Monday, November 3, 2008

Chronicles Of Depression 2.0: #364: Quadrillion

The mainstream media and Wall Street have reached the consensus that the current credit crisis is the worst since the post-war period. George Soros’ statement that ”the world faces the worst finance crisis since WWII” epitomizes the collective wisdom. The crisis is currently the ultimate scapegoat for all the economic evils that currently plague the global financial system and the global economy – from collapsing stock markets of the world to food shortages in third world counties. We are repeatedly assured that the ultimate fault lies with the Credit Crisis itself; if there were no Credit Crisis, all of these terrible things would never have happened in the economy and the financial markets.

The most extraordinary thing is that the mainstream media has never attempted to compare the current economic environment to the one preceding the Great Depression. In essence, it is assumed outright that the Great Depression can never possibly happen again, ever, thus obviating the need for such a comparison. I actually believe that the macroeconomic fundamentals today are much worse, so that we are in for a protracted period of economic depression – a depression much worse than the Great Depression, a depression that would likely be remembered in history as “The Second Great Depression” or The Greater Depression, as Doug Casey has called it so aptly. Here is why I believe that this is the case.

Emphasis added by me.

This is a lengthy must-read article, filled with charts and convincing reasoning.

This is the nuclear bomb:
Explosion of Derivatives. Derivatives have been likened by Warren Buffet to “financial weapons of mass destruction”. The notional amount of total derivatives, as well as “Value at Risk” (VaR), has skyrocketed in recent years with the potential to destabilize the financial system for decades. To put it more allegorically, derivatives hang like a sword of Damocles over the financial system.

A comparison with the 1920s is difficult to make. mostly Derivatives back then were extensively used, although not widely understood. Given that I am not aware of any statistics of derivatives for the period of the 1920s, a meaningful comparison based on hard data is admittedly impossible. Nevertheless, I would venture to make an intelligent guess that the size of modern-day derivatives is hundreds or even thousands of times larger relative to the size of the economy in comparison to the 1920s. Some of the latest reports indicate that the total notional value of derivatives outstanding surpasses one quadrillion dollars. To put this into perspective, this amounts to almost 100 times the GDP of the U.S. economy.

Emphasis added by me.

Do you understand what a quadrillion is?

It continues on this subject:
The chart below shows an even more telling picture. It shows world GDP and world’s notional value of derivatives. Again, while there is no direct comparison with the 1920s, it is clear that the overall level of derivatives has skyrocketed during the last two decades and presents risks that were simply not present at the onset of the Great Depression. The unwinding of these derivatives could only be compared with a nuclear explosion in the financial system.

Emphasis added by me.

He also cites gold:
The very high Dow-Gold Ratio in 1929 was followed by the Great Depression, while the higher level in 1966 was followed by the stagflationary 70s. It is evident from the chart the peak in 2000 surpassed the previous two peaks in 1929 and 1966, so this provides a reasonable expectation that the forthcoming return to “normalcy” will be more painful than the Great Depression, at least in terms of cumulative pain over the next 10-15 years.

Emphasis added by me.

Here I must disagree. Using gold as a foundational standard of value is just -- dammit, there's no other word for it -- stupid.

It's a frikkin rock, goddammit!

The standard of value must be human beings. Anything other than that is a fantasy, a construct. And we're soon to suffer unbearably for continuing to embrace such delusions. Let them go!

Continuing onto real estate. As I've already pointed out, it hasn't been only America:
Today the picture is very different. The U.S. economy had a stock market and real estate bubble that has surpassed its own during the 1920s. Colossal US current account deficits have fuelled extraordinary growth in global monetary reserves. As a result, Europe has real estate bubbles across the board, from the U.K. and Ireland, throughout the Mediterranean (Spain, France, Italy and Greece), to the entire Baltic region (Latvia, Lithuania, and Estonia) and the Balkans (Romaina and Bulgaria). Even worse, many Asian countries (China, Korea, etc.) also have their own stock and property bubbles, only with the exception of Japan, which is still in the process of recovering from its own during the 1980s. Thus, during the 1920s only the U.S. suffered from gross financial imbalances, while today the imbalances have engulfed the whole world – both developed and developing. It stands to reason that the unwinding of those global imbalances is likely to be more painful today than it was during the Great Depression due to both size and scope.

Emphasis added by me.

Final paragraph:
Based on indicators like (1) global real estate overvaluation, (2) indebtedness, (3) leverage, (4) outstanding derivatives, (5) global bubbles, and (6) the precariousness of the global monetary system, I would argue that the accumulated imbalances in the current period surpass significantly those preceding the Great Depression. I therefore conclude that the coming U.S. (and possibly) global depression will be of greater magnitude than the Great Depression of the 1930s. It likely suggests that we are entering a historic period that will likely be known as The Greater Depression.

Emphasis added by me.

The question now is no longer, If this happens. The question now is, When will it detonate?

And once the devastation begins and we all begin to sink. the question will be, What's the way out?

This book has a clue, but it's otherwise almost utterly wrong.

All prior Chronicles of Depression 2.0 posts. Read them now.

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