Con-tango

How long?

Paul Krugman. Economist
Courtesy of The Rolling Stone Magazine

Congrats to Paul Krugman on his Nobel prize. Now, this is his view of what’s coming:

Just this week, we learned that retail sales have fallen off a cliff, and so has industrial production. Unemployment claims are at steep-recession levels, and the Philadelphia Fed’s manufacturing index is falling at the fastest pace in almost 20 years.

All signs point to an economic slump that will be nasty, brutish — and long.

How nasty? The unemployment rate is already above 6 percent
(and broader measures of underemployment are in double digits). It’s now virtually certain that the unemployment rate will go above 7 percent, and quite possibly above 8 percent, making this the worst recession in a quarter-century.

How long? It could be very long indeed.

I also have a pretty dim view of what’s coming…

It’s only natural that if credit liquidity dries up, economic activity slows down. And, we are coming down from the most expansive credit peak that history has ever known, fueled by the exuberance of some derivatives, but, of one ‘credit default swap’ gem of a financial instrument, in particular.

I can’t get myself to shoot the CDS bastard in the head, as my feelings demand. Unregulated, uncovered insurance, exerting unbridled exuberance bank lending, all the way to $62 trillion USD. This wretched financial contraption brought out the worst from traders, bankers, insurance companies, and why not, mongrels of all sorts that must’ve taken insurance on their companies debts with full knowledge that their companies were doomed.

The criminal possibilities involved are better understood if you think of a CDS as an insurance on a house mortgage debt, –which by the way, do exist.

First, since nobody had ever offered this kind of insurance before, it was one hell of a profitable business to collect premiums at an average 2.5% of the value of the debts, or $1.5 trillion premiums off a $62 trillion debt. And, the cherry on the cake: there was no collateral requirement to sell this type of insurance.

Second, it’s one hell of a payback to take an insurance on a house, pay the premium, light it up, see it burn to cinders, and collect the insurance. And, as I’ve explained, this was the weakness of the banks involved in selling CDS, which attracted shark attacks, whom shorted bank’s stock as well as bought its CDS to collect the huge insurance involved in a bank debt default, as in the Lehman case.

I also want to stress that the insurance of debts has a wonderful side, it makes credit cheaper. So, CDSs are in fact a gem of an instrument, within the regulations and oversight of an appropriate exchange.

But, I’m getting sidetracked. The underlined issue is that world
liquidity is contracting from dizzying heights, so economic activity
must contract accordingly.

Although, there is the question of how far will the waters rise as a consequence of the central banks spigot opening?

My first thought is will the US consumer purchase of Chinese low price exports, and Chinese buying of US Treasuries cycle stop? I don’t think so, because the original low Chinese labor price condition persists.

If this is the case, then a good percentage of this CB infussion of liquidity should end in places like China, India, Malasya, Thailand, Vietnam and alike countries; where there’s still plenty of this cheap resource, without the western companies entanglement in expensive legacy union negotiated labor contracts –where GM and Ford are good examples.

So, deterioration in the west should continue, through periods of inflation and depression, till the arbitrage in the east-west labor prices adjust to equilibrium. In the meantime, we build houses… I’m sorry, we repair roads and infrastructure funded by the government…