Juggling Dynamite

Fear about soaring inflation and plunging growth are becoming increasingly palpable in world leaders both in business and politics.
Today the Bank of England's new chief economist Spencer Dale warned that the UK is facing its toughest economic prospects in over a decade, as unemployment increases at the fastest rate since 1992: See: Bank of England chief sees rocky ride ahead for the economy.
And Spain's finance minister Pedro Solbes stunned markets with an admission that his country faces the worst economic crisis in its history as the full effects of the property crash spread through the economy.
“This crisis is the most complex we have ever lived through given the plethora of factors on the table at the same time,” he told Punto Radio in Madrid, breaking with past efforts to put a reassuring gloss on events.
Mr Solbes said the Madrid bourse [stock exchange] had suffered an “earthquake”, crashing 27pc since the start of June. He blamed the toxic cocktail of high oil prices, the global credit crisis and the sharp slowdown in the key export markets of North America and Germany. See Spain drops reassuring gloss as crisis deepens.
This week the Bank of Canada and our minister of finance gave a fairly upbeat report on the Canadian economy, but both acknowledged that Canada cannot hope to be immune from the ongoing global slowdown and our risks to the downside include:
• Inflation could take root more easily in Canada if potential growth is lower than the bank assumes.
• Global inflation may drive up costs of imports more than expected.
• Commodity prices could tumble.
• The U.S. downturn could be worse than expected and hammer Canadian exports.
• Financial markets could further hurt credit availability in Canada.
As I was explaining in a series of CBC radio interviews across Canada this morning, in the global business cycle Canada is a lagging economy. Our growth and stock market tends to turn down later than the US and other countries. This means that at the end of each cycle while other countries are already in distress we are sort of oblivious to the coming storm even as it hovers over us. Our resource rich and export dependent economy makes our growth greatly tied to the present downturn in world consumption. So Canada is not above or insulated from contraction periods; we're just latent.
A clip of my CBC Calgary “Turbulent Times in the Canadian economy” interview can be heard for a limited time on the CBC Calgary Eye-opener web site here.

Over the past 36 hours, equity markets have been staging yet another relief rally. Days and even weeks of counter-trend rally are typical within on-going bear markets such as the present cycle. Bear markets typically grind investors down in fits and starts of hope and fear a few times, before a final wave of desperation selling brings the ultimate capitulation and a lasting bottom.
This recent swing of hope has come on falling crude prices and some better than expected earnings reports from a couple of companies such as investment bank JP Morgan this morning. But even while JP Morgan executives reported on a better than anticipated second quarter, the company sounded strong warning bells over growing trouble in the US mortgage market. Soaring defaults on sub-prime mortgages have been a big problem over the past 18 months, but it seems the next and likely bigger default wave is now underway: defaulting prime mortgages.
CEO Jamie Dimon was trying to prepare analysts and investors for the next wave of losses: ““Prime looks terrible,” he told analysts on the call. “And we’re sorry, and there’s nothing else we can say.”
“Dimon was clearly trying to temper investors’ newfound enthusiasm with a dose of market reality:
“Our expectation is for the economic environment to continue to be weak – and to likely get weaker – and for the capital markets to remain under stress,” he said in a press statement. “We remain conscious that since substantial risks still remain on our balance sheet, these factors will likely affect our business for the remainder of the year or longer.” See: JP Morgan's Dimon: prime mortgages look “terrible.”
The tragedy of this over-juiced credit cycle has been that even many hard-working, otherwise stable people have been suckered into jeopardizing their financial health with habitual over-spending, negative savings and soaring debt. Default rates are now spreading from sub-prime to prime, from residential to commercial real estate, to credit cards, student loans, auto loans, to municipal and corporate bonds and on throughout the entire financial system.
This is the reason this downturn and market correction are poised to last longer than the average bear.

A colourful and honest rant on the Big Picture this morning is a refreshing read: Idiots Fiddle while Rome burns: ” This is financial incompetence writ on a scale far grander than anything seen for centuries”.
It reminds me of something I have been asking my speaking audiences for several months now: why are regular people and investors not mad as hell at banks, brokers, regulators and our so called leaders? Capital markets have had plenty of dumb, wasteful and greed-fuelled disasters in our history, but recent years will go down as one of the more epic episodes. Ritholtz puts it very well:
“Books will be written about this period of time, and our descendants will wonder in awe as to how this was allowed to happen. Tulips got nothing on us! It’s not just the total dollar value of the losses that have exceeded all other global fits of financial madness combined, but rather, how so many warning signs were so blithely ignored by so many and for so long. What was wrong with these people, the authors and historians will wonder. Did the antibiotics in the food supply drive them mad? Did the High Fructose Corn Syrup compromise their ability to think? Some form of viral plague? Roid rage? What else could have created such a mass delusion amongst not just the populace, but their leadership and institutions? ”
Two years ago I wrote that watching this insanity unfold around the world was like being the only sober one who points out that their family members are becoming drug addicts. While they are still in denial, others may shun you as judgmental and alarmist. But when the inevitable hell does break lose, others are shocked and want to know how you saw disaster looming.
The proverbial hell is now breaking lose. In a well reasoned series of articles over the past several months, RGE Monitor Nouriel Roubini – Chairman of RGE Monitor and Professor of Economics at the NYU Stern School of Business – has argued that the U.S. is experiencing its worst financial crisis since the Great Depression and will undergo its worst recession in the last few decades. It is useful to read his recent summary of the fall-out and ramifications for capital market investors here. Please do read it.
And before we Canadians give a smug glance at the reckless US, we must see that we too have succumbed to folly and reckless indulgence over the past few years. Our national saving rate has been falling since 1980 and was virtually zero the past couple of years.
Our national mortgage insurer CMHC last week announced it was tightening lending standards in Canada to “avoid a US like real estate bubble”. But recall that it was only a couple of years ago as Canadian real estate soared that the same CMHC watered down all rational standards and opted to guarantee 0% down, 40 year amortization mortgages in the first place. This added fuel to already over-heated markets. They did this following the US model and pretty much in line with the peak of bubble housing prices. What the hell were they thinking? Where are our sober leaders and keepers of the public trust when you need them? Their well-meaning regulatory revisions now are reactive, and perfectly timed to exasperate the credit crunch from here.
Economist John Kenneth Galbraith once wrote: “who is to make wise those who are required to have wisdom?”
Free markets are a nice idea, but in the end our laws must set out minimal standards of governance to reign in our human tendency to wanton spending and self-destructive behaviour. Most regular citizens don’t know what is best for them in this. It is up to the government to set rational, paternalistic limits on the financial sales world. We do it on drugs, cigarettes, gambling and alcohol use. There is a societal interest in limiting our use of credit and risk too. Self-preservation demands that we do. Our myopic, profit-hungry financial institutions and banks are certainly not the ones to set the rules on this. Dressing a shark in a flashy suit and tie does not make them any less of a shark.
For the past few years we have literally borrowed consumption from the future and spent it. Now comes the inevitable pay-back and growth going forward must suffer the consequences. We have had a systemic failure of good judgment. The cost to clean up the mess will be great. Hopefully we will learn and retain (at least for a while) some valuable wisdom.