June 2009 - What's Next?
This is cast in the form of a
reply to Jonty Crossick's business barometre recently uploaded to the
Ready2Invest website.
I do not believe we are in a recession but a depression. There is a
difference. When I was at Oxford studying economics I was taught that a
recession was when there were two consecutive quarters of negative
growth, and a depression was when there were two years of the same. I
prefer a more modern definition. Recessions are temporary lulls in
business allowing over-exuberance to correct. Depressions are when
everything goes phut, and the system crashes. It doesn't get up. There
has to be a new start, new directions, new rules.
If we were in a recession your charts would help. We aren't, so they
wont.
Even by the old definition we wont be out of this in a hurry. With the
US commercial real estate now on skid row, and several large mall
owners in bankruptcy or close to it, there is one heck of a lot more to
come. With Alt-A mortgage resets still to come next year and in 2011
there is much more to come from the US property debacle.
When the world's reserve currency is in a mess, and the largest economy
on the planet, which accounts for 35% of world trade, is in
retracement, the rest of the world is going to have problems. Germany's
exports are down 28%. Japan is down by a similar amount, and China's
exports are even worse.
Add to the above the problems throughout the western world where
governments are selling bonds to raise cash to bail out various
disaster areas, and we can guarantee a rise in interest rates. Bond
rates are already rising in the States. There have also been some very
serious auction failures. How about Germany selling 3 billion of a 90
billion issue!
A Reuters clip on my desktop last week reads "does the steepening yield
curve mean investors are worried about the deterioration in the U.S.
fiscal outlook, or the potential for a collapse in the U.S. dollar as
the Fed floods the world with newly minted currency as part of its
quantitative easing program?"
Another quote goes "Only in the logic of central banking can a nation
sustain itself by purchasing its own bonds with a currency that the
nation prints for itself. This process is utterly asinine, utterly
ridiculous and utterly doomed to failure. The world simply does not
work this way, no matter how many Harvard MBAs and Wall Street
strategists argue the contrary."
As an old fashioned economist I have to agree.
What we need to know is:
1 What is the real state of bank finances, including
off-balance-sheet debts?
2 How long and how much money, or money debasement,
will it take to reduce those debts to comply with Basle II?
3 How much more government debt is still to be sold,
who wants it, and how high are the interest coupons going to go in
order to convince others to buy?
4 How long before those higher interest rates feed
through to the market and affect mortgage rates? And how high are they
likely to go?
5 Where is the next engine of world trade coming
from? And how long before that can take the place of the sick American
consumer? An alternative question here is: when is the earliest the
American consumer can start consuming again?
6 Since the existing system is dead, what is the next
system? What will drive it, and how can one get on board?
My May update deals with (1). (Note the story about the banks trying to
fiddle the books with loans to pay off loans, and hiding those other
loans as savings accounts. That kind of thing can only extend the mess,
probably for years.)
How much is there to pay? My article quotes figures for that as well.
The US cant do it without seriously messing up the world financial
system. Ireland has just admitted mortgaging itself for ten years (and
probably the rest).
The answers to (5) are that the next world engine for trade is already
in place and doing deals all over the place. The world from now on is
going to be China-centric. Miss that major point and all calculations
will be off-target. The American consumer wont get up for a long time,
at least until after personal asset classes stop tanking, and start
rising again. They cant stop tanking before 2012 when the final batch
of mortgage resets ends. And I strongly suspect the average US citizen
will be punch-drunk on the ropes by then and in no condition to get up
and kick arse. I cant see the US back in a positive frame this side of
five years minimum. This is a balance sheet depression. Watch the
balance sheets. Difficult, as the banks are lying.
As for (6) how about this from my newsfile?
"Daewoo, a big South Korean conglomerate, worried about how it would
increase food supplies, given its water-stressed homeland. So it signed
a deal with Madagascar to lease half of its arable land to grow crops
to ship back home to South Korea.
When the people of Madagascar heard about the deal, they were very
unhappy. The new president of Madagascar wasted no time and scotched
the deal. It’s just another step along the road to water becoming a
strategic asset, just like oil."
And a quote from one of the UN organisations:
"farmers will need to use 60% more water to feed the extra 2 billion
people coming online over the next 15 years."
I have been following the price of Canadian farmland, and farmland in
New England. I have also noticed some interesting developments in South
America.
I have also been putting together my own farming program in Europe. I
am currently negotiating to control several thousand hectares of land
with a view to going into farming in a big way. It's where the money
will be in the future.
This is a depression; that means the old order passeth, and the new one
will come into being over the course of the next five years. That means
watching the old indicators is not going to help. Alternatively, it
means watching the old indicators to see how much worse they make
things. You cant cure a debt problem with more debt. Watch the debt
levels. The higher they get the worse the problem. The higher they get
the higher the interest levels get in order to attract those who have
money to lend. To avoid that, more money has to be printed, and that
leads to currency debasement.
Your indicators are seeking to find a bottom. Those of us who have been
in this business a long time learned a couple of very good rules. Rule
one in these circumstances is: Never buy a falling market. Rule two is:
Bottom picking is for tramps. You only know the bottom is in after the
event. You need two consecutive cycles of upward movement to prove it
was for real.
On the more positive side; the important points in terms of residential
property are: Does the investment make money? What happens to the
business model when interest rates go up?
Nothing else matters at the moment. You can work out the former easily.
The latter is another matter altogether. I have another rule which
says: Dont make long term investments using short term indicators.
Interest rates have never been lower throughout recorded time. They
must go up. US rates are going up as we speak.
So there you have it. Look at bank balance sheets. At present they are
an unmitigated disaster. Yesterday the estimate for US banks' hidden
off-balance-sheet duff assets was $5 trillion. (Forgive me, but that is
very high and scary, and those dodgy assets are only covered by $1
trillion of tangible equity. That is not a basis for moving forward.)
And look at bond issuance. It's too high right across the western
world. And look at the interest rates governments are forced to offer
to attract investors. That will feed through to mortgage rates. Also
look at bond issuance failures, and the resultant money printing. That
will lead to inflation and higher interest rates.
I'm sorry to say I do not see happy things ahead in property markets.
Either interest rates stay on the floor for a decade, in which case
folks with property will make money from rentals; so far that seems
doubtful from watching the indicators mentioned above. Alternatively
inflation will cause basic asset classes to increase in price (that
includes property), but the downside here will always be the cost of
borrowed money, which tends to rise dramatically under such
circumstance. The indicators above also show that happening right now.
The only answer I can see is to make sure your leverage is very low so
you aren't castrated by rising interest rates. Anyone in real estate
with mortgage levels above 60% stands a good chance of being wiped out
when interest rates rise. A golden rule here is to check what happens
to the maths should interest rates go back to their long term average,
and then add 2%.
I like things to be easy, so I'm concentrating on farming and food,
that's where the future is.
best wishes
john
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