I like this so much by Karl Denninger. At last a fr----ng economist who doesn't try to pull rank with his jargon and who explains things to us plebs in language we can understand:Let's say that today you wish to buy a car. You go into a bank and get them to agree to issue you a loan to buy that car. Let's say the loan is for $20,000. You sign a contract promising to pay back the $20,000 plus a rate of interest, which is charged so that the bank is covered for the risk that you won't pay them, and the value of the car at that time might not be as much as you owe. The car is the "security" for the loan - if you fail to pay, they will come and repossess it.
You now have $20,000 in your pocket, and you purchase the car. (We'll get back to how the $20,000 came to be in a minute.)
If these were the only two transactions in the world, you would soon recognize a serious problem - there is only $20,000 in money in the world, but you owe more than $20,000! The interest you must pay means that you somehow must acquire more money than exists in the world over the life of that loan in order to pay it back.
There is only one solution to this problem - the amount of money in the world must increase.
So the government will just print some more, right? After all, the can do anything they want.
Uh, no. If the government were to do that then the value of all the money currently in existence would go down by the exact amount that they printed. You could pay your debt but the bank would be in serious trouble because the money they got paid back with would not be worth as much as the money they gave you!
Further down:
WE ARE NOW FACING A "RESET" IN THE SYSTEM!
What happens in a "reset"?
1. The rate of credit creation slows precipitously as the list of assets that can be pledged dwindles down.
2. The interest and principal payments due on existing debt get close to and ultimately exceed the amount of money in the system, as the rate of credit (money) creation slows.
3. Those who detect this while they still have money pay off their debts, (correctly) deducing that a "reset" is about to take place - and that cash (assets) will have value, while debt will be a millstone that will drag you underwater.
4. Those who are unable to pay off their debts will find that a contracting credit (money) supply leaves them with insufficient funds to pay their debts. Debt defaults at a rapidly increasing rate.
5. The creditors (who granted the credit) will repossess the assets pledged for the debt in lieu of payment, while the debtors are financially destroyed.
6. The destruction of outstanding credit via default shrinks the money supply further, and we go back to #1.
This continues until equilibrium is reestablished, and the cycle begins anew.
Do read the whole thing at Market Ticker: The Money/Credit Cycle..... You might disagree but at least you can understand it.
For anyone (especially an economist) to rely on the argument that there is only 20k in the world (in his scenario) is foolish and hurts his argument.
ReplyDeleteThere aren't many people in the world who won't realize fairly quickly that there are more than the bank and the borrower in the world (since there was a car salesman, someone built the car, etc.) and to say that more money must be 'created' because of this is asinine at best.
It does mean that the guy has to EARN more money than he borrowed, but that has been true since the first time someone borrowed anything from anyone.
You read the whole article at his site, Verlin? The point you make was the next he made.
ReplyDeleteKD isn't an economist, he's an active investor / options trader. Nothing like the prospect of losing fistfuls of your own cash for sharpening the mind!
ReplyDeleteThat explains a lot. So let's have just these sort of people telling us how it is, people with their butts on the line.
ReplyDeleteI read your post, you didn't hint that he was going that direction and after the start, his article wasn't interesting enough for me to read.
ReplyDeleteIt isn't 'their' butts on the line, it's the people that give them money.
:)
ReplyDeletewhich makes it ultimately "their"butts on the line if their clients loose confidence.
ReplyDeleteAfter all, it's their business.
It's really simple, James.
The problem is one of bank solvency, not liquidity.
The Fed can create liquidity, but can't cure insolvency
Reverse engineered fractional lending is destroying asset bases when losses happen.
Banks pull in their horns. Libor and euribor go higher. Everything stalls, circulation stops. Opaque balance sheets. Opaque asset bases.
ECB open market operations are actually removing cash from the stage.
Sovereign Wealth Funds investments are good baleouts.
Politically acceptability may limit though.
Fannie and Freddie asset base is just about fried.
Ron Paul tried to get taxpayer liability for Fannie and Freddie removed, a few months ago.
Everyone ignored, or laughed.
Fools.
Watch out for a massive socialization of debt.
SWFs got screwed the first time round (citi). They'll wait for better deals next time.
Maybe the 5% limit on foreign ownership that restricted citi will vanish from the rule book.
Fiscal stimulant from Dubya? - budget deficit is less than 2% of GDP, so there is room, but will it be enough? Can it be enough? The Dems are bound to howl "helping the rich", and then propose similar.
ALL the stimulus from equity withdrawal is now gone, - how many points on the GDP do you figure that created.
Jobs report has financial services creating jobs for the last full year, via "births and deaths". Expect a massive revision shortly, as that just has to be bullshit.
The productivity adjustment on the GDP is just pure fiction, and the CPI is even worse.
It's real world, man in the street, inflation, that affects discretionary spending power, not some massaged figure constructed to avoid the truth. And in an economy dependent on the consumer, discretionary spending power is king. Grain futures are through the roof, so is oil ($200/b futures by the year end).
A 2 year slow motion train wreck. At least.
SWF baleouts do carry risk, as explained here
Food prices are through the roof but I am suspicious of manipulation, as Rockefeller, Monsanto, and the usual cabal seem to be behind all this.
Indeed, the current Global pantomime with military re-alignments, oil, the dollar, and food, seem like a pre-programmed dance to me.
The survivors get to use the proper, un-fucked-with grains that I mentioned in my last post, re Rockefeller/Billy Gates Grain Store in the arctic circle.
Yes, the creation of the Store of all global grain seeds is highly significant, given Rockefellers Pre-occupation with eugenics, populations, Genetically Modified foods, etc.
Not a nice story.
The reset commences.
ReplyDeleteCreditors are making borrowers from Carlyle Group's LifeCare Holdings Inc. to casino owner Tropicana Entertainment LLC increase the interest on their debt by an average 0.83 percentage point to change the terms of their loans, the highest price since at least 1997, according to data compiled by Standard & Poor's in New York. The penalties are four times higher than six months ago, S&P said.
A total of 179 North American companies have a high risk of default or may need to change details of their debt agreements, Moody's Investors Service said. Lenders are taking advantage of the distress to recoup losses after the collapse of the subprime mortgage market caused $551 billion of so-called leveraged loans tracked by S&P to fall below 95 cents on the dollar, from 100 cents before June.
"There's been a dramatic shift in negotiating leverage from borrowers to debt holders," said Scott D'Orsi, who helps manage $1.4 billion in loans as a partner at Boston-based Feingold O'Keeffe Capital. "We will see more of this with companies that are susceptible to a slower economy."
Creditors are also demanding fees of as much as 0.35 percentage point of the value of loans to relax terms, or covenants, such as the minimum ratio of earnings to debt they require or deadlines for reporting quarterly financial results, S&P said. Before June, lenders charged 0.125 percentage point.
Carlyle, the Washington-based private-equity firm led by David Rubenstein, bought LifeCare, the third-largest long-term health-care operator in the U.S., for $555 million in August 2005. In November the Plano, Texas-based company broke a covenant limiting debt to less than 8.5 times earnings before interest, tax, depreciation and amortization, or Ebitda.
LifeCare asked banks to change the loan terms to allow Carlyle to invest more money in November. They [the bond vigilantes] demanded a $2 million payment and raised the interest rate on $250 million of loans by 1 percentage point to 4.25 percentage points more than the London interbank offered rate. The increased interest will cost LifeCare an extra $2.5 million a year.
Tropicana borrowed $3.1 billion a year ago to help fund the takeover of its parent Aztar Corp. by closely held Fort Mitchell, Kentucky-based hotel owner Columbia Sussex Corp. Chief Executive Officer William Yung promised lenders the company would retain its casino licenses.
The New Jersey Casino Control Commission revoked Tropicana's gaming permit last month, citing "lack of business ability, a lack of financial responsibility and a lack of good character, honesty and integrity."
Tropicana's lenders agreed on Dec. 21 to delay a declaration of default on $1.34 billion of loans in return for a $7 million payment and a 3.6 percentage point increase in the interest rate to 10.5 percent, costing about $48 million more a year, regulatory filings show. The company also pledged to sell the Tropicana in New Jersey and casinos in Indiana and Mississippi to repay the debt.
"It was a bad time" to be seeking a waiver, said Derek Haught, vice president of finance at Columbia Sussex. "There was pushback from lenders."
"Anytime you need to go a bank it's a problem right now," said Jonathan Rather, general partner and chief financial officer of Welsh, Carson in New York. "Banks are going to extract some flesh. They have to."
the whole article suggests that the world is a zero sum place. there is only so much money.
ReplyDeletepure baloney. there is only so much productivity and resources - money is just a means of exchange.
with huge population growth and rapid extraction of resources, the real wealth grows all the time - thus we need more means of exchange, that being money.
Of course fractional reserve has been dangerous and clearly the current crunch shows that issuing too much money is a danger - no real surprise here.
This does not mean the end of everything; even though it will mean a nasty recession as part of the correction.
Thanks for that. You see the creation of wealth as infinite? That's an interesting take.
ReplyDeleteJames: if cityun wasn't correct, we wouldn't be where we are now.
ReplyDeleteLong long ago, we would have run out of 'riches' and the world would have ended (minorities and poor hardest hit) etc.