A Glimpse of the Apocalypse

Today’s New York Times has a front page story that features the concerns of the Chinese premier over the US’s ability to pay the trillion US dollars it owes Beijing. They seek assurances that the money won’t go up in smoke. As a friend of mine much smarter than me once said, “They’ll get their dollars back. Can’t promise what those dollars will be worth.” The point is (obviously to economists) that the best way for a nation (from its’ point of view) to pay off deft is to inflate the currency.

Unfortunately, this is rarely the lenders’ view. Should the Chinese stop loaning us money, the price of our bonds would have to fall so someone would want them. Uncle Sam’s crazy bond blowout! Prices so low, it’s insane!

Brief note here. As the price of a bond falls, the interest rate goes up. The dollar denomination is what you get at the maturity of the bond, either months or years from now. Here’s how it works:

I loan you $90 for your offer to pay me $100 in a year. I earn $10 for my trouble, so I get (10/90=0.11) 11% interest.

Later, I loan you $80 for your offer to pay me $100 in a year. I earn $20 for my trouble, so I get (20/90=0.22) 22% interest.

Much later I loan you $70 for your offer to pay me $100 in a year. I earn $30 for my trouble, so I get (30/90=0.33) 33% interest.

Get it? The cheaper the loan (basically a 1 year $100 bond) the higher the interest. And while the full $100 has to be paid on all three loans, until the end of the year (the maturity), the first guy is screwed if he needs his money sooner, since no one will give him the $90 he loaned, just the $70 the last guy got.

Throw in the higher inflation inevitable with falling bond prices, voila! You see why the Chinese have their knickers in a knot. They can sell (or just stop buying) and the value of their holding will fall in dollar terms immediately, or they can hold on and have the value of the dollar decline, getting back at maturity the right number of dollars, but much less value in what they can buy with these new smaller dollars.

Got it? Good.

Basically, we all know that the US Treasury isn’t like Scrooge McDuck’s basement, with piles of cash and gold lying around. To fight the Iraqi war, bail out the banks and stimulate the economy, we’ll need to borrow the money from guess who?

As noted previously, most Americans never saw this thing coming. Imagine being Chinese! They didn’t have a market economy the last time a nasty spell came around in the early 80’s. Yours truly was moving furniture for $3 an hour with an Economics degree from Trinity College. My friend who cleaned the Slurpee machine at 7/11 wasn’t a Pakistani immigrant. He was a native Californian with a Doctorate in Physical Chemistry.

I’ll be 50 this month, so I remember the hard times and have been cautious about risk, markets and debt. Any American under 50 never saw it first hand. Any Chinese of any age has never been through this. It will become very political, very contentious and very dangerous when 100 million newly middle class Chinese get sent back to the rural villages.

May you live in interesting times.

The new reality

There’s no way in hell that the economy we enjoyed for the last 25 years is coming back. No amount of stimulus, tax cutting, free trading or anything else can bring it back. It was an unsustainable bubble created by a deregulated FIRE economy (finance, insurance and real estate), denial of risk and an unprecedented use of credit and debt. It’s amusing to watch the pundits slowly catch on, but only ever so slowly.

The economy of the last 25 years is no more going to bounce back in a year or two than the NASDAQ. It was widely believed in 2000 that the index would be back to its’ peak in a matter of months. I was literally laughed at for saying it could take a decade. Looks like I might have been too optimistic, since at under 1600 it’s off its’ peak of over 5000 by what, about 70%? How’s that Enron stock holding up?

So in my view it’s a given that credit will be very, very much more rare in the future. I’m not sure the credit card companies will be able to survive it, but the rest of us will manage to muddle through. Once again, one will have to save up to buy a car. Doesn’t say much for demand for new cars does it? Sorry Detroit.

Same for flat screen TV’s, video games, computers, MP3 players, cell phones and all the other extras we’ve come to believe we not only need, but deserve. Sorry China. Sorry Best Buy.

I expect to see a lot more cohabiting, and hopefully more niceness. When everyone is skating on thin ice financially, wouldn’t it be nice to see acts of kindness as self-insurance in the case that your situation falls apart? It’s going to be easier to crash in someone’s spare room and help with the rent if you did the same for them before your situations reversed themselves.

Here’s another thought somebody clever will come up with- a value menu at local restaurants. You know, rice and beans for a buck. Maybe takeout only. Maybe with donated ingredients. Food will definitely be viewed and consumed differently. The fast food industry is going to either adapt and change or go the way of the dodo.

The other thing will be housing. There already exists a huge number of foreclosed and vacant houses in America. It’s in nobody’s best interest for them to remain vacant. They represent a nearly worthless asset to the banks that seized them. I believe there’s a great business opportunity for someone to manage renting out rooms in foreclosed houses and getting people housed, as well as getting the banks something for their investment.

Hello? Underemployed real estate workers this is your opportunity!