When Debt comes calling by Sarel Oberholster

[c1ue]

Re: When Debt comes calling by Sarel Oberholster

Liquidity creation will not stimulate unless a debtor of quality can be found

Mssr. Oberholzer,

Thank you for joining and contributing to this forum.

The statement I quoted from your post - above - is interesting.

From your point of view, what might the list of such 'debtors of quality' look like?

It seems to me that there are no longer ANY classes of individuals nor institutions within the United States which would fall into this category - that in fact the only such possible entities are:

1) US mercantilist subject allies - Japan as prime example
2) US mercantilist partner/rivals - China as prime example
3) US geopolitic rival/economic disassociates - Russia as prime example
4) US geopolitic partner/economic partners - EU as prime example

Note that I subsume the sovereign wealth funds as extensions of the above nations.

Even given the global nature of this list, it would appear that 2 or more of these categories would need to cooperate in order to bankroll the debt inflation of magnitude sufficient to turn the tide.

Your thoughts?

[Sarel]

Re: When Debt comes calling by Sarel Oberholster

You're welcome Sapiens.

c1ue here goes.

The basic definition of a debtor of quality is one that has the cash flow and the collateral for the debt. Lenders would sometimes accept one of the two if it is strong enough. The beauty of asset inflation flowing from liquidity abundance is that it creates for a time a positive self promoting cycle where the asset inflation actually facilitates the debt absorption. This process is infinite in theory but requires the suspension of the cash flow requirement. This suspension is limited and will become a drag on the process. Thus a person may be able to service a debt on $5000 pm and will even be allowed to over extent the actual income stream but at some stage a cash flow default risk will agonise lenders. Same principles apply to larger entities. Lenders do not relish the prospect of large scale foreclosures. That will always become a deterrent towards the end of an asset inflation cycle, which will then team up with initially stagnating asset prices and probably asset price deflation. The process would now become a vicious cycle downwards. Thus a debtor of quality will be one that can sustain both the cash flow and collateral of each level of debt taken on. It also requires a debtor willing to play the asset inflation game.
Human will is a powerful force. Before we play the speculation game we need to understand that every effort will be made to avoid the asset deflation outcome. Humans love the up and will fight the down with survival instinct. Now we play the speculation game. An area that I have not had chance to investigate to a large extent is for the liquidity to find its way into developing countries. The desire to look for “yield pick-up” makes investing in developing country debt an attractive option. How many willing Developing Countries are there to take on an infinite supply of liquidity? How many resource rich Developing Countries now has the appearance of having strong collateral? This is an “asset class” that can in fact sustain a vast asset bubble. Add Eric’s energy and infrastructure views to this and perhaps there is potential for a new wave. Add more such ideas and asset inflation can win another round but what then? Every asset inflation cycle takes us closer to the abyss and solves no problems. Near the end it will show in grossly distorted trade deficits. An over extended country is just as much a bad debtor as a sub prime borrower. Also expect rational self interest to play its part. Corroboration and co-operation will be a natural survival behavioural pattern. I have dealt with the trade deficit issue in my essay. Here’s how looks presently (I have also added it as an attachment). Another exponential curve. Perhaps even that bubble has already matured?
Chart compiled by Sarel Oberholster from data obtained from the South African Reserve Bank statistical service.
That is what my essay was about, do we proceed with asset inflations or do we set a new course? The lesson from history is not a friendly one.

[metalman]

Re: When Debt comes calling by Sarel Oberholster

Thank you for appreciating the essay and your kind comments. I am still searching for answers and a debate is great for opening new thought patterns. I wear my trading scars from underestimating the powers of government. I also believe that intervention will increase rather than decrease. Creating new asset classes to inflate would certainly be an option and it will no doubt be effective. What I did find is that the ability of the markets to absorb more debt has an absolute nemesis in credit quality. Liquidity creation will not stimulate unless a debtor of quality can be found. The next condition is that the collective effect of the sum of new asset inflations must exceed the collective effect of the sum of old asset deflations. The monstrous size of the housing market will not be easily counteracted. I am a bit uneasy to make predictions during the current phase which I perceive as an aggressive high intervention phase. I do expect this phase to be followed by a more defensive phase in which damage control will become more important. My essay was meant to stimulate speculation on the outcome scenarios of the intervention phase, which I personally believe is undecided at this point and subject to the intervention routes to be adopted. It is in the cause and effect nature of those choices that the outcome will be decided. In this I also found that the depression in the highly indebted ffice:smarttags" />:place w:st="on">Germany:place> after 1929 was certainly a match and more for the depressions in other economies. It was thus not prudent in my analysis to conclude that the debtor nation (importer-on-credit) will never be faced with the depression outcome. I will most certainly get a copy of “The Next Bubble” as this subject is close to my heart.

welcome! great essay. i joined itulip in 2001 just after their post bubble recession forecast of coordinated government "reflation" started to kick in. .. what you call intervention. maybe we can call it counter intervention since the original asset inflation was caused by government activity in the first place. itulip also underestimated governments in 2001. this next bubble piece is i'm guessing the lesson from that error. there are two possible outcomes: for the housing bubble... inflationary depression or new asset inflations. let's call ej an optimist then for calling for new asset inflations. the other principle (he talks about this in the select area) is that governments can't re-inflate old bubbles but can move the game to a new asset arena... in the process a fresh new pool credit-worthy borrowers is made.

[c1ue]

Re: When Debt comes calling by Sarel Oberholster

How many willing Developing Countries are there to take on an infinite supply of liquidity? How many resource rich Developing Countries now has the appearance of having strong collateral? This is an “asset class” that can in fact sustain a vast asset bubble.

Mssr. Oberholzer,

Thank you for your further thoughts.

It is true that there are countries who fit the definition of 'debtor of quality'; perhaps the dichotomy between my thoughts and Eric Janszen's is my belief that said possible debtors would not be lured into yet another bubble - coming so closely after their negative experiences with the presently passing one.

However, it is equally possible that said possible debtors may not have a choice in doing so; that these nations are more willing to accept a later greater default than to preside over failed or incomplete 'economic miracles' now.

Were said countries democracies, I would whole-heartedly agree that reflation is inevitable; however given that these nations are not I still cleave to the belief that the better long term course will be taken - by China, if not by India.

The Gulf Coast nations are also not democracies, but their implicit bargain with US military protection does lend weight to the possibility that they will be complicit in a reflation as well.

I will redouble my monitoring of the behavior of these possible debtors of quality to see which direction will be taken.

[jk]

Re: When Debt comes calling by Sarel Oberholster

assorted comments on this thread [i'm just back from a week away, so this is catch up]:

1. re the so-called "captive bid" of social security: the social security "surplus" just points to the fact that currently social security tax receipts are greater than social security payments. under the unified budget used by the federal government, this reduces the current deficit and thus reduces federal funding requirements. fewer treasury bills/notes/bonds are issued and thus rates are somewhat lower than they would be otherwise. basically, the "surplus" could be replaced by any other source of revenue - income tax, tariff, value-added tax, with the same effect on funding requirements [leaving out the impacts on the economy and thus indirect effects on future receipts].

2. re "debtors of quality": isn't every government, at every level, a debtor of quality? they have their infrastructure to privatize or monetize by selling the right to charge tolls and use fees, and they have their taxing powers as well. thus they have collateral and they have income.

3. re the "each successive bubble must dwarf its predecessor" problem: inflation helps "solve" this problem. when i first took out a mortgage, in the 1970's, the figures involved seemed overwhelming. some time later, not so much. don't forget that the disappearance of fictitious value can happen in real terms but less so in nominal terms, the difference being the effect of inflation. all those million dollar bungalows may look cheap when gasoline is $12/gallon and the dollar-menu at your local fast-food joint has been replaced by the ten-dollar-menu.

[Andreuccio]

Re: When Debt comes calling by Sarel Oberholster

If you are an iTulip Select subscriber* as of January 15, 2008, and provide us with a mailing address, we will send you a copy of the magazine for free.

* You must be either subscribed for 1 year or subscribed as a 3 months recurring subscriber.

Fred,

I'm looking forward to reading the article. Thanks for the offer of the free copy. Do you want mailing addresses by PM or by another method?

[c1ue]

Re: When Debt comes calling by Sarel Oberholster

2. re "debtors of quality": isn't every government, at every level, a debtor of quality? they have their infrastructure to privatize or monetize by selling the right to charge tolls and use fees, and they have their taxing powers as well. thus they have collateral and they have income.

JK,

It is true that every government has the ability to generate revenue via taxation (in various forms), but it is not true that every government at every level is a debtor of quality.

Those countries/levels of government that already have large overhangs of existing debt cannot necessarily take on more - especially if existing revenue is already being consumed paying interest on said debt.

Unless, of course, loans are made to these countries/levels of government without due fiscal process.

[jk]

Re: When Debt comes calling by Sarel Oberholster

JK,

It is true that every government has the ability to generate revenue via taxation (in various forms), but it is not true that every government at every level is a debtor of quality.

Those countries/levels of government that already have large overhangs of existing debt cannot necessarily take on more - especially if existing revenue is already being consumed paying interest on said debt.

Unless, of course, loans are made to these countries/levels of government without due fiscal process.

in the u.s. at least, the various governmental entities can still follow the path of their citizens - sell or mortgage assets to support consumption. every road and tunnel, every public building, can be sold or mortgaged. the privatization of infrastructure can be the new source of funding and collateral. we are in the process of selling off all embodiments of wealth in this country - why stop now?

[c1ue]

Re: When Debt comes calling by Sarel Oberholster

every road and tunnel, every public building, can be sold or mortgaged. the privatization of infrastructure can be the new source of funding and collateral. we are in the process of selling off all embodiments of wealth in this country - why stop now?

JK,

A good point.

On the other hand, the assets in question are worthless without a revenue stream behind them.

A bridge in South Dakota is probably not nearly as worthwhile as the George Washington bridge in NY, for example.

New York is running a surplus (so far), but I'd guess the states with the greatest need for money also probably have the least revenue to back up the asset - California being a notable exception.