The boa constrictor economy

If you are wondering why the stock market has been soaring when we have a credit crunch, job layoffs, a housing crisis among other negative factors, you are not alone.

But...maybe there is an explanation. I call it the boa constrictor economy.

Consider the following analogy.

What is going on is akin to walking through the jungle when suddenly a boa constrictor drops from the tree and wraps itself around you.

Now your first instinct is to panic and think, "I'm going to die". That is what the January/February stock market drop and the Bear Sterns bail-out were about. Fear of instant death ... a market meltdown.

But the market did not melt down, and once you regained your composure you realized that you were still alive and that the boa constrictor had not killed you. You start to breathe a sigh of relief. You think, "Hey, Maybe I can get out of this". This is the stock market rally phase.

But of course the boa constrictor is till wrapped around you ... and soon enough it starts to tighten itself around you bit by bit. At first you just feel a little tingle, a little pressure, and you start to get a bit worried. Slowly but surely the pressure is increased. Now you find it harder to breathe. You start to think you might not make it....

The parallel to the boa constrictor tightening its grip is the steady erosion of access to credit in the banking/financial system. As access to credit becomes more and more constricted companies find first that they can't expand, then that they can't get money even for regular business. Individuals find that they can't get a new credit card, then that their limits are being lowered, or line's of credit restricted.

Throughout the economy the effect is not immediate, but it slowly builds individual by individual, company by company ... just like the pressure from the boa constrictor.

Someone once asked "When was the last time the economy expanded when the amount of credit was decreasing. The answer...Never.

Today we have some system wide evidence

The Federal Reserve said the proportion of U.S. banks making it tougher for companies and consumers to borrow approached a record in the past three months as the credit crunch deepened.

A net 70 percent of banks increased loan rates over their cost of funds for commercial and industrial borrowing, according to the central bank's quarterly survey of senior loan officers released today in Washington. That compares with 45 percent in the January survey, the Fed said.

Week after week now I have been watching as the amount of outstanding debt in the commercial paper and the asset backed commercial paper market drops. That means less debt is outstanding (unless it is borrowed in another market), which means companies on average are not expanding.

A look at last months auto sales is indicative. It is especially timely as it is the earliest economic data provided for last month. The results were in a word Horrible. Remember that old saying .. "What's good or GM is good for America". Well maybe that should be reversed.

U.S. auto sales fell 14 percent to their lowest annual rate in a decade in April as weak consumer confidence and rising gas prices hit the industry's most profitable vehicles hardest.

General Motors Corp, Ford Motor Co and Chrysler LLC posted deeper sales declines than expected, led by a sharp drop in trucks and SUVs. GM sales fell 23 percent, Ford 19 percent, and Chrysler nearly 30 percent, the automakers said on Thursday.

If auto sales are dropping, it impacts the entire manufacturing industry. Anecdotally we also hear that not only are gas prices hurting, but it is harder and harder for buyers to get financing for a new car. This is especially true because so many people are upside down on their car loans.

Again the boa constrictor tightens. As gas prices soar, car owners who are tempted to trade in for a better fuel efficiency vehicle soon find that they are upside down on their existing car loan, as the length of car loans has increased, and also that the value of used trucks and SUV's has dropped. They find they can't afford to trade down.

Then there are food prices. We have gotten used to relatively stable food prices over the last 20 years. Now the spike in commodities means that grocery prices are starting to accelerate. Flour and rice prices were first to spike. Now as these are ingredients in so many products the cost of processed food and meat is starting to climb. Next you will see bigger spikes in restaurant prices.

Today's Pilgrim's Pride, the largest supplier of chicken in the US came out with poor quarterly results. Here is what they had to say:

Prices for corn and soybean meal, which are important feeds, soared this year, due in part to greater use of corn to make the biofuel ethanol.

"While we continue to pass along price increases to our customers, the simple fact is that to date, we have not been able to raise prices fast enough to match the extreme price volatility in the grain markets," Pilgrim's Chief Executive Clint Rivers said in a statement.

Rivers also warned that "American consumers are only just beginning to feel the impact of sharply higher food prices" as the higher costs are passed on.

Wrap-Up:

What we are seeing right now is the pause before the boa constrictor starts to take real action. All the signs are there, its just a matter of when and how hard and how fast the pressure is applied. This is going to hurt.

Xposted at DailyKos

Meta: 

Comments

I love this analogy

What a great analogy! Buffet yesterday thinks the worse is over and we'll go through more of a shallow recession but I question that. The underlying financials have looked like a ticking time bomb for so long.

You must have Javascript enabled to use this form.

Great diary, even if I disagree

politely of course.

The counter to the shrinkage of commercial paper, it seems to me, is that the Fed is now backstopping the entire financial system. And boy is Wall Street a fast learner. First we heard that brokerages were putting together the cr*ppiest CDOs they could that would still specifically comply with the Fed's guidelines for accepting paper. Then we found out the Fed was also backstopping student loans. Now we see Bank of America backing out of its purchase of Countrywide, no doubt reckoning that Countrywide is also "too big to fail" and the Fed will be forced to backstop its purchase as well.

I long ago learned to trust the numbers, no matter how compelling the logical story was. And the numbers say to me that Buffett is right, at least for now.

You must have Javascript enabled to use this form.

Kunstler

I like Kunstler's take. His comment this week is quite good.
http://www.kunstler.com/

One feature of the risk economy is the Federal Reserve's new willingness to absorb any sort of crap collateral in exchange for massive cheap loans to insolvent companies and institutions. The Fed has, in effect, made itself the world's largest financial shit-magnet. It has already taken in a few hundred billion in securities based on non-performing real estate loans, and has now opened the window to securities based on non-performing credit card debt, car loans, and other miscellaneous IOUs still drifting un-hedged in the banking ether.
It's a mark of our collective desperation to avoid the consequences of so much reckless behavior that no credible authorities have stepped up to denounce this racket

In the financial world the problem has been temporarily solved, but in the real world ... the Fed can not solve the problem and this will be the slow constriction we are only starting to witness with inflation, unemployment, slumping car sales, rising gas prices, and unsaleable houses.

The way out is a decline in standard of living that, because no one will accept it as an option, will have to slowly work its way through the system on its own.

You must have Javascript enabled to use this form.

Fed now accepting credit card, auto loan cdo's

Reported by Calculated Risk this morning. The Fed is now underwriting everything, it seems. I see that midtowng has a blog up about Countrywide.

Let me just put it this way. If you were a Big Insider on the Street, wouldn't you be thinking of unloading as much toxic junk on the Fed as possible? If we can see that, why don't we think Wall Street sees that -- and can execute the plan 1000 times better (for lining their own pockets) than we ever could?

You must have Javascript enabled to use this form.

Holy Shit

Although I kind of knew this but I hope you can write a blog post analyzing just how much this is going to affect the US economically would be good. (I can't get to it, on other issues). People fiddle while Rome burns.

You must have Javascript enabled to use this form.