TIPPING POINTS

"The moment of critical mass, the threshold, the boiling point"

The tipping point is the critical point in an evolving situation that leads to a new and irreversible development. The term is said to have originated in the field of epidemiology when an infectious disease reaches a point beyond any local ability to control it from spreading more widely. A tipping point is often considered to be a turning point. The term is now used in many fields. Journalists apply it to social phenomena, demographic data, and almost any change that is likely to lead to additional consequences. Marketers see it as a threshold that, once reached, will result in additional sales. In some usage, a tipping point is simply an addition or increment that in itself might not seem extraordinary but that unexpectedly is just the amount of additional change that will lead to a big effect. In the butterfly effect of chaos theory , for example, the small flap of the butterfly's wings that in time leads to unexpected and unpredictable results could be considered a tipping point. However, more often, the effects of reaching a tipping point are more immediately evident. A tipping point may simply occur because a critical mass has been reached.

The Tipping Point: How Little Things Can Make a Big Difference is a book by Malcolm Gladwell, first published by Little Brown in 2000. Gladwell defines a tipping point as "the moment of critical mass, the threshold, the boiling point." The book seeks to explain and describe the "mysterious" sociological changes that mark everyday life. As Gladwell states, "Ideas and products and messages and behaviors spread like viruses do."

The three rules of epidemics

Gladwell describes the "three rules of epidemics" (or the three "agents of change") in the tipping points of epidemics.

• "The Law of the Few", or, as Gladwell states, "The success of any kind of social epidemic is heavily dependent on the involvement of people with a particular and rare set of social gifts."According to Gladwell, economists call this the "80/20 Principle, which is the idea that in any situation roughly 80 percent of the 'work' will be done by 20 percent of the participants." (see Pareto Principle) These people are described in the following ways:

• Connectors are the people who "link us up with the world ... people with a special gift for bringing the world together." They are "a handful of people with a truly extraordinary knack [... for] making friends and acquaintances". He characterizes these individuals as having social networks of over one hundred people. To illustrate, Gladwell cites the following examples: the midnight ride of Paul Revere, Milgram's experiments in the small world problem, the "Six Degrees of Kevin Bacon" trivia game, Dallas businessman Roger Horchow, and Chicagoan Lois Weisberg, a person who understands the concept of the weak tie. Gladwell attributes the social success of Connectors to "their ability to span many different worlds [... as] a function of something intrinsic to their personality, some combination of curiosity, self-confidence, sociability, and energy."

• Mavens are "information specialists", or "people we rely upon to connect us with new information." They accumulate knowledge, especially about the marketplace, and know how to share it with others. Gladwell cites Mark Alpert as a prototypical Maven who is "almost pathologically helpful", further adding, "he can't help himself". In this vein, Alpert himself concedes, "A Maven is someone who wants to solve other people's problems, generally by solving his own". According to Gladwell, Mavens start "word-of-mouth epidemics" due to their knowledge, social skills, and ability to communicate. As Gladwell states, "Mavens are really information brokers, sharing and trading what they know".

• Salesmen are "persuaders", charismatic people with powerful negotiation skills. They tend to have an indefinable trait that goes beyond what they say, which makes others want to agree with them. Gladwell's examples include California businessman Tom Gau and news anchor Peter Jennings, and he cites several studies about the persuasive implications of non-verbal cues, including a headphone nod study (conducted by Gary Wells of the University of Alberta and Richard Petty of the University of Missouri) and William Condon's cultural microrhythms study.

• The Stickiness Factor, the specific content of a message that renders its impact memorable. Popular children's television programs such as Sesame Street and Blue's Clues pioneered the properties of the stickiness factor, thus enhancing the effective retention of the educational content in tandem with its entertainment value.

• The Power of Context: Human behavior is sensitive to and strongly influenced by its environment. As Gladwell says, "Epidemics are sensitive to the conditions and circumstances of the times and places in which they occur." For example, "zero tolerance" efforts to combat minor crimes such as fare-beating and vandalism on the New York subway led to a decline in more violent crimes city-wide. Gladwell describes the bystander effect, and explains how Dunbar's number plays into the tipping point, using Rebecca Wells' novel Divine Secrets of the Ya-Ya Sisterhood, evangelist John Wesley, and the high-tech firm W. L. Gore and Associates. Gladwell also discusses what he dubs the rule of 150, which states that the optimal number of individuals in a society that someone can have real social relationships with is 150.

 

RESEARCH METHODOLOGY

 

PROCESS OF ABSTRACTION

 

 

SOVEREIGN DEBT & CREDIT CRISIS

 

MUNI BOND OUTFLOWS

RISK REVERSAL

 

RESIDENTIAL REAL ESTATE - PHASE II

 

COMMERCIAL REAL ESTATE

2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.

2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least.

Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due.

Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the commercial banking conduit?

Wiil the regulators force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it.

We have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.

So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.

9 - CHRONIC UNEMPLOYMENT

There are 3 major inflationary drivers underway.

1- Negative Real Interest Rates Worldwide - with policy makers' reluctant to let their currencies appreciate to market levels. If no-one can devalue against competing currencies then they must devalue against something else. That something is goods, services and assets.

2- Structural Shift by China- to a) Hike Real Wages, b) Slowly appreciate the Currency and c) Increase Interest Rates.

3- Ongoing Corporate Restructuring and Consolidation - placing pricing power increasingly back in the hands of companies as opposed to the consumer.

FOOD PRICE PRESSURES

RICE: Abdolreza Abbassian, at the FAO in Rome, says the price of rice, one of the two most critical staples for global food security, remains below the peaks of 2007-08, providing breathing space for 3bn people in poor countries. Rice prices hit $1,050 a tonne in May 2008, but now trade at about $550 a tonne.

WHEAT: The cost of wheat, the other staple critical for global food security, is rising, but has not yet surpassed the highs of 2007-08. US wheat prices peaked at about $450 a tonne in early 2008. They are now trading just under $300 a tonne.

The surge in the FAO food index is principally on the back of rising costs for corn, sugar, vegetable oil and meat, which are less important than rice and wheat for food-insecure countries such as Ethiopia, Bangladesh and Haiti. At the same time, local prices in poor countries have been subdued by good harvests in Africa and Asia.

 

- In India, January food prices reflected a year-on-year increase of 18%t.

- Buyers must now pay 80%t more in global markets for wheat, a key commodity in the world's food supply, than they did last summer. The poor are especially hard-hit. "We will be dealing with the issue of food inflation for quite a while," analysts with Frankfurt investment firm Lupus Alpha predict.

- Within a year, the price of sugar on the world market has gone up by 25%.

US STOCK MARKET VALUATIONS

 

WORLD ECONOMIC FORUM

Potential credit demand to meet forecast economic growth to 2020

The study forecast the global stock of loans outstanding from 2010 to 2020, assuming a consensus projection of global
economic growth at 6.3% (nominal) per annum. Three scenarios of credit growth for 2009-2020 were modelled:

• Global leverage decrease. Global credit stock would grow at 5.5% per annum, reaching US$ 196 trillion in 2020. To
meet consensus economic growth under this scenario, equity would need to grow almost twice as fast as GDP.
• Global leverage increase. Global credit stock would grow at 6.6% per annum, reaching US$ 220 trillion in 2020.
Likely deleveraging in currently overheated segments militates against this scenario.
• Flat global leverage. Global credit stock would grow at 6.3% per annum to 2020, tracking GDP growth and reaching
US$ 213 trillion in 2020 – almost double the total in 2009. This scenario, which assumes that modest
deleveraging in developed markets will be offset by credit growth in developing markets, provides the primary credit
growth forecast used in this report.

Will credit growth be sufficient to meet demand?

Rapid growth of both capital markets and bank lending will be required to meet the increased demand for credit – and it is
not assured that either has the required capacity. There are four main challenges.

Low levels of financial development in countries with rapid credit demand growth. Future coldspots may result from the
fact that the highest expected credit demand growth is among countries with relatively low levels of financial access. In
many of these countries, a high proportion of the population is unbanked, and capital markets are relatively undeveloped.

Challenges in meeting new demand for bank lending. By 2020, some US$ 28 trillion of new bank lending will be
required in Asia, excluding Japan (a 265% increase from 2009 lending volumes) – nearly US$ 19 trillion of it in China
alone. The 27 EU countries will require US$ 13 trillion in new bank lending over this period, and the US close to US$
10 trillion. Increased bank lending will grow banks’ balance sheets, and regulators are likely to impose additional capital
requirements on both new and existing assets, creating an additional global capital requirement of around US$ 9 trillion
(Exhibit vi). While large parts of this additional requirement can be satisfied by retained earnings, a significant capital gap in
the system will remain, particularly in Europe.

The need to revitalize securitization markets. Without a revitalization of securitization markets in key markets, it is doubtful
that forecast credit growth is realizable. There is potential for securitization to recover: market participants surveyed by
McKinsey in 2009 expected the securitization market to return to around 50% of its pre-crisis volume within three years.
But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and
better quality ratings.

The importance of cross-border financing. Asian savers will continue to fund Western consumers and governments:
China and Japan will have large net funding surpluses in 2020 (of US$ 8.5 trillion and US$ 5.7 trillion respectively), while
the US and other Western countries will have significant funding gaps. The implication is that financial systems must
remain global for economies to obtain the required refinancing; “financial protectionism” would lock up liquidity and stifle
growth.

 

US$ RESERVE CURRENCY

SocGen crafts strategy for China hard-landing

Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over the next year, with major ramifications for the rest of the world.

Société Générale said China's overheating may reach 'peak frenzy' in mid-2011

- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over coming months that will push commodity prices much higher, followed by a sudden reversal as China slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9 trillion) or 50pc of GDP over the past two years.

- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain Bokobza, Glenn Maguire and Wei Yao.

- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe. "The skew of risks is very much for an extended period of overheating, and therefore uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit 10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and risks a "pernicious wage-price spiral".

- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would destabilise the global economy. It is not our central scenario, but if it happens: commodities won't like it; Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).

- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in December is meaningless because the regime has resorted to price controls on energy, water, food and other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without disclosure. She said inflation is running at 7.6pc on a six-month annualised basis, and the sheer force of money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is set to accelerate.

- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be highly destabilising for the world." Charles Dumas, Lombard's global strategist, said the Chinese and emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-go funds is wrong: they risk losing half their money like last time."

- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year end".

- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a 70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and energy equities will prosper under a soft-landing,

- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese equities. It will be clear enough by June which of these two outcomes is baked in the pie.

SocGen crafts strategy for China hard-landing Pritchard

PUBLIC SENTIMENT & CONFIDENCE

 

 

SHRINKING REVENUE GROWTH RATES

PIMCO'S NEW NORMAL: According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform (as per Exhibit 1).

Federal Reserve Chairman Ben Bernanke gave his predictions on a House Republican plan to cut $60 billion dollars from the FY 2011 budget, saying it would eliminate 200, 000 jobs and only slightly lower economic growth.

He instead endorsed a Congressional federal deficit reduction plan that would take effect over a five to 10 year period, saying that markets look more towards Congressional action than the actual state of the economy. His remarks came during a House Financial Services Committee hearing in which he delivered his agency's semi-annual monetary report.

Despite Bernanke’s observations, several Republican lawmakers expressed doubt based on past efforts by the Fed and Congress to prompt economic growth through large stimulus packages.

Yesterday, the Fed Chair told the Senate Banking Committee that the U.S. economy will continue to grow this year despite rising oil prices, a high employment rate and weak housing market.

The 1978 Humphrey-Hawkins Act requires the Federal Reserve Board of Governors to deliver a report to Congress twice a year on its past economic policy decisions and discuss recent financial and economic developments.

The end of cheap oil, or more exactly of the indirect control of oil prices through the protection afforded to the oil monarchies

Between 1945 and 1975, the US strategy in the region has been determined by the desire to ensure control over the vast oil reserves in the region, then by the objective of forcing payment for oil in “paper-” dollars, that’s to say, a dollar free of any fixed parity with gold. This double objective was achieved in the 1980s. In 2011, the whole structure is collapsing under the battering of the Arab populations. Because, as regards oil, the real shock emanating from Tahrir Square that has been felt in Riyadh and in the oil monarchies of the region, is the discovery that the United States is not a reliable "bodyguard". In practical terms, as local reactions show for that matter, the Egyptian crisis and the lack of US support for Mubarak, has initiated a review process of the entire relationship with Washington in Riyadh and other oil monarchies, including the dependence of these countries’ leaders on military trained and equipped by the United States...

“If you look at the government’s latest statistics - the poverty survey of 2009, which is the most recent release, with average and median household income adjusted for inflation (and they use a really gimmick low inflation rate with that one) - it shows that not only has household income been falling the last year or two, but it’s below its near-term peak before the 2001 recession. Household income has not recovered above that, and if you use the CPI-U (the usual inflation rate to deflate that by instead of the gimmick one) it shows that household income today is below where it was in 1973. Again, the average household has not been able to keep up here. If income growth is not keeping ahead of inflation, very simply you can’t have consumption growing faster than inflation on a sustainable basis.”

Government statistics guru and believes the most important economic outlook used by our political leaders in their decison-making - the Consumer Price Index, the unemployment rate, the Gross Domestic Product - are deeply flawed in how they're calculated. Whether these flaws result from letting theory trump reality or by machinating politicians, the result is the same: we are fooling ourselves at our peril. We have been understating the risks we face - which is why we are working harder for less today than the previous generation, and why our economy is not only not in "recovery" - but on the precipice of crisis.

• John came to understand how changes in the way the key economic indicators are calculated has resulted in an outcome in which they no longer reflect reality. No one believes, values or knows how to accurately apply them anymore.
• There is rampant precedent for political manipulation of how these indicators are calculated. Past administrations forced changes in the forumlae for many reasons - a common one being optics.
• Using erroneous indicators is dangerous - not just for the governement, but for everyone. When inflation is running higher than most expect (as it is today), investors are cheated out their returns, wage earners wonder why their paychecks buy less goods, and fixed income earners suffer greatly. Unfortunately, there are myraid incentives for politicians and corporations to embrace artificially-low calculations - as they justify reducing obligations owed.
• The key approaches to calcualting inflation are especially convoluted, especially the practice of applying hedonics. If we instead calculate inflation according the formula used in 1980, we would see a number closer to 8%+ vs today's 1.5% rate.
• Similarly with unemployment, John calcualtes the true rate in the country today is 22% (vs the reported 9%).
• In sum, he sees the US suffering from structural issues that are extremely hard to address - but impossible if we continue to let fantasy data be our guide. Our circumstances are not sustainable and, in his eyes, have us on an inexorable path to higher inflation - and likely hyperinflation.

That government projections are not worth the price of the paper (especially not in today's dis-disinflationary environment) they are printed on is no secret. As Zero Hedge recently demonstrated the margin of error in the most recent budgetary prediction can only be classified as insane. We wrote: "On February 28, 2021 George Bush said this about his 2002 Budget: “It will retire nearly $1 trillion in debt over the next four years.” Instead, US debt, which at that point was $5.7 trillion, rose to $7.7 trillion. $3 trillion rounding error? Also in the same budget, Bush predicted a $5.6 trillion surplus over the next ten years, which would wipe out all of America's debt by 2011. The latest debt figure was $14.1 trillion. A $14.1 trillion rounding error, or a nearly five fold increase in "rounding errors" in a decade." So that's debt, what about budget surplus and/or deficit projections? It's not any prettier. And courtesy of the NYT we can now see this in an easy to comprehend animation. Following the jump readers can see just how endlessly upward biased projections tend to almost without fail deviate with reality (and unemployment rates as well). The best indication: the 2012 projection to the 2008 budget forecast callsed for a surplus. Now we are expecting a massive deficit. So why do we listen to these monkeys with typewriters again?

The Telegraph's Ambrose Evans-Pritchard has published one of his usual insightful analyses on the upcoming difficulties the Irish will face in renegotiating debt payments to prop up failing Irish banks (see article excerpt above). Irish bank bonds are held by German and French banks, among others, and there has been overwhelming pressure placed on Ireland ‘s government to borrow money, raise taxes and cut expenses so as to ensure the ailing banks do not founder entirely.

The stresses placed on the Irish economy and Irish taxpayers in particular are tremendous. Iceland chose not to support its insolvent banks and as a result the Icelandic economy has show some improvement; the Irish economy still lags badly and there is no expectation that it will much improve; in fact it is likely to end in a kind of national bankruptcy or popular rebellion.

For this reason, the Irish turned to the country's main opposition party, Fine Gael, in recent elections to provide a clear alternative to what has already been agreed upon with the EU. Nonetheless, as Evans-Pritchard shows, there are grave obstacles in the way of renegotiating an agreement with the EU that provided bank bailout money to stabilize Irish finances last year.

Much of the problem with renegotiating the current, likely unsupportable, agreement lies with Germany itself. Most recently it has been suggested that the EU could issue "eurobonds" that would considerably ease the financial crunch that countries like Ireland face. But Angela's Merkel's three-party German coalition is opposed to the eurobond idea, Evans-Pritchard reports, because ultimately all EU countries would end up guaranteeing such bonds. The coalition intends to put any agreement reached by the EU to a vote in the Bundestag. More than this, "A group of 189 German professors has [warned] of ‘fatal consequences for the whole process of European integration' if the EU crosses the Rubicon to a de facto debt union."

"I cannot remember any occasion when lawmakers have set guidance like this before: Merkel has very little leeway," Pritchard-Evans quotes Hans Redeker, currency chief at BNP Paribas as saying. "There is going to be disappointment at the summit and that will make life even harder for the EMU periphery." Meanwhile, an oil spike will considerably reduce EU growth and make the Irish economy (among others) even less responsive. Such "peripheral countries" are most at risk from exogenous financial difficulties.

Merkel's administration has an alternative plan to offer Eurocrats. In return for expanding the bailout pool, those recipients of aid will agree to an intrusive EU (German) regulatory and inspection reign. This has already met stiff resistance from the Irish and others. Resentments from World War II are still evident, especially in such countries as Greece, and the perception is that Germany is trying to use its financial clout to gain in peacetime the European empire it could not claim long ago by war.

The European Commission, Evans-Pritchard points out, has drafted a compromise plan, but in Germany, already, it is seen as more of the same. Outgoing Bundesbank chief Axel Weber – a vehement critic of any agreement that would further enmesh Germany financially into third-party bailouts – has attacked the plan, claiming it would eventually resolve itself into a move toward a eurobond program. Germany's views on this matter are increasingly shared in Holland and Finland – other so-called "Northern" states that are considerably more solvent than Southern ones.

Ireland currently pays nearly 6 percent for EU loans, versus the EU funding cost of 2.6 percent and there is no guarantee that the carrying costs won't rise as the EU gradually continues its recovery from the 2008 crisis. Evans Pritchard believes the new Irish regime has one considerable weapon in its arsenal, which is to "threaten 'haircuts' on senior bank creditors if the EU refuses to compromise, a move that might set off EMU-wide contagion and inflict big losses on German Landesbanken." To play it, he concludes, would encourage the wrath of the eurozone. To allow the situation to remain as it is will reignite the wrath of the voters that the just handed a resounding defeat to the previous regime that negotiated the current bailout terms. The alternatives could not be starker.