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The End Of The Bubble Finance Era
Submitted by David Stockman via The Daily Reckoning blog,
We are nearing a crucial inflection point in the worldwide bubble finance cycle that has been underway for more than two decades. To wit, the world’s central banks have finally run out of dry powder. They will be unable to stop the credit implosion which must inexorably follow the false boom.
We will get to the Fed’s upcoming once in a lifetime shift to raising rates below, but first it is crucial to sketch the global macroeconomic context.
In a word, we are now entering an epic deflation. Its leading edge is manifested in the renewed carnage in the commodity pits.
This week the Bloomberg commodity index, which encompasses everything from crude oil to soybeans, copper, nickel, cotton and livestock, plunged below 80 for the first time since 1999. It is now down nearly 70% from its all-time high on the eve of the financial crisis, and 55% from its 2011 recovery high.
Wall Street bulls and Keynesian apologists for the Fed want you to believe that there isn’t much to see here. They claim it’s just a temporary oil glut and some CapEx over-exuberance in the metals and mining industry.
But their assurances that in a year or so current excess supplies of copper, crude, iron ore and other commodities will be absorbed by an expanding global economy couldn’t be farther from the truth. In fact, this error is at the heart of my investment viewpoint.
We believe the global economy is vastly bloated with debt-based spending that can’t be sustained. And that this distortion is compounded on the supply side by an incredible surplus of excess production capacity. As well as wasteful malinvestments that were enabled by dirt cheap central bank credit.
Consequently, the world economy is actually going to shrink for the first time since the 1930s. That’s because the plunging price of commodities is only a prelude to what will amount to a worldwide CapEx depression — the kind of thing that has not happened since the 1930s.
There has been so much over-investment in energy, mining, materials processing, manufacturing and warehousing that nothing new will be built for years to come. The boom of the last two decades essentially stole output from many years into the future.
So there will be a severe curtailment in the production of mining and construction equipment, oilfield drilling rigs, heavy trucks and rail cars, bulk carriers and containerships, materials handling machinery and warehouse rigging, machine tools and chemical processing equipment and much, much more.
The crucial point, however, is that sharp curtailment of the capital goods industries has far more destructive implications for the macro-economy than a reduction in consumer appliance sales or restaurant and bar tabs.
Service operations have virtually no working inventories and the supply chains for durable consumer goods such as dishwashers and cars typically have perhaps 50 to 100 days of stocks on hand. So when excessive inventory investments accumulate, the destocking and resulting supply chain curtailments are relatively short-lived.
But when it comes to capital goods the relevant inventory measure is capacity in place. That’s where the bubble finance policies of the Fed and other central banks have done so much damage.
Prolonged periods of below market capital costs induce business customers to drastically over-estimate investment returns. And therefore to eventually accumulate years and years worth of excess capacity.
This is very different than your grandfather’s consumer goods recessions of the 1950s and 1960s. Those typically involved moderate production cutbacks and several quarters of inventory destocking. But this time the capital goods adjustment will take years, perhaps more than a decade.
Here’s why.
When iron ore mines are drastically overbuilt, for example, new orders for Caterpillars’ (CAT) big yellow mining machines can drop to nearly zero. That’s why CAT is already in the longest string of dealer sales declines — 35 straight months and running — in its 100 year history.
That’s also why the coming global recession will be so prolonged and stubborn. When cheap credit generates a boom in long-lived and expensive capital goods, it gives rise to a pipeline of new capacity.
This pipeline is not easy to shut-off and often makes sense to complete — say containerships, steel plants or new field mines — even if pricing and profitability have already headed south. That’s known as the sunk cost problem.
Mining equipment orders are likely to remain deeply depressed for the rest of the decade. And this syndrome will be repeated in most other sectors such as heavy trucks, shipyards, oil drilling equipment etc.
This depression in the capital goods industries, in turn, means the disappearance of thousands of typically high pay, high skill jobs at companies like Caterpillar. The same will happen among their extensive chains of outsourced components, materials and service suppliers. And the cascade of those contractions down the economy’s food chain will further intensify and extend the deflationary dynamic.
The graph below give some hint of the massive downturn which lies ahead on a worldwide basis.
During the last 25 years CapEx spending by the publicly listed companies of the world grew by an incredible 500%. Much of this happened in China and the Emerging Market (EM) economies, and in the transportation and distribution infrastructure that connects them.
Yet this massive explosion of investment spending didn’t happen because several billion Asian peasants suddenly decided to save-up a storm of new capital.
Instead, this unprecedented construction and CapEx campaign was financed almost entirely by a massive issuance of printing press credit at virtually zero real interest rates.
That means capital was drastically underpriced and that waste, excess and inefficiency abounded.
At length, the global economy became dangerously unbalanced. And these adverse consequences of the false central bank credit boom, in fact, highlight the investment opportunity ahead.
Healthy capitalist investment based on market prices and savings set aside from current income can go on indefinitely, fueling rising efficiency, output and wealth.
But CapEx based on printing press credit only temporarily enabled the world economy to have its cake and eat it, too. Now it’s payback time.
Needless to say, during the expansion phase of central bank enabled bubble finance, optimism reigns and bulls and speculators insist that “this time is different.”
Yet the laws of sound finance and market economics never change. It often just takes an extended time for all the excesses to work their way through the system and finally reach the blow-off stage.
The graph below summarizes this great deformation.
Over the last two decades, global credit market debt outstanding has soared from $40 trillion to $225 trillion. This represents an incredible $185 trillion debt expansion. That eruption would be simply unimaginable without the help of money printing central banks.
By contrast, global GDP only expanded by $50 billion during the same period, and even that’s an overstatement. Much of that reported gain merely represented the one-time pass-through of fiat credit, not real savings put to work in efficient production.
Consequently, it is likely that the global economy accumulated more than $4 of new debt for every $1 of incremental GDP.
Not only is that self-evidently an unsustainable financial equation, it also means that when credit growth stops, the bottom will drop out of reported GDP. It wasn’t new wealth in the first place, just production stolen from the future.
And this gets us to the Fed’s upcoming move to raise interest rates for the first time in 10 years. It will amount to a sea-change that in due course will shatter the entire regime of bubble finance that gave rise to the false credit and CapEx boom depicted above.
As I have often said, the Fed has become addicted to the “Easy Button.” During more than 80% of the 300+ months during the last quarter century it has either cut rates or left them unchanged.
Accordingly, the professional gamblers in today’s Wall Street casino have no real experience of a time when the “Fed is your friend” adage failed to work. They have experienced essentially false one-way markets, knowing that the Greenspan/Bernanke/Yellen “put” under stocks and other risks assets would come to the rescue.
But here’s the thing. After 84 months of zero interest rates — and folks that’s pure lunacy by all historic standards — the Fed has run out of time and excuses.
If it doesn’t begin to normalize rates at last, and as repeatedly promised, its credibility will be shattered. And what it long has been deathly afraid of will happen. That is, the market will plunge into a hissy fit that will shatter confidence in what is essentially a giant credit-based Ponzi.
And the other major central banks of the world are in the same boat.
Just last week we saw the ECB stopped short by its powerful Germany contingent that essentially said to Draghi that $1.3 trillion of money printing is enough.
Likewise, the People’s Bank of China (PBOC) has run out of dry powder, too. And that’s of monumental importance.
The epicenter of the global commodity, industrial and CapEx boom was in China. Thanks to the greatest money printing spree by the PBOC in recorded history, outstanding public and private debt there has exploded from $500 billion in 1994 to $30 trillion at present.
That’s a 60-fold gain. Is it any wonder that the commodity and CapEx charts shown above went nearly vertical during the peak of the global boom?
But now China is facing the collapse of its credit Ponzi, and capital is fleeing the country at a prodigious pace.
In the last 15 months alone, nearly $1 trillion has high tailed it for London, New York, Australia, Vancouver and other resting places for flight capital.
So the PBOC is being forced to stop its printing presses in order to prevent the Yuan exchange rate from collapsing and the capital outflow from getting totally out of hand.
Even in Japan, the Bank of Japan’s printing press is no longer accelerating. That because notwithstanding trillions of new money conjured from thin air during recent years, Japan is on the verge of its 5th recession in seven years. Even in Japan, bubble finance is losing its credibility.
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Got my bag of popcorn out...watching and munching away.
Welfare class sure to uprise....moar free stuff or we hang the bankers.
The welfare class has the government doing their dirty work of extortion, it is you who will have to revolt. They will cause a political shit storm and the government will then cause a real shit storm for producers.
The fed is far from out of bullets, they have plenty of bullets left, but that won't matter if the gun blows up in their face.
Something went terribly wrong in Ukraine, also
http://thesaker.is/ukraine-sitrep-december-13th-2015-by-scott/
I always chuckle when I hear someone say the Fed has to raise rates soon or they lose their credibility. So 7 years of QE/ZIRP all the while telling everybody how awesome everything is remains credible?
The Fed has credibility in the MSM and therefore main street. It will be fun to watch this change occur.
Good....lets get this fucker on.
You know I have been hearing how everything for the past 5 years was going to go into Hyperiflation. All evendence has been Stagflation. So it seems like the surfs are realizing this now, after bashing any of the economist that have said it will be deflation over the past 5 years. Kind of like the global warming thing. Bash all the nay sayers yet NASA has said the temps have not gone up for 16 years now? And the ice is coming back in force?
Life in the world is mainly Lies and deception. Yes Virgina, there is a Devil.
Hyperinflation continues in the Auckland housing/rental market. And petrol prices are stuck at around $1.90 a litre despite the crude oil deflation. Food prices at the market continue to rise. When do we get a deflation in the things we need?
Don't know what the NZ/USD exchange rate is, but it sounds like you are getting the Order of the Purple Shaft with pineapple clusters. I paid $1.73 a US gallon yesterday. So I might suggest that some of the problem lies with government policies designed to encourage or discourage some sort of behavior as much as it does with Arab rapacity.
As for deflation, you are getting plenty of it-- in the buying power of your local currency. And all done deliberately to maintain "competitiveness".
Deflation will provoke a reaction. Politicians will not accept serious deflation.
The pain ahead I believe will be far greater than any of us imagine it to be.
By the time real interest rates assert themselves on market participants
By the time excess capacity is shelved or scrapped
By the time that ponzi like asset values deflate
By the time unserviceable and unrepayable debt is written off
By the time governments start to pay real inteest on ballooning debt
By the time the welfare state wakes up to its arithmetic and structural incapabilities
By the time we wake up to the damage done to the propspects of the next generation
By the time the US is weened off its geopolitical aspirations and machinations
Well by that time we will have run out of time.
There will be a generation of dislocations, violent jerks and reactions that wil be beyond our full comprehension and control.
Nothing will be as we know it today and the only thing that will be crossing our minds will be the question "what were we all thinking."
So what are you doing in advance of this event?
Getting rid of debt
Buying gold
Reducing unnecessary private expenditures
Preaching to my children and friends like never before.
Praying as always
bravo !
As someone who nearly got a full swirly out of the 2008 construction collapse and had to live on the stuff I'd set aside, here is what I learned from it:
1) Food. Real food, not bags of rice and beans. I had tons of that stuff and NEVER used it even though I was practically starving. Candy. Caffeine. Canned meats. MREs. Mountain House (but no other freeze dried-- which all tastes like homemade shit while you could serve a lot of MH entrees in restaurants). You'll go mad for pizza or tacos and the stuff you normally eat. So build up your pile of it.
2) Gas. What can I say about gas? I can say that at times I made it into town in my trusty old 64 GMC because it would run on a combination of rotten gas out of lawnmowers and junk cars mixed with vodka and coleman fuel. You can never have enough gas.
3) Electricity. Just for fun, shut off the main breaker on your house next Saturday and see how long you can hold out. Get a generator. Then go get a real generator that isn't some dinky piece of shit from China. Drop by the local rental yard and see which brand they use. But don't buy one from them because it will be crapped out after hundreds of hours of use.
4) Other sources of light and heat. Kerosene or oil lamps, stuff like that. A woodburning stove or fireplace and a real chainsaw.
As long as you have these things, you won't be getting into your stash of gold, silver, or currency. If you do, you're just going to trade it in for these things anyhow. The same thing goes for masses of guns and other exotic toys. I ended up with one gun, tons of ammo, and a lot of fine weaponry that I sold at the bottom of the market just to put gas in the truck and Taco Bell in the belly. You need food, gas, and electricity a lot more than you need overkill on firearms and ammo or piles of bullion. I sold all mine, generally at a loss, one piece at a time just to live. It helped but it was also very sad and humiliating.
One final piece of advice. The impulse in any crisis is to hold the fort and wait for better days. If I'd given up and sold out early, I would have been better positioned to get something going somewhere else. Eventually, you get to the point where you can do nothing but hold out and wait for the inevitable knock on the door. There are times and places when bailing out early is the better option compared to starting over with all your assets burned up in a doomed attempt to hang on.
May God run with you all
I cannot see how any bond from any nationstate can have any value, They can never be repaid, and investors have stopped buying new bonds, so it is all fiat $ from here on our. Now rollover of the national debts everywhere will be fiat, QE x 5.
Inflation, from the gov's POV, should be short and sharp. Reduce the value of existing debt to near-zero, buy it back with a revalued- and gold-linked dollar, begin the ponzi again, while SS and retirees on pensions starve.
Which is why the CBs of the world have been purchasing bonds from investors as a QE and 'stability' mechanism.
"I cannot see how any bond from any nationstate can have any value, They can never be repaid, and investors have stopped buying new bonds, so it is all fiat $ from here on our. Now rollover of the national debts everywhere will be fiat, QE x 5."
You nailed it. The question is 'when will the larger market realize and admint that none of this will ever be repaid?'. This realization will happen, but when?
And when it does happen, 95% of pensions will go to zero because if your bonds drop to nothing, what's the point of paying interest?
Oh dear, oh dear, oh dear.
i have no idea what that will look like.
Squid
In-between this pain you speak of and getting across the creek to the other side, there will have been plenty of time for 'political dissension' camps - of which, a large percentage of posters right here will either be permanent residents of, or 'wanted' both.
Perhaps we should work out some sort of secret recognition signal in advance-- like the nose rub from The Sting.
"In a word, we are now entering an epic deflation."
No, we've already been in one now - for how many months/years...? And when the Fed is forced to again purchase assets, that 'deflation' in commdodities will vanish like the tide, before the tsunami of currency again floods the market, and people again look to put their money in Real Things.
"Likewise, the People’s Bank of China (PBOC) has run out of dry powder, too. And that’s of monumental importance."
They have...? What then explains why they are still expanding influence all over the globe for resource opportunities, not to mention the plans they have for the new Silk Road? Also, we don't know for certain, precisely how much 'dry powder' China has left, but if one were to substitue the term 'dry powder' for physical gold, the current global dynamic takes on an entirely different perspective. One that China is all too aware of and is simply waiting for the opportune time to deploy.
Next up, a fleet of helicopters. Too much capacity = print & give directly to consumers,
I count 452 "End of ...." articles on Zero Hedge since 2009.
When will one of them actually come true?
What no one is talking about is the bubble that was blown in population growth.
The 30s taught us the the sever dampening effect of deflation on population.
The globalists want everyone to believe that population is inevitably going from the current 7.5B to 9B by 2025.
We probably see a decline to 3.5B as the great deflationary culling kills off nearly half the bubble masses.
It's certainly going to be a great shock when the public finds out about the criminal globalists behind the curtain that have brought us all this destruction and fraud.
That bubble in population growth was responsible for the tech-driven society that we have. The one that allows TPTB to dream of global domination.
Take that number down significantly, and all those toys start to go away. The high-tech world requires elevated population levels, both to man all the delicate supply-chains, and more importantly, to get to the density required for innovation to take off. We settle into a pre-industrial way of life for most, with a few wealthier areas that still retain a few of the perks we remember.
Since the only way TPTB have to attain their goal is to destroy the foundations of the system that gives them the power to even think of it, it is a self-defeating goal.
Without the tech, you lose all control, and have to depend on brute force alone. Cut the global population by the amounts you are talking about, and we all go back to the farm, full-time. No cell phones, no Internet as we know it, no 'smart cars', 'smart phones', 'smart appliances'...Your refrigerator won't be calling the manufacturer to alert them to anything...your refrigerator will be a deeply-dug pit in your backyard where you store the surplus turnips and potatoes.
Your 'smart cars' will be assembled from whatever parts are on hand, and drivers will be fueling the engines with everything from scavenged gas and diesel, vegetable oil, burning wood, whatever will ignite. Getting a seat on one of the few airplanes still flying will be like getting a seat on the space shuttle today...not for you, that's for sure.
You can't have the tech without the numbers. Crash the global population, and TPTB will be digging for turnips right alongside you. Eventually they will revert to form and try to seize local power like barons in the Dark Ages, but they won't be using any 'Deep State' tactics, they'll just send some thugs to hack you up with machetes or something.
Same as it ever was.
Let us hope that marginal revenue is actually greater than marginal cost in future production.
Although I agree with the article these analysis are overstated by comparing balance sheet debt and income statement gdp. Debt is up 180T and gdp up "only" $50T. But that $50t is generated every year.
Again Inlike ZH because I mostly agree with these articles and where the global economy is heading but this point keeps being repeated.