Saturday, November 8, 2008

How did we get here? And where do we go from here?

Things have changed so much since this blog was started in February 2007. There was euphoria in the markets at that time. The housing bubble in the US had burst, but the sheer magnitude of the devastation it would unleash, as well as its ramifications on the rest of the world had not been anticipated by most observers. Only those in the 'borderline insanity' category had the prognosis of the disease whose symptoms are now becoming visible.

The disease was easy credit abetted by the viruses of greed, speculation, leverage, stupidity, lax regulation, hubris and ignorance. In almost every asset class in almost every part of the world, there was an asset bubble. From the trailer homes in Fort McMurray to the art market in Eastern Europe, from the high end apartments in Bombay to the stocks in China. Easy credit of last twenty years gave high hopes and ‘can’t go wrong with xyz’ mentality to almost everyone. There was 'death of risk.' Even know, despite all that has transpired, morons are dime a dozen, who want to borrow and invest in Canadian stocks.

The period of easy credit is over. And so is the period of feigning low risk by absurd mathematical models created by armies of glorified economists. When I try to put a perspective on the massive oil sands related investments that had been planned for Alberta, I see that they were fueled more by the easy credit and low risk environment than by any fundamental factors. Most readers are familiar with Warren Buffett’s comments (paraphrased) on oil sands that ‘you could be the best mining engineer in the world, but if you are not sure that the price of oil would be in the $120 range, oil sands may not be the best investment.’ Of course, the temporary high prices speciously bolstered by the doomsday scenarios (but fundamentally caused by speculation and leverage) gave enough reasons to almost all underwriters to finance the billions of dollars of projects easily. As the price of oil comes down further, oil sands will be get hit twice as hard inasmuch as they are very high risk investments (environmental, economic, currency) amortized over very long periods. In easy credit environment such investments could be financed easily but in tougher environment where cash is the most precious thing anyone wants to possess, such projects become akin to financing in year 2001. Not impossible (there are always some fools around), but very hard. I trust bulls in Alberta and Canada have at least that much intelligence to figure out the ramifications of significantly depleted oil sands investments on the province, the loonie and Canada as a whole.

Cash really will be the king, as I have tried to mention numerous times in the past. Deflation really is strengthening its hold and there’s nothing central banks can do about it. The sins of past have to be absolved for; and the time to do that has arrived. You just can’t weasel your way out of the bad karmas of credit orgy so easily.

Being early in the deflationary bust cycle is one common mistake most people will make. Yesterday, even I committed such a mistake. No, I didn’t buy a house, but I did buy a new car. I thought I was getting a great deal-Almost $5k off the sticker price of a Honda Accord. But giving up almost $25k in cold cash from savings account did not feel very good. But my rationalization was that my old civic is almost ten years old now and hasn’t been reliable. And I needed to reward myself (yeah, the same North American malaise that leads to the current mess)…Perhaps, I will look at my Accord whenever the temptation of buying a house comes to me in the next few years.

Now the mainstream media is catching up with the sea of negative news that was predicted here and at so many other blogs. Pretty soon, it will be self reinforcing cycle. An economy that is driven 70% by consumption will feel the pain when people stop buying cars and houses, reduce their vacations, minimize eating out, stop buying expensive clothes and desert the malls. Businesses will start laying off people and the anti-goldilocks economy will be at work. Businesses dependent on retail companies (IT, Human Resources staffing etc) will cut down their investments and hiring, making things even worse. And all this while the central banks have interest rates at zero.

Yet, all this is necessary for the revitalization of the economy. The inefficient and diseased corporate hierarchies of North America and much of the first world need cleansing. The FIRE based economies of First World need real savings, real production and real wages.

The coming bust will be a hard one. Unemployment will be high, bankruptcies will soar. A lot of generation X and Y kids will learn painful but much needed lessons. By the time this is all over, savings in bank accounts will not be derided upon.

I’m flying to Boston for a week long vacation to escape from everything for a while. Have a great weekend.

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