All the negative things I've said about the economy in recent months and years still apply. We've only just begun the correction that should have happened in 2007/08, but which was pushed out into the future by central banks desperate to preserve whatever semblance of order they could. Consider these recent reports. (Click on their titles to go to the source article.)
The truth about China's dwindling war chest
In order to defend the value of the renminbi, China has shifted from becoming a net buyer, to a net seller of dollar assets. This has sparked concern that Beijing's actions are having an asphyxiating affect on global credit and liquidity conditions.
This phenomena - dubbed "quantitative tightening" - is seen as particularly worrying at a time when China can no longer play its role as the driver of global economic prosperity and when the Federal Reserve is finally poised to start normalising monetary policy.
Reserve depletion has also been coupled with record levels of capital outflows in the wake of the currency regime shift. Outflows hit an unprecedented $142bn in August, as "hot money" has fled the country and ordinary Chinese pull their money out of the financial system to escape the clutches of state capital controls.
World set for emerging market mass default, warns IMF
The IMF said corporate debts in emerging markets ballooned to $18 trillion (£12 trillion) last year, from $4 trillion in 2004 as companies gorged themselves on cheap debt.
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It warned that this could create a credit crunch as risks "spill over to the financial sector and generate a vicious cycle as banks curtail lending".
In a double warning, the IMF said market liquidity, or the ease with which investors can quickly buy or sell securities without shifting their price, was "prone to sudden evaporation", particularly in bond markets, when the Federal Reserve started to raise interest rates.
It said a steady growth environment and "extraordinarily accommodative monetary policies" around the world had helped to maintain a "high level" of liquidity. However, it warned that this was not the same as "resilient" liquidity that could support markets in time of stress.
Gaston Gelos, head of the IMF's global financial stability division, said these factors were "masking liquidity risks" that could trigger violent market swings.
"Liquidity is like the oil in an engine, when there's too little of it, the machine starts stuttering," he said.
Chart: Caterpillar digs hole for world economy
Caterpillar is the perfect proxy for the infrastructure build required to sustain the world economy. When economies are booming, Caterpillar is climbing. The sustained fall in Caterpillar prices indicates a sustained fall in infrastructure investment. This is not just greenfield investment in new infrastructure, road, and mining projects. It's also a decline in brownfields investment in the renewal of ageing infrastructure.
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Caterpillar machinery will continue to be the favorite among earthmovers, but it's a screaming short for traders and a poison pill for investors. It's doubtful if its on the list of Yellen economic indicators, but it should be. The collapse in the Caterpillar price shows a world economy that is slowing, not growing.
The Echo Bubble in Housing Is About to Pop
If we look at the ratio of mortgage debt to household income, the current level is still double the pre-financialization level. A slight decline from the insane levels of the bubble mania do not qualify as sane.
The Fed goosed the Echo Bubble by buying up an insane $1.75 trillion in mortgages, almost 20% of the entire mortgage market in the U.S. The Fed has kept buying mortgages to maintain this level, but the Fed is no longer expanding their mortgage holdings. That well has run dry.
And here's the knife in the heart of the Echo Housing bubble: household income - stagnating for decades for 90% of households - has declined since the Bubble Top when adjusted for inflation. Please explain how declining real income can support nosebleed home prices now that mortgage rates have bottomed and started their inevitable rise from absurdly low levels.
Bill Gross thinks everything sucks
High quality global bond markets offer little reward relative to durational risk. Private equity and hedge related returns cannot long prosper if global growth remains anemic. Cash or better yet "near cash" such as 1-2 year corporate bonds are my best idea of appropriate risks/reward investments. The reward is not much, but as Will Rogers once said during the Great Depression – "I'm not so much concerned about the return on my money as the return of my money."
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Finance based capitalism with its zero bound interest rates has now produced global imbalances that impair productive growth and with it the chances for "old normal" prosperity.
Please note, in particular, Charles Hugh Smith's comments about the housing market, as given above. There are a lot of people living in larger homes, who are relying on the capital they've built up in those homes to fund most of their retirement. They intend to sell them at a substantial profit when the time comes, then reinvest the profits to live on the interest and dividends. Now they're between a rock and a hard place. Many buyers simply can't afford very expensive homes. They're 'buying down', or paying for renovations and extensions to property they already own rather than move up-market. Furthermore, the housing market as a whole is on very shaky ground. With the Federal government underwriting much of the US mortgage market through the Federal Housing Administration, and the Federal Reserve (until recently) buying up a vast proportion of the more risky mortgages out there, the housing market was effectively backstopped by the government. The latter program has now ended, and ongoing funding for the former is by no means guaranteed.
I'm staying well away from the property market for now. If you're planning to sell your home, I repeat my earlier advice to do so as quickly as possible, and if necessary accept a lower price rather than be stuck with something you can't sell at all when things collapse.
I've taken the following additional steps to protect my family's finances as best I can.
- Some months ago I instructed the investment company managing our retirement account to keep all (yes, ALL) of our retirement funds in cash. I won't invest in a single stock or bond right now until there's greater clarity about where the market is going. (See Bill Gross' quote from Will Rogers, as cited above.)
- I've invested 10% of our liquid capital (i.e. cash on hand) in precious metals, splitting it equally in value between gold and silver coins. I take the current crunch seriously enough that I want to have at least some of my money in an asset that historically has proved to be a reliable store of value. It may lose value in the short term, but I'm not in this for the short term.
- I'm retaining two months' expenditure on hand, in cash. I don't know whether we'll see a run on the banks here, as happened in Cyprus a few years ago, or in Greece earlier this year: but I don't know that we won't, either. I'd rather be safe than sorry.
- I've arranged secure storage for our precious metals, cash and other valuables in a private vault facility. Keeping them in a safe deposit box in a bank is all very well . . . but if the bank's closed, you can't get to them. A private vault isn't regulated in the same way as the banks, and won't be subject to the same risk of closure. Also, as Greeks found out earlier this year, when criminals know people are hoarding cash and valuables, they break into homes to look for them. I'd rather they didn't steal ours.
I think the worst is yet to come. The next month or two are likely to be 'interesting times'.