Thursday's Top 10 with NZ Mint: Ultimate death by debt; Growing energy inefficiency; What QE III might look; Why a Greek default would hammer US banks; Dilbert

Here's my Top 10 links from around the Internet at 10 to 4 pm  in association with NZ Mint.

I'll pop the extras into the comment stream. See all previous Top 10s here.

I welcome your additions in the comments below or via email to bernard.hickey@interest.co.nz.

The key point in the Greek debt crisis is if and when Greek debt is restructured to the point that it triggers the payout of credit default swaps. Then Europe's crisis goes global through the US megabanks.

1. Death by Debt - US banking analyst and survivalist Chris Martenson writes here about the inevitability that the US economy can't be fixed because it relies too much of unending debt creation and peak oil.

This all sounds a bit chicken littlish (attention Gummy Bear) but it's worth reading.

Martenson is no mug and covers America's banking system very closely.

The implications of what he is saying are profound and a tad scary.

But he makes a strong case and it's hard to see a way out.

His views are similar in many ways to those of Steve Keen.

The old regime of general economic stability and rising standards of living fueled by excessive credit are a thing of the past.  At least they are for the debt-encrusted developed nations over the short haul -- and, over the long haul, across the entire soon-to-be energy-starved globe.

The basis for this view stems from understanding that debt-based money systems operate best when they can grow exponentially forever. Of course, nothing can, which means that even without natural limits, such systems are prone to increasingly chaotic behavior, until the money that undergirds them collapses into utter worthlessness, allowing the cycle to begin anew.

All economic depressions share the same root cause. Too much credit that does not lead to enhanced future cash flows is extended.  In other words, this means lending without regard for the ability of the loan to repay both the principal and interest from enhanced production; money is loaned for consumption, and poor investment decisions are made. Eventually gravity takes over, debts are defaulted upon, no more borrowers can be found, and the system is rather painfully scrubbed clean. It's a very normal and usual process.

So here we are, just a few weeks away from the end of the second round of quantitative easing (QE II) , with massive public debts and liabilities having only grown larger instead of shrinking during the Great Recession, everybody in nearly the same boat, and no clear plan for how all the sovereign debts will be funded from current productive cash flows (i.e., existing GDP).

This is why so many commentators, myself included, are convinced that more thin-air money printing is on the way. My thesis, laid out back in early March is that the Fed will stop QE II on schedule and that the financial markets will react exceptionally poorly to this loss of support. Commodities will tank first, then stocks, then bonds; from riskiest and most-leveraged to least.

It is time to face the music; the levels of indebtedness now require permanent support from thin-air money in order to avoid a deflationary collapse.

2. Markets keep falling - Bloomberg reports stocks and currencies (vs the US) have kept falling through Asia as fears grow about a likely Greek default.

Greek Prime Minister George Papandreou will reshuffle his Cabinet and seek to win a confidence vote today as escalating protests over budget cuts fuel speculation that the austerity measures needed to qualify for international aid will be put in jeopardy. Global shares fell the most in almost three months yesterday amid concern that a Greek default will cause a freeze in credit markets worldwide, similar to the one in 2008 when Lehman Brothers Holdings Inc. collapsed.

“The bottom line is a default or restructuring on the part of Greece is going to end up being the Lehman event for Europe and the question is whether policy makers push this to the brink,” Scott Minerd, the New York-based chief investment officer at Guggenheim Partners LLC, said in a Bloomberg Television interview. “The bottom line is, if they keep kicking the can down the road, we’re going to face a disaster.”

3. Equally unequal - Paul Kedrosky at Bloomberg points to a chart below showing New Zealand's income inequality is only slightly better than Britain and America, and is worse than Japan, Canada, Australia, Germany etc.

For the squinters amoung you, we're in between Britain and Romania on the right hand (most unequal) side of the chart.

Kedrosky then makes some depressing points about why there aren't riots in America.

There are really two aspects to this, especially to how people (read: voters) respond to the skew. There are structural issues — safety nets, education, poverty and immigration — and there are identity issues.

At the margin, identity trumps structure, with people living less unhappily with income disparity because it reinforces their sense of societal self. Income skew supports American exceptionalism, the idea that the U.S. is different, because look at what happens to successful people here, unlike elsewhere. “That could be me,” is the story people tell themselves, a story that causes them to vote for fewer structural supports, the sort of thing that could get in the way of their achieving the American Dream, or so the story goes.

In short, the skew in U.S. income is a feature, not a bug. It is an essential myth in which people in this country believe, one that reinforces exceptionalism, identity and entrepreneurial opportunity. It creates the perception of an economic lottery, one that you too could win, if only you worked hard enough and long enough. Further, and more than a little worryingly, it has positive feedback, in that the more skewed incomes become the more the lottery effect is reinforced. Bad income news is good news, and worse income news is even better news.

4. Falling energy efficiency - Early Warning points to a BP report on global energy use in 2010. The one hope in a world of peak oil is that we become more efficicient at using oil. But as this chart below showing GDP per tonne of oil equivalent energy demonstrates, we have become less efficient in the last year or two.

The first thing that struck me was that the headline growth in global primary energy consumption, 5.6%, was likely larger than the growth in global GDP, implying that the efficiency with which the global economy uses energy must have declined.

5. What QE III could look like - Ed Harrison does a great job at Credit Writedowns explaining what a (now apparently inevitable) third round of quantitative easing might look like.

The Fed could announce long bond yield targets and then buy up as much as required to hit that target...God help us all. The Fed somehow thinks it can do this without having to buy US Treasuries itself. As if by magic...

Harrison quotes from current US Federal Reserve Chairman Ben Bernanke in his infamous Helicopter speech.

There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). 

The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

And here's Harrison with the 'just like magic' thinking:

My understanding about what (PIMCO boss Bill) Gross believes is that the Fed could see QE3 "guaranteeing" a 2 year or 3 year yield at a certain level---say 50 basis points. Moreover, the Fed would not necessarily have to buy any Treasures to defend this target. Gross understands that the private sector “would do it” for the Fed via the language and confidence in the "guarantee". I think this point about not having to buy any securities despite offering to defend the rate with an unlimited supply of liquidity is significant.

6. And it starts - The FT (via CNN) reports Standard and Poor's has lowered its outlook on Chinese property.

The outlook for the Chinese property development sector was downgraded to negative by Standard & Poor's on Wednesday, as the rating agency pointed to worsening credit conditions and the likelihood of a fall in transaction volumes.

The downgrade comes as analysts warn of a potential impending "price war" among property developers starved of cash by Beijing's efforts to rein in the red-hot residential property sector .

"In the near term, what worries us most is the liquidity position of developers, who are facing very tight lending controls," said Bei Fu, an analyst at S&P in Hong Kong. "In this situation developers really need to rely on their own sales but this is a highly uncertain prospect given government attempts to suppress the market and the fact sales volumes have already started to come down."

7. More capital and less leverage - Simon Johnson at the NYTimes points out that even the Federal Reserve is trying to rein in the leverage by the Too Big To Fail monster banks.

Less leverage means less lending, which means deleveraging, which means asset sales and/or losses for the most leveraged ad infinitum...refer above to Martenson.

As the bankers busily rallied their forces to fight on debit cards and spent a great deal of time lobbying on Capitol Hill, they were doused with a bucket of cold water by Daniel K. Tarullo, a governor of the Federal Reserve.

In a speech on June 3, Mr. Tarullo implied capital requirements for systemically important financial institutions — a category specified in the sweeping overhaul of financial regulation last year — could be as high as 14 percent, or roughly double what is required for all banks under the Basel IIIagreement.

Whether the Federal Reserve will go that far is not certain; a capital requirement of an additional 3 percent of equity (on top of Basel’s 7 percent) may be more likely, but that is still 3 percent more than big banks were hoping for.

8. What happens if Greece defaults - The question of whether Greece defaults is very important from the point of view of European banks because any default would force them to revalue their assets and report losses. It may force them to raise fresh capital from shareholders or governments.

However, many of them have bought credit default swaps or bond insurance from US institutions. Here's where it gets interesting.

Kash Mansori at The Street Light has looked at figures from the Bank of International Settlements (BIS) which show who would be hurt most if a formal default is called.

It's worth noting that once you account for the substantial payouts that US agents will have to make to European creditors in the case of a default by one of the PIGs, financial institutions in the US have roughly as much to lose from default as those in France and Germany. The apparent eagerness of US banks and insurance companies to sell default insurance to European creditors means that they will now have to substantially share in the pain inflicted by a PIG default.

This has some important implications. First, US and European financial institutions are likely to have very different incentives as negotiations regarding debt restructuring and reprofiling proceed. US banks and insurance companies are surely delighted with the "soft restructuring" that is currently being discussed. Such a partial default would probably not trigger default insurance payments, and so the pain would be borne almost exclusively by European institutions.

On the other hand, some time soon it seems likely that European creditors will begin to prefer a "hard restructuring" that would require default insurance payouts from the US institutions that sold such insurance. Given how strikingly one-sided the net default insurance payments will be (from the US to Europe), it's easy to imagine how that could shape future negotiations over debt relief for the PIGs.

So there we have it. The American banks are just as worried about a full Greek default.

9. American bank fears - It seems they were similarly worried when Ireland almost defaulted last year.

Apparently US Treasury Secretary Tim Geithner got involved at the last minute to stop a default by Ireland. Morgan Kelly tells the story in his now epic May 7 column in the Irish Times. 

Ireland’s Last Stand began less shambolically than you might expect. The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average. Lenihan was overjoyed, according to a source who was there, telling the IMF team: “You are Ireland’s salvation.”

The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of US$13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers. The only one to speak up for the Irish was UK chancellor George Osborne, but Geithner, as always, got his way. An instructive, if painful, lesson in the extent of US soft power, and in who our friends really are.

This has since been raised in discussions between the new Irish government and President Obama. The reasons why have since been Wikileaked, Namawinelake points out. HT CreditWritedowns.

Secretary Geithner was concerned that if Ireland refused to repay bank bondholders then, in the words of Britain’s Telegraph “that could have spread contagion to the entire European system, to which American-backed “credit default swaps” were exposed to the tune of €120bn”

10. Totally Greek crisis video - Here's the Taiwanese animation treatment with a twist.