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What really is this notorious SubPrime (high risk credit given to low income segment of population) that is causing financial turmoil all around the world, everybody is talking about since August 2007?
To summarize in one sentence: only the tip of the iceberg.
I would like to analyze the topic under five headlines:
A. How did we reach this point?
B. What is currently happening around the world? 1) 1991 - 2001 era
2) 2001 - 2007 era
3) post 2007 era
C. 2015/2020 onwards: Energy crisis, increasing food and energy prices, decreasing world population
I will put more weight on developments that began mid 2007 and continuing to this day. In order to fully understand the whole picture, the possible direction of world economic balances, and the interrelated extraordinary circumstances of today, I will start by touching important roadblocks of the post World War II era.
A. How did we reach this point?
Following the end of World War II, the dominance of the United States, with the leadership of the US government, the international financial system, known as Bretton Woods was adopted. Under this system, the US Dollar was accepted as the world's reserve currency, and all central banks around the world accepted to fix the US $ in exchange for their gold reserves. The US $ was fixed to 1 ounce of Gold, for a rate of 1:35. The central banks around the world were tied to the Gold, hence couldn't print as much money as they wanted, nor manipulate the markets.
During 1960s and 1970s, as a result of increasing demand and import of relatively cheap European and Asian goods into the US, the trade deficit of the United States began to increase. Feeling disturbed by this situation, European and Asian central banks lined up and demanded to exchange their dollar reserves for Gold, hence the system locked up and in 1971, the US government withdrew from their promise of giving 1 ounce of gold for every $35, causing Bretton Woods system to collapse.
In an economy that is tied to Gold, the amount of money in markets was capped by amount of gold available. Following the collapse of the system, the central banks were given freedom to print as much money as they wanted to.
In the graphics below, the total amount of money circulating in the system is shown (M3). The blue lines are denoting annual rate of change.
Following the collapse of the system in 1970s, Gold prices broke all time high records and topped on January 3, 1980 with $850 an ounce; 2400% in 9 years. Excess money, increasing demand and collapsed system caused several other commodities and tangibles to spike higher.
In order to stop this situation, all central banks around the world began increasing interest rates rapidly. Fed Funds rate increased from under 4% in 1971 to 19% in 1980.
After the inflation was controlled, the interest rates entered in a bear trend and decreased around the world during following years. The increasing use of technology and production efficiency played major roles to cap inflation rates after 1980. (Production efficiency was set to continue increasing until end of 1990s and early 2000s, which then began sliding down.)
B. What is happening now?
1) 1991 - 2001 era
The US $ followed a stable path between years of 1980-1991 and under the light of superpower America, began to appreciate following the collapse of the Soviet Union in 1991. Following the lead of the US Central Bank (FED), major central banks around the world including Japan and Europe began to create and pomp increasing amounts of money into the markets and left key interest rates low for extended periods of time. This lead to bubbles around the world; the mortgage bubble in Japan, the Asia crisis in 1998, the tech bubble of NASDAQ in 2000, ...
Lead by the US Central Bank, major central banks continued to print more and more money and gave free credit to consumers and businesses to avoid economic collapses that threatened the system after collapse of each bubble. This increasing amount of money and lower interest rates continued to form bubbles; stock market -> housing market ...) The food and commodity prices didn't increase during this period, due to increasing efficiency in production and technology, they even declined. This equilibrium began to change in late 1990s. The technological developments couldn't neutralize the ever increasing demand. Global warming, inability to increase arable land, capping of production per land, inability to increase energy resources and the increasing demand of increasing population caused the demand to surpass supply in years after 2000. This sensitive equilibrium lasted until the day of September 11, 2001, attacks of twin towars in New York, and began to get out of control after that day.
2) 2001 - 2007 era
The value of US $ continued to increase between 1991 and 2001, along with enlarding US economy and the superpower status of the United States of America. The appreciation of the US $ also helped to cap prices of food, energy and commodities. In order to prop up the shocked economy following 2000 crash and 2001 attacks, FED dropped interest rates to levels unseen since 1950s, to 1%. As the FED continued to increase money supply around 12-15% a year, the "untouchable" status of the US $ began to change and the dollar has lost more than 40% of its value in the last 7 years.
The decreasing interest rates allowed banks to book massive profits (they borrow at low rates from FED, loan to consumers at higher rates) and allowed all consumers around the world to borrow at levels unseen before. This abuse of the system reached unbelievable levels, that someone with $1000 income per month was applying as if he was making $10000 per month and getting that credit. Car credits, mortgage credits, school loans, credit cards, you name it. Banks didn't investigate the truth of applications, because they were making a lot of money. This situation began to slow down and reverse as the consumers began to top their maximum levels of debt and the collateral values they used to borrow against began to drop. As the loans didn't get back and the borrowers couldn't pay back, the loaners began to write the loans off (banks).
In summary, this is the history of the financial turmoil that began in August 2007 as SUBORIME, high risk loans, failed to return.
The era that began in 1991, and hastened after 2001, where customers were made "artificially rich" with ever increasing debt levels has come to an end. One of the world's largest savings bank, Citigroup's stock price since August 2007 summarizes this below very clearly:
Citigroup, has lost more than 50% of its value in the last 6 months. As seen in the graph, the stock has seen these levels in 2001, too, however, the economy that had drawn back on track with FED moves in 2001 will not be able to react similar this time around.
One of the major support points of the economy, the consumer, is now topped up and buried under burden of debt. This is the major difference with 2001.
3) 2007 onwards
It is the beginning of financial turmoil that we are seeing, following the downturn in mortgage market, and write offs by banks since August 2007. The era of lenders "writing off" the credits will be followed by increasing unemployment, credit defaults and inflation. World economies will be pushed into further slowdown. This situation will continue until it is realized that whatever FED and other central banks do, even decreasing the interest rates to 0%, all credits and loans without a base will have to written off.
C. 2015/2020 and onwards
These two graphics is summarizing what to come after 2015/2020 very well. It is clearly seen that the increasing availability of energy played a major role in allowing the world population to increase. Following the increase in energy availability and productivity, the natural resources have been able to support the increasing population of the world. Availability of fundamental needs of humanity, energy and food, continued to increase between 1950 and 2000, and was able to meet the demand, and increase in response. This situation has been changing since 2000 in agriculture industry. Current arable lands, regardless of technological developments, do not show productivity gains, and are falling behind the demand. This is one of the major factors effecting the food prices. It is seen that the supply demand equilibrium will be broken around 2015/2020 and the production will not be able to meet the demand. Looking at the energy production data from www.energyfiles.com, it is possible to conclude that most energy producing countries had topped their production since 2000. The current situation in countries producing more than 50% of world's energy is shown below:
United States - peaked around 1970/80
Canada - expected to peak around 2034
China - expected to peak around 2015
Russia - expected to peak around 2034
Saudi Arabia - expected to peak around 2019
It is very clear that the base of every creation, the world resources, will not be able to support the current economic system and increasing population after 2015/2020. The only way to change this circumstance is by decreasing the consumption and move towards renewable energy. I believe it would be right to conclude that we had come to the end of the abundant era of 1950 - 2000 period and the world will witness a period of shrinkage.
February '08
SG
To summarize in one sentence: only the tip of the iceberg.
I would like to analyze the topic under five headlines:
A. How did we reach this point?
B. What is currently happening around the world? 1) 1991 - 2001 era
2) 2001 - 2007 era
3) post 2007 era
C. 2015/2020 onwards: Energy crisis, increasing food and energy prices, decreasing world population
I will put more weight on developments that began mid 2007 and continuing to this day. In order to fully understand the whole picture, the possible direction of world economic balances, and the interrelated extraordinary circumstances of today, I will start by touching important roadblocks of the post World War II era.
A. How did we reach this point?
Following the end of World War II, the dominance of the United States, with the leadership of the US government, the international financial system, known as Bretton Woods was adopted. Under this system, the US Dollar was accepted as the world's reserve currency, and all central banks around the world accepted to fix the US $ in exchange for their gold reserves. The US $ was fixed to 1 ounce of Gold, for a rate of 1:35. The central banks around the world were tied to the Gold, hence couldn't print as much money as they wanted, nor manipulate the markets.
During 1960s and 1970s, as a result of increasing demand and import of relatively cheap European and Asian goods into the US, the trade deficit of the United States began to increase. Feeling disturbed by this situation, European and Asian central banks lined up and demanded to exchange their dollar reserves for Gold, hence the system locked up and in 1971, the US government withdrew from their promise of giving 1 ounce of gold for every $35, causing Bretton Woods system to collapse.
In an economy that is tied to Gold, the amount of money in markets was capped by amount of gold available. Following the collapse of the system, the central banks were given freedom to print as much money as they wanted to.
In the graphics below, the total amount of money circulating in the system is shown (M3). The blue lines are denoting annual rate of change.
Following the collapse of the system in 1970s, Gold prices broke all time high records and topped on January 3, 1980 with $850 an ounce; 2400% in 9 years. Excess money, increasing demand and collapsed system caused several other commodities and tangibles to spike higher.
In order to stop this situation, all central banks around the world began increasing interest rates rapidly. Fed Funds rate increased from under 4% in 1971 to 19% in 1980.
After the inflation was controlled, the interest rates entered in a bear trend and decreased around the world during following years. The increasing use of technology and production efficiency played major roles to cap inflation rates after 1980. (Production efficiency was set to continue increasing until end of 1990s and early 2000s, which then began sliding down.)
B. What is happening now?
1) 1991 - 2001 era
The US $ followed a stable path between years of 1980-1991 and under the light of superpower America, began to appreciate following the collapse of the Soviet Union in 1991. Following the lead of the US Central Bank (FED), major central banks around the world including Japan and Europe began to create and pomp increasing amounts of money into the markets and left key interest rates low for extended periods of time. This lead to bubbles around the world; the mortgage bubble in Japan, the Asia crisis in 1998, the tech bubble of NASDAQ in 2000, ...
Lead by the US Central Bank, major central banks continued to print more and more money and gave free credit to consumers and businesses to avoid economic collapses that threatened the system after collapse of each bubble. This increasing amount of money and lower interest rates continued to form bubbles; stock market -> housing market ...) The food and commodity prices didn't increase during this period, due to increasing efficiency in production and technology, they even declined. This equilibrium began to change in late 1990s. The technological developments couldn't neutralize the ever increasing demand. Global warming, inability to increase arable land, capping of production per land, inability to increase energy resources and the increasing demand of increasing population caused the demand to surpass supply in years after 2000. This sensitive equilibrium lasted until the day of September 11, 2001, attacks of twin towars in New York, and began to get out of control after that day.
2) 2001 - 2007 era
The value of US $ continued to increase between 1991 and 2001, along with enlarding US economy and the superpower status of the United States of America. The appreciation of the US $ also helped to cap prices of food, energy and commodities. In order to prop up the shocked economy following 2000 crash and 2001 attacks, FED dropped interest rates to levels unseen since 1950s, to 1%. As the FED continued to increase money supply around 12-15% a year, the "untouchable" status of the US $ began to change and the dollar has lost more than 40% of its value in the last 7 years.
The decreasing interest rates allowed banks to book massive profits (they borrow at low rates from FED, loan to consumers at higher rates) and allowed all consumers around the world to borrow at levels unseen before. This abuse of the system reached unbelievable levels, that someone with $1000 income per month was applying as if he was making $10000 per month and getting that credit. Car credits, mortgage credits, school loans, credit cards, you name it. Banks didn't investigate the truth of applications, because they were making a lot of money. This situation began to slow down and reverse as the consumers began to top their maximum levels of debt and the collateral values they used to borrow against began to drop. As the loans didn't get back and the borrowers couldn't pay back, the loaners began to write the loans off (banks).
In summary, this is the history of the financial turmoil that began in August 2007 as SUBORIME, high risk loans, failed to return.
The era that began in 1991, and hastened after 2001, where customers were made "artificially rich" with ever increasing debt levels has come to an end. One of the world's largest savings bank, Citigroup's stock price since August 2007 summarizes this below very clearly:
Citigroup, has lost more than 50% of its value in the last 6 months. As seen in the graph, the stock has seen these levels in 2001, too, however, the economy that had drawn back on track with FED moves in 2001 will not be able to react similar this time around.
One of the major support points of the economy, the consumer, is now topped up and buried under burden of debt. This is the major difference with 2001.
3) 2007 onwards
It is the beginning of financial turmoil that we are seeing, following the downturn in mortgage market, and write offs by banks since August 2007. The era of lenders "writing off" the credits will be followed by increasing unemployment, credit defaults and inflation. World economies will be pushed into further slowdown. This situation will continue until it is realized that whatever FED and other central banks do, even decreasing the interest rates to 0%, all credits and loans without a base will have to written off.
C. 2015/2020 and onwards
These two graphics is summarizing what to come after 2015/2020 very well. It is clearly seen that the increasing availability of energy played a major role in allowing the world population to increase. Following the increase in energy availability and productivity, the natural resources have been able to support the increasing population of the world. Availability of fundamental needs of humanity, energy and food, continued to increase between 1950 and 2000, and was able to meet the demand, and increase in response. This situation has been changing since 2000 in agriculture industry. Current arable lands, regardless of technological developments, do not show productivity gains, and are falling behind the demand. This is one of the major factors effecting the food prices. It is seen that the supply demand equilibrium will be broken around 2015/2020 and the production will not be able to meet the demand. Looking at the energy production data from www.energyfiles.com, it is possible to conclude that most energy producing countries had topped their production since 2000. The current situation in countries producing more than 50% of world's energy is shown below:
United States - peaked around 1970/80
Canada - expected to peak around 2034
China - expected to peak around 2015
Russia - expected to peak around 2034
Saudi Arabia - expected to peak around 2019
It is very clear that the base of every creation, the world resources, will not be able to support the current economic system and increasing population after 2015/2020. The only way to change this circumstance is by decreasing the consumption and move towards renewable energy. I believe it would be right to conclude that we had come to the end of the abundant era of 1950 - 2000 period and the world will witness a period of shrinkage.
February '08
SG
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