Hyperinflation or deflation?

This weekend, ZeroHedge noted an interesting working paper from Cato Institute titled "World Hyperinflations". Hyperinflation is defined there as a yearly price inflation rate of 50 percent or more and it contains a list of the worst known examples. Apart from the yearly inflation rate, which in the worst cases amounts to completely unfathomable numbers, they have also included hyperinflation measures that are easier to grasp, such as the daily rate of price inflation and how fast the prices doubled when the inflation rate was at its peak. In Hungary 1946 the prices doubled in 15 hours, in Zimbabwe 2008 they doubled in 24.7 hours, in Yugoslavia 1994 they doubled in 1.41 days and in Germany 1923 they doubled in 3.7 days.


However, the examples of hyperinflation from Cato Institute are simply not relevant parallels for today's situation. The economies that have been hit by hyperinflation have been mostly cash based. Today, however, most of the money supply has been created as credit. Less than ten percent of the money supply in developed economies consists of debt-free money. Instead we mostly have "debt money". ECB, IMF and others extend credit to the PIIGS countries, not cash. The Federal Reserve does not create a large amount of cash, but creates a heap of credit. Debts have to be repaid at some time, or disappear through default. In addition you have to pay interest on your debt, and even though interest rates in many countries are currently extremely low, they are not negligible for most debt.

Many get the concepts mixed up and think that "money printing" by creating more credit will have the same effect as creating more money by physically printing more cash. The Fed:s "Helicopter Ben" Bernanke is famous for saying in 2002 that they have access to a printing press (or its electronic equivalent) for money, and in theory could prevent deflation by distributing freshly printed cash by helicopter, but this is not what has happened during the past few years. If the world's central banks had created new debt-free money either through physical printing or through creating new electronic account balances without any demand for repayment, then I would have worried about hyperinflation. Instead the central banks have created new "money" as credit to compensate the defaults which have been forced by the financial crisis. What has happened is that the debt as simply been redistributed (largely to tax payers)

 This is why I still, as long as the current monetary policies continue, do not see any large inflation threats (and definitely not hyperinflation), but instead a big deflationary threat, when the sum of credit becomes too large in relation to the size of the real economy. When debtors can no longer keep up with debt payments, creditors are forced to accept credit write-downs, which lead to a diminishing money supply (which is the definition of deflation). Greece's creditors have already been forced to do this, as well as creditors to US housing loans.

Surely the list of hyperinflations from Cato Institute is interesting, but mostly for those who study the history of monetary policy. When the piles of credit floating around the world have been broken down, which will surely take many years, it might be relevant for certain countries to study historical examples of hyperinflation, but today I cannot see any such countries among the world's most important economies. Even in countries like China it's credit that has grown most over the last years. It is often said that it's not "different this time", but one thing that makes today's situation different from all historical parallels is that we have a global system of "credit money", where the total amount of credit is many times larger than ever before. This is a translation of an article from my Swedish blog.

The European Unemployment Map

Yesterday I compared Italy and Spain, and noted that when it comes to unemployment the worst regions in Italy have roughly the same unemployment rate as the best regions in Spain. This led me on to making this map (using data from Eurostat) to show unemployment rates for all EU and EES regions

The map gives some hints about where there might be problems - the unemployed who have debts have more difficulties keeping up with their loan payments - the unemployed don't pay very much in taxes and thus don't contribute to the government coffers - the unemployed are rather more prone to engage in activities such as social unrest.

The biggest problem is obviously in Spain, which stands out like a sore thumb! Greece has nearly the same level of unemployment, but Spain is much larger. Add to this the fact that the Spaniards are up to their ears in debt after the popping of their monumental real estate bubble...

It's also interesting to see how unemployment often does not follow national borders. Northern Italy, for example, seems to have more in common with the German-speaking area of Europe than with southern Italy. Sometimes, however, the national borders make a big difference, e.g. between Spain and Portugal.

Also note that France looks a lot more like the central part of Italy than it looks like Germany when it comes to unemployment. Bienvenue au club PIIGSF, monsieur Hollande!

The difference in Germany between former East Germany and West Germany is still clearly visible, as the east still hasn't caught up with the west.

Another striking difference is that between Czechia and Slovakia, where Czechia looks like Germany, but Slovakia (except the Bratislava region) has a high unemployment rate that increases towards the east.

This is a translation of a post from my Swedish blog.

Peak Oil and Denial

This is a translation of a post from 2009 on my Swedish blog, with some adaptations and updates.

Many confuse peak oil with running out of oil. This is not what it is about - in 2008 I wrote this.

What peak oil is about is instead that for more than 100 years we have lived in a world of increasing oil supply and cheap oil. This has fuelled an economic expansion unmatched in all of human history. When the peak comes and is passed we will instead have to endure a steadily diminishing oil supply and therefore more expensive oil. The biggest worry among "peak oilers" is how our global societies, completely built around cheap oil and constant economic growth, will handle this. Which economic, political and social problems will this lead to? We already see some of them, but more will come the more expensive oil becomes. Will we instead see an economic contraction unmatched in human history?

And there are no other energy sources that can completely replace fossil fuels. I've written about this in my review of the alternatives (only in Swedish).

Now this is a very drastic change that is happening. Many of the economic theories that form the base for our societies' planning will be turned topsy-turvy, since they have only been tested during periods of long term global economic growth. What happens for example to loans with interest when growth slows or turns into contraction? Or pension funds? The change is so big that it will be a severe shock to many people. So how do people react to this?

Elisabeth Kübler-Ross was a Swiss-American psychiatrist who worked with terminally ill and dying people. She created a description of the stages that a terminally ill human goes through, which can also be applied to other shocking information, e.g. when somebody realises the implications of peak oil. Kübler-Ross divided the reaction into five stages - denial, anger, bargaining, depression and acceptance.

1. Denial. This is the first natural reaction to shocking information, which entails a loss and/or change. You refuse to accept reality as it is.
2. Anger. When you gradually have understood that the shocking information really is true and unavoidable the denial is transformed into anger. You become raging and angry at yourself and other people, sometimes including "scapegoats".
3. Bargaining. After the anger is over you instead try to bargain about the unavoidable that is about to happen and try to find something that can postpone the unavoidable.
4. Depression. When you can no longer deny, see that it no longer helps to become angry, and see that you can no longer bargain to avoid the unavoidable you fall into depression. This depression can throw you back to one of the earlier stages.
5. Acceptance. When (and if) you have managed to get through the first four stages you get to the stage where you accept the unavoidable and are ready to deal with it in the best way.

There are many examples of this from real life, for example the debt crisis of Greece, Ireland, Italy, etc., which was first denied, and then met by anger at "evil speculators". At the moment it looks like the EU leaders are in the stage of bargaining, when central banks and politicians try to find ways to "save" countries with far too large public debt.

Another example is Norway's oil production, which started contracting by several percent per year around 2001. This came as a surprise to most people, even those in the business. At first denial was the response, and they believed it was only a temporary production drop. The anger stage is often not seen so much in public in these cases, but I guess that many directors in the Norwegian oil business and oil directorate became very angry that their engineers could not keep the production up. Now it seems that Norway has reached the bargaining stage, where they try just about anything to keep their oil production from falling too fast.

So how do our politicians relate to peak oil? Where are they on the Kübler-Ross scale? Most of them still seem not to have heard of peak oil, or are in the stages of denial or bargaining, since they still mostly talk of how we should create economic growth, although global growth is no longer possible when the global oil production falls. If there are any politicians who have fully understood the implications of peak oil, they still do not want to talk about it in realistic terms, since politicians don't like problems without solutions. Besides it is politically impossible to speak about deteriorating standards for most people. The voters will demand that the politicians "do something about it".

Among other people in power (business directors, central bank directors, etc.) it seems like the situation is similar. It really isn't that strange. All people in most OECD countries who are alive now have lived the most part of their lives in a period of historically unparalleled economic growth and are completely indoctrinated that most things constantly improve.

The "average Joe" has probably never even heard of peak oil and the problems that come with it. When I speak about this with many of my friends and relations they mostly deny that there is even a problem. They start talking about electric cars and solar cells and that "they'll probably invent something new". If you try to counter these arguments you will be classified as a hopeless pessimist.

Journalists then? Well, the peak oil awareness level seems to be low here too. Gunnar Lindstedt is one of the few established Swedish journalists to write about this subject. He has also written the books "Olja" (Oil) and "Svart Jord" (Black Earth), both well worth reading.

In Sweden we happen to have one of the internationally best known researchers in peak oil, Kjell Aleklett, professor of physics at Uppsala University, leader of the Uppsala Hydrocarbon Depletion Study Group and one of the founders of ASPO, the Association for the Study of Peak Oil and Gas. In spite of this Swedish media are rather silent when it comes to peak oil.

On the World Wide Web the situation is better. The first Swedish site about peak oil was energikris.nu, which started in May 2005 but is no longer updated. Nowadays there is the news and discussion site oljepris.se. There are also a number of Swedish bloggers that often write about peak oil (apart from myself), notably Sweden's most read finance blog Cornucopia. ASPO Sweden also has a blog and news.

So it seems to me that most of society does not know about peak oil or is in denial about it.

So where are you on the Kübler-Ross scale when it comes to your view on peak oil? If you've made it to the end of this article at least you are not unaware of it.

Falling Swedish Housing Prices Again

I think it's about time I updated the English version of my Swedish housing bubble diagram and analysis from September 2007.

The following is based on articles from my Swedish language blog from the past year or so.

At the end of 2010 real house prices in Sweden fell quarter over quarter for the first time since the first quarter of 2009. According to Statistics Sweden's "Fastighetsprisindex småhus" and CPI, inflation adjusted house prices fell from the third to the fourth quarter of 2010. The falling prices have continued during the first quarter of 2011. See diagram below for prices in the whole country and in the Stockholm area.

For comparison I've also included real wages. The Swedish housing bubble is credit driven, as you can see if you compare housing prices, wages and household credit. In 2007 I thought we had seen the top, but during the financial crisis of 2008 the Swedish central bank, Riksbanken, took interest rates down sharply, and since Sweden was relatively mildly hit by the crisis the Swedes started bidding up housing prices even more using borrowed money at low interest rates.

The question now is - have we seen the real top in the Swedish housing market this time? I find it hard to see any factors that could inflate the Swedish housing bubble further, so this time I definitely call it a top.

There are always "fundamentalists" who argue that there is no housing bubble in Sweden, citing for instance supply and demand showing that there is not enough housing in for example Stockholm. However, housing price increases in Sweden are not limited to the large cities. Percentage-wise prices have even increased more in some smaller towns. Sweden also has among Europe's largest dwelling area per capita, even compared to neighbours such as Finland.

What the "fundamentalists" also miss is that this is really a household credit bubble, which happens to manifest itself in housing prices. It also manifests itself in household consumption, which continues unabated in Sweden, though there are recent signs of a softening. This of course drives the strong Swedish GDP increase, which however is largely driven by credit-fuelled household consumption. If household credit expansion should stand still, Swedish GDP will no longer increase.

Now it's not just Sweden that still has an unpopped housing bubble. Our neighbours Norway and Finland also do. Denmark's bubble popped in 2007, however, which has caused the demise of nine smaller Danish banks, but has so far left the large banks relatively unscathed.

Norway's bubble is bigger than Sweden's, and Finland's is smaller, using 1993 as the base year. All the Nordic bubbles are larger percentage-wise than the American one. One cannot help but wonder what will happen to the Norwegian bubble, considering that Norwegian oil production has been falling for about ten years now.

Also read the Australian blog Macrobusiness' recent analysis of the Swedish housing bubble.

Western European Banks' Exposure to Eastern Europe

This article is a translation of an article on my Swedish language blog.

Last week I wrote about Eastern Europe's loans from Western European Banks (in Swedish). Now I've taken the latest figures from BIS and made graphs to illustrate how the situation is. Please note that the figures are only for claims from banks. There may be other lenders too, but it's not as easy to find statistics for them.

First I'll present an illustration of which Eastern European countries have borrowed most. The colours indicate which in Western European countries the they have borrowed from belong. Click the graph for a sharper version.This graph shows clearly that we don't need to worry too much about Western Europe's banks if Macedonia, Moldova, Montenegro, Belarus, Albania, Bosnia or Serbia should be hit by a collapse of the economy and currency, since their loan volumes are relatively small. The other countries, however, are potential threats to Western Europe's banks. This becomes especially clear when one Western European country has a large proportion of the lending to a certain Eastern European country, e.g. Sweden to Estonia, Latvia and Lithuania.

Huge figures have been floating around when it comes to the exposure of Western European banks to Eastern Europe, but the total sum of bank lending is "only" slightly more than 1.4 trillion dollars, which should be quite close to the actual figure. This is still, however, a very large figure.

Now I'm going to look at it from "the other side", i.e. divided per lender country instead.Here you can see that Austria is at the top of the risk list for lending to Eastern Europe. As for Sweden we can note that the major part of the lending is to the three Baltic states. Since these three economies risk following each other, Sweden is much more exposed to a single risk factor.

However, absolute numbers don't often say that much. If Italy lends a bit over 200 billion dollars that's a larger share of the country's GDP than if Germany lends the same amount. So below I compare the banks' lending to Eastern Europe to the GDP of the countries (taken from the 2008 GDP estimates from the CIA Factbook).Then you suddenly see what a huge risk Austria is taking! Their banks have lent roughly 64% of the country's GDP just to Eastern Europe! Even a mild crisis in Eastern Europe would thus probably suffice to topple Austria's banks - we don't even need a serious crisis. The biggest Austrian claims are on Czechia, Romania and Hungary. At least Romania and Hungary are already on the problem radar...

By Austrian measures the other Western European countries have taken limited risks towards Eastern Europe, even if they definitely aren't negligible. Belgium's banks have lent about 25% of Belgium's GDP to Eastern Europe, and Swedish banks about 20% of our GDP, most of it to Estonia, Latvia and Lithuania.

Let us also take a look at which Eastern European countries have borrowed the most in relation to their GDP, and thus have taken a large risk. This is according to my usual identification mechanism for potential problems in this crisis. Large loans = large problem risk.Here you can see that Croatia and Estonia are in a risk class of their own. Their claims from foreign banks are more than 120% of their GDP. But Latvia, Hungary, Czechia, Slovakia, Lithuania and Bulgaria are also risk factors that cannot be ignored (the nominal sum of their borrowing according to the first graph in this article also plays a part here). Add to this the fact that GDP for many Eastern European countries is now falling rapidly, and we will quickly get even bigger loans-to-gdp ratios.

Part of the risk is also the currency risk. A large part of the loans from Western to Eastern Europe are denominated in euros or Swiss francs. This causes payment difficulties when the local currency sinks against the euro and/or the franc. Unfortunately I don't have any figures for how much of the loans are denominated in foreign currencies, but we can take a look at how some currencies have moved against the euro since the end of August last year.Here you can see that Ukraine's hryvnia and Poland's zloty have fared worst. We have all heard about Ukraine's problems, but there has not been much mention of Poland during this crisis. Hungary, Romania, Russia and Czechia have also been hit by falling currencies, though not as badly.

To conclude, we can see that the banks of several Western European countries have taken large risks towards the now faltering economies of Eastern Europe. There is an immediate risk that for example a currncy and/or economic collapse in one of the risk countries I've presented above could topple e.g. Austria's banks. This in turn would probably give serious repercussions for the whole euro area (Austria is part of it). As I see it it is only a matter of time before something drastic happens. Exactly what will happen is hard to predict, but Sweden is definitely also in the risk zone.

In this context it is interesting to note that the bank crisis of 1931 had its origins in Austria, where their then largest bank Creditanstalt went bankrupt in May of that year. Will we get a replay?

P.S. I recommend the following two articles by Ambrose Evans-Pritchard at the Telegraph for those who want to read more about the risks from Eastern Europe:
Failure to save East Europe will lead to worldwide meltdown
Eastern European currencies crumble as fears of debt crisis grow

Swedish and Danish Kronas and Interest Rates

This is a partial translation of my original article in Swedish.

Sweden and Denmark have gone different ways when it comes to currencies. Both countries have kronas, as you probably know, and have not joined the euro. But while the Danish krona is pegged to the euro through the European Exchange Rate Mechanism ERM the Swedish krona has no peg. This can be seen from how the Swedish krona, being a small currency, fluctuates much more than the euro against the dollar.As you can see from the graph above one paid about 9.30-9.50 Swedish kronor for a euro until the beginning of September 2008. When the crisis then gained momentum the krona fell against the euro so that one at times had to pay more than 11 kronor for a euro (today we're at 10.76 kronor per euro). This means that the krona lost about 13% against the euro, just because we have a small currency, which is not attractive to investors in a crisis. Theoretically a weak currency should be good for our export industry (Sweden runs a current account surplus) but in a global crisis where world trade is generally diminishing one can question how much this is worth.

The Danish krona however has been stable around 7.45 DKK/EUR all the time - lucky them, one could believe. But the Danes have been hit by something else - look at the diagram below for the rates of the Danish central bank (red), the European Central Bank (blue) and the Swedish central bank (green):Danmarks nationalbank had to raise their rate at the beginning of October to defend the value of the Danish krona against the euro, when ECB and Sweden instead lowered their rates to cushion the effects of the financial crisis. Even though the Danish central bank rate has been lowered in three steps since then, it is still a good deal higher than the ECB rate, which has also been lowered during this period. The higher interest rate climate in Denmark can also be seen when you look at the interbank rates - Danish 3 month CIBOR was at 3.9317% today, while Swedish 3 month STIBOR was at 2.023%. A rather hefty difference, I would say. So this is the price Denmark pays for its stronger currency.

Now voices are being raised in Sweden for us to join the euro. The Swedish small enterprises association's leader Anna-Stina Nordmark Nilsson and professor of economics Harry Flam have written an article each in Sweden's two largest newspapers where they argue for joining the euro. Well, it might not be very good timing to join the euro now, when it seems the euro co-operation itself might break.

Anyway, Sweden cannot join the euro straight away, since a country's currency must be part of the ERM for two years first according to the rules. So the Swedish euro friends will have to wait for the continuing onslaught of the financial crisis before they get what they want.

Wild Price Swings Could Implode Hedge Funds

I guess nobody has missed the wild swings during the first weeks of 2008 in the prices of just about everything that can be traded.

• S&P 500 stock index from 1471 down to 1388 up again to 1429 down again to 1270 up again to 1396 down again to 1317. A span of about 16%.
  
• Crude oil from 95 up to 100 down again to 86 up again to 92 down again to 87 $/barrel. A span of about 16%.
  
• Gold from 840 up to 912 down again to 860 up again to 930 down again to 885 $/oz. A span of about 11%.
• 10 year US treasury note yield from 4.05% down to 3.28% up again to 3.74% down again to 3.53% up again today to 3.74%.
• And so on...

These wild swings in prices of equities and commodities have been very hard to predict. Now, hedge funds all around the world are making bets all the time on the direction that certain prices will take, and these bets are often highly leveraged (i.e. they borrowed a lot of money to bet). This means that a number of hedge funds have probably made bad bets over the last few weeks, some of them maybe bad enough to "implode" the fund, because prices have quickly and unexpectedly moved in the "wrong" direction. So I predict that we will soon see a number of hedge fund failures, and some of them might be rather spectacular.
We have already seen an example of what can happen when big trades go wrong in the case of the "rogue trader" at the French bank Société Générale. The losses in this case were about €4.9 billion, enough to topple most hedge funds.