How Long the Economic Slump?

Congrats to Paul Krugman on his Nobel prize. Now, this is his view of what's coming:

Just this week, we learned that retail sales have fallen off a cliff, and so has industrial production. Unemployment claims are at steep-recession levels, and the Philadelphia Fed’s manufacturing index is falling at the fastest pace in almost 20 years. All signs point to an economic slump that will be nasty, brutish — and long.

How nasty? The unemployment rate is already above 6 percent (and broader measures of underemployment are in double digits). It’s now virtually certain that the unemployment rate will go above 7 percent, and quite possibly above 8 percent, making this the worst recession in a quarter-century.

And how long? It could be very long indeed.

I also have a pretty dim view of what's coming...

It's only natural that if credit liquidity dries up, economic activity slows down. And, we are coming down from the most expansive credit peak that history has ever known, fueled by the exuberance of some derivatives, but, of one 'credit default swap' gem of a financial instrument, in particular.

I can't get myself to shoot the CDS bastard in the head, as my feelings demand. Unregulated, uncovered insurance, exerting unbridled exuberance bank lending, all the way to $62 trillion USD. This wretched financial contraption brought out the worst from traders, bankers, insurance companies, and why not, mongrels of all sorts that must've taken insurance on their companies debts with full knowledge that their companies were doomed.

The criminal possibilities involved are better understood if you think of a CDS as an insurance on a house mortgage debt--which by the way, do exist.

First, since nobody had ever offered this kind of insurance before, it was one hell of a profitable business to collect premiums at an average 2.5% of the value of the debts, or $1.5 trillion premiums off a $62 trillion debt. And, the cherry on the cake: there was no collateral requirement to sell this type of insurance.

Second, it's one hell of a payback to take insurance on a house, pay the premium, light it up, see it burn to cinders, and collect the insurance. And, as I've explained, this was the weakness of the banks involved in selling CDS, which attracted shark attacks, who shorted bank's stock as well as bought its CDS to collect the huge insurance involved in a bank debt default, as in the Lehman (LEH) case.

But, I also want to stress that the insurance of debts has a wonderful side, it makes credit cheaper. So, CDSs are in fact a gem of an instrument, within the regulations and oversight of an appropriate exchange.

But, I'm getting sidetracked. The underlying issue is that world liquidity is contracting from dizzying heights, so economic activity must contract accordingly.Although, there is the question of how far will the waters rise as a consequence of the central banks spigot opening?

My first thought is, will the cycle of US consumer purchase of Chinese low price exports, and Chinese buying of US Treasuries stop? I don't think so, because the original low Chinese labor price condition persists.

If this is the case, then a good percentage of this CB infusion of liquidity should end in places like China, India, Malaysia, Thailand, Vietnam and like countries; where there's still plenty of this cheap resource, without the western companies entanglement in expensive legacy union negotiated labor contracts --here GM (GM) and Ford (F) are good examples.

So, deterioration in the west should continue, through periods of inflation and depression, till the arbitrage in the east-west labor prices adjust to equilibrium. In the meantime, we build houses... I'm sorry, we repair roads and infrastructure funded by the government...

Comments

[User 167260:]

Armageddon, It's the last Holiday!

2008 Oct 19 08:47 AM

[User 167260:]

Exactly ON, what the earlier comment said about the gas saving, they raised everything, and now want to give back crumbs, but keep raising everthing even currently. TELL KUDLOW robbing peter to pay paul, is now not even going to work because paul charges more. IT's simple, if I raise you 5 and give you back 1, do the math, it's not that hard, I say F**K You Too! You Greedy Bastards!

2008 Oct 19 08:54 AM

[henarl:]

You can't compare a CDS with an insurance policy on a house. If your house is worth $300.000 you can't take out $1,000,000 worth of insurance on it and expect to get more than $300,000 for a total loss. The insurance company(s) simply wont pay more than replacement value. What Lehman & others did was buy 350 billion dollars of CDS to cover 150 billion dollars of mortgages. Of course they must have realized that AIG, etc. didn't actually have 350 billion or even 150 billion to pay up with but they were able to collude with the rating companies, because of the "insurance", to get investment grade ratings and sell their CDOs for a better price to retirement funds, etc. They just got caught with a bunch of this over-rated crap before they could unload it. All of the organizations in this Ponzi scheme should have been allowed to fail and their executives jailed, and the consequences be damned.

User 167260: Armageddon Day - I love it! Maybe it should be Armageddon Season when everybody takes a three month long holiday. That would help the unemployment rate as you wouldn't be counted while your were on holiday (from your unemployment).

2008 Oct 19 03:39 PM

[Urbane Gori...:]

Kudlow is a sad old gas-bag..... He's a senile old man babbling 'Drill, Drill, Drill' and telling people to squander their retirement in an unsafe market. For all the heat that Cramer gets, I'm fascinated that this 'Bull on America' still has a TV show. Time to put him an a wheelchair, place a blanket on his knees and park him somewhere with a nice view and several old crones with bad hearing aids to talk to.

jegan

2008 Oct 19 05:58 PM