Financial Armageddon

A Big Joke...

...in honor of yet another hopium-fueled stock market rally (via Capitalists@Work):

Once upon a time, in a place overrun with monkeys, a man appeared and announced to the villagers that he would buy monkeys for $10 each.

The villagers, seeing that there were many monkeys around, went out to the forest, and started catching them.

The man bought thousands at $10 and as supply started to diminish, they became harder to catch, so the villagers stopped their effort.

The man then announced that he would now pay $20 for each one. This renewed the efforts of the villagers and they started catching monkeys again. But soon the supply diminished even further and they were ever harder to catch, so people started going back to their farms and forgot about monkey catching.

The man increased his price to $25 each and the supply of monkeys became so sparse that it was an effort to even see a monkey, much less catch one.

The man now announced that he would buy monkeys for $50! However, since he had to go to the city on some business, his assistant would now buy on his behalf.

While the man was away the assistant told the villagers, “Look at all these monkeys in the big cage that the man has bought. I will sell them to you at $35 each and when the man returns from the city, you can sell them to him for $50 each.”

The villagers rounded up all their savings and bought all the monkeys.

They never saw the man nor his assistant again, and once again there were monkeys everywhere.

Now you have a better understanding of how the stock market works.

(Image: source)

The Value of Preparing for the Worst

While I only briefly touched upon the topic in Financial Armageddon, I devoted a chapter (and more) of my third book, When Giants Fall, to the disruptive impact that economic, social, political, and geopolitical upheaval would have on the day-to-day operations and bottom-line profitability of large and small businesses.

One key recommendation was that managers would need to strike a better balance between efficiency and redundancy. Instead of being anchored to a "just-in-time" approach, with minimal reserves of inventory and other resources, businesses would also need to think about "just-in-case" -- that is, what they would do if they were unable to get what they needed through "normal" channels.

Prior to the financial crisis and the other unsettling developments we've seen in recent years, many so-called experts pooh-poohed this kind of talk, suggesting that globalization and technology had rendered such concerns obsolete. Now, of course, attitudes have changed, and some are suggesting, as CFO.com reports in "Why Inefficiency Is a Balance Sheet Asset," that there's value in preparing for the worst.

Excess capacity and surplus working capital help companies survive shocks to the supply chain.

CFOs and the accounting profession know well how to do an upbeat financial report on the performance of any efficiently-run organization. But how can you turn inefficiency into a profit or an asset?

Well, why would you want to? Prof, Ian Goldin knows why. He's the director of the Oxford Martin School at Oxford University, an educational establishment that specializes in thinking about global questions that affect the future. In short, Goldin believes that "the professional push to sweat your assets is dangerous."

In a recent presentation to CFOs at the annual Finance Directors' Forum conference in London, Goldin talked about how the high degree of globalization, integration, and connectivity has been "the best positive force that humanity has ever known." At the same time, he argued, "we must get much smarter at managing the systemic risks — whether they are cyber risks, pandemic risks, financial risks, or other risks."

In business, he said, we see this with "increasingly tight, elongated, tense supply chains and smaller capacity": efficient, yes; highly connected, certainly. But "whether it's your working capital, oxygen bottles in a hospital, parts in a factory, spare people in your
firm . . . when there's a shock in the system, it amplifies much quicker," he warned. A factory in Oxford can be brought to a standstill because of a small disruption in the English Channel.

Goldin challenged the accounting profession, which, he said, "is not giving us a reward for resilience and spare capacity." And he asked the CFOs present, "How do you ensure that you're able as a finance director to value resilience and some capacity to absorb shock? How do you explain to your shareholders that actually having some spare capacity or backup systems is a good thing for the long-term survival of your firm?"

Econonomic and Social Conditions: More Closely In Synch

"Crime will run rampant as police departments and other government services that help maintain  public order eliminate or cut back on jobs, overtime, and equipment, while growing numbers of formerly law-abiding but now desperate citizens reveal their dark side."
-- Chapter 9, "Economic," Financial Armageddon

Although a number of the predictions I made in my March 2007 book have come true, one thing we haven't seen is a dramatic rise in illegal activity, despite evidence, as sociologist Steven Box concluded in his 1977 book, Recession, Crime, and Punishment, that a "deterioration in material circumstances [leads] to more crime."

Some have argued -- probably rightly so -- that the reason why things are different this time is because an extraordinary large percentage of Americans are currently in prison. Others maintain that the modern social safety net has alleviated at least some of the pressure that turns law-abiding citizens into opportunistic criminals. Regardless, a report at Business Insider, "Stockton Goes Bankrupt And Already The Murder Rate Is Soaring," suggests we may be getting closer to the point where economic circumstances and social conditions are more closely in synch:

Stockton, California is filing for the largest bankruptcy of any U.S. city in history due to the decline in the once hot housing market and an intake of debt during its boom years.

The city has cut more than $90 million in spending over the past few years, specifically in its police department. The city has cut over one quarter of its police jobs, which has led to a "surge in murders," and has created an "emboldened criminal element" in the city. According to police spokesman Joe Silva, the city has had 87 murders since the start of 2011, 29 of which have already occurred this year. In contrast, there were 35 murders in 2009 and 48 in 2010. With six months left in the year, there have already been more murders in the city since the start of 2011 than the two-year stretch of 2009-2010.

A Little Bedtime Reading...

...for those who like nightmares:

"America Is No Longer a Land of Opportunity" (Joseph Stiglitz, Financial Times op-ed)

US inequality is at its highest point for nearly a century. Those at the top – no matter how you slice it – are enjoying a larger share of the national pie; the number below the poverty level is growing. The gap between those with the median income and those at the top is growing, too. The US used to think of itself as a middle-class country – but this is no longer true.

"We Are Living in a ‘Modern-Day Depression’: David Rosenberg" (Yahoo! Finance)

While some, notably the cycle watchers at ECRI, believe the U.S. economy is definitely heading for another recession (or already there), Gluskin Sheff's chief economist and strategist David Rosenberg goes a big step further.

"We are living in a modern-day depression," he declares.

This dramatic statement is based on several factors, including the record number of Americans living on Food Stamps — 46 million or 1-in-7 in 2011. Because these benefits are now given in the form of electronic debit cards, we don't have bread lines like in the 1930s, but they are there in virtual form. And that's just the most obvious form of government support for its struggling citizenry.

"Government transfers to the personal sector now makes up nearly one-fifth of total household income," Rosenberg writes. "Even Lyndon Johnson, architect of the 'Great Society', would blush at that."

"SURVEY: The World's Top Executives Are Losing Faith In The Economy" (Business Insider)

McKinsey has just published the finding of its global survey of executives, and it shows a startling downturn in sentiment about the direction of the economy.

Back in March, 45 percent of respondents expected the economy to improve moderately over 6 months. Now, that number is down to 19 percent.  The number that expect it to do moderately worse is up to 42 percent.

"Enter, the Blindside Recession" (Hussman Funds Weekly Market Comment)

In recent months, our measures of leading economic pressures have indicated the likelihood of an oncoming U.S. recession. Our view is based on the analysis of leading/coincident/lagging indicators (see Leading Indicators and the Risk of a Blindside Recession) as well as more statistical signal processing methods that extract "unobserved components" from noisy data (see the note on extracting economic signals in Do I Feel Lucky?). As Lakshman Achuthan at the ECRI has noted on the basis of different but related evidence, the verdict has been in for a while. The interim has been little more than waiting for the coincident data to catch up to the leading evidence that is already in place.

This wait is by no means over. As Achuthan has observed, economic data such as GDP and employment data are heavily revised over time. Very often, the first real-time negative GDP print occurs about two quarters after the recession actually begins. It is only later that the data are revised to show an earlier downturn. For that reason, it's important to pay attention to the joint action of numerous economic data points, rather than selecting any specific indicator as an "acid test." The joint evidence suggests that the U.S. economy has entered a recession that will later be marked as having started here and now.

"A Nation Too Scared to Quit" (New York Post)

More than 1 million fewer Americans a month are quitting their jobs than before the recession.

Quits aren’t supposed to be falling during a recovery. During a recession, sure: With poor prospects of landing a good new job quickly, people hesitate to voluntarily leave.

But the opposite is supposed to happen in a recovery: People sense opportunity, and they chase it. (The rebound is especially strong after longer recessions, as people who’ve been putting off quitting finally decide it’s safe to bite the bullet.)

Yet now we have a “recovery” where Americans have grown even more fearful about quitting their jobs.

Nighty night...

(Image: source)

Good News, Bad News

The good news, according to a new IMF working paper, Systemic Banking Crises Database: An Update, is that financial crises are more likely to begin in September than in any other month, which suggests we may have a bit of time before the stuff (Europe, China, fiscal cliff, etc., etc., etc.) really hits the fan (hat tip to Free Exchange).

The bad news, however, is that no matter when the next disaster strikes -- and it will -- a lot of people are going to have a hard time coping with the economic fallout, based on the following Los Angeles Times report, "Two-Thirds of Americans Wouldn't Survive a Financial Emergency":

If the standard financial wisdom is true – that surviving a financial catastrophe requires a 6-month cache of emergency savings – then two-thirds of Americans may be in for a nasty surprise.

Only a quarter of U.S. adults have more than six months of funds set aside and readily accessible for such disasters; 28% had none at all, according to Bankrate.com.

Of the 1,000 survey respondents, 17% said they had three to five months of expenses squirreled away in case of job loss, sudden medical bills or other unexpected events; 9% didn’t answer the question.

Doing Real Fine

More evidence, as President Obama said a few weeks ago, that "the private sector is doing fine" (via The Christian Science Monitor) [italics mine]?

A shocking figure from the Wave [Accounting] survey [of their 250,000 micro and SMB customers] relates to how well the business owners were able to meet their basic needs through their business. An incredible 52 percent of American small business owners can’t put food on the table through the earnings from their business over the past 12 months.

Even though many said they can’t make ends meet, it is not due to a lack of effort. Two thirds (66 percent) of business owners in the Wave survey reported struggling with time management and work/life balance with 43 percent of respondents having to work after normal business hours to take care of administrative tasks like accounting and bookkeeping.

If this is Mr. Obama's idea of "doing fine," I'd love to see his definition of "doing poorly."

Three Charts, One Word

Household income data continues to disappoint (except for the already well-to-do) --

(From "The Housing Recovery: Based on What?" Of Two Minds)

People are increasingly disappointed with U.S. institutions --

(From "Losing Faith in American Institutions," Economix)

and retirement prospects look ever more disappointing by the day --

(From "Half of Current Workers Won't Be Able to Retire at 65," The Atlantic)

Remember When...

...there was excited talk from highly-paid Wall Street "strategists" about a U.S. "decoupling"?

"Adobe Cuts FY Rev Outlook on Weak Europe Demand" (Reuters)

Adobe Systems Inc (ADBE.O), maker of Photoshop and Acrobat software, reported a modest fall in quarterly net income, and cut its full-year revenue outlook to reflect weaker demand in Europe.

"P&G Cuts Forecasts as Sales Growth Slows in Europe, U.S." (Bloomberg)

Procter & Gamble Co. (PG), the world’s largest consumer-goods company, cut its earnings and revenue forecasts for the second time in less than two months as slowing economies in Europe and the U.S. weigh on sales growth.

"FedEx Posts Lower Profit; Outlook Falls Below Wall St. Forecasts" (Los Angles Times)

FedEx predicts earnings for its fiscal year will be hurt by slow global economic growth. The shipping giant posts a drop in fiscal fourth-quarter profit despite an increase in revenue.

FedEx Corp. said Tuesday that slow global economic growth would crimp its earnings over the next 12 months. The company vowed to make significant cost cuts to counter any drop in package shipments as it reported lower fiscal fourth-quarter profit.

The world's second-largest package delivery company is closely watched for signs about the health of the economy. It forecast moderate growth for the U.S. and global economies, citing the debt crisis in Europe and slowing growth in Asia.

"Actuant Shares Fall on Wary Outlook" (Fox Business)

Fueled by new acquisitions that helped offset some of the turbulence in Europe, Actuant revealed on Wednesday a better-than-expected third-quarter profit.

However, the company expressed worries about macroeconomic conditions in Europe and China that could weigh on earnings over the next two years, sending its shares down more than 4.75% early in the session

"U.S. CEOs View of Economy Dims in Quarter: Roundtable" (Reuters)

U.S. chief executives' view of the economy dimmed in the second quarter, with fewer expecting to grow sales or add workers than three months earlier, according to a survey by the Business Roundtable released on Wednesday.

The group's CEO Economic Outlook Index fell to 89.1 in the second quarter, down from 96.9 in the first quarter but still well over the 50 mark that separates growth from decline. The drop reflected increasing worry in corporate America that Europe's economic troubles could take a toll on sales.

Can somebody please shut those guys up before their clients lose all their money?

Still a Big Divide

Although the gap narrowed somewhat during the late-Spring selloff, the divergence between equity and credit markets has grown once again because the recent rebound in share prices has not been matched by a comparable move in credit spreads. That suggests fixed-income traders remain much less sanguine about the economic outlook than their stock market peers.

While it is possible that the latter group are ahead of the curve, the history of the past decade or so suggests that is not the case. More than likely, credit traders have actually been paying attention to what is going on, as detailed in reports like this:

"Consumers Spending Less, Expectations Falling" (24/7 Wall St.)

Consumer spending in June has fallen as shoppers save more and pay down existing debt. According to a survey by ChangeWave, some 31% of respondents plan to spend less in the next 90 days, a jump of 5% since the May survey. Those who said they would spend more also totaled 31%, but that represents a -1% drop compared with May.

The ChangeWave data notes other significant points:

• Low-income households continue to be the weakest spending group, but the largest drop in June was among households with incomes of $100,000-$150,000.
• Spending declined in many categories, including home improvement, durable goods, restaurants, electronics, and travel.
• More than half (55%) of all respondents say that the US economy will get worse in the next 90 days — a jump of 19% since May — and only 12% say the economy will get better.
• In the past three months, consumer expectations have plummeted by a net 55%.
• More than 60% of respondents are less confident in the US equity market.

The trend toward lower spending is a replay of last summer’s experience according to ChangeWave. Besides saving more and reducing debt, 40% of those surveyed said they are spending less because their incomes are lower.

But, But, But...

...I thought the experts said the U.S. was decoupling from the rest of the world --

"Europe Imperils U.S. Sales From Chemicals to PCs: Economy" (BusinessWeek)

American exporters from Dow Chemical Co. to Hewlett-Packard Co. are preparing for a further decline in demand from Europe as the region’s deepening debt crisis threatens to derail a source of strength for the U.S. economy.

JPMorgan Chase & Co. cut its forecast for second-quarter growth to 2 percent from 2.5 percent last week, in part because of a deteriorating trade balance. Earlier this month, it lowered its third-quarter estimate to 2 percent from 3 percent, “with much of the downward revision accounted for by an expectation that the pace of export growth will slow,” chief U.S. economist Michael Feroli said in a June 1 research note.

U.S. exports to the 27-nation European Union dropped 4.8 percent in the year ended April, the worst 12-month performance since November 2009, Commerce Department figures show. By comparison, total U.S. exports were up 3 percent in April from the same time last year. The slump in Europe coincides with slowing growth in other major markets for U.S. goods, such as China and Brazil.

“The decline in Europe will weaken our exports over the long term,” said Michelle Meyer, a senior U.S. economist at Bank of America Corp. in New York. “We look for the trade deficit to widen not only to the euro zone but developing economies as well,” she said, consistent with their forecast that the U.S. economy will slow to just 1 percent growth by year-end from the 1.9 percent annual pace in the first quarter. --

...and that deficit spending would help our economy --

"Study: Long-Term Deficits Are Linked to 24 Percent Lower Growth" (The Washington Post)

What’s the real harm of a massive government deficit? Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff find that high public debt is associated with a significantly lower level of GDP in the long run.

In a new paper for the National Bureau of Economic Research, the researchers examined the historical incidence of high government debt levels in advanced economies since 1800, examining 26 different “debt overhang episodes” when public debt levels were above 90 percent for at least five years.

The National Debt Clock. (Andrew Burton/GETTY IMAGES) The debt episodes included everything from Netherlands’ Napoleonic War debts and the Japan banking crisis of the 1990s to Greece’s current fiscal crisis. On average, the researchers found that growth during these periods of high debt were 1.2 percent lower on average, consistent with Reinhart and Rogoff’s findings in 2010. What they also found, however, was these episodes of high debt and lower growth were quite lengthy, averaging 23 years. And the accompanying long-term drag on GDP was substantial. “By the end of the median episode, the level of output is nearly a quarter below that predicted by the trend in lower-debt periods,” they explain. --

...and that our economy was on the mend?

"The Hill Poll: Voters Fear US Could Slip into a Double-Dip Recession" (The Hill)

A massive majority of likely voters fear America could be slipping into a second economic downturn just four years after the Great Recession, according to a new poll for The Hill.

...

Amid worrisome jobs numbers and the looming threat of a eurozone crisis, the survey found 75 percent of people were either very or somewhat worried the country is headed toward another recession.

Among those concerned, 46 percent said they were “very” worried and 29 percent said they were “somewhat” worried.

I guess all those "experts" are...but-heads?

A Bloody Taste

In "The (Ever-Expanding) War Next Door," I highlighted an article detailing the expanding presence of Mexican drug cartels in cities throughout the U.S., and suggested that it was only a matter of time before the increasing bloodshed south of our border flowed northward.

While that sort of carnage and mayhem in our country is probably some ways off, an ABC News report, "Travel Warning for Mexico: Possible Violent 'Retaliation' Against Americans," suggests that some of us may nonetheless get a taste of it very soon:

American travelers to Mexico should beware of possible violent retaliation for this week's arrest of alleged Zetas drug cartel associates and family members inside the U.S., the U.S. State Department has warned.

Though the warning does not specify which "Transnational Criminal Organization" might engage in "anti-American" violence, on Tuesday federal authorities arrested seven alleged associates of the powerful Zetas drug cartel in New Mexico and Oklahoma for allegedly laundering millions in drug profits through breeding and racing quarterhorses in the U.S. Those arrested included Jose Trevino Morales, the brother of Zetas leaders Miguel Angel and Oscar Omar Trevino Morales, who were also indicted but remain at large in Mexico.

According to the indictment, the Zetas cartel steered drug money to Jose Trevino Morales and his wife to purchase, train and race quarterhorses. Horses owned by the Zetas' alleged front companies competed at Ruidoso Downs in New Mexico and won lucrative races, including the $1 million All American Futurity in 2010. Some of the horses, like Morning Cartel and Coronita Cartel, had the word "cartel" in their names.

The travel warning issued Tuesday, the day of the arrests and the unsealing of the indictment, urges U.S. citizens in Mexico to be on guard. "Given the history and resources of this violent TCO, the U.S. Embassy urges U.S. citizens to maintain a low profile and a heightened sense of awareness."

The NIghtmare Waiting In the Wings

I know it's not the sort of thing that people talk about when they are focused on what band-aid-cum-can-kicking "solution" authorities are going to come up with in the next 24 hours, but even if by some miracle they sort out the current round of problems, just look at what's waiting for us in the wings:

"Treasurers Face $46 Trillion Financing Cliff" (CFO.com)

A massive amount of global corporate debt matures in the next four years, and it’s causing treasurers to refocus their efforts on securing access to credit.

A measure of the scale of the refinancing problem is revealed in a recent report by Standard & Poor’s Ratings Services. S&P suggests there is as much as a $46 trillion “credit overhang” — the amount of money corporates will need to raise between 2012 and 2016 to refinance their soon-to-mature debts and to fund capital expenditure and working capital growth.

The combination of bank balance-sheet restructuring, a euro zone crisis, a softening U.S. recovery, and the prospect of slower growth in China could make for what S&P calls “a perfect storm” in credit markets. S&P’s working assumption is that “global banks and debt capital markets will largely be able to continue to provide the majority of liquidity to allow most corporate issuers to proactively manage their forthcoming refinancings.” However, S&P warns, “the balance is fragile” and there is the threat of financing disruptions “even for borrowers that are not highly leveraged.”

New money requirements from 2012 to 2016 could be as much as $2.3 trillion in the euro area and the United Kingdom, $3 trillion in the United States, almost $10 trillion in China, and $1 trillion in Japan. (Those numbers assume corporate debt grows at 1.2 times the rate of GDP over the next five years.)

Added to this are estimated refinancing needs of $8.6 trillion in the euro area and the United Kingdom, $8.6 trillion in the United States, $7 trillion in China, and $5.8 trillion in Japan.

But then again, it's only money, right? If we need more, we can just print it.

Here and Abroad

The latest Pew Global Attitudes Project global survey finds that America's standing in the world has continued to deteriorate:

The Obama era has coincided with major changes in international perceptions of American power – especially U.S. economic power. The global financial crisis and the steady rise of China have led many to declare China the world’s economic leader, and this trend is especially strong among some of America’s major European allies. Today, solid majorities in Germany (62%), Britain (58%), France (57%) and Spain (57%) name China as the world’s top economic power.

Indeed, it is not just those who live beyond our shores who feel this way, as the following table attests [red and blue annotations mine]:

Admittedly, most analysts would consider a one-percentage point differential to be the satistical equivalent of a dead heat, but even so, the fact that most Americans no longer see a large gap in our favor is not a good sign.

'The Whole World Economy Is On a Path Towards Some Major Collisions -- Dislocations -- Towards the End of This Year'

Here's today's economic reality check, courtesty of David Stockman, former budget director in the Reagan Administration and author of The Great Deformation: How Crony Capitalism Corrupted Free Markets and Democracy, due out in January (via Fox News):

(Hat tip to The Cynical Economist.)

The (Ever-Expanding) War Next Door

With reports like this --

"In Small-Town USA, Business as Usual for Mexican Cartels" (CNN)

Wilmington, North Carolina -- Less than a mile off a county road in Ivanhoe near the Black River, federal drug agents and local authorities found exactly what their informant had promised.

"We saw what looked like, as far as you could see, marijuana plants," said Drug Enforcement Administration agent Michael Franklin.

There were about 2,400 in all, surrounded by a makeshift camp where the growers had illegally squatted on private property, setting up a generator and pump to tap the river for irrigation. The camp, which had been recently inhabited, contained a tarp shelter, canned fuel, drinking water, toiletries and old clothing, some of it camouflage.

Authorities staked out the "grow" for two days waiting for the marijuana farmers to return. They didn't. It was just as well, Franklin said.

"The people we were really focusing on were not the guys tending the field. The guys bankrolling the field were the target," he said.

Those guys, according to the DEA's source, were members of La Familia Michoacana, a Mexican drug cartel that the Justice Department says focuses primarily on moving heroin, cocaine, marijuana and methamphetamine into the southeastern and southwestern United States.

Because the investigation into the June 2009 seizure is still ongoing, the DEA would not divulge further details. But Franklin said the case is one in a growing list of cartel-linked busts he is seeing in largely rural southeastern North Carolina. The area's Latino population has grown considerably in the past 20 years, and authorities say cartel operatives use Latino communities as cover.

"While the majority of (Latino residents in the area) are hardworking people like anyone else, it's an opportunity for the cartels to have their foot soldiers do their thing, too," Franklin said. Based in Wilmington, he is resident agent in charge of 14 counties.

News of cartel machinations are common in cities near the border, such as Phoenix, and the far-flung drug hubs of New York, Chicago or Atlanta, but smaller towns bring business, too. In unsuspecting suburbs and rural areas, police are increasingly finding drugs, guns and money they can trace back to Mexican drug organizations.

The numbers could rise in coming years. The Justice Department's National Drug Intelligence Center estimates Mexican cartels control distribution of most of the methamphetamine, heroin and marijuana coming into the country, and they're increasingly producing the drugs themselves.

In 2009 and 2010, the center reported, cartels operated in 1,286 U.S. cities, more than five times the number reported in 2008. The center named only 50 cities in 2006. --

I wonder how long it will be before the reds on the bottom of this map start bleeding (no pun intended) into the top:

(Image: "Mexican Drug War: Waves of Violence," The Economist)