No new loans until there are 6 consecutive quarters of bank profits!!!

[Sapiens]

Heard through the grape vine: "We will not know that the system is stable and the reserves accessible until we have 6 consecutive quarters of bank profits."

There have been 2 consecutive quarters, can we wait another year for credit to become available?!

[Sapiens]

John Kutyn: Dead Brain Economists

http://www.gold-eagle.com/editorials...tyn082509.html

Dead Brain Economists
John Kutyn
Economists, bankers and investment advisors are now calling for the end of the global recession. This forecast reflects their inability to properly analyze financial cash flows. This mental blindness is first the logical result of the failure to properly understand how the banking system actually functions. Secondly, it reflects the inability to understand how the financial instruments which are created when banks advance loans affect both the financial system and the underlying economy.

There is no question that a massive debt financed spending spree can stabilize GDP. The real question is whether this massive increase in debt can solve fundamental financial and economic problems.

Focusing only on GDP data gives a poor understanding of the fiscal shape of the economy, because it fails to consider the ability of consumers, business, and governments to actually meet their debt obligations. In addition, reported GDP is adjusted for inflation or deflation. If income falls, but prices fall even more, the argument is that you are actually better off and so GDP is shown as increasing. For example, Germany, France, and Japan have recently reported a small increase in GDP compared to the previous quarter. However, even in these countries, nominal GDP (not adjusted for deflation) continues to fall. The fall in nominal GDP in the U.S. is much greater than reported falls in GDP, as prices have fallen 2.1% y/y in July. Ireland's nominal GDP is collapsing 13%.

From a financial perspective, loan payments are made from nominal income. Economists may show falling income as an increase in GDP, but the financial reality is that falling income means loan defaults. Inflation makes existing debts easier to repay, while deflation makes debts more difficult to repay.

Much of the world is in a deflationary trend, with prices falling by -5.9% in Ireland, -4.4 % in Thailand, -2.3 % in Taiwan, -1.8% in Japan, -1.8% in China, -1.7% in Belgium, -1.4% in Spain, -1.4% in Malaysia, -1.2% in Switzerland, -.7% in France, -.6% in Germany, and -.9% in Canada.

Much of this deflationary trend is driven by large falls in industrial production with resulting falls in capacity utilization. Capacity utilization has fallen to 72% in Germany, 65% in Japan and the U.S., and as low as 50% in poorer countries. With high debt levels and falling incomes, consumers must reduce spending, and with low levels of capacity utilization, business has no pricing power. German producer prices are down 7.8% y/y with U.S. wholesales prices down 5.8% y/y in July.

Over the last year, the world has witnessed the greatest fiscal and monetary expansion in history. Government deficits are at record highs, interest rates at record lows, and central banks are monetizing large amounts of debt. All of these measures are highly stimulative and inflationary. However, existing debt levels are de-stimulative and deflationary. Moreover, once created, this new government debt only adds to the deflationary nature of existing debt.

What government efforts to date have done is slowed down a massive deflationary collapse. Even with these efforts, nominal GDP continues to fall in a deflationary world. Without these actions, the worlds economy and financial system would have by now collapsed. However, government actions have not addressed the fundamental problem that the debt levels of consumers and business exceed their capacity to repay, and this fundamental problem only gets larger on a daily basis.

The key question is not how governments should withdraw stimulus measures to prevent inflation, but can governments expand these programs to prevent a deflationary collapse. The financial reality is that the economy and banking system will collapse if governments are unable to continually increase the level of support that they are injecting into the economies.

The U.S. recession began in Dec 2007. At the time, the economy appeared to be in good order, and there were no apparent internal or external shocks. However, debt levels had doubled in recent years, and loan repayments could not be made from existing cash flow. The weakest link, the sub-prime mortgages started to default. This cash flow deficiency has now spread to the general economy with over 13% of all house mortgages either in foreclosure or behind in payments. As of July 2009, debt levels have continued to increase (in the case of Government debt by very substantial amounts), while income has shown a large contraction. The economy has lost 6.7 million jobs, which greatly understates the loss, as many full-time jobs have been replaced with part-time jobs, and weekly hours worked have fallen. Considering the governments U6 measure of unemployment, and subtracting the fictional jobs added by the governments birth/death model, unemployment is now over 20%. Income tax receipts best reflect the fall in personal and business income, with personal income tax down receipts down 21% and corporate tax receipts down 58% from 2008 levels. The government fiscal position is even worse. With tax receipts collapsing, and increasing financial demands from social security, medicare, defense, financial bailout programs, etc., the government deficit will exceed $1.8 billion. U.S. federal government expenditure is now 185% of tax receipts. State governments are also seeing large falls in tax revenue. With increased debt levels, and large falls in income, the financial situation on all fronts is much worse that in Dec 2007. Despite a massive increase in government debt, GDP continues to fall. Even if GDP could be stabilized, to stabilize GDP based on massive public borrowing does not create financial stability, it only makes matters worse.

Consumers have not only experienced a large decrease in personal income, but also a large decrease in personal net worth, with a collapse in real estate values, pension values, and stock investments. Given present debt levels, they are in no position to increase spending back to 2007 levels. The reality is that things are going to get worse. Business has seen large falls in profits, with industrial utilization down to 65.4% in July. Business will not expand until sales improve dramatically, which given the financial position of consumers is not going to happen. The U.S. government has undertaken the greatest fiscal and monetary expansion in world history. In doing so, they may have temporarily stabilized GDP, but they have not addressed the real problem that income on all levels is not sufficient to meet debt repayments.

The economic reality is that in 2009, the government will have added another $2 trillion to the nations debt, and the Federal Reserve will have monetized $2 trillion in debt while bringing interest rates down to zero. Despite these measures, nominal GDP continues to fall, jobs continue to disappear, personal bankruptcies are up 34%, foreclosures are up 32%, 15 million home owners owe more on their house than their house is worth, retail sales are down 8.3%, and industrial output is down by 13.1%.

Given the present state of affairs, it does not take a financial expert to realize where things would be right now if stimulative measures were not taken. The real question is what happens in 2010, because if the government cannot support the economy by borrowing a further $2 to $3 trillion dollars, the economy and financial system will melt down. In 2011, borrowing will have to be even higher.

The people advising the government and Federal Reserve are guided by useless economic theories and seem incapable of doing a basic cash flow analysis. They have taken an economy which is imploding because of excessive debt and leverage, and have done everything they can to increase debt further. Greater debt and less income does not cash flow.

Foreign governments have been investing their trade surplus into U.S. government debt in order to limit the value of their currencies. For many years, this has financed the government deficit. However, a fall in consumer spending is decreasing the U.S. trade deficit, and with a dramatic increase in the government deficit, foreign governments can no longer finance the deficit even if they wanted to. The financial position of U.S. consumers and U.S. business is such that they do not have the cash flow to meet their own debt obligations, let alone lend money to the government. Banks have relied on government bailouts, which are only a short-term measure as loan defaults continue to increase. The banks are in no position to bail out the government. This means that the only option is a drastic reduction in government spending, or have the Federal Reserve monetize a further $2.0 to $3 trillion in debt in 2010.

Neither of these options solves the underlying debt problem, and either solution would concern the large foreign holders of U.S. debt like the Chinese. The Chinese are presently attempting to place as much of their U.S.$2 trillion reserves into tangible assets, but with only limited success. What happens if they decide to sell their U.S.$ assets? What happens if someone in China actually wakes up and realizes that the U.S. does not cash flow? With China reducing holdings of U.S. debt by 3% or $25 billion in June, this may indicate that the Chinese are finally realizing the serious financial situation that their debtor is in.

With current financial problems, investors have sought the apparent safety of government guaranteed bank deposits and government debt. This perception is based on the belief that rising loan defaults, falling tax revenues, large increases in government debt, and a large monetization by the Federal Reserve do not matter. A proper cash flow analysis indicates that moving into 2010, loan defaults will continue to increase, tax revenues will continue to fall, and government debt and monetization by the Federal Reserve will increase further than they increased in 2009. I repeat that the real risk to these investors is that someone wakes up from a state of mental comatose, does a cash flow analysis and realizes that these debt obligations are never going to be repaid.

While much of the above analysis has focused on the U.S., a similar analysis would reveal similar results in every major world economy. Even China utilizes a similar banking system, with a massive U.S.$1.1 trillion in bank debt over the last six months needed to achieve moderate reported economic growth. China is an export dependant country, and with exports falling 23% y/y in July, it is difficult to see where the cash flow will be generated to repay further U.S.$1.1 trillion in debt.

Ultimately, holders of debts such as bank deposits and government bonds will witness a default on these investments. Investors should consider moving from intangible assets into tangible assets to preserve real wealth. While owning commodities as a form of wealth as opposed to using in a productive capacity will create it's own distortions, it is difficult to see meaningful alternatives given the present state of the financial system.

In summary, there are two views of the current economic situation. The first view holds that the government and Federal Reserve know what they are doing, and have taken appropriate actions to solve underlying economic and financial problems. These actions form the basis of substainable economic growth as reflected by a rising stock market and a decrease in the rate that nominal GDP is falling.

The second view recognizes the creation of a debt pyramid that is crushing corporate profits, employment, and government tax revenue. In view of existing debt levels, it does not see falling corporate sales and profits, falling employment, and falling government tax revenues as being the basis for a substainable economy. This view recognizes that by increasing government debt by between , this has prevented a collapse of the economy and financial system. However, as this has only increased the debt pyramid, this view holds that fundamental economic and financial problems are not solved, and that increased debt levels only make matters worse going into 2010. With 20% of personal income coming from government transfer payments, this view recognizes the necessity of increasing government borrowing in 2010 and beyond in order to prevent a total meltdown of the economy and financial system. What is uncertain is how cooperative government bond markets will be.

John Kutyn
August 19, 2009

Where will you be when the Reset is pressed?

[ThePythonicCow]

Re: John Kutyn: Dead Brain Economists

Is this guy an iTulip member? His cash flow analysis of the Great Debt Bubble Collapse sounds familiar.

[Sapiens]

Re: John Kutyn: Dead Brain Economists

Is this guy an iTulip member? His cash flow analysis of the Great Debt Bubble Collapse sounds familiar.

I don't think John is a member.

[Slimprofits]

Re: No new loans until there are 6 consecutive quarters of bank profits!!!

http://www.nytimes.com/2008/10/17/bu...ss&oref=slogin

“I don’t think that the market wants to see that capital being put to work to leverage the business up again,” said Roger Freeman, an analyst at Barclays Capital, which acquired parts of the now-bankrupt Lehman Brothers last month. “My expectation is it’s quarters off, not months off, before you see that capital being put to work.”

[Jay]

Re: John Kutyn: Dead Brain Economists

http://www.gold-eagle.com/editorials...tyn082509.html

Where will you be when the Reset is pressed?

Sapiens, where will you be? Give me some suggestions, clearly you have been ruminating over this for a millenium. Great article BTW.