Submitted by Mark J. Grant, author of Out of the Box,
I think we are progressing into the next economic cycle.
“In my youth, I, too, entertained some illusions; but I soon recovered from them. The great orators who rule the assemblies by the brilliancy of their eloquence are in general men of the most mediocre political talents: they should not be opposed in their own way; for they have always more noisy words at command than you. Their eloquence should be opposed by a serious and logical argument; their strength lies in vagueness; they should be brought back to the reality of facts; practical arguments destroy them. In the council, there were men possessed of much more eloquence than I was: I always defeated them by this simple argument that two and two make four.”
With all of the money thrown into the system by all of the major central banks in the world we had a number of consequences. First and foremost we learned that the money had to be used somewhere and so it was as the equity markets danced into the next stratosphere and bonds compressed like a Cuban sandwich. Benchmark interest rates have also fallen as the hunt for yield became ferocious and as sovereign debt rates fell to ever lower levels all driven by the newly minted cash.
The banks also did well as consistently lower interest rates allowed for quite profitable spreads. Corporations also benefited from the lower yields and have been able to borrow at very attractive levels due to the largesse of the Fed and its brethren. Where the policy has failed though or at least not dampened the problem has been in the underlying economies and the consumers.
Most of Europe is in a serious recession which affects the United States regardless of anyone having the mistaken belief that America is a country that stands alone. Next we have not had any inflation while Europe has experienced deflation as the little pieces of blue and green paper are not having the desired effect on consumers. Finally while reported unemployment in the U.S. has declined slightly the money pumped into the system has not accomplished one of the stated goals of the Fed which is to significantly reduce unemployment. It just has not happened.
“There are some people who live in a dream world, and there are some who face reality; and then there are those who turn one into the other.”
Part of the reason for all of this, in America and in Europe, is that consumers have been penalized by the central banks given the very low interest rates. Over a period of time savers/investors/consumers have seen the return on their money in banks, bonds and various insurance products shrink and then shrink some more as their investments return less and less. This then means that the consumers, the bedrock of all economies, have less and less money to spend as they receive so little on their invested assets. This is also a consequence of Quantitative Easing that plays out over time and we are entering the time, in my opinion, where the cheese is beginning to bind.
Then we have the equity markets, singularly driven by all of this newly created money, which are dislocated from the underlying economies which eventually, and I think eventually is now at our doorsteps, begins to notice that something is amiss. Yet even laying relative valuations aside we are beginning to notice that revenues and profits are shrinking at many U.S. corporations as the European effect takes place, as consumers spend less because of their shrinking cash flows and as people become fearful that we are, in fact, living in some kind of central bank created bubble.
“In business, words are words; explanations are explanations, promises are promises, but only performance is reality.”
-Harold S. Geneen
We are also witnessing, I believe, the effects of reality and not what the fantasy accounting of all of the governments on Earth would lead us to believe. America may say that the unemployment rate is 7.7% but the reality is 11.6% and so the 33% differential means far less buying power in the economy which is beginning to be recognized. In Europe we can point to the uncounted liabilities in their sovereign debt numbers and then the reality there that just because liabilities are not counted does not mean that they must eventually get paid. Then the confiscation of assets in Ireland, Greece and Cyprus and the unpaid bills in these countries and in Spain, Portugal et al finally must be reckoned with so that large chunks of money leave the economy when eventuality wanders into the present. The falsification of data has taken some time to become realized but I think we are now at a moment when the truth of all of this has found roots.
Many banks in Europe are also beginning to suffer. They have pledged assets at the ECB which have deteriorated and the ECB will not be taking the hit I can assure you so that additional demands for collateral have been made. Some are just the responsibility of a given bank but some securitizations are guaranteed by the sovereign and so one or the other will have to foot the bill. I expect quite severe pressure on the balance sheets of many of the European banks during the next year as further collateral demands are made by the ECB and as these securitizations mature.
One possibility for the markets to reverse has always been some grand event but another is just the economic deterioration that wears away at the markets as current levels cannot be rationally supported. It is not just the Law of Diminishing Returns which is coming into play as the central banks create more money but the effects on the consumer of seriously declining available cash to be used to purchase goods and services.
We have been subject to a massive amount of monetary printing and an unconscionable manipulation of data but the affects of reality cannot be ignored forever because reality forces the consequences as the fantasy gives way over time.
“Reality is that which, when you stop believing in it, doesn't go away.”
-Philip K. Dick