipping Burgers somewhere, this does NOT provide enough income to service a mortgage at anywhere NEAR typical McMansion Valuations.  So there will NOT be massive creation of new MBS for Da Fed to Buy here.  All they really can buy are all the old non-performing loans already handed out.

Similarly, the ECB can buy more Sovereign Debt, but they are not getting paid back EITHER.  All these CBs are becoming “Bad Banks”, the final Bag Holder for a LOT of irredeemable debt.  However, as long as they keep printing in UNISON and the holders of energy reserves ACCEPT this toilet Paper for the energy, the system can exist for another hour, another day.

A point here will come though at which the Money is not accepted and the available fuel to distribute out is not enough.  We appear to be very close to this point if we are not already there.

Hyperinflation in the Dollar remains unlikely in the near term, and in fact as long as the Major CBs print in Concert, Hyperinflation of any of these currencies also remains unlikely. Commodity Price Inflation is likely but this is Range Limited by the Distribution problem.  What will occur is that Speculators will drive the wholesale prices  up on on the markets while the consumption decreases through Demand Destruction, forcing more bankruptcies.  IOW, QE3 will have precisely the same effect as QE1&2, which is to do absolutely NOTHING to stop the deflationary spiral.

It is a MISTAKE to focus on the Prices here, it takes your eye off the ball of the economic dynamic in effect, which is credit contraction.  Even if Da Fed or the ECB mkes EZ credit available to the TBTF, that does not mean they move the money further out into the retail economy.    The “Wealth Effect” of an increasing Stock Market price is very limited overall and does not jump start the Main Street economy a priori.

What it WILL do likely here for enough time is to get the Elections done with. Long as they keep pitching out Funny Money, long as this money serves to buy Oil from somewhere, you can perpetuate a Long Emergency/Slow Collapse.  The problems created though are more Political than they are Economic, and you just never know when a Fruit Vendor Self Immolating will get enough people motivated to set fire to a few Embassies.  That is the War economy we are working our way into now.


Theory of Everything: Part I

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Frostbite Falls Daily Rant-4/25/2011

Posted originally on TBP on 25th April 2011 by Reverse Engineer  in Economy

Tonight’s topic is a tough one.  The bickering regarding precisely how the monetary system will collapse framed around Inflation and Deflation is getting us precisely NOWHERE.  The reason for this I think is because it is mostly ex-post facto analysis of the money supply and asset values, and this bogs you down in conflicting numbers, many of which are not even certain to be valid given how the data is manipulated these days.  So what I am going to try to do in this post is look at precisely how fiat money accrues value and how that attaches to physical resources, energy and labor to create an economic system.  It’s a Theory of Everything kind of post, and I have no idea how its going to come out here as I begin.  My objective in developing a TOE here is to try to get a better idea of how the folks in current control over the monetary system will behave as the system disintegrates. I am trying to figure this out, and I do not have an absolute answer, but writing about it helps me to frame the questions, and responses I get help me refine it. I am just “thinking out loud” as I go, and no besides everything I remember I haven’t done ANY research for this post.   Its a thought experiment.

Now, I am using “disintegrates” with respect to the economic system not in the colloquial meaning of being hit by a Phaser blast and vanishing, but in a more pure concept of dis-Integration, where to be integrated means to be connected.  The problem we are faced with at the moment is that Money is becoming less and less connected to Real Value.  This is not simply because a lot of it is being “printed” by the various CBs around the world, but rather because it is becoming further disconnected from the value creation mechanism of the money itself.  Lots of freely floating money in the market certainly should devalue it, but competing against that is what causes fiat to have any value at all, which is Interest.  If you create more money but at the same time make that money more expensive in terms of interest, the money will retain value with respect to whatever it is buying.  So the freshly printed money the Greeks need right now is still actually worth something because the interest rates they have to pay for it are skyrocketing upwards.

In the Fiat system as it has been pursued since around 1692, CBs have had a virtually unlimited ability to create money.  Money is a great Lubricant for trade, it allows you to rise above a pure barter exchange mechanism utilizing a portable store of value.  Whatever that store of value is has to be recognized as such all across the trading markets, which these days are global and interconnected via computers.  It wasn’t always that way though, certainly not in 1692, at that time it was all Paper that had to hold value across the world.  How do you go about making a piece of paper a valuable instrument of monetary transaction across societies?  To do it, you need to have Banking Houses established in different societies which all recognize the paper as holding value.  A note written by the House of Medici in Venice has to be recognized in the Mongol Empire as “Good as Gold”, so that when the Note arrives by Camel train with Marco Polo, the Credits it represents actually buy real goods for Ghenghis Khan, so he can buy more Saddles for the Mongol Horde and expand his Raping and Pillaging Empire a bit further.  Needless to say, if you actually have control over the trade routes and have warehouses stocked with real goods those credits can buy, the Paper has very real value.

It is of course very important for anyone running such a monetary system based on Notes they create that they in fact do maintain real value to buy goods and services.  It is not generally in the interest of a Bankster to create worthless notes, because once those notes stop functioning to buy goods and services, the Bankster is outta biz.  It should be noted here that the TBTF banking houses which grew out of this era have NEVER allowed their notes to go completely worthless, although any number of small countries have been in some way shut out of the system and seen this occur. Argentina, Weimar Germany, and Zimbabwe are all examples of small countries who got shut out of the credit system periodically and saw their currencies completely lose value.  All paper currencies amount to is a Note of Zero Duration with no coupon attached issued by the Central Bank of a local Goobermint.  Long as it is respected internationally, it holds value to buy goods and services.  When it is not, Hyperinflation results. As Jesse points out on Café Americain, Deflation, Hyperinflation and Stagflation are all possible outcomes for a collapsing monetary system, your main problem is to figure out how the politics will evolve to force a given choice.

As the Global system of trade grew in size and complexity, a mechanism needed to be created to both perpetually increase the Money Supply to match the growing population AND to insure that the notes they created would retain their value.  How do you do that?  You do it through the Bond Market, which essentially attaches all the Value a given society can create through its Labor and Natural resources to a Bond of the perceived value of those assets.  So if a given country has a lot of Coal in the ground and Laborers to dig up the coal, you issue out a Loan in the form of a Bond to start money circulating to pay the laborers to dig up the coal, and attach an interest rate to that loan to in theory compensate for the risk involved in getting the project going.  As long as you have new projects and new ways to use labor and natural resources to keep expanding, you can keep expanding the money supply and keep sieving back interest on the money you create, and of course if you have a monopoly on this money creation you get fabulously wealthy in the process.

The primary Debtors to attach here in this process are the Sovereigns, since they have the power to Tax the entire population on some portion of their productive enterprise.  So for the most part, Sovereign nations have always been the biggest debtors. (This begs the question of why Sovereigns that can issue their own money have to go in debt to get it.  That question is a whole other rant. Part II coming soon to a Theatre Near You.)  However, through the Capitalist era, its also been possible to Loan large sums of money to individual Entrepreneurs and Corporations to build large scale projects, and then in addition to that the advent of “Home Ownership” in the post WWII years allowed large scale loaning of money in aggregate on the retail level to individuals.  All 3 of these classes of Debtors accumulated a very large Debt through the post WWII years to finance further expansion of this system.  It is this debt overhang now that is causing so much worldwide havoc with the monetary system, and it is not just in the FSofA. Every last country connected up to this banking system is in precisely the same pickle, even what appear to be net creditors like China.  This because the savings they accumulated is mostly irredeemable debt.  It is irredeemable debt that cannot be serviced anymore, because the growth necessary to service it simply is not happening.  The lowest level debtors, J6P Home “Owners” are the ones being hit first here, because J6P is not getting ANY kind of Bailout.  Stuff like HAMP is just smoke and mirrors to bail out the TBTF Banks, not J6P. The Sovereigns are being Bailed out, but the peripheral ones are seeing their Interest Rates rise to compensate for the risk that they won’t pay off and to maintain the value in the money they are being issued through the loans.  The least affected so far are the TBTF Banks, which are being issued money at near ZIRP  to speculate in the markets which they are not accountable for, it’s other Low Hanging Fruit who will eventually lose their shirts.  Long as that speculation continues, regardless of whether these companies actually turn a profit the managers and executives can pay themselves quite well and the wheels keep turning on the bus.

The thing to remember here is that the CBs cannot keep issuing money in perpetuity, because if they do so the money will go worthless and no longer measure the value of what it is supposed to be buying.  As the Sovereigns become increasingly unable to Tax enough money to pay their bonds, they will fail and I do not see it as likely that after anything bigger than about Portugal you will see the CBs bailing out Sovereigns.  To do so, they would have to create valueless money, and that is not in their interest to do so.

Now, it is unclear as to whether Sir Isaac Newton as Master of the Mint back in 1692 really understood all the implications of a velocity based money supply of perpetual growth, but IMHO by the 1970s  when Local Peak Oil was reached here in the FSofA and when all the bad Loans to South America made by my Dad and other apparatchiks of the system in the name of Chase Manhattan, JP Morgan et al went South, the folks running this system were quite aware of the flaws and that it had a limited lifespan.  The last 40 years have been spent manipulating the system to consolidate ownership and further capture the political process, quite successfully.  However, the whole ball of wax is now up between a Rock and a Hard Place GLOBALLY, which is why the idea Capital will take off and run for cover outside our own borders is IMHO ridiculous.  There just isn’t anywhere to run now, all the sovereigns are in the deep doo doo, so the idea you can pull value from any of them through taxation is ludicrous.  People are going to rapidly be moving to subsistence level almost everywhere, there is not going to be surplus to sieve anywhere.  If the surplus does not EXIST, no financial instrument can make it exist.  Of course, people can be starved out of existence to reduce demand, but they do not go quietly into that Good Night either.  So this requires military action which draws down your own surplus, such as it might still exist. See the Roman Empire to understand this problem.

This still does not answer the question of how our Goobermint and Da Fed will behave as the debt default moves up the chain to the Too Big to Bail.  This besides nation-states like Spain includes our own States like CA, IL, NJ, TX et al.  They cannot issue high interest bonds to rollover the debt they already cannot afford to service, but with low interest there is no incentive for anyone to buy this debt.  No incentive for anyone except Da Goobermint, which wishes to perpetuate itself.  So the TBTF Banks will offload sovereign bonds on Da Fed, which serves as the “Bad Bank” upon which to dump all your losing bets.  The large Banking Houses will consolidate down to just holding and trading about anything perceived as an asset holding real value, commodities for the most part.  Regardless of the numerical denomination, with respect to each other these commodities will more or less move in tandem in perceive value, though it is likely in this scenario that PMs will crash with margin calls across other commodities Put it this way, if you are a Sovereign Nation holding a few tons of Gold and you need to buy Rice to feed the population, you are going to put that Gold up for sale at whatever the market will bear, elsewise your people are likely to Riot and string you up by the Gonads.

At this point, you have major banking houses owning large quantities of “stuff” everybody needs at a relatively high dollar denominated value.  There are two roads possible, one is to issue money on the retail level to J6P to be able to buy the stuff at these high prices.  In a country where most of the population is employed through Goobermint Trade Unions, you could just start indexing and raising the salaries to meet the rising costs of the commodities, but that isn’t the model the FSofA is working under.  Rather what you see at the moment here is wage depression, more unemployment and further loss of purchasing power amongst the people who would buy the commodities for end use.

The most sensitive commodity here in the FSofA would be refined gasoline for private automobiles.  As the price continues to rise here, it has to force people to start conserving and cutting back on usage.  This would force inventories to rise as long as the supply chain is still producing the same amounts, but it may not be doing that.  Libya for instance is not contributing its share to the supply chain at the moment.  However, what is produced will move in the direction where the most people still have money to pay for it, and that would be toward the western nations with some percentage of the population still solvent.  Less wealthy countries will begin to see shortages.

It is unclear how high a price the remaining solvent people in the FSofA can tolerate for gas before it forces too many people out of the market to maintain the distribution chain.  I’m going to make a WAG it could go to $10/gallon at some stage before there is a complete collapse of distribution, but even a perpetuated period at the $5 range will have a devastating effect on commerce and GDP.

Similar effect here with Food, which as a percentage of the budget of even the lowest paid of the still employed here is relatively low, compared to countries where people subsist on $2/day.  I think most Amerikans could withstand a doubling of food prices as long as they are still employed, simply by buying cheaper foods.  As long as the SNAP card program keeps the unemployed fed, again we can see a steady rise in these prices that is compensated for by a forced economic rationing.

The problem is much larger and more immediate in the poorer countries of the world, and this is the most destabilizing aspect of the spin down.  Again unclear is exactly how many places we can try to police to keep the Oil moving out of the M.E., so this can force a breaking point to occur much faster than just the economics.

In no scenario I can imagine would it behoove our Goobermint or Da Fed to keep issuing essentially free money to the States and Municipal Goobermints.  So like Meredith Whitney, I see a period coming of Defaults through these entities, with less and less money circulating through their economies, which means ever falling tax receipts to fund their local Goobermints.  This doesn’t mean an overnight failure of the monetary system, but it will put many places in a grinding down phase of increasing poverty which will be very difficult, complete with the kind of social dislocation you see now in places like Greece and Portugal, getting worse as time goes by.

Is this Inflation or Deflation?  You could look at it either way, since core commodities will be increasing in price but real wages and purchasing power will be decreasing.  Far as Hyperinflation goes, that is another phenomenon altogether, more Political in nature than economic.  A given currency has to be more or less abandoned by the BIS and the country cut off from the international trade system to get a hyperinflation rolling.  It does not seem likely that the BIS will abandon the Dollar as a currency unless and until there is a workable alternative to it, and there isn’t one on the Horizon at the moment.  There will thus be political pressure both internally here and internationally to withdraw credit issuance by Da Fed, which Da Fed is looking for ways to do ever so gently so as not to rock the boat too much, but at this point it is a very unstable boat and very sensitive to perturbation of any kind.  The effect remains possible of a virtually instant Lock Up in the financial markets if too much liquidity is withdrawn from the market, because without that liquidity a few margin calls can cause a cascade selling event on the markets with no bottom in sight.  The Doomer in me waits impatiently for that day, because it would be a sight to behold indeed.  It would make the Flash Crashes we have seen as Coming Attractions look like Chump Change.  Credit where credit is due however, Helicopter Ben and the other Geniuses running the Super Computers for the PPT have demonstrated they have the ability to freeze, re-capitalize and manipulate these markets at will, so such an instantaneous crash may never happen.  I have been regularly wrong in looking at the collapse at the gross market level because I underestimated just how smart these folks really are and how much control they actually do have over the markets. They cannot stop the eventual recognition though that the system is globally bankrupt, several times over actually.

To conclude this portion of the argument, I don’t think that examining the prices ex-post facto is the best way to understand how the collapse will proceed.  In essence what we are looking at is a failure of the Credit-Debit model of the Bond Market at the Sovereign level.  Because of the simultaneous geometric growth in population size and the tandem consumption of resources upon which to build those large populations, the ability of Sovereigns to tax out their populations to pay off on Bonds predicated on growth has for all intents and purposes disappeared.  Without that ability, what gives money any value at all?  Fiat money is a debt instrument, a Note of Zero Duration based on future production that isn’t coming down the pipe.  So the fiat system will collapse as a result, though it can be a long grinding collapse because all production does not cease instantly everywhere.

Far as utilizing PMs as money, they do not represent Debt on future production but rather are the result of past production, the effort to dig up and smelt the relatively rare metal and then coin it.  What value they actually hold depends upon exactly what there is available to buy with them, and whether it is in surplus or not. Anything still in surplus you will be able to buy with very little Gold; anything not in surplus you may not be able to buy with all the Gold in your basement safe.  What you are dependent on here is the overall ability of your society to produce a surplus of food to feed the population, at its most basic level.  Here in the FSofA, as long as some portion of the Oil Conduit keeps moving and we can as a society produce a surplus of food, the PMs will hold some value, but trading with them will likely become difficult and dangerous, and the Goobermint confiscation of such things becomes ever more likely if they gain any traction as a trading mechanism.  I do not think they will gain such traction in most places, so I think the value of these metals will fall with respect to more necessary items.

In the medium term as a result, I see fewer Dollars being available to J6P to buy STUFF, which thus will continue to keep the Dollar valuable to J6P through its scarcity.  I just do not see it likely that Helicopter Ben and TPTB will start sprinkling down higher wages and free money to J6P.  In this environment, prices can rise as commodities become more scarce and Profit margins disappear on production, but as long as the Dollars are scarce to the consumer of the end products, you cannot support a Hyperinflationary event.  The abandonment of the Dollar on the international level of trade by the BIS would cause a Hyperinflation, but there isn’t a readily available alternative to it right now so such an abandonment does not seem immediately likely.

However it does play itself out on the monetary level, inflation or deflation,  the primary problem you are going to have is decreasing availability of the products of industrialized society.  No matter how much Gold you have, if you want to buy a Plasma TV you won’t be able to do so, because the Plasma TV factories will shut down.  Not ENOUGH people will have Gold to buy Plasma TVs to make running such a factory model profitable.  You probably won’t miss a Plasma TV all that much, but when the profit margins in producing food along the industrial model disappear, this you will miss VERY much. It is as we approach that stage of the Spin Down that how you position yourself will become very important, because no group of people anywhere ever goes Quietly into the Good Night of Starvation.  The industrial model of food production will be replaced on the local level in areas that can produce food for their populations.  Farmland that is dependent on water pumped up from deep aquifers utilizing the thermodynamic energy of Oil will no longer produce, so these are not good long term areas for survival.

You cannot know how the climate might change in the future, but where you settle yourself must most certainly right NOW have enough Water dropping down as rainfall or sluicing down from mountains during the spring thaw.  Water is NUMERO UNO in picking your hole.  After the water, the condition of the local soil for supporting agriculture is the next bet you make, unless you are near a Coast where there is still good fisherie not contaminated by Radioactive Cesium and Iodine effluent from Fuk-U-Shima Nukes or Spilled Oil from BP’s Macondo Well in the GOM. After the water and food are covered, the next one to consider is Energy resources.  The best places have all of these things, but of course in the future they will be popular places every last Zombie out there wants to migrate to.  No guarantees you or your progeny will be able to keep or “own” the land you live on because you bought it with 10 pieces of Silver from the last Goobermint to run the show in that neighborhood.  Your only Property Rights are what you can Protect and Defend, and nobody can do that effectively alone.  So pick a place somewhere on the face of the earth with the Water and the Food resources and Good People you affiliate with well, and make yourself ready to defend that little patch of land.  Because when this monetary system crashes and when the industrial model goes the way of the Dinosaur which they both inevitably MUST, that is all you will have left.  If it is not enough to support you and your Tribe, you too will go the way of the Dinosaur.

See You on the Other Side.


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