Stagflation

My overriding theme and the central drama for the coming year is that unexpected events can take on greater importance as the Federal Reserve ends its near-decade-long Zero Interest Rate Policy. Consensus premises and forecasts will likely fall flat, in a rather spectacular manner. The low-conviction and directionless market that we saw in 2015 could become a no-conviction and very-much-directed market (i.e. one that's directed lower) in 2016. There will be no peace on earth in 2016, and our markets could lose a cushion of protection as valuations contract. (Just as "malinvestment" represented a key theme this year, we expect a compression of price-to-earnings ratios to serve as a big market driver in 2016.) In other words, we don't think 2016 will be fun.

"The trouble is that rents are running high not because house prices are booming and/or construction is sawing but because structurally new entrants to the housing market are renters not owners. This is reflected in the very low first time homebuyer rate, less than 30 percent."

Economists have put together models of how an economy works, but these models were developed years ago, when the world economy was far from limits. These models may have been reasonably adequate when they were developed, but there is increasing evidence that they don’t work in an economy that is reaching limits.

If you follow geopolitics, you might have noticed that many of the world’s emerging markets are beset with fractious political dynamics, violence, protests, and any number of other tail risks that could at any time mushroom into black swan events with ramifications for the developed world. As we head into 2016, it’s worth taking stock of the geopolitical events that have shaped EM in 2015 and it's also worth cataloguing what we know about the landscape for the coming year.

"At first read, the report recalls an obituary. There is no room for any growth in the coming quarters. The situation is really, really bad."

Last week's arrest of Latin America's most prominent investment banker sent shares of BTG Pactual plunging as investors pulled a third of their money from the firm's fixed income funds. As shocking as Andre Esteves' detention most assuredly was, analysts say the real risk may stem from the investigation into Rousseff's "guy" in the Senate, Delcidio Amaral, who was also detained last Wednesday. As Bloomberg reports, Amaral's "arrest not only delayed government efforts to resolve this year’s budget dispute, but it also dispelled a long-held belief that sitting lawmakers are all but untouchable because of a quirk in Brazilian law that affords politicians special treatment in criminal investigations." 

By now, everyone knows Brazil is stuck in a stagflationary nightmare that's made immeasurably worse by the country's seemingly intractable political crisis. But what about the rest of Latin America? Goldman takes a close look at the regional outlook for the next four years and finds a decidedly unfavorable growth-inflation mix. 

"Then tell me, future boy, who's President of Brazil in 2016? Then who's vice president?"

“Capitalism is not primarily an incentive system but an information system.” Prices are the information. And the price of time itself is the single most valuable piece of information. Time, as we intuitively know, is money; they are two sides of the same coin. Mess with time and money, and you mess with everything else. Yet as with central planning in general, the central planning of either money, or time, cannot possibly work. Hayek warned the economics profession of precisely this in the 1970s. They didn’t listen, ensconced as they still remain within their interventionist Keynesian paradigm. Well that paradigm is about to be blown apart, time and money are about to return to the market, where they belong, and real, sustainable economic progress is about to restart once again.

Governments and their central bank creations usurped market-based monetary and banking systems to serve the plundering purposes of kings, princes, parliaments, and special interest groups who all wanted to hold the magical hand of the monetary printing press. Print up money (or its digital substitutes and surrogates in more modern times) and you can have access to all the hard work of others without the reciprocal effort. The monetary social engineers' century-long legacy in the arena of money and banking has been the booms and busts of the business cycle. The time has come to end the tragic and disruptive reign of monetary central planning.

Heroic efforts are being made to cloak the stagnation of the U.S. economy. One of these is to shift the unemployed work force from the negative-sounding jobless category to the benign-sounding Not in the Labor Force (NILF) category. But re-labeling stagnation does not magically transform a stagnant economy. To get a sense of long-term stagnation, let's look at the data going back 38 years, to 1977.

It just keeps getting worse, and worse, and worse...

And just like that Weimar 2.0 is born.

The negative feedback look between Brazil's political and economic crises is serving to make each day worse than the last. Tuesday was no exception...

As of today you really can pay your taxes, your credit cards, your mortgage, shop at Costco, and buy your groceries without so much as a bank account while using sound money.