We Can Be Certain Of This

Submitted by Charles Hugh Smith from Of Two Minds

We Can Be Certain of This  

Just as the addict feels “I can’t live any other way,” so we continue clinging to a way of living that is equally self-destructive because we too see no other way to live.

Yesterday I discussed the intrinsic uncertainties in complex systems. (Certainty, Complex Systems, and Unintended Consequences). Amidst this sea of uncertainty we can be certain of this: humans will continue down an unsustainable path that inevitably leads to a tragic end until they succeed in destroying themselves or they reach a point of no return and abruptly change course.

That process of clinging to the present arrangement “because I can’t live any other way” until that arrangement collapses is the primary narrative of our era. It is truly remarkable how humans will cling to a visibly self-destructive, no-exit arrangement because they see no alternative, and then after the present arrangement crumbles and the wreckage is cleared, we somehow manage to find some other arrangement.

Sadly, we only rouse ourselves to change when there is no other choice, that is, after we’ve destroyed the previous arrangement. Take the seas, for example: we’re losing the oceans. The scale of our destruction of this resource is unprecedented and easily visible to all. The Consequences of Oceanic Destruction (Foreign Affairs) Over the last several decades, human activities have so altered the basic chemistry of the seas that they are now experiencing evolution in reverse: a return to the barren primeval waters of hundreds of millions of years ago.

Every trawler that goes to sea (often subsidized by governments anxious to maintain the employment and protein offered by wild fisheries) stripmines another percentage of a fast-dwindling resource, and as a result fisheries are collapsing around the globe.

This propensity to exploit a resource made a certain kind of sense when humans numbered a few tens of thousands. Find a tree with ripe fruit? Pick every one, and then move on.

Unfortunately there are no other blue-water planets teeming with edible fish within our reach. Once we stripmine and despoil our planet’s oceans, there is no “move on to the next one.” The same is true of fresh-water aquifers, soil, and so on.

We can print IOUs, credit and paper money, but we can’t print fresh water once the aquifers are drained. Yes, we can spend billions of dollars and build desalination plants, but this option is limited to small wealthy populations. It is not a solution, it is simply a work-around that consumes extraordinary quantities of energy and capital.

Those of us who are not addicted to heroin wonder how addicts can continue down such a visibly self-destructive path. But how different are we? Just as the addict feels “I can’t live any other way,” so we continue clinging to a way of living that is equally self-destructive because we too see no other way to live.

Just as the addict feels that the alternative is too frightening and painful to contemplate and shooting smack is by far the easier, more comforting routine than risking the pain and trauma of going clean, so we cling to the present arrangement, as doomed and self-destructive as it is, because we too are afraid of change and want to avoid the pain of adapting to new arrangements.

And so the addict continues to the inevitable fork in the road; he either succeeds in destroying himself, and the arrangement ends that way, or he reaches a point so close to the inevitable end that the recognition awakens his instinct not just for survival but for a better life.

And then a small miracle occurs. An alternative way of living becomes visible in the addict’s mind. His fear and desire to avoid pain (not just the pain of withdrawal but the pain of self-awareness and personal responsibility) are still present, but he finds the pain is bearable and the benefits of pursuing this alternative way of living outweigh his fear of change.

His certainty that there is no other way to live but addiction was false. It was always false, but in the mindset of fear and fierce devotion to the present arrangement, no matter how self-destructive, there was no alternative.

And so we continue clinging to the present arrangement, certain there is no other way and that we are powerless to change our circumstances, until the current arrangement collapses beneath us, and we have no other choice but to make another arrangement.

This is the second great narrative of our era. Our job is to describe and discuss another arrangement, a sustainable, non-addictive one that isn’t doomed to collapse from the start, so all those currently clinging to the path of self-destruction will have an alternative when the Status Quo comes apart and the smack they “need” to continue living is no longer available, or no longer available in sufficient quantity or quality.

There is no point in trying to take the needle from the addict when he is certain there is no other way to live; for him, there is no other way to live. The only point of change lies ahead, when he reaches the cliff edge and must decide to plunge to his death, clinging to the present arrangement to the end, or he stumbles away from the edge and musters the courage to seek some alternative arrangement that doesn’t lead to the abyss.


    



via Zero Hedge http://ift.tt/1dzLl6K Tyler Durden

Dan Ariely: Why Humans Are Hard-Wired To Create Asset Bubbles

Submitted by Adam Taggart via Peak Prosperity,

Renowned behavioral economist Dan Ariely explains why humans are biologically wired to make irrational decisions when money is involved. It's a case of our evolutionary wiring interfering with the decisions we face in a modern world very different from the one our ancestors adapted to.

For instance, he explains how one of the easiest phenomena to create in a lab are valuation "bubbles". Our vestigial herding instinct encourages us to imitate the actions of those around us (e.g. bidding for a particular asset), which then strengthens that signal for others (leading to even higher bidding), resulting in behavior not justified by the underlying fundamentals of reality (asset prices destined to crash).

In this podcast, Chris and Dan explore the human cognitive triggers that have led us to our third major bubble in 15 years (tech stocks, housing, credit) and why our natural programming often works against our best interests. In certain cases, like the banking sector, bad decision-making has become so ingrained in our institutions that Ariely thinks the "clean slate" approach is our best option should we have the courage to deploy it:

In very general brushstrokes I think that most bankers are in fact inherently decent people. We just put them in situation in which their conflict of interest is tremendously high and their social norms are incredibly dysfunctional.

 

When you hear bankers talking about their customers as Muppets, for example, they are forgetting who they are serving. They are hired by the rest of us to do a particular job; and they forget this. And then they have terrible conflicts of interest.

 

Imagine that I give you a world in which, if you can adopt a particular perspective on life, you could get $5 Million as a bonus. Wouldn’t you start believing that world? And then everybody around you is doing the same thing, and you have some justification for it by talking about financial market theory and so on. All of a sudden you could see how you could take good people and you could put them in this distorted way — in the same way that we talked about how global warming is probably the perfect storm for inaction — I think Wall Street is the perfect storm for allowing people to rationalize their own selfish motivations as if they are serving other people.

 

It is really, really terrible because we have not done anything to change the way we pay bankers. And we have not changed anything in terms of the code of ethics and morality.

 

On the consumer side, there is a tremendous loss of faith. We have been screwed and we know that we have been screwed. And we know that we are not trusting other people. And I think loss of trust is a central issue for this financial crisis and sadly nobody is trying to do anything about that. Human beings are incredibly forgiving, but nobody has really stood up and said, "I am really sorry. I made all of these terrible mistakes. I want this particular bank to start fresh and caring about people," right? Nobody has admitted anything. So we as consumers feel that there are these other people on the other side who have behaved terribly, which is true, and that are smug about it, and that nothing is different. And why should we trust them? And we do not.

 

I don't think it is a generational thing. I think there is a tremendous feeling of lack of control, agency, and helplessness. And the sad realization — this is one of the things that came out of financial crisis — is that it is much harder to start a new bank now. So young people are actually quite idealistic and I think people would have started new banks where they behaved very, very differently. But what happened is that it is really, really tough to open a new bank now. But I am still hopeful: I think that this anger and frustration just needs to be channeled in a better way.

 

I am not a religious person but the story from the Bible is that God made the people of Israel walk around the desert for 40 years until the old generation that worshipped the golden calf passed away. I do think that we need a new generation of bankers. I think you cannot take the old generation of bankers and rehabilitate them.

 

Recent history is not showing us that this is something we should hope for. But there is a real question of, How do we create a new generation of bankers that are going to think of themselves as the caretakers of society, rather than the rapists?

Click the play button below to listen to Chris' interview with Dan Ariely (42m:54s):

 

 


    



via Zero Hedge http://ift.tt/1nCOvYc Tyler Durden

California’s New ‘Dust Bowl’: “It’s Gonna Be a Slow, Painful, Agonizing Death” For Farmers

It’s really a crisis situation,” exclaims one California city manager, “and it’s going to get worse in time if this drought doesn’t alleviate.”

 

For the state that produces one-third of the nation’s fruits and vegetables, the driest spell in 500 years has prompted President Obama to make $100 million in livestock-disaster aid available within 60 days to help the state rebound from what he describes is ” going to be a very challenging situation this year… and potentially some time to come.”

 

As NBC reports, Governor Jerry Brown believes the “unprecedented emergency” could cost $2.8 billion in job income and $11 billion in state revenues – and as one farmer noted “we can’t recapture that.” Dismal recollections of the 1930’s Dust Bowl are often discussed as workers (and employers) are “packing their bags and leaving town…” leaving regions to “run the risk of becoming desolate ghost towns as local governments and businesses collapse.”

 

 

Via NBC,

The truth of the matter is that this is going to be a very challenging situation this year, and frankly, the trend lines are such where it’s going to be a challenging situation for some time to come,” Obama said Friday during a meeting with local leaders in Firebaugh, Calif., a rural enclave not far from Fresno.

 

Obama promised to make $100 million in livestock-disaster aid available within 60 days to help the state rebound from what the White House’s top science and technology adviser has called the worst dry spell in 500 years.

 

 

A lot of people don’t realize the amount of money that’s been lost, the amount of jobs lost. And we can’t recapture that,” Joel Allen, the owner of the Joel Allen Ranch in Firebaugh, told NBC News.

 

“It’s horrible,” Allen added. “People are standing in food lines and people are coming by my office every day looking for work.”

 

Allen — whose family has been in farming for three generations — and his 20-man crew are out of work.

 

He said: “We’re to the point where we’re scratching our head. What are we gonna do next?

 

At the local grocery store, fruit prices are up — but sales are down. The market was forced to lay off three employees — and many more throughout the town are packing their bags and leaving town.

 

McDonald said farming communities like Firebaugh run the risk of becoming desolate ghost towns as local governments and businesses collapse.

 

“It’s going to be a slow, painful process — but it could happen,” McDonald said. “It’s not going to be one big tsunami where you’re gonna having something get wiped out in one big wave. It’s gonna be a slow, painful, agonizing death.

 

 

The problem is not just in California. Federal agriculture officials in January designated parts of 11 states as disaster areas, citing the economic strain that the lack of rain is putting on farmers. Those states are Arkansas, California, Colorado, Hawaii, Idaho, Kansas, New Mexico, Nevada, Oklahoma, Texas and Utah.


    



via Zero Hedge http://ift.tt/1nCL8Ax Tyler Durden

California's New 'Dust Bowl': "It's Gonna Be a Slow, Painful, Agonizing Death" For Farmers

It’s really a crisis situation,” exclaims one California city manager, “and it’s going to get worse in time if this drought doesn’t alleviate.”

 

For the state that produces one-third of the nation’s fruits and vegetables, the driest spell in 500 years has prompted President Obama to make $100 million in livestock-disaster aid available within 60 days to help the state rebound from what he describes is ” going to be a very challenging situation this year… and potentially some time to come.”

 

As NBC reports, Governor Jerry Brown believes the “unprecedented emergency” could cost $2.8 billion in job income and $11 billion in state revenues – and as one farmer noted “we can’t recapture that.” Dismal recollections of the 1930’s Dust Bowl are often discussed as workers (and employers) are “packing their bags and leaving town…” leaving regions to “run the risk of becoming desolate ghost towns as local governments and businesses collapse.”

 

 

Via NBC,

The truth of the matter is that this is going to be a very challenging situation this year, and frankly, the trend lines are such where it’s going to be a challenging situation for some time to come,” Obama said Friday during a meeting with local leaders in Firebaugh, Calif., a rural enclave not far from Fresno.

 

Obama promised to make $100 million in livestock-disaster aid available within 60 days to help the state rebound from what the White House’s top science and technology adviser has called the worst dry spell in 500 years.

 

 

A lot of people don’t realize the amount of money that’s been lost, the amount of jobs lost. And we can’t recapture that,” Joel Allen, the owner of the Joel Allen Ranch in Firebaugh, told NBC News.

 

“It’s horrible,” Allen added. “People are standing in food lines and people are coming by my office every day looking for work.”

 

Allen — whose family has been in farming for three generations — and his 20-man crew are out of work.

 

He said: “We’re to the point where we’re scratching our head. What are we gonna do next?

 

At the local grocery store, fruit prices are up — but sales are down. The market was forced to lay off three employees — and many more throughout the town are packing their bags and leaving town.

 

McDonald said farming communities like Firebaugh run the risk of becoming desolate ghost towns as local governments and businesses collapse.

 

“It’s going to be a slow, painful process — but it could happen,” McDonald said. “It’s not going to be one big tsunami where you’re gonna having something get wiped out in one big wave. It’s gonna be a slow, painful, agonizing death.

 

 

The problem is not just in California. Federal agriculture officials in January designated parts of 11 states as disaster areas, citing the economic strain that the lack of rain is putting on farmers. Those states are Arkansas, California, Colorado, Hawaii, Idaho, Kansas, New Mexico, Nevada, Oklahoma, Texas and Utah.


    



via Zero Hedge http://ift.tt/1nCL8Ax Tyler Durden

Puerto Rico – America’s Version Of Greece?

Submitted by Pater Tenebrarum of Acting-Man blog,

The Crisis Worsens

We previously discussed Puerto Rico in these pages in October of last year (see “Puerto Rico’s Debt Crisis – Another Domino Keels Over”). At the time, the public debt crisis looked increasingly worrisome – in fact, it seemed as though Puerto Rico would eventually have to apply for a federal bail-out, and if it failed to get one, it might have to restructure its debt (it actually cannot do that, see further below). Several months have now passed and the situation apparently hasn't gotten better. Before we continue, allow us to point out though that noted contrarian Jeff Gundlach thinks that Puerto Rico will eventually be rescued – he believes that too many politicians have a vested interest in not letting anything bad happen:

“Municipal bonds are slightly overvalued, he said. Investors who are willing to tolerate volatility will get rewarded for the risk in Puerto Rico’s bonds. Too many politicians rely on votes tied to the stability of Puerto Rico to allow a crisis there, according to Gundlach. “Puerto Rico’s bonds are going to make it to the other side of the valley,” he said.”

(emphasis added)

We should point out to this that politicians don't always get what they want, especially in the event of a debt crisis. The cost of rescuing Puerto Rico may be deemed too high, and the politicians with a vested interest are not the only ones needed to green-light rescue measures. In the event of a bailout, others will have to justify their support to their own constituents. With that out of the way, here is a fairly recent chart of the Barclay's Puerto Rico municipal bond index:

 


 

Puerto Rico bond index

Puerto Rico's bonds continue to plummet – click to enlarge.

 


 

S&P has just downgraded Puerto Rico's debt to junk, as reported here:

“The most recent blow to Puerto Rico’s economic reputation is yet another downgrade of its debt, this time to junk. S&P slashed the rating on Tuesday because, in a nutshell, the commonwealth is going to need a lot more money and that money isn’t going to get any easier to come by.

 

Although some initial reports indicate that investors are shrugging off the downgrade, the possibility of further downgrades by the other two major ratings agencies, Moody’s and Fitch (which both currently rate Puerto Rico a mere notch above junk), could spark a sell-off by institutional debt holders. That would make it even more difficult for the government to raise the cash it sorely needs.”

(emphasis added)

There has of course already been a lot of institutional selling in Puerto Rico's debt, as the decline in its bond prices attests to. However, to the extent that the bonds are contained in investable indexes and other tracker products such as ETFs, future rating downgrades would of course provoke additional selling.

The economic backdrop meanwhile isn't particularly encouraging:

 


 

puerto-rico-annual-gnp-growth-annual-gnp-growth_chartbuilder

Puerto Rico's annual GDP growth – essentially the territory has been in a severe recession since 2007 – click to enlarge.

 


 

puerto-rico-public-debt-debt_chartbuilder-1

Total public debt since 2007. The public debt-to-GDP ratio is almost at 100% by now – click to enlarge.

 


 

On the Skids

According to a recent article in the NYT, Puerto Rico has a set of problems that reminds us a bit of Greece in several respects. Specifically, the persistence of the economic slump, the high unemployment rate, the incredible size of the public debtberg relative to the population, and an accelerating exodus of said population as it no longer sees a future for itself in the territory. The new governor has even jokingly wondered whether it was really such a good idea to take the job:

“Puerto Rico’s slow-motion economic crisis skidded to a new low last week when both Standard & Poor’s and Moody’s downgraded its debt to junk status, brushing aside a series of austerity measures taken by the new governor, including increasing taxes and rebalancing pensions. But that is only the latest in a sharp decline leading to widespread fears about Puerto Rico’s future.

 

In the past eight years, Puerto Rico’s ticker tape of woes has stretched unabated: $70 billion in debt, a 15.4 percent unemployment rate, a soaring cost of living, pervasive crime, crumbling schools and a worrisome exodus of professionals and middle-class Puerto Ricans who have moved to places like Florida and Texas.

 

The situation has grown so dire that this tropical island, known for its breathtaking beaches, salsero vibe and tax breaks, is now mentioned in the same breath as Detroit, with one significant difference. Puerto Rico, a United States territory of 3.6 million people that is treated in large part like a state, cannot declare bankruptcy.

 

From bottom to top, Puerto Ricans are watching it unfold with a mixture of disbelief and stoicism. Alejandro García Padilla, who was elected Puerto Rico’s governor by a sliver of a margin in 2012, said that after he began to wade deeply into the island’s economic and social quagmire, his fight-or-flight instincts kicked into high gear.

 

“I thought about asking for a recount,” Mr. García Padilla, 42, said with a grin during a recent interview in La Fortaleza, the 500-year-old government residence, recalling, among other things, the $2.2 billion deficit. “But now it’s too late.”

(emphasis added)

Puerto Rico cannot declare bankruptcy, but that doesn't actually matter. It can still go bankrupt anyway, with or without a 'declaration'. We're actually not sure what this is supposed to mean in practice. Does it mean that servicing its debt takes precedence over all other government expenditures? In that case one could envisage a hypothetical future in which the only remnant of its government will be a band of armed tax collectors.

Similar to Greece, the measures taken to lower the deficit have probably made the deficit ultimately worse by destroying large swathes of the small business sector:

“A sense of pessimism pervades on the island. Streets are lined with empty storefronts in San Juan and in smaller cities like Mayagüez; small businesses, hit hard by high electricity, water and tax bills and hurt by drops in sales, have closed and stayed closed.

 

Schools sit shuttered either because of disrepair or because of a dwindling number of students. In this typically convivial capital, communities have erected gates and bars to help thwart carjackers and home invaders. Illegal drugs, including high-level narco-trafficking, are one of the few growth industries.”

(emphasis added)

Evidently, the government has taken the euro area approach to dealing with excessive government debt. This is to say, instead of concentrating on cutting its spending, it has raised the fiscal burden on businesses, many of which cannot continue to operate given the new impositions. This in turn lowers tax revenues, as many formerly tax paying establishments no longer exist. The predictable effect on the public debt is that it keeps growing.

Austerity always seems to mean 'austerity for everyone except government'. However, that is a formula that cannot possibly work, as it amounts to slaying the goose that lays the golden eggs. The result is a never-ending tale of woe:

“Puerto Rico, about 1,000 miles from Miami, has long been poor. Its per capita income is around $15,200, half that of Mississippi, the poorest state. Thirty-seven percent of all households receive food stamps; in Mississippi, the total is 22 percent.

 

But the extended recession has hit the middle-class hardest of all, economists said. Jobs are still scarce, pension benefits for some are shrinking and budgets continue to tighten. Even many people with paychecks have chosen simply to parlay their United States citizenship into a new life on the mainland.

 

Puerto Rico’s drop in population has far outpaced that of American states. In 2011 and 2012, the population fell by nearly 1 percent, according to census figures. From July 2012 to July 2013, it declined again by 1 percent, or about 36,000 people. That is more than seven times the drop in West Virginia, the state with the steepest population losses.”

(emphasis added)

The shrinking population is obviously a significant problem as well – it means that the burden of the government's debt is borne by fewer and fewer citizens, who must fear that even more hardship will be imposed on them. This in turn is likely to accelerate the exodus.

And indeed, the enormous costs businesses face in Puerto Rico are inter alia a direct result of government running major industries – running them into the ground, that is. Citing the example of a struggling small business owner the NYT writes:

“But his expenses mounted, including $600 a month in power bills, more than double what consumers pay on the mainland. The sky-high cost is a consequence of Puerto Rico’s inefficient government-run monopoly on electricity and its 67 percent dependency on petroleum for electric power. Other utilities are exorbitant, too. Last year, water rates rose 60 percent in a bid to help cut the state-run water company’s debt.

(emphasis added)

Obviously letting the government run electricity and water utilities was a bad idea, as it always is. Such publicly-owned monopoly industries usually provide ample opportunities for graft and political cronyism (see Greece as a pertinent example) and it was probably no different in Puerto Rico. Here are a few of the things the new governor has done to bring the deficit down:

“Vowing not to lay off any more workers, he raised taxes sharply to provide much-needed revenue and moved aggressively to promote incentives to entice wealthy investors, like the hedge fund billionaire John Paulson, who has invested in an exclusive beach resort and condo complex.”

(emphasis added)

The workers he didn't want to lay off are of course government employees. In other words, net consumers of the wealth others produce (government doesn't produce anything of value – if it were, it would not need to obtain its revenue by coercion).

And if at the same time, he moved to 'entice billionaires' like John Paulson to invest, he obviously has to get tax revenue from someone other than billionaires. The 'sharply raised taxes' have have thus hit small business and the middle class the hardest. Some of the tax impositions are so bizarre as to defy belief:

“His tax increases have hit some businesses hard, which could pose a further drag on the economy. Among the many taxes he initiated, the governor raised the corporate tax rate to a maximum of 39 percent. Last year, the economy continued on a slide. “The new administration has a bookkeeping mentality as opposed to an economic development mentality,” said Pedro Pierluisi, Puerto Rico’s nonvoting representative in Congress and a political opponent of the governor. “Here you find Puerto Rico with an underlying economic problem charging its corporations — its job creators — 39 percent. Hello!”

 

Perhaps the most maligned is the new lucrative gross receipts tax, which some owners of small- and medium-size businesses say threatens to put them out of business. Because of the way the tax is structured, it affects companies with less than a 5 percent net profit margin. This means that many food-related companies, like supermarkets, and new businesses, are hit hardest. The smaller the margin, the higher the tax.

 

Some stores are paying an effective tax rate of 130 percent, said Manuel Reyes Alfonso, the vice president of a trade association that represents the food industry. If the tax is not revised, some will be forced to shut down and others will have to raise prices, he said. “It is absurd,” said Mr. Reyes Alfonso. “It’s like selling the car to buy gas.”

(emphasis added)

A 130% tax rate? Yes, that is going to work out for sure. The lower one's profit margins the more tax one is forced to pay? We wonder who came up with this stroke of governmental genius.

 

Conclusion

Frankly, it is a complete mystery to us how a small territory enjoying all the advantages of being part of the US while remaining largely self-administered, sporting an inviting climate and endowed with great natural beauty, could ever be so insanely mismanaged that it ends up with an unbearable debt burden and an economy that seems caught in an unending downward spiral. It must have  taken a real effort to bugger such excellent starting conditions up.

The global crisis that began in 2007/8 has unmasked many unsustainable economic dispositions. Unfortunately, the proper conclusions have still not been arrived at, as evidenced by the fact that the same old Keynesian recipes that have failed over and over again are being implemented on an even grander scale. One must not be misled by the claims of 'austerity' being imposed, as this has evidently little bearing on government spending as such, but is rather an attempt to squeeze more blood out of an already shriveled turnip, namely what remains of the private sector. Puerto Rico seems – at least so far – not any different in that respect.


    



via Zero Hedge http://ift.tt/1gMeiLA Tyler Durden

Felix Zulauf Warns Of “Another Deflationary Episode” As “The Mother Of All Bubbles” Pops

"There is a valuation problem with most global equity markets – the most with the US," warns Felix Zulauf in the following brief clip, adding that sentiment "is extremely one-sided," but the classic bear-market-inducing recession, he notes, is not on the immediate horizon. Instead, he warns, other problems may be the catalyst for a correction in the US – specifically China's "mother of all bubbles", fragility in Asian banks, and balance of payments crises continuing in emerging markets. Zulauf suggests "you have to be short stocks, own US treasury bonds, and also buy gold as panic and risks go up."

 

Via WSJ,

 

Authored by Felix Zulauf (via Brazilian Bubble blog),

The U.S. has run an ever increasing deficit in her trade and current account since the early 1980s. She has thereby provided tremendous stimulus to the rest of the world by allowing other countries to export to an increasing extent. Some have accepted this opportunity with pleasure and have built a powerful export industry due to their competitive labor costs. The U.S. policy of increasing monetary and often also fiscal stimulus has allowed countries like China to build up their economies and become large and competitive economic powers. The U.S. behavior really triggered the rise of the emerging economies to a very large degree.

Like an oil supertanker that turns very slowly when changing direction, the U.S. is improving to smaller deficits in her trade and current account (Chart 1). The main reasons are a domestic energy production boom (and much cheaper energy prices than in other parts of the world), cheap and more competitive labor (due to a weak U.S. dollar over the last 15 years) and the end of a leverage-driven consumption boom. Smaller deficits by the largest economy have unpleasant implications for many other nations. Of course, foreign oil producers will earn less income, but foreign exporters selling to U.S. markets are also being hurt. Simply speaking, what once was ever-increasing economic stimulus provided to the world is now turning into restraining factors for the rest of the world.

For the U.S., it means she is now losing less growth to the rest of the world and keeping more for herself, which is growth positive. That is one of the reasons why the U.S. is performing relatively better than other economies, although still well below an average recovery. While I completely disagree with the consensus about the “normalization” of the world economy and the reacceleration thesis, if one economy can achieve the forecasts, it will be the U.S.

Credit Booms Are Followed by Busts

As Chart 1 shows, China’s surpluses are declining and therefore trade data for many other economies are deteriorating. At the same time, many of the EM economies have gone through a tremendous boom in recent years, driven by their previous success story and large capital inflows. As I outlined in the second quarter of last year in my piece “Butterfly Effect,” we have witnessed many years of a virtuous cycle. The inflow of capital (Chart 2) revalued those currencies, and while many central banks intervened to dampen the revaluation, the liquidity thereby created fueled a domestic investment and consumption boom. It was a great success story leading to a credit and real estate boom of large proportions virtually everywhere. In the last five years, Hong Kong real estate has doubled in price, Singapore’s has increased by 70% and China’s has more than doubled. It was felt throughout the whole Asian region and also in selected EM economies in other parts of the world. Of course, they and many Western commentators interpreted this as “normal” because they all believed clocks tick differently in those economies. While some may have better demographics and less government debt, they have created private sector credit bubbles of historic proportions (Chart 3). Most importantly, they are exposed to cycles as everybody else. And that is exactly the point.

The problem with credit booms is that they always end badly, although they usually go further and last longer than rational minds expect. The weakest links are breaking first, as always. Completely mismanaged economies like Argentina and Venezuela are already in deep crisis, but that was no surprise. Next follow the deep and chronic deficit countries like Turkey or South Africa, which have already seen their currencies declining sharply. Both have little foreign exchange reserves and virtually no tools to defend the currency except for raising interest rates, which will trigger a recession. Whatever these countries do, they will end in a recession because that is the way balance-of-payment crises are resolved. It is Ying and Yang, action and reaction; booms will be followed by busts, particularly when built on quicksand of phony money and credit creation. These are of course also the unintended consequences of many years of quantitative easing (QE) in the major economies spilling over to emerging economies.

Now, markets have become aware of the problem and are attacking the imbalances. Research on private sector credit booms over the last 20 years show that whenever credit to the private sector expanded by 30% or more within a 10-year period, a banking crisis and recession resulted without any exception. The following countries are all far above that danger level today and candidates for a banking crisis: Hong Kong, China, Thailand, Brazil, Turkey and Singapore. And recently even Korea, Romania, Ukraine and even Russia have broken the danger level. This is quite a long list, and the big EM economies are all part of it except India that has other deficiencies.

Now, these economies differ from each other, of course, but they share a common disease, namely a previous economic boom built on excessive credit. Most have chronic deficits in their external accounts that were unimportant as long as foreign capital flowed in at large. The response to current problems – which have been with us since the tapering was announced last summer – also differs as some simply cannot intervene in the currency market due to the lack of enough foreign exchange reserves (Turkey, South Africa) while others do intervene due to large reserves, like Brazil or Russia. Some are struggling due to the compounding effect of political trouble (Turkey) and some like Russia due to spending their foreign exchange reserves on weak political allies, in this case the Ukraine. All of them will end up with higher interest rates, a weaker economy and a weaker currency, eventually.

The Mother of All Bubbles

While some may understand the mechanism of a balance of payment that is seriously out of line and its ultimate adjustment process, most investors don’t. That’s why most voices one hears do not, in our view, address the problem properly and think it is an isolated case. While some may understand a case like Turkey, most disagree when it comes to China. While I am as impressed as others by China’s economic performance over the last 2-3 decades, we shouldn’t overlook the fact that, particularly since 2008, the economy enjoyed the most dramatic credit boom ever seen in modern history.

China became the second largest economy in a very short period. In the last five years, China’s total credit outstanding more than doubled and grew more than the equivalent of the total U.S. commercial banking sector, namely the equivalent of $14 trillion. That is equivalent to 150% of their current GDP. Moreover, the balance sheet of the Chinese central bank showed the biggest balance sheet expansion since 2000 of all central banks, which is testimony of an ultra-easy monetary policy.

Credit growth in the years leading to the bursting of previous bubbles has been 40%-50%, as was the case in the U.S. from 2002-2007, in South Korea in the mid-90s and in Japan in the late 80s. China’s credit growth has been by far higher than all of those. Now, we see all the signs one usually sees before the bubble bursts. For instance:

– Large expansion and acceleration of credit not matched by GDP, as credit growth is still 2.5 times faster than GDP but slowing.

– An aggressive expansion of a shadow banking system (wealth management products WMP) that has similarities to the U.S. subprime loans.

– Massive investments in property leading to a bubble in many locations. Tier 3 and 4 cities already see real estate prices declining, while prices are still rising in tier 1 and 2 cities.

– Weak risk management at financial institutions similar to U.S. and European banks before the Great Financial Crisis. There are recurring stories of banks in trouble in China and the government throwing money at them. Recently, some shadow banking institutions went bust and investors lost money.

– Finally, a heavily state-directed financial and corporate sector, which in China is a given, primarily in banking. In the U.S. it was Freddy Mac and Fanny Mae.

– Rising interest rates driven by competitive bidding for funding, not by central bank tightening. We saw this first in spring 2013, then in December of last year and now again.

China is facing the ugly choice of either deflating the bubble, hopefully in a controlled way, or of re-inflating even more, leading to an even bigger debt crisis further down the road. Continuing on the current path and procrastinating would mean even more waste investment than has already occurred and would be rather stupid. Hence, I think the chances are better than 50:50 that China will try to deflate in a controlled way, although it would be a hesitant approach at the beginning. Whether it would remain controlled is another question as it would lead to bankruptcies, an economic crisis of some sort and big problems in the financial, real estate and construction sectors. It is clear that such an outcome in the second largest economy of the world wouldn’t remain a domestic affair but impact the rest of the world. At particular risk are those financial institutions exposed with large loan portfolios to China, including WMPs. Hong Kong is at extreme risk, with bank loans amounting to almost 150% of GDP. The U.S. will certainly be impacted the least, as I have outlined above.

If the Chinese try to procrastinate by throwing more liquidity at the problem, capital would flow out and weaken the yuan despite capital controls. If China tried to support her currency, she would face a situation similar to Russia today. Supporting your own currency by intervention drains liquidity from your domestic credit system, and that’s why Russia is facing a banking crisis at present. Hence, if China chose this route, her currency would weaken and compound the structural problems due to capital outflow weakening the banking system’s deposit base. A weaker yuan could trigger the next problem as it would hurt Asian competitors in particular. Japan’s weakening of the yen was an important trigger to weaken many other Asian competitors, recently. If China would follow suit, it would simply be another deflationary hit for many others, probably the world as a whole.

While the timing of this described process is open as is the way the Chinese will choose, we must expect it to begin at any time and last many quarters if not years. The message is that problems in emerging economies are not over, and weakness in currencies, bonds and equities are in general not an opportunity to buy, yet. What investors should be aware of is that the problems in Turkey, South Africa or Russia are only sideshows compared with what’s out there in China and its implications for the world, which in our view are still not understood and not priced in by markets.

As we don’t live in an isolated world, there will be knock-on effects. Emerging markets ex China account for virtually 1/3 of total global imports, similar to the European Union, while the U.S. accounts for approximately 15% and China for only 10%. Arthur Budaghyan of BCA, Montreal, who does excellent work on emerging markets, recently published Chart 4, showing the high correlation and leading function of emerging equity markets’ relative performance to global industrial production. Moreover, Chart 5 illustrates so clearly how weakening currencies in emerging economies will eventually lead to sharp declines of imports. Those imports are of course someone else’s exports.

The mechanism, in simple terms, has been QE in the developed world leading to capital flows into emerging markets, triggering an investment and consumption boom built on cheap credit. The boom led to rising wages, reduced competitiveness, less household income after inflation, taxes and rent (which rose sharply due to the real estate boom). Now, domestic and external demand is weakening while inflation is high and external accounts are imbalanced. Hence, the world will see the next chapter of the unintended consequences of QE, namely many economies going through a balance-of-payment crisis leading to recessions and banking crises and hurting global economic growth. The U.S. will be hurt too, but is the least exposed.

Fragile Euro Zone

The big winner in equity markets in recent quarters has been the euro zone, the periphery in particular. Those yield-hungry investors who previously bought emerging market bonds have switched to buying peripherals driving the yield down to almost half the level of what prevailed in 2012, when many feared an immediate euro breakup. U.S. and Japanese investors were at the margin quite active due to the strengthening euro and the “normalization” of yields. The thesis has been sharply reduced risks due to stabilization and expected recovery.

Indeed, some like Spain have made some progress but the fundamental problems of the monetary union have not been resolved. Part of the stabilization is due to less austerity leading to growing public sector deficits again. At present, nobody cares about it and believes the situation will heal over time. It won’t, in my view. Problems have a habit to stay and grow bigger and not right themselves without proper tackling. It is true, some indicators have improved, but most of them are sentiment-based, like PMIs. As long as short-term improvements are not supported by monetary aggregates – and they are definitely not, with total credit shrinking by more than 4% year over year in the euro zone – upticks are simply coincidental and no indication of a new trend. There is no change on the horizon, as the banking industry continues to shrink its balance sheet in view of the upcoming stress test.

The ECB has recently decided not to sterilize its bond purchases any longer, which is a slight easing move. It was supported only by the Bundesbank to prevent other more aggressive steps, of course. While some may think this step will lead to a better European economy, I rather see it as too little, too late to make a change.

Risk aversion will rise again, once investors find out the world has entered another deflationary episode, with many balance-of-payment crises that are only now beginning. Yes, it may look far away in the emerging world, but it will have knock-on effects and slow down the global economy much more than expected and hurt particularly multinationals’ revenues and profits. Nowadays, the emerging world is half of the world economy, and the world economy is more intertwined than ever before.

Changing Market Character

“As January goes, so goes the year” has an accuracy of 73% for the U.S. equity market, according to the Trader’s Almanac. I don’t rely on such statistics, but what is clearly visible is the changing character of the market. This correction so far is already the most vicious in many months. Importantly, sharp short-term sell-offs could not attract new buying, as was the case all of last year, but triggered renewed selling. Some important momentum and trend indicators are breaking down (Chart 6), and divergences built up over many months are now forcing the indices down. In Chart 7, we also witness fewer and fewer markets with rising 200-day moving averages (71%) and less and less trading above that moving average (59%). A break below 60% in the first in combination with a break below 50% in the second usually confirms a global bear market underway.

The well-performing markets in Europe and the U.S. didn’t see any new negative news, but they were so overheated and overbought that markets were selling off without. Markets had entered a highly speculative stage, with sentiment indicators hitting multi-year extremes. U.S. margin debt as a percentage of GDP has now hit 2.6%, the same extreme as in 2007 at the peak and close to the all-time high of 2.8% in 2000.

In discussions with European investors in recent months, it was unbelievable how bullish they have become. Picking the right stock was all they cared about, since in their view it was a given that stock prices could only rise as long as central banks pursued easy money and low interest rate policies. Any word of caution was moved to the side. I spoke at a conference recently, before this sell-off really began, and was looked at like somebody from another planet, as all others were so indiscriminately bullish. They didn’t even care about asset allocation. Equities were simply the only game in town – no bonds, no cash, no gold, no real estate, just equities. Frothy markets by themselves may not make a top, but they indicate high vulnerability for corrections.

The most important fundamental change at the margin is the “tapering” by the Fed. There have been intense internal discussions at the Fed, and the way I am reading the tea leaves, the Fed is tired of money printing and wants out. Hence, I am expecting their tapering to continue and to be complete later this year, provided no major accident happens in the financial markets in between. This is equivalent to raising interest rates from minus two percent to zero. And while zero is still low, it is in my view a step by step removal of stimulus and therefore a regime shift in monetary policy at the most important central bank of the world. This is a strong message. Unfortunately, we have no experience with “tapering” and therefore do not know when and how it impacts markets. However, such a change in combination with frothy markets has now triggered a serious correction that in our view has more to run. Since developments in the developed world will not lead to an immediate economic downturn, opportunity hunters will appear and buy the dip, perhaps several times. Hence, it could be a step by step correction during this quarter followed by another upside attempt, particularly in the U.S. and Europe.

In our reading, the current weakness is led by emerging equity markets, and most of them are already deep in their second downleg of this cyclical bear market, while for most equities in developed markets it is only the first downleg of a new bear market. There is an outright chance that once this downleg ends, a few indices may make it back to the highs or even marginally above, but now is not the time to decide that. Now, the message for investors simply is to pursue defensive strategies.

The sell-off has now created an oversold situation at a time when the U.S. and European markets reached the December lows, while Japan is a bit weaker. Hence, some attempts to bounce off these levels are likely in the short-term. If recovery attempts remain weak and do not lead far, which is my hunch, we may be facing the right shoulder of a head and should top, from where markets could break down further thereafter.

Strong Dollar

In the currency arena, the U.S. Dollar has been firming for quite some time against virtually all others except the euro family of currencies. I expect the stronger dollar trend to continue despite some interest rate hikes in selected emerging economies. Those economies have to be rebalanced through a full-fledged balance of payment crisis that does include a recession. While the extremes of last week may lead to a temporary pause in EM currencies, I expect them to continue weak later.

The euro is a deflation currency with the same characteristics of the Japanese yen until the regime change in the country of the rising sun. We see chronic current account surpluses, a stagnating and aging population and a deflationary economic policy mix with economic stagnation. This condition must change, similar to Japan in late 2012. We don’t know when, but further disappointments this year will create rising stress in the euro zone. The recent change at the ECB of withdrawing the sterilization of bond purchases amounts to some easing and a weakening of the euro; however, it will not be enough to improve the economy. Hence, we see the upside of the euro against the U.S. unit as very limited and expect a weaker euro in coming months and lasting well into next year, as the ECB will at some point be forced to do a lot more.

The big surprise for the world will in our view be a temporary strengthening of the yen. The world is short yen, as it has been used as a funding currency that declines in value and costs extremely low interest. Moreover, the Japanese have outlined their goal of weakening the currency to end deflation. The economy will do well up until April 1, when the VAT will be hiked by 3%. This will lead to CPI inflation of close to 4% while wages will only be raised by 1%-2%, leading to an income shortfall in real terms. Hence, the economy will most likely be quite weak in the 2nd and 3rd quarters. The Bank of Japan is aware of this and has recently stopped buying JGBs to make room for more aggressive steps later. Hence, I expect the world to be forced to cover their yen shorts, as Abenomics will look like a failure. We expect the Japanese to launch another stimulus program, including aggressive monetary easing, that will most likely start sometimes in the second half and trigger the next phase of yen weakness, but only after a temporary correction that could amount to approximately 10% from recent extremes versus the U.S. dollar and more versus other major currencies.

Bonds Offer a Safe Haven

We share the view that bond yields of perceived quality borrowers have terminated their 30-year secular decline and are in a multi-year bottoming process. Within this bottoming, our hunch is that the cyclical rise from the secular low in 2012 has ended. As outlined, we are expecting another deflationary episode and see in particular U.S. Treasuries with maturities of 10 years and longer as offering attractive trading opportunities over the next 6-12 months, whereby 10-year yields could decline to around 2%. This may not be attractive in the eyes of many, but in view of medium- and most likely cyclical declines in equities, Treasuries offer a safe haven.

While yields on German Bunds or some other selected quality bonds may also decline, I think U.S. paper will be the most attractive and offer the best total return potential, as capital will be returning from virtually all other parts of the world and thereby strengthening the currency, which will not be the case for others.

Restrained Bottoming Attempt for Gold

In the scenario outlined, economic-sensitive commodities are unattractive and at risk of further declines. I would exclude them from portfolios.

Gold has disappointed so many that it is hard to see how Western investors who have sold are getting back into gold anytime soon. Rising deflationary risks could hinder a gold recovery despite its deeply oversold cyclical position. In fact, I wouldn’t be surprised to see gold breaking $1,180 first for a final washout before the recovery starts, most likely from late spring onwards, when rising risk in the global credit system will become more visible. It is reasonable to expect citizens in those countries directly impacted to store part of their wealth in gold instead of paper currencies, which are losing value virtually every day.

Since the gold market is very oversold from a cyclical point of view after declining from $1,920 to $1,180 in more than two years, investors should take a constructive and contrarian view of gold and accumulate step by step on weakness. It may take a few more months until the dimension of risk in the credit system become more visible, but I expect this to be on the table in the second half at the latest, when the price of gold should be higher again. Even gold mining stocks can be purchased with a 12-month view, as they have been beaten down badly and are cheap on a valuation basis. They are, however, not for widows and orphans.

In general, we expect another deflationary episode leading to systemic risks and economic disappointments. Hence, it is time to structure portfolios much more conservatively and put capital preservation ahead of aggressive return strategies. In contrast to last year, 2014 will hardly be a year with a powerful and easy trend to ride. Instead, it will bring much more volatility but also plenty of trading opportunities for flexible investors.


    



via Zero Hedge http://ift.tt/1bzxtdL Tyler Durden

Felix Zulauf Warns Of "Another Deflationary Episode" As "The Mother Of All Bubbles" Pops

"There is a valuation problem with most global equity markets – the most with the US," warns Felix Zulauf in the following brief clip, adding that sentiment "is extremely one-sided," but the classic bear-market-inducing recession, he notes, is not on the immediate horizon. Instead, he warns, other problems may be the catalyst for a correction in the US – specifically China's "mother of all bubbles", fragility in Asian banks, and balance of payments crises continuing in emerging markets. Zulauf suggests "you have to be short stocks, own US treasury bonds, and also buy gold as panic and risks go up."

 

Via WSJ,

 

Authored by Felix Zulauf (via Brazilian Bubble blog),

The U.S. has run an ever increasing deficit in her trade and current account since the early 1980s. She has thereby provided tremendous stimulus to the rest of the world by allowing other countries to export to an increasing extent. Some have accepted this opportunity with pleasure and have built a powerful export industry due to their competitive labor costs. The U.S. policy of increasing monetary and often also fiscal stimulus has allowed countries like China to build up their economies and become large and competitive economic powers. The U.S. behavior really triggered the rise of the emerging economies to a very large degree.

Like an oil supertanker that turns very slowly when changing direction, the U.S. is improving to smaller deficits in her trade and current account (Chart 1). The main reasons are a domestic energy production boom (and much cheaper energy prices than in other parts of the world), cheap and more competitive labor (due to a weak U.S. dollar over the last 15 years) and the end of a leverage-driven consumption boom. Smaller deficits by the largest economy have unpleasant implications for many other nations. Of course, foreign oil producers will earn less income, but foreign exporters selling to U.S. markets are also being hurt. Simply speaking, what once was ever-increasing economic stimulus provided to the world is now turning into restraining factors for the rest of the world.

For the U.S., it means she is now losing less growth to the rest of the world and keeping more for herself, which is growth positive. That is one of the reasons why the U.S. is performing relatively better than other economies, although still well below an average recovery. While I completely disagree with the consensus about the “normalization” of the world economy and the reacceleration thesis, if one economy can achieve the forecasts, it will be the U.S.

Credit Booms Are Followed by Busts

As Chart 1 shows, China’s surpluses are declining and therefore trade data for many other economies are deteriorating. At the same time, many of the EM economies have gone through a tremendous boom in recent years, driven by their previous success story and large capital inflows. As I outlined in the second quarter of last year in my piece “Butterfly Effect,” we have witnessed many years of a virtuous cycle. The inflow of capital (Chart 2) revalued those currencies, and while many central banks intervened to dampen the revaluation, the liquidity thereby created fueled a domestic investment and consumption boom. It was a great success story leading to a credit and real estate boom of large proportions virtually everywhere. In the last five years, Hong Kong real estate has doubled in price, Singapore’s has increased by 70% and China’s has more than doubled. It was felt throughout the whole Asian region and also in selected EM economies in other parts of the world. Of course, they and many Western commentators interpreted this as “normal” because they all believed clocks tick differently in those economies. While some may have better demographics and less government debt, they have created private sector credit bubbles of historic proportions (Chart 3). Most importantly, they are exposed to cycles as everybody else. And that is exactly the point.

The problem with credit booms is that they always end badly, although they usually go further and last longer than rational minds expect. The weakest links are breaking first, as always. Completely mismanaged economies like Argentina and Venezuela are already in deep crisis, but that was no surprise. Next follow the deep and chronic deficit countries like Turkey or South Africa, which have already seen their currencies declining sharply. Both have little foreign exchange reserves and virtually no tools to defend the currency except for raising interest rates, which will trigger a recession. Whatever these countries do, they will end in a recession because that is the way balance-of-payment crises are resolved. It is Ying and Yang, action and reaction; booms will be followed by busts, particularly when built on quicksand of phony money and credit creation. These are of course also the unintended consequences of many years of quantitative easing (QE) in the major economies spilling over to emerging economies.

Now, markets have become aware of the problem and are attacking the imbalances. Research on private sector credit booms over the last 20 years show that whenever credit to the private sector expanded by 30% or more within a 10-year period, a banking crisis and recession resulted without any exception. The following countries are all far above that danger level today and candidates for a banking crisis: Hong Kong, China, Thailand, Brazil, Turkey and Singapore. And recently even Korea, Romania, Ukraine and even Russia have broken the danger level. This is quite a long list, and the big EM economies are all part of it except India that has other deficiencies.

Now, these economies differ from each other, of course, but they share a common disease, namely a previous economic boom built on excessive credit. Most have chronic deficits in their external accounts that were unimportant as long as foreign capital flowed in at large. The response to current problems – which have been with us since the tapering was announced last summer – also differs as some simply cannot intervene in the currency market due to the lack of enough foreign exchange reserves (Turkey, South Africa) while others do intervene due to large reserves, like Brazil or Russia. Some are struggling due to the compounding effect of political trouble (Turkey) and some like Russia due to spending their foreign exchange reserves on weak political allies, in this case the Ukraine. All of them will end up with higher interest rates, a weaker economy and a weaker currency, eventually.

The Mother of All Bubbles

While some may understand the mechanism of a balance of payment that is seriously out of line and its ultimate adjustment process, most investors don’t. That’s why most voices one hears do not, in our view, address the problem properly and think it is an isolated case. While some may understand a case like Turkey, most disagree when it comes to China. While I am as impressed as others by China’s economic performance over the last 2-3 decades, we shouldn’t overlook the fact that, particularly since 2008, the economy enjoyed the most dramatic credi
t boom ever seen in modern history.

China became the second largest economy in a very short period. In the last five years, China’s total credit outstanding more than doubled and grew more than the equivalent of the total U.S. commercial banking sector, namely the equivalent of $14 trillion. That is equivalent to 150% of their current GDP. Moreover, the balance sheet of the Chinese central bank showed the biggest balance sheet expansion since 2000 of all central banks, which is testimony of an ultra-easy monetary policy.

Credit growth in the years leading to the bursting of previous bubbles has been 40%-50%, as was the case in the U.S. from 2002-2007, in South Korea in the mid-90s and in Japan in the late 80s. China’s credit growth has been by far higher than all of those. Now, we see all the signs one usually sees before the bubble bursts. For instance:

– Large expansion and acceleration of credit not matched by GDP, as credit growth is still 2.5 times faster than GDP but slowing.

– An aggressive expansion of a shadow banking system (wealth management products WMP) that has similarities to the U.S. subprime loans.

– Massive investments in property leading to a bubble in many locations. Tier 3 and 4 cities already see real estate prices declining, while prices are still rising in tier 1 and 2 cities.

– Weak risk management at financial institutions similar to U.S. and European banks before the Great Financial Crisis. There are recurring stories of banks in trouble in China and the government throwing money at them. Recently, some shadow banking institutions went bust and investors lost money.

– Finally, a heavily state-directed financial and corporate sector, which in China is a given, primarily in banking. In the U.S. it was Freddy Mac and Fanny Mae.

– Rising interest rates driven by competitive bidding for funding, not by central bank tightening. We saw this first in spring 2013, then in December of last year and now again.

China is facing the ugly choice of either deflating the bubble, hopefully in a controlled way, or of re-inflating even more, leading to an even bigger debt crisis further down the road. Continuing on the current path and procrastinating would mean even more waste investment than has already occurred and would be rather stupid. Hence, I think the chances are better than 50:50 that China will try to deflate in a controlled way, although it would be a hesitant approach at the beginning. Whether it would remain controlled is another question as it would lead to bankruptcies, an economic crisis of some sort and big problems in the financial, real estate and construction sectors. It is clear that such an outcome in the second largest economy of the world wouldn’t remain a domestic affair but impact the rest of the world. At particular risk are those financial institutions exposed with large loan portfolios to China, including WMPs. Hong Kong is at extreme risk, with bank loans amounting to almost 150% of GDP. The U.S. will certainly be impacted the least, as I have outlined above.

If the Chinese try to procrastinate by throwing more liquidity at the problem, capital would flow out and weaken the yuan despite capital controls. If China tried to support her currency, she would face a situation similar to Russia today. Supporting your own currency by intervention drains liquidity from your domestic credit system, and that’s why Russia is facing a banking crisis at present. Hence, if China chose this route, her currency would weaken and compound the structural problems due to capital outflow weakening the banking system’s deposit base. A weaker yuan could trigger the next problem as it would hurt Asian competitors in particular. Japan’s weakening of the yen was an important trigger to weaken many other Asian competitors, recently. If China would follow suit, it would simply be another deflationary hit for many others, probably the world as a whole.

While the timing of this described process is open as is the way the Chinese will choose, we must expect it to begin at any time and last many quarters if not years. The message is that problems in emerging economies are not over, and weakness in currencies, bonds and equities are in general not an opportunity to buy, yet. What investors should be aware of is that the problems in Turkey, South Africa or Russia are only sideshows compared with what’s out there in China and its implications for the world, which in our view are still not understood and not priced in by markets.

As we don’t live in an isolated world, there will be knock-on effects. Emerging markets ex China account for virtually 1/3 of total global imports, similar to the European Union, while the U.S. accounts for approximately 15% and China for only 10%. Arthur Budaghyan of BCA, Montreal, who does excellent work on emerging markets, recently published Chart 4, showing the high correlation and leading function of emerging equity markets’ relative performance to global industrial production. Moreover, Chart 5 illustrates so clearly how weakening currencies in emerging economies will eventually lead to sharp declines of imports. Those imports are of course someone else’s exports.

The mechanism, in simple terms, has been QE in the developed world leading to capital flows into emerging markets, triggering an investment and consumption boom built on cheap credit. The boom led to rising wages, reduced competitiveness, less household income after inflation, taxes and rent (which rose sharply due to the real estate boom). Now, domestic and external demand is weakening while inflation is high and external accounts are imbalanced. Hence, the world will see the next chapter of the unintended consequences of QE, namely many economies going through a balance-of-payment crisis leading to recessions and banking crises and hurting global economic growth. The U.S. will be hurt too, but is the least exposed.

Fragile Euro Zone

The big winner in equity markets in recent quarters has been the euro zone, the periphery in particular. Those yield-hungry investors who previously bought emerging market bonds have switched to buying peripherals driving the yield down to almost half the level of what prevailed in 2012, when many feared an immediate euro breakup. U.S. and Japanese investors were at the margin quite active due to the strengthening euro and the “normalization” of yields. The thesis has been sharply reduced risks due to stabilization and expected recovery.

Indeed, some like Spain have made some progress but the fundamental problems of the monetary union have not been resolved. Part of the stabilization is due to less austerity leading to growing public sector deficits again. At present, nobody cares about it and believes the situation will heal over time. It won’t, in my view. Problems have a habit to stay and grow bigger and not right themselves without proper tackling. It is true, some indicators have improved, but most of them are sentiment-based, like PMIs. As long as short-term improvements are not supported by monetary aggregates – and they are definitely not, with total credit shrinking by more than 4% year over year in the euro zone – upticks are simply coincidental and no indication of a new trend. There is no change on the horizon, as the banking industry continues to shrink
its balance sheet in view of the upcoming stress test.

The ECB has recently decided not to sterilize its bond purchases any longer, which is a slight easing move. It was supported only by the Bundesbank to prevent other more aggressive steps, of course. While some may think this step will lead to a better European economy, I rather see it as too little, too late to make a change.

Risk aversion will rise again, once investors find out the world has entered another deflationary episode, with many balance-of-payment crises that are only now beginning. Yes, it may look far away in the emerging world, but it will have knock-on effects and slow down the global economy much more than expected and hurt particularly multinationals’ revenues and profits. Nowadays, the emerging world is half of the world economy, and the world economy is more intertwined than ever before.

Changing Market Character

“As January goes, so goes the year” has an accuracy of 73% for the U.S. equity market, according to the Trader’s Almanac. I don’t rely on such statistics, but what is clearly visible is the changing character of the market. This correction so far is already the most vicious in many months. Importantly, sharp short-term sell-offs could not attract new buying, as was the case all of last year, but triggered renewed selling. Some important momentum and trend indicators are breaking down (Chart 6), and divergences built up over many months are now forcing the indices down. In Chart 7, we also witness fewer and fewer markets with rising 200-day moving averages (71%) and less and less trading above that moving average (59%). A break below 60% in the first in combination with a break below 50% in the second usually confirms a global bear market underway.

The well-performing markets in Europe and the U.S. didn’t see any new negative news, but they were so overheated and overbought that markets were selling off without. Markets had entered a highly speculative stage, with sentiment indicators hitting multi-year extremes. U.S. margin debt as a percentage of GDP has now hit 2.6%, the same extreme as in 2007 at the peak and close to the all-time high of 2.8% in 2000.

In discussions with European investors in recent months, it was unbelievable how bullish they have become. Picking the right stock was all they cared about, since in their view it was a given that stock prices could only rise as long as central banks pursued easy money and low interest rate policies. Any word of caution was moved to the side. I spoke at a conference recently, before this sell-off really began, and was looked at like somebody from another planet, as all others were so indiscriminately bullish. They didn’t even care about asset allocation. Equities were simply the only game in town – no bonds, no cash, no gold, no real estate, just equities. Frothy markets by themselves may not make a top, but they indicate high vulnerability for corrections.

The most important fundamental change at the margin is the “tapering” by the Fed. There have been intense internal discussions at the Fed, and the way I am reading the tea leaves, the Fed is tired of money printing and wants out. Hence, I am expecting their tapering to continue and to be complete later this year, provided no major accident happens in the financial markets in between. This is equivalent to raising interest rates from minus two percent to zero. And while zero is still low, it is in my view a step by step removal of stimulus and therefore a regime shift in monetary policy at the most important central bank of the world. This is a strong message. Unfortunately, we have no experience with “tapering” and therefore do not know when and how it impacts markets. However, such a change in combination with frothy markets has now triggered a serious correction that in our view has more to run. Since developments in the developed world will not lead to an immediate economic downturn, opportunity hunters will appear and buy the dip, perhaps several times. Hence, it could be a step by step correction during this quarter followed by another upside attempt, particularly in the U.S. and Europe.

In our reading, the current weakness is led by emerging equity markets, and most of them are already deep in their second downleg of this cyclical bear market, while for most equities in developed markets it is only the first downleg of a new bear market. There is an outright chance that once this downleg ends, a few indices may make it back to the highs or even marginally above, but now is not the time to decide that. Now, the message for investors simply is to pursue defensive strategies.

The sell-off has now created an oversold situation at a time when the U.S. and European markets reached the December lows, while Japan is a bit weaker. Hence, some attempts to bounce off these levels are likely in the short-term. If recovery attempts remain weak and do not lead far, which is my hunch, we may be facing the right shoulder of a head and should top, from where markets could break down further thereafter.

Strong Dollar

In the currency arena, the U.S. Dollar has been firming for quite some time against virtually all others except the euro family of currencies. I expect the stronger dollar trend to continue despite some interest rate hikes in selected emerging economies. Those economies have to be rebalanced through a full-fledged balance of payment crisis that does include a recession. While the extremes of last week may lead to a temporary pause in EM currencies, I expect them to continue weak later.

The euro is a deflation currency with the same characteristics of the Japanese yen until the regime change in the country of the rising sun. We see chronic current account surpluses, a stagnating and aging population and a deflationary economic policy mix with economic stagnation. This condition must change, similar to Japan in late 2012. We don’t know when, but further disappointments this year will create rising stress in the euro zone. The recent change at the ECB of withdrawing the sterilization of bond purchases amounts to some easing and a weakening of the euro; however, it will not be enough to improve the economy. Hence, we see the upside of the euro against the U.S. unit as very limited and expect a weaker euro in coming months and lasting well into next year, as the ECB will at some point be forced to do a lot more.

The big surprise for the world will in our view be a temporary strengthening of the yen. The world is short yen, as it has been used as a funding currency that declines in value and costs extremely low interest. Moreover, the Japanese have outlined their goal of weakening the currency to end deflation. The economy will do well up until April 1, when the VAT will be hiked by 3%. This will lead to CPI inflation of close to 4% while wages will only be raised by 1%-2%, leading to an income shortfall in real terms. Hence, the economy will most likely be quite weak in the 2nd and 3rd quarters. The Bank of Japan is aware of this and has recently stopped buying JGBs to make room for more aggressive steps later. Hence, I expect the world to be forced to cover their yen shorts, as Abenomics will look like a failure. We expect the Japanese to launch another stimulus program, including aggressive monetary easing, that will most li
kely start sometimes in the second half and trigger the next phase of yen weakness, but only after a temporary correction that could amount to approximately 10% from recent extremes versus the U.S. dollar and more versus other major currencies.

Bonds Offer a Safe Haven

We share the view that bond yields of perceived quality borrowers have terminated their 30-year secular decline and are in a multi-year bottoming process. Within this bottoming, our hunch is that the cyclical rise from the secular low in 2012 has ended. As outlined, we are expecting another deflationary episode and see in particular U.S. Treasuries with maturities of 10 years and longer as offering attractive trading opportunities over the next 6-12 months, whereby 10-year yields could decline to around 2%. This may not be attractive in the eyes of many, but in view of medium- and most likely cyclical declines in equities, Treasuries offer a safe haven.

While yields on German Bunds or some other selected quality bonds may also decline, I think U.S. paper will be the most attractive and offer the best total return potential, as capital will be returning from virtually all other parts of the world and thereby strengthening the currency, which will not be the case for others.

Restrained Bottoming Attempt for Gold

In the scenario outlined, economic-sensitive commodities are unattractive and at risk of further declines. I would exclude them from portfolios.

Gold has disappointed so many that it is hard to see how Western investors who have sold are getting back into gold anytime soon. Rising deflationary risks could hinder a gold recovery despite its deeply oversold cyclical position. In fact, I wouldn’t be surprised to see gold breaking $1,180 first for a final washout before the recovery starts, most likely from late spring onwards, when rising risk in the global credit system will become more visible. It is reasonable to expect citizens in those countries directly impacted to store part of their wealth in gold instead of paper currencies, which are losing value virtually every day.

Since the gold market is very oversold from a cyclical point of view after declining from $1,920 to $1,180 in more than two years, investors should take a constructive and contrarian view of gold and accumulate step by step on weakness. It may take a few more months until the dimension of risk in the credit system become more visible, but I expect this to be on the table in the second half at the latest, when the price of gold should be higher again. Even gold mining stocks can be purchased with a 12-month view, as they have been beaten down badly and are cheap on a valuation basis. They are, however, not for widows and orphans.

In general, we expect another deflationary episode leading to systemic risks and economic disappointments. Hence, it is time to structure portfolios much more conservatively and put capital preservation ahead of aggressive return strategies. In contrast to last year, 2014 will hardly be a year with a powerful and easy trend to ride. Instead, it will bring much more volatility but also plenty of trading opportunities for flexible investors.


    



via Zero Hedge http://ift.tt/1bzxtdL Tyler Durden

Spot The Real Liquidity Bubble

Overnight the PBOC released the latest Chinese bank loan and liquidity data for the month of January. Those who have been following our recent series on Chinese liquidity measures will know that when it comes to the real marginal source of global liquidity, it is China that is the true unprecedented juggernaut, putting both the Fed and the BOJ’s “puny” QE programs to shame (see “Chart Of The Day: How China’s Stunning $15 Trillion In New Liquidity Blew Bernanke’s QE Out Of The Water“, “Some Stunning Perspective: China Money Creation Blows US And Japan Out Of The Water“). And January’s data was simply the final exclamation mark in a decade-long series in which China’s prosperity has been simply the result of an exponentially increasing amount of loan and liquidity creation by the Chinese semi-national and government backstopped financial system.

Here are the numbers:

Total Chinese loan creation in January was CNY 1.32 trillion, or $218 billion. While January traditionally sees a pick up in loan creation (and demand), the 174% increase in bank loans from December was an unprecedented number, was above the CNY 1.1 trillion, and CNY 250 billion more than a year ago. More notably, this was the largest monthly bank loan injection since January 2010. The last time China scrambled to inject massive amounts of bank loans was in late 2008 and early 2009 when the world was ending, and it was China’s money that stabilized the global financial system far more so than the Fed’s whose QE 1 did not begin in earnest until March 2009.

The far broader monetary aggregate, Total Social Financing, which is the most encompassing calculation of credit and liquidity created in China in any one month, rose to CNY 2.58 trillion. This was more than double the December’s $1.23 trillion, and beat last January’s CNY 2.545 trillion. In fact, this month’s broad liquidity creation was the largest monthly amount in China’s history!

 

Here is what Reuters had to say about the overnight data:

January’s lending surge aside, China’s central bank has consistently signaled in recent months that it wants to temper credit growth to slow a rapid rise in debt levels across the economy.

 

It has focused in particular on keeping short-term interest rates elevated to force banks to stop lending to speculators or high-risk borrowers.

 

Analysts polled by Reuters in January said they expect China’s economy to grow 7.4 per cent this year, an enviable performance for a major economy, but still the worst for China in 14 years. The economy grew 7.7 per cent last year.

Here’s the problem: one can’t put the January lending surge aside, as it came at a time when for the second time in six months the PBOC tried to taper, only to be forced to not only bail out its money markets, but is on the verge of a bankruptcy tsunami involving its shadow banking products, the first of which it also bailed out despite repeated warnings this time it means business and would let it die. In this context, the January number is precisely what it appears: the bank’s logical response to a liquidity crunch as the Chinese regime finds itself in the same spot that the Fed has been in for the past 5 years – it must keep the monetary spice flowing, or else the party is over. And just like the Fed, and now the BOJ, so too does China not want to deal with the fall out if all it takes to created yet another quarter of increasingly subpar economic growth is another record of funny money conceived out of thin air.

The only problem is that it is becoming increasingly difficult to hide all the pieces of funny money, most of which result in bad and otherwise impaired loans, under the rug. And just to show the problem in its context, here is how China’s banks created some 50% more in bank loans in January than the QE credit money created by both the Fed and the BOJ combined.

And finally, here is China’s nearly half a trillion in total liquidity added to the system in just one month (some deleveraging, right?) looks compared to the Fed and the BOJ’s much maligned and unprecedented uncovnentional monetary policy.


    



via Zero Hedge http://ift.tt/1jnUrUq Tyler Durden

The Drugging Of America Summarized In 19 Mind-Altering Facts

Submitted by Michael Snyder of The American Dream blog,

The American people are the most drugged people in the history of the planet.  Illegal drugs get most of the headlines, but the truth is that the number of Americans that are addicted to legal drugs is far greater than the number of Americans that are addicted to illegal drugs.  As you will see below, close to 70 percent of all Americans are currently on at least one prescription drug.  In addition, there are 60 million Americans that “abuse alcohol” and 22 million Americans that use illegal drugs.  What that means is that almost everyone that you meet is going to be on something.  That sounds absolutely crazy but it is true. 

We are literally being drugged out of our minds.  In fact, as you will read about below, there are 70 million Americans that are taking “mind-altering drugs” right now.  If it seems like most people cannot think clearly these days, it is because they can’t.  We love our legal drugs and it is getting worse with each passing year.  And considering the fact that big corporations are making tens of billions of dollars peddling their drugs to the rest of us, don’t expect things to change any time soon.  The following are 19 statistics about the drugging of America that are almost too crazy to believe…

#1 An astounding 70 million Americans are taking legal mind-altering drugs right now.

#2 According to the Centers for Disease Control and Prevention, doctors wrote more than 250 million prescriptions for antidepressants during 2010.

#3 According to a study conducted by the Mayo Clinic, nearly 70 percent of all Americans are on at least one prescription drug.  An astounding 20 percent of all Americans are on at least five prescription drugs.

#4 Americans spent more than 280 billion dollars on prescription drugs during 2013.

#5 According to the CDC, approximately 9 out of every 10 Americans that are at least 60 years old say that they have taken at least one prescription drug within the last month.

#6 There are 60 million Americans that “abuse alcohol”.

#7 According to the Department of Health and Human Services, 22 million Americans use illegal drugs.

#8 Incredibly, more than 11 percent of all Americans that are 12 years of age or older admit that they have driven home under the influence of alcohol at least once during the past year.

#9 According to the Centers for Disease Control and Prevention, there is an unintentional drug overdose death in the United States every 19 minutes.

#10 In the United States today, prescription painkillers kill more Americans than heroin and cocaine combined.

#11 According to the CDC, approximately three quarters of a million people a year are rushed to emergency rooms in the United States because of adverse reactions to pharmaceutical drugs.

#12 According to Alternet, “11 of the 12 new-to-market drugs approved by the Food and Drug Administration were priced above $100,000 per-patient per-year” in 2012.

#13 The percentage of women taking antidepressants in America is higher than in any other country in the world.

#14 Many of these antidepressants contain warnings that “suicidal thoughts” are one of the side effects that should be expected.  The suicide rate for Americans between the ages of 35 and 64 rose by close to 30 percent between 1999 and 2010.  The number of Americans that are killed by suicide now exceeds the number of Americans that die as a result of car accidents every year.

#15 In 2010, the average teen in the United States was taking 1.2 central nervous system drugs.  Those are the kinds of drugs which treat conditions such as ADHD and depression.

#16 Children in the United States are three times more likely to be prescribed antidepressants as children in Europe are.

#17 A shocking Government Accountability Office report discovered that approximately one-third of all foster children in the United States are on at least one psychiatric drug.

#18 A survey conducted for the National Institute on Drug Abuse found that more than 15 percent of all U.S. high school seniors abuse prescription drugs.

#19 It turns out that dealing drugs is extremely profitable.  The 11 largest pharmaceutical companies combined to rake in approximately $85,000,000,000 in profits in 2012.

In America today, doctors are trained that there are just two potential solutions to any problem.  Either you prescribe a pill or you cut someone open.  Surgery and drugs are pretty much the only alternatives they offer us.

And an endless barrage of television commercials have trained all of us to think that there is a “pill for every problem”.

Are you in pain?

Just take a pill.

Are you feeling blue?

Just take a pill.

Do you need a spark in your marriage?

Just take a pill.

And most Americans assume that all of these pills are perfectly safe.

After all, the government would never approve something that wasn’t safe, right?

Sadly, what most Americans don’t realize is that there is a revolving door between big pharmaceutical corporations and the government agencies that supposedly “regulate” them.  Many of those that are now in charge of our “safety” have spent their entire careers peddling legal drugs to all of us.

We have become a nation of drugged out zombies, and it is all perfectly legal.  The funny thing is that many of these “legal drugs” have just slightly different formulations from their “illegal” counterparts.

If more Americans understood what they were actually taking, would that cause them to stop?

Perhaps some would, but for the most part Americans are totally in love with their drugs and giving them up would not be easy.

Just ask anyone that has tried.


    



via Zero Hedge http://ift.tt/1gLutsn Tyler Durden