The Oil Drum: Canada

This is an allegory explaining some of the monetary issues associated with the current financial crisis. It was written by Jason Bradford. Jason was an academic biologist who "retired" at a young age to become a community organizer and learn how to farm with peak oil in mind. He also hosts a biweekly radio show on public radio called The Reality Report.

I have never been a huge follower of Star Trek, but when thinking about the financial beast thrashing about the Borg comes to mind.

The Borg is a hive-like hybrid swarm of humanoid species, turned partially robotic. They are distinctly goal oriented towards “assimilation” of all other humanoids and press themselves relentlessly with the creepy mantra “Resistance is futile.”

The money system is eerily Borg-like. Because it structurally requires growth, it works relentlessly to assimilate all forms of capital. The natural consequence is that everything must be for sale. Values of freedom, independence, self-reliance, and even conservation are subservient to the goal of growth—which is really just growth of the financial Borg, not human welfare or the security of a habitable planet.

Talks Continue in Effort to Rescue Lehman

The fate of Lehman Brothers, the beleaguered investment bank, hung in the balance on Sunday as Federal Reserve officials and the leaders of major financial institutions continued to gather in emergency meetings trying to complete a plan to rescue the stricken bank.

The talks took on even greater urgency on Sunday as government officials push for a deal to be completed before the markets open.

After weeks of agony, Lehman's fate appeared sealed by the end of last week, as its stock market value dropped 74% in a few days, after having lost more than 80% since the beginning of the year. That the Fed and Treasury have called an emergency meeting over the week-end ensures that things are over for the bank and it will either be bought over the week-end (with someone taking over its liabilities) or go bankrupt.

Note: This is a cross-posting of Jerome's essay from European Tribune.

[UPDATE] JP Morgan agrees to buy Bear Stearns for $2 a share (Stock closed Friday at $30).
Also, Fed cuts rates (on Sunday) from 3.5% to 3.25%.

The WSJ has a decent article describing the current financial crisis and pulling no punches:

Debt Reckoning: U.S. Receives a Margin Call

The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts.

The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer.

In the US, as one door has closed on subprime lending, another has opened on credit card debt. Actually living within one's means doesn't always seem to be an option, for some due to poverty and for others due to greed. Either way, the debt hole Americans (and Canadians, and the British) are collectively digging themselves into is getting deeper by the day, and they start young.

As losses mount, the role of mortgage fraud, by both borrowers and lenders, and also potential securities fraud, is being revealed. The litigation is only just beginning, but be prepared for a storm of legal action and recriminations. The ratings agencies are looking vulnerable to European action as their ratings enabled the sale of bad loans to European institutions, under conditions of conflict of interest.

Signs of stress are spilling over from the world of high finance to the real economy, where trucking and shipping are feeling the slowdown. Meanwhile Canada (several months behind the US) is still seeing a booming housing market, but for how long?

With frozen ABCP (asset-backed commercial paper) apparently about to spawn a litigation nightmare in Canada, huge bank writedowns in the US and Europe, bank closures, a lack of interbank lending, large-scale ARM readjustments, exploding credit card debt, a growing surge in foreclosures, and homebuilders further depressing real estate prices by selling off their inventory for whatever they can get, one could be forgiven for wondering why global stock markets seem so unconcerned.

Some aggressive speculators - cushioned by the moral hazard of central bank liquidity injections - may be prepared to throw caution to the wind in overextending the trend, but others are waiting in the wings, well placed, through bets in the derivatives market, to profit from its eventual reversal. In a market at the peak of a mania, where rampant speculation drives volatility for short-term gain, arguably the best place to be is out of the game.

This is a Finance Round-Up by ilargi.

We have a 'luxury' problem today. Not only was Thursday Stoneleigh’s birthday, at least 4 articles deserve our top spot. And there’s much more.

Highly regarded finance writer Mike ‘Mish’ Shedlock has a list that looks like “Peak oil survival guide Part 1”:

Drowning in Debt - How do we protect ourselves?

• Don't Buy Stuff You Cannot Afford (classic SNL video)
• Have a Years' Worth of Living Expenses in Cash
• Buy Food On Sale
• Consider Wants vs. Needs vs. Affordability
• Reduce Leverage
• Consider Retirement Plans
• Challenge Traditional Thinking

And this House testimony by Robert Kuttner is a must read:

The Alarming Parallels Between 1929 and 2007

Your predecessors on the Senate Banking Committee, in the celebrated Pecora Hearings of 1933 and 1934, laid the groundwork for the modern edifice of financial regulation. I suspect that they would be appalled at the parallels between the systemic risks of the 1920s and many of the modern practices that have been permitted to seep back in to our financial markets.

Tighter credit regulations? It’s only gotten worse!:

Subprime Delinquencies Accelerating

Subprime mortgage bonds created in the first half of 2007 contain loans that are going delinquent at the fastest rate ever.

“It’s shocking what you see,'' said Kyle Bass of Hayman Advisors LP. “Anything securitized in 2007 has got to have the worst collateral performance of any trust I've seen in my life.''

And the icing on the cake:

The Death Of Investment
_{THE GREATEST STOCK MARKET MANIA OF ALL TIME}

By comparing how swiftly money passes through stocks in relation to both gross domestic product (GDP) and total stock market capitalization, we can see how the relative importance of the stock market rises and falls over the course of the last 80 years.

Quite obviously, in 1929, nothing was more important than stocks and when the corresponding mania peaked, trading was 133% of gross domestic product stock market and 228% of total stock market capitalization. In 2000, trading was 328% of gross domestic product and 203% of total stock market capitalization, a mania fully equivalent to the madness of the "Roaring Twenties."

Today, trading is 326% of gross domestic product and 237% of total stock market capitalization. For all intents and purposes, the current environment represents the greatest velocity of trading ever seen. However, by the end of the year, we expect that the current stats will be far more extreme, a bizarre circumstance that lends itself to only one description - a continuing stock market mania, the greatest mania of all time.

From July to August, in the span of just one month, the New York Stock Exchange reported that the monthly total for dollar trading volume had risen 21.7%. Share volume surged 29.7%. The number of trades soared 39.6%. The sheer speed at which our capital markets are evolving and metamorphosing is frightening.

The theme of investment is for all intents and purposes, dead.

An inflationary future is becoming conventional wisdom, but, as consensus takes time to develop, the stronger the consensus, the later it is in the trend. A consensus is a backward-looking phenomenon of little use - except as a general contrarian indicator - in detecting the inevitable discontinuities that can abruptly and painfully invalidate all one's assumptions.

We have lived through a long period of inflationary credit expansion, and regard it as normal, but credit expansion is a self-limiting condition. Credit bubbles are merely the rediscovery by a new generation of the powers of leverage (see for instance A Short History of Financial Euphoria by Galbraith, Manias, Panics and Crashes by Kindleberger or Financial Armageddon by Michael Panzner). Every credit bubble that ever existed has eventually deflated, and this one will be no different.

We have essentially already reached the limit of debt serviceability that brings an expansion to an end. We are already seeing the tightening of credit standards, the refusal of banks to lend to one another, the frozen commercial paper, the bank runs, the redefinition of what constitutes a store of value, the rejection of financial alchemy, the debt defaults that reduce the money supply, the falling prices in the housing market, the lack of confidence - which together unmistakably herald deflation. Central banks can do nothing more than paper over the cracks for a short time, at the cost of aggravating the eventual impact of deflation.

Time to Aim High?

I salute Wasik for pointing out the sham that the CPI is. However, it is because of the debasement of the dollar and distortions in the CPI that the Fed has practically forced risk down everyone's throat. But one must be cognizant of herding behavior that has nearly everyone thinking exactly like he is and the Fed wants. Aim high. Shoot for the moon. Do or die. You are losing money by saving. Buy assets. Only fools save. In the long term, stocks always go up.

The problem is that aiming high is synonymous with increasing risk. Up till now, risk taking has been rewarded. But what happens when everyone does the same thing? More to the point, what happens when everyone does the same thing for 20 years or longer? Eventually, risk gets so unappreciated that various asset classes go to the moon....

....Essentially, the same advice given for real estate (you cannot buy too much home, home prices always go up) is now being touted for stocks. There is an amazing belief in the Fed's ability right now to control the business cycle, as well as price stability. It's not warranted. At this stage of the cycle in a slowing economy, with rampant overcapacity, a tenuous job climate, and no real reason for businesses to expand, the odds are that aiming high is precisely the wrong thing to do.

This is a Finance Round-Up by ilargi. An Energy and Environment Round-Up will follow over the weekend.

Et tu, Canada?

There's a country just south of here that pretends to be the world's richest economy, but in reality seems headed for the Halliburdened poorhouse. Et tu, Canada? Depends on where you look.

The papers' front pages show Prime Minister Stephen Harper, knowing there's no opposition left to speak of, though he leads a minority Cabinet. Stephen, too stiff to even play golf, shuffling the greens with Tiger Woods for a photo-op. Then a broad media smile: an alleged record federal budget surplus ($13.8 billion). To top it off, the new King of Nadamaskakas magnanimously hints at tax cuts. Little detail: it's $35 per person per year, less than 10 cents per day. But it sounded good at first, right, tax cut? Bienvenue à la politique.

In the finance pages, a different take: lax laws have allowed trusts, funds and your pet parakeet to issue non-bank commercial paper (ABCP), to the tune of $40 billion (bank ABCP: $80 billion more). On August 16, the biggest gamblers tried hard to change this from short-to long term debt. Turns out, that won't fly: nobody can even figure out where it is or what it's worth. Caught in their own trap.

Québec's massive Caisse de Dépot pension fund holds $20 billion worth of it, a sizable chunk of their $240 billion portfolio, and that's just their domestic toilet paper. Our advice: Keep the day job. Till you're, like, 95. Your pension has been gambled away.

About that federal budget surplus: Canada's federal debt is $467 billion. Which, to our untrained eye, means the term "budget surplus" is the victim of acute and intense inflation. Harper actually said on TV that the surplus will be used to pay off the debt. On our untrained calculator, that would take, at the current rate, a negligible 33.8 years, or until 2041, providing no new debts are incurred, and inflation stops dead in its tracks. But we kid you not, at the moment of writing this, Harper's on TV, saying he does this for future generations.

To finish off this sunny newscast, while TD Bank raves about the tar profits, despite royalty reviews, Big Oil has launched the first lawsuit against Canada under NAFTA law. We'll see much more of that, soon, as in the Alberta royalty revision plans. Send your kids to law school.

This is the second of a three part series giving my view of the economic impact of peak oil.

Peak oil seems likely to make a huge change in our economic system--more than would be expected by a worldwide decline in oil production by a few percentage points a year. In Part 1, we looked at the contrast between economic systems before the industrial revolution and the current economic system. We also looked at economic studies that suggested that energy, and the more efficient use of energy, seem to be big contributors to the real economic growth that took place since the industrial revolution.

In this segment, we will look at some other changes affecting the economy besides the growth in the use of fossil fuels. We will look particularly at debt and how peak oil is likely to affect a financial system that is tied to debt. We will also look at some the stresses that the economy is currently under. Some of these stresses seem to stem from a failure of the United States to fully adapt to its own decline in oil supply since 1971; some of these stresses come from the fact that the world is finite, and we are reaching the earth's limits with respect to more than just oil.

1. Why is debt important to our economy today?

This is the first part of a three-part series providing my ideas on the economic impact of peak oil.

What happens when peak oil collides with our economic system? It seems to me that there is a high probability of a major discontinuity of some type. What exactly happens after the discontinuity is likely to vary from country to country. It seems to me that the United States is especially vulnerable to a drastic drop in the amount of oil available for import because of the large amount of oil we import and the relatively small amount of goods we export.

Many people when analyzing the world oil situation focus on the relatively small drop in overall world supply in the first few years. From this, they conclude that peak oil will primarily raise the price of oil and some related goods, but not have a huge effect otherwise. If the decrease in oil products is severe, some rationing may be required. I think this analysis misses the big part of the problem – the impact of peak oil on the overall economic system, particularly in the United States.

The world is very different now than it was before the industrial revolution, which began about 1800 when fossil fuels were first used extensively. It seems to me that there is a significant chance that over the long term there will be just as big a change as we leave the age of fossil fuels. To start the discussion, let's start with where we are, and then take a look back.

1. What is our current economic system like?