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Reaching Debt Limits: With or without China’s problems, we have a problem | Our Finite World

Reaching Debt Limits: With or without China’s problems, we have a problem | Our Finite World.

Credit Problems are a Very Current Issue

In the past several years, the engine of world’s growth has been China. China’s growth has been fueled by debt. China now seems to be running into difficulties with its industrial growth, and its difficulty with industrial growth indirectly leads to debt problems. A Platt’s video talks about China’s demand for oil increasing by only 2.5% in 2013, but this increase being driven by rising gasoline demand. Diesel use, which tracks with industrial use, seems to be approximately flat.

The UK Telegraph reports, “Markets hold breath as China’s shadow banking grinds to a halt.” According to that article,

A slew of shockingly weak data from China and Japan has led to a sharp sell-off in Asian stock markets and the biggest one-day crash in iron ore prices since the Lehman crisis, calling into question the strength of the global recovery.

The Shanghai Composite index of stocks fell below the key level of 2,000 after investors reacted with shock to an 18pc slump in Chinese exports in February and to signs that credit is wilting again. Iron ore fell 8.3pc.

Fresh loans in China’s shadow banking system evaporated to almost nothing from $160bn in January, suggesting the clampdown on the $8 trillion sector is biting hard.

Many recent reports have talked about the huge growth in China’s debt in recent years, much of it outside usual banking channels. One such report is this video called How China Fooled the World with Robert Peston.

Why Promises (and Debt) are Critical to the Economy

Without promises, it is hard to get anyone to do anything that they really don’t want to do. Think about training your dog. The way you usually do this training is with “doggie treats” to reward good behavior. Rewards for desired behavior are equally critical to the economy. An employer pays wages to an employee (a promise of pay for work performed).

It is possible to build a house or a store, stick by stick, as a person accumulates enough funds from other endeavors, but the process is very slow. Usually, if this approach is used, those building homes or stores will provide all of the labor themselves, to try to match outgo with income. If debt were used, it might be possible to use skilled craftsmen. It might even be possible to take advantage of economies of scale and build several homes together in the same neighborhood, and sell them to individuals who could buy the homes using debt.

Adding debt has many advantages to an economy. With debt, a person can buy a new car or house without needing to save up funds. These purchases lead to additional workers being employed in building these new cars and homes, adding jobs. The value of existing homes tends to rise, if other people are available to afford them, thanks to cheap debt availability. Rising home prices allow citizens to take out home equity loans and buy something else, adding further possibility of more jobs. Availability of cheap debt also tends to make business activity that would otherwise be barely profitable, more profitable, encouraging more investment. GDP measures business activity, not whether the activity is paid for with debt, so rising debt levels tend to lead to more GDP.

Webs of Promises and Debt

As economies expand, they add more and more promises, and more and more formal debt. In high tech industries, supply lines using materials from around the world are needed. The promise made, formally or informally, is that if more of a supply is needed, it will be available, at the same or a similar price, in the quantity needed and in the timeframe needed. In order for this to happen, each supplier needs to have made many promises to many employees and many suppliers, so as to meet its commitments.

Governments are part of this web of promises and debt. Some of the promises made by governments constitute formal debt; some of the promises are guarantees relating to debt of other parties (such as nuclear power plants), or of the finances of banks or pensions plans. Some of a government’s promises are only implied promises, yet people depend on these implied promises. For example, there is an expectation that the government will continue to provide paved roads, and that it will continue to provide programs such as Social Security and Medicare. Because of the latter programs, citizens assume that they don’t need to save very much or have many children–the government will provide funding sufficient for their basic needs in later years, without additional action on their part.

What is the Limit to Debt?

While our system of debt has gone on for a very long time, we can’t expect it to continue in its current form forever. One thing that we don’t often think about is that our system or promises isn’t really backed by the way natural system we live in works. Our system of promises has a hidden agenda of growth. Nature doesn’t  have a similar agenda of growth. In the natural order, the amount of fresh water stays pretty much the same. In fact, aquifers may deplete if we over-use them. The amount of topsoil stays pretty much the same, unless we damage it or make it subject to erosion. The amount of wood available stays pretty constant, unless we over-use it.

Nature, instead of having an agenda of growth, operates with an agenda of diminishing returns with respect to many types of resources. As we attempt to produce more of a resource, the cost tends to rise. For example, we can extract more fresh water, if we will go to the expense of drilling deeper wells or using desalination, either of which is more expensive. We can extract more metals, if we use as our source lower grade ores, perhaps with more surface material covering the ore. We can get extract more oil, if we will go to the expense of digging deeper wells is less hospitable parts of the world. We can even use substitution, but that will likely be more expensive yet.

A major issue that most economists have missed is the fact that wages don’t rise in response to this higher cost of resource extraction. (I have shown a chart illustrating that this is true for oil prices.) If the higher cost simply arises from the fact that nature is putting more obstacles in our way, we end up spending more for, say, desalinated water than water from a local well, or more for gasoline than previously. Much of the cost goes into fuel that is burned, or building special purpose equipment (such as a desalination plant or offshore drilling rigs) that will degrade over time. Our system is, in effect, becoming less and less efficient, as it takes more resources and more of people’s time, to produce the same end product, measured in terms of barrels of oil or gallons of water. Even if there are additional salaries, they are often in a different country, around the globe.

At some point, the amount of products we can actually produce starts shrinking, because workers cannot afford the ever-more-expensive products or because some essential “ingredient” (such as fresh water, or oil, or an imported metal) is not available. Since we live in a finite world, we know that at some point such a situation must occur, even if  the shrinkage isn’t as soon as I show it in Figure 2 below.

Figure 1. Author's image of an expanding economy.

Figure 1. Author’s image of an expanding economy.

Figure 2. Author's image of declining economy.

Figure 2. Author’s image of declining economy.

The “catch” with debt is that we are in effect borrowing from the future. It is much easier to pay back debt with interest when the economy is growing than when the economy is shrinking.  When the economy is shrinking, there is less in the future to begin with. Repaying debt from this shrinking amount becomes a problem. Even promises that aren’t formally debt, such as most Social Security payments, Medicare, and future road maintenance become a problem. With fewer goods available in total, citizens on average become poorer.

Governments depend on tax revenue from citizens, so they become poorer as well–perhaps even more quickly than the individual citizens who live in their country. It is in situations like this that richer parts of countries decide to secede, leading to country break-ups. Or the central government may fail, as in the Former Soviet Union.

Which Promises are Least Affected?

Some promises are very close in time; others involve many years of delay. For example, if I bring food I grew to a farmers’ market, and the operator of the market gives me credit that allows me to take home some other goods that someone else has brought, there are some aspects of credit involved, but it is very short term credit. I am being allowed to “run a tab” with credit for things I brought, and this payment is being used to purchase other goods, or perhaps even services. Perhaps someone else would offer some of their labor in putting together the farmers’ market, or in working in a garden, in return for getting some of the produce.

As I see it, such short term promises are not really a problem. Such credit arrangements have been used for thousands of years (Graeber, 2012). They don’t depend on long supply lines, around the world, that are subject to disruption. They also don’t depend on future events–for example, they don’t depend on buyers being available to purchase goods from a factory five or ten years from now. Thus, local supply chains among people in close proximity seem likely to be available for the long term.

Long-Term Debt is Harder to Maintain

Debt which is long-term in nature, or provides promises extending into the future (even if they aren’t formally debt) are much harder to maintain. For example, if governments are poorer, they may need to cut back on programs citizens expect, such as paving roads, and funding for Social Security and Medicare.

Governments and economies are already being affected by the difficulty in maintaining long term debt. This is a big reasons why Quantitative Easing (QE) is being used to keep interest rates artificially low in the United States, Europe (including the UK and Switzerland), and Japan. If interest rates should rise, it seems likely that there would be far more defaults on bonds, and far more programs would need to be cut. Even with these measures, some borrowers near the bottom are already being adversely affected–for example, subprime loans were problems during the Great Recession. Also, many of the poorer countries, for example, Greece, Egypt, and the Ukraine, are already having debt problems.

Indirect Casualties of the Long-Term Debt Implosion

The problem with debt defaults is that they tend to spread. If one major country has difficulty, banks of  many other countries are likely be to affected, because many banks will hold the debt of the defaulting country. (This may not be as true with China, but there are no doubt indirect links to other economies.) Banks are thinly capitalized. If a government tries to prop up the banks in its country, it is likely to be drawn into the debt default mess. Insurance companies and pension plans may also be affected by the debt defaults.

In such a situation of debt defaults spreading from country to country, interest rates can be expected to shift suddenly, causing financial difficulty for those issuing derivatives. There may also be liquidity problems in dealing with these sudden changes. As a result, banks issuing derivatives may need to be bailed out.

There may also be a sudden loss of credit availability, or much higher interest rates, as banks issuing loans become more cautious. In fact, if problems are severe enough, some banks may be closed altogether.

With less credit available, prices of commodities can be expected to drop dramatically. For example, during the credit crisis in the second half of 2008, oil prices dropped to the low $30s per barrel. It was not until after  QE was started in November 2008 that oil prices started to rise again. This time, central banks are already using QE to try to fix the situation. It is not clear that they can do much more, so the situation would seem to have the potential to spiral out of control.

Without credit availability, the prices of most stocks are likely to drop dramatically. In part, this is because without credit availability, it is not clear that the companies listed in the stock market can actually produce very much. Even if the particular company does not need credit, it is likely that some of the businesses on which it depends for supplies will have credit problems, and not be able to provide needed supplies. Also, with less credit availability, potential buyers of shares of stock may not be about to get the credit they need to purchase shares of stock. As a result of the credit problems in 2008, the Dow Jones Industrial Average dropped to $6,547 on March 9, 2009.

Furthermore, lack of credit availability tends to lead to low selling prices for commodities, making production of these commodities unprofitable. Production of these commodities may not drop off immediately, but will in time unless the credit situation is quickly turned around.

Can’t governments simply declare a debt jubilee for all debt, and start over again?

Not that I can see. Declaring a debt jubilee is, in effect, saying, “We have decided to renege on our past promises. In fact, we are letting others renege on their promises as well.” This means that insurance companies, pension plans, and banks will all be in very poor financial situation. Many who depend on pensions will find their monthly checks cut off as well. In fact, businesses without credit availability are likely to lay off workers.

If it is possible to start over, it will need to be on a much more restricted basis. Everyone will be poorer, so there won’t be much of a market for expensive new cars and homes. Instead, most demand will be for will be the basics–food, water, clothing, and fuel for heat. Unfortunately, it is doubtful that prices will be high enough, or the chains of supply robust enough, to again produce fossil fuels in quantity. Without fossil fuels, what we think of as renewables will disappear from availability quickly as well. For example, hydroelectric, wind and solar PV all work as parts of a system. If the billing system is unavailable because banks are closed, or if the transmission system is in need of repair because lines are down and the diesel fuel needed to make repairs is unavailable, electricity may not be available.

As indicated above, demand will be primarily for basics such as food, water, clothing, and fuel for cooking and heating. It will still be possible to use local supply chains, even if long distance supply chains don’t really work well. The challenge will be trying to shift modes of production to new approaches in which goods can be made locally. A major challenge will be training potential farmers, getting needed equipment for them, and transferring land ownership in ways that will allow food to be produced in ways that do not depend on fossil fuels.

Belief in credit will be severely damaged by a debt jubilee. The place where credit will be easy to reestablish will be in places where everyone knows everyone else, and supply lines are short. Debt will mostly be of the nature of “running a tab” when one type of good is exchanged for another. Over time, there may be some long-term trade re-established, but it is likely to be much more limited in scope than what we know today.

Conclusion

Long-term debt tends to work much better in a period of economic growth, than in a period of contraction. Reinhart and Rogoff unexpectedly discovered this point in their 2008 paper “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises.” They remark “It is notable that the non-defaulters, by and large, are all hugely successful growth stories.”

Slowing growth in China is likely to mean that world economic growth is slowing. This will add to stresses, making failure of the system more likely than it otherwise would be. We can cross our fingers and hope that Janet Yellen and other central bankers can figure out yet other ways to keep the system together for a while longer.

Reaching Debt Limits: With or without China’s problems, we have a problem | Our Finite World

Reaching Debt Limits: With or without China’s problems, we have a problem | Our Finite World.

Credit Problems are a Very Current Issue

In the past several years, the engine of world’s growth has been China. China’s growth has been fueled by debt. China now seems to be running into difficulties with its industrial growth, and its difficulty with industrial growth indirectly leads to debt problems. A Platt’s video talks about China’s demand for oil increasing by only 2.5% in 2013, but this increase being driven by rising gasoline demand. Diesel use, which tracks with industrial use, seems to be approximately flat.

The UK Telegraph reports, “Markets hold breath as China’s shadow banking grinds to a halt.” According to that article,

A slew of shockingly weak data from China and Japan has led to a sharp sell-off in Asian stock markets and the biggest one-day crash in iron ore prices since the Lehman crisis, calling into question the strength of the global recovery.

The Shanghai Composite index of stocks fell below the key level of 2,000 after investors reacted with shock to an 18pc slump in Chinese exports in February and to signs that credit is wilting again. Iron ore fell 8.3pc.

Fresh loans in China’s shadow banking system evaporated to almost nothing from $160bn in January, suggesting the clampdown on the $8 trillion sector is biting hard.

Many recent reports have talked about the huge growth in China’s debt in recent years, much of it outside usual banking channels. One such report is this video called How China Fooled the World with Robert Peston.

Why Promises (and Debt) are Critical to the Economy

Without promises, it is hard to get anyone to do anything that they really don’t want to do. Think about training your dog. The way you usually do this training is with “doggie treats” to reward good behavior. Rewards for desired behavior are equally critical to the economy. An employer pays wages to an employee (a promise of pay for work performed).

It is possible to build a house or a store, stick by stick, as a person accumulates enough funds from other endeavors, but the process is very slow. Usually, if this approach is used, those building homes or stores will provide all of the labor themselves, to try to match outgo with income. If debt were used, it might be possible to use skilled craftsmen. It might even be possible to take advantage of economies of scale and build several homes together in the same neighborhood, and sell them to individuals who could buy the homes using debt.

Adding debt has many advantages to an economy. With debt, a person can buy a new car or house without needing to save up funds. These purchases lead to additional workers being employed in building these new cars and homes, adding jobs. The value of existing homes tends to rise, if other people are available to afford them, thanks to cheap debt availability. Rising home prices allow citizens to take out home equity loans and buy something else, adding further possibility of more jobs. Availability of cheap debt also tends to make business activity that would otherwise be barely profitable, more profitable, encouraging more investment. GDP measures business activity, not whether the activity is paid for with debt, so rising debt levels tend to lead to more GDP.

Webs of Promises and Debt

As economies expand, they add more and more promises, and more and more formal debt. In high tech industries, supply lines using materials from around the world are needed. The promise made, formally or informally, is that if more of a supply is needed, it will be available, at the same or a similar price, in the quantity needed and in the timeframe needed. In order for this to happen, each supplier needs to have made many promises to many employees and many suppliers, so as to meet its commitments.

Governments are part of this web of promises and debt. Some of the promises made by governments constitute formal debt; some of the promises are guarantees relating to debt of other parties (such as nuclear power plants), or of the finances of banks or pensions plans. Some of a government’s promises are only implied promises, yet people depend on these implied promises. For example, there is an expectation that the government will continue to provide paved roads, and that it will continue to provide programs such as Social Security and Medicare. Because of the latter programs, citizens assume that they don’t need to save very much or have many children–the government will provide funding sufficient for their basic needs in later years, without additional action on their part.

What is the Limit to Debt?

While our system of debt has gone on for a very long time, we can’t expect it to continue in its current form forever. One thing that we don’t often think about is that our system or promises isn’t really backed by the way natural system we live in works. Our system of promises has a hidden agenda of growth. Nature doesn’t  have a similar agenda of growth. In the natural order, the amount of fresh water stays pretty much the same. In fact, aquifers may deplete if we over-use them. The amount of topsoil stays pretty much the same, unless we damage it or make it subject to erosion. The amount of wood available stays pretty constant, unless we over-use it.

Nature, instead of having an agenda of growth, operates with an agenda of diminishing returns with respect to many types of resources. As we attempt to produce more of a resource, the cost tends to rise. For example, we can extract more fresh water, if we will go to the expense of drilling deeper wells or using desalination, either of which is more expensive. We can extract more metals, if we use as our source lower grade ores, perhaps with more surface material covering the ore. We can get extract more oil, if we will go to the expense of digging deeper wells is less hospitable parts of the world. We can even use substitution, but that will likely be more expensive yet.

A major issue that most economists have missed is the fact that wages don’t rise in response to this higher cost of resource extraction. (I have shown a chart illustrating that this is true for oil prices.) If the higher cost simply arises from the fact that nature is putting more obstacles in our way, we end up spending more for, say, desalinated water than water from a local well, or more for gasoline than previously. Much of the cost goes into fuel that is burned, or building special purpose equipment (such as a desalination plant or offshore drilling rigs) that will degrade over time. Our system is, in effect, becoming less and less efficient, as it takes more resources and more of people’s time, to produce the same end product, measured in terms of barrels of oil or gallons of water. Even if there are additional salaries, they are often in a different country, around the globe.

At some point, the amount of products we can actually produce starts shrinking, because workers cannot afford the ever-more-expensive products or because some essential “ingredient” (such as fresh water, or oil, or an imported metal) is not available. Since we live in a finite world, we know that at some point such a situation must occur, even if  the shrinkage isn’t as soon as I show it in Figure 2 below.

Figure 1. Author's image of an expanding economy.

Figure 1. Author’s image of an expanding economy.

Figure 2. Author's image of declining economy.

Figure 2. Author’s image of declining economy.

The “catch” with debt is that we are in effect borrowing from the future. It is much easier to pay back debt with interest when the economy is growing than when the economy is shrinking.  When the economy is shrinking, there is less in the future to begin with. Repaying debt from this shrinking amount becomes a problem. Even promises that aren’t formally debt, such as most Social Security payments, Medicare, and future road maintenance become a problem. With fewer goods available in total, citizens on average become poorer.

Governments depend on tax revenue from citizens, so they become poorer as well–perhaps even more quickly than the individual citizens who live in their country. It is in situations like this that richer parts of countries decide to secede, leading to country break-ups. Or the central government may fail, as in the Former Soviet Union.

Which Promises are Least Affected?

Some promises are very close in time; others involve many years of delay. For example, if I bring food I grew to a farmers’ market, and the operator of the market gives me credit that allows me to take home some other goods that someone else has brought, there are some aspects of credit involved, but it is very short term credit. I am being allowed to “run a tab” with credit for things I brought, and this payment is being used to purchase other goods, or perhaps even services. Perhaps someone else would offer some of their labor in putting together the farmers’ market, or in working in a garden, in return for getting some of the produce.

As I see it, such short term promises are not really a problem. Such credit arrangements have been used for thousands of years (Graeber, 2012). They don’t depend on long supply lines, around the world, that are subject to disruption. They also don’t depend on future events–for example, they don’t depend on buyers being available to purchase goods from a factory five or ten years from now. Thus, local supply chains among people in close proximity seem likely to be available for the long term.

Long-Term Debt is Harder to Maintain

Debt which is long-term in nature, or provides promises extending into the future (even if they aren’t formally debt) are much harder to maintain. For example, if governments are poorer, they may need to cut back on programs citizens expect, such as paving roads, and funding for Social Security and Medicare.

Governments and economies are already being affected by the difficulty in maintaining long term debt. This is a big reasons why Quantitative Easing (QE) is being used to keep interest rates artificially low in the United States, Europe (including the UK and Switzerland), and Japan. If interest rates should rise, it seems likely that there would be far more defaults on bonds, and far more programs would need to be cut. Even with these measures, some borrowers near the bottom are already being adversely affected–for example, subprime loans were problems during the Great Recession. Also, many of the poorer countries, for example, Greece, Egypt, and the Ukraine, are already having debt problems.

Indirect Casualties of the Long-Term Debt Implosion

The problem with debt defaults is that they tend to spread. If one major country has difficulty, banks of  many other countries are likely be to affected, because many banks will hold the debt of the defaulting country. (This may not be as true with China, but there are no doubt indirect links to other economies.) Banks are thinly capitalized. If a government tries to prop up the banks in its country, it is likely to be drawn into the debt default mess. Insurance companies and pension plans may also be affected by the debt defaults.

In such a situation of debt defaults spreading from country to country, interest rates can be expected to shift suddenly, causing financial difficulty for those issuing derivatives. There may also be liquidity problems in dealing with these sudden changes. As a result, banks issuing derivatives may need to be bailed out.

There may also be a sudden loss of credit availability, or much higher interest rates, as banks issuing loans become more cautious. In fact, if problems are severe enough, some banks may be closed altogether.

With less credit available, prices of commodities can be expected to drop dramatically. For example, during the credit crisis in the second half of 2008, oil prices dropped to the low $30s per barrel. It was not until after  QE was started in November 2008 that oil prices started to rise again. This time, central banks are already using QE to try to fix the situation. It is not clear that they can do much more, so the situation would seem to have the potential to spiral out of control.

Without credit availability, the prices of most stocks are likely to drop dramatically. In part, this is because without credit availability, it is not clear that the companies listed in the stock market can actually produce very much. Even if the particular company does not need credit, it is likely that some of the businesses on which it depends for supplies will have credit problems, and not be able to provide needed supplies. Also, with less credit availability, potential buyers of shares of stock may not be about to get the credit they need to purchase shares of stock. As a result of the credit problems in 2008, the Dow Jones Industrial Average dropped to $6,547 on March 9, 2009.

Furthermore, lack of credit availability tends to lead to low selling prices for commodities, making production of these commodities unprofitable. Production of these commodities may not drop off immediately, but will in time unless the credit situation is quickly turned around.

Can’t governments simply declare a debt jubilee for all debt, and start over again?

Not that I can see. Declaring a debt jubilee is, in effect, saying, “We have decided to renege on our past promises. In fact, we are letting others renege on their promises as well.” This means that insurance companies, pension plans, and banks will all be in very poor financial situation. Many who depend on pensions will find their monthly checks cut off as well. In fact, businesses without credit availability are likely to lay off workers.

If it is possible to start over, it will need to be on a much more restricted basis. Everyone will be poorer, so there won’t be much of a market for expensive new cars and homes. Instead, most demand will be for will be the basics–food, water, clothing, and fuel for heat. Unfortunately, it is doubtful that prices will be high enough, or the chains of supply robust enough, to again produce fossil fuels in quantity. Without fossil fuels, what we think of as renewables will disappear from availability quickly as well. For example, hydroelectric, wind and solar PV all work as parts of a system. If the billing system is unavailable because banks are closed, or if the transmission system is in need of repair because lines are down and the diesel fuel needed to make repairs is unavailable, electricity may not be available.

As indicated above, demand will be primarily for basics such as food, water, clothing, and fuel for cooking and heating. It will still be possible to use local supply chains, even if long distance supply chains don’t really work well. The challenge will be trying to shift modes of production to new approaches in which goods can be made locally. A major challenge will be training potential farmers, getting needed equipment for them, and transferring land ownership in ways that will allow food to be produced in ways that do not depend on fossil fuels.

Belief in credit will be severely damaged by a debt jubilee. The place where credit will be easy to reestablish will be in places where everyone knows everyone else, and supply lines are short. Debt will mostly be of the nature of “running a tab” when one type of good is exchanged for another. Over time, there may be some long-term trade re-established, but it is likely to be much more limited in scope than what we know today.

Conclusion

Long-term debt tends to work much better in a period of economic growth, than in a period of contraction. Reinhart and Rogoff unexpectedly discovered this point in their 2008 paper “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises.” They remark “It is notable that the non-defaulters, by and large, are all hugely successful growth stories.”

Slowing growth in China is likely to mean that world economic growth is slowing. This will add to stresses, making failure of the system more likely than it otherwise would be. We can cross our fingers and hope that Janet Yellen and other central bankers can figure out yet other ways to keep the system together for a while longer.

oftwominds-Charles Hugh Smith: Who Gets Thrown Under the Bus in the Next Financial Crisis?

oftwominds-Charles Hugh Smith: Who Gets Thrown Under the Bus in the Next Financial Crisis?.

The speculative excesses and political power of Wall Street pose a strategic threat to the Deep State, and as a result a showdown between the Deep State and the surface machinery of governance that has been captured by Wall Street is looming.

The basic idea of the Deep State is that the visible machinery of governance–electoral politics and the Federal Reserve–doesn’t set strategic policy, it ratifies and implements decisions made behind closed doors. In Mike Lofgren’s definition, the Deep State is “effectively able to govern the United States without reference to the consent of the governed as expressed through the formal political process.”

In my analysis, the Deep State is the National Security State which enables a vast Imperial structure that incorporates hard and soft power–military, diplomatic, intelligence, finance, commercial, energy, media, higher education–in a system of global domination and influence.

The Dollar and the Deep State (February 24, 2014)

Ukraine: A Deep State Analysis (February 27, 2014)

Like any other bureaucracy, the Deep State is prone to group-think, the tendency to join the prevailing “herd” in accepting a dominant paradigm and narrative that identifies key dynamics and sets priorities.

Group-think responds to both success and failure. In the case of the Deep State, key elements of the neo-conservative paradigm have been discredited. The Rise and Fall of the Failed-State Paradigm: Requiem for a Decade of Distraction (Foreign Affairs)

(Anyone seeking a public reflection of the current thinking within the Deep State would do well to read Foreign Affairs, with an emphasis on reading between the lines.)

For the sake of argument, let’s assume the leaders of the U.S. Deep State are not complete morons. Granted, that is quite a stretch, given that these are the people who gambled the lives of thousands of American troops and trillions of dollars in treasure on discretionary wars in Iraq and Afghanistan.

But it is also reasonable to assume that the neo-conservatives who naively assumed that residents of Baghdad would not only welcome their foreign liberators with baskets of flowers but would magically reconstruct the social institutions that had been systemically destroyed by Saddam over the previous 30 years–yes, those neo-con nincompoops– have been quietly put to pasture on their mini-estates in Northern Virginia.

In other words, it is reasonable to assume that the Deep State has accepted that “mistakes were made” and flushed those responsible for the previous decade’s disasters.

The Deep State undoubtedly has its own niceties and protocols, but it is by necessity ruthlessly Darwinian: failure is not only always an option, it is inevitable as a systems-level consequence of tightly connected, interactive complex systems; such failures are known as “normal accidents,” catastrophes resulting from seemingly small miscalculations and miscues that cascade into systemic crises.

As a result, incompetence cannot be rewarded lest the Deep State itself suffer the consequences.

The Deep State’s prime directive is to preserve the Deep State itself and the nation it depends on for its survival. My analysis starts by identifying the vectors of dependency. (To the best of my knowledge, I am the first to use this term in this context.) The Deep State depends on the survival of the U.S. nation-state, but the nation-state does not depend on the Deep State for its survival, despite the certainty within the Deep State that “we are the only thing keeping this thing together.”

Strategy is one thing, responding to crisis is another. The surface government (elected officials, regulatory agencies, the Federal Reserve, etc.) responds to crisis in two basic ways: it chooses whatever short-term politically expedient fix reduces the immediate political pain (also known as “kicking the can down the road”) and it sacrifices the interests of politically weak groups to protect its cronies and fiefdoms.

This crisis-response triage requires that somebody gets thrown under the bus. In the 2008 financial crisis, the Fed threw savers and the bottom 95% under the bus to funnel hundreds of billions of dollars–what was previously paid in interest–to the banks to rebuild their broken balance sheets. The Fed also provided limitless liquidity to bank trading desks and financiers to skim billions from carry trades, effectively channeling the nation’s financial resources to enrich its cronies, the top 1/10th of 1%.

The Deep State must take a longer view, and make strategic triage decisions. All sorts of people, groups and policies are routinely tossed under the bus–foreign leaders, resistance groups, civil liberties, etc.–as the Deep State adjusts to long-term developments and crises with strategic consequences.

Many Deep State decisions and policies are barely noticed, even though they are completely public. For example, the U.S. Deep State recognized that the dissolution of the Soviet Union opened an extremely dangerous door to nuclear weapons falling into non-state hands. So the U.S. spent tens of billions of dollars helping secure the thousands of Soviet nuclear weapons left in limbo after the breakup.

Though the Deep State’s institutional bias is to focus on conventional national security issues, it must also monitor potential strategic threats created by issues such as climate change, immigration and Peak Cheap Oil. The financial crisis was apparently an unexpected and unwelcome distraction from the geopolitical Great Game, and the response of the Deep State was muted.
while the surface policies of the Federal Reserve and Federal government appear to serve the interests of the financial Elites, I am beginning to discern the possibility of a strategic Deep State response to the next (and inevitable) financial crisis.

This crisis is simple to summarize: the paper claims on wealth so far exceed actual wealth that something’s gotta give. These claims include trillions of dollars in shadow-banking bets (derivatives and other leveraged claims all teetering on a tiny base of real collateral) and trillions of dollars in debt-based claims on future income.

Simply put, the vast majority of these claims will have to be zeroed out, i.e. these phantom-claim “assets” will be voided and declared worthless. This leads to the key question: who will the Deep State throw under the bus to preserve itself and the nation-state?

Once again, identifying the vectors of dependency clarifies the strategic priorities. As I pointed out in The Dollar and the Deep State, the pre-eminence of both the Deep State and the U.S. nation-state depend on the U.S. dollar remaining the key reserve currency in the global economy.

The collapse of the U.S. dollar would destroy the foundation of both the Deep State and the U.S. nation-state, hence my conclusion that the Deep State will not enable that collapse.

As for all the financial claims on real wealth that will have to go to zero value, let’s identify the operative vector of dependency with a question: which scenario most threatens the Deep State: 50 million hungry Americans taking to the streets shouting, “we’re mad as hell and we’re not going to take it any more!” or 10,000 financiers losing a couple trillion dollars in phantom wealth?

In other words, the phantom financier claims of Wall Street now pose a strategic threat to the integrity of the U.S. and its Deep State.

The Deep State needs a functioning U.S. nation-state, and a mass uprising arising from the collapse of the state cannot be suppressed with a few whiffs of grapeshot. The collapse of global pre-eminence and state financing of food stamps and other social welfare programs directly threaten the Deep State.

The collapse of financier fortunes? While that would hurt some Yalie cronies, the Deep State is not Wall Street; it attracts those who prefer power to wealth and strategy to trading. I have no doubt whatsoever that the leadership of the Deep State would have no qualms about throwing bankers and financiers under the bus once they pose a strategic threat to the U.S. dollar and other financial interests vital to the Deep State, for example, keeping 300 million Americans distracted, placated and docile.

It’s certainly not lost on the Deep State that a palpable hatred of bankers, financiers and the Federal Reserve is taking root across the land. I know this is outside the mainstream, but I think it is increasingly likely that the financial system’s skimmers and swindlers are being recognized as potential strategic threats to the Deep State.

What is essential to the Deep State’s survival and supremacy and what is not essential? Are 10,000 obscenely wealthy financiers essential? No. Between saving the U.S. dollar and making whole the $100 trillion in nominal-value bets made by financiers in offshore shadow-banking accounts–there’s no contest.

Conventional wisdom has it that Wall Street dominates the state and the Fed. To the degree that these formal surface institutions can be influenced by lobbying, campaign contributions and plum positions, this is true. But these surface institutions only ratify and implement Deep State directives.

I know this sounds “impossible” within conventional narratives, but I am increasingly confident that the financiers’ phantom claims on real wealth will be thrown under the bus in the next global financial crisis. Look at it this way: there’s essentially nothing left to stripmine from the bottom 80%; most have been reduced to neofeudal debt-serfdom. Since the survival of the nation-state depends on the 80% remaining either passive or productive, the Deep State has a vital strategic interest in both the U.S. dollar and in maintaining the social welfare programs that enable the bottom 80%’s survival.

The Three-and-a-Half Class Society (October 22, 2012)

The Deep State also needs the top 20% to remain productive to maintain U.S. soft and hard power. Transferring trillions of dollars in real wealth to make good the claims of the financier class would require the stripmining of the whatever assets the top 20% still hold. This transfer would directly threaten both the nation-state and the Deep State.

The dominance of Wall Street over the formal, visible machinery of governance has persuaded many that Wall Street is the Deep State. I believe this is a serious misread of the real Deep State. As I noted in The Dollar and the Deep State, to even discern the outlines of the Deep State requires a senior military position or national-security civilian equivalent.

Those writing knowledgeably about Wall Street and finance typically show near-zero knowledge of high-echelon U.S. military and national-security assets, policies and networks, so this blind spot is understandable.

It’s widely assumed that Wall Street rules the roost in both the mainstream financial media and in the alternative financial blogosphere. In my view, the speculative excesses and political power of Wall Street pose a strategic threat to the Deep State, and as a result a showdown between the Deep State and the surface machinery of governance that has been captured by Wall Street is looming.

Though everyone who is convinced the U.S. dollar will go to zero is confident that Wall Street will emerge victorious from the next financial crisis, I am convinced of the opposite: the Deep State will do whatever it takes to eliminate strategic threats to the integrity of the Deep State and the nation it depends on for its power and survival. In a financial crisis that threatens the dollar and the Deep State, the phantom claims of Wall Street’s financier skimmers, scammers and swindlers will be tossed under the bus with few qualms. The triage might even be performed with a certain relish.

Put another way: we’ve reached Peak Wall Street and it’s all downhill from here.

Why the Crowd Is About to Get Destroyed in US Stocks |

Why the Crowd Is About to Get Destroyed in US Stocks |.

February 27, 2014 | Author 

Debt – the Name of the Game

Dow down a bit on Tuesday. Gold up a bit. The upward trend of US stocks – and now gold – has not yet been broken. Looking broadly at major trends of the last 50 years, debt was the name of the game from 1980 to 2007. Is it still the most important thing?

From about 160% of GDP in 1980, total debt in the US rose to about 360%. That was a big deal. Not the least because it meant that US businesses availed trillions of dollars in income with no offsetting labor charge.

Stocks, earnings, GDP, employment – with all this borrowed money flowing into the economy, the whole shebang looked good.

Dr. Jekyll, Meet Mr. Hyde

As we’ve been saying, debt may be the kindly Dr. Jekyll when it is expanding. But it becomes maniacal when it contracts. Mr. Hyde showed up in 2008, and the party was over. The US went into a debt contraction. We’ve been living with it ever since. Until the last quarter of last year, the private sector was either paying down or defaulting on its debt.

But since 2008, we’ve also lived with ambiguity, split personalities and confusion. As households and businesses deleveraged, Washington leveraged up. The feds added nearly $7 trillion in debt after 2007. Overall, debt to GDP shrank… but not much. The tally fell from 360% of GDP down to 345%.

Deleveraging was the market’s natural reaction to excess debt. QE was the unnatural and monstrous response of the Fed. It expanded its balance sheet to reach a staggering $4 trillion, as it tried desperately to keep the EZ credit flowing. From a recent Bank of America Merrill Lynch research report:

 

“The US Fed’s modus operandi worked through asset prices, and animal spirits. This involved getting stock prices up, getting corporate animal spirits up by issuing cheap debt, buying back stock with cash or cheap debt to raise EPS, lowering government borrowing and mortgage costs, and raising consumer net worth/income ratios. Also, asset bubbles were generated in emerging markets, raising their growth, labor costs and currencies.”

 

Sharp operators followed the Fed like vultures trailing a sick cow. They borrowed at the Fed’s ultra-low rates… and bought stocks, real estate, contemporary art and emerging market debt. Anything that promised a higher yield than was available in the Treasury market.

 

Monetary Mambo

QE has been the name of the game since 2008. But QE helped Wall Street, not Main Street. Just look at charts of shipping indexes, real wages or the velocity of money. You see lines that head down in 2008… and don’t come back up. In recent Diary entries, we’ve focused on two factors that weigh heavily on the economy: debt and demography.

And we warned that these two factors will weigh heavily on US stocks prices. But we also noticed a possible spoiler – no prediction based on history has ever included the effects of QE or Janet Yellen! Eventually, everything normalizes. Eventually, we will almost certainly be right about stock market performance. But eventually can still be a long way into the future. Which brings us to our updated, revised, and improved outlook:Remember our prediction six years ago?

“Tokyo, then Buenos Aires,” we said.

The idea was that the US economy would stay in deleveraging mode for “7 to 10 years”… and then, it would be off to the races. We suspected that the feds would get tired of Tokyo. We figured they’d be ready for some Latin-style action – a little central bank salsa… a bit of monetary mambo.

We predicted that QE wouldn’t work… and that the Fed would want to be more activist – probably by giving up on QE and directly intervening in the money supply (which it is currently constrained from doing; the effects of QE are limited to boosting only the monetary base).

So, what have we learned in the last six years? How has our view changed?

The answer to both questions is “not much.” As we guessed, an aging, deeply indebted, zombie-ridden economy will not improve by adding more debt. Instead, it is doomed to follow Japan down that long, lonesome road of low consumer prices, low growth and high debt.

This road leads to eventual destruction. But when? And how?

In the US, as in Japan, QE does not help stimulate a real recovery. But it does help simulate one. House prices are up (thanks, in part, to ultra-low mortgage rates). The middle class has more “wealth” (albeit the paper kind) due to gains in their stock market portfolios. The rich are feeling fat and sassy, too.

The Fed can continue modest tapering. But this is likely to produce a sell-off in the stock market. Then the Fed will stop tapering. But it will be too late to reverse the damage to equities. They will go down for many years… bringing us even closer to the Japanese model. Our guess now is that this situation will persist for a few years. As long as the pain is tolerable, the Fed will not be so bold as to abandon QE or take up more daring measures.

Tokyo today. Tokyo tomorrow. After tomorrow… we’ll see.

 


 

The above article is from Diary of a Rogue Economist originally written for Bonner & Partners.

Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.

 

USAWatchdog Discusses Economic Collapse With Alt-Market’s Brandon Smith

USAWatchdog Discusses Economic Collapse With Alt-Market’s Brandon Smith.

 

Wednesday, 26 February 2014 09:44 USAWatchdog.com

The following video was produced by USAWatchdog.com

I recently participated in an interview with Greg Hunter of USAWatchdog.com, a website which focuses primarily on the continuing financial crisis around the globe.  The information I briefly cover can be studied in depth in my article The Final Swindle Of Private American Wealth Has Begun, which deals with the likelihood of our current fiscal collapse becoming far more visible this year, if not fully developed.  Greg Hunter’s full article on the interview can be read here:

http://usawatchdog.com/debt-default-will-kill-the-dollar-brandon-smith/

USAWatchdog.com is a great resource for the liberty minded and economically concerned, and I highly recommend that you add it to your favorites if you haven’t already.

 

Emerging Markets Crisis – It’s Not Over Yet |

Emerging Markets Crisis – It’s Not Over Yet |

February 20, 2014 | Author 

Economic and Political Quagmires

We want to briefly take another look at the situation in four of the emerging market countries that have recently been the focus of considerable market upheaval. The countries concerned are Turkey, Venezuela, Argentina and South Africa. There are considerable differences between these countries. The only thing that unites them is a worrisome trend in their trade and/or current account balances and the recent massive swoon in their currencies as foreign investors have exited their markets (this in turn has pressured the prices of securities). There is currently an economic and political crisis in three of the four countries, with  South Africa the sole exception.

However, even South Africa is feeling the heat from the fact that it has a large current account deficit and the ongoing exodus of foreign investors from emerging markets. However, the country is actually used to experiencing vast fluctuations in foreign investment flows in short time periods and has the potential to relatively quickly turn its balance of payments position around. Of the four countries in question, it seems to us to be the most flexible one in this respect.

Argentina and Venezuela

Argentina and Venezuela are special cases in that their trade resp. current account positions are actually comparatively stronger, but the economic policies pursued by their governments are so utterly harebrained and repressive that everybody tries to get their money out as quickly as possible. The immediate problem is that both countries are being drained of foreign exchange reserves at an accelerating clip, inter alia a result of trying to keep their exchange rates artificially high. This is actually quite astonishing considering their considerable latent export prowess.

Both countries have governments that steadfastly deny the existence of economic laws and apparently genuinely believe that their absurd repressive decrees can ‘fix’ their economies. The markets regard Argentina as the slightly greater credit risk, as it is still fighting the so-called ‘hold-outs’ from its 2001 default. However, Venezuela is lately catching up, in spite of its vast oil wealth. The two countries currently have the dubious distinction of being the nations with the highest probability of sovereign debt default in the world – not even the crisis-ridden Ukraine comes remotely close (see chart of CDS spreads further below for details).

We have recently discussed the deteriorating situation in Venezuela in some detail and a more in-depth update on Argentina is in the works. Let us just note here that Argentina (the government of which is incidentally the fiercest supporter of Venezuela’s president Maduro at the moment) seems to be where Venezuela was about a year or so ago. Both countries are on the same path of inflationism and growing economic and financial repression.


argentina-balance-of-trade

Argentina’s balance of trade remains positive – click to enlarge.


argentina-current-accountHowever, the current account balance has begun to deteriorate. The country’s foreign exchange reserves have collapsed due to a doomed attempt to defend the exchange rate – click to enlarge.


venezuela-balance-of-tradeVenezuela is a big oil exporter, but needs to import 70% of the consumer goods sold in the country. Its balance of trade is therefore deeply negative, especially as the state-run (‘very, very red’) PDVSA is being run into the ground and produces less and less oil – click to enlarge.


venezuela-current-accountIn spite of reporting a positive current account balance, Venezuela is losing foreign exchange reserves fast, due to trying to maintain an artificially high exchange rate even in the face of soaring inflation – click to enlarge.


In Venezuela’s and Argentina’s case, the markets are rightly worried that the situation will probably deteriorate further. The intransigence of their governments with regard to pursuing economic policies that demonstrably don’t work and the resultant growing political risks conspire to create a highly unstable backdrop. As in all such cases, one must expect knock-on effects to emerge elsewhere.

Turkey

Turkey has been hailed as a shining example of how an emerging economy should grow, but as is so often the case, it has in the meantime become evident that what it has mainly done was to engage in a massive credit-financed boom, displaying all the associated bubble activities, malinvestment of capital and overconsumption. This unsustainable boom was exacerbated by the fact that the Erdogan government pressured the central bank to keep rates extremely low. Even while prices were obviously misbehaving, with the rate of change of CPI oscillating between about 6.2% and nearly 11% and the stock market rising in parabolic fashion, the central bank kept its repo rate in the low single digits (this has only very recently changed).

With his country in the middle of a serious economic crisis, Erdogan has come under fire politically because his government has turned out to be a den of corruption to boot. So what does he do? He is taking a leaf from what the Western nations have demonstrated to be de rigeur these days, since don’t you know, we’re all surrounded by evil terrorists hiding in caves in the Hindu Kush somewhere. In short, he is moving toward increasingly authoritarian rule. Just take a look at this recent press report:

“Battling a corruption scandal, Turkish Prime Minister Tayyip Erdogan is seeking broader powers for his intelligence agency, including more scope for eavesdropping and legal immunity for its top agent, according to a draft law seen by Reuters.

The proposals submitted by Erdogan’s AK Party late on Wednesday are the latest in what his opponents see as an authoritarian backlash against the graft inquiry, after parliament passed laws tightening government control over the Internet and the courts this month.

The bill gives the National Intelligence Organisation (MIT) the authority to conduct operations abroad and tap pay phones and international calls. It also introduces jail terms of up to 12 years for the publication of leaked classified documents. It stipulates that only a top appeals court could try the head of the agency with the prime minister’s permission, and would require private companies as well as state institutions to hand over consumer data and technical equipment when requested.

“This bill will bring the MIT in line with the necessities of the era, grant it the capabilities of other intelligence agencies, and increase its methods and capacity for individual and technical intelligence,” the draft document said.

(emphasis added)

The ‘necessities of the era‘ – we couldn’t have put it in a more Orwellian fashion. And guess what? The vaunted ‘defenders of freedom’ in the West probably aren’t going to object for even a millisecond.

Turkey’s economy is a shambles right now, and Erdogan wants to cling to power by any means possible – that is what the ‘necessities of the era’ are really all about. For a long time it was held that the world as a whole was moving toward more, rather than less freedom. We regret to inform you that this trend has reversed more than a decade ago, on the day the WTC towers crumbled.

Meanwhile, what is now also crumbling is Turkey’s economy. However, we would argue that Turkey’s economic situation isn’t ‘unfixable’ if the proper policies are implemented quickly. After all, there has been a very successful period of economic liberalization under Erdogan’s government as well, which has left the economy more flexible and thus better able to deal with adverse developments. A wrenching adjustment is nevertheless unavoidable at this point.


turkey-current-accountTurkey has a large current account deficit. The fact that foreign investment inflows have now dried up is putting enormous strain on the economy. Consumer confidence has plunged, as has the currency – click to enlarge.


turkey-inflation-cpiDuring a time when inflation remained stubbornly high, the central bank left its repo rate at 4% – click to enlarge.


As one analyst sagely remarked:

“From 2009 to 2013, Turkey was considered by many to be a rising star among the emerging markets, but currently it may be the triggering force for worsening the emerging-market outlook globally in 2014.”

South Africa

South Africa’s case is in many ways comparable to Turkey’s – the country also sports a large current account and trade deficit for example. However, while South Africa’s CPI ‘inflation’ rate has always been high by developed country standards, it has on average been much lower and less volatile than Turkey’s, fluctuating between 5% and 6.4% in recent years. Contrary to Turkey’s central bank, South Africa’s central bank is fiercely independent and focused solely on keeping CPI in check. In fact, it may well be one of the world’s most conservative central banks. It also refuses to intervene in the currency market and allows the Rand to go to wherever market forces push it. This non-intervention policy was actually quite difficult to defend while the Rand was among the world’s strongest currencies during the emerging markets boom of the 2000d’s. A plethora of special interests in South Africa were pleading with the central bank to do something to weaken the Rand, but it remained steadfast.

While the current account deficit means that more currency weakness is probably in store, South Africa does have a vibrant export sector. During the apartheid years, it had a perennial trade surplus, partly a result of being forced to conserve foreign exchange reserves in the face of economic sanctions. Similar to Turkey, South Africa imports all the oil it uses, which is a key vulnerability of both countries. However, the weakening of the Rand already has an effect: the trade balance has recently turned positive for the first time since 2010.


south-africa-current-account

South Africa’s current account is still deeply in the red – click to enlarge.


south-africa-balance-of-trade

However, a trade surplus has begun to emerge on the back of the weaker Rand – click to enlarge.


Investors in emerging markets like to use the Rand as a hedge for EM currency exposure, due to its relatively good liquidity and the fact that the central bank isn’t going to intervene directly. At times this fact probably exacerbates the moves in the Rand.

The political situation in South Africa is almost always somewhat dubious, and the  Zuma presidency is no exception to that rule. There is a lot of corruption and quite a few economic policy decisions appear to us to be misguided. One must keep in mind in this context that the ANC government is continually under pressure to deliver an improvement in living standards to the formerly oppressed parts of the population, which often leads to the adoption of populist positions that are not economically sensible.

However, there exist also many misconceptions about SA and the ANC’s political legacy in the West. In spite of being formally allied with the communists (SACP) and the trade union umbrella body COSATU, the ANC has for instance privatized many of the companies that used to be state-owned under the national-socialist regime of the National Party (NP) that ruled the country during the apartheid years (a funny aside to this: the NP has dissolved itself and has been amalgamated with the ANC a few years ago). One slightly worrisome development is that the government deficit has grown sharply since 2010. While the government previously ran an almost balanced budget, the annual deficit amounted to more than 5% of GDP over the past four years. Nevertheless, due to the tight fiscal policy implemented previously, the public debt-GDP ratio is still below 40% – a number most developed countries can only dream of.

Sovereign Credit Risk


CDS Turkey, Argentina, Venezuela, SA5 year CDS spreads on the sovereign debt of Argentina, Venezuela, South Africa and Turkey. Keep in mind that the scaling is different for each of the data series – click to enlarge.


As can be seen above, the markets consider Turkey the second-smallest sovereign credit  risk among the four nations at the moment.  Its debt-to-GDP ratio is very similar to South Africa’s, at just 36%. The budget deficit has fluctuated between 2.8% and 5.5% of GDP over the past four years. Both data points are however what we would term ‘remnants of the bubble’, as the government’s tax revenues soared along with the economic boom. With the boom faltering, a sharp deterioration in these data points should be expected.

South Africa is actually in a slightly better position in this regard, as it has not experienced comparable boom conditions. Consequently the fact that the CDS spread on its sovereign debt is actually slightly below that of Turkey makes sense.

Argentina is currently considered the worst sovereign credit risk in the world – not least due to the fact that its foreign exchange reserves have declined dramatically and the trend is ongoing.


argentina forex reservesArgentina’s reserves are falling sharply – click to enlarge.


This throws more and more doubt on the country’s ability to service its foreign debt, which in the light of the 2001 default and its aftermath has made the markets wary. 5 year CDS spreads at 2,206 basis points reflect a great deal of risk (this represents an annual default probability of roughly 17% at an assumed 40% recovery rate).

Venezuela is lately catching up – its 5 year sovereign CDS spreads have soared to  almost 1,700 basis points from less than 1,200 at the end of last year. This is testament to the fact that the economy has begun to implode under the Maduro government. While Maduro himself is just as bad as Chavez was in terms of economic policy, it should be pointed out that Chavez’ policies are what laid the foundations for current events. It has taken a while for this South America-style goulash-socialism to fail, as it allowed a remnant of the market economy to operate most of the time. However, the impositions on the private sector have simply become too onerous and galloping inflation has delivered the coup de grace, as economic calculation has become extremely distorted, if not nigh impossible.

Conclusion:

The crisis in emerging market economies vulnerable to capital flight is unlikely to be over. Note that we have picked merely four cases, but there are several other developing countries that are currently in various states of political and economic crisis as well (e.g. India, Thailand, Brazil, to name a few). We have looked the two worst cases here, one of medium severity (Turkey) and one of the better cases (South Africa) in order to present as broad an overview as possible. The fate of Argentina and Venezuela is up in the air – it will require massive political change to alter their prospects.

However, other emerging market economies are bound to eventually bounce back and exhibit strong economic growth again. The imbalances can all be overcome, but the adjustments required are liable to play out in the form of economic and financial market crises of varying severity.

One must not forget in this context that Japan continues to pursue a mercantilist currency policy, which redounds on its competitors in Asia, which in turn affects their main suppliers. We continue to believe that Japan’s decision to weaken the yen has been a major contributor to recent currency turmoil elsewhere (of course, this does not mean that many of the countries concerned have not been wanting in terms of their own policies).

Moreover, China is hanging over the proceedings like the proverbial Sword of Damocles. HSBC has just reported its latest flash estimate on China’s manufacturing PMI (pdf), which was quite weak at 48.3, a seven month low  indicating a worsening contraction. In view of the enormous credit bubble which China has embarked on since 2008 (about $15 trillion in additional debt have been created since then), the danger of a larger setback being set in motion by a sharp slowdown or even recession in China cannot be dismissed.

Charts by: Tradingeconomics, Reuters, Bloomberg

Can the Markets Crash? | Zero Hedge

Can the Markets Crash? | Zero Hedge.

This is the trillion-dollar question. From a common sense perspective, the simple answer is “absolutely!”

 

Since 1998, the markets have been in serial bubbles and busts, each one bigger than the last. A long-term chart of the S&P 500 shows us just how obvious this is (and yet the Fed argues it cannot see bubbles in advance?).

 

 

Moreover, we’ve been moving up the food chain in terms of the assets involved in each respective bubble and bust.

 

The Tech bubble was a stock bubble.

 

The 2007 bust was a housing bubble.

 

This next bust will be the sovereign bond bubble.

 

Why does this matter?

 

Because of the dreaded “C word” COLLATERAL.

 

In 2008, the world got a taste of what happens when a major collateral shortage hits the derivatives market. In very simple terms, the mispricing of several trillion (if not more) dollars’ worth of illiquid securities suddenly became obvious to the financial system.

 

This induced a collateral shortfall in the Credit Default Swap market ($50-$60 trillion) as everyone went scrambling to raise capital or demanded new, higher quality collateral on trillions of trades that turned out to be garbage.

 

This is why US Treasuries posted such an enormous rally in the 2008 bust (US Treasuries are the highest grade collateral out there).

 

Please note that Treasuries actually spiked in OCTOBER-NOVEMBER 2008… well before stocks bottomed in March 2009.

 

 

The reason?

 

The scrambling for collateral, NOT the alleged “flight to safety trade” that CNBC proclaims.

 

WHAT DOES THIS HAVE TO DO WITH TODAY?

 

The senior most assets backstopping the $600 trillion derivatives market are SOVEREIGN BONDS: US Treasuries, Japanese Government Bonds, German Bunds.

 

By keeping interest rates near zero, and pumping over $10 trillion into the financial system since 2007, the world’s Central Banks have forced investors to misprice the most prized collateral backstopping the entire derivatives system: SOVEREIGN BONDS.

 

SO what happens when the current bond bubble bursts and we begin to see bonds falling and yields rising?

 

Another collateral scramble begins… this time with a significant portion of the interest rate derivative market (over 80% of the $600 TRILLION derivative market) blowing up.

 

At that point, rising yields is the last thing we need to worry about. The assets backstopping a $600 trillion market themselves will be falling in value… which means that the real crisis… the crisis to which 2008 was the warm up, will be upon us.

 

This is why Central Banks are so committed to keeping rates low. This is also why all Central Bank policy has largely benefitted the large financial institutions (the Too Big To Fails) at the expense of Main Street…

 

THE CENTRAL BANKS AREN’T TRYING TO GROW THE ECONOMY, THEY’RE TRYING TO PROP UP THE FINANCIAL INSTITUTIONS’ DERIVATIVE TRADES.

 

They will fail eventually. When they do, the markets will experience yet another terrible collapse even worse than that of 2008.

 

For a FREE Special Report on how to prepare your portfolio for this, visit us at:

 

http://phoenixcapitalmarketing.com/special-reports.html

 

Best Regards

 

Phoenix Capital Research

Activist Post: 20 Signs That The Global Economic Crisis Is Starting To Catch Fire

Activist Post: 20 Signs That The Global Economic Crisis Is Starting To Catch Fire.

Michael Snyder
Activist Post

If you have been waiting for the “global economic crisis” to begin, just open up your eyes and look around.  I know that most Americans tend to ignore what happens in the rest of the world because they consider it to be “irrelevant” to their daily lives, but the truth is that the massive economic problems that are currently sweeping across Europe, Asia and South America are going to be affecting all of us here in the U.S. very soon.

Sadly, most of the big news organizations in this country seem to be more concerned about the fate of Justin Bieber’s wax statue in Times Square than about the horrible financial nightmare that is gripping emerging markets all over the planet.  After a brief period of relative calm, we are beginning to see signs of global financial instability that are unlike anything that we have witnessed since the financial crisis of 2008.  As you will see below, the problems are not just isolated to a few countries.  This is truly a global phenomenon.

Over the past few years, the Federal Reserve and other global central banks have inflated an unprecedented financial bubble with their reckless money printing.  Much of this “hot money” poured into emerging markets all over the world.  But now that the Federal Reserve has begun “tapering” quantitative easing, investors are taking this as a sign that the party is ending.  Money is being pulled out of emerging markets all over the globe at a staggering pace and this is creating a tremendous amount of financial instability.  In addition, the economic problems that have been steadily growing over the past few years in established economies throughout Europe and Asia just continue to escalate.

The following are 20 signs that the global economic crisis is starting to catch fire…

#1 The unemployment rate in Greece has hit a brand new record high of 28 percent.

#2 The youth unemployment rate in Greece has hit a brand new record high of 64.1 percent.

#3 The percentage of bad loans in Italy is at an all-time record high.

#4 Italian industrial output declined again in December, and the Italian government is on the verge of collapse.

#5 The number of jobseekers in France has risen for 30 of the last 32 months, and at this point it has climbed to a new all-time record high.

#6 The total number of business failures in France in 2013 was even higher than in any year during the last financial crisis.

#7 It is being projected that housing prices in Spain will fallanother 10 to 15 percent as their economic depression deepens.

#8 The economic and political turmoil in Turkey is spinning out of control.  The government has resorted to blasting protesters with pepper spray and water cannons in a desperate attempt to restore order.

#9 It is being estimated that the inflation rate in Argentina is now over 40 percent, and the peso is absolutely collapsing.

#10 Gangs of armed bandits are roaming the streets in Venezuela as the economic chaos in that troubled nation continues to escalate.

#11 China appears to be very serious about deleveraging. The deflationary effects of this are going to be felt all over the planet. The following is an excerpt from Ambrose Evans-Pritchard’s recent article entitled “World asleep as China tightens deflationary vice“…

China’s Xi Jinping has cast the die. After weighing up the unappetising choice before him for a year, he has picked the lesser of two poisons.

The balance of evidence is that most powerful Chinese leader since Mao Zedong aims to prick China’s $24 trillion credit bubble early in his 10-year term, rather than putting off the day of reckoning for yet another cycle.

This may be well-advised for China, but the rest of the world seems remarkably nonchalant over the implications.

#12 There was a significant debt default by a coal company in China last Friday

A high-yield investment product backed by a loan to a debt-ridden coal company failed to repay investors when it matured last Friday, state media reported on Wednesday, in the latest sign of financial stress in China’s shadow bank sector.

#13 Japan’s Nikkei stock index has already fallen by 14 percent so far in 2014.  That is a massive decline in just a month and a half.

#14 Ukraine continues to fall apart financially

The worsening political and economic circumstances in Ukraine has prompted the Fitch Ratings agency to downgrade Ukrainian debt from B to a pre–default level CCC. This is lower than Greece, and Fitch warns of future financial instability.

#15 The unemployment rate in Australia has risen to the highest level in more than 10 years.

#16 The central bank of India is in a panic over the way that Federal Reserve tapering is affecting their financial system.

#17 The effects of Federal Reserve tapering are also being felt in Thailand

In the wake of the US Federal Reserve tapering, emerging economies with deteriorating macroeconomic figures or visible political instability are being punished by skittish markets. Thailand is drifting towards both these tendencies.

#18 One of Ghana’s most prominent economists says that the economy of Ghana will crash by June if something dramatic is not done.

#19 Yet another banker has mysteriously died during the prime years of his life.  That makes five “suspicious banker deaths” in just the past two weeks alone.

#20 The behavior of the U.S. stock market continues to parallel the behavior of the U.S. stock market in 1929.

Yes, things don’t look good right now, but it is important to keep in mind that this is just the beginning.

This is just the leading edge of the next great financial storm.

The next two years (2014 and 2015) are going to represent a major “turning point” for the global economy.  By the end of 2015, things are going to look far different than they do today.

None of the problems that caused the last financial crisis have been fixed.  Global debt levels have grown by 30 percent since the last financial crisis, and the too big to fail banks in the United States are 37 percent larger than they were back then and their behavior has become even more recklessthan before.

As a result, we are going to get to go through another “2008-style crisis”, but I believe that this next wave is going to be even worse than the previous one.

So hold on tight and get ready.  We are going to be in for quite a bumpy ride.

Ponzi World (Over 3 Billion NOT Served): Buy The Fucking Collapse (BTFC)

Ponzi World (Over 3 Billion NOT Served): Buy The Fucking Collapse (BTFC).

Aside from the totally asinine and impossible strategy of attempting to borrow the global economy out of a debt crisis, we currently face a staggering array of risks unprecedented in modern history. Fortunately, the Idiocracy is fat and happy, comforted by the abiding assumption that printing money is the secret to effortless wealth…

 

MAXIMUM RISK
 
The Log Periodic Bubble formation called for a top by mid-January, which is exactly when the current top occurred in the S&P 500 (even earlier in the Dow – see below).
 
The maximum reading in the Greedometer, confirms the log periodic wave formation. 
 
And then there are all of the other risk factors simmering in the background (NYSE margin at record high, carry trades unwinding, Fed tapering, bullish sentiment @26 year high, lack of hedging, IPO speculation, earnings valuation, sector correlation, low volume, HFT glitches) etc. etc. 
 
The Week In Review: Still Buying the Dip with Both Hands
Once the HFT bots figured out that Friday’s weak employment report may mean a slowing of Fed tapering, they ramped the futures, driving massive short-covering and the obligatory sell-off in Japanese Yen.
Still, for the week, the markets were just barely positive and by no means recovered overall losses for the past two weeks. Bulls have expended a huge amount of firepower to basically get them back at the same level they were at last Friday. It took a mere 8 trading days to wipe out 3 and half months of upside gains, as volume doubled on the down days.
Dow Casino: 
The Dow hit its 200 DMA (red line) for only the second time in a year. It’s currently still well below the 50 DMA (blue line)
Russell 2000
The R2K small cap index was the leading market index since 2009. It is now dramatically underperforming and the past week’s rally barely made a dent.
Emerging Markets Death Cross
The 50 DMA crossing over the 200 DMA
The Fadebook Indicator: 100 P/E stock trading @ the whim of teenage girls
Facebook is still leading the market. Unbelievable
These are early days for this market “sell-off”:
 
 
Full Casino In the Casino
Go All In @WYNN
Walmart can’t meet estimates, but casinos are rocking…
 
 
Much Ado About Nothing
Here is some perspective for those getting all lathered up about this rally. The Nasdaq is still over a thousand points below where it was @Y2K. Unbelieveable. 
Skydiving Without a Parachute
CBOE Index Put/call ratio (50 DMA)
The reason why this collapse will go further and faster than anyone can predict
It’s hard to put a parachute on in mid-air…
 
It’s still going down…
 
BitCasino
Not This Again !
 
Lurching Towards the Minsky Moment
Of course, the stock market is merely a side show – a barometer of social mood and risk appetite. The real money is in the bond (credit) markets. As the various speculative excesses unwind during this collapse, one by one we will find out who has been taking the fullest advantage of 0% interest rates and printed money. Like dominoes falling, it will start in one region and spread like an epidemic. Asset “re-pricing” will reveal underlying insolvency that has been papered over solely by asset price levitation.
 
The Elliot Straight Down Wave (ESDW)
– “In the broadening top formation five minor reversals are followed by a substantial decline.”
– “most of the selling is completed in the early stage by big players and the participation is from general public in the later stage.”
– “It is a difficult formation to trade in” [No shit, thanks for sharing]
 
Of course we can only be certain that it’s a broadening top, if the market pierces the floor which is below 666 SPX (i.e. the Lehman Low)…
 

Is the Stock Market Repeating the 1929 Run Up to the Great Depression? Washington’s Blog

Is the Stock Market Repeating the 1929 Run Up to the Great Depression? Washington’s Blog.

Is History Repeating … Or Throwing a Head-Fake?

Chart courtesy of Tom McClellan of the McClellan Market Report (via Mark Hulbert)

Hulbert notes that the chart “has been making the rounds on Wall Street.”

On the other hand, Martin Armstrong predicts that a worsening economy – and bank deposit confiscation – in Europe will cause people to flood into American stocks as a “safe haven” for a couple of years.

And the Fed has more or less admitted that propping up the stock market is a top priority.

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