Global Economy 2015 – Tale of Three Realities: Contraction…Conflicts…Crashes (#27)


On the other side of the ideological, political and economic spectrum, the United States has been, all professed good-intentions aside, extremely damaging to the international geopolitical and economic stability. Its heavy-handed, incredibly sloppy and disastrous interventions in the Middle East has destroyed entire countries and regimes, cost hundreds of thousands of civilian lives and seriously destabilized the entire area. Today, there is more war, terrorism, lack of security, lack of human rights or proper governance than ever before. It’s embarrassingly hypocritical slogans of the export of “democracy, equality and human rights” etc. has left a swath of troubled and strife torn countries from Afghanistan to Iraq to Syria to Libya, whose innocent citizens are left to deal with the God-awful mess of ungoverned countries and sectarian/terrorist dominated violence. Those of us who believe in the genuine values of democracy, equality and human rights, are deeply disappointed in the performance of the sole ‘Super-power’ as it “policed” the World. While not all the problems can be attributed to the U.S. interventions, yet it had a large part to play in the mess the Middle East is today.

We are also deeply disappointed in the performance of the US when it comes to it the being the bastion of honest, ethical capitalistic values. Its performance on that front over the past decades has given the not-so-capitalist World enough ammo to jeer and sneer at the so called capitalist system. Bluntly put, the American capitalist economic system and values have been hijacked by rampant greed and extreme unethical behavior of its financial community, powerful elite and selfish vested interests and lobbyists. Over the past two decades, the expose of fraudulent, deceitful and criminal behavior of its political, banking, financial and business individuals and institutions has been stunning. It is not that this sort of thing does not happen anywhere else, in fact it almost routine in other parts of the World, but we hold the American system to a much higher standard - because they profess loudly to the World to do so themselves. Now that America exposes feet-of clay, it is very disappointing and dangerous to the rest of the World.

Apart from having spawned fraudulent and reckless behavior in its own asset and financial markets through increasing deregulation, excess liquidity and greed, it exported vast quantities of toxic assets to foreign markets, creating waves of destabilizing crashes, volatility and insolvencies. Its sub-prime credit shenanigans along with all the other toxic financial instruments created to leverage returns and fees almost limitlessly, through packaging and repackaging, for all intents and purposes broke the global financial system, which after over $57 Trillion dollars being injected into it, is still is not quite fixed. Not only is it not fixed but it has turned into a new type of reality which is detached from all known models and past economic realities. The only ‘old thing’ this new reality is doing is creating an enormous global bubble in debt, equity and real estate markets that once again threatens the global financial and economic system.

The Federal Reserve led and set the pace for the rest of the Central Banks, particularly in the advanced economies, in opening the spigots of excessive quantitative easing and extreme interest rate suppression. The pseudo recovery in the US is encouraging other countries and economic zones to adopt the ‘Fed Model’, as their own condition continues to worsen, even though the supposed architect of the successful model of ever expanding liquidity coupled with increasing deregulation, former Federal Reserve Chair, Alan Greenspan, has been busy discrediting it and acknowledging the harm it has caused and is about to cause yet again. Now, after all the Trillions spent the questionable ‘recovery’, if any’ is fragile, tenuous and generally reversing. But the stock and bond markets along with the US dollar have been unstoppable as they shrug off all manner of national and international stream of bad, and at times, alarming bad news and totally ignore fundamental economic realities.

The first Chart below shows the stock market ignoring developments such as the end of QE3, deteriorating ‘Macro’ economic data, and even dramatically declining ‘Forward Earnings’. With the markets ignoring all negative news that in normal times would have caused retrenchment, or at the very least – hesitation - today’s markets just keep going. The effect of the policy of excess liquidity in the form of QE and zero rates has been to create an unstoppable stock market, and an unprecedented enriching of the top 10% (2nd Chart) while the majority 90% lose ground.

Source: 1st Chart: ZeroHedge; 2nd Chart: Pavlina R/Picketty/Saez Data NBER

The American profligate spending recently, and over the past decades, and its current gravity-defying, levitating financial markets pose a serious threat to its economy, and hence to the global economy. The day its markets correct, they will take down the global markets far more dramatically than after the 2008 crash. This seeming invincibility of the US currency and financial markets, along with a seeming recovery, has greatly emboldened other Central Banks to follow suit and hit every recurring sag, in economic performance with greater doses of liquidity. The fact that the economies aren’t recovering and are requiring deep structural changes is being ignored, as that would be painful, and could exact a price from the ruling class.

The low unemployment numbers achieved by the US do not reflect the steadily declining rate of labor participation (Chart below), nor do they reflect the poorer quality of jobs being the mainstay of the current improving unemployment numbers, nor do they indicate the declining and stagnant compensation for all workers over the past decades.

This reality of the ‘much worse off’ majority - coupled with the loss of wealth and equity of the average person, in the crash of 2008, has resulted in home ownership in the United States being pushed back to pre-1995 levels.

Middle class America that built the wealth and economic might of America have lost serious ground, with their incomes declining or stagnating at best, and their household wealth having fallen by almost 41% since 2008 (Chart below).

The top 10%, while enriched incredibly in the past 6 years - do not the American economy make; nor do the stock or bond markets; which also have soared to record highs. They reflect, to a degree, the underlying wealth of the general economy. But in this case (post 2008), the incredible growth in wealth, as denoted by the rise of the top 10% and the financial markets, is directly due to the flood of cheap money pushed into the markets by the Federal Reserve in the past 6 years, and certainly not due to the growth in productivity in the economy, or any other economic fundamentals. Yes, there has been an improvement in the growth of the economy, but it was at the cost of more than $4.0 Trillion being printed and pushed out by the Federal Reserve, most of which didn’t go into the economy. Our steadfast contention has been that the American economy never did recover, and any signs of health are primarily due to an extraordinary intervention by the Fed to inflate it, at great future expense. Having said that, in our previous Reports we had identified the US economy as one of the few that would show growth, and it has. But from here on out, while most analysts and economists expect strong on-going recovery we expect retrenchment. As mentioned above, we expect all the negatives in the current global economic structure and the retrenchment in most of the major global economies to act as a drag on the US economy in spite of the fact the Fed cannot afford to raise interest rates.

In an increasingly unstable and dangerous global geopolitical environment, the wealth, military power and relative stability of the US economy, has acted as a magnet to capital fleeing the more dangerous or unstable places, thus helping to drive up the dollar, asset prices in real estate, and stock and bond markets, beyond the prolonged active inflating by the Fed. This is where we feel the greatest danger now lies, in the inflated values of the asset markets in a volatile and increasingly unstable global environment. The current situation makes the possibility of a major correction sometime this year almost a certainty and the avoidance of one a miracle. Yet at times miracles have known to have happened. The United States of today may be known as ‘the cleanest shirt in a basket of dirty laundry’, but we over the past few years have not seen it as such. We see too much dirt of its own to differentiate it much from most of the others in deep trouble. The Federal Reserve white wash has not washed much with us.

There are a number of other major economies that could be covered in greater detail but the economies covered above, in our estimation pose the greatest risks for the global economic system today. So briefly:

Australia is on the edge of the precipice for having bet heavily on a deflating China; while Canada’s resource rich economy is also beginning to unravel as commodities markets worldwide face a prolonged slump. In anticipation of an eroding global environment, the Bank of Canada has already started cutting its historically low interest rates further, in the forlorn hope of avoiding a serious slowdown. Unfortunately as a major export nation Canada is always seriously exposed, particularly to the US, and to the rest of the external economic environment, and at this time that external environment is looking really bleak.

The U.K. which posted positive growth numbers last year, along with the US, is also going to be sucked into the spinning vortex of the economic negativity created by all of the crumbing economies named above, and will therefore deteriorate over this year.

Most of the rest of Asia (China already covered above) is generally going to grow, including India, but the entire area is increasingly vulnerable to the continuing deflating western demand on the export front, and the strengthening US dollar on the financial front, even as the resulting collapse in commodities is helping the energy and resource importing economies for now. But the receding tide of contracting global demand, increasing export competition leading to continuing currency devaluations, and the threat of US dollar flight back to the US may still drag them backwards and into shallower economic growth rates.

Last year we foresaw a ‘Looming Catastrophe’ in the making. Well here it is, with enough geopolitical conflicts, asset and debt bubble threats, and violent volatility in play, to satisfy the most ardent dooms-dayers, and give commentators and analysts more material to discuss and pontificate on, on a daily basis, than they could possibly have hoped for. Practically, every single day some geopolitical-economic bad news explodes on to the global stage, and is shrugged off, because now the global financial markets have bought into the fact that the Central Banks are the global economy, and this state of constant injections of stimulus is the ‘new normal’, and it won’t change, because it can’t, because governments and their Central Banks won’t let it. A surprise awaits those with such faith in governments and Central Banks.

Behind the current disturbing kaleidoscope of events and developments, is a larger looming catastrophe of truly worrisome proportions, as the three realities of asset and debt bubbles, persistent global economic stagnation, and geopolitical conflicts spin ever closer to one another, till the day they intertwine and become a marauding global monster of falling markets, sharply contracting economies, conflicts, global political fragmentation, and protracted global deleveraging and restructuring.

As we survey the current global economic reality, it is starkly clear that Quantitative Easing (QE) in all its excessive glory has failed miserably these past six years, to bring about any semblance of sustainable economic recovery. We had been steadfast in our contention all along that overly prolonged stimulus would not bring about economic recovery but in fact would be counterproductive, and after a point become the problem itself. That point was long reached in the global economies, and today (beginning of 2015), none of the major economies are able to stand on their own feet without their respective Central Bank’s constant, active, and at times excessive support, either by cash stimulus or through extreme historic low rates, or both; not Europe, not China, Japan, all the others, not even the US economy. And thus the global debt continues to climb as Central Banks keep propping up the shaky and retrenching economies, particularly since 2008.

The growth in debt in of itself would not be such a problem if it produced measurable economic value at a rate greater than the rate of its own growth. But as we see in the Chart on the following page, the global GDP rate (69%) which is the blunt instrument of value creation, is substantially lower than the growth rate of the global debt growth rate (103%).That growing and accumulating debt ‘overhang’ (Japan and Europe have dramatically ramped up recently) and the net deficit in productivity and value, will have to be paid sometime in the future, and it is a fast growing bill.

As global governments increasingly encumber themselves under mountains of debt, a greater percentage of their future GDP will be used to just try and service that debt. That is why they must have inflation and extremely low interest rates - otherwise the cost of servicing the debt becomes too high.

What a quandary the Central Banks of major economies have created for themselves and everyone else, an economic environment based on steadily climbing unprecedented amounts of debt, where they cannot afford to raise interest rates, or to stop quantitative easing, doing either risks a collapse.

For governments and Central Banks to keep going with the quantitative easing is to substantially increase risk as relatively unproductive money floods the financial system, increases debt and feeds the speculative bubbles in the asset markets that have no economic foundation under them. It is all starting to resemble the scene from one of the Indiana Jones movie where he is frantically running in-front of the giant round boulder that is rolling towards him and threatening to crush him (the boulder being the economic/financial catastrophe that has been created to-date, and the Central Banks and their governments being the running Indiana Jones trying to outrun it).

This current economic aberration has so distorted the normal market forces that we cannot blame anyone for feeling that we are in some sort of a surreal movie environment, where reality is permanently suspended and everything in the end is going to be alright. Unfortunately, everything is not going to be alright as the current global economic status and data shows. It’s an unmitigated disaster, being compounded by the very practices that caused it in the first place. All the unlimited printing of money by the Central Banks is doing, is making the rolling rock bigger and faster.

After being proven right in our anticipation of a ‘non-recovery’ to-date, we remain skeptical of a global economic rebound in 2015 for the same reasons as before. We believe global overcapacity coupled with low global consumer demand is the real problem, and is going to remain a problem as modernization in the advanced and emerging markets, coupled with global technological advances (higher efficiencies - robotics) continue to increase per capita productivity, thus further exacerbating the over capacity problem globally.

Furthermore, the integrated global economies, in what now seems to be the former golden days of inter-dependent and expanding global trade, have developed into antagonistic, competing, disparate, self serving opponents rather than the collectively supporting allies that everyone had hoped for, a couple of decades ago. The age of narrowing interests driven by the fight to survive at the cost of other economies is here (the age of beggar thy neighbor). The weapons of this particular type of warfare are the Central Bank printing presses and the drive for lower interest rates to debase currencies and support speculation in their respective asset markets.

It has been our contention that methods employed so far by governments and Central Banks will not work because they overwhelmingly favor the already privileged and the wealthy 1% to 10%, create potentially dangerous asset and debt market bubbles, and the hoped for trickle-down effect to the masses does not materialize, and is an imperfect, clumsy, and agonizingly slow process which has proven ineffective in combating the tri-part impact of over capacity of the global economies, the indebtedness of the consumer and the resulting lack of consumption demand since the 2008 crash.

It’s not surprising that global growth is under-performing, but it is problematic that it is under-performing after global stimulus of about $57 Trillion has been already spent over six years, trying to make it perform!

Additionally, with the absence of any real stable recovery, or the return to a pre-2008 ‘normal economic environment’, without the need for abnormal interest rate suppression, and the extraordinary injections of financial stimulus, and the weak job markets, the global consumer has no confidence to go out and spend, particularly when most of the them have not been the recipients of the near free cash that has been flowing by the Trillions from the Central Banks into the Banks, without directly benefiting the personal financial condition of the majority of consumers, which for most remains highly uncertain and stressed.

As we don’t see a return to a robust demand by the global consumers any time soon, we do not see any chance of a sustainable recovery this year, but we do see a real likelihood of all things getting worse. The problem areas that are going to contribute to the growing threat of a disaster are the ‘Greek problem’, the ‘Russia/Ukraine problem’, the ‘Contracting China problem’, the ‘Irrational Exuberance in the US problem’, and the ‘Excessive Global Debt problem’.

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