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Can an Empire Fall Without Either an External or Internal Threat?

Off the keyboard of Sig Silber

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Published on Global Economic Intersection on November 30, 2013

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Random Thoughts from the High Desert

There have been many alarmist predictions recently. Some of those I have paid close attention to are by Scott Brown, Leap/Europe 2020 and John Hussman. These articles suggest that the U.S. and the World in general may be heading for really hard times.

Follow up:

The Raymond James piece by Scott Brown is pretty much the standard fare that the economy has not been performing very well and we may have become increasingly dependent on bubbles for what growth we have been achieving. This is pretty much a call for a War on Bubbles.

I am not very familiar with LEAP but their article is far more upsetting. They show a particularly interesting set of data:


Number of prisoners, engineers, nurses, secondary school teachers, etc., in the US.
Source : Huffington Post.

More prisoners than engineers! That is a dynamic economy – NOT. Much of the paper deals with the threats to the U.S. dollar as a reserve currency. Along these lines and separate from the LEAP article we see that Russia has intimidated the Ukraine to be allied with Russia rather than the EU. We see surveys showing the citizens of Turkey are not very interested in joining the EU and some nations in the EU are not that interested in having Turkey join. We see Israel and Saudi Arabia potentially becoming more neutral rather than aligned with the U.S. Egypt has already taken steps to detach from the U.S. Empire. Clearly, U.S. foreign policy is in disarray.

And what about the economic condition of the U.S. Empire? Here one pays careful attention to what John Hussman has to say. Although his funds may have been a bit too timid about joining in on BubbleMania, he remains one of the most thoughtful financial analysts. I am hoping I have not gone too far in relying so heavily on one of his exhibits and other information in his article but since it is called an Open Letter to the FOMC (Federal Reserve Open Market Committee) I have to assume that John Hussman wants his position publicized.

Lets start with:

This shows the ratio of corporate profits to GDP. One might interpret this as a sign of business vitality. But then we take a look at the National Accounting relationships (works for international accounting also) which Hussman reminds us of.

Investment = Savings

Corporate Profits = (Investment – Foreign Savings) – Household Savings – Government Savings + Dividends

Investment = Household Savings + Government Savings + Corporate Savings + Foreign Savings (the inverse of the current account)

I will take exception to the first relationship as it is clearly true for the World but not necessarily true for an individual nation. Certainly investment can only come from production (including services) not consumed but instead “saved”.

But that which is “saved” may remain “saved” (for example gold bullion) or invested in another country or vice versa rather than “put to use”. And savings from a prior period can be consumed or invested in the current period. So it gets a bit complicated but, in the long run, investment can not exceed savings. So the savings rate of a nation becomes quite important. I do not believe we are seeing strong investment in the U.S. or sustainable household saving.

The next relationship is perhaps the more critical one. Not only is it stated here but Hussman provides empirical data to show that this relationship reduces to Corporate Profits being basically the inverse of the change in Household Savings and Government Savings. Thus, for all practical purposes, the extraordinary increase in Corporate Profits represents government spending and transfers from households to corporations.

Hussman does not actually come out and say it but corporate profits are way up because household income is down and people are depleting their savings or going into debt to jack up Corporate Profits. That is not sustainable.

One aspect of this is the revival of the trend of increasing home equity loans. One source suggests that $29 billion of home equity loans will need to begin paying off principal next year. This need to start paying off principal will rise to $73 billion in 2017.

On top of all that, we all know about the large increase in student loans with few jobs available to graduates.

So basically we have impoverished the Middle Class and turned the Lower Class into kept persons.

In Switzerland, voters voted a week ago on a proposal to cap executive salaries at twelve times the compensation of the average worker. It did not pass but the fact that it even got on a ballot indicates an undercurrent of dissatisfaction with Capitalism as it currently operates.

In essentially all the developed nations, demographics are putting a strain on the ability to fund social programs. And what are we to make of Larry Summers, the once presumed new Fed Chair, suggesting that the natural rate of interest may be as low as -3%? Can you spell “deflation”?

Bubbles and deflation do not go together. One can imagine that negative nominal interest rates, if that fantasy somehow became reality, might provide one more boost to asset bubbles since it is better to own a questionable asset than suffer a guaranteed loss by keeping money in your bank and being charged a stiff penalty for doing so. But deflation means declining wages and labor strife. There is a limit to how much household income can be transferred into corporate profits. Thus there is a limit to the strategy of creating asset bubbles. The discounted future earnings stream will not support inflated asset prices.

In some ways this appears to fit with Classical Marxist Theory as to what will eventually lead to the overthrow of Capitalism. But do we indeed have true Capitalism? To the extent businesses survive and prosper to a large extent based on their relationship with the government in power, this relationship seems to have evolved significantly. In my career which has involved working for the Bell System, IBM, and Kennecott Copper and being a consultant to a large number of businesses, the relationship to the Federal Government was far less symbiotic than what I see today. In many cases it is now essentially impossible to identify where government ends and big business begins.

It is difficult to lay these problems at the feet of any particular political party as this process has been going on for some time. But the recent acceleration of the extraction of the wealth of the middle class and essentially turning the lower class into wards of the State, has accelerated recently, especially in the U.S. Only seniors (due to social security) have bucked the trend. But you can be sure that one way or another, Corporate America or Government will find a way to gain access to their savings as well.

This looks to me like a negative feedback loop that creates a distinct risk of leading to a Worldwide Depression or a World War or both.

It is not a process that necessarily will come to a head over the next weeks or months and most likely will involve a series of mini-crises with actions taken that are claimed to be solutions but which will trigger either a worsening of the problems intended to be mitigated, or the creation of new problems, or both. Thus it is difficult to see how the situation can fundamentally improve. Think of it as a whirlpool which is sucking the world economy into depression.

To expand on the empirical relationships that Hussman has assessed in the scatter diagrams in his article, he detects a weak relationship between the inflation of stock prices and the employment rate. He calculates this as being at most a 1% decrease in unemployment for a 40 percent increase in the S&P 500. But however weak the wealth effect, it works in reverse as well. So pricking the stock market and other asset bubbles is likely to increase unemployment. Hussman sees the same sort of relationship between the Fed balance sheet and interest rates. Although he again sees only a weak relationship between increases and decreases in the Fed balance sheet and interest rates, we know that increases in interest rates negatively impact housing prices.

So, in this Federal Government / Big Business alignment, the only real planning function is the Fed and they are caught between a rock and a hard spot. This dilemma is not unique to the U.S. It is pretty much the situation worldwide but it is especially problematical for an Empire such as the U.S., since reserve currency status has value and is difficult to maintain if a nation is perceived to be in serious decline.

The worst case scenarios for how this situation will play out may indeed make the economic and geopolitical impacts of Climate Change seem like a secondary issue over the next twenty years and could definitely dramatically impact political and strategic relationships worldwide.

Chinese Debt Binge

Off the keyboard of Michael Snyder

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Published on Economic Collapse on November 26. 2013

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China Is On A Debt Binge And A Buying Spree Unlike Anything The World Has Ever Seen Before

When it comes to reckless money creation, it turns out that China is the king.  Over the past five years, Chinese bank assets have grown from about 9 trillion dollars to more than 24 trillion dollars.  This has been fueled by the greatest private debt binge that the world has ever seen.  According to a recent World Bank report, the level of private domestic debt in China has grown from about 9 trillion dollars in 2008 to more than 23 trillion dollars today.  In other words, in just five years the amount of money that has been loaned out by banks in China is roughly equivalent to the amount of debt that the U.S. government has accumulated since the end of the Reagan administration.  And Chinese bank assets now absolutely dwarf the assets of the U.S. Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England combined.  You can see an amazing chart which shows this right here.  A lot of this “hot money” has been flowing out of China and into U.S. companies, U.S. stocks and U.S. real estate.  Unfortunately for China (and for the rest of us), there are lots of signs that the gigantic debt bubble in China is about to burst, and when that does happen the entire world is going to feel the pain.

It was Zero Hedge that initially broke this story.  Over the past several years, most of the focus has been on the reckless money printing that the Federal Reserve has been doing, but the truth is that China has been far more reckless

You read that right: in the past five years the total assets on US bank books have risen by a paltry $2.1 trillion while over the same period, Chinese bank assets have exploded by an unprecedented $15.4 trillion hitting a gargantuan CNY147 trillion or an epic $24 trillion – some two and a half times the GDP of China!

 Putting the rate of change in perspective, while the Fed was actively pumping $85 billion per month into US banks for a total of $1 trillion each year, in just the trailing 12 months ended September 30, Chinese bank assets grew by a mind-blowing $3.6 trillion!

I was curious to see what all of this debt creation was doing to the money supply in China.  So I looked it up, and I discovered that M2 in China has grown by about 1000% since 1999…

M2 Money Supply China

So what has China been doing with all of that money?

Well, they have been on a buying spree unlike anything the world has ever seen before.  For example, according to Reuters China has essentially bought the entire oil industry of Ecuador…

China’s aggressive quest for foreign oil has reached a new milestone, according to records reviewed by Reuters: near monopoly control of crude exports from an OPEC nation, Ecuador.

Last November, Marco Calvopiña, the general manager of Ecuador’s state oil company PetroEcuador, was dispatched to China to help secure $2 billion in financing for his government. Negotiations, which included committing to sell millions of barrels of Ecuador’s oil to Chinese state-run firms through 2020, dragged on for days.

And the Chinese have been doing lots of shopping in the United States as well.  The following is an excerpt from a recent CNBC article entitled “Chinese buying up California housing“…

At a brand new housing development in Irvine, Calif., some of America’s largest home builders are back at work after a crippling housing crash. Lennar, Pulte, K Hovnanian, Ryland to name a few. It’s a rebirth for U.S. construction, but the customers are largely Chinese.

“They see the market here still has room for appreciation,” said Irvine-area real estate agent Kinney Yong, of RE/MAX Premier Realty. “What’s driving them over here is that they have this cash, and they want to park it somewhere or invest somewhere.”

Apparently a lot of these buyers have so much cash that they are willing to outbid anyone if they like the house…

The homes range from the mid-$700,000s to well over $1 million. Cash is king, and there is a seemingly limitless amount.

“The price doesn’t matter, 800,000, 1 million, 1.5. If they like it they will purchase it,” said Helen Zhang of Tarbell Realtors.

So when you hear that housing prices are “going up”, you might want to double check the numbers.  Much of this is being caused by foreign buyers that are gobbling up properties in certain “hot” markets.

We see this happening on the east coast as well.  In fact, a Chinese firm recently purchased one of the most important landmarks in New York City

Chinese conglomerate Fosun International Ltd. (0656.HK) will buy office building One Chase Manhattan Plaza for $725 million, adding to a growing list of property purchases by Chinese buyers in New York city.

The Hong Kong-listed firm said it will buy the property from JP Morgan Chase Bank, according to a release on the Hong Kong Stock Exchange website.

Chinese firms, in particular local developers, have looked overseas to diversify their property holdings as the economy at home slows. Chinese individuals also have been investing in property abroad amid tight policy measures in the mainland residential market.

Earlier this month, Chinese state-owned developer Greenland Holdings Group agreed to buy a 70% stake in an apartment project next to the Barclays Center in Brooklyn, N.Y., in what is the largest commercial-real-estate development in the U.S. to get direct backing from a Chinese firm.

And in a previous article, I discussed how the Chinese have just bought up the largest pork producer in the entire country…

Just think about what the Smithfield Foods acquisition alone will mean.  Smithfield Foods is the largest pork producer and processor in the world.  It has facilities in 26 U.S. states and it employs tens of thousands of Americans.  It directly owns 460 farms and has contracts with approximately 2,100 others.  But now a Chinese company has bought it for $4.7 billion, and that means that the Chinese will now be the most important employer in dozens of rural communities all over America.

For many more examples of how the Chinese are gobbling up companies, real estate and natural resources all over the United States, please see my previous article entitled “Meet Your New Boss: Buying Large Employers Will Enable China To Dominate 1000s Of U.S. Communities“.

But more than anything else, the Chinese seem particularly interested in acquiring real money.

And by that, I mean gold and silver.

In recent years, the Chinese have been buying up thousands of tons of gold at very depressed prices.  Meanwhile, the western world has been unloading gold at a staggering pace.  By the time this is all over, the western world is going to end up bitterly regretting this massive transfer of real wealth.

Unfortunately for the Chinese, it appears that the unsustainable credit bubble that they have created is starting to burst.  According to Bloomberg, the amount of bad loans that the five largest banks in China wrote off during the first half of this year was three times larger than last year…

China’s biggest banks are already affected, tripling the amount of bad loans they wrote off in the first half of this year and cleaning up their books ahead of what may be a fresh wave of defaults. Industrial & Commercial Bank of China Ltd. and its four largest competitors expunged 22.1 billion yuan of debt that couldn’t be collected through June, up from 7.65 billion yuan a year earlier, regulatory filings show.

And Goldman Sachs is projecting that China may be facing 3 trillion dollars in credit losses as this bubble implodes…

Interest owed by borrowers rose to an estimated 12.5 percent of China’s economy from 7 percent in 2008, Fitch Ratings estimated in September. By the end of 2017, it may climb to as much as 22 percent and “ultimately overwhelm borrowers.”

Meanwhile, China’s total credit will be pushed to almost 250 percent of gross domestic product by then, almost double the 130 percent of 2008, according to Fitch.

The nation might face credit losses of as much as $3 trillion as defaults ensue from the expansion of the past four years, particularly by non-bank lenders such as trusts, exceeding that seen prior to other credit crises, Goldman Sachs Group Inc. estimated in August.

The Chinese are trying to get this debt spiral under control by tightening the money supply.  That may sound wise, but the truth is that it is going to create a substantial credit crunch and the entire globe will end up sharing in the pain…

Yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing’s relentless drive to tighten the monetary spigots in the world’s second-largest economy.

The higher yields on government debt have pushed up borrowing costs broadly, creating obstacles for companies and government agencies looking to tap bond markets. Several Chinese development banks, which have mandates to encourage growth through targeted investments, have had to either scale back borrowing plans or postpone bond sales.

This could ultimately be a much bigger story than whether or not the Fed decides to “taper” or not.

It has been the Chinese that have been the greatest source of fresh liquidity since the last financial crisis, and now it appears that source of liquidity is tightening up.

So as the flow of “hot money” out of China starts to slow down, what is that going to mean for the rest of the planet?

And when you consider this in conjunction with the fact that China has just announced that it is going to stop stockpiling U.S. dollars, it becomes clear that we have reached a major turning point in the financial world.

2014 is shaping up to be a very interesting year, and nobody is quite sure what is going to happen next.

Knarf plays the Doomer Blues

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