Unimaginable wealth destruction

[MrBurns]

This is worth reading by Alan Kohler

http://www.businessspectator.com.au/bs.nsf/Article/Brace-for-a-20-trillion-write-down-$pd20090127-NNQY6?OpenDocument&src=ea&ir=4

 

[Prospector]

Can't access it Mr Burns - you need to subscribe to it. Maybe its better if I dont read it though...

 

[MrBurns]

There you go, perhaps the link needs you to sign up, it's free.
Yes just read your post properly, you do need to subscribe but it's free.

We learned today that the global recession, as defined by rising global unemployment, is only just getting underway.

It might feel like it has been going for more than 12 months and you might be getting very tired of it already, but the collapse in the real economy is just a few months old – following the global economic “cardiac arrest” last October – and is now building a head of steam.

In the past 24 hours companies in the United States and Europe announced job cuts totalling 62,000, headed by Caterpillar’s decision cut its workforce by 20,000.

In addition there was Sprint Nextel (8,000), Home Depot (7,000), Pfizer (8,000), General Motors (another 2,000), ING (7,000), Phillips (6,000) Corus (3,500). Last week Microsoft announced 5,000 lay-offs, while in Australia BHP Billiton said it was cutting 3,000 jobs.

So the rise in unemployment, especially in Australia, is still in its infancy, as is the impact of the slowdown on corporate earnings.

Although this began as a credit crisis and will only end when the world’s banks are repaired and can reopen for business, what is now unfolding is the “reverse wealth effect” – the opposite of the consumer spending and business investment boom that came out of the housing and sharemarket bubbles.

In his latest letter to clients, Jeremy Grantham of the Boston based investment firm GMO, lays out graphically how the reverse wealth effect works for the United States.

Assuming declines in value of 50 per cent for the stockmarket, 35 per cent for housing and 35-40 per cent for commercial real estate, there has been a total loss in perceived wealth (my emphasis) of about $US20 trillion from a peak of $US50 trillion.

US GDP – the annual value of goods and services produced – is $US13 trillion.

“These write-downs not only mean that we perceive ourselves as shockingly poorer, they also dramatically increase our real debt ratios."

The national private asset base of $US50 trillion was supported by debt of $US25 trillion. Now the asset values have fallen back to $US30 trillion, while the debt remains at $US25 trillion, “give or take the miserly $US1 trillion we have written down so far”.

Maintaining the same gearing ratio means the debt has to be written down to $US15 trillion. However, as Grantham points out: “As always, now that it’s raining, bankers want back the umbrellas they lent us.” That is, they are demanding lower gearing ratios – no more than 40 per cent, not 50 per cent.

That means $US12 trillion in debt, not $US15 trillion – half the current level. So somewhere between $US10 trillion and $US15 trillion in US needs to disappear.

That’s just the United States. The story is being repeated around the world – in the UK, Europe, Japan, Australia, Russia, Iceland and now China.

The decline in real wealth, and the amount of debt that has to “disappear” is almost unimaginable.

Short of finding another bubble to reinflate asset values, there are only three ways to do it: write the debt off, inflate the money supply and reduce the real value of the debt, or do what Japan did and take years – decades – to gradually save more and pay down the debt (that hasn’t actually worked for Japan yet, by the way).

Each of these three measures is now underway. Each is extremely painful and takes a long time.

The sharemarket has already anticipated a big decline in earnings with its fall of 50 per cent. Is it enough?

The problem is that price/earnings multiples can change for long periods at the same time as profits fall. A profit decline of a third accompanied by a halving of the P/E ratio produces a price fall of two-thirds.

Over the next few weeks we will get a clearer idea of the likely decline in corporate earnings, although it's clear that companies are already seeing what’s coming and are cutting staff in readiness.

No one can really know what’s coming – it’s too early in the process.

But as Grantham reminds us, only “make-believe assets” are being destroyed – that is, the inflated values of shares and houses.

“It is worth remembering that real wealth lies not in debt but in educated people, laws, and work ethic, as well as in the quality and quantity of fixed assets and the effectiveness of corporate organisation.”

When we have dealt with this crisis all of those assets will be sitting around waiting to be put to full use again.

 

[Glen48]

Luck for us in OZ we can't be un-employed for long because the Feds put you on Medical benefits to keep the numbers down, once those working their 2 hrs a week are put of we will see some rises here. I think a lot of shops will shut at the end of this month as well.
This how bad it is getting:
MCDONALD'S Q4 PROFIT FALLS] McDonald's - world's largest restaurant chain, reported a 23% profit drop in Q4 despite a tax gain in the year-earlier period, according to Bloomberg news. The company's net income fell $985.3MM, or $0.86 per share vs $1.27bln, or $1.06 per share a year earlier. Analyst's F/C a profit of $0.83 per share.

 

[basilio]

Pretty scary stuff. There is a somewhat similar analysis by Ambrose Evans-Prirchard. Basically he sees the world as early 1931 when the depression was beginning. I think that is what Alan Kohler is suggesting.

Everyone is hoping that, one way or another, we don't get to 1933 again. I have attached just a clip from Ambrose's article of what 1933 looked like when Roosevelt came to power.

But then the world seemed benign enough in early 1931. It is the second phase of depression that does terrible things.

Roosevelt took over a country where the economic machinery had completely broken down. The New York Stock Exchange and the Chicago Board of Trade had closed. Thirty-two states had shut their banks. Texas had restricted withdrawals to $US10 a day.

Few states could borrow on the bond markets. Illinois and much of the South had stopped paying teachers. Schools closed for months. An army of 25,000 famished war veterans squatting in view of Congress had been charged by troopers of the 3rd US Cavalry with naked sabres, led by a Major George Patton.

Armed farmers threatening revolution had laid siege to a string of Prairie cities. A mob had stormed the Nebraska Capitol. Minnesota's governor was recruiting communists only for the state militia. Lawyers attempting to enforce foreclosures were shot. More than 100,000 New Yorkers applied to go to the Soviet Union when Moscow advertised for 6000 skilled workers.

We forget how close America came to open revolt.

http://business.theage.com.au/business/world-like-early-1931-but-not-yet-1933-20090126-7q11.html?pag

 

[MrBurns]

Pretty scary stuff. There is a somewhat similar analysis by Ambrose Evans-Prirchard. Basically he sees the world as early 1931 when the depression was beginning. I think that is what Alan Kohler is suggesting.
Everyone is hoping that, one way or another, we don't get to 1933 again. I have attached just a clip from Ambrose's article of what 1933 looked like when Roosevelt came to power.
http://business.theage.com.au/business/world-like-early-1931-but-not-yet-1933-20090126-7q11.html?pag

I think what Rudd is saying (all doom and gloom) combined with Kohlers writings lately it's beginning to look worse almost by the day.

I guess at some stage you have to turn off the PC and TV and just go out into the sunshine and forget it.

 

[Julia]

Let's remember that the people who are supposed to be fixing this mess consider they have learned a fair bit since the 1930's.

I might be wrong but I think we can make everything worse for ourselves in a 'self fulfilling prophecy' sort of way if we anticipate we are all doomed.

 

[MrBurns]

Let's remember that the people who are supposed to be fixing this mess consider they have learned a fair bit since the 1930's.

I might be wrong but I think we can make everything worse for ourselves in a 'self fulfilling prophecy' sort of way if we anticipate we are all doomed.

But we aren't in control Julia, doesn't matter what we think it all happens around us, it's real we can only anticipate and watch.

 

[Prospector]

I might be wrong but I think we can make everything worse for ourselves in a 'self fulfilling prophecy' sort of way if we anticipate we are all doomed.

I am with Julia on this. For years Companies have needed a level of debt to service their business. That has never been a problem; they can service their debt and continue operating normally. While many businesses have been proven unprofitable and have needed and sometimes received additional injections of cash (and the car industry rates highly here) many other businesses would be fine under their current debt levels. But in order to do so needs business and consumer confidence for people to keep spending as they did in the past. All the doom and gloom stories keep pulling the rugs out from good businesses; that creates unemployment, that means welfare funding and less spending. It is a vicious circle.

Think about the home mortgage market. Most people have a mortgage which they pay off regularly with no issues. But what would happen if the Bank said they were pulling in all their loans! For no particular reason, they just want to reduce their risk. There would be chaos on the home front, basically for no reason. Other than the Bank's whim.

 

[Julia]

But we aren't in control Julia, doesn't matter what we think it all happens around us, it's real we can only anticipate and watch.

Mr Burns, I'm not saying it's not real. Prospector has picked up on what I mean. In order to protect themselves, companies will quite possibly be 'pro-active' and fire staff e.g. before it's necessary in order to have the sense of being in control.

I've noticed myself that I am spending a little less freely in anticipationof reduced interest rates while I remain out of the market.
That's not actually necessary, but I expect I'm subconsciously absorbing more of the doom forecasts than I really need to.

 

[MrBurns]

I am with Julia on this. For years Companies have needed a level of debt to service their business. That has never been a problem; they can service their debt and continue operating normally. While many businesses have been proven unprofitable and have needed and sometimes received additional injections of cash (and the car industry rates highly here) many other businesses would be fine under their current debt levels. But in order to do so needs business and consumer confidence for people to keep spending as they did in the past. All the doom and gloom stories keep pulling the rugs out from good businesses; that creates unemployment, that means welfare funding and less spending. It is a vicious circle.

Think about the home mortgage market. Most people have a mortgage which they pay off regularly with no issues. But what would happen if the Bank said they were pulling in all their loans! For no particular reason, they just want to reduce their risk. There would be chaos on the home front, basically for no reason. Other than the Bank's whim.

True BUT people are spending less not only because they're scared many have already lost their jobs and just cant spend.

People dont stop spending for no reason and it's unrealistic for Rudd or anyone else to say simply "start spending" it doesnt work that way.

We were on a debt binge and it simply stopped working.

BTW did anyone see the Govenor General's speech on Australia Day ? he said something like "the financial crisis was caused by some very greedy people in America" I thought that was a bit over the top and simplistic for a respresentatrive of the Queen.

 

[Wysiwyg]

“It is worth remembering that real wealth lies not in debt but in educated people, laws, and work ethic, as well as in the quality and quantity of fixed assets and the effectiveness of corporate organisation.”

When we have dealt with this crisis all of those assets will be sitting around waiting to be put to full use again.

Supply and demand, supply and demand.
Been the common denominator for eons, since the first uprights.

 

[MrBurns]

Mr Burns, I'm not saying it's not real. Prospector has picked up on what I mean. In order to protect themselves, companies will quite possibly be 'pro-active' and fire staff e.g. before it's necessary in order to have the sense of being in control.

I've noticed myself that I am spending a little less freely in anticipationof reduced interest rates while I remain out of the market.
That's not actually necessary, but I expect I'm subconsciously absorbing more of the doom forecasts than I really need to.

Once again I say, that's not the cause of all this, it's the result of a real situation of bloated financial markets imploding, some reaction is in advance but that is not the cause of the root problem but is merely a small part of it.

 

[Prospector]

Mr Burns, I'm not saying it's not real. Prospector has picked up on what I mean. In order to protect themselves, companies will quite possibly be 'pro-active' and fire staff e.g. before it's necessary in order to have the sense of being in control.

Exactly. Last year the retrenchments in Australia started, but at the time the situation was not predicted to be as bad as current forecasts. But those early anticipatory movements started the avalanche which is gathering momentum rapidly. And consumers, fearing unemployment, will stop spending. And when consumers stop spending, businesses retrench people.

But Mr Burns (makes you sound like a Teacher!) all businesses are being swept into this maelstorm; I would argue there were some businesses that were highly inflated, and they needed to go, but this response to the debt issue is killing off businesses that have a great business model.

 

[explod]

There would be chaos on the home front, basically for no reason. Other than the Bank's whim.

No reason??

We have chaos. Have another read of Cohler's report. I have been following the economic sums now for 3 years, they are far too varied and compex to even begin to put into a simple text. But instead of going out into the sunshine to turn off we need to turn on for very survival of Family and self.

Talking Doom and Gloom is frowned apon because it is said to be self fulfilling. Maybe, but being a realist may save you from flying over a cliff.

 

[nomore4s]

Exactly. Last year the retrenchments in Australia started, but at the time the situation was not predicted to be as bad as current forecasts. But those early anticipatory movements started the avalanche which is gathering momentum rapidly. And consumers, fearing unemployment, will stop spending. And when consumers stop spending, businesses retrench people.

While I can see the points both yourself and Julia are making, having worked for big corps, they don't start slashing jobs until they start to see some sort of slow down in earnings.
The fact is corporate earnings have taken a dramatic dive in the last 6-12 months especially in the US, and this will now have a snowball effect which is what we are starting to see.

It is time for some of the massive levels of debt we have racked up during the last cycle to be paid back and unfortunately this will be somewhat painful.

 

[MrBurns]

No reason??

We have chaos. Have another read of Cohler's report. I have been following the economic sums now for 3 years, they are far too varied and compex to even begin to put into a simple text. But instead of going out into the sunshine to turn off we need to turn on for very survival of Family and self.

Talking Doom and Gloom is frowned apon because it is said to be self fulfilling. Maybe, but being a realist may save you from flying over a cliff.

I agree, it anoys me when people say your're a pessimist, my next door neighbor said that to me awhile ago, he would, I estimate, have lost close to $1M now, I've lost nothing.

I have to get off this machine for a while it becomes an all day thing if you're not careful.

No not a teacher Julia, commercial real estate agent for 20 years, now out of it thankfully.

Errrr sorry Prospector said I sounded like a teacher not you Julia.

 

[Prospector]

I agree, it anoys me when people say your're a pessimist, my next door neighbor said that to me awhile ago, he would, I estimate, have lost close to $1M now, I've lost nothing.

Errrr sorry Prospector said I sounded like a teacher not you Julia.

Nah, you dont sound like a teacher Mr Burns, just the last time I called someone Mr, I reckon it was a teacher!

So, you have lost nothing, but according to the 'real world' the value of your house is about to fall. Did you sell out all your shares prior to 2008? Wise move, but I still think the totally negative thinking has played a huge part on what is happening now. Not all of it of course, but certainly a significant contribution.

 

[Aussiejeff]

I agree, it anoys me when people say your're a pessimist, my next door neighbor said that to me awhile ago, he would, I estimate, have lost close to $1M now, I've lost nothing.

Sanity??? :bananasmi

 

[MrBurns]

Nah, you dont sound like a teacher Mr Burns, just the last time I called someone Mr, I reckon it was a teacher!

So, you have lost nothing, but according to the 'real world' the value of your house is about to fall. Did you sell out all your shares prior to 2008? Wise move, but I still think the totally negative thinking has played a huge part on what is happening now. Not all of it of course, but certainly a significant contribution.

I was about to invest heaps in 06' but I knew something wasnt right so I stayed out, shares kept rising.

I did go in for the T3 bought a heap of those THEN subscribed to the Rivkin newsletter which said "sell" So I did, that cost me $50,000 at least.
Dabled in Fairfax, got out quick they're a basket case.

But no have no shares apart from those 2 little flutters but was waiting for whatever it was I was fearing to break so I could go in a buy but 3 years later it's still not time and I'm not a trader.

Now waiting for property to tank and will go in there I think, within 2 years, it takes a while for property to sink.