Has The Global Recession Begun In Earnest?

Whilst riding in the car with my girlfriend and talking about how close we are to a possible financial Armageddon, she couldn’t help but notice the tone of  my last Zerohedge article, and that maybe the entire site,was decidedly negative, bordering on the side of paranoia, inciting the rabble to potential violence. Having viewed some of the comments myself,there are definitely a couple of rather unstable people out there.So I began to wonder what was the appropriate response should be. “it is not paranoia if they really are out to get you!” I retorted. But as in 2007, whilst some had seen the writing on the wall ,the ones claiming that there was something very wrong in the markets were being told that we were fear-mongers, that we used exaggeration and continual repetition to alter the perception of the public in order to achieve a desired outcome, that how could we possibly believe what we were saying to be true… so I thought the best way was to systematically list the things I know to be.... 


Are You Sitting Comfortably? Then I’ll Begin:

Where to even begin...we started off with fears about oil and China, followed by an assortment of political tensions, Brazil’s faltering economy and if that wasn’t enough, attention has been drawn to Japan’s flip flop and race to the bottom in rates. With the addition of tightening in financial conditions in European Banking credit,Portugal and the Greek tragedy back on the table and now various houses concerned about recent macro-economic data which is indicating a possible slow-down in the economy, concerns abound.



Fiat money refers to any currency lacking intrinsic value that is declared legal tender by a government.

As valid currency solely by virtue of a government declaration, fiat money is not backed by any commodity, such as gold, but only by the full faith and credit of the bearer. In this respect, unlike currencies backed by gold or silver, fiat money does not have any intrinsic value (e.g., remember when all bank notes used to carry the phrase , “I promise to pay the bearer”?)

Now that we know the money used today is nothing more than paper backed up by full faith and a government decree, the next logical questions are, 1) Where does it come from?, and 2) Who has the power to create money? In the case of the US Dollar, it is not the government. The Federal Reserve System (Fed) is one of the ways in which money is created today (the other being fractional reserve banking).

Central banks create money from thin air, which is then used to for buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased. The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn supposedly boosts investment by encouraging banks to make more loans, but instead the banks use the funds to buy other assets.


Have You Ever Played Monopoly ?  

Imagine that one player can print all the money they want.

Before long, that one player will own everything, and everyone else is broke or in debt.  

For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent.

However, exponential growth can only be maintained over a finite period of time. Just in case of Ponzi schemes, during this time the scam works and investors are paid in full to attract future investors. Everyone believes therefore that the scheme works. But when the exponential growth slows down, the pyramid collapses, primarily because the initial interest rate that was set was too high. Bernard Madoff's Ponzi scheme has shown that choosing a lower interest rate prolongs the time the scam works. Banks indeed work with even lower interest rates, so draw your own conclusion.


Here is a Real World Example

Banks are required to hold a capital cushion against liabilities, but it doesn’t cover their total potential liabilities. Rather, they are only required to hold sufficient assets to cover some of their potential liabilities (a “fractional reserve”) and this can be easily masked .This is how Italian banks and the Italian government are helping each other in pretending that they are more solvent than they really are: the banks buy government properties (everything from office buildings to military barracks) from the government, and pay for them with government bonds. The government then leases the buildings back from the banks, and the banks pool the properties and then issue asset backed securities. The Italian government then slaps a “guarantee” on these securities, which makes them eligible for repo with the ECB. The banks then repo (repurchase agreement)  these ABS with the ECB and take the proceeds to buy more Italian government bonds. Rinse and repeat. 


The Issue Hinges on “Credibility” and “Confidence”.

The art and craft involved in managing a good Ponzi scheme is in how well the perpetrators can position themselves for the inevitable crash and bust before it actually happens. While things are going relatively well for all in the economy, the financial elite spend their time and money buying up land, industry, war materials, yachts and anything else you can imagine. When the economy finally cracks completely, they are prepared to survive, and perhaps hoping to usher in a new world. Just look at the recent history of luxury real estate purchases or gold repatriation.


DEBT TO GDP: The Math Simply Doesn’t Add Up

  The last US GDP report was noteworthy in three respects. First, nominal GDP growth continued to decelerate, and is now at levels that have been historically consistent with recessions. Second, health care accounted for more than one-fifth of real GDP growth, but this was largely driven by Obamacare. Third, it marked a full decade that the annual rate of real GDP growth failed to break above 3%. The textbook definition of a recession is a downturn in economic activity, characterized by at least two consecutive quarters of decline in a country's gross domestic product (GDP). So take that away.



This is not a good sign…but to simplify it even further (and I know some of you have seen this before, but to those who have not…):

Some stats about the US government:

U.S. Tax revenue: $2,170,000,000,000

 Fed budget: $3,820,000,000,000

New debt: $ 1,650,000,000,000

National debt: $18,990,000,000,000

Recent budget cuts: $ 38,500,000,000


Now, remove 8 zeroes and pretend it’s a household budget:

Annual family income: $21,700

Money the family spent: $38,200

New debt on the credit card: $18,990

Outstanding balance on the credit card: $142,710

Total budget cuts: $385!!!!!


The Newest Monetary Contagion

As more central banks resort to negative interest rates, will economic conditions take a turn for the worse?  

After Japan lowered the interest rate it pays on bank reserves to negative territory, 23% of global GDP is now overseen by central banks with negative policy rates, while 24% of the market value of the world’s largest companies ($2 billion-plus market cap) are based in economies with negative policy rates.  The wider adoption of negative rates on excess bank reserves, designed to force banks to pump more of their excess reserves into the real economy rather than keeping them on deposit at the central bank, is an acknowledgment that years of quantitative easing have done little to spur real economic activity. The BOJ’s bond purchases have expanded its balance sheet to 75% of GDP from 35% in 2013, compared to the U.S. Federal Reserve’s 25% of GDP. Yet growth in Japanese bank lending, now 2.2% per year, has barely budged. Companies are sitting on about $2 trillion in cash(Corporate cash and deposits increased 4.3 percent from a year earlier to 231 trillion yen ($1.9 trillion) at the end of December, close to last March’s all-time high of 233 trillion yen, according to Bank of Japan data.), and real wages have declined. The market’s verdict on Japan’s latest move is a resounding thumbs down. After the ECB lowered its deposit facility rate to negative territory in 2014 and despite a sharp decline in its currency, Eurozone growth this year is only expected to be an anemic 1.6%. Sweden and Denmark who also adopted these negative interest rate policies in 2014 are showing growth of 0.8% for Sweden and a contraction of 0.1% for Denmark. 

This new contagion is the latest confirmation that competing economies are in a “race to the bottom.” As global growth rates continue to shrink, each economy is forced to resort to “beggar thy neighbor” policies to steal growth from other countries. Simply put, negative policy rates are simply the latest fad designed to keep currencies depressed, in an effort to support exports and avoid deflation. It may seem counter-intuitive, but a strong currency is not necessarily in a nation's best interests.


Beggar Thy Neighbor

A weak domestic currency makes a nation's exports more competitive in global markets, and simultaneously makes imports more expensive. Higher export volumes spur economic growth, while pricey imports also have a similar effect because consumers opt for local alternatives to imported products. This improvement in the terms of trade generally translates into a lower current account deficit (or a greater current account surplus), higher employment, and faster GDP growth. The stimulative monetary policies that usually result in a weak currency also have a positive impact on the nation's capital and housing markets, which in turn boosts domestic consumption through the wealth effect.

Since it is not too difficult to pursue growth through currency depreciation – whether overt or covert – it should come as no surprise that if Nation A devalues its currency, Nation B will soon follow suit, followed by Nation C, and so on. This is the essence of competitive devaluation.

This phenomenon is also known as "beggar thy neighbor," which, far from being the Shakespearean drama that it sounds like, actually refers to the fact that a nation which follows a policy of competitive devaluation is vigorously pursuing its own self-interests to the exclusion of everything else.

However, some of the worst fears about negative interest rates are that the banks would pass them on to consumers, causing them to withdraw their deposits and stash the money under their mattresses—as of yet it has not yet come to pass. However, to the extent the banks absorb the cost of the negative interest rate on their own, profit margins will come under even further pressure than they have already, adding to the stress on the credit markets.


Now Let’s Move Briefly On To Brazil.

Brazil is not the same country it was in 1930, but it’s economy is sure looking that way. The country is facing its worst economic crisis since the Great Depression in the United States. This year will be another year of contraction. Labor markets are shedding employees and inflation, once under control, is now over 10.6%. There is no end in sight to this crisis. China won’t save it. A weaker dollar won’t save it. A lot of Brazil’s problems are boring, old school budget woes…As the B in BRICS, Brazil is supposed to be in the vanguard of fast-growing emerging economies. Instead it faces political dysfunction and perhaps a return to rampant inflation. That our own debt to GDP ratio is over 102% whist Brazil’s is around 66% should tell you something.

The Drugs Don’t Work

When the drugs don’t work it is time to put the priest on notice that he may be called at any minute to perform the last rights.

Given the recent moves in the stock and credit markets it is further proof that QE and low interest rates are not working but they remain the favored and only tool available to the Bank of Japan and ECB to keep their patients alive.

As it becomes ever clearer that the drugs are losing their potency the gloom deepens on the prospects for economic growth. Banks do not make money in a negative interest rate environment nor one in which the risk of corporate and sovereign default rises.

Table of bank performance prior to todays debacle;


This Time, It’s Different?

Many economists have already compared the years 1929–1932 to those of 2007–2009, and the current period of recovery to the time period 1933–1939. It was only a matter of time before they began to look for a comparison between the recession of 1937 and a potential "double dip" today.

The 2007-2009 recession was mostly blamed on a housing bubble. After a run-up in housing prices in the early part of the decade, home prices plummeted, then thousands of borrowers couldn't afford to pay their loans. Meanwhile, Wall Street sold financial instruments tied to the loans that were eventually discovered to be of little value (after seeing The Big Short, I may be being a little kind in that assessment)

Looking at other recessions, we can see their shocks. Albeit in hindsight, the recession of 2001 was caused by the 'Internet Bubble,' in which internet stocks and businesses eventually fell to much lower price.

The recession of 1973-1975 in the U.S. came about from rocketing gas prices, because OPEC raised oil prices and embargoed oil exports to the U.S. Other major factors included heavy government spending on the Vietnam War, and a Wall Street stock crash in 1973-74.

“This time its different”?, These words are often uttered near the peak of bull markets, as dewy-eyed investors attempt to justify unsustainable market trends by arguing that the past is no longer a relevant guide to the future.

They are , without a doubt , the four most dangerous words in investing. 

The deep recession  in 1937 and 1938 had several causes. When the U.S. was trying to get out of the Great Depression, it spent a lot of money. That was the New Deal — President Franklin Roosevelt's plan to get the economy moving — which started in 1933,not to dissimilar to our current QE program initiated by various central banks.

But as the economy appeared to be recovering in 1937 and because Congress wanted to balance the budget, the government pulled back on spending and then raised taxes. That was enough of a 'shock' to put the economy into recession. Unemployment rose again and business profits declined, as did business investing.

As a result, the Great Depression continued, economists say, until the U.S. entered World War II in 1941.

We are told that there will not be a repeat of 2008 but the doubts are growing, cracks are appearing.



Liquidity has a reputation for being very much in evidence when not required, and then disappearing without trace the moment you need it.There is a broad-based problem insofar as the investor base across markets has developed a greater tendency to crowd into the same trades, to be the same way round at the same time. This “herding” effect leads to markets which trend strongly, often with low day-to-day volatility, but are prone to abrupt corrections.In principle, markets could gap to a point where they went from being absurdly expensive to being absurdly cheap, without very much trading. But the existence of the feedback loop to the real economy means that the fundamentals tend also to be affected by extreme market moves: “cheap” may be a moving target. This in turn could force central banks to step back in again.In principle, markets could gap to a point where they went from being absurdly expensive to being absurdly cheap, without very much trading. But the existence of the feedback loop to the real economy means that the fundamentals tend also to be affected by extreme market moves: “cheap” may be a moving target. This in turn could force central banks to step back in again.But then we are left with a paradox,The more liquidity the central banks add, the more they disrupt the natural order of the market. On the way in, it has mostly proved possible to accommodate this; however the way out is proving not to be so easy....


 I will leave you with a quote from a book/movie set during the US civil war. 

“This isn’t the first time the world’s been upside down and it won’t be the last. It’s happened before and it’ll happen again. And when it does happen, everyone loses everything and everyone is equal. And then they all start again at taw, with nothing at all.That is, nothing except the cunning of their brains and strength of their hands… But there are always a hardy few who come through and given time, they are right back where they were before the world turned over.”

Margaret Mitchell, Gone With The Wind

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