Nov. 20th, 2008

peterbirks: (Default)
I went into Lewisham yesterday to take my shoes in for repair and to buy a mop -- since my cleaner seems so efficient with the cleaning that a mop I bought only six months ago is on the verge of disintegration.

The mop shop had closed, but I did spot a "nothing over a pound" store. I wandered in and, betweeen the no-brand shampoo/washing-up liquid and the rather dubiously-coloured soap was a new range -- retail companies in the shit. I declined to buy Woolworths, but I might pop in there in January to see if Marks & Spencer's is on offer.


"Lifeline for small companies" is the lead in today's Financial Times.

"Alistair Darling is to underwrite new loans to small firms as part of a package of measures to help the sector", the article continues.

Which is all very fine, except that, as Robert Peston points out this morning, the net debt of small companies in the UK is, wait for it, zero.

In fact, throwing a lifeline to foolishly indebted small companies is grossly unfair to the prudent small companies that have not accumulated debt. Just crying "it's a cashflow problem! We are profitable" is not enough. There are small companies out there that are profitable and which do not have a cashflow problem. Why should they suffer for their prudence in cash conservation?

What it's all really about is "throwing a lifeline to bigger companies", who depend on lots of smaller companies surviving. The bigger companies in the UK most certainly do have net debt -- about 120% of the UK's gross domestic product, according to Peston.

The thing is, although Gordon Brown can say with a straight face that "we will take all measures necessary to help small businesses get the loan capital that they need", even though this is very unfair on prudent small businesses, what he cannot say is "we will take all measures necessary to help big businesses get the loan capital they need".

That's a rather harder sell to the public, which remembers multi-milion pound bonuses to CEOs, chauffeur-driven BMWs and parties in Monaco.

The other matter, and it's not a minor one, is that putting together a piddling scheme to lend to the minority of small companies that stupidly got themselves into too much debt is feasible; to put together a gigantic scheme that guarantees, say, all the banks, all the motor industry, all the building industry, and so on, is rather more problematic. Hell, even the US is now in the dificult position of explaining why the $700bn largesse that it struggled so hard to get is actually just a piece of piss in the ocean.

All of which is rather odd since, as you may recall, I stick doggedly to my theory that only $300bn or so has actually been "lost" as a result of the subprime lending lunacy.

Why is $700bn all of a sudden so ineffective?

Basically because we have three separate factors at work here, and various interested parties are trying to merge them into a single conceptual sludge for their own gain. No-one, for example, could claim that General Motors needs money because of dodgy lending to subprime borrowers. GM wants money because if it doesn't get it it will run out of cash in three months, and it will run out of money because (a) we are heading into recession and (b) it owes bundles of cash that it can't roll over into new loans.

GM, in other words, is in trouble now because it should have gone broke years ago, but only the new reality of tight credit has brought the matter to a head. The subprime lending was an example of easy credit, the survival of GM was the same. But the imminent demise of GM is nothing to do with the money that's been lost on dodgy home loans in the past. It's more to do with the fact that there won't be any more dodgy loans in the future. GM, as it were, relies on people buying cars with borrowed money.

So, working backwards from the most recent developments, problem 1 is a recession caused by an end to easy borrowing. This is a fundamental economic situation that affects the whole economy and is one which we have suffered before, although the triggers have varied (in 1973 it was the oil price, today it's the end of the easy credit years). The standard Keynesian solution will be to print money and that, in the end will wipe out debts and screw the savers.

Before that we had the solvency crisis. This was the bit where people realized that banks were not just suffering liquidity problems because they didn't know where the toxic sludge was, but that several of them (the ones where the toxic sludge was) actually had solvency problems. The solvency crisis had two parts -- a fundamental solvency issue (see the $300bn above) and a mark-to-market solvency issue, which was probably in the region of $2trn to $3trn (and this number was the one relevant to the US government's TARP figure of $700bn). Some banks that had probably "really" only lost about $10bn out of their capitalization of $30bn or so, might go broke because mark-to-market rules meant that, technically, they owed $40bn tomorrow. This might be called "Long Term Capital Management" insolvency.

Before THAT we had the liquidity crisis -- halcyon days not more than a year ago when some people actually believed that if you could just reinstall confidence, everything would be fine.

Paradoxically, the liquidity crisis is now easing. As the solvency issue makes it clearer in the financial sector who is in the shit, so LIBOR comes down, because if you know that bank X is in deep trouble because of the toxic sludge it owns, that makes it less likely that bank Z is going to go broke (because there isn't an infinite amount of toxic sludge). So, whereas before you wouldn't deal with anyone, you are now willing to deal with bank Z.

Where the liquidity crisis is now manifesting itself is outside the financial sector -- in retail, in building. Credit insurers are pulling in the reins, and that makes things tough for a number of non-financial players. Eventually this too will work through the system (as it is doing now in finance), but we face a ride as rocky in the non-financial sector (perhaps rockier) than we did in the finance sector. None of this is anything directly to do with the lost $300bn. It's a lack of trust based on fears for the economy as a whole in the future (what people will spend tomorrow) rather than what people spent in the past (the money that they borrowed to overpay for houses that they can't afford).

Which brings us back to the recession. Here we are not talking about $300bn that has been lost, but on the amount that will be lost because of a contracting economy.

Now, world GDP is about $66trn a year. If the markets had been expecting 2% growth year on year, but comes up against a 1% contraction next year and a flat 2010, that gives us a "real" loss of $200bn in 2008 ($66bn lost and $132bn not gained), followed by a $338bn loss in 2010 (the amount lost in 2008 carried over, plus the amount lost in 2009). Continuing forward, the loss from what might have been carries on at increasing "might have been" levels that only gets cancelled out when growth gets back to more than the long-term average.

So, adding all that up, we have a $300bn or therabouts loss on money already spent that won't be paid back (the subprime crisis), a further $550bn or thereabouts lost (by 2011 alone) because of GDP that we won't get that we thought we would get, and somewhere in the region of a $3trn mark-to-market termporary hiccup which is really little more than everyone hiding their money under the mattress for a year or so. The trouble is, you can't print an extra $3trn to cover that money because (a) people just hide that under the mattress too and (b ) when they take it out from under the mattress, that means you have $3trn more money chasing $900bn less GDP. In a GDP land of $65trn, that effectively means you devalue money by 6.5% or thereabouts overnight.

If you punch 6.5% of inflation into the ecomony in a couple of months, you are likely to change inflationary expectations very quickly.

What you would really like is short-term money. Print new cash on a use-it-or-lose it basis, which can be exchanged back for "real" cash on an amortized basis over the next two years, at which point it becomes worthless. That way you could pump money into the economy and banks/people would have to spend it as soon as possible.


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