Everything and Nothing

SUBHEAD: The returns on wasting expensive oil are insufficient to service the loans required to enable the waste! Image above: Painting by Viktor Visnetsov of "The Flying Carpet". A magic carpet or golden goose are examples of something for nothing. They share being unreal. From (http://lukemcreynolds.com/wallpaper/images/viktor_vasnetsov_-_the_flying_carpet). By Steve Ludlum on 24 November 2010 in Economic Undertow - (http://economic-undertow.blogspot.com/2010/11/everything-and-nothing_24.html)

"Happy families are all alike; every unhappy family is unhappy in its own way." - Tolstoy

This may be so at home with the sorrowing wife, screaming kids and angry dog but passing the world's unhappy economies through a TSA scanner reveals that all share the same rot at the center. This being the failure of waste-based economies to pay for themselves regardless of how hard the participants cheat. This is a fact that is self-evident. If economies could support their own input costs, they would. There would be no recession. That they avoid doing so by every available means indicates they cannot! In Europe, the Key Man strategy to prop up failing systemically important institutions is running into trouble. The strategy's purpose has been to prevent a single-entity failure from triggering a cascading deflationary collapse: dreaded 'Contagion'. Supporting Key Men unconditionally implies that failure of any particular Key Man is fatal to all. A robust economy takes failure in stride. It is the central feature of capitalism, that success is rewarded and blunder is not. The Key Man Strategy denies failure and by doing so insures its inevitability. Frederick the Great suggested that, "He who defends everything defends nothing!" The scope of Key Man's 'everything and nothing' folly is now heaving into (x-ray) view. Beginning in 2008, the initial rounds of bailouts and creative accounting practices were aimed at banks -- and at a remove hedge funds and participants in the Shadow Banking empire: SIVs, investment house trading desks and private money managers writing or holding swaps and other derivatives. Shadow banking had to be bailed out because they held the entire finance universe hostage. The money- center banks and their minions were the first-order Key Men. Private risk was shopped to the sovereigns whose feeble balance sheets soon groaned with the added dead weight of impaired loans and zombie institutions. Fast forward eighteen months: and these second-tier Key Men require rescue. What now? The answer is that the means to bail at such high levels does not exist in any real sense. 'Stimulus' and 'Easing' are reasonable at the € billion level or even $ trillion level but quadrillions are absurd and pointless. The amounts offered so far in the form of future tax revenues are unsupportable by fact. The establishment has painted itself into yet another corner. Output cannot grow because of long-running resource constraints. Administrative interest rates are already at zero. Bailout funds cannot be increased because the countries are broke. Fiscal policy is stymied because of the austerity political fad. Assets that can be sold to others are losing value rapidly. Putting all the 'rescue and reform' resources into the Key Man effort has left the finance establishment with no strategic reserve. It has shot its bolt: if (when) QE fails, what's next Mr. Bernanke? What is needed is a 'Plan B' and there is no such thing. The world's economies cannot support their input costs. Consequently, Key Man has failed. Ireland is at the Icelandic crossroads of rejecting the EU/IMF bail. The European Financial Stability Facility (EFSF) is funded by the entities it is supposed to support which means it's effectively bankrupt. Euro-bond traders are fleeing Portuguese and Spanish debt. European The Key Men cannot feed themselves. If When they default they take the euro ... and god knows what else ... with them:

THE INCREDIBLE SHRINKING EFSF One of the many flaws in the EFSF bailout mechanism is that it is funded by the very problem children that it is intended to save. A good way to think of the fund is to imagine California, New Jersey, Nevada, Illinois, Texas, New York and Pennsylvania coming together to create a bailout fund. Of course, several of these states are financial disasters. When a country applies for aid to the EFSF they no longer contribute to the fund. So what’s going on as the dominoes fall is that the fund is actually shrinking (via FT Alphaville):

… it now looks something like this: (all figures in euros)

Germany	119,390.07
France	89,657.45
Italy	78,784.72
Spain	52,352.51
Netherlands	25,143.58
Belgium	15,292.18
Greece	12,387.70
Austria	12,241.43
Portugal	11,035.38
Finland	7,905.20
Ireland	7,002.40
Slovakia	4,371.54
Slovenia	2,072.92
Luxembourg	1,101.39
Cyprus	863.09
Malta	398.44
Total	404,143.20

So you can see the sad math here. Italy and Spain are vitally important contributors to the fund. And ultimately, it’s Germany and France that are shouldering the majority of the burden here with almost half of the funding coming from those two countries alone. So we have failing austerity and no central treasury that can actually bailout the states. Ultimately, the markets are likely to continue attacking these countries as the austerity measures fail to lead to prosperity and in fact worsens the crisis across Europe.

Key Man strategy worked only as long as the vulnerable were scattered across markets where the propaganda supporting 'growth' could not be effectively scanned. The Key stooges that were propped to a point were Dubai/Dubai World, AIG, General Motors/Chrysler, state of California, Fannie Mae, etc. Out of sight, out of mind! Coagulating default risk within a single market or region quickly escapes the reach of effective policy. As more Key Men fall into the drain, risk explodes tilting the entire enterprise. There is simply insufficient real output to bail out the whole of Europe's deadbeats. One or two smaller Key Men can be propped up, not all of them. The same Key Man approach has the US establishment holding the economy together with bailing wire and duct tape. The unemployed are abandoned to their fates as funding is funneled into the different banking and finance Key Men ratholes. Despite the funneling exercise the banks teeter; nobody can tell precisely how much exposure the banks have. As in Europe the real output of business -- manufacturing and extractive enterprises, excluding finance and retail -- shrinks. Business can only approximate 'growth' by holding off desperately needed deleveraging. American Key Men can only succeed by jeopardizing other Key Men elsewhere! It's more 'borrowing your way out of debt' or building a successful company by firing the entire workforce. Here is the abject failure of critical thinking. Intellectual reductio ad absurdum has reached its limit as platitudes and bromides that have been undressed as demonstrable failures are trotted out again and again. We have the growth -- or China has it -- and the result is failure. Minus the growth and the result is failure. Where is the beef? Critical thinking admits the possibility of thermodynamics as being something other than a long word that sissies use. Thermodynamics does not allow energy and resource waste to pay for itself. The only reason it has appeared to do so is because of a one-time state of resource bounty, rapidly undone by economic rationalizations that allowed the mispricing of that bounty. Here is the Tom Friedman critical thinking singularity in action:

... just as the world was getting flattened by globalization, technology went on a rampage — destroying more low-end jobs and creating more high-end jobs faster than ever. What computers, hand-held devices, wireless technology and robots do in aggregate is empower better-educated and higher-skilled workers to be more productive — so they can raise their incomes — while eliminating many lower-skilled service and factory jobs altogether. Now the best-educated workers, capable of doing the critical thinking that machines can’t do, get richer while the least-educated get pink slips. (We used to have a receptionist at our office. She was replaced by a micro-chip. We got voice mail.) Finally, just when globalization and technology were making the value of higher education greater than ever, and the price for lacking it more punishing than ever, America started slipping behind its peers in high school graduation rates, college graduation and global test scores in math and critical thinking.

Where is the critical thinking? Just about every remark in Mr. Friedman's paragraph is wrong. What "computers, hand-held devices, wireless technology and robots" do in aggregate is empower a handful of financiers, 'entrepreneurs' and venture capitalists. The waste-based items that are this group's products are time- and energy wasting toys that are supported by legacy output derived from simpler machines such as vacuum cleaners, diesel trains and sewing machines. Unlike the foregoing, neither TVs and video games -- nor their hand held cousins -- pay for themselves! Business automation is self-defeating as it strips final demand and reduces the overall skill level of the population. Viewed as such the machines are not assets but liabilities. The use of gadgets does not represent any net increase in aggregate output but instead, strip- mines output from other, more productive sectors. Computers and cell phones are convenient, but are functionally little different from dial telephones and typewriters. These were machines that cost much less and did not require massive amounts of cheap electricity or gargantuan infrastructures to function. Workers who used the typewriters and telephones earned good wages that enabled them to purchase labor-saving tools for their own use such as washing machines and flush toilets. What do the unemployed buy? Automation of management jobs has Friedman's, "better-educated and higher-skilled workers" milling alongside "lower-skilled service and factory workers" in the food-stamp line. If this is progress, the world needs less of it! The rich get richer and the rest get screwed. Modernity has ossified into religious dogma. The happenstance of big box-like buildings and automobiles have become representatives of an idea rather than useful things on their own account. Their abjectness -- as unsupportable liabilities -- is ignored. Modernity cannot pay its own way, it pimps the novelty of its own appearance and nothing else. Underneath modernity's shiny exterior is the waste pumping process which efficiently undermines itself. The throughput of the shiny thing carries resources from mine to processor to landfill ... or to the ocean or atmospheric dumping grounds. Automobiles do not make people or the world 'better' in any meaningful sense of the term. For auto users the use/non- use is a trade off of conflicting balance sheet entities smeared onto a spam crafted fantasy of 'speed' and 'convenience'. Like Tom Friedman's evanescent 'highly paid managers' the speed fantasies are lies. Expanding consumption makes sense if you reside at the top of the economic pyramid: it is ruin for everyone else. Where ruin beckons are Key Men far away? Here, David Leonhart's 'Growth' dogma creates China as a Key Man due for a bailout:

To continue growing rapidly, China needs to make the next transition, from sweatshop economy to innovation economy. This transition is the one that has often proved difficult elsewhere. Once a country has turned itself into an export factory, it cannot keep growing by repeating the exercise. It can’t move a worker from an inefficient farm to a modern factory more than once. It cannot even retain its industrial might forever. As a country industrializes, workers will demand their share of the bounty, as has started happening in China, and some factories will start moving to poorer countries. Eventually, a rising economy needs to take two crucial steps: manufacture goods that aren’t just cheaper than the competition, but better; and create a thriving domestic market, so that its own consumers can pick up the slack when exports inevitably slow. These steps go hand in hand. Big consumer markets become laboratories where companies know that innovations will be tested and the successful ones richly rewarded. Those products can then expand into countries with less mature consumer markets. Look at the telephone, the personal computer and the iPhone and iPad, all of which were designed in the United States and are now sold around the world.

Leonhart paints endless growth as the same promised land that industrialists have been promoting since 1710. Where is it, already? Leonhart should know better when he suggests iGadgets as successors to China's primary industries in ransacking the world's resources along with their their own overseas customers. Meanwhile, the various markets are repricing inputs to reflect both scarcity AND actual final value. In the process they are pricing waste- based consumption into bankruptcy. China can only succeed long term by succeeding where America and the West have failed: by somehow suppressing input prices. In this effort, China's growth imprimatur works against itself. It's industries' colossal demand drives input prices to levels where labor cannot afford the industries' products. As in the US, rising input prices punish labor which becomes expendable. What is left is theft. Theft is profitable -- ask Goldman Sachs -- but not sustainable. Risk emerges from all the usual and unusual hiding places. Investors make ready to abandon the markets, when this happens there is little left to steal:

Nearly everyone is underestimating the likelihood of a significant selloff in corporate bonds, especially junk, not because of a strengthening economy, but because of a weakening economy and rising default risk.

This is Mike Shedlock writing about the rising yields in various corporate bonds since the QE Key Man gambit was launched. You can take out the word 'corporate' and insert 'Irish', 'Greek', 'Spanish' or any other euro- using country. Given enough time you can insert 'US Treasury' in that paragraph as well. The rise in US government and municipal issues is starting to reflect the increase in risk the establishment has taken on. The time for effective remedial action is running out. Only restructuring and conservation will work. Here's Ambrose Evans- Pritchard:

The eurozone will face its moment of existential danger the day that (Key Man) Portugal is forced to tap the EU bail-out fund. A third rescue in months will push the combined bill towards €300bn (£257bn) and risk exhausting the political capital of EMU, leaving little left for (Key Man) Spain even if the European Financial Stability Facility can in theory handle one more domino. Chancellor Merkel was assured in May that words would be enough to chase away speculators and restore calm to Europe’s bond markets, that the "shock and awe" effect of a €750bn safety-net would conjure away the crisis without the need for real money. This bluff is now being called. What happens if Spain tips back into recession in 2011, and or when Spanish banks start coming clean on the true scale of their property losses, and Spanish companies have trouble rolling over foreign loans? What happens if Spanish 10-year bond yields creep above 5pc? Can Mrs Merkel go back to the Bundestag and request fresh money to boost the collateral of the EFSF in order to cope with the next casualty? A reader asked me this week whether there is any graceful way to avoid this coming chain of disasters. Yes, there are two options, neither entirely graceful. The European Central Bank can print money like a drunken sailor, flood the bond markets with €2 trillion, and tank the euro against China’s yuan for good measure. If the Germans refuse to accept this, they should abandon EMU at once, leaving France and southern Europe with the residual euro and the institutions of monetary union. Existing euro debt contracts would be upheld. Germany would revalue – alone or with Finns, Dutch, etc - so holders of Bunds would enjoy a windfall gain. France could revive the Latin Union of the late 19th Century, a more benign venture than the Máquina Infernal now asphyxiating Portugal, and deflating Spain. Any better ideas out there?

Not really, since growth is structurally limited there is little maneuvering room. Notice how any times the price of crude elevates to $80 and above risk appears and Key Men crumble? It's not coincidence. Here's a chart from TFC commodities charts of the front month Brent contract. The current price is an economy-annihilating $85 per barrel.

• The world's economies were reeling from the Great Price Spike [1]

• The Green Shoots period occurred when oil prices were below $40 per barrel.

• The Dubai crisis took place when oil prices had risen to the $80 level. [2]

• The Greek debt crisis took place when oil futures prices rose to near $ 90 per barrel [3]

• The current euro- related crisis has emerged just as the Establishment was patting its back with one hand and turning on the QE reserve spigot with the other ... and just as oil prices leapt above $ 80 again. [4]

The average price for crude oil in 2008 was $97. This particular year saw a world flush with excess credit, high stock prices, a growing Eurozone and a China pouring funds into its economy. There were trillion$ looking for a home. Even so, the world could only support $97 oil for a little while and prices collapsed. Plus-$80 oil insures the unavailability of credit! Why? Because the returns on wasting expensive oil are insufficient to service the loans required to enable the waste! The 2010 world is a lot poorer. Credit is unavailable. Plus-$80 oil insures the unavailability of credit! Why? Because the returns on wasting expensive oil are insufficient to service the loans required to enable the waste! It is this simple and easy-to-understand economic dynamic that escapes 'pros' like Eurozone money managers, the various central bankers, the Chinese authorities, Tom Friedman, David Leonhart, Paul Krugman, thousands of highly-paid finance analysts and just about every single economist which hops, flies, crawls or slithers over, under or above the surface of the Earth! Good grief, people! What is so hard to understand? Just as non-existent credit cannot support a price higher than an average $97 price neither can output support an $97 price. Why? Because any return on output -- after ordinary business expenses -- does not allow a profit! No profit, no business. Raise prices to gain a profit and customers -- who cannot afford the higher price -- vanish. No customers, no business. Lower prices to gain more customers and costs overrun profits. (This is the slippery slope both Wal- Mart and China itself finds themselves on). Send expensive labor overseas to allow business to afford higher fuel prices and you send your customers overseas at the same time. No customers, no business. You'll notice that none of the foregoing has anything to do with the pump price of gasoline. The failures and rot at the center of the world's economies are at the business level. The cost structure that is unique to modernity is 'sticky'. In fact, costs tend to expand. The TSA scanners are a good example. The scanners represent a 'new' cost that is added to all the other air travel costs alongside increasing real fuel costs. Who pays the added costs? Air travelers. Believe it or not, costs are subtracted from the airlines' bottom lines. TSA is another dead weight on the air-transport industry. What it cannot pay for itself is shifted by the sovereign tax regime to those who would not fly. This cost shifting by itself cannot support the airlines. As fuel costs rise the airlines will have to choose between operating and supporting the TSA. The TSA becomes the mechanism by which various phantom and hobgoblin 'Terrorists' destroy the airlines. Meanwhile, any argument that TSA prevents air calamities is impossible to make. TSA cannot be credited for any calamity that does not happen, the same way the president cannot be credited for jobs that are not lost. Meanwhile, an aircraft 'incident' would be the sole fault of the TSA and its 'growth' strategy of ever-widening responsibility. From a logic standpoint the Homeland Security chief Janet Napolitano should resign right now because of the inevitable security failure that will be her fault. This is all part of the dynamic of expanding costs that underlies all the unhappy economic families and fuels their laments. These won't end until modernity and its diabolical set of unsatisfiable demands is lured into the airlock then jettisoned into the deep space of obsolete ideas. The +$80 price is a throttle on business, on 'growth', upon modernity and on wishful thinking. At bottom all the unhappy families are unhappy for the same reason. They know they must waste no more. .