Global Economy

It would appear that between the historical revisions of over-optimistic initial prints in macro data in the last few months and the reality of the weakness in Europe; the global economy is in Slowdown. Goldman's Swirlogram has now seen its Global Leading Indicator in the 'slowdown' phase for two months as momentum fades rapidly and seven of the ten major factors in the index declining with Global (Aggregate) PMI, and Global New Orders-less-Inventories worsening. Quite comically, the three factors providing some positivity are the Baltic Dry Index (which we are told is irrelevant when it drops), Japanese Inventory/Sales (which improved but remains at depression-era levels), and US initial jobless claims (which have become a farce statistically from what we can tell). Of course, none of this macro reality matters for now - until it does that is.

We have shown the endless hockey-stick-like charts of hope that are the coming margin expansion, dramatic earnings growth, and revenue increases (all juxtaposed against the reality of a labor-destroying cost-cutting and growth-disabled global economy) but perhaps nowhere is the 'hope' in the US more evident when compared to the rest of the world. Around the world, analysts and strategists are comfortable marking down expectations for British, European, Asian, and Emerging Market nations but not the good ol' USofA. We cannot help but believe that while momentum in US equity markets dominates all sense and rationality, it would appear the US will struggle to realize these 'hopeful' expectations if the rest of the world is collapsing... unless of course, Mars does indeed start importing Fords and GMs.

In one of a few early hints that Europe might surprise the world with its Cyprus bailout, on February 10th the Financial Times leaked the content of a secret EU memo. It reported that bank depositor haircuts were among three options being considered to reduce bailout costs. And the memo also warned ominously that “such drastic action could restart contagion in eurozone financial markets.” Clearly, policymakers decided to take their chances. And now we’re living through the contagion that the memo’s authors predicted. But what exactly does that mean? Sure, we can see volatility in asset prices, but how long will it last? Some pundits say it’ll blow over like a late afternoon shower on an otherwise sunny day. I disagree. I’ll suggest there’s more to it than rising market volatility and that we should take a closer look at the meaning of contagion. I’ll argue there are three different types at work today: vanilla contagion, latent contagion and stealth contagion. And when you add up the three effects, Cyprus will have a bigger global impact than many expect.

We cautioned readers in 2011 that in a broke world in which the ridiculously named "muddle-through" has miserably failed, a global wealth tax seeking to expropriate some 30% of all financial assets is coming. Few took it seriously, and why should they - after all the market has been blissfully rising before and ever since then, which implies everything was ok, right? Wrong, as those who are lining up right now in the Cyprus late of night not to buy a shiny new iTrinket, but to access a measly €300 of their own money would promptly admit. Naturally, if more of our Cypriot readers had paid attention, they would have far more of their own money at their disposal right now, instead of having to beg Merkel's emissaries for a €300 handout tomorrow. Now, a year and a half later, the realization that the global wealth tax is not only coming but is inevitable in practically every developed country, is finally sinking in, as this interview with Marc Faber confirms: "Until now, the bailouts in Europe and the U.S. were at the expense of the taxpayer. And from now onwards, in my view, the bailouts will also be at the expense of the asset holders, the well-to-do people. So if you have money I am sure the governments will one day take away 20-30% of my wealth."

He is correct, but probably optimstic.

What once was a distant noise is now ringing loudly through the streets of Europe. The pain of Cyprus is being felt throughout the Euro-Zone as their inability to curb the current crises is wreaking havoc on the value of the Euro.

If we shed our fixation with the Fed and look at global supply and demand, we get a clearer understanding of the tailwinds driving the U.S. dollar higher. I know this is as welcome in many circles as a flashbang tossed on the table in a swank dinner party, but the U.S. dollar is going a lot higher over the next few years. In a very real sense, every currency is a claim not on the issuing central bank's balance sheet but on the entire economy of the issuing nation. All this leads to two powerful tailwinds to the value of the dollar. One is simply supply and demand: as the global economy slides into recession, trade volumes decline, and the U.S. deficit shrinks. (It's already $250 billion less than was "exported" in 2006.) That will leave fewer dollars available on the global market. The second tailwind is the demand for dollars from those exiting the euro and yen. The abandonment of the euro is already visible in these charts.

This divergence between the global economy and the US, Europe, and Japan is really just the difference between the money printers and those that devalue their currency and everybody else.

This is what the world's "smartest" economist is calling for.

Why is the global economy in so much trouble?  How can so many people be so absolutely certain that the world financial system is going to crash?  Well, the truth is that when you take a look at the cold, hard numbers it is not difficult to see why the global financial pyramid scheme is destined to fail.  In the United States today, there is approximately 56 trillion dollars of total debt in our financial system, but there is only about 9 trillion dollars in our bank accounts.  So you could take every single penny out of the banks, multiply it by six, and you still would not have enough money to pay off all of our debts. Overall, there is about 190 trillion dollars of total debt on the planet.  But global GDP is only about 70 trillion dollars.  And the total notional value of all derivatives around the globe is somewhere between 600 trillion and 1500 trillion dollars.  So we have a gigantic problem on our hands.  The global financial system is a very shaky house of cards that has been constructed on a foundation of debt, leverage and incredibly risky derivatives.

For a while there, one might have been forgiven for believing that all was going to be well; that the recovery was V-shaped and the new-normal was nothing but the old-normal and Goldilocks would reappear. It appears, however, that the central bank lipstick slapped on the deflationary pig of the over-levered global economy is starting to wear off. As the following 4 charts show, things are not as 'recovering' as many hoped (and still hope).

If you don’t collapse the system, the system will collapse you.

These photos illustrate the fundamentally arbitrary nature of fiat (paper) money. Why do we prefer the $100 greenback over the $100 trillion note issued by the Reserve Bank of Zimbabwe? The purchasing power of the Benjamin far exceeds the purchasing power of the $100 trillion bill. But the Benjamin is not immune to inflation; the dollar has lost about 95% of its 1900 purchasing power.  If 95% of households are experiencing a loss of purchasing power and most of the new money and credit are flowing to the top 5%, you get asset bubbles, not demand-driven inflation. When 95% of the households are poorer in terms of purchasing power and financial wealth, where can demand-driven inflation arise in a global economy of massive manufacturing and labor over-capacity? The rise in costs within industries controlled by cartels (healthcare, higher education, defense, etc.) may look like demand-driven inflation, but are actually transfers of wealth and purchasing power from households to the government-protected cartels.

We all know what's supposed to happen in the global economy: we get more of everything: more stuff manufactured, more coal dug up and burned, more "aggregate demand" i.e. insatiable desire for more of everything, more innovation, more wealth, more money printed, more debt taken on to buy more stuff and more education, more tourists occupying more beaches sipping more drinks, more strip malls built, more airports expanded, more jobs created, more taxes collected-- more "growth" of everything, in every way and every day. But what if this baseline scenario doesn't appear and the center cannot hold, and the Status Quo devolves - there will be less of everything, not more, and a gradual but steady erosion of all "growth" baselines: fewer jobs, lower wages, fewer taxes collected, less profits, fewer retail outlets. In this case, printing more money and spewing more reassuring propaganda will no longer tamp down the crisis. Rather, the failure of these Status Quo responses will unleash an even more destabilizing crisis.

The Troika has run roughshod over the rule of law. By calling for a universal bail-in of depositors (the securest part of bank capital ladder) before extracting money from shareholders, junior and subordinated bondholders, the EU bureaucrats and IMF have unilaterally ripped up the legal framework for property rights. This is a truly worrying and frightening progression – actually regression – in economic freedom. Unfortunately bank depositors (savers) have long been under the misguided impression that they are potentially immune from a bank collapse, with the State providing a safety net in the form of deposit guarantees up to a declared sum.  I would argue that individuals, partly due to government propaganda in the good times, have long since forgotten – or indeed have never understood – that once you deposit your money into a bank, you give up your right to ownership, ie, It’s a LOAN! An asset which is lent out multiple times as is the agreed practice under fractional reserve banking, clearly has a risk of no return, albeit a seemingly a low risk when confidence and trust is high in the economic system... The bail-in announcement for the Cypriot banks late Friday night was one of those events when we all look back and think that was the beginning of the end of the real global financial crisis. This should leave any individual in Europe under no illusion that the political elite will enact whatever it deems fit to protect their positions in the name of the euro and their own positions of power.

Prior to yesterday, if you were trying to handicap how the unelected leaders of the Eurozone were going to react to a tough situation, you only had to refer to the quote "When it becomes serious, you have to lie" from Mr. Junker to understand their mindset. But so long as someone at the ECB was willing to flood the world with free EURs (with significant backup provided the US Federal Reserve) the market closed its eyes, held its breath and took the leap of faith that all was well. However, post the Cyprus decision, the curtain has been pulled back and wizard revealed with all his faults and warts. It would be hard to over-emphasize how significant the Cyprus situation is. The damage done here is not related to the size of the haircut - currently discussed between 3 and 13% - but rather that the legal language which each and every investor on the planet must rely on in order to maintain confidence in the system has been subordinated to the needs of the powerful elite.