Monday, May 22, 2006

Another walkabout on money futures

Gentle readers (all six of you), this isn't really going to be new. I still feel as though I've not quite got a grasp on something critical, and this is an rolling meander to see if I can find that "aha" point. Basically, I think we're going to have economic difficulties in the near future, and I'd like to not only get through it but gain (relatively speaking) against it. In other words, if the man knows there's a flood coming he can ensure he has adequate insurance and he can put everything up out of reach - but if he really wants to profit he buys a boat for during the flood and prepares a "post-flood cleanup equipment business" for afterward - with the equipment put somewhere to get through the flood itself. I'd like to get the boat and the business if I can, but I also want to put my stuff in the right shelter. (Pushing the analogy almost too far - the man putting his stuff in the attic is well-protected against most floods, but it's in the wrong place if the actual disaster is a tornado.)

Let's start with cusp issues - issues that look scary and may have a nasty impact. I'm going to take each in isolation to see what its primary 'economic difficulty' would be.

Housing. There are a houses out there that people are willing/able to purchase at the current prices. There always have been, but there appear to be significantly more than normal, and it's pretty much across the country. I can see two breakdowns in housing. First is a sales decline, second is a foreclosure surge. They're not necessarily unrelated, but I'm going to try to take each one separately.

As prices climb, fewer and fewer people are willing to buy. That's a pretty simple supply and demand chart. Now, if people are convinced they can buy now and sell later for a profit they'll chase the price higher than normal S&D curves would anticipate, but even so there is a point where the next buyer - REGARDLESS OF FINANCIAL SHELL GAMES - cannot raise the asking price. At that point the price stops till incomes/financial tools/whatever can catch up to continue the surge. However, this pause breaks the self-fulfilling prophecy curve. People see that there was a pause, and are more likely to hesitate. The pain here is twofold. First, builders have to do their jobs in anticipation, and they're as likely to get caught in the feeding frenzy as anyone else. Second, a lot of people rode the edge of the financial shell games, either gambling on swift turnover so they'd get a big payoff before the money ran out or that there'd be no surprising expenses to knock the legs out of their financial balancing act. Let's pick on builders first.

The 'pause' will cause builders to stop making new houses. No (or a slowdown) in construction means construction workers laid off. Also, many builders work on a cyclical pay system - start house B even though you can't afford to finish it because you'll more than be able to do so once house A is sold. If A doesn't sell in the expected time frame, the builder has to carry A and eat into savings (or loans) to finish B. If the builder has to carry A for too long, he goes out of business. It's worse if he can't finish B during that time, because there was always a chance B would cover A (more or less). And at worst case, B complete is a much more transferable asset than incomplete if/when it's time to make a deal with creditors and existing assets (aka bankruptcy). So the effect on the builder is an increase in unemployment and bankruptcies. Oh, and more houses hit the market (A, maybe B) as 'fire-sale' inventory.

This last problem is what happens to the riders of the edge - flippers and other investors. Again, it's bankruptcy if carried too far. For what it's worth, I expect to see a lot of people just walk away - punt, take their beating, and quit bleeding green on a monthly basis. Even with the much harder bankruptcy laws, even with the staggering costs and penalties, they'll bail. heh - it's worth looking at the two 'modes' of bankruptcy. See, regardless of whether it's chapter 7 or chapter 13, the house can be exempt *IF* the creditor (the person trying to declare bankruptcy) agrees to maintain payments. However, due to the nature of real property the creditor can clear that particular debt by turning the property over to the mortgage holder. Errmmm, that's a simplification, there are potential complications, see a qualified attorney, yada yada. Bottom line, though, is that the person that wants to abandon the mortgage can do so and there's not a lot the mortgage companies can do about it. Result: A bunch of people ineligible for new credit by way of bankruptcies, a significant increase of houses on the market. And since held property isn't bringing in ANY money, banks are trying to sell at any price that'll work.

OK, there's the start of a cycle. *IF* the housing sales slump it invokes a positive feedback cycle (that is, the slump has effects which increase the slump). It's not a forever thing as eventually the prices fall to a point where those left out can afford them and want them regardless of whether they're falling or not. Just a matter of what point this new reversal occurs. We also get an increase in unemployment. Secondary unemployment comes from financial industries geared to home sales - though there's a possible shift into foreclosure and bankruptcy related actions. [Ha - I see a boat, I just don't think I've the expertise to operate it.]

Broad economic effect is recession. The ability of consumers to purchase dries up which has businesses battening down the hatches till they're ready to buy again. At the federal level the normal response is to encourage spending again by dropping interest rates.

But there are other problems on the horizon.

The second big stormcloud is the incipient 'push' inflation. A moment, while I clarify the adjective. From "my" point of view, inflation is the price of everything going up. That includes, fortuitously, the price of my labor. Normally. [More formally, there is an increase in the amount of 'free' money. Money is a commodity and attempts to reside in equilibrium with other commodities. More money available in relation to other commodities means each other commodity takes a greater quantity of actual money even though the proportion of total available remains nominally balanced. Nominally, because you've got multiple relationships all in tension, and because money today is a faith-based instrument, and because everything moves at its own pace, and a host of other complicating factors I'll leave unsaid. But basically, dump more money in the system and everything takes a bigger share - but the APPEARANCE is that the price of something goes up and all other prices and/or wages increase to try and keep up.] However, all that's a 'pulled' inflation - the money supply (usually appearing early on in wages) 'pulls' everything up to the new equilibrium. A push is when something goes up for a reason unrelated to money supply, and it forces a significant proportion of other commodities to increase as well. This is bad in a couple of ways.

First, it's bad because wages are often the tail end of the inflation cycle in this pattern. People cut back what they're buying (which impacts businesses trying to sell things) as far as they can, but at a certain point the only solution besides throwing in the towel is start a new income source. Second jobs - part time or full time - become the norm. Except a lot of families today are already double-income, and a sadly large proportion are double-income-double-employer. There are no more opportunities for income. At a certain point there's a revolt. Unfortunately it's delayed because nobody's hiring - remember that many businesses weren't selling as much which means less income which means expenses need cut to stay in operation which means... goodbye, recent hires. (Or maybe most expensive hires, or maybe...)

I said it's bad in a couple of ways, however. See, normally the way you curb inflation is to tighten the money supply - to reduce how much new money is being introduced. But in this case the problem is that in relation to the other commodities money isn't keeping pace. Tightening the money supply - which can be done by increasing rates at a pace slower than the other commodities are increasing - won't make any difference. Money supply is the caboose, not the engine. The inflation's going to run regardless, what you're trying to do is try to keep employment up - because if unemployment gets too high, people can't buy goods, no goods means businesses failing, and you're back to a recession. Except it's a recession with an unstoppable inflation, which earned the label stagflation back in the 1970s. Push it too far and it's got another label. Depression.

I see I didn't mention what's driving this train in this post, but the handful of readers know where it is. Oil is the driver. Easy oil (sweet light crude) is past the 'peak' hump. Production/demand margin is within a percentage point - most producers are running pretty close to full out, and any hiccups will cause a short-term (at least) shortage with a price spike resulting. And almost everything in the US runs on oil. Now we can reduce some of our expenses - drive less, consolidate more - but there's a limit. And according to the EIA and its use statistics we've been cutting our consumption. I think we have some left, but the range isn't infinite. (and again, as we cut we don't buy other things and that cycle's already discussed).

But wait, there's more.

Sitting in the wings is a huge trade deficit. And it's paid for by foreign agencies - mostly governments - owning lots and lots of US IOUs. OK, time for an old lecture just to see if I've changed any subparts - what is money?

Money is a medium of exchange. It's a token that's used as a substitute for direct barter. I can trade the apples I grow for the fish you catch. But sometimes I don't have apples while you don't have fish, or we're separated by several days of travel. (I know - fish, travel, bleah. Bear with me here.) So we make IOUs - I trade you apples for a token that I can redeem tomorrow (or next year or whatever) for the fish. Now if a community agrees upon a common token, then I don't have to use it for your fish. I can exchange it for shoes or wheat or... all at more-or-less what most folk (or my trading skills) decide my apples were worth. All we have to do is TRUST that the number of tokens I got for my apples today will be worth about that many apples when I exchange them later - they're representative of them even though when I exchange them for ice cream I don't even mention the apples. Just "this many tokens" for "that much ice cream".

Now, I'm not going to digress into how counterfeiters shake the trust, except to note a similar situation occurs when the body responsible for ensuring that the tokens I got for my bushel of apples last year can still be spent on about what I could trade that bushel for today. (see above about inflation.) Instead I'm going to note a different angle of trust, bringing us back to that issue of trade.

Sticking with the tokens, let's say I make a deal with that community over there. I'll borrow some of their tokens - they use bling, but they'll change it into tokens - with a promise to give them that many tokens plus some extra inn a while. All is well unless they get the impression that I'm counterfeiting, er, making more tokens. So they loaned 100 bling turned into 100 tokens, I promised 110 tokens back, but I've made so many that the 110 tokens will only buy 90 bling - I win ... in the short term. So long as I don't have to borrow again, or if next time I can do better, then there's no problem. But I've ruined the other community's trust in my tokens, so if there IS a next time they're going to do something not good - like demand that I return the loan in bling, and ohbytheway it's 120 bling for the 100 borrowed, not 110. In the end, money is trust.

Oh, and a brief digression. The above is why some people like gold or silver backed money. The harder it is to create money out of thin air, the better. Now there are problems with gold and silver, but I'll leave them as relatively immaterial to the current portion of this post. No, the US dollar isn't backed by anything but trust.

But there are other ways besides printing extra money to cause problems. Another way is to borrow and borrow and borrow till suddenly we have borrowed so much we can't repay. It's kind of funny, but you don't (or didn't, anyway) usually see poor people going into bankruptcy. They don't get to borrow much. No, it's the people who look like good risks, who just get a little overextended - buying that investment house, sure the money's coming in tomorrow, not expecting the trip to the emergency room or the fire or the new kid - those are the ones that lose it all. And the answer is some sort of bankruptcy - pay the creditors what you can, let them seize what assets they want (except for what the court says "no"), and live within drastically reduced means rebuilding your reputation because NOBODY will loan you what they used to give... even when you're "back", you're never where you were.

We the United States have borrowed $8.3 Trillion from various places. Of that, at least a quarter - $2.1 Trillion officially - is owed to foreign banks. Our government collects approximately $2.3 Trillion of a total GDP of $13 Trillion. We are almost at the point where the entire government budget is insufficient to pay off our foreign loans. Worse, the dollar's been sliding against other currencies - that "110 yesterday is 90 today" thing mentioned above. Now we're the biggest customers the world's got right now - we're the consumer for the businesses everywhere else. But we're reaching the point where the lenders are worrying about getting their loans back. It's not unlikely they'll start hedging their bets - trading our IOUs for tokens for yet another country's moolah notes. And maybe buying in moolahs and bling because a bling today isn't 90% of a bling tomorrow. And... and each person that does it encourages the next to do it before it's too late, and suddenly nobody's willing to loan us money and we owe a LOT right now that we just can't pay off - except since we're a nation we can pay it off. We just print a bunch more money. Which - back to the beginning - is inflationary. But people don't buy our stuff because we're consumers not manufacturers, and nobody uses our services because we screwed up, and... Two ugly solutions. One is pay a hard coin now and be better off tomorrow, the other is get what you can now and hope tomorrow never comes. I'm a cynic, I say the 'cure' to be used will be inflation through increased money supplies.

OK, that's the big three in more-or-less isolation.
1) Housing, with threat of depression and high unemployment with some deflationary tendencies. sorta-cure - print more money. Tightened money increases the risk of the housing problem happening, and makes it worse if it's in progress.

2) Push inflation due to oil. Depression and unemployment risk along with the inflation aka stagflation. Because it's a push it's a 'damned if you do, damned if you don't." Increase money supply balances the depression and unemployment at the cost of higher inflation. Tighter money controls the inflation but increases the severity of depression and unemployment. There are no good answers, there's just trying to find a balance point that minimizes the worst.

3) Overextended international loans. The risk is devaluing and even defaulting on our international loans. A tightened money supply is the better cure. See "housing" for why this will hurt. Inflation is the alternate short-term cure with long-term major penalties - it just requires massive runs of the printing press (figuratively speaking).

OK, it's time to think about the objectives of the FED. Nominally it's got two - and actually three - objectives. Those are minimize inflation, maximize employment, and minimize the occurrences of, duration of, and severity of recessions (avoid depressions). Though the majority of talk is about controlling inflation, I suspect that the recession point is Objective One - when in a recession unemployment is high and inflation's ills are relatively immaterial. Inflation's number two - at heart the Fed's a financial institution, and it's biased to think saving financial institutions will in the end save everyone else. Unemployment happens if Bidness is fine, or so the basic thinking goes.

I am 100% sure we'll face a recession. Integrated in this and quite possibly instigating it will be a decline in housing sales. I think we'll see some loosening of credit to balance it. As a bonus, wages will catch up (some) with the push inflation. I think that the fed would continue to tighten in the face of continued push inflation - failing to differentiate (all inflation is inflation) till it's too late if it weren't for the housing effect. Unfortunately, I think the combination of recession and it's counter-inflation (pull) plus the push-inflation will cause a number of nations to begin hedging their loans. I don't know how severe it'll be, but it will skirt the edge of being a perfect storm.

If it's not a perfect storm, we'll end with... 10-15% inflation, I think, after a year. We'll have spiked to almost 10% OFFICIAL unemployment. And the dollar will be a little weaker but still the international currency of choice. Perfect storm? edge toward if not into hyperinflation, definite double-digit unemployment, and the dollar is the new peso - a currency of last resort. Oh, and the majority of the world suffers major economic difficulties as well - just like the US businesses can't sell when the customers can't buy, other nations can't sell as much when customer number one can't buy. That last, by the way, is part of why we're still getting the credit we're getting - dropping the big boy means you lose that money. Of course, if you've decided you're NEVER getting your money from the big boy, it's called cutting your losses. Is some better than none? Depends on how much "some" is.

OK, I've meandered. I have a general prediction. One of the three triggers the rest, and the "cure" is (eventually) an increased money supply which results in pull inflation. Yes, even against push inflation - they just try to outrun it. Kind of like establishing a fire break, and you just hope that you can make the break small enough it's not a new conflagration that makes your problems worse, but big enough to stop the first problem.

recap of recap - or, is it flood or tornado? Looks like it'll be flood, but there might be some high winds so don't forget to watch the skies. (sorry, it's late and I'm stretching analogies too far. Oh well.) Unemployment and inflation with a recessional window. I'll stop here tonight and ponder this to see if I can plan both the boat and the 'flood cleanup business'. All with some orientation on me and my situation - no sense getting a boat if I don't know how to use it

Thursday, May 11, 2006

two cents on the New NSA scandal

So, the NSA is recording what number is calling what number, and (apparently) how long the call lasts, without warrant. This one's simple, folks. It's illegal.

Recording what number is calling what number is called a pen register. To establish a pen warrant requires a warrant. The standards for getting the warrant are NOT the normal fourth amendment protection, but rather that the phone might be connected to an ongoing crime.

A number of defenders will focus on the last sentence - it's connected to terrorism, a crime. The key fact, however, is that no warrant was requested even on these grounds.

No warrant, no legal basis for the pen register.

Still, I think the ACLU suit is brilliant. They're not attacking the NSA or the administration. Nope, those sort of attacks have been successfully delayed and frustrated far too long by claims of national security. This one bypasses those completely. They're attacking the telephone companies for violations of a 1937 communications act. And they're doing it as a class action suit. Money talks, and this one's going to SHOUT. And they don't have to expose a darn thing about 'national security'. So no quelling by the administration.


Not good for me, yet good for me

I like to cook. And I like to eat what I cook. Sometimes, though, I find fine dining too much. I hit these depressions, and the urges hit in response.

A cheap can of cashew halves and pieces. A big one - 16 ounces - from Walmart does me.
A bag of chocolate chips. This is not going to be a fine meal, it's stuffing the beast - cheap chips from Walmart are again fine.
Half a bag of cheap, small marshmallows. See the above.

Toss. Gorge.

When I get told of someone needing a carton of ice cream, I do not smirk. We each have that which fills the urge, and the shame is not ours but belongs to those who lack the humanity to have them (or more likely, the honesty to admit them).

Thursday, May 04, 2006

Broken Record

As in I keep sounding like one. Thing is, I'm treating this blog as a sounding board, and I know I've not really figured this one out. This one being - what's coming, and how am I going to thrive (or maybe it's survive).

Here's the thing. The Nattering Naybob brought to his reader's attention an ugly fact. Ameriquest announced it's closing ALL it's branch offices. Cutting over a third of its employees. Actually that's not quite accurate. ACC Capital, Ameriquest's parent company, made the announcement. It's closing Ameriquest except for regional consolidated offices. It's doing the same for Town and Country. And just so we know it's not an isolated incident, Washington Mutual's doing just about the same thing.

These are two really big players in the Real Estate Loans business. They're terribly profitable - or at least they were as of their last fiscal reports. So the question that has to be asked is: Why are they cutting a third of their employees? Related - why are they closing offices?

My guess is that business isn't as good as it was - or maybe they suspect it's about to be a lot slower. Either way, it's quite the canary in the coalmine. Fewer mortgages means fewer houses sold means a) fewer new houses need built AND b) more houses sitting empty for longer.

A measurable proportion of the growth of GDP last year was due to the growth of housing related industries - construction and sales mostly, but lots of ancillary support as well. I've not seen a lot of hope that other industries are prepared to take up the slack. Offhand, this means GDP growth isn't as strong - and quite possibly declines. That's called a depression.

A depression this summer - starting now, but "everyone knows" by July - seems inevitable. Add in the anticipated increases inn gas prices (they "always" go up for vacation travel) and things aren't looking so hot.

Polish your resumes. Make sure your other-hire skills are up to snuff in case you can't stay in your industry. Clear your debt load. And hope it is 'just' a recession.