3D View: Debt, Deleverage and Definancialisation

It’s taken me a long time to get round to this post. My eyes have been glued to the train wreck that is European fiscal management. Who could forget the financial gymnastics performed by many EU wanna-bees prior to EMU integration. 3% budget deficit….no problem said Greece….we have some very good accountants in Athens.

So the chickens have finally come home. And now the Euro project is in harms way. Or is this just the next stage in complete sovereign consilience? It’s fiscal consolidation or that’s the end of the road.

The real problem, if you look hard enough under the falling limbs of the EU forest, is simply debt and its modern bedfellow, leverage. The financial binge of the last decade, built upon market deregulation in the 80s, has simply finished. Apres le binge, le deluge as they might say in Paris. A bad hangover is one thing but watching bankers get on the big white telephone is no fun at all.

The debt binge primarily was brought about not so much by low interest rates (though that helped) but by the belief that capital gain was guaranteed. Stocks always go up in the long run, property always goes up in the long run…..don’t worry about income, just borrow as much as you can and buy an asset. These financial assets have become a magnet for all investors and, naturally, sellers of investment products. I wonder how many people are holding derivative products which allow them to catch the upside of the stock market with no risk unless the market falls 50%….oops. Certainly Mr Buffet has a few of those.

The return to a time when people invested in companies based on their fundamental performance and bought houses to live in is long overdue. That people cannot afford to buy a home is without doubt the result of excessive lending by banks over the last 30 years. This is the root cause of the problem. Banks have actually created the inflation we have seen in financial assets….unearned income to be exact. That asset price inflation has seen real wages fall heavily over the years consigning the average wage earner or those unable to access leveraged credit to a lifetime of renting and debt.

The maths of excessive leverage is the simple maths of compound interest….compounded.

As Paul Volcker noted in this recent piece,

“There was one great growth industry. Private debt relative to GDP nearly tripled in thirty years. Credit default swaps, invented little more than a decade ago, soared at their peak to a $60 trillion market, exceeding by a large multiple the amount of the underlying credits potentially hedged against default.”

The bottom line is very simple: we have spent our GDP already….for many years hence.

Now it’s payback time. The payback process could take many forms: bankruptcy, forced asset sales or a slow descent back to a normalized level of activity - actually living within our means. Stripping away the financial sector so it works for people and business rather than conspiring against them will be the first requirement: not so much regulation as reengineering.

Whichever route we take it will be a painful adjustment made worse by the fact that those who are in charge are actually responsible for perpetuating the current system or refusing to question and change it.

Market watch: G20 tightens the purse strings

Well after years of allowing banks to categorise any paper bearing the words “i hope to pay back” as Tier 1 capital, G20 has agreed to a new global framework on bank capital under which “banks will face higher capital requirements”.

I guess we can call this Basel III or maybe a souped up Basel II. Who knows? When you have an inherently unstable system any new plan for control is likely to end up in the round filing cabinet before it has a chance to be implemented.

But one thing is clear from the latest global pow-wow: monetary stimulus will remain in place for some time as extra tightening through higher capital requirements sucks in more capital. With all the talk of recovering economies and poistive GDP reads in some countries, it is easy to forget the amount of wealth that has been sucked into the black hole of balance sheet never never land.

Who would be a bean counter these days?

It reminds me of the time I was working on the ticket sales operation for the Brisbane Expo back in 1988. It was a $60m take and I was drafted in to make the numbers balance. It was a lot of fun and eventually I got to the point where I had accounted for everything but there was still a pesky $110 I couldn’t reconcile. It simply didn’t make any sense to me but in the end I just gave up and figured it didn’t matter that much.

Now the numbers seem a bit larger when it comes to bank meltdowns. We have a long way to go before we actually can understand where the money has gone, who owes it, who lost it and what the actual impact on the supply of money is.

So in this case G20 are spot on. Deflationary forces abound. I have no worry about inflation at all. Sure we will keep seeing short term rebounds in some statistics and small sighs of relief. Let’s face it, the markets ahve had an enormous rally in the last 6 months. But do they reflect the underlying reality? Nope.

That’s because the crevasses have been papered over with huge swathes of new paper. But underneath they lie there waiting for some poor fool to fall in again. Slowly it feels like the bankers are starting to understand that they let credit growth go bananas and that their carefully constructed inflation numbers didn’t always tell the truth about asset prices.

We still have major systemic problems to deal with. Tightening credit will cause severe pain but low rates will help ease some of that. But catching the tiger by the tail is the only way forward.

Currency Intervention: Kiwis don’t fly (Episode 2)

2 years seems a long time but feels like yesterday. In that period the NZ$ fell from 0.82 to 0.49 and now is back trading just below 0.68. Wow…talk about currency whiplash.

So back then I suggested the RBNZ should think about selling as much NZ$ as they could. Why? Why go against prevailing market sentiment which is that intervention doesn’t really work and simply provides a target for the speculating hordes which incidentally account for 95% of the volume of daily trades.

That’s a fair sentiment when your currency is falling but when it’s rising? And when you have an eye popping foreign debt of almost 140% of GDP……that’s foreign debt not overall debt.

And yet the punters keep buying the NZ$. Perhaps they know something I don’t. Maybe 50 years worth of oil has been discovered in the Southern Basin. Who knows?

The point is that at some point that money has to be paid back and at the moment, due to the sneaky monster that is compound interest, we can’t even get close to reducing it.

But now is the time to strike.

Again I would like to suggest that the RBNZ starts selling NZ$. When you have a lot of something to sell it’s always best to do it when others are keen to buy. Now is that chance.

By selling NZ$ now and paying back, or at least holding for that same purpose, it will take the pressure off the very precarious dependency we have on overseas lenders.

This doesn’t eliminate the debt but simply transfers it to a domestic situation where it can be managed at lower rates and where there is no threat of having to suddenly repay.

How can the RBNZ do this? Again this is very simple. Print NZ$ and buy US$. There is no change to the actual money supply just how the debt is denominated.

Considering the implosion Iceland experienced and the unfolding disaster that is Ireland (surviving only due to its membership of the Euro), it makes complete sense just to get on with this now.

To allow foreign debt to be run at such a level is financial mismanagement of the highest level.

It also shows a willingness to be dictated to and dependent on overseas interests. This makes no sense at all when the country’s economy security is at stake.

Chimerica: $ Dis-Ease rumbles on

To the joy of conspiracy theorists everywhere, the new “United Future World Currency” coin was presented at the recent G8 summit in Italy. So far though its just a piece of alloy metal but hey value is in the eye of the holder.

As usual it was the Russian President, Dimitry Medvedev, giving the $ a good roasting and moving the debate forward to the minting process. But really how far advanced is this process and how serious are they? More to the point what would a global currency unit look like?

To answer the first question is simple: I have no idea. At the political level it is mere grandstanding usually for the domestic audience. Sometimes it’s easy to forget that most politicians have little understanding of how the global financial system works (no different from anyone else!) but back in the offices of Treasuries and Central Banks it may be a different story.Though I was struck by the recent bizarre questioning of Bernanke over the issue of $ currency swaps with central banks. It’s a classic.

I do think though that the Eurasian block are serious about making this move. Each step is a step closer to creating a multipolar currency whether its based on the Special Drawing Rights (SDRs), a Commodity Backed Currency (CBC) or an Energy Backed Currency (EBCU). Even the Amero could be a consideration.

But the key outcome will be whether we move from a Fiat based system to a hard currency system. That would make a major change in the structure to the global system perhaps taking us back to Keynes’s suggestion, the Bancor. If we stay with a Fiat system then we simply exchange one piece of paper for another.A hard backed system would certainly restore some much needed reality to the meaning and value.

What’s clear is that the US has become a fiscal disaster and holders of paper issued by the US have said enough is enough: your paper is not “as good as gold“.

Volunteering: Everyone should do it

You may not know it but this last week has been Volunteering Awareness Week in New Zealand. Here are some facts and figures to consider:

· New Zealand is a leading nation in contribution made by volunteers. A recent study of the New Zealand Non-profit sector estimated that volunteers make up 67 per cent of non-profit workforce equal to 133,799 full time positions, a higher proportion than in any of the other 40 world countries participating in the research project. This represents 6.4 per cent of economically active population.

· Non-profit institutions contributed 2.6 per cent to New Zealand’s gross domestic product (GDP) in 2004. When volunteer labour is included, non-profit institutions’ contribution to GDP increases from 2.6 percent to 4.9 percent.

· More than one million New Zealanders are actively involved in volunteer work. Statistics NZ estimated that in the year ended March 2004, there were 1,011,600 who volunteered for one or more of 97,000 non-profit organisations. This represented 31 percent of the population aged 12 and over.

· New Zealanders contribute 270 million hours of formal, unpaid work for non-profit organisations annually. The time given has been valued at almost $3.31 billion in the year ended March 2004.

· Volunteers contribute these millions of unpaid hours to human rights, faith communities, health, education, sports and recreation, social services, arts and culture, emergency services, the environment and conservation, animal welfare, and community support and development.

· When reporting on unpaid activities undertaken in the 4 weeks prior to the 2006 NZ Census:

- 460,143 people (14.56%) aged 15 years and over looked after a child who did not live in their household

- 258,708 people (8.13%) aged 15 years and over helped someone who was ill or had a disability, and did not live in their household

- 437,241 people (13.84%) aged 15 years and over were involved in other helping or voluntary work for or through an organisation, group or marae

· Some community and voluntary organisations report shortages of volunteers, but others have waiting lists and have more potential volunteers than they need. The underlying reason for either of these situations is often how the organisation manages its overall volunteer programme from recruitment through orientation and training to support and manage the volunteers. In addition, the issue might be a supply and demand one - volunteering hasn’t declined but demand has gone up, and many people prefer ‘project-type’ volunteering over long-term commitments.

· There is an ongoing research into various aspects of volunteering in New Zealand. An inventory of existing NZ research is available at www.volunteeringnz.org.nz/resources/research.php and www.ocvs.govt.nz/work-programme/volunteering-research.html.

Those statistics make impressive reading. It’s clear the social fabric of the country would be seriously impaired without the contribution of this army of volunteers. So why volunteer?

Why not is the obvious answer. For me though it’s about making a contribution and performing a service to your community. You can think of it as giving back something or simply being grateful for what you have in your life and projecting that gratitude out into the world.

And it’s free. All you give is your time. It keeps your feet on the ground, teaches you humility and opens your eyes to people and situations you may not come across in your daily life. All in all its a fabulous thing to do.

I’ve been a volunteer for a 3 years now and am involved in 3 different organisations. I’ll tell you a bit about them because I simply want to promote them and hope that maybe someone out there will find that it spurs them on to get involved.

I’ve been a Budget Service Advisor for Christchurch Budget Services for a few years now. It’s a debt counselling service focused on helping people understand basic budgeting and how to navigate their way out of the debt trap and take a responsible approach to managing their financial position. i’ve met some interesting people and hopefully helped them on their way to a better position for themselves. Sometimes i’ve felt like a personal counsellor as well as often money issues can reveal personal problems. You don’t have to be an expert in money issues as full training is provided. What i like about it is there is often a very concrete outcome and i love taking financial and lending organisations to task! I’ve yet to meet anyone who isn’t serious about paying off their debts. But boy I wish i’d been around before they started!!

Nearly a year ago I joined up with PILLARS, an organisation dedicated to improving the lives of children who have parents in prison. They match volunteers with these children for a year’s worth of mentoring in the hope that it will have a positive impact. It really does. It’s a proactive approach to ended the cycle of criminalty and making sure these children are not lost and forgotten by adults when their parents disappear for no fault of the child’s. It’s been anincredible experience getting to know a young boy who has come from a very difficult family situation. The role is to spend 2-6 hours a fortnight with your mentee basically hanging out and doing stuff and be able to commit for a year. We’ve done all sorts over the last year: biking, climbing, mini-golf, walking, playing in the park, reading in the library, wandering around town visiting the various sites. It takes time getting to know a child who is often naturally wary of strangers but the rewards come later. Again all it takes is a bit of your time and a belief that all children deserve a decent crack. It’s a wonderful organisation to be involved in and lots of training is provided with courses throughout the year.

This year I decided to volunteer at Refugee Services and help a family resettle in Christchurch. Each year the UN resettles thousands of refugees in third party countries, where there is no hope of return to one’s homeland and the country they are currently in will not take them permanently. New Zealand takes about 750 a year of these “quota refugees” and helps them settle into their new life. There is a very thorough training program to prepare you for the job ahead. It’s a 6 month commitmnet but usually it’s the first 4 weeks that are full on and then it settles down. You work in teams and all undertake different tasks such as dealing with WINZ (that’s me!), housing, education, health, english language and general hospitality. My team has been helping a Bhutanese family settle in. It’s been a marvellous experience and has really stretched me at times. The families arrive almost as a clean slate and hurriedly must put a new life together. Yet they are so keen, hopeful and desperate to start a normal life, get jobs and contribute. They are immensely grateful for the help New Zealand has provided. As a volunteer it’s a chance to make a real difference and also experience a new culture and have your eyes opened to the lives that some people live through no fault of their own. Globally the refugee community numbers over 11m people……people who have been forcibly displaced from their homes and in many cases will never go back.

It makes me feel very humble and very grateful for the comfortable life I have. I think that’s what volunteering really does. It makes you appreciate what you have; it connects you with your fellow man; it teaches you new skills and it takes you out of your comfort zone.

As the proverb states; ” You must give in order to receive”.

So what’s stopping you?

Tipping Points

Why do models never predict catacylsmic events? you know the ones where everything gets blown up….20 years of making safe returns followed by a complete loss of capital.

After LTCM blew up and was repackaged it seemed like no drama was too big to handle. Just reinflate, repackage, securitise and call in the delivery men. But a look at nature shows us this isn’t always possible.

We have reached tipping points before. Easter Island was a good example of how populations and resources co-exist in relationship which should be predictable but actually isn’t. When do you realise that you have cut down too many trees?

We fished cod merrily out of the Grand Banks, a steady and stable provider of cod still one day they disappeared never to return.

Now we have Peak Oil or do we? When will oil production drop off the cliff and what will that mean. Will we continue to fool ourselves into believing that there is actually an endless supply. Can we predict the outcome? I doubt it. Like the Easter Islanders we will merrily be chugging away until one day it dawns on us that its over.

We will fight it of course. However, nature is alot harder to work with than numbers on a spreadsheet. Boy we can make those up forever even if we can’t magic up fish, trees or oil.

Here’s a nice piece from Taleb, of the Black Swan, talking about our inability to forecast meltdowns. The question we have to ask ourselves is simple. Deep down do we really believe we can continue on in the same over consumptive, debt leveraged manner?

We have a great opportunity to sweep away the excesses of the last 20 years.

But try telling that to the masters of the universe. To them it’s just another hiccup in an new paradigm of economic stability.

Somehow I think they will be proved wrong again.