Tuesday, February 17, 2015

Staring economic reality in the face

David Stockman has given a podcast-format interview to Chris Martenson.  I happen to think it's a very important discussion of our present economic situation, but one part in particular struck me as very profound.  I'll quote it in full from the transcript of the interview.  Please take the time to read it in full.  It really is that important.  Stockman says:

I think the central bank-driven global boom of the last two decades is over. Perhaps it started in 1994 when the Greenspan Fed lost its nerve in the face of that little bond market hiccup and over on the other side of the Pacific, Mr. Deng said, you know, “To be rich is glorious,” and the great China construction and debt boom got underway.

We are now through that, we’re done with that. We’re in the crackup phase. And I think there are four big characteristics of that, which are going to basically shape the way the economy and the markets unfold as we go forward. I think you’re going to see increasing desperation and extreme central bank financial repression because they have gotten themselves painted so deep into the corner that they are lost, they are desperate. And so one, you know, almost week by week, we have another central bank – this week, it was Sweden – lowering their money market rates into negative territory. You know, obviously, the Swiss Bank is already there, Denmark’s Bank is there, the EC is there on the deposit rate, the Bank of Japan’s there. All of the central banks of the world now are desperately driving interest rates into negative territory. And I believe that they’re lost. They are in a race to the bottom whether they acknowledge it or not. You know, the central bank of China can’t sit still much longer when the RMB has appreciated something like 30% against the Japanese yet because of the massive bubble – or monetary expansion – that’s being created there.

So that’s the first thing going on. Central banks out of control in a race to the bottom, sliding by the seat of their pants, making up really incoherent theories as they go. Everybody’s talking about deflation and 2% inflation targets as being some magic elixir. There isn’t a shred of proof anywhere that economies grow better over time at 2% than .8%. It is just made up. So I think that’s the first thing.

The second thing is increasing market disorder and volatility. In the last three months, the stock market has behaved like a drunken sailor but it’s really just a bunch of robots and day traders that are trading chart points until somebody can figure out what is happening directionally in the world. They just keep trading it back to 2090, it bounces off, it takes a dive, they trade it back-up. It has nothing to do with information or incoming data about the real world. We have today the 10-year German bond trading at 29.5 basis points. Well, the German economy’s been reasonably strong, fueled by the Chinese boom. But that export boom is over. The Chinese economy is faltering. Germany is going to soon have its own problems. But clearly, 29 basis points on a 10-year is irrational, even in the case of Germany, to say nothing of the 160 available today on the 10-year for Spain and Italy. Both of those countries are in deep, deep fiscal decline. There is no obvious way for them to dig out of the debt trap that they’re in. It’s going to get worse over time. There’s huge risk in those bonds, especially because there’s no guarantee that the EU will remain intact or the euro will survive. Why in the world would anybody in their right mind be owning Italian debt at 160 other than the fact that they’re front running the massive purchases that Draghi has promised and now the Germans have acquiesced to over the next year or two.

But that only kicks the can down the road. One of these days, the central banks are going to falter and the market is going to reset violently to prices that reflect the true risk on all this sovereign debt and the pretty cloudy outlook that’s ahead for the world market.

We now have something like four trillion worth of sovereign debt spread over Japanese issues, the major European countries that are trading at negative yields. Obviously, that is one, irrational, and second, completely unsustainable. And yet, it’s another characteristic of what I call these disorderly markets.

Thirdly, mal-investment is now coming home to roost. It will be driving a huge deflation of commodity and industrial prices worldwide. You can see that in iron ore, now barely holding $60 from a peak of $200. Obviously, it’s the whole oil patch that we talked about. Look at the Baltic Dry Index. That is a measure, one, of faltering demand for shipments and two, massive overbuilding of bulk carrier capacity as a result of this central bank driven boom that we’ve had in the last 10 to 20 years.

So that is going to be ripping through the financial system, the global economy, in ways that we’ve never before experienced. And so therefore, in ways that are hard to predict what all the ramifications and cascading effects will be. But clearly, it’s something that we haven’t seen in modern times or ever before—the degree of over investment, excess capacity, and everything from iron ore mines to dry bulk carriers, aluminum plants, steel mills, and on down the line.

And then, finally, clearly, demand has run smack up against peak debt, and I think that’s the right word for it. We had a tremendous study come out in the last week or so from McKinsey, who do a pretty good job of trying to calculate and track and tote up the amount of credit outstanding, public and private, in the world. We’re now at the 200 trillion threshold. That’s up from only about 140 trillion at the time of the crisis. So we’ve had a 60 trillion expansion worldwide of debt just since 2008. During that same period, though, the GDP of the world saw a little more than 15 trillion from 55 or mid-50s, roughly, to 70 trillion.

So we’ve generated, because of central bank money printing and all of this unprecedented monetary stimulus, we’ve generated something like 60 trillion of new debt in the world and have barely gotten 15, 17 billion of new GDP for all of that effort. And I think that is a measure of why the fundamental era is changing. That the boom is over and the crackup is under way when you see that kind of minimal yield from the vast amount of new debt that has been generated.

Now I’d only wrap this up by calling attention to the fact that within that global total of 200 trillion, the numbers from China are even more startling. At the time of the crisis, let’s go back to 2000, China had two trillion of credit outstanding. It’s now 28 trillion. So we’ve had just massive 14X growth in 14 years. There’s nothing like that in recorded history nor is there any plausible reason to believe that an economy, which is basically under a command and control system that is run from the top down through the party cadres, could possibly create 26 trillion in new debt in that period of time without massive inefficiencies in waste and mistakes everywhere within the system, especially since they have no markets. They have no feedback mechanisms. It all comes cascading down from the top and everybody lies to the next party above them. And I think the system is irrationally out of control.

In any event, my point was that at the time of the 2008 crisis, China had allegedly – if you believe their numbers, which no one really should – but as reported, they had five trillion worth of GDP;  it’s now ten trillion. So they’ve gained five of GDP. Their debt at the time of the crisis was seven trillion, now it’s 28. So the debt is up more than 20 trillion and the GDP is up five. These are extreme, unsustainable deformations, if I can use that word, that just scream out, “Danger ahead. Mayhem has happened.” And the unwinding of this and the resolution of this is not going to be pretty.

There's more at the link.  Bold, underlined text is my emphasis.  (If you'd prefer to listen to the interview rather than watch it, you'll find it here.)

This is exactly, summarized in a nutshell, what I and many others have been fearing and speaking about for years.  The entire structure of the world economy today can be compared to a financial house of cards.  It's so delicately balanced that any blow or push might collapse it.  It won't just affect one card out of the whole;  they're all so interconnected and mutually supporting that if one goes, the rest must inevitably follow sooner or later.

As just one symptom of the irrationality of the stock market today, consider the grilled cheese truck company that's worth over $100 million according to its stock valuation.  That's about as ridiculous a thing as I've ever heard of . . . but there are investors willing to pay that price for what is, at best, a lunch counter concession.  It's so over the top that 'ridiculous' is actually far too mild a word.  It's insane.  I'll be darned if I trust any market where such unbelievable valuations are attached to a business with less than one hundredth of that sum in actual assets.

Keep your head down, your larder stocked and your powder dry.  I foresee grim times ahead.  The only question is how far ahead . . . and I'm not going to bet on that at all.


1 comment:

JK Brown said...

The real threat is the declining/aging populations. That is because the economists have no idea how an economy works without a growing population. An aging population settles in, buys higher quality stuff, but buys less of it.

This is why we see economists jumping up and down about places like Japan and Europe where the birth rate isn't keeping up the population. In other areas, immigration is hiding the trend. the economists have nothing to explain how such an economy works. Somebody's gonna get a Nobel for figuring it out.

Now declining populations aren't a huge problem normally. People move out if job opportunities can't be sustained and others remain living off their savings. However, in the 20th century, the Welfare State was built up on the premise of an ever increasing number of young workers to keep up the rest. Now, you have a problem in that a decline in workers means a decline in support to those who aren't supporting themselves. Moving doesn't help the latter unless they miraculously go to work.

But now that fertility (late marriage, birth control, abortion) control is kicking in to limit the population growth of the modern world and there are fewer pro-modern parts of the world with expanding populations due to modern elimination of mortality (disease, accident, etc.) population controls, the overall population is likely to stop growing and where it is increasing the people will be in the wrong place.