Financial Crisis 14 Feb 2009
14 Feb 2009
I have been asked to expand a bit on the shorter term .
See http://andreswhy.blogspot.com "Financial Crisis 31 Jan 2009"
The trigger to the crisis .
The crisis is a typical bubble , triggered by the rise in food prices that started in May 2007 . The figures are rounded to the nearest ten .
May 07 Mar 08 Oct 08
Wheat Futures (Chicago USc/bushel) 400 1190 400
Aug 07 Jul 08 Dec 08
Brent Crude(US$/barrel) 70 150 40
The primary driver is the rise in food prices as discussed in Maslow hierarchies in http://andreswhy.blogspot.com "Financial Crisis 31 Jan 2009" . This destabilized the global financial systems with a lag of about three months . (Remember the food riots? Wonder why they went away ?)
Note that the primary driver , namely the wheat price , rose by 200% , before plunging .
This is to be expected from the general argument in http://andreswhy.blogspot.com "Optimal Markups"
What happened ?
A steady increase in the oil price led to a switch to biofuels as producers tried to out-guess the market . The speculators and hedge funds got on board and the bubble was off . The rise in the food prices triggered the bubble .
The end of the trigger bubble :
As can be seen from the figures , this ended about Oct 2008 . Stock markets stabilized around then , then fell again .
What happened ?
Skeletons in the closet .
The bad mortgage-debts alone would have been mostly out of the system . It was never very large to start off with (a few trillion at most) , and could be rolled over .
But there was a decade of bad loss-making business decisions which had been hidden in footnotes or securitised and sold on with a nudge and a wink , so the CEO's and assorted managers could keep on receiving their exorbitant bonuses . The oversight by politicians and boards of directors here must carry a large part of the blame .
These amounts are much larger than the toxic mortgages . They are now creeping out of the woodwork .
The companies see this as a golden opportunity to get rid of these millstones , preferably with the taxpayer footing the bill for their greed and incompetence .
This is standard technique during big downturns .
Get rid of all the bad news in one fell swoop .
Fire a lot of people and renegotiate liabilities like defined benefit pension plans and health schemes .
When the upturn comes , it will be so much bigger as they rehire at reduced wages the same people they fired before . Big bonuses and kudos for management .
This has been the way it has been done before .
The Credit Freeze .
The mechanism is fascinating .
Not all companies were reckless and incompetent . Those who were not , were asked lend money to the bad ones . They refused . They saw it as being penalized for prudence and competence . Jealousy amongst CEO's also played a role .
Companies had and has a very good idea who were credit-worthy , and lending between them still goes on . It just does not make the press .
The bad-debt companies cleverly play the mass-media hysteria , equating their survival with economic well-being of the society .
The Fashion .
A CEO or manager who does not make noises like laying off thousands and being tough on credit-applicants runs a real danger of facing the chopping-block himself .
As can be seen , industrial-scale lying is going on . The statistics are even more worthless than normal .
These are fairly reliable for the "real" economy . These have stabilized since Oct 2008. It is the fat cats who are squealing the most .
The stampede .
Prudent companies have large capital reserves . They are using the hysteria and short-selling mechanisms in the market to drive down prices so they can buy assets at very reduced prices . This has happened many times before . The best-known one is Rothschild in London in 1815 , but the same happened in Russia during the 1990's (Ask Abramovich et al) . The result are oligarchs .
Expect private equity companies to expand greatly .
The iniquitous practice that companies (like insurance or pension fund administrators) can be bought for a fraction of the cost of the funds they control and stripped at leisure will be a challenge to future oversight mechanisms .
But at present , it continues apace and some people are literally increasing their net-control ten-fold or more . (Cf Rupert and Lehman )
Is there a bottom ?
It has already been reached in Oct 2008 . What the financial vultures are squabbling about is who will end up with the largest share of the spoils ("market share") .
The uncontrolled market has failed .
Adam Smith's Invisible Hand has become a fly-swatter wielded by the Owner-Managerial Oligarchies . Shades of the 19'th Century .
Remember , money is just a futures contract . It is subject to revision and contractual law . The Social Contract of Rousseau is still the underlying basis of all money-systems . If the owners of the money do not satisfy the Maslow-hierarchy needs as set out in http://andreswhy.blogspot.com "Financial Crisis 31 Jan 2009" , revision will follow , peaceful or not .
Toxic debts .
All debts are toxic . Some are just more toxic than others .
(Ask anybody getting married.)
We used to be in debt to the past (inheritances and savings ) .
Then they invented credit , and now we are also indebted to the future .
But we can and have managed it .
1.Bad-mortgage debts .
This has already been managed . The system has already absorbed it. Scale about $2 trillion .
2. Futures contracts (going back to LTCM at least) . Large amounts . See my previous estimates in 2005 . $300 trillion . But not all are bad . Even the bad ones have a decreasing toxicity . The trick is not to write them down all at once . Use a half-life formula (it seems to be happening in any case in the valuation models : if probability of repayment is smaller than interest )
3. Only a few firms are badly contaminated . The good ones are still trading . The bad ones have been isolated and are withering on the vine . The good ones are using the hysteria to get the non-toxic parts of the others at knock-down prices .
4. A trillion here , and a trillion there . Pretty soon we will be talking real money .
What does it mean ?
It means that human societies are immensely rich in promises .
The trick is not to renege on any one .
Remember , money is just future contracts on goods and services . As long as no promise is broken , the virtuous circle can remain unbroken and we don't have to run around reducing each other's populations .
The short term (2009)
The most important feedback-loop is US-China trade . The US has large amounts of capital invested in China , and China holds large amounts of US bonds . The netto is probably in favour of the US . But they are all promises . If either sides reneges , it is war . Both societies will probably disintegrate into civil war in a general war .Exciting times all round .
If this happens , place your head firmly between your knees and contemplate your spare navel .
The large US bond holdings of China are future contracts on goods and services of the US society . Inherent in this is the understanding that the services include buying from China . Ditto vice-versa .
But , hopefully , sanity will prevail . They will get together and pick on the weaker ones in true human fashion .
How do we know that the bottom has been reached ?
See http://andreswhy.blogspot.com "Exchange Rates"
The unit price of Alan Gray Orbis Feeder Fund (a SA rand denominated foreign exchange fund) has been fairly constant since Oct 2008 . Since the R-$ exhange rate tracks the DOW , especially on the down-side , it means that "real-value" is remaining unchanged (otherwise it would have gone down) . In other words , the market has reached bottom and is going sideways . (An amusing application of conservation laws) . See appendix a below .
How long can it go sideways ?
The world value-markets are already oversold . None of the stimulatory capital-injection packages have been implemented yet . All is hot air and reduced interest rates , but where is the money?
Markets are driven by velocity of money , not the amount of money . This is where the banks have the system by the short-and-curlies at the present moment . All the money is still there , but it is not moving , except between trusted clients .
This means that once money is injected , some will go into neutralizing toxic debts , but more will go into healthy firms , and we are back to the races .
Expect markets to rebound sharply towards July-Aug 2009 in value stocks .
Expect a sharp two-tier market . Good credit risks will get a much more favourable rate , while bad risks will pay considerably more . This is already happening in the raising of minimum amounts in Money Market accounts .
Only a problem if money is considered as real .
I have written about this before in previous posts . The problem is that the present monetary systems have no formal mechanism for destroying money except through inflation or exchange rates .
The problem with inflation is that it hits everybody , instead of just the culprits . (like a broad-spectrum antibiotic.)
What is evolving is two-tiered interest mechanism that not only destroys money in the culprit's hands , but puts it into the more efficient company's hands . This sounds like we already have , but the sharp differentiation between tiers means it is one of those rare instances where quantitive change brings about qualitative change . It almost always presages major sociological changes (eg French financial crises in early 1700's , SA in the 1980's , Zimbabwe in the 1990's , etc) .
An intriguing question :
Can an exchange rate mechanism give a constant value , reflecting the real , underlying value ?
The amazing answer is that it can !
And it does it by destroying or creating money using the exchange-rate mechanism .
In other words , the response is non-linear .
Saying something is non-linear means that there is discrepancies from linear paths . These are usually interpreted as forces or destruction/creation .
What is really amazing is that the relationship is so simple . and so similar to orbital dynamics . On second thought , not so strange , as the dominant currency plays the role of the central mass .
The Relationship is
R/D^2 = K
Where R= rands , D = dollars and K is some constant . K can be fairly fuzzy .
The derivation is given in appendix A .
The primary bottom has been reached in Oct 2008 .
Secondary financial cycles are felt as companies jockey for position . Extremely sharp recoveries can be expected in July , Aug 2009 , unless the politicians muck it up completely .
After that , the usual ups and downs , but with a sharp upward bias as we go towards the singularity .
Money makes the world go elliptical .
Derivation of Rand(R) and Dollar(D) exchange rate relationship .
The symbol " ~ " means proportionate .
The prefix d means an infinitesimal .
R = dR/dD * D
This means the Rand is equal to the exchange rate times the Dollar . Not that the values are assumed to be continuously differentiable . This is a simple tensor equation. R is the number of Rands one dollar buys .
dR/dD ~ (-1)*d(DOW) / dt
where DOW is Dow Jones Index , and dt the usual time derivative .
It means that the Rand exchange rate tracks the DOW.
If the DOW goes down , the Rand exchange rate will go up .
http://andreswhy.blogspot.com "Exchange Rates" for why .
Combining the two above gives
R ~ - D * d(DOW)/dt
But the value of the Dollar is dependant on the value of the DOW .
It is the dominant currency in the relationship .
Then we have :
d(Dow) ~ dD ( infinitesimals may be used in this relationship) and thus
R ~ - D * d(D)/dt
Integral( R)*dt ~ Integral (- D * dD)
Integral( R)*dt ~ -1/2 * (D^2)
Integral( R)*dt means the value of the Rand after an infinite summation between boundaries .
I have not bothered with constants , so the term (-1/2) can be disregarded after the integration . You can insert boundary conditions if you want to re-invent Newtonian orbital mechanics .
The above means that R ~ D^2
R/D^2 = Konstant .
Note that in real life , the tracking between the Rand/Dollar exchange rate is close if the DOW decreases , but is much looser when it increases . This is one of the mechanisms of making money using exchange rates .
See the table in http://andreswhy.blogspot.com "Exchange Rates"