"I promise to pay the bearer on demand..." - Panics and Populism.

From the Bank of England's website:

http://www.bankofengland.co.uk/banknotes/about/faqs.htm#2

"The words "I promise to pay the bearer on demand the sum of five [ten/twenty/fifty] pounds" date from long ago when our notes represented deposits of gold. At that time, a member of the public could exchange one of our banknotes for gold to the same value. For example, a £5 note could be exchanged for five gold coins, called sovereigns. But the value of the pound has not been linked to gold for many years, so the meaning of the promise to pay has changed. Exchange into gold is no longer possible and Bank of England notes can only be exchanged for other Bank of England notes of the same face value. Public trust in the pound is now maintained by the operation of monetary policy, the objective of which is price stability."

Indeed in a deleveraging and restructuring world, the promise to pay the bearer has changed.

Public trust has been seriously impaired in the latest financial crisis, in both the financial sector as well as in trust in elected governments in general and politicians in particular.

The difficulties of imposing drastic austerity measures in numerous European countries are indeed endangering democracies. General strikes are on the rise in many European countries, France, Greece, Spain, etc.

The rise of populism is a stark reminder of the impact of economic crisis on fragile democracies as seen in the 30's in numerous European countries which led to the Second World War.

Populism in Latin America has had important impacts.

Populism has been fiscally supported in Latin America during periods of growth such as the 1950s and 1960s as well as during commodity price booms such as in oil and precious metals, which also explains today how Chavez in Venezuela is able to maintain his grip of the country. The fate of Chavez is intimately linked to the price of Oil.

Highly unequal societies leads to a rise in populism.

It is a global trend.

From Latin America, to Europe and the US, populism is dangerously rising.

Populism movements are deeply correlated to Panics and Depression throughout human history.

The emergence of the Tea Party movement in the US in 2009 is reminescent of the rise of the Greenback Party, which was active between 1874 and 1884, following the US civil war.

The Greenback Party was born because of the Great Depression of 1873:

http://en.wikipedia.org/wiki/Panic_of_1873

"The Panic of 1873 or Depression of 1873 marked a severe international economic depression in Europe and United States that lasted until 1879, and even longer in some countries. It began with financial failures in Vienna (capital of Austria–Hungary then) that spread to most of Europe and overextended American banking in late 1873. It was one of a series of economic crises in the 19th and early 20th centuries. In Britain, the result was two decades of stagnation known as the "Long Depression", during which Britain lost its world economic leadership. In U.S. literature this global event is usually known as "Panic of 1873", while in Europe it is known as Long Depression or Great Depression."

Effects in the U.S.
The failure of the Jay Cooke bank, followed quickly by that of Henry Clews, set off a chain reaction of bank failures and temporarily closed the New York stock market. Factories began to lay off workers as the United States slipped into depression. The effects of the panic were quickly felt in New York, more slowly in Chicago, Virginia City, Nevada and San Francisco.

The New York Stock Exchange closed for ten days starting September 20. Of the country's 364 railroads, 89 went bankrupt. A total of 18,000 businesses failed between 1873 and 1875. Unemployment reached 14% by 1876. Construction work halted, wages were cut, real estate values fell and corporate profits vanished."

Sounds eerily familiar doesn't it?

From the same Wikipedia document we learn about the impact this crisis had in both Germany and Austria.

Germany and Austria:
A similar process of overexpansion was going on in Germany and Austria, where the period from German unification in 1870-71 to the crash in 1873 came to be called the Gründerjahre or "founders' years". A liberalized incorporation law in Germany led to the founding of new enterprises, such as the Deutsche Bank, as well as the incorporation of established ones. Euphoria over the military victory against France in 1871, combined with the influx of capital from the payment by France of war reparations, encouraged stock market speculation in railways, factories, docks, steamships - in short, the same areas of overexpansion as in the United States. It was in the immediate aftermath of Bismarck's victory against France that he began the process of silver demonetization. The process began on 23 November 1871 and cumulated in the introduction of the gold mark on 9 July 1873 as the currency for the new united reich to replace the silver coins of all the constituent parts. Germany was now on the gold standard. Demonetization of silver was therefore a common element in the crises on both sides of the Atlantic Ocean.

On May 9, 1873, the Vienna Stock Exchange crashed, no longer able to sustain false expansion, insolvency, and dishonest manipulations. A series of Viennese bank failures resulted, causing a contraction of the money available for business lending. In Berlin, the railway empire of Bethel Henry Strousberg crashed, bursting the speculation bubble there. The contraction of the German economy was exacerbated by the conclusion of war reparations payments to Germany by France in September 1873. Coming two years after the founding of the German Empire, the panic became known as the Gründerkrach or "founders' crash".

Britain
In Britain the long depression resulted in bankruptcies, escalating unemployment, a halt in public works, and a major trade slump that lasted until 1897.

The Austrian Business Cycle Theory I reviewed in a previous post is a very good explaination of the recent crisis as well as the previous ones:

http://macronomy.blogspot.com/2010_05_01_archive.html

The over expansion of credit and loosening of credit standards seem to always led us to economic crisis.

The panic of 1873 was followed by a similar panic in 1893 in the US.

Similar to 1873, the crisis was caused by railroad overbuilding and unsound railroad financing which led to a series of bank failures. Compounding market overbuilding and a railroad bubble was a run on the gold supply and a policy of using both gold and silver metals as a peg for the US Dollar value. Until the Great Depression, the Panic of '93 was the worst depression the United States had ever experienced.

http://en.wikipedia.org/wiki/Panic_of_1893

"The 1880s had been a period of remarkable economic expansion in the United States. In time, the expansion became driven by speculation, much like the tech bubble of the late 1990s and the housing bubble of the early 21st century, except that the associated industry was railroads."

And the panic of 1893 was followed this time by another panic in 1907.

http://en.wikipedia.org/wiki/Panic_of_1907

"The Panic of 1907, also known as the 1907 Bankers' Panic, was a financial crisis that occurred in the United States when the New York Stock Exchange fell close to 50% from its peak the previous year. Panic occurred, as this was during a time of economic recession, and there were numerous runs on banks and trust companies. The 1907 panic eventually spread throughout the nation when many state and local banks and businesses entered into bankruptcy. Primary causes of the run include a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets at bucket shops."

The panic of 1907 led to the creation of the FED in 1913, the financial system was shored up in 1907 by the intervention of J.P. Morgan and other bankers.

The market overbuilding and the the real estate bubble led to the financial crisis of 2007 which started with subprime.

The Greenback Party:

http://en.wikipedia.org/wiki/United_States_Greenback_Party

"The Greenback Party (also known as the Independent Party, the National Party, and the Greenback-Labor Party) was an American political party with an antimonopoly ideology that was active between 1874 and 1884. Its name referred to paper money, or "greenbacks," that had been issued during the American Civil War and afterward. The party opposed the shift from paper money back to a bullion coin-based monetary system because it believed that privately owned banks and corporations would then reacquire the power to define the value of products and labor. It also condemned the use of militias and private police against union strikes. Conversely, they believed that government control of the monetary system would allow it to keep more currency in circulation, as it had in the war. This would better foster business and assist farmers by raising prices and making debts easier to pay. It was established as a political party whose members were primarily farmers financially hurt by the Panic of 1873.

The Gilded Age was an era of political ferment and conflict over the proper uses of governmental activity. The Greenback movement began as a protest against the national system of money and banking that had emerged by the mid-1870s. In particular, Greenbackers condemned the National Banking System, created by the National Banking Act of 1863, the harmonization of the silver dollar (Coinage Act of 1873 was in fact the "Crime of '73" to Greenback), and the Resumption Act of 1875, which mandated that the U.S. Treasury issue specie (coinage or "hard" currency) in exchange for greenback currency upon its presentation for redemption beginning on 1 January 1879, thus returning the nation to the gold standard. Together, these measures created an inflexible currency controlled by banks rather than the federal government. Greenbacks contended that such a system favored creditors and industry to the detriment of farmers and laborers.

In 1880 the Greenback Party broadened its platform to include support for an income tax, an eight hour day, and allowing women the right to vote. Ideological similarities also existed between the Grange (The National Grange of the Order of Patrons of Husbandry) and the Greenback movement. For example, both the Grange and the GAP favored a national graduated income tax and proposed that public lands be given to settlers rather than sold to land speculators. The town of Greenback, Tennessee was named after the Greenback Party about 1884."

In the US the Tea Party movement has been building up following the massive economic recession:
On June 8, 2010, in the Super Tuesday primary election, several tea party backed candidates have won.

http://en.wikipedia.org/wiki/Tea_Party_movement

"According to president of the American Enterprise Institute, Arthur C. Brooks, America is locked in a culture war in which either America will continue to be an exceptional nation organized around the principles of free enterprise, limited government, a reliance on entrepreneurship and rewards determined by market forces, or America will move toward European-style statism grounded in expanding bureaucracies, a managed economy and large-scale income redistribution. Brooks states that while some have tried to dismiss the "tea party" demonstrations and the town hall protests as the work of extremists, ignorant backwoodsmen or agents of the health-care industry, this movement reveals much about the culture war that is underway, and it is not at all clear which side will prevail."



Untermyer: Is not commercial credit based primarily upon money or property?

Morgan: No, sir. The first thing is character.

Untermyer: Before money or property?

Morgan: Before money or anything else. Money cannot buy it ... a man I do not trust could not get money from me on all the bonds in Christendom

J.P. Morgan testifying before the Pujo Committee

About Sovereign risk in 2010 and about the risk of Stagflation à la mode 1970...

In December last year when I first wrote about Greece, CDS 5 year was trading around 260 bps. Now CDS 5 year is trading above 400 bps, and the CDS curve is completely inverted.

As per CMA DataVision, the cumulative probability of default (CPD) is now around 28.55%.

Greece came to the market with a 8 Billion Euros 5 yeard bond issue and the following day of the issue, bonds were trading one point lower. Greece is in trouble. They need to raise another 50 Billions Euros.

Confidence in the Euro currency is getting tested with the situation in Greece and as per my previous post: The importance of being earnest, about the Eurozone in general and the Euro in particular.

">http://macronomy.blogspot.com/2009/12/importance-of-being-earnest-about.html">

There is a risk the Eurozone could implode. Greece is showing the first signs of weaknesses, but Portugal and Spain, are also facing troubles of their own.

We are still in a deflationary environment which could lead afterwards to a period of stagflation in the coming years. Low growth and higher inflation. All the governments are scrambling to tackle the huge deficits they have created and did not control properly.
Take for instance France, the last time the budget was balanced was 1980 and the last time France had an excess budget was 1976 (very good year for wine and the public finances...).

As per Wikipedia on Stagflation, we can see some heery similarities with what we are starting to witness in the current environment.

http://en.wikipedia.org/wiki/Stagflation



Keynes described the inflation and economic stagnation gripping Europe in his book The Economic Consequences of the Peace. Keynes wrote:

"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some." [...]

"Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

Keynes explicitly pointed out the relationship between governments printing money and inflation.

"The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance."

Keynes also pointed out how government price controls discourage production.

"The presumption of a spurious value for the currency, by the force of law expressed in the regulation of prices, contains in itself, however, the seeds of final economic decay, and soon dries up the sources of ultimate supply. If a man is compelled to exchange the fruits of his labors for paper which, as experience soon teaches him, he cannot use to purchase what he requires at a price comparable to that which he has received for his own products, he will keep his produce for himself, dispose of it to his friends and neighbors as a favor, or relax his efforts in producing it. A system of compelling the exchange of commodities at what is not their real relative value not only relaxes production, but leads finally to the waste and inefficiency of barter."

Any similarities with what Venezuela is experiencing at the moment is "purely fortuitous"...

Yes, Sovereign risk is going to be the big theme for 2010.

Everyone is trying to debase their currencies and need to borrow heavily at the same time.

Countries immediately at risk are:
Greece
Venezuela
Argentina

We are facing a crisis of confidence in the system and a crisis of confidence in our governments.
Let's all hope governments will starting facing their responsibilities and make the necessary cuts in spendings and implementation of regulations sufficient enough to pull us out of the hole we have dug ourselves in.

2010: Happy New Year and welcome to the New Normal

Happy New Year to all of you and welcome to the new normal economy in 2010.

In the new economy, unemployment levels are going to stay high and all the politicians are under tremendous stress of the need to cut into public spendings.

It is election year for both the UK and the US, and you can expect a lot of discussions relating to public spendings.

We can only hope that the time for complacency and misguided economic politics have come to an end.

Troubles are unfortunately still brewing in many parts of the world. It is important to track the below countries and situations.

Take Venezuela for instance, they have just announced a 50% devaluation and are facing inflation levels of around 20% and rising. They also have escalating tensions with their neighbors Colombia. Although Venezuela is highly dependent on the prices of oil, it looks like Chavez Socialist Revolution is heading towards a Zimbabwe situation.
Argentina is also facing troubles, with the president removing the president of the central bank.
Greece hasn't yet come up with a drastic plans to rebalance its books and the EU doesn't want to come to bail out Greece until they have done their homework in the first place.
In Iran, civil unrest is gathering momentum and one could expect its president to follow the same fate as Nikita Khrushchev.

But there are also some bright spots in all that doom and gloom, you can expect the BRICS countries to continue powering ahead. China has raised its rates in an attempt to control the hot money pouring into its economy. Indonesia, Vietnam, Singapore, are all growing strongly.

Everyone is talking about the power shift between the West to the East. The reality is that the world is shifting again to its equilibrium, and for those of you who have read the excellent work from Angus Maddison, Contours of the World Economy, Asia is basically claiming back its once 50% owned market share of world GDP. We are seeing a reverse to the mean.