World Economy

Our big macho male politicians and even bigger macho male bankers with their entourage of middle men and servants are in trouble. They tell us it a “lack of trust” credit crisis but it is really a “too much” credit crisis with very poor leverage, between 20 in the USA (legal limit) to 50 or 60 in Europe (no legal limit). They don't know what to do. Europe is worst hit in exposure. When 2% of a bank's loan defaults, the bank is broke. Governments are increasing their leverage to 25 by giving them extra cash.Now when 4% default, still a small proportion, they are still broke.

Writing off all these loans with lots of bank bankruptcies would be the solution. In this case, the USA is doing better than Europe. There is only so much money around and room for so many players, a classical supply and demand balance; and there were too many players thinking you can make money out of money. Sorry, you can't. This is called a Ponzi or pyramid scheme.

The 70% figure is popping up in all sectors the Western society. Value has been inflated by at least 40% and the real value is only 70% of what we want to believe. There is a gaping hole of 30%.

30% percent less value in stocks price, in real estate value, in the number of jobs, in salaries (from low to high), in wholesale prices and in consumer prices.

The best example is the real estate marker. Since 1998, the value has doubled. In 2007, it was already argued by academics that of the 100% value, only 20% could be explained by inflation and appreciation. 30% couldn't be explained.

Some sectors were betting on 30% profits, not just the bank sectors with their odd split salary scheme where bonuses are 30% (mail men) to 1000% (ceo) of the total income. It happened in all sectors.

Very few businesses manage to have 30% profit year in year out. Not even high tech firms like Apple and Microsoft who just milk software products.

The only “firms” that manage to do this use dubious constructions and are illegal. Well-known examples are the Maffia with their so-called egal laundry busines (charging high fees for washing the laundries of restaurants).and cartels like Rockefeller's Standard Oil in the 19^th century.

Why did so many banks like Santandar believe you could make 10% profit year in year out by making money out of money? Madoff was suspicious already a few years from the start. Many did not step in, those hoping for short term gains did and there was no way back.

The upper and upper middle class lost most of the money, at least 30%, not the rest. A group of only some 100 million people world wide. They will be on par with 1999 soon. Memorizing absolute numbers remain difficult for most people, also for academics. People usually think in relatively numbers, thing normally go up (of course) and only rarely down (sorry, wrong).

Writing off the weakest banks and companies would be the only way. 30% has to go, they are just watching each other currently, who will go first, simply the “angry tiger in the forest” principle, it is not who can run fast will survice but who can just stay a little bit ahead of the other, someone will get killed.

When increase in productivity is based on loans, not on hard work, we sooner or later discover that the pie to share is too small for all of us. They participated in a classical Ponzi scheme, also called a pyramid game. This is making money out of money. The difference this time around is that everybody took a small percentage as profit but used very high amounts (in the billions) by using loans at a leverage between 20 (USA) and 50-60 (Europe).

This created huge profits for many banks. However, instead of investing it into the company or keeping a large proportion as cash for the lean times to come, almost 100% was paid out into luxurious offices, fringe benefits and bonuses. Any company would pay much less of such extravagant profits, at most 10%. Why the banks did this, remains a mystery to me. It is likely to be illegal and such profits should have gone to the share holders, if anyone.

Firstly, high profits should have make the bosses think, this will not last, so you have to store the cash for the bad years. These will come, not later but sooner. Common sense? Every religion tells you this. Taoist, Buddhist, Jews, Christians (yes, they as well) and Muslims consider a high profits made on money lending a serious sin. They developed this idea since 1200 BC, since they invented the evil single god. The worst sin is shark loaning, asking very high interests.

Secondly, it is not profit that gives you an income but revenue (or turn over as in goods). Less revenue gives you small profit but still an income to live off. Not just for you but for all your relations who depend on this as well. High profits, but based on much lower revenue will in the end reduce all revenues to zero. And no revenue is no income.

A black swan or the inevitable

Taleb in his book “The Black Swan” calls the current credit crunch an the extraordinary event, a black swan, and uses the turkey analogue to explain it.

For 1000 days a turkey thinks all is fine. Good fodder, and it is getting nicely fat. Never a day without food On day 1001 is is slaughtered for Thanksgiving. Like a stock market crash, very sudden, and at the height of prosperity.

Taled explains this as “the past is no garantuee for the future”. True, but if our turkey had looked around, at its neighbours, it would have been able to notice alarming case histories and should have known better. One by one his older turkey friends are disappearing, like lay-offs of senior banking staff, the managers, at the business banks.

The correlation is that they tend to be very fat and have been around the longest. Again like our bank managers who reaped the highest “bonus”, they go first and are replaced by younger guys.

If our the turkey was smart, using historical knowledge he is picking up “on the job”, it would have taken measures into its own beak. It would have eaten less, at subsistence level, stay out of the limelight. It would now take much longer to get big or it may remain skinny. When a female it may have been selected to rear chicks, looking so healthy, lean and agile, less suitable to be slaughtered..

How does looking at the past help us understand and solve the current “too much credit crisis” in the world?

Mostly bad times, rarely good times

We know that periods of extreme prosperity are rare, they may last for 4-5 years. Periods of moderate prosperity are also not so common, these tend to last for 7 years. Periods of poor economics are very common. 10-15 years is no exception, sometimes even longer. In short, enjoy the rare good periods while you still can but accept the dominant poor periods and be ready for it. One way is to spent only 70% and save the other 30%. Loans should never exceed 70% of what you could get. Also, always pay off the loan, as soon as you can.

The so-called good times we had for the last few years happened before, for example during Emperor Augustus in Rome around 40-0 BC, in Italy in the late Middle Ages, the 15^th century, in the 1600's in Holland, 1850's in England, Germany and France, 1920's in the USA, and again in the 1950's in the USA and Sweden, and now in last 5 years in most of the world. Periods of high prosperity are rare and are really fake. They all ended in a fat, but dead turkey, slaughtered after gulping down too much profits. We knew it was coming but kept on raking in the money as nobody knew “when the turkey would be slaughtered they say. Wrong, on thanksgiving day.

What is scary, is that much of the world participated in this scheme. Solution is simple, write off agressively. America's solution would be to move many millions of people from middle class to lower class, simple cut their well-paid jobs and let them work in other jobs at minimum wages instead. They will take it. Europe will have to do the same but hesitates. To give an analogy, even during the great depression in Europe in the thirties some 85% of the people in the Netherlands had jobs, and only 15% were employed, forced into extreme poverty.