It’s over…just like 1929…

There is no shortage of optimism in the markets these days, it seems everybody is bullish about everything, we had predictions of S&P hitting 1,000 (and then it hitting said mark), 27 out of 47 economists say the recession has already ended, I have people e-mailing me about how The Great Depression 2.0 is over/what an idiot I am for suggesting otherwise, women are desperate for bankers again, and to add insult to injury even the Great Roubini thinks I’m wrong(what happen’d dogg?? I thot u had ma back negro??! UPDATE 19/08/2009: It appears the Great Roubini may have been misquoted). Well I very well could be….

…however, I wonder if these guys were thinking the same thing in 1929:


via dshort.

…and I wonder if there’s a chance something could go wrong with these derivatives(the number on the Y-axis is in TRILLIONS of dollars, and the ‘blue cones’ represent how many trillions worth of derivatives these banks have on their books):


Few commentators care to mention that the total notional value of derivatives in the financial system is over $1.0 QUADRILLION (that’s 1,000 TRILLIONS).

US Commercial banks alone own an unbelievable $202 trillion in derivatives. The top five of them hold 96% of this.

As you can see, Goldman Sachs alone has $39 trillion in derivatives outstanding. That’s an amount equal to more than three times total US GDP. Amazing, but nothing compared to JP Morgan (JPM), which has a whopping $80 TRILLION in derivatives on its balance sheet.

If Wall Street did put $50 trillion at risk… and 10% of that money goes bad (quite a low estimate given defaults on regulated securities) that means $5 trillion in losses: an amount equal to HALF of the total US stock market.

via Seeking Alpha.

Oh well, we can be certain of some things, like death and taxes…though the latter ain’t looking so great these days…


The debt doesn’t help either, witness how the blue dotted line below keeps going down and down and down..


via The Business Insider.

And all of this includes all the things I can’t find pretty graphs for, like the fact that High-Frequency Trading now accounts for 70% of traded volume on the US Stock Market. High Frequency Trades involve trading institutions using computer algorithims to discover when others are trying to buy blocks of shares and then buying those shares before said others can get to them. The institution then sells that block of shares to the person who wanted them in the first place for a small profit which, when spread over billions of transactions, turns into millions:

Currently, roughly five billion shares trade per day. Take away HFTP’s transactions (70%) and you’ve got daily volume of 1.5 billion. That’s roughly the same amount of transactions that occur during Christmas (see the HUGE drop in late December), a time when almost every institution and investor is on vacation.

via Seeking Alpha.

Some would argue this is inconsequential because the world is more globalised than it was in the 1920s(I actually disagree with this point, I think people overlook just how globalised the world was back then due to colonisation/imperialism but let’s leave that argument for another time..)


Another area where we are “surpassing” our forbearers is in destroying trade. World trade is falling much faster now than in 1929-30 (Figure 3). This is highly alarming given the prominence attached in the historical literature to trade destruction as a factor compounding the Great Depression.

via vox – Research-based policy analysis and commentary from leading economists.

This data is from May, and might have gone up since then, we’ll find out on August 25th(when next World Trade report is released by NPB), but the shape of the decline only a few months before a ‘recovery’ is supposed to have started should surely ring some alarm bells.

Another source for optimism is supposed to be China. Why not? It’s a big country and they have great food… unfortunately their so called ‘recovery’ also has big problems, the following is from Chinese Shanghai-based economist Andy Xie:

China’s credit boom has increased bank lending by more than 6 trillion yuan since December. Many analysts think an economic boom will follow in the second half 2009. They will be disappointed. Much of this lending has not been used to support tangible projects but, instead, has been channeled into asset markets.

Many boom forecasters think asset market speculation will lead to spending growth through the wealth effect. But creating a bubble to support an economy brings, at best, a few short-term benefits along with a lot of long-term pain. Moreover, some of this speculation is actually hurting China’s economy by driving asset prices higher.

The current surge in commodity prices, for example, is being fueled by China’s demand for speculative inventory. Damage to the domestic economy is already significant. If lending doesn’t cool soon, this speculative force will transfer even more Chinese cash overseas and trigger long-term stagflation.

Commodity prices have skyrocketed since March. The Reuters-Jefferies CRB Index has risen by about one-third. Several important commodities such as oil and copper have doubled in value from this year’s lows. As I have argued before, demand from financial buyers is driving commodity prices. The weak global economy can’t support high commodity prices. Instead, low interest rates and inflation fears are driving money into commodity buying.

Exchange-traded funds (ETFs) alone account for half of the activity on the oil futures market. ETFs allow retail investors to act like hedge funds. This product has serious implications for monetary policymaking. One consequence is that inflation fears could lead to inflation through massive deployment of money into inflation-hedging assets such as commodities.

Financial demand alone can’t support commodity prices. Financial investors can’t take physical delivery and must sell maturing futures contracts. This force can lead to a steep price curve over time.

For some commodities, warehousing costs are low, limiting net losses for financial buyers. Some commodities can be used just like stocks, bonds and other financial products. Precious metals, for example, are like that. Copper, although 5,000 times less valuable than gold, still has low warehousing costs relative to its value. Some commodities such as lumber and iron ore are bulky, costly to warehouse, and should be less susceptible to financial speculation. Chinese players, however, are changing that formula by leveraging China’s size. They’ve made everything open to speculation.

There’s little doubt that China’s bank lending since last December has driven speculative inventory demand for commodities. Chinese banks lend for commodity purchases, allowing the underlying commodities to be used as collateral. These loans are structured like mortgages.

Banks usually have to be extremely cautious about such lending, as commodity prices fluctuate far more than property prices. But Chinese banks are relatively lenient. As an industrializing economy, China’s support for industrial activities such as raw material purchases for production is understandable. However, when commodities are bought on speculation, lenders face high risks without benefiting the economy. In some cases, this practice hurts banks and the economy at the same time.

via Fear the Dark Side of China’s Lending Surge.

In other words, Banks are under instruction to get rid of all this money and said money is being lent for commodity purchases (a bet on commodity prices rising) and to inefficient State Owned Enterprises who are themselves sometimes speculating on the bubble markets! The commodity itself is used as collateral for these loans, which explains why Chinese are buying them up like crazy.

And where there isn’t commodity lending bubble there’s property lending bubble:

The most basic approach in studying bubbles is to look at valuation. For property the most important measures are price to income ratio and rental yield. China’s average price per square meter nationwide is quite close to the average in the US. The US’s per capita income is seven times China’s urban per capita income. The nationwide average price is about three months of salary per square meter, probably the highest in the world. As far as I can tell, a lot of properties can’t be rented out at all. Those that can bring in 3% yield, barely compensating for depreciation. The average rental yield, if one including those that can’t be rented out, is probably negligible. China’s property price doesn’t make sense from affordability or yield perspective. Some argue that China’s property is always like this: appreciation is the return. This is not true. The property market dropped dramatically from 1995-2001 during a strong dollar period.

A property bubble usually leads to overbuilding. The empty buildings represent permanent losses. Most people would laugh at such a possibility in China. After all, 1.3 billion would need unlimited properties. The reality is quite different. China’s urban living space is 28 square meters per person, quite high by international standard. China’s urbanization is about 50%. It could rise to 70-75%. Afterwards the rural population would decline on its own due to its high average age. So China’s urban population may rise by another 300 million people. If we assume they all can afford property (a laughable notion at today’s price), Chinese cities may need an additional 8.4 billion square meters. China’s work-in-progress is over 2 billion square meters. There is enough land out there for another 2. The construction industry has production capacity of about 1.5 billion square meters per annum. Absolute oversupply, i.e., there aren’t enough people for all the buildings, could happen quite soon. When it happens, the consequences are quite severe. Property prices could drop like Japan has experienced in the past two decades, which would destroy the banking system.

via This is China Blog

And where there isn’t property lending there are the makings of excessive stockmarket speculation..

In a bubble resources are diverted to bubble making activities. The resources will be permanently wasted. For example, businessmen in China are reluctant to focus on real economic activities and are devoting time and energy to market speculation. It means that China wouldn’t have many globally competitive companies in the future. Even though China has had three decades of high growth, few companies are globally competitive. The serial bubble making in the Chinese economy may be the reason.

A generation of young people is not interested in real jobs and is addicted to stock market speculation. They see their holdings changing in value in a day more than their monthly salary and have the illusion that they would make a lot of money in the market. Of course, most of them will lose everything and may take extreme actions afterwards. The social consequences could be quite serious.

via This is China Blog

All of this is a far cry from bank lending to ‘green shoot’ enterprises, but the reality is such enterprises have a hard time sourcing funds in China, you have to be politically connected and potential green shoot entrepreneurs usually aren’t. As I have pointed out before there are also big problems determining what is happening in China from the official statistics.

So, on the one hand I have everyone telling me how much of a depressing person I am. On the other hand I have a situation analagous to 1929 in more ways than one, trillions in derivatives, large deficits, and a Chinese boom fueled by speculation on commodities. As far as I’m concerned this is not a sound basis on which to be sending out ‘End of the Depression’ party invites just quite yet… Note, I very well could be incorrect. I freely admit this, I could easily have underestimated/overestimated the importance of one or all of these things, and that could have caused me to make an error. To add to the litany of potential arguments against me some very educated people have reasoned the exact opposite to what I have reasoned, which should be a warning sign that I’m wrong (or a warning side that I’m right…depending on your opinion of intellectuals ;)). However, unfortunately, I just don’t see it at the moment so, alas, I shall just have to remain the most depressing person at the cocktail party..again..for now.

7 thoughts on “It’s over…just like 1929…

  1. So many graphs in one post 🙂
    No, I don’t think its time to party yet. Cleaning the musical instruments for a big party doesn’t mean its time to party or the party will be soon. Its a way to get some anticipation into people which doesn’t work that well to make a situation better (though the opposite happens pretty quick).

  2. Great post.

    It’s clearly a contest of confidence at the moment … China is trying to outlast the US before the s###t really begins hitting the fan. The fundamentals in the US are terrible, couple that with the total notional value of derivatives in the financial system, and you have a pretty bleak outlook. You’ve collated some fascinating information regarding China…on the basis of that information they look like they’re tracking for a similar kind of collapse as the one the US is facing. The quadrillion dollar question is whether their political structures are sufficiently robust to handle that kind of collapse.

    Interesting point re early twentieth century globalisation. Few seem to be aware that the world was very well interconnected, for both political and trade purposes prior to the ‘Great World Wars.’

    There are some pretty persuasive arguments that the collapse in world trade directly led to world war. This is a scenario that has been concerning me for some time … and the data you’ve highlighted regarding the collapse in world trade in Figure 3 doesn’t bode well in that regard.

  3. Metahound, with regard to China I would say the Chinese have been reading Sun Tzu:

    “Hence, when able to attack, we must seem unable; when using our forces, we must seem inactive; when we are near, we must make the enemy believe we are far away; when far away, we must make him believe we are near.”

    The early Twentieth Century round of globalisation was something I only heard about very recently. Not sure about Trade declines leading to WW2, but World War I almost certainly ruined trade(and trade did not prevent the war, even though most thought it would), the stock market declines caused by the outbreak of war would have almost certainly outshone those of the Great Depression if Governments had not chosen to close the markets for several months. The reason why I am unsure whether the decline of trade cause WWII is because WWI happened even despite the huge amount of trade around the globe at the time.

    Pakistani Punisher, I don’t think I quite understood your extension of the ‘party’ metaphor 😛

    1. Remove your post?? What? We never unsubscribe anybody, all are welcome! Even spam bots (which you aren’t but I am close to being :))

      1. I meant to say ‘we never remove posts’ not ‘we never unsubscribe anybody’, but…you get the idea 😉

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