Weekly Article 11-15-2018
Last week I made a point that 89% of all global assets had a negative return in US dollar terms in 2018. As far as I know this has not happened in the last 100 years. Part of the reason for this would be the strength of the US dollar and the weakness of the global economy.
Many may ask “with all of the numbers we see how can you possibly say the global economy is weak?”
First of all, as we have covered ad nauseum here the numbers can (and are) made to produce a certain view of how things are and in many cases do not accurately portray what is actually happening.
The weakness in emerging economies has been evident since the first quarter of 2018 with many feeling the effects of high inflation and stagnating economies. These people are well aware of the slowdown taking place globally.
China, while many may think that they can just “print” their way to prosperity, is seeing major cracks in their economy as the Yuan (their currency) is weakening and there are a reported 50 million empty apartments in China as their real estate market is showing serious signs of slowing down. Zerohedge reported a few weeks ago there were riots because new construction was being offered at a 25% discount to what previous buyers paid.
There have also been some underreported bank runs in China.
While many are aware of the Chinese stock market being in a bear market there are many other signs all is not well in the Middle Kingdom. According to Bloomberg News on 11-8-2018 “Publicly setting targets reflects policy makers’ urgency as they try to stem China’s economic slowdown amid an escalating trade war, record corporate defaults and a plunging stock market.” Basically, they are taking a play from the Fed’s and other central bank playbooks and trying to fix the problem of too much debt that can’t be serviced as we speak with more debt. Also in the Bloomberg article “Companies are finding it harder to repay debt as demand for goods and services stays sluggish.” Does this sound like a growing economy or the growing of a massive debt bubble that is nearing (or may have already passed) its apex?
Without Central banks buying sovereign bonds many countries would have already been exposed as insolvent- that includes where we live. How do you suppose the economy would be doing if real bond investors were determining a fair price for the risk being assumed rather than central banks buying and keeping rates artificially suppressed? Could homes have risen as they did with fair rates? Would the auto industry have had the boom they had in the past few years with substantially higher rates? Could companies have bought back stock or investors gone so far into margin debt with higher rates?
All of this was made possible by “printing” up money from nowhere and pretending all was well.
As I write this we are in a place where it appears to me we are seeing a managed implosion of asset prices. What I mean by that is, as I have written many times before, once you go down the money creation and buying of assets path each and every action has to be larger to get the same result. That basically means “inflate or die”. This means more and more credit creation forever. Of course, this can’t go on forever because all of the debt has to be serviced. So the question comes up “How do we stop?”
There are a few answers. #1 Just stop. This would likely lead to the greatest crash the world has ever seen because this is the first truly worldwide bubble where virtually all countries or their central banks are creating currencies out of thin air and buying assets like stocks and bonds. Once this faux demand is removed the stock markets would likely race back to a fair value (Probably multiples lower) and bond prices would likely plummet as yields would rise because the demand would be non-existent at current rates. This would also likely lead to a lack of confidence in virtually all paper assets. In my opinion, this is the least likely outcome because it would admit defeat and it would be obvious that the cause was all of the false pricing to start with.
#2 Just keep going until the end. This would likely lead to very high inflation and a lack of purchasing power for just about everyone. This is the most likely outcome as we look back at history and see that this is what happened in Germany in the 1920s, Brazil many times, Argentina many times, USA a couple of times – most notable the Continental which the British counterfeited to make it lose value so we couldn’t continue the war. See- our enemies knew how to destroy us- debase the currency! Of course, here we are doing it to ourselves!
#3 Find a scapegoat and default. My opinion on this is that this is the way to go. Those who “printed” the “money” and bought assets should get full value for what they bought- NOTHING. This way, the public will likely be hurt but not decimated as we would be in either a deflationary or inflationary depression.
Just look at Iceland and Greece. They both defaulted at the same time- 10 years ago. The Greeks are now deeper in debt and selling off national assets by playing the carry the debt with more debt game.
The ECB and others issue more debt to pay interest on existing debt. Of course, once the interest is paid all that is left is more debt.
In contrast Iceland defaulted on their debt, threw the bankers in jail, and moved on. Of course, they had a couple of lean years but today they have had a thriving economy with little debt and have been raising capital in international markets for the past 5 years. Who is better off?
Many will say “we will just default”. That may be true. Don’t think that won’t have massive repercussions. How many millions of people who were planning on using that investment at a future date would be left holding the bag? What would be the ramifications for their future income projections and standard of living going forward?
I believe that the stagnation we are seeing in the world economy is due to a leveling off of the artificial stimulus rather than stopping altogether. If the central banks follow through with their plans to withdraw stimulus there will likely be continued weakness in all paper assets. My guess is that, at some point, the pain will become real and then we will see what they do- it could be almost anything.
I have had many people asking me “What is going on with oil?” It has been going down! I’m sure most know that already. I have seen articles about traders selling and making the decline deeper and Goldman Sachs chief commodity strategist said “driving the most recent leg of the selloff has instead first been momentum trading strategies and second, increased selling of crude oil futures by swap dealers as they manage the risk incurred from existing producer hedging programs in a falling price environment.” To me , this sounds like an explanation of why it may be a more drastic move than normal but my guess is that this is telling us that demand is slacking. Would that be a surprise if we are in a contraction rather than a growth mode globally? In another Bloomberg article Bloomberg’s Ziad Daoud calculates that weaker demand accounts for $18.00, or 85% of the $21.00 per barrel price decline since October 3rd. and that supply would account for 15%. Daoud said the IEA and even OPEC recently lowered forecasts for the growth in oil demand next year citing a slowing global economy.
My guess is that the traders have made the oil market more volatile in each direction but this pullback may be forecasting a slower economy moving forward.
I have said many times- paper assets can, and often do, go to zero. Real assets generally do not. Prices may fluctuate wildly at times but real assets like gold, silver, real estate, desirable art, coins, food, water etc. always have value. Supply and demand will determine that value unlike the paper assets that many times relies on another’s promise to repay. When interest is being paid with newly-issued currencies and higher debts I believe it is only a matter of time before we get our lesson yet again.
Of course, when prices correct it is often the time of greatest opportunity for those who keep their heads- and have purchasing power.
Mike Savage, ChFC, Financial Advisor
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