Global Economy

Booms powered by credit, new markets and speculation are followed by busts as night follows day. This creates a very difficult test for every nation-state facing the inevitable bust: how does the leadership deal with the end of the boom? As the world is about to learn once again, the "fix" may make the next bust even more destructive.

China as the global Bubble’s focal point – the weak link yet, at the same time, the key marginal source of Bubble finance. China’s policy course appears to focus on two facets: to stabilize the yuan versus the dollar and to resuscitate Credit expansion. For better than two decades, similar policy courses were followed by myriad EM policymakers in hopes of sustaining financial and economic booms. Many cases ended in abject failure – often spectacularly. Why? Because when officials resort to such measures to sustain faltering Bubbles it generally works to only exacerbate systemic fragilities. For one, late-stage reflationary measures compound Credit system vulnerability while compounding structural impairment to the real economy. Secondly, central bank and banking system Credit-bolstering measures create liquidity that invariably feeds destabilizing “capital” and “hot money” outflows.

The talking heads were busy this week powdering the GDP pig. By averaging up the “disappointing” 1.5% gain for Q3 with the previous quarter they were able to pronounce that the economy is moving forward at an “encouraging” 2% clip. And once we get through this quarter’s big negative inventory adjustment, they insisted, we will be off to the ‘escape velocity’ races. Again. No we won’t! The global economy is in an epochal deflationary swoon and the US economy has already hit stall speed. It is only a matter of months before this long-in-the-tooth 75-month old business expansion will rollover into outright liquidation of excess inventories and hoarded labor. That is otherwise known as a recession.

In a "world of disappointments", where beta is king and where alpha has become a joke (or, now that equity is a risk-free asset and debt is risky, is outright punished) where growth no longer exists, drowning under the weight of $200 trillion in debt, and where value strategies have been all but forgotten replaced instead with "stories" about companies that have no cash flows but just might be "the next big thing" (one day), what should one to do? Why, engage in the most idiotic of strategies: chase momentum.

Gold is up 3.1% in October and had even larger gains in other currencies. Entering gold’s “seasonal sweet spot” in November, December, January and February.

Based on the overnight market prints which are an oddly reddish shade of green, it took algos about 12 hours to realize that the reason they soared for most of October, namely hopes of an easier Fed which were launched with the terrible September jobs report and continued with increasingly worse US economic report in the past month, can not be the same reason they also soared yesterday after the announcement of a more hawkish than expected Fed statement which envisioned a stronger US economy and a removal of foreign considerations, which even more curiously took place on even worse data than the Fed's far more dovish September statement.

Fearing the size of Mario Draghi's bazooka (so to speak), Sweden's Riksbank has just expanded QE by SEK65 billion, marking the fourth expansion in nine months and serving notice that the beggar-thy-neighbor, monetary madness gripping DM central banks isn't likely to dissipate anytime soon.

Back in 1999, a quarter of all 25-year-olds lived with their parents. By 2013 this number has doubled, and currently half of young adults live in their parents home. Here, according to the St. Louis Fed, is the answer why.

Sorry Fed, here is why your attempt at terminal reflation was doomed from day one.

News That Matters

"... if you look at what is supporting equity prices - how much of that support is coming from real economic activity versus from using stock buybacks, using cash on balance sheet for stock buybacks, or mergers and acquisitions, to reduced competition in the marketplace. These are the sort of stories that if there were a small increase in interest rates, you would temper some of that frothiness. Eliminating the incentive to engage in that kind of activity seems to me to be a good idea... There would be a proportion of the population that would have less capital gains - but they’ve been enjoying very big capital gains, and it is a narrow segment of the population."

The weakness seen in world economic activity is partly the result of the lack of a real purge of the financial system in 2008. It has become unimaginable to let entire parts of the system collapse, and the titling of some financial institutions as “systemic” is part of this logic. Policymakers attempting to keep unhealthy economic and financial institutions alive are making a mistake. The very essence of capitalism lies in the process of creative destruction. What we see here is not a way out of the crisis. Instead, we are on the edge of a new financial disaster.

"Investors are now facing the second most extreme episode of equity market overvaluation in U.S. history (current valuations on similar measures already exceed those of 1929). The belief that zero interest rates offer no alternative but to accept risk in stocks is valid only if one believes that stocks cannot experience profoundly negative returns. We know precisely how similar valuation extremes have worked out for investors over the completion of the market cycle, and those outcomes have never been deferred indefinitely. The only question at present is how many grains are left in the hourglass."

Accounting fraud remains at the heart of the fix instituted by Ben Bernanke and the ploy has been copied by authorities throughout the global financial system, including the central banks of China, Japan, and the European Community. That it seemed to work for the past seven years in propping up global finance has given too many people the dangerous conviction that reality is optional in economic relations. The recovery of equity markets from the disturbances of August has apparently convinced the market players that stocks are invincible. Complacency reigns at epic levels. Few are ready for what is coming.

It was only a couple of months ago that a rapidly rising dollar was pushing the global economy closer to a new crisis. It seems unlikely that the conditions that made a rapidly rising dollar a problem in August have all been resolved by October. Those who bought stocks last week in response to hints of more easing from Draghi – and the rate cut in China – may find themselves in the same position as Pavlov’s dogs, wondering why no meal follows the ringing of the bell.