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The "Game Over" Redux
Back in November, we posted a piece by Knight Research titled "The Game Is Over" in which the firm's strategist Mark Lapolla presented his thesis why he believes that "the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyze a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over." And while the article came out just as the barrage of $750 billion in daily POMOs courtesy of QE2 was starting and hence masked the true state of reality, now that QE2 is finishing, it is only appropriate to bring Mark back up front, as the imminent and very violent convergence of the rosy myth that is the stock market, and of the underlying miserable reality, is about to wake up all those who have been dozing under the Pied Printer of Eccleslin's soothing tune, and Lapolla's thesis is about to see its first validation. In essence, while we have heard much from those who claim that the end game will come as a result of hyperinflation, Lapolla is convinced in the opposite: namely that the end will be not a bang but a hyperdeflationary whimper. In order to refresh readers with his thoughts, recently Lapolla conducted an interview with the master questioner Kate Welling in which the Knight strategist laid out his uber-bearish case in more gruesome detail than most can stomach. Below we present the key points from his interview, as well as the full thing subsequently.
In a nutshell, and this won't come as a surprise to anyone, Lapolla believes that "the game is over because there is no collateral... When consumer debt is rooted 75%-plus in residential real estate and residential real estate is impaired, easy Federal Reserve monetary policy simply cannot make it to Main Street. The transmission mechanism is broken. There is no conduit. "
Lapolla's observations on the secular shift in the employment structure:
What's going on here is very simple. John Maynard Keynes wrote a letter entitled, "Economic Possibilities for our Grandchildren "in 1930, in which he coined the term "technological unemployment." He said it's a term nobody has heard of, but you are going to be hearing a lot about it. Of course, he was writing about the use of technology to supplant labor in the factory... Any way you slice it, nominal wages, real wages, hourly wages, the duration of unemployment — all of these measures imply that we have a growing structural fracture in the labor markets.
On the irrelevance of week to week and month to month micro fluctuations in the jobs numbers:
Right now, the full employment gap is running about 11 million jobs. That's a shocking gap and, although this is very difficult to quantify, we have a sinking suspicion that — while a number of the jobs that are being created right now might in fact be "good jobs" - they're being filled by over-qualified labor no longer able to wait for jobs at compensation levels similar to what they had before. Now, in the very long run, this might work itself out, but in the short run it doesn't do anything to change the outlook for the consumer. What it does is suggest that people are going to have to shift down the way they live and the way they expect to live — perhaps even further than they already have. Thus, the propensity to save in this country has to continue to rise — which (although not in the short term) is very bullish long term — whether that's captured in the aggregate data or not. So as you've gathered, we are very different from consensus, first and foremost, when it comes to the secular structure of labor and credit in the U.S.
On the previously discussed topic of Squatter's Rent (discussed extensively here):
There are roughly six to seven million folks who are no longer paying on the mortgages on their homes, so if we do some really simple arithmetic, it suggests in the aggregate as much as $100 billion of annualized consumer income is being freed up to find its way into consumer spending elsewhere in the economy, instead of going towards the satisfaction of housing debt..., the real question is if, or when, does the foreclosure mechanism begin to kick back into gear and then accelerate? At this juncture, there really isn't a tremendous amount of evidence that it's going to accelerate. Let me give you a tangible example. We know someone who has lost his job and is in a home with a $1.45 million mortgage. The house is on the market at $1.3 million, which we guess is the degree to which the home has been written down on the books of the mortgage holder. The property taxes on the home are about $20,000 a year, so he has been expecting an eviction notice or a foreclosure proceeding for almost 18 months. Yet his property taxes have been mysteriously paid every year. What is going on is clear: If the bank or whomever holds that mortgage note were to foreclose, the house's liquidation value is prob¬ably about $900,000. So they would have to take a further $400,000 writedown on that mortgage. Which makes paying $20,000 a year in property taxes, look like a relative bargain.
On Europe's state of suspended animation:
Europe right now is still kicking the deflationary can down the street; trying to postpone and prolong the inevitable. Meanwhile, they're trying to cover their tracks with verbiage claiming they're pursing mandated fiscal and monetary austerity policies and monetary policy. But the ECB's bump up in rates of 25 basis points isn't material. And all of this is intensifying the deflationary pressures on the periphery countries. So Europe is in a state of suspended animation, where the deflationary pressures are spilling out but even the sort of modest financial restructuring the United States is trying is still being resisted. It's clearly not a stable situation.
On the "China" question:
I think the China situation, how¬ever, is profoundly obvious and profoundly simple. The idea that the free world is placing its hope in a repressive, communist regime employing command and control economic management while violating trade protections and human rights everywhere is absolutely astounding, amazing. I would suggest that, in itself, should be a sufficient warning flag. But let's be a lot more specific. I actually see the situation in China as very analogous to the U.S. in 1929 and Japan in the 1980s....I'll just tick off eight similarities between China circa 2011 and the U.S. before the Depression. 1) Massive disparity of wealth, income, and education. 2) Rapid industrialization and displacement of labor. 3) Opaque and misleading economic and financial data. 4) Massive build-up of leverage across the "rising" class. 5) Bubbles in both residential real estate and fixed asset/infrastructure development. 6) Accelerating and uncontrolled growth in disintermediated credit. 7) Expected transference of economic growth to domestic demand. And, finally, an accelerating price/wage spiral. Nonetheless, to China's credit, they have a booming economy which has drawn the attention, admiration and certainly the economic aspirations of the world. The irony is, despite its hubris, China appears to have lost control — and has done so by doing everything it could to avoid that. Essentially, in its own zeal to placate its masses with rapid growth, China has created a tide of inflation that threatens it with wide-spread social unrest. But if it crushes speculation and clamps down on credit, it risks a deflationary collapse that would also threaten social harmony. The upshot is that China no longer controls its own destiny. The free markets do. As an aside, I would suggest that in the not-too distant future, when this all unravels, there will be downside as well as upside for the U.S., particularly as it relates to what we were talking about before, the way the U.S. has benefited from the value of intellectual property versus scale.
On China's Lewis Point (discussed extensively here):
If there was one thing that pushed us over the edge to publish it last November, it was our belief, now confirmed, that China and an increasing number of other emerging markets are caught in a price/wage spirals that they're not going to be able to control through monetary, fiscal or legislative policy. These are an inevitable result, not only of the credit boom, but of the manufacturing engine they're living by. This is the great differentiator between the U.S. and China. The reason a systemic inflation cannot happen here for a long time and why it is happening in China is simply this: When labor is in the business of manufacturing goods (as opposed intellectual property or services), labor has a call on rising finished goods prices. When commodities prices begin to increase and manufacturers attempt to raise finished goods prices, wage rates must go up or labor's value is necessarily diminished. This is the dynamic traditional U.S. manufacturing businesses faced decades ago, and now, in China, it has reached epic proportions. We've seen 20% to 30% wage increases by the government on the low end and by contract manufacturers such as Foxconn (FXCNF), which does the Apple (AAPL) iPhone, on the high end. It has raised wage rates, almost 30%. China bulls believe this wage inflation is good for workers and so ultimately is going to help China accelerate consumer demand as an engine of their growth. Nonetheless, it hasn't and won't, for a couple of reasons. 1) Savings rates actually are rising in the major city centers. 2) China's consumer confidence numbers and research on the ground in China both show that labor has never been less secure than they are now, which seems paradoxical. One would think that China's new¬found international power, along with higher incomes, would make Chinese workers feel all is right with the world. The problem is that the cost of living is growing even faster. Without getting too technical, China has probably crossed over what's called, in academic theory, the Lewis Point, where the movement of labor from agriculture into manufacturing reaches a peak and begins to taper off as manufacturing labor begins to reconsider whether life in fact wasn't better back on the farm.
On the link between inflation and money:
Increased money supply is not a causal factor for inflation. It's like suggesting that a bartender is a causal factor for alcoholism. In reality, reserves, whether they exist in the system's books or not, are always available. Credit creation cannot really be controlled. If you and I want to create a loan between ourselves, we can do it. If a bank wants to create a loan, it can do it. The only thing that can mitigate that ability is regulation of the banks. However, if we consider the off-balance-sheet and shadow banking mechanisms, there really is no way to control that credit creation. The only way the Federal Reserve can influence credit creation is by raising or lowering short-term rates. With that said, we're at the outer bound, at zero, and what we're finding is that demand for money is not increasing as the cost of money goes to zero — which is not unlike what we saw in Japan. What is happening, however, as ever when the cost of money stays this low, is that speculators are inclined to speculate because the cost of speculation on leverage is negligible.
The reason why, in Lapolla's opinion, the Fed has failed in generating systemic inflation (and why the Fed will keep coming back, and doing the same wrong things over and over until everything finally breaks)
The reason [we don't have systemic inflation] is that the labor markets are fractured. So, at the end of the day, what we're having now is an asset inflation again, an echo. We're not seeing the seeds or leading edge of wage/price inflation, the true driver of damaging systemic inflation. Asset inflation resolves itself in one way, and one way only, and that's through asset deflation. So we have ongoing asset deflation in the residential real estate market. We have ongoing asset deflation in the commercial real estate market and we will ultimately have asset deflation across China and Asia.
On what would happen to the global economy if the dollar were to collapse versus the euro and commodities:
Global deflation and depression are what would happen.
On what self-cannibalizing HFT algorithms means for volume and for the markets in general.
Doesn't it necessarily imply that there must be real inefficiencies in pricing on the table, for long-term investors, if everyone is totally focused on the short term? So, suggesting that "the game is over" has implications across the board. It has implications in terms of the way asset allocators think about investing, the way their money managers think about deploying capital, and ultimately about the way corporate managers think about deploying shareholder capital. We in effect are in this very awkward "teenage" stage where we've just had this fracturing shock, the credit crash, the exposing of all the financial hubris and misallocation of capital. We haven't even moved to credibly addressing those issues in Europe and we're still holding onto the notion that the emerging markets — which are just getting their first taste of capitalism on the back of reckless credit expansion and speculation — can somehow become the engine that overwhelms the massive deleveraging of the developed world. It's a preposterous notion. I'm not being fatalistic. This is the way history moves. In 30 years, it will be clear to people, looking back, that this is the final chapter of the old story in which finance, financiers, leverage and short-term trading ruled the world.
On what the "sequel" is:
We're moving towards something that, by definition, is going to have to address the real structural issues — in the U.S., fractured labor markets, still-excessive credit and unsupportable levels of debt tied to homes, a rising propensity to save, bleak expectations for wages and investment returns. From our vantage point, it's only a question of timing. But it's entirely possible that there won't be an asymmetrically positive outcome for the globe. "Growth" is not a fait accompli. In fact, there can and probably should be periods, lengthy periods, of virtually no growth; of consolidation and pruning. So we would reject the notion that growth necessarily has to happen. Very marginal, just population-type, growth could in fact be the order of the day, and that implies a re-pricing of risk capital across the board.
Lastly, his investment advice:
Those who are bit more speculative, we're encouraging to pick a spot where they will buy the U.S. long bond, if not zeros on the U.S. long bond, as rates start to move closer to 5%. It's likely to have very high, equity-type returns, in short bursts.
Full interview with Kate Welling:
h/t Michael
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Pfft, bankers and the government don't like to print their own money? Oh, but that devalues the money they already have. Riiiight...
You are a worthless little clown. I don't know you ,and you know nothing.
Guilty.
Forgiven. Thank you.
Mark Lapolla makes some fine observations and I agree with him in general, although I tend to shun all investment advice at this stage. The "markets" - and there are no free markets anymore save for the black markets that are, by definition, not monitored by the police state - are rigged. The best I can think of is to keep your health and your job and enjoy a simple life. The future will be rough on the old, the infirm, the disabled and the unemployable or unemployed. Oh, and be ready to shoot roving zombies....
The future will be particularly rough on the employed who must carry an increased tax burden and diminishing income.
Someone has to support the unemployed and the retired. Quit talking about those groups so much. At least they get their basic needs met without having to work a shitty job.
@topcallingtroll
Don't make the mistake of extrapolating today's status quo into the future. Your so-called "shitty" jobs will have the future benefit of participating in a black market and, therefore, will provide a source of tax-free income. The social safety net is collapsing. This has dire consequences for the unemployed and retired and, by extension, everyone else since we will have trouble maintaining social order when the promises made to these people are exposed as empty promises. A dark future awaits us in the near term.
I look forward to the collapse of socialism.
Felix Zuluaf concurs ..
http://www.readtheticker.com/Pages/Blog1.aspx?65tf=214_hurst-cycles-confirm-felix-zuluaf-bearish-outlook--update-2011-05
http://www.readtheticker.com/Pages/Blog1.aspx?65tf=207_hurst-cycles-confirm-felix-zuluaf-bearish-outlook-2011-05
"...easy Federal Reserve monetary policy simply cannot make it to Main Street...."
That was the point I was making last night on the Inflation thread.
If you try to loan money, but no one borrows, How do you lend debt into creation.
I don't see how wages will ever increase. How do you get high inflation without high wages.
I'm not talking about PRICE inflation in oil, food etc.
I am talking about MONETARY inflation.
Pushing on a string has always in the past been a false analogy, yet this time seems different.
My personal view is that this deflation if it happens may be very short lived and one will need to nimbly move back into risk assets perhaps sooner than expected.
Without wage increases inflation in "things" is self limiting and cant spiral out of control.
10's and 2's are flat. The real news is CAD. Thanks for not junking me. I'll Reciprocate.
Just teasing. I don't junk anyone.
"China will lead us out of the global recession," is the Biggest pile of Bunk I heard in a long time when MSM was pumping that....EMs are teetering on self destruction since they all piled on their own version of TARP, QEs, etc and now their portfolios, full of bad loans, are coming back to haunt them...example:
State Bank of India Plummets in Mumbai After Profit Unexpectedly Plunges
By Ruth David and Pradipta Mukherjee
http://www.bloomberg.com/news/2011-05-17...
I have to agree with Shilling and economist who say the market is 40% overpriced right now for most equities.
So foreclosuregate is just a ploy on the part of the banks to circumvent their writedowns?
I take it Mark Lapolla resides in ivory tower, and doesn't get out to the Emerging Markets much. A deflationary death spiral after the the BS money printing of the last few years only exascerbates the desire to exit from the USD which is responsible for the inflation that Emerging Markets have been importing from the US.
Suppressed manipulated currencies are responsible for the transmission of dollar inflation to a third world economy.
If they quit manipulating their.currencies and let them appreciate against the dollar then the inflation wouldnt exist.
Let them leave the dollar, for what? Lmfao!
It's an option and a goal for China, but I was actually referring to smaller countries that don't have a natural external market market for their currencies and whose only current options are dollar, euro, or yen pegs.
I am looking forward to the article in the morning.
newsflash...ECB has threatened to refuse greek bonds as collateral if greece initiates a restructuring. This would make all greek banks immediately insolvent.
Looks like the greeks are going to quit cooperating and now the ECB has to issue public threats.
To set the record straight. What is the difference between Stagflation and this so called ( Hyperinflation)? I just don't see the demand in Europe or America. I do see the Euros and Dollars buying western exports. I see slaves of labor, which will offset the disparity that Asian sweatshops pay their employees. A devalued dollar is the same as a stronger Yuan.
If i understand you i think you are right.
Stagflation here in the usa helps readjust wages downward. A yuan revaluation makes the usa a little more competitive. This is global wage convergence finally arriving. My little poor area of america is becoming competitive again if we keep this up. If we all grow from here on out that is a good thing, but the convergence is an unpleasant process for some. For my area in the usa the slaves are hapy and we are benefiting from a falling dollar and real wage loss while maintaining stable nominal wages.
yes perfect.
TCT and YC,
M Pettis has a very good article, dated May 15, that "nicely" picks apart your conclusions/assumptions on this matter.
You might want to have a read..
http://mpettis.com/2011/05/rebalancing-through-wage-increases/
I saw that article as well. The only flaw I found in it is the statement that the author makes regarding food and agricultural products not being "tradable goods". Bullshit, we sell food to China all the time and things like cotton and wheat are very traded extensively. There has been real inflation in both. The author focuses on the "productivity" of workers but then ignores the "productivity" of arable land. Again, total bullshit, the productivity of arable land (especially for tradable crops) matters BIG TIME. Another economist using another model that ignores reality, nothing new here.
Brilliant article. Absolutely all encompassing and thorough diagnosis of the global system. This is not going to be Zimbabwe here...it's going to be a different set of variables far more consistent with Japan.
Thanks for posting the opposite of what you believe ZH. I have a confirmation bias going on here in Howard's brain but at the same time, I could not wrap my mind around the scenarios painted day after day here.
Somewhere between the death of the dollar and the death of the BRICs we will find our answer.
Somewhere in between all those deaths you will have a world war. Don't believe for a second that the BRICs are going to die peacefully.
Click below to watch YouTube's Harisebon7777777 short videos. He should be commended for his work on measuring the radiation levels in Tokyo. The device he uses costs about $1000, which I am sure he has paid out of his own pocket to provide us with the truth of what is really going on in Japan.
It is eerie to watch his videos. Typically, his hand is shown holding a geiger counter in some public place with people walking all around him as if there was nothing of importance going on; while all along, the geiger counter in his hand reveals what is really happening. Harisebon is documenting the slow irradiation of the Japanese archipelago. A visual unfolding of a tragedy.
While watching these videos. it is hard not to wonder how many of the folks one sees walking down the street will come down with cancer in 10, 20 or 30 years. In fact, the videographer's life itself is in peril. Poignant.
Go to Harisebon's YouTube channel and give him a shout-out. He deserves it.
http://fukushimadisaster.blogspot.com/2011/05/radiation-harajiku-omotesa...
Next, click below to read about the Orwellian steps taken by the Japanese government to hide from the foreign press (and its citizens) what is really going on in Fukushima:
http://fukushimadisaster.blogspot.com/2011/05/japanese-government-takes-...
Moon cycles and Black Swans mutating
Funny how Dubai has been so far off the radar for so long.
"It" doesn't matter until it does, then it springs out.
As mentioned before the market and moon cycles are sometimes incredibly
aligned, and then they go out of alignment, for many months (many moons
as the saying goes). The moon is cool, it's adds alot to our existence
here on earth.
http://oahutrading.blogspot.com/
Plenty of money is flowing to hookers.
Filthy deflationary kanigit.
The Italian brand of clothing has been to the simple design is given priority to batterie especially today season of men's clothing, clipping novel...
It is truly amazing how all money is not being accounted for with respect to those who fear inflation.....
Commodity prices are transitory and will go down when pomos are finished.....and maybe when they are not.....
Why.....
Very simple.....the US$ declined because of excessive private credit demands of the baby boomers.....This number was over $40 Trillion.....and it is not coming back.....because the baby boomers demands change.....and these demands are not going to be replaced.....
And you do not have to put any labels on the numbers.....
Its just math....
In 2006.....total credit and supposed equity was over $70 Trillion.....
By 2012.....the number will most likely be below 50% of this number....
If one gives you $20....and you buy one item.....What can be the item´s maximum price.....$20.....
If one gives you $10....what is the highest price that you can pay for this item....$10.....
It does not matter if the cumulative FED pomos total $4 Trillion ...it will not replace the lost $30 Trillion....etc....
.............................
And furthermore nothing can happen on the upside in the US until real employment gains are made and are of longevity....
Is it possible that the PMs are so hideously undervalued that even with deflationary scenarios they will do well ? I've been hoardin' since Viet Nam ! No one, I repeat, no one is going to scare me into selling ! I laugh ina yo face ! Monedas 2011 http://trololololololololololo.com/
Can you say: Usury?
Can you say: Taxes?
Can you say: Big Government?
Can you say: Big Business?
Can you say: FAIL?
I knew you could.
http://www.youtube.com/watch?v=z_aGrZu5tUM
If China in 2011 is equivalent to the U.S. in 1929, then that makes the U.S. Germany in 1929. Anyone else see that? How is that a "good" thing again?
"What is going on is clear: If the bank or whomever holds that mortgage note were to foreclose, the house's liquidation value is prob¬ably about $900,000. So they would have to take a further $400,000 writedown on that mortgage. Which makes paying $20,000 a year in property taxes, look like a relative bargain."
This is not correct, the bank holding the note maintains the full 30 year P&I on their balance sheet as an asset even after the stream of income from payments has ended, only when the property is liquidated at sale is that amount recognized as a liability/loss. If the house in question has a mortgage principal balance of 1.45 million then the remaining amount of the P&I over 30 years would be in the region of just over 4 million which is the amount they will have to shift from asset to liability. The DIFFERENCE between +4 million and -4 million is $8 million, not only does this make the tax bill look insignificant when you multiply by several million mortgages this means that all banks everywhere would be wiped out if the losses were to be booked at any point.
Uber-alles analysis...for an uber-alles result. Now we can chart real events in comparison to these premises.