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The Five Stages of Collapse
Energy Bulletin ^ | Nov 11 2008 | by Dmitry Orlov

Posted on 05/16/2009 5:56:38 PM PDT by Lazamataz

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To: palmer
"This whole mess could be easily rectified with a return to market interest rates combined with investment tax incentives (mainly reduction of the corporate taxes and elimination of the long term capital gains tax). We would also suffer an inflationary burst as this happens but that should be a one time event. Economies cannot grow on credit, only suffer booms and busts and in our condition a bust could end our financial system."

No.

The core problem is global overcapacity. Markets respond to overcapacity with deflation.

Governments fight deflation for political reasons, but deflation will continue globally until excess capacity is removed from the economy.

Tax credits, as you pretend above, could help...or could do harm if they are designed to encourage additional manufacturing, housing, or service expansion.

Expanding capacity when you already have overcapacity will simply accelerate deflation.

This isn't theory; it's real-world fact. Japan today has done *precisely* what you suggest above with industrial tax credits, and Japan has now given itself 12% annual deflation.

This is unsustainable, globally.

What Business Schools never told the MBA kids was what happened when you built too many factories. It was as if it wasn't possible to build too many houses, or too many shopping malls, or too many cars, or too many ships, or too many memory chip fab plants.

And building even *more* such capacity as above will accelerate deflation...the enemy of all *productive* wealth.

181 posted on 05/18/2009 8:57:55 AM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: palmer
"There is also reduced demand as you point out for imported products (and therefore shipping) and other discretionary goods. That is indeed deflation due to the recession, but very minor as I pointed out above. Most importantly there is no deflationary spiral like the 1930's."

You are kidding yourself if you believe that GM isn't squeezing its auto parts suppliers.

You are kidding yourself if you believe that Wal-Mart isn't squeezing its consumer goods suppliers.

You are kidding yourself if you believe that consumers aren't squeezing their retailers. Neiman Marcus lost a half Billion last year. Consumers squeezed retailers by moving down-market. High end shoes for women have fallen from $600/pair to $160/pair.

Likewise, employers are squeezing their employees by cutting hours, cutting bonuses, cutting salaries/wages, and by cutting employment. 401k contributions are likewise being stopped.

Companies are squeezing their shareholders by cutting dividends, too.

And that's your deflationary spiral. Less consumer spending causing businesses to cut dividends and employment and squeeze suppliers, who in turn are unable to spend as much as before.

Doubly true when reduced credit availability (e.g. no more HELOCs) is factored in. Tough to live large for a lot of wannabes when they can't use their home as an ATM of endless credit.

182 posted on 05/18/2009 9:06:20 AM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: Lazamataz

Dammit Laz, now I have to break up my gang of roving wastelanders. Just what in the hell am I supposed to do with all of this fuel, food, and ammunition that I have stockpiled? Nobody knows the hours and years that we invested in developing a genetically superior breeding stock of women.

And all of the sudden YOU turn into little miss economic sunshine.


183 posted on 05/18/2009 9:18:52 AM PDT by AH_LiveRight
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To: Southack
The core problem is global overcapacity.

The core problem is overleverage and the subsequent systemic risk from derivatives and fractional reserves. The sector that plummeted the most since last fall is financial, not industry. The rather trivial overcapacity you are looking at is a minor symptom of the "credit overcapacity".

184 posted on 05/18/2009 9:21:49 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: Southack
And that's your deflationary spiral. Less consumer spending causing businesses to cut dividends and employment and squeeze suppliers, who in turn are unable to spend as much as before.

All less than 1982 and trivial compared to the Great Depression. Yet our financial system needed a bigger bailout than ever before to survive. The spiral you need to look at is relatively minor asset price corrections causing credit defaults due to massive overleverage (up to 100 to 1). The resultant defaults wipe out default insurers and cause massive hits in financial balance sheets. The result is insolvency and potentially more defaults (until the Fed swapped out at least $10 trillion in bad assets for treasuries). The result of de facto nationalization of banks is loss of equity leading to insufficient equity to debt ratios.

The consumer retrenchment and consumption pattern changes are a relatively minor result of the housing and equities busts. Unlike the Fed intervention, they are a long run positive for the economy resulting in more savings and investment and greater production efficiency in new and retooled industries.

185 posted on 05/18/2009 9:33:51 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: Lazamataz
Here's the funny part. After the collapse, he says things will work if we:
I believe that the financial pyramid scheme and globalized consumerism are done. But I think that having no government at all is not an option. Forget entitlements, forget military bases on foreign soil, forget the three-ring circus that passes for representative democracy here, but we will still need agencies to print passports, to control the nuclear stockpile, as well as many other mundane but essential services that only a central government can provide. For most other needs, local self-government may be the best we can do, but that may not be bad at all.

Commercial collapse need not be final. It is quite possible that a new economy will arise spontaneously, one without all the frills and the waste, but able to provide for most of the basic needs. In the places that are socially and culturally intact, this is almost inevitable, as people take charge and start doing what's necessary without waiting for official sanction.

Doesn't that sound a LOT like the small government conservatism many of us have been wanting?
186 posted on 05/18/2009 9:41:07 AM PDT by Richard Kimball (We're all criminals. They just haven't figured out what some of us have done yet.)
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To: palmer
"The core problem is overleverage and the subsequent systemic risk from derivatives and fractional reserves."

Nope. You can't get surplus leverage if there is a deficit of supply for the underlying factor. E.g. you can't get a loan with 0% down (infinite leverage) for an office building and then get in financial trouble if a dozen tenants are constantly bidding to get into your building.

Instead, where you get into trouble with leverage is when demand for your building subsides.

So, again...the core problem is global overcapacity.

Loaning the money wildly comes in a distant 2nd place...and derivatives are financial zero sum non-events. Derivatives, even with massive notional values, are trivial because the money merely moves between players instead of wealth being created or destroyed.

187 posted on 05/18/2009 10:26:53 AM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: palmer
"Yet our financial system needed a bigger bailout than ever before to survive. The spiral you need to look at is relatively minor asset price corrections causing credit defaults due to massive overleverage (up to 100 to 1)."

Propping up zombie banks is pricey. I wouldn't do it, but I'm not God making all decisions, obviously.

To supply liquidity, I would have used a large fraction of the bailout/surplus monies to make a new federal bank that had no prior liabilities rather than propping up an insurer (AIG) and a few zombie banks that still aren't loaning out money.

Heck, you *want* zombies to die. Pouring money into them only makes political, not economic sense.

As for leverage, 10% down and 90% financed is 9 to 1 leverage. 3% down and 97% financed (a typical FHA loan that has been around for decades prior to this crisis) is almost 33 to 1 leverage.

And "no money down" loans are infinite leverage.

Works great in inflationary periods. The asset rises but the loan doesn't.

Fails entirely during deflation, however. See Japan 1989 to today, as well as the U.S. today.

...moreover, all business models fail during systemic deflation. You can't "buy and hold" during deflation. Buying a building to lease out to tenants is a good business model during inflation, but when the building loses more value each year due to deflation than it takes in rent, the business model falls apart.

So it's not just leverage or overleverage that fails during deflation...though the drama is certainly there. Everything fails.

Collection agencies and cash work during deflation. Not much more.

You can have overleverage and still have a viable economy, in contrast...the difference is that overleverage can work (potentially) during inflation.

Ergo, overleverage isn't the core problem. Deflation, however, is said beast. And you always get deflation when you have overcapacity.

188 posted on 05/18/2009 10:39:25 AM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: Southack
Instead, where you get into trouble with leverage is when demand for your building subsides.

So 100 to 1 leverage would have worked provided that demand never decreased to reduce asset values by 1%. And if demand looks like it is about to go down, we can just increase leverage to create more demand. You are right, leverage is second place so long as demand increases monotonically. In that case asset prices will never get ahead of demand so they will never drop and wipe out the principle.

Sounds nice, but unfortunately impossible in the real world. So the leverage becomes a problem, the more the leverage, the bigger the problem.

189 posted on 05/18/2009 10:40:38 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: Southack
You can have overleverage and still have a viable economy, in contrast...the difference is that overleverage can work (potentially) during inflation.

Can work to create more inflation (including money velocity increases) which creates spurious demand. Can also work to misallocate resources including investment dollars which drives up costs for all business whether leveraged or not. A short term gain for long term pain. You are quite close to understanding the problem and you also realize that the current solutions will basically just add debt to the federal balance sheet. Pretty soon you will close the loop and see how today's solutions are what created the original problem.

190 posted on 05/18/2009 10:48:34 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: Southack
Derivatives, even with massive notional values, are trivial because the money merely moves between players instead of wealth being created or destroyed.

Understood. I only mention derivative and fractional reserves because they create systemic risk. Under the current circumstances, Citi cannot fail without bringing down the other large banks and other financial entities (e.g. insurance companies). There is no deflation risk from derivatives, but massive derivative positions ensure financial collapse when there is enough deleveraging to bring down a large player. No spiral, just collapse.

191 posted on 05/18/2009 10:57:09 AM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: palmer
"So 100 to 1 leverage would have worked provided that demand never decreased to reduce asset values by 1%. And if demand looks like it is about to go down, we can just increase leverage to create more demand. You are right, leverage is second place so long as demand increases monotonically. In that case asset prices will never get ahead of demand so they will never drop and wipe out the principle. ... So the leverage becomes a problem, the more the leverage, the bigger the problem. "

Yes, the leverage *becomes* the bigger problem...after...after overcapacity is reached.

As long as home prices are going up, leverage is a plus, not a negative.

As long as office rents are going up, leverage is a plus, not a negative.

But once you reach surplus capacity with too many office buildings, too many houses, too many cars, too many cargo ships...prices start to fall (deflation).

After that excess capacity inflection point is reached, then the game is reversed. Suddenly leverage that was a positive is now a giant liability.

What this means is that overleverage isn't the core problem. Overleverage does the most damage, the fastest, but only under the circumstance of the deflation inflection point being reached first.

And deflation is merely the Markets reacting to surplus capacity.

Too many automobile manufacturers making too many cars.

Too many shipbuilders making too many cargo ships.

Too many contractors and real-estate investors building too many shopping malls and too many office buildings.

It is only when you reach the point of first having "too much" of something that deleveraging debt comes into play.

Prior to that point the debt is fine...even beneficial. But alas, all good things must come to an end.

Welcome to deflation...what you get after saturating the surplus capacity inflection point even if your government is pouring $12.8 Trillion in freshly printed money into the economy during the previous 12 months...a remarkable time for prices to decline.

192 posted on 05/18/2009 10:58:05 AM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: Southack
So all of these people are mindlessly saying exactly the same thing...saying something that fails to explain the U.S. in 1945...saying something that fails to explain Japan today, last year, last decade, and last 20 years.

One big overriding but all important difference between Japan in the 80s, the US in 1945 and the US Now. EXPORTS. Both Japan and the post war US had massive trade surpluses. These helped to finance the spending spree and draw off excess production. Hence keeping inflation in check. The US today has some of the largest trade deficits in the world. The effect is just the opposite. Even mild inflation will make it harder to get oil, which will drive up prices, causing more inflation and onward into a spiral.
193 posted on 05/18/2009 11:25:52 AM PDT by GonzoGOP (There are millions of paranoid people in the world and they are all out to get me.)
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To: L,TOWM
I agree with your analysis. However, interest rates might climb a lot higher than 12%. Think twice that or more.
194 posted on 05/18/2009 11:41:08 AM PDT by Former Proud Canadian (How do I change my screen name now that we have the most conservative government in the world?)
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To: palmer
"Understood. I only mention derivative and fractional reserves because they create systemic risk. Under the current circumstances, Citi cannot fail without bringing down the other large banks and other financial entities (e.g. insurance companies). There is no deflation risk from derivatives, but massive derivative positions ensure financial collapse when there is enough deleveraging to bring down a large player. No spiral, just collapse."

No. Derivatives can be thought of as mere insurance policies. That's an oversimplification, but the point is that your insurance company failing isn't systemic...it won't cause *you* to file bankruptcy just because Mutual of Omaha or Hartford goes bankrupt.

You'd be irritated if you had a claim that couldn't be paid, of course, but having a claim is rare, having an unpaid claim even moreso, and needing to file personal bankruptcy just because your life insurer filed bankruptcy is pretty much unheard of.

And so go derivatives. Even if the counter-parties file bankruptcy, the buyer of the derivatives and the borrower on which the derivative is based will likely both remain solvent (or perhaps it would be better to say that they won't become insolvent directly *because* of the failure of a counter-party).

So no, derivatives do *not* create systemic risk.

Derivatives are an insurance policy...a backstop. The pitcher throws the ball. The catcher misses the catch. That's the action. You don't lose the game (systemic risk/failure) just because the backstop failed. Heck, you might play the whole game and never even need the backstop.

195 posted on 05/18/2009 12:09:09 PM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: GonzoGOP
"One big overriding but all important difference between Japan in the 80s, the US in 1945 and the US Now. EXPORTS."

No. Japan has been printing money from 1989 to today, and will be doing so tomorrow, too. But Japan has a current account *deficit* this year. Just like the U.S.

Japan is importing more than it exports this year, yet Japan has 12% deflation this year.

So one errs when one says that Japan and the U.S. pursuing the same policies will somehow magically get different results (e.g. deflation in one, inflation in the other) based upon trade balances.

196 posted on 05/18/2009 12:14:30 PM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: Southack
What this means is that overleverage isn't the core problem. Overleverage does the most damage, the fastest, but only under the circumstance of the deflation inflection point being reached first.

Overleverage causes malinvestment which causes surplus capacity. The malinvestment also strangles other industry which slows economic growth. The economic problems start with the overleverage and start to get fixed at the excess capacity inflection point (provided the market is not interfered with to produce even more excess capacity).

197 posted on 05/18/2009 12:16:06 PM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: Southack
Derivatives can be thought of as mere insurance policies. That's an oversimplification, but the point is that your insurance company failing isn't systemic...it won't cause *you* to file bankruptcy just because Mutual of Omaha or Hartford goes bankrupt.

If my house burns down and my insurance company fails, then I will still owe on the mortgage and have no place to live, so I will have to file for bankruptcy. Naked credit default insurance allows me to get paid if YOUR house burns down and you are right that if I gamble on your house burning down and the insurance company fails, I should not have to declare bankruptcy. However, the systemic risk is increased anyway because I now have an economic incentive for making your house burn down.

198 posted on 05/18/2009 12:23:41 PM PDT by palmer (Cooperating with Obama = helping him extend the depression and implement socialism.)
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To: palmer
"Overleverage causes malinvestment which causes surplus capacity."

That *can* happen, but it's not a hard and fast rule. Other causes of malinvestment are possible beside overleverage...e.g. currency manipulation.

China undervalues its Yuan so investors flock to the "cheap" labor. Investors typically use their own cash, though they may invest in some proven activities with limited borrowing (banks aren't investors...investors are like stock owners whereas banks are like bond owners...different beasts).

But you'll still get malinvestments even without overleverage due to that currency manipulation.

Heck, you can get malinvestments simply from poor investment decisions...again...overleverage is not required to get malinvestments.

So you can't just claim that overleverage is the cause of malinvestments. Overleverage will exacerbate the pain once a malinvestment is discovered, of course, but you can get that bad investment with zero leverage (i.e. using just your own cash). Penny stock players find this rule out the hard way every day. Suckers!

199 posted on 05/18/2009 12:24:40 PM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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To: palmer
"If my house burns down and my insurance company fails, then I will still owe on the mortgage and have no place to live, so I will have to file for bankruptcy. Naked credit default insurance allows me to get paid if YOUR house burns down and you are right that if I gamble on your house burning down and the insurance company fails, I should not have to declare bankruptcy. However, the systemic risk is increased anyway because I now have an economic incentive for making your house burn down."

That's not "systemic" risk. To be systemic, all houses would have to burn down after all insurance companies filed bankruptcy, or one house burning down and one insurance company failing to honor one policy would have to trigger other insurance policy failures and house burnings (or would have to at least trigger some greater event such as your one house fire causing a bank to fail).

Limited risk is *not* the same as systemic risk. One house burning down bites hard, and your insurance company not honoring your insurance policy on said house sux even harder, but that's limited risk, not systemic risk.

More to the topic at hand, a limited risk event causes no grand chain reaction. It sux that your house burned down, that you got stiffed on your insurance, and that you had to file bankruptcy...but that bankruptcy filing and insurance failure and house fire isn't going to cause all of your neighbors to immediately file their own bankruptcies.

Hence, counter-party failure is *not* systemic.

200 posted on 05/18/2009 12:31:29 PM PDT by Southack (Media Bias means that Castro won't be punished for Cuban war crimes against Black Angolans in Africa)
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