Western Credit Finally Dries Up

Bill Bonner - Fri 21 Dec, 2007

Yesterday didnt bring any big news. The important story remains the same: The tide of cash and credit is receding.credit is drying upand credit-driven markets are falling. Housing hit its high-water mark last year. Its been going down ever since. Stocks, too, reached a level that was equivalent to a 40-year flood this year. The larger story on stocks is that they hit a flood-tide high three times in the last century in 29, again in 66, and finally in 99/00. What weve seen this year was merely a follow-on gush of liquidity. In terms of gold, the euro, or real dollars (adjusted to consumer price inflation), stocks were actually down from their January 00 level...

The First Day of Winter

Well, it doesn’t seem like winter down here. Because it’s not winter; it’s the first day of summer in the Southern Hemisphere.

Here at the Daily Reckoning, we tend to be skeptical. Someone tells us something; we don’t quite believe it. There’s always a different angle…and always more to the story.

Since we were little, we’ve been told that the earth was round and that the people on the bottom don’t fall off because of ‘gravity.’ Well, now we can report that it is true. Or, at least it seems to be true. Newton and Copernicus were right…the celestial system works just as they said it did…more below…

But first let us turn to what makes the world go ‘round – money. What’s new in the world of money?

Yesterday didn’t bring any big news. The important story remains the same:

The tide of cash and credit is receding….credit is drying up…and credit-driven markets are falling.

Housing hit its high-water mark last year. It’s been going down ever since.

Stocks, too, reached a level that was equivalent to a 40-year flood this year. The larger story on stocks is that they hit a flood-tide high three times in the last century – in ’29, again in ’66, and finally in ‘99/’00. What we’ve seen this year was merely a follow-on gush of liquidity. In terms of gold, the euro, or real dollars (adjusted to consumer price inflation), stocks were actually down from their January ’00 level.

Of course, we’ve also seen high water records set in markets all over the world. Many emerging markets hit all-time highs. Many stock markets are still near all-time highs. So are many peripheral markets. Shares in Sothebys, the celebrated auction house, ran up 600% from 2003 to 2007. A tide of liquidity floats heavy boats…as well as a lot of light, trivial trash. Nothing is more insubstantial than contemporary art. Now it too seems to be coming down; the art market itself reached a peak this year.

Likewise, gold is near an all-time high. Oil seems to have hit its high at almost $100…and has since eased off. The commodity index is in record territory still. But there are different types of commodities. Industrial commodities – copper, iron, tin – peaked out back in May. Agricultural commodities are a different story…about which, more in a minute.

Certain marginal tidal basins and low-lying marshes have already been left high and dry by the receding waters. House builders, house financers, and financing generally have dried up. Big financial stocks – such as Merrill and KKR – are down nearly 50%. Here is where the story has been most exciting…and most alarming. Because investors and lenders don’t know how much liquidity these outfits have left. Often, they don’t know themselves. Many of the derivative contracts they sold to others, and sold to themselves, were never ‘marked to market.’ Instead, they were ‘marked to model,’ mathematical models with deep, obvious flaws. Worse, many were ‘marked to make-believe’ in a way similar to sub-prime mortgages themselves. The borrower lied about his income, his assets, his age, his employment, his marital status and how many points were on his driver’s license. The appraiser lied about the value of the collateral. The lender lied about the terms and conditions of the loan. And then Merrill, or Citigroup, or Goldman lied about the quality of loans generally…and Moody’s backed them up!

As we noted yesterday, in the heyday of the credit bubble, bank robbers set aside their handguns and ski masks; it was easier just to borrow the money like everyone else, and not pay it back.

Investors knocked MBIA shares down 25% yesterday, after the big financial product insurer disclosed that it had $8.1 billion in exposure to sub-prime debt.

Investors are now reluctant to put money into lenders. And lenders are reluctant to lend. This is the basis of the ‘credit crunch’ you read about. And it’s what is worrying central bankers. It is why the Fed cut rates again this month…and why, this week, the European Central Bank put up an extraordinary half a trillion dollars to try to get cash moving.

Here is where we find the dramatic tension in our story…the War of the Titans…the Clash between Unstoppable and Immoveable Forces…the Battle the Market and the Manipulators…

Will we get the widespread correction the market seems to want? Or will the feds manage to get enough liquidity in the system to keep things wet and slippery? Inflation…or deflation?

Our stock answer is ‘yes.’ We will get them both. Everything in due course…

More news:

'Twas the Night Before Christmas (give or take…)
By Mark Siara

A lyrical look at some of the financial and economic events of 2007, with sincere apologies to the memory of the wonderful Clement Clarke Moore:

Twas the night before Christmas and all through the land,
The people were crying and wringing their hands.
The roads are all flooded, the train network’s slow,
Christmas shopping’s a nightmare wherever you go.

But the year’s almost over, so let’s spend some time,
And talk about oil and gold and subprime.
And Mister Bernanke who thinks it’s okay
To let the old Greenback just slip slide away.

He followed old Greenspan, kept interest rates low,
To get a high yield, where’s the money to go?
We’ve got an idea, said financial whiz kids
We’ll lend it to people who are on the skids.

That’s great, said the bank CEO’s
We’ll sell MBS, CDS, CDO’s
But how can we sell them? They’re worthless for sure,
Step right this way Moody’s and Standard & Poor.

So everything’s alright, they’re doing just fine,
Until house prices fell into decline.
The defaulting homeowners are in such a fix,
What’s this paper worth now? The answer is nix.

Now Spector! Now, Wuffli! Now, Prince and O’ Neal!
We’ve heard all the Wall Street firms’ shareholders’ squeal:
You’ve lost lots of money, you’ve made some bad calls
Now dash away! Dash away! Dash away all!

But before British traders could even take stock,
Came a run on a bank by the name, Northern Rock.
Then Mervyn and Darling entered the mix,
‘Cause Gordon Brown wanted a quick fix.

The man’s chubby and plump, like a jolly old elf,
And I cry when I see him, in spite of myself!
That glint in his eye and that nod of his head,
Means the UK consumer should be full of dread.

The man who was Chancellor and is now PM
Thought his prudent policies worked like a gem.
But inflation threatens and we’re all in debt
With house prices falling, how bad can it get?

There are not the same problems for all of the rest
Those booming economies, the World Without West.
But don’t jump in now, you’ll be asking for trouble
Their stock markets’ rise has the look of a bubble.

Let’s buy raw materials, everyone cries
So oil, wheat and platinum continue their rise.
They’re climbing more quickly than anyone thought
Now some say commodities are overbought.

So let’s ask an expert with a global view,
He’s been making toys now for a good year or two.
Exports all over the world and he understands
The need for a very strong marketing brand.

As he came down my chimney I wanted to know,
If Santa had money, then where would it go?
But he turned with a wink and a tap of his nose
And before he could speak up the chimney he rose.

Up over the rooftops St. Nicholas flew,
And I looked and I wondered how much Santa knew.
Then I heard him exclaim, as he flew through the cold,
"Happy Christmas to all and remember – buy gold!"


And more thoughts from Bill:

*** “Food prices soar in America,” says one headline. The price of milk, we discover, has gone up nearly 25% since the beginning of the year.

We can see the cold, miserable crowds gathering in front of the White House already.

“Our children have no milk,” say the impoverished ones.

“Then, let them drink diet coke,” comes the answer from the West Wing.

No, that is a scene you are not likely to see. Today’s politicians always have a soft word for the lonely, the poor, and the disheartened. And then they have a solution! Right this minute there is probably some nerdy staff worker figuring out a bill that will end the ‘milk crisis.’

You see, dear reader, in this age of Win-Win Capitalism politicians cannot permit real capitalism to work. They cannot leave bad enough alone. Got a problem? They will figure out a solution…so we all come out winners.

The trouble is that the government’s solution to one problem is the cause of two more. The feds man the pumps 24/7 to try to keep the consumer economy from drying up. But the extra liquidity drives up consumer prices!

(Here we pose the problem in philosophical terms: if you could really solve problems by passing laws and printing money…wouldn’t we all be rich and happy by now?)

Meanwhile, in China, food prices are rising at 18% per year. Officials fear ‘social unrest.’ But what can they do? Well, they can take a page of Richard Nixon’s playbook; they can put on price controls. And they can put up interest rates too; now at a nine-year high.

But where’s the Paul Volcker of Beijing? And how can the Chinese stop the flood of money coming from their main customer – the United States of America? It is that very cash coming from North America that is the source of China’s rising food prices. It is also the source of China’s rising wealth. When the money stops flowing, it will be as if the Yangtze had dried up…and the Good Earth is no longer quite as bountiful as it had been.

Of course, when the money stops flowing from the US consumer the whole world economy is likely to feel a little dry and thirsty.

*** We’ve crossed the equator five times in the last three weeks, going back and forth to South Africa, Australia and now here. In each place, people walk around just as they do north of the equator. Trees grow up. Balls bounce. We’re no experts, but it looks like Copernicus and Newton were right.

And yes, it is summer down here. The sun is almost directly overhead at noon. It is hot. The leaves are out on the trees. People dress in light, summery clothes and run air-conditioners to keep cool. Again, we don’t know what really happened, but the southern hemisphere seems to have tilted towards the sun, while back in the northern hemisphere, it is cold with the sun’s rays low in the sky. In London, when it is not raining, the sun barely clears the tops of the houses. You have to go out into parks and open spaces to see it at all. So, yes, the whole story hangs together. The earth goes around the sun…is tilted on its axis…and gravity makes it feel like up is over your head, no matter where you are on the planet. 

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