"By the same definition, the overbuilding of industry beyond any probable demand for the product represents devoured credit. Here the spirit of aggrandizement acts as if it were a biological law, each separate organization trying to outgrow all the others of its kind in the industry of one country, and then that industry as a whole trying to outgrow the competitive industry of another country, and this going on with the benefit of more and more credit, until at last what is the problem? The problem is that so much credit, that is to say labour, is trapped, frozen, locked up in the worlds' industrial machine that people cannot afford to buy the whole of its product at prices which will enable industry to pay interest on its debt. This is perhaps the most involved form of pyramid that human ingenuity has yet devised."
Garet Garrett in Anatomy of a Bubble, 1932
Have you every read a more nearly perfect description of the Telecom industry seventy years on?
Western Governments to this point have been laughing, reaping the usual benefits of an inflationary episode to pay down their debt in a very New Millennium fashion.
This time, as a result of the encouragement of a prolific expansion of the global money supply, most of the rise in prices this last five years has occurred in assets. This, by helping absorb the extra money substitutes, coupled with the fortuitous firesale of goods which resulted from the Asian credit implosion, kept product prices relatively well-behaved up until last year, at least and so allowed the fiction to be maintained for much longer than usual that exploding levels of credit were acting as a benign influence, rather than wreaking their age-old havoc upon the free market's price mechanism.
Soaring stock prices and heady appreciation in the real estate markets of the West have made people feel wealthier (confused as most are in the modern age between u2018money' and u2018wealth') and thus encouraged them to embark on a consumptive binge which makes the Prodigal Son look like Ebenezer Scrooge, boosting tax revenues in the process.
Moreover, the stock Bubble itself has been of inordinate assistance in the US, for one, with the unprecedented levels of stock turnover catching a greater proportion of the notional profits in the capital gains trap. Other exchequers have gratefully gathered in extra stamp duty monies, a Tobin tax on you and me, rather than Soros and Robertson. If you doubt this, pull up the monthly US federal budget receipts chart and see how non-April months are on a smooth trend, while April's year-end is on an exponential path.
Finally, European government has become rapacious with its extortion racket over UMTS phone licences. Making over-eager Telco's compete in a bidding system which would have made game theory pioneers Morgenstern and von Neumann proud has extracted untold bounties from this multi-billion winner's curse. Or, perhaps we should say, has generated a massive down payment against any future default on the part of their victims which might then require a socialization of the problem (read: a return to plundering taxpayers directly).
Anticipating and diverting returns from Techmania share holders to the public fisc for a totally non-productive capital levy is one thing, degrading the credit worthiness of the rest of the public's pension funds by substituting junk for the now wildly-expensive remaining government debt is another. Confiscation is what government is about, after all. None of this would have been possible, however, without the inflation-driven New Era hunger for the equities in the first place. None of it would have been possible without the inflation- driven availability of credit, enabling vast bond issues and even more vast syndicated lending to finance this high bandwidth Canal Boom.
Now, however, with Telco stocks leading the declines in most indices, with their bonds becoming tainted with toxicity, the regulators are looking askance at the exposure of the banking sector to this welter of potential malinvestment.
Very rich indeed since central bank-sanctioned credit expansion has been behind the whole process! But then Austrians know that business depressions result from the banking authorities deciding to forestall the potential hyperinflation, whose seeds they alone have sown, by belatedly withdrawing the oxygen of easy money, thus asphyxiating the boom and precipitating a crash instead.
The FT says the financial stability chiefs have u2018launched inquiries' into Telco lending, saying variously that matters are u2018of great concern' because of the risks the banks are taking with one sector. Others likened the concentration of debt to the run-up to the 1992 property crash and the 1998 hedge fund crisis, both of which caused major problems for banks. Naturally, what they do not say is that such a move, even if it does not stretch beyond u2018moral suasion' (bullying), could easily trigger the very disaster they are supposedly keen to avert.
European banks could do without this. We have noted on www.capitalinsight.co.uk that the US FDIC was expressing anxiety over the growing illiquidity of commercial banks there, pointing out a loan:deposit ratio approaching 95% at larger institutions. In Europe, using the ECB monthly report as a rough guide, for Euro-residents alone and stripping out interbank transactions, loans:deposits stands at 128%. Total assets are a lofty 18 times capital and reserves and loans to private, non-financial corporations (roughly, C&I loans) alone are 2.8 times capital and nearly 50% of non-MFI deposits. With real estate lending accounting for another 34% of such deposits, the vulnerabilities are patent, even without beginning to sweat over an equity portfolio equal to some 76.5% of equity, 44% of it acquired in the last 18 months.
So much for banks, but look at another little case of the-thigh-bone's connected-to-the-hip-bone.
Telcos are a weather vane for the whole Tech fantasy. They need fibre optics (JDSU et al). They need chips (INTC's pals) and handsets (NOK and co). They need software (ORCL and the like), hardware (SUNW & friends) and infrastructure (CSCO and its ilk). If they find financing more difficult, much less impossible, these suppliers will be squeezed (especially if current revenues are in Euros and billings in USD). Moreover, heavy capital investment in Tech has been a feature of much of the rest of industry, or so Mr. Greenspan keeps telling us. Now correct us if we're wrong, but a major slowdown usually impacts CapEx very heavily as cost-cutting takes over and projects revealed to be sub-marginal by the end of the boom are postponed or scaled back. Not much solace for Tech there, either.
Oh and guess which sector has had Dollars, Euros and Yen in mind-boggling amounts to spend in recent years on systems? That's right, the Bubble-blowers themselves Financials. Whether equipping Star Trek bridge dealing rooms or launching online banking and stockbroking services, not to mention retooling for the great Y2k hoax, a lot of revenue has been derived from this source. Any impairment of the worth of banks and brokers, or a dimming of their prospects, will see the shutters slam down on the cashier's window, blocking off another channel for Silicon Valley's finest, thus exacerbating the problems for the bottom-line once again. Oh and so making the bank lending look all the more intemperate! Round and round and round she goes and where she stops nobody knows.
October 2, 2000
Sean Corrigan writes from London on the financial markets, and edits the daily Capital Letter and the Website Capital Insight.