Category: zerohedge

In Feb 2007, Oaktree Capital's Howard Marks wrote 'The Race to the Bottom', providing a timely warning about the capital market behavior that ultimately led to the mortgage meltdown of 2007 and the crisis of 2008 as he worried about "carelessness-induced behavior." In the pre-crisis years, as described in his 2007 memo, the race to the bottom manifested itself in a number of ways, and as Marks notes, "now we’re seeing another upswing in risky behavior." Simply put, Marks warns, "when people start to posit that fundamentals don’t matter and momentum will carry the day, it’s an omen we must heed," adding that "the riskiest thing in the investment world is the belief that there’s no risk."

Excerpted from OakTree Capitals' Howards Marks most recent letter to investors:

Of all the cycles I write about, I feel the capital market cycle is among the most volatile, prone to some of the greatest extremes. It is also one of the most impactful for investors. In short, sometimes the credit window is open to anyone in search of capital (meaning dumb deals get done), and sometimes it slams shut (meaning even deserving companies can’t raise money).

…

The cycles I describe aren’t predictable as to timing or extent. However, their fluctuations absolutely can be counted on to recur, and that’s what matters to me. I think it’s also what Mark Twain had in mind when he said “History doesn’t repeat itself, but it does rhyme.” The details don’t repeat, but the rhyming patterns are extremely reliable.

Competing to Provide Capital

When the economy is doing well and companies’ profits are rising, people become increasingly comfortable making loans and investing in equity. As the environment becomes more salutary, lenders and investors enjoy gains. This makes them want to do more; gives them the capital to do it with; and makes them more aggressive. Since this happens to all of them at the same time, the competition to lend and invest becomes increasingly heated.

When investors and lenders want to make investments in greater quantity, I think it’s also inescapable that they become willing to accept lower quality. They don’t just provide more money on the same old terms; they also become willing – even eager – to do so on weaker terms. In fact, one way they strive to win the opportunity to put money to work is by doing increasingly dangerous things.

This behavior was the subject of The Race to the Bottom. In it I said to buy a painting in an auction, you have to be willing to pay the highest price. To buy a company, a share of stock or a building – or to make a loan – you also have to pay the highest price. And when the competition is heated, the bidding goes higher. This doesn’t always – or exclusively – result in a higher explicit price; for example, bonds rarely come to market at prices above par. Instead, paying the highest price may take the form of accepting a higher valuation parameter (e.g., a higher price/earnings ratio for a stock or a higher multiple of EBITDA for a buyout) or accepting a lower return (e.g., a lower yield for a bond or a lower capitalization rate for an office building).

Further, rather than paying more for the asset purchased, there are other ways for an investor or lender to get less for his money. This can come through tolerating a weaker deal structure or through an increase in risk. It’s primarily these latter elements – rather than securities merely getting pricier – with which this memo is concerned.

History Rhymes

In the pre-crisis years, as described in the 2007 memo, the race to the bottom manifested itself in a number of ways:

There was widespread acceptance of financial engineering techniques, some newly minted, such as derivatives creation, securitization, tranching and selling onward. These innovations resulted in the creation of such things as highly levered mortgage-backed securities, CDOs and CLOs (structured credit instruments offering tiered debt levels of varying riskiness); credit default swaps (enabling investors to place bets regarding the creditworthiness of debtors); and SPACs (Special Purpose Acquisition Companies, or blind-pool acquisition vehicles). Further, the development of derivatives, in particular, vastly increased the ease with which risk could be shouldered (often without a complete understanding) as well as the amount of risk that could be garnered per dollar of capital committed.

 

While not a novel development, there was an enormous upsurge in buyouts. These included the biggest deals ever; higher enterprise values as a multiple of cash flow; increased leverage ratios; and riskier, more cyclical target companies, such as semiconductor manufacturers.

 

There was widespread structural deterioration. Examples included covenant-lite loans carrying few or none of the protective terms prudent lenders look for, and PIK-toggle debt on which the obligors could elect to pay interest “in kind” with additional securities rather than cash.

 

Finally, there was simply a willingness to buy riskier securities. Examples here included large quantities of CCC-rated debt, as well as debt issued to finance dividend payments and stock buybacks. The last two increase a company’s leverage without adding any productive assets that can help service the new debt.

Toward the end, my 2007 memo included the following paragraph:

Today’s financial market conditions are easily summed up: There’s a global glut of liquidity, minimal interest in traditional investments, little apparent concern about risk, and skimpy prospective returns everywhere. Thus, as the price for accessing returns that are potentially adequate (but lower than those promised in the past), investors are readily accepting significant risk in the form of heightened leverage, untested derivatives and weak deal structures. The current cycle isn’t unusual in its form, only its extent. There’s little mystery about the ultimate outcome, in my opinion, but at this point in the cycle it’s the optimists who look best. (emphasis in the original)

Now we’re seeing another upswing in risky behavior. It began surprisingly soon after the crisis (see Warning Flags, May 2010), spurred on by central bank policies that depressed the return on safe investments. It has gathered steam ever since, but not to anywhere near the same degree as in 2006-07.

• Wall Street has, thus far, been less creative in terms of financial engineering innovations. I can’t think of a single new “modern miracle” that’s been popularized since the crisis.
• Likewise, derivatives are off the front page and seem to be created at a much slower pace. A full resumption of derivatives creation and other forms of financial innovation appears to be on hold pending clarification of the regulatory uncertainty surrounding acceptable activity for banks.
• Buyout activity seems relatively subdued. In 2006-07, it seemed a buyout in the tens of billions was being announced every week; now they’re quite scarce. Many smaller deals are taking place, however, including a large number of “flips” from one buyout fund to another, and leverage ratios have moved back up toward the highs of the last cycle.
• “Cov-lite” and PIK-toggle debt issuance is in full flower, as are triple-Cs, dividend recaps and stock buybacks.

It’s highly informative to assess how the other characteristics of 2007 enumerated above compare with conditions today:

• global glut of liquidity – check
• minimal interest in traditional investments – check (relatively little is expected today from Treasurys, high grade bonds or equities, encouraging investors to shift toward alternatives)
• little apparent concern about risk – check
• skimpy prospective returns everywhere – check

Risk tolerance and leverage haven’t returned to their pre-crisis highs in quantitative terms, but there’s no doubt in my mind that risk bearing is back in vogue.

…

Perhaps most tellingly, the November 19 Bloomberg story referenced above included the following observation from a strategist whom I’ll allow to go nameless: “The analysis at some point shifts from fundamentals to being purely based on the price action of the stock.” When people start to posit that fundamentals don’t matter and momentum will carry the day, it’s an omen we must heed.

While the extent is nowhere as dramatic as in 2006-07 – and the psychology behind it isn’t close to being as bullish or risk-blind – I certainly sense a significant increase in the acceptance of risk. The bottom line is that when risk aversion declines and the pursuit of return gathers steam, issuers can do things in the capital markets that are impossible in more prudent times.

 

Why Is Risk Bearing on the Rise, and What Are the Implications?

To set the scene for answering the above questions, I’m going to reiterate and pull together some observations from recent memos.

Psychologically and attitudinally, I don’t think the current capital market atmosphere bears much of a resemblance to that of 2006-07. Then I used words like “optimistic,” “ebullient” and “risk-oblivious” to describe the players. Returns on risky assets were running high, and a number of factors were cited as having eliminated risk:

• The Fed was considered capable of restoring growth come what may.
• A global “wall of liquidity” was coming toward us, derived from China’s and the oil producers’ excess reserves; it could be counted on to keep asset prices aloft.
• The Wall Street miracles of securitization, tranching, selling onward and derivatives creation had “sliced and diced” risk so finely – and directed it where it could most readily be borne – that risk really didn’t require much thought.

In short, in those days, most people couldn’t imagine a way to lose money.

I believe most strongly that the riskiest thing in the investment world is the belief that there’s no risk. When that kind of sentiment prevails, investors will engage in otherwise-risky behavior. By doing so, they make the world a risky place. And that’s what happened in those pre-crisis years. When The New York Times asked a dozen people for articles about the cause of the crisis, I wrote one titled “Too Much Trust; Too Little Worry.” Certainly a dearth of fear and a resulting high degree of risk taking accurately characterize the pre-crisis environment. But that was then. It’s different today.

Today, unlike 2006-07, uncertainty is everywhere:

• Will the rate of economic growth in the U.S. get back to its prior norm? Will unemployment fall to the old “structural” level?
• Can America’s elected officials possibly reach agreement on long-term solutions to the problems of deficits and debt? Or will the national debt expand unchecked?
• Will Europe improve in terms of GDP growth, competitiveness and fiscal governance? Will its leaders be able to reconcile the various nations’ opposing priorities?
• Can Abenomics transform Japan’s economy from lethargy to dynamism? The policies appear on paper to be the right ones, but will they work?
• Can China transition from a highly stimulated economy based on easy money, an excess of fixed investment and an overactive non-bank financial system, without producing a hard landing that keeps it from reaching its economic goals?
• Can the emerging market economies prosper if demand from China and the developed world expands more slowly than in the past?

Looking at the world more thematically, a lot of questions surround the ability to manage economies and regulate growth:

• Can low interest rates and high levels of money creation return economic growth rates to previous levels? (To date, the evidence is mixed.)
• Can inflation be returned to a salutary level somewhat above that of today? Right now, insufficient inflation is the subject of complaints almost everywhere. Can the desired inflation rate be reinstated without going beyond, to undesirable levels?
• Programs like Quantitative Easing are novel inventions. How much do we know about how to end them, and about what the effects of doing so will be? Will it prove possible to wind down the stimulus – the word du jour is “taper” – without jeopardizing today’s unsteady, non-dynamic recoveries? Can the central banks back off from interest rate suppression, bond buying and easy money policies without causing interest rates to rise enough to choke off growth?
• How will governments reconcile the opposing goals of stimulating growth (lower taxes, increased spending) and reining in deficits (increased taxes, less spending)?
• Will prosperous regions (e.g., Germany) continue to be willing to subsidize profligate and poorer ones (e.g., Spain and Portugal)?

As to investments:

• When the Fed stops buying bonds, will interest rates rise a little or a lot? Does that mean bonds are unattractive?
• Are U.S. stocks still attractive after having risen strongly over the last 18 months?
• Ditto for real estate following its post-crash recovery?
• Can private equity funds buy companies at attractive prices in an environment where few owners are motivated to sell?

As I’ve said before, most people are aware of these uncertainties. Unlike the smugness, complacency and obliviousness of the pre-crisis years, today few people are as confident as they used to be about their ability to predict the future, or as certain that it will be rosy. Nevertheless, many investors are accepting (or maybe pursuing) increased risk.

The reason, of course, is that they feel they have to. The actions of the central banks to lower interest rates to stimulate economies have made this a low-return world. This has caused investors to move out on the risk curve in pursuit of the returns they want or need. Investors who used to get 6% from Treasurys have turned to high yield bonds for such a return, and so forth.

Movement up the risk curve brings cash inflows to riskier markets. Those cash inflows increase demand, cause prices to rise, enhance short-term returns, and contribute to the pro-risk behavior described above. Through this process, the race to the bottom is renewed.

In short, it’s my belief that when investors take on added risks – whether because of increased optimism or because they’re coerced to do so (as now) – they often forget to apply the caution they should. That’s bad for them. But if we’re not cognizant of the implications, it can also be bad for the rest of us.

Where does investment risk come from? Not, in my view, primarily from companies, securities – pieces of paper – or institutions such as exchanges. No, in my view the greatest risk comes from prices that are too high relative to fundamentals. And how do prices get too high? Mainly because the actions of market participants take them there.

Among the many pendulums that swing in the investments world – such as between fear and greed, and between depression and euphoria – one of the most important is the swing between risk aversion and risk tolerance.

Risk aversion is the essential element in sane markets. People are supposed to prefer safety over uncertainty, all other things being equal. When investors are sufficiently risk averse, they’ll (a) approach risky investments with caution and skepticism, (b) perform thorough due diligence, incorporating conservative assumptions, and (c) demand healthy incremental return as compensation for accepting incremental risk. This sort of behavior makes the market a relatively safe place.

But when investors drop their risk aversion and become risk-tolerant instead, they turn bold and trusting, fail to do as much due diligence, base their analysis on aggressive assumptions, and forget to demand adequate risk premiums as a reward for bearing increased risk. The result is a more dangerous world where asset prices are higher, prospective returns are lower, risk is elevated, the quality and safety of new issues deteriorates, and the premium for bearing risk is insufficient.

It’s one of my first principles that we never know where we’re going – given the unreliability of macro forecasting – but we ought to know where we are. “Where we are” means what the temperature of the market is: Are investors risk-averse or risk-tolerant? Are they behaving cautiously or aggressively? And thus is the market a safe place or a risky one?

Certainly risk tolerance has been increasing of late; high returns on risky assets have encouraged more of the same; and the markets are becoming more heated. The bottom line varies from sector to sector, but I have no doubt that markets are riskier than at any other time since the depths of the crisis in late 2008 (for credit) or early 2009 (for equities), and they are becoming more so.

….

However, Marks has a silver lining,

No, I don’t think it’s time to bail out of the markets. Prices and valuation parameters are higher than they were a few years ago, and riskier behavior is observed. But what matters is the degree, and I don’t think it has reached the danger zone yet.

 

Over the last 2-3 years, my motto for Oaktree has been consistent: “move forward, but with caution."

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/NiQ3WFgVzwI/story01.htm Tyler Durden

Since expectations of Q3’s GDP growth began to get ratcheted lower with reality (in March), ‘economists’ have banked on Q4’s fiscally-dragless-renaissance to fill the wedge between equity prices and fundamentals. That ‘hope’ has been dashed (once again) on the shores of QE insanity as Q4 2013 expectations have collapsed 30% in 2 months to only 1.8%… but ‘hope’ and ‘faith’ remain as Q1 2014 will save the day. Of course, all this is magically achievable – like this.

 

 

How much longer until everyone gets the joke?

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/lLb9FS-z_rs/story01.htm Tyler Durden

Submitted by Brandon Smith of Alt-Market blog,

By any reasonable measure, I think it is safe to say that the last quarter of 2013 has been an insane game of economic Russian Roulette.  Even more unsettling is the fact that most of the American population still has little to no clue that the U.S. was on the verge of a catastrophic catalyst event at least three times in the past three months alone, and that we face an even greater acceleration next year. 

The first near miss was the Federal Reserve's announcement of a possible “taper” of QE stimulus in early fall, which sent shivers through stock markets and proved what we have been saying all along – that the entire recovery is a facade built on an ever thinning balloon of fiat money.  Today, markets function entirely on the expectation that the Fed will continue stimulus forever.  If the Fed does cut QE in any way, the frail psychology of the markets will shatter, and the country will come crashing down with it.

The second near miss was the possible unilateral invasion of Syria demanded by the Obama Administration.  As we have discussed here at Alt-Market for years, any invasion of Syria or Iran will bring detrimental consequences to the U.S. economy and energy markets, not to mention draw heavy opposition from Russia and China.  Though the naïve shrug it off as a minor foreign policy bungle, Syria could have easily become WWIII, and I believe the only reason the establishment has not yet followed through with a strike in the region is because the alternative media has been so effective in warning the masses.  The elites need a certain percentage of support from the general public and the military for any war action to be effective, which they did not receive.  After all, no one wants to fight and die in support of CIA funded Al Qaeda terrorist cells on the other side of the world.  The establishment tried to hide who the rebels were, and failed.  

The third near miss was, of course, the debt ceiling debate, which has been extended to next spring.  America came within a razor's edge of debt default, which many people rightly fear.  What some do not yet grasp, though, is that debt default of the U.S. was NOT avoided last month, it is INEVITABLE.  Debt default will ultimately result in the death of the dollar as the world reserve currency, and the petro-currency.  This final gasp will lead to hyperstagflation within our financial system, and third world status for most of the citizenry.  It is only a matter of time, and timing.

“Timing” is truly what we are all concerned about.  Those of us in the field of alternative media and economics understand well that the U.S. is on a collision course with disaster; it is a mathematical certainty.  We no longer think in terms of “if” it happens – we only question “when” it will happen.  Our fiscal structure now hangs by the thinnest of threads, a thread which for all we know could be cut at a moments notice.  However, economic and political storms appear to be brewing with the year 2014 as a target. 

Globalists have been openly seeking the destabilization of U.S. sovereignty, and they have openly admitted that the destruction of the dollar and our economic foundations will aid them in their goal.  It is important to never forget that international financiers WANT to absorb America into a new global economic structure, and that the U.S. must be debased before this can be accomplished.   Here are a few reasons why I believe 2014 may be the year they make their final move…       

Debt Debate On Steroids

Nothing concrete was decided during the highly publicized “battle” between Democrats and the GOP on what would be done to solve the U.S. debt addiction.  Some people might assume that the fight will go on indefinitely, and that the “can” will be kicked down the road for years to come.  This assumption is a dangerous one.  If you thought the last debt debate was hair raising, the next is likely to give you a coronary.  Think of 2013 as a practice run, a warm up to the main event in 2014.  Why will next year be different?  Because the motivations behind a debt ceiling freeze (and thus debt default) are now supported by the obvious failure of Obamacare.

Funding for Obamacare was the underlying issue that gave strength to the push for new debt ceiling extensions.  The U.S. government has overreached financially in ever way imaginable.  We have long running entitlement programs that have been technically bankrupt for years.  But, Obamacare was so pervasive during the debt debate that we heard nothing of these existing liabilities.  Ultimately, Obamacare is the primary reason why so many Americans on the “left” want unlimited spending and inflation, and why so many Americans on the “right” are actually seeking debt default. 

We all know that at the top of the pyramid the debt debate itself is false left/right theater, but it is still theater with a purpose.

In my articles 'The Socialization Of America Is Economically Impossible' and 'Obamacare: Is It A Divide And Conquer Distraction', I discussed why universal healthcare could not be implemented in America, and I predicted in advance that Obamacare was actually a farce that was designed to fail.  The program's only purpose is to provide a vehicle by which divisions between the fake left and the fake right could be solidified in the minds of the common populace.  A lot of cynicism was directed at the notion that the government might create a socialized healthcare initiative and then allow it to fail.  Of course, we now know that is exactly what they had in mind.

During the last debt debate, Obamacare was just a policy waiting to be implemented; next debate, that policy will be rightly labeled a train wreck.  Obamacare is falling apart at it's very inception, and evidence makes clear that the White House KNEW in advance that this would occur.  In the days before it's launch, performance tests on the Obamacare website showed conclusively that the system could not handle more than 500 users.

Obama promised that preexisting healthcare plans would be retained by Americans and that the Affordable Care Act would not do damage to established insurance models.  He made this promise knowing full well that he could not or would not keep it.  This dishonesty has resulted in rebellion by Democrats who have sided with Republicans to pass a bill which obstructs the erasure of existing health coverage.

States once disturbingly loyal to the White House are now moving to limit the application of the Obamacare structure.

The White House had foreknowledge that the program was nowhere near ready, yet, they moved forward anyway.  Why wouldn't they stall?  Why would Obama knowingly unleash his “opus” before it was finished?  He had it in the bag, right?  He won, right?  All he had to do was build a functioning website and keep his promises at least long enough to sucker the majority of Americans into the system.  Instead, he throws the fight and hits
the canvas before he's even punched?  Why?

It all sounds rather insane if you aren't aware of the bigger picture, and I'm sure the average Democrat out there is wide-eyed and bewildered.  Some might blame it on “ego”, or “hubris”, but this makes little sense.  Obamacare is an American socialist's dream.  With a simple working public interaction model, Obama would be worshiped by leftists for decades to come as the next Franklin Delano Roosevelt.  Hubris should have ENSURED that the White House launch of Obamacare would be flawless. 

Once you realize that this is not about Obama, and that Obama is nothing but a middle-man for the globalists, and that the actual implementation of Obamacare never mattered to the establishment, the fog begins to clear.

With Obamacare in shambles, the dynamic of the debt debate theater changes completely.  Some Democrats may well show support for a hold on the debt ceiling, for, what reason do they have to champion more spending?  Obama has already made fools of them all, and the Obamacare motivator is essentially out of the picture.  The GOP will be energized and more unified than the last debate, giving more momentum to a debt ceiling lock.  The argument will be made that a resulting debt default will not be harmful, and that the U.S. can carry the weight of existing liabilities until the budget is balanced.
This is certainly a lie, but it is a fashionable lie that Americans will want to hear. 

Americans do not want to hear that our economy is too far gone and that any motion, to spend, or to cut, will have the same result – currency collapse and fiscal implosion.  They do not want to hear that pain must be suffered before a realistic solution can be applied.  They do not want to hear the the system will have to be brought down before it can be rebuilt.  And, they definitely do not want to hear that the system will be deliberately brought down and replaced with something even worse. 

Will the next debt debate in Spring 2014 end in debt default and the collapse that globalists desire so much?  It's hard to say, but many insiders appear to be preparing for just such a scenario…

The Fed's Buzz Kill

No one, and I mean no one, believes the private Federal Reserve will ever commit to a taper of fiat stimulus.  Hell, I barely believe it's possible, and I'm open to just about any scenario.  That said, I have to ask a question which few analysts seem to be asking – why does the Fed keep pre-injecting the concept of taper into the mainstream if they never intend to implement it?  When has the Fed ever pre-injected a plan into the MSM which it did not eventually implement? 

The banksters have the markets in the palm of their hand, or at least they seem to.  Stocks now rise and fall according to whatever meaningless press release the central bank happens to put out on any given morning.  What do they have to gain by consistently shaking the confidence of investors around the world by suggesting that the fiat party they created will abruptly end?

The impending approval by the Senate of Janet Yellen, a champion of the printing press, would suggest to many that QE-infinity is assured.  We know that the black hole generated by the derivatives implosion cannot be filled (debts still exist in the quadrillions of dollars), and that the Fed will have to print endlessly in order to slow the deterioration of the the banking sector.  We know that none of the currency flows created by the Fed are trickling down to main street, which is why credit remains mostly frozen,  real unemployment counting U-6 measurements remains at around 25%, food stamp recipients have risen to around 50 million, and the only sales boosts to property markets are those caused by big banks buying bankrupt houses and then reissuing them as rentals.

We know that it makes sense for the central bank to continue QE, if only to continue pumping up banks and the stock market and hide the truly dismal state of the overall system.  But let's forget about what we think “makes sense” for just a moment…

What if the Fed no longer WANTS to hide the true state of the system anymore?  What if QE is now giving back diminishing returns, and will soon be no longer effective at hiding economic weakness?Central bankers surely don't want to take the blame for a collapse, but what if the perfect patsy is already lined up?  A patsy so hated and despised that no one would think twice about their guilt?  I am, of course, talking about the Federal Government itself.

Think about it; the failure of Obamacare promises a debt debate in the Spring of 2014 that will rock the very foundations of the global economy.  Both sides, Democrat and Republican, are ready to blame the other fully for any disastrous outcome, though “Tea Party” conservatives have been painted by the mainstream media as the lead culprits behind a financial catastrophe that began before the Tea Party was born.  The idea of “gridlock” leading to impasse and calamity is already built into the country's consciousness.  The general public's opinion of all areas of government has recently hit all time lows.  In fact, our opinion of government could scarcely go any lower than it already has.  Everyone HATES what government is, or what they think it is.  Most Americans would be happy to place the brunt of the blame for an economic disaster on the shoulders of Washington DC.

The genius of it is, they deserve a large part of the blame.  They helped to make possible all of the horrors the citizenry will face in the coming years.  The problem is, the public may become so blinded with rage over the failure of the political system, that they may completely forget about the role of international and central banks and turn on each other instead. 

Why is the Fed now discussing, just before the possible confirmation of Janet Yellen, a stimulus dove, the need for taper measures by 2014?

Is it just coincidence that the taper discussion is taking place parallel to the debt ceiling battle, or are these two things related?  What if the Fed plans to apply QE cuts during or after the renewed debt debate in order to make the market effects even more negative?  What if the Fed is timing the taper to give energy to a debt default?  What if the Fed wants to reduce support, so that later, when all hell breaks loose, we'll come begging them for support?

Whether you believe a debt default will be deliberately induced or not, certain foreign investors have been preparing for such a U.S. breakdown for years, and once again, the apex investor, China, has made plans for dramatic economic policy changes to take place in 2014…              

China Is Ready To File For Divorce

The economic marriage between China and the U.S. has been touted Ad nauseum as an invincible relationship chained in eternity by unassailable interdependency.  I've just never bought this fanciful tale.  For years I've written about the likelihood that China will decouple from the American dollar apparatus, and so far, most of my warnings have come to pass. 

China has pushed forward with massive physical gold purchases despite all arguments by skeptics that gold is no longer necessary or prudent as a safe haven investment.  Apparently, the Chinese know something they do not.  China is on pace to become the largest holder of gold in the world as early as 2014.

China has now issued Yuan denominated bonds and other assets around the globe, and its central bank has expanded its total balance sheet to at least $24 Trillion, outmatching the reported increased balance sheets of all other central banks:

Now, some feel that this Chinese liquidity should be considered a massive bubble on the verge of exploding, and that it will be Chinese instability, not U.S. instability, that triggers renewed crisis.  I would like to offer an alternative view…

I am not shocked at all by this incredible spike in Yuan circulation.  In fact, I expected it.  The fall back argument against China dumping the dollar as the world reserve has always been that there is no alternative currency that boasts as much liquidity as the dollar.  Well, as we now know, China has been raining Yuan down on every continent.  International banks like JP Morgan have been HELPING them do it.

China is not desperately attempting to prop up its own markets like we are in the U.S.  China is DELIBERATELY generating massive liquidity because they seek to aid the IMF in its longtime plan to replace the greenback as the world reserve currency.  These are not the activities of an investor that wants to stick with the U.S. or the dollar.  These are not the activities of a nation that wishes to continue its limited role as a source of cheap industrial labor.    

China, being the largest importer of petroleum surpassing the U.S., is now planning to price its crude oil futures in Yuan, instead of the dollar.

And, the Chinese central bank has announced that it now plans to stop all purchases of U.S. dollars for its reserves.

These decisions are part of a precision strategy, a formula which was finalized during a little discussed and very secretive economic policy meeting which took place in China this past month.

While much of the media was focused on China's call for softer restrictions on its one-child policy, they ignored the thrust of the meeting, which was to establish Chinese consumption over exports, and internationalize the Yuan.  All that is left is for China to “float” the Yuan's value on the open market, which is an action the head of the PBOC, Zhou Xiaochuan, says he plans to expedite.

All of the reforms discussed at China's Third Plenum meeting are supposed to begin taking shape in…that's right…2014.

A Storm Of Septic Proportions

As I have always pointed out, economic collapse is not necessarily an event, it is a process.  The most frightening elements of this process usually do not become visible until it is too late for common people to react in a productive way.  All of the dangers covered in this article could very well set fires tomorrow, that is how close our nation is to the edge.  However, the culmination of events so far seems to be setting the stage for something, an important something, in 2014.  If the worst is possible, assume the worst is probable.  The next leg down, or the next economic carpet bombing.  Maybe slightly painful, maybe mortal.  Sadly, as long as Americans continue to remain dependent on the existing corrupt system, global bankers can pull the plug at their leisure, and determine the depth of the wound with scientific precision.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/t9NHxkzYYQ0/story01.htm Tyler Durden

Submitted by Brandon Smith of Alt-Market blog,

By any reasonable measure, I think it is safe to say that the last quarter of 2013 has been an insane game of economic Russian Roulette.  Even more unsettling is the fact that most of the American population still has little to no clue that the U.S. was on the verge of a catastrophic catalyst event at least three times in the past three months alone, and that we face an even greater acceleration next year. 

The first near miss was the Federal Reserve's announcement of a possible “taper” of QE stimulus in early fall, which sent shivers through stock markets and proved what we have been saying all along – that the entire recovery is a facade built on an ever thinning balloon of fiat money.  Today, markets function entirely on the expectation that the Fed will continue stimulus forever.  If the Fed does cut QE in any way, the frail psychology of the markets will shatter, and the country will come crashing down with it.

The second near miss was the possible unilateral invasion of Syria demanded by the Obama Administration.  As we have discussed here at Alt-Market for years, any invasion of Syria or Iran will bring detrimental consequences to the U.S. economy and energy markets, not to mention draw heavy opposition from Russia and China.  Though the naïve shrug it off as a minor foreign policy bungle, Syria could have easily become WWIII, and I believe the only reason the establishment has not yet followed through with a strike in the region is because the alternative media has been so effective in warning the masses.  The elites need a certain percentage of support from the general public and the military for any war action to be effective, which they did not receive.  After all, no one wants to fight and die in support of CIA funded Al Qaeda terrorist cells on the other side of the world.  The establishment tried to hide who the rebels were, and failed.  

The third near miss was, of course, the debt ceiling debate, which has been extended to next spring.  America came within a razor's edge of debt default, which many people rightly fear.  What some do not yet grasp, though, is that debt default of the U.S. was NOT avoided last month, it is INEVITABLE.  Debt default will ultimately result in the death of the dollar as the world reserve currency, and the petro-currency.  This final gasp will lead to hyperstagflation within our financial system, and third world status for most of the citizenry.  It is only a matter of time, and timing.

“Timing” is truly what we are all concerned about.  Those of us in the field of alternative media and economics understand well that the U.S. is on a collision course with disaster; it is a mathematical certainty.  We no longer think in terms of “if” it happens – we only question “when” it will happen.  Our fiscal structure now hangs by the thinnest of threads, a thread which for all we know could be cut at a moments notice.  However, economic and political storms appear to be brewing with the year 2014 as a target. 

Globalists have been openly seeking the destabilization of U.S. sovereignty, and they have openly admitted that the destruction of the dollar and our economic foundations will aid them in their goal.  It is important to never forget that international financiers WANT to absorb America into a new global economic structure, and that the U.S. must be debased before this can be accomplished.   Here are a few reasons why I believe 2014 may be the year they make their final move…       

Debt Debate On Steroids

Nothing concrete was decided during the highly publicized “battle” between Democrats and the GOP on what would be done to solve the U.S. debt addiction.  Some people might assume that the fight will go on indefinitely, and that the “can” will be kicked down the road for years to come.  This assumption is a dangerous one.  If you thought the last debt debate was hair raising, the next is likely to give you a coronary.  Think of 2013 as a practice run, a warm up to the main event in 2014.  Why will next year be different?  Because the motivations behind a debt ceiling freeze (and thus debt default) are now supported by the obvious failure of Obamacare.

Funding for Obamacare was the underlying issue that gave strength to the push for new debt ceiling extensions.  The U.S. government has overreached financially in ever way imaginable.  We have long running entitlement programs that have been technically bankrupt for years.  But, Obamacare was so pervasive during the debt debate that we heard nothing of these existing liabilities.  Ultimately, Obamacare is the primary reason why so many Americans on the “left” want unlimited spending and inflation, and why so many Americans on the “right” are actually seeking debt default. 

We all know that at the top of the pyramid the debt debate itself is false left/right theater, but it is still theater with a purpose.

In my articles 'The Socialization Of America Is Economically Impossible' and 'Obamacare: Is It A Divide And Conquer Distraction', I discussed why universal healthcare could not be implemented in America, and I predicted in advance that Obamacare was actually a farce that was designed to fail.  The program's only purpose is to provide a vehicle by which divisions between the fake left and the fake right could be solidified in the minds of the common populace.  A lot of cynicism was directed at the notion that the government might create a socialized healthcare initiative and then allow it to fail.  Of course, we now know that is exactly what they had in mind.

During the last debt debate, Obamacare was just a policy waiting to be implemented; next debate, that policy will be rightly labeled a train wreck.  Obamacare is falling apart at it's very inception, and evidence makes clear that the White House KNEW in advance that this would occur.  In the days before it's launch, performance tests on the Obamacare website showed conclusively that the system could not handle more than 500 users.

Obama promised that preexisting healthcare plans would be retained by Americans and that the Affordable Care Act would not do damage to established insurance models.  He made this promise knowing full well that he could not or would not keep it.  This dishonesty has resulted in rebellion by Democrats who have sided with Republicans to pass a bill which obstructs the erasure of existing health coverage.

States once disturbingly loyal to the White House are now moving to limit the application of the Obamacare structure.

The White House had foreknowledge that the program was nowhere near ready, yet, they moved forward anyway.  Why wouldn't they stall?  Why would Obama knowingly unleash his “opus” before it was finished?  He had it in the bag, right?  He won, right?  All he had to do was build a functioning website and keep his promises at least long enough to sucker the majority of Americans into the system.  Instead, he throws the fight and hits the canvas before he's even punched?  Why?

It all sounds rather insane if you aren't aware of the bigger picture, and I'm sure the average Democrat out there is wide-eyed and bewildered.  Some might blame it on “ego”, or “hubris”, but this makes little sense.  Obamacare is an American socialist's dream.  With a simple working public interaction model, Obama would be worshiped by leftists for decades to come as the next Franklin Delano Roosevelt.  Hubris should have ENSURED that the White House launch of Obamacare would be flawless. 

Once you realize that this is not about Obama, and that Obama is nothing but a middle-man for the globalists, and that the actual implementation of Obamacare never mattered to the establishment, the fog begins to clear.

With Obamacare in shambles, the dynamic of the debt debate theater changes completely.  Some Democrats may well show support for a hold on the debt ceiling, for, what reason do they have to champion more spending?  Obama has already made fools of them all, and the Obamacare motivator is essentially out of the picture.  The GOP will be energized and more unified than the last debate, giving more momentum to a debt ceiling lock.  The argument will be made that a resulting debt default will not be harmful, and that the U.S. can carry the weight of existing liabilities until the budget is balanced.
This is certainly a lie, but it is a fashionable lie that Americans will want to hear. 

Americans do not want to hear that our economy is too far gone and that any motion, to spend, or to cut, will have the same result – currency collapse and fiscal implosion.  They do not want to hear that pain must be suffered before a realistic solution can be applied.  They do not want to hear the the system will have to be brought down before it can be rebuilt.  And, they definitely do not want to hear that the system will be deliberately brought down and replaced with something even worse. 

Will the next debt debate in Spring 2014 end in debt default and the collapse that globalists desire so much?  It's hard to say, but many insiders appear to be preparing for just such a scenario…

The Fed's Buzz Kill

No one, and I mean no one, believes the private Federal Reserve will ever commit to a taper of fiat stimulus.  Hell, I barely believe it's possible, and I'm open to just about any scenario.  That said, I have to ask a question which few analysts seem to be asking – why does the Fed keep pre-injecting the concept of taper into the mainstream if they never intend to implement it?  When has the Fed ever pre-injected a plan into the MSM which it did not eventually implement? 

The banksters have the markets in the palm of their hand, or at least they seem to.  Stocks now rise and fall according to whatever meaningless press release the central bank happens to put out on any given morning.  What do they have to gain by consistently shaking the confidence of investors around the world by suggesting that the fiat party they created will abruptly end?

The impending approval by the Senate of Janet Yellen, a champion of the printing press, would suggest to many that QE-infinity is assured.  We know that the black hole generated by the derivatives implosion cannot be filled (debts still exist in the quadrillions of dollars), and that the Fed will have to print endlessly in order to slow the deterioration of the the banking sector.  We know that none of the currency flows created by the Fed are trickling down to main street, which is why credit remains mostly frozen,  real unemployment counting U-6 measurements remains at around 25%, food stamp recipients have risen to around 50 million, and the only sales boosts to property markets are those caused by big banks buying bankrupt houses and then reissuing them as rentals.

We know that it makes sense for the central bank to continue QE, if only to continue pumping up banks and the stock market and hide the truly dismal state of the overall system.  But let's forget about what we think “makes sense” for just a moment…

What if the Fed no longer WANTS to hide the true state of the system anymore?  What if QE is now giving back diminishing returns, and will soon be no longer effective at hiding economic weakness?Central bankers surely don't want to take the blame for a collapse, but what if the perfect patsy is already lined up?  A patsy so hated and despised that no one would think twice about their guilt?  I am, of course, talking about the Federal Government itself.

Think about it; the failure of Obamacare promises a debt debate in the Spring of 2014 that will rock the very foundations of the global economy.  Both sides, Democrat and Republican, are ready to blame the other fully for any disastrous outcome, though “Tea Party” conservatives have been painted by the mainstream media as the lead culprits behind a financial catastrophe that began before the Tea Party was born.  The idea of “gridlock” leading to impasse and calamity is already built into the country's consciousness.  The general public's opinion of all areas of government has recently hit all time lows.  In fact, our opinion of government could scarcely go any lower than it already has.  Everyone HATES what government is, or what they think it is.  Most Americans would be happy to place the brunt of the blame for an economic disaster on the shoulders of Washington DC.

The genius of it is, they deserve a large part of the blame.  They helped to make possible all of the horrors the citizenry will face in the coming years.  The problem is, the public may become so blinded with rage over the failure of the political system, that they may completely forget about the role of international and central banks and turn on each other instead. 

Why is the Fed now discussing, just before the possible confirmation of Janet Yellen, a stimulus dove, the need for taper measures by 2014?

Is it just coincidence that the taper discussion is taking place parallel to the debt ceiling battle, or are these two things related?  What if the Fed plans to apply QE cuts during or after the renewed debt debate in order to make the market effects even more negative?  What if the Fed is timing the taper to give energy to a debt default?  What if the Fed wants to reduce support, so that later, when all hell breaks loose, we'll come begging them for support?

Whether you believe a debt default will be deliberately induced or not, certain foreign investors have been preparing for such a U.S. breakdown for years, and once again, the apex investor, China, has made plans for dramatic economic policy changes to take place in 2014…              

China Is Ready To File For Divorce

The economic marriage between China and the U.S. has been touted Ad nauseum as an invincible relationship chained in eternity by unassailable interdependency.  I've just never bought this fanciful tale.  For years I've written about the likelihood that China will decouple from the American dollar apparatus, and so far, most of my warnings have come to pass. 

China has pushed forward with massive physical gold purchases despite all arguments by skeptics that gold is no longer necessary or prudent as a safe haven investment.  Apparently, the Chinese know something they do not.  China is on pace to become the largest holder of gold in the world as early as 2014.

China has now issued Yuan denominated bonds and other assets around the globe, and its central bank has expanded its total balance sheet to at least $24 Trillion, outmatching the reported increased balance sheets of all other central banks:

Now, some feel that this Chinese liquidity should be considered a massive bubble on the verge of exploding, and that it will be Chinese instability, not U.S. instability, that triggers renewed crisis.  I would like to offer an alternative view…

I am not shocked at all by this incredible spike in Yuan circulation.  In fact, I expected it.  The fall back argument against China dumping the dollar as the world reserve has always been that there is no alternative currency that boasts as much liquidity as the dollar.  Well, as we now know, China has been raining Yuan down on every continent.  International banks like JP Morgan have been HELPING them do it.

China is not desperately attempting to prop up its own markets like we are in the U.S.  China is DELIBERATELY generating massive liquidity because they seek to aid the IMF in its longtime plan to replace the greenback as the world reserve currency.  These are not the activities of an investor that wants to stick with the U.S. or the dollar.  These are not the activities of a nation that wishes to continue its limited role as a source of cheap industrial labor.    

China, being the largest importer of petroleum surpassing the U.S., is now planning to price its crude oil futures in Yuan, instead of the dollar.

And, the Chinese central bank has announced that it now plans to stop all purchases of U.S. dollars for its reserves.

These decisions are part of a precision strategy, a formula which was finalized during a little discussed and very secretive economic policy meeting which took place in China this past month.

While much of the media was focused on China's call for softer restrictions on its one-child policy, they ignored the thrust of the meeting, which was to establish Chinese consumption over exports, and internationalize the Yuan.  All that is left is for China to “float” the Yuan's value on the open market, which is an action the head of the PBOC, Zhou Xiaochuan, says he plans to expedite.

All of the reforms discussed at China's Third Plenum meeting are supposed to begin taking shape in…that's right…2014.

A Storm Of Septic Proportions

As I have always pointed out, economic collapse is not necessarily an event, it is a process.  The most frightening elements of this process usually do not become visible until it is too late for common people to react in a productive way.  All of the dangers covered in this article could very well set fires tomorrow, that is how close our nation is to the edge.  However, the culmination of events so far seems to be setting the stage for something, an important something, in 2014.  If the worst is possible, assume the worst is probable.  The next leg down, or the next economic carpet bombing.  Maybe slightly painful, maybe mortal.  Sadly, as long as Americans continue to remain dependent on the existing corrupt system, global bankers can pull the plug at their leisure, and determine the depth of the wound with scientific precision.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/t9NHxkzYYQ0/story01.htm Tyler Durden

The top holder of Bitcoins is the unlikely named… ‘1933phfhK3ZgFQNLGSDXvqCn32k2buXY8a’ with 111,111 units of the crypto-currency (up from 40,000 units in the summer of 2011) for a total value over $110 million. Perhaps most interesting is these 100 Bitcoin holders represent over 20% of the entire outstanding amount of the alternative currency.

 

The following 100 Holders represent 2.23 million Bitcoins of the 11.12 million total oustanding currently…

(click image for full list)

 

and the Number 1 Holder has been adding (though hasn’t added since Feb 2013…)

 

And the concentration of Bitcoins has fallen from its early incarnation highs but has been static for recent months…

 

Source: BitcoinRichList

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Also… “Heal“

 

 

(h/t broga)

 

Which reminds us…

(via Sunday Funnies at The Burning Platform blog)

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Also… “Heal“

 

 

(h/t broga)

 

Which reminds us…

(via Sunday Funnies at The Burning Platform blog)

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/VqQHa4Fca4E/story01.htm Tyler Durden

Submitted by Simon Black of Sovereign Man blog,

Do you remember the days when travel used to be glamorous and sexy? The mere prospect of getting on an airplane was tremendously exciting. Friends and family would come with you to the gate to see you off and pick you up.

Today, millions of passengers in the Land of the Free will take off their shoes and assume the “I surrender” pose inside a radiation machine that provides negligible benefit and maximal cost to taxpayers.

Our modern security theater is a stark contrast to the past. But there’s been something else happening over the last several decades that is even more insidious… and far less obvious.

In 1979, Texas International Airlines (the precursor to Continental) introduced the first modern frequent flier program. American Airlines soon followed, launching their AAdvantage frequent flier program in 1981.

When the program launched, you could upgrade to a first class seat on the Concorde for 20,000 miles (something that you couldn’t even do today). Today, an upgrade to first class between the US and Europe would set you back 50,000 miles, plus $900 in fees.

In fact, just about every mileage award category has been getting more ‘expensive’, particularly among the major US carriers. The majority of the increases have taken place in the last several years.

United Airlines, for example, is raising the number of miles required for most of its awards starting February 1st. The steepest is an 87% increase for first class award seats on United’s partner airlines flights to the Middle East.

A United economy class ticket to Hawaii will increase by ‘only’ 12%. And business class to Europe and Japan will increase 20%.

Just like central bankers with paper currencies, airlines are devaluing their miles.

They have created trillions of miles in the system, many of these through special gimmick promotional giveaways. We’ve probably all seen the ‘sign up for the new credit card and receive 25,000 bonus miles’.

But just like the real economy, rapidly increasing the money supply (airline miles) devalues the currency and creates inflation.

That’s exactly what’s happening here. Airline miles are worth less and less.

Moreover, the airlines have begun to restrict award seat capacity. If you have ever tried to actually USE your miles, you’ve probably become very frustrated. Sometimes you have to book those flights a year in advance just to get one crummy seat.

They’ve also begun increasing fees on top of the mileage awards– so now if you want to use miles to upgrade, you have to pay a steep fee on top of the miles.

Airline miles are a great analogy of how inflation works in the real economy. It’s clear that the supply of miles is increasing rapidly. But the effects go unnoticed for a long time.

Then suddenly, one day, prices go up dramatically (as in the case of United).

And most people who have been responsibly saving for a rainy day (or that dream trip to Paris) suddenly find that years of their savings are worth less.

Airline miles are the most rapidly depreciating currency in the world. And they’re an interesting sign of things to come with fiat currencies.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/ndY3L7OWakY/story01.htm Tyler Durden

With every other bear throwing in the towel left and right these days, we fully expected that the latest letter by SocGen’s Albert Edwards would have something about “how much he hates looking at himself in the mirror, but…” and then we would be served with some garbage like the following margin expectations chart.

Luckily none of that happened. Instead we were greeted by the sharp insight and keen intellect that we have grown to expect from AE, and that have disappeared from the repertoire of so many other sellouts and lemming cheerleaders. Ironically, the topic of Edwards’ latest piece is precisely the chart above – the explosion in future margins, or rather the complete lack thereof. In fact, what Edwards is seeing is quite the opposite. To wit:

The margin squeeze that is unfolding as unit labour costs climb above company selling price inflation…

 

 

… leaves the economy extremely vulnerable to a downturn in the investment cycle. Business output inflation is measuring a wider basket of goods and services than the Fed?s favoured measure of inflation, the core personal consumption expenditure (PCE) deflator, but it does move in a very similar fashion (see chart below). Low pricing power is leaving the US economy more vulnerable than many suppose. In my view, a full-blown profits and investment downturn is most likely to be triggered by Asian and EM devaluations releasing surplus capacity onto the West and crushing pricing power even further. As Ian Harwood, my former boss used to say, ?”Watch the profit cycle closely. We ignore it at our peril?.”

 

This is a useful follow up to our earlier observations on the current status of the leverage cycle, when we noted that while the business cycle may be dead, but if it isn’t we are now on the verge, if not have entered a full-blown recession.

We have, on these pages, long believed that corporate profits should be watched closely, not for their direct impact on equity valuations, but their impact on the economic cycle. Most economic models have profits dropping out as a residual, but they are a key driver of the economic cycle. Growth in profits determines the growth of investment, inventories and employment. (Note I emphasise the growth, and not the level, of profits or the rate of profitability).

 

Over the years I have tended to focus on US pre-tax domestic non-financial profits as a best lead indicator for US-based company business spending. In the chart below I show this profits measure together with real growth in business investment, including inventories. Profits growth typically leads investment spending.

 

 

If we can get a handle on the profits cycle we can avoid being caught out by the investment cycle and recessions. Typically it was said that ?recessions were made in Washington? as the Fed jacked up rates to fight inflation. This not only curbed the credit cycle but squeezed corporate profits to the point that it triggered a downswing in the investment cycle and ?caused? a recession.

 

So in many investors? minds a recession will not occur unless the Fed triggers one with monetary tightening. That is of course nonsense. A credit bubble can burst without any monetary tightening and similarly the profit cycle can turn down due to a variety of factors.

This is a critical observation, one that everyone ignores, and one which as the first two charts above show, means that unless the Fed proceeds to inject funds directly into corporate revenues (there is a reason why revenues will have declined for 3 quarters in a row), one can kiss not only the idiotic hockeystick forecast margin chart goodbye, but that negative margins, and earnings, are just around the horizon.

Edwards’ conculsion is simple: if the US economy continues on the current track, an economic decline is inevitable, which in turn will crush confidence in the Fed, and make future monetary policy prohibitively costly:

… a recession seems a distant prospect in the minds of most investors. Yet one key precursor for a recession has now fallen into place. Slowing productivity growth means that unit labour costs are now running well ahead of output price inflation. This means a margin and profits downturn is now about to unfold. That typically is a key precursor of recession.

Finally, for those who are will be quick to acuse Edwards of crying wolf, he has a few words for you too:

That confidence in a long cycle comes partly with a high level of certainty that the monetary authorities remain in control of the economic cycle. The doomsayers who predicted that this recovery was on the verge of faltering have been proved wrong, and like the boy who cried wolf, can be safely ignored by the market. Yet that is exactly what happened in 2006 with the US consumer and housing boom, where the voices of caution had been so wrong, for so long, that their Cassandra-like utterances were ignored. Cassandra?s forecasts may have been ignored, but they proved to be correct. Investors demand a sign of when to get out and that trigger may have just arrived.

Crying wolf or not, what Bernanke and his central-planning henchmen are now doing, is simply delaying the inevitable day when realty finally catches up with every cycle, and law of nature that the Fed, courtesy of hundreds of billions of de novo liquidity, has – until this point – successfully deferred. The problem is that perhaps the most important law – that of diminishing returns – is now fianlly breathing down Mr. Chair(wo)man’s neck.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-M9ngJLC3tk/story01.htm Tyler Durden

With every other bear throwing in the towel left and right these days, we fully expected that the latest letter by SocGen’s Albert Edwards would have something about “how much he hates looking at himself in the mirror, but…” and then we would be served with some garbage like the following margin expectations chart.

Luckily none of that happened. Instead we were greeted by the sharp insight and keen intellect that we have grown to expect from AE, and that have disappeared from the repertoire of so many other sellouts and lemming cheerleaders. Ironically, the topic of Edwards’ latest piece is precisely the chart above – the explosion in future margins, or rather the complete lack thereof. In fact, what Edwards is seeing is quite the opposite. To wit:

The margin squeeze that is unfolding as unit labour costs climb above company selling price inflation…

 

 

… leaves the economy extremely vulnerable to a downturn in the investment cycle. Business output inflation is measuring a wider basket of goods and services than the Fed?s favoured measure of inflation, the core personal consumption expenditure (PCE) deflator, but it does move in a very similar fashion (see chart below). Low pricing power is leaving the US economy more vulnerable than many suppose. In my view, a full-blown profits and investment downturn is most likely to be triggered by Asian and EM devaluations releasing surplus capacity onto the West and crushing pricing power even further. As Ian Harwood, my former boss used to say, ?”Watch the profit cycle closely. We ignore it at our peril?.”

 

This is a useful follow up to our earlier observations on the current status of the leverage cycle, when we noted that while the business cycle may be dead, but if it isn’t we are now on the verge, if not have entered a full-blown recession.

We have, on these pages, long believed that corporate profits should be watched closely, not for their direct impact on equity valuations, but their impact on the economic cycle. Most economic models have profits dropping out as a residual, but they are a key driver of the economic cycle. Growth in profits determines the growth of investment, inventories and employment. (Note I emphasise the growth, and not the level, of profits or the rate of profitability).

 

Over the years I have tended to focus on US pre-tax domestic non-financial profits as a best lead indicator for US-based company business spending. In the chart below I show this profits measure together with real growth in business investment, including inventories. Profits growth typically leads investment spending.

 

 

If we can get a handle on the profits cycle we can avoid being caught out by the investment cycle and recessions. Typically it was said that ?recessions were made in Washington? as the Fed jacked up rates to fight inflation. This not only curbed the credit cycle but squeezed corporate profits to the point that it triggered a downswing in the investment cycle and ?caused? a recession.

 

So in many investors? minds a recession will not occur unless the Fed triggers one with monetary tightening. That is of course nonsense. A credit bubble can burst without any monetary tightening and similarly the profit cycle can turn down due to a variety of factors.

This is a critical observation, one that everyone ignores, and one which as the first two charts above show, means that unless the Fed proceeds to inject funds directly into corporate revenues (there is a reason why revenues will have declined for 3 quarters in a row), one can kiss not only the idiotic hockeystick forecast margin chart goodbye, but that negative margins, and earnings, are just around the horizon.

Edwards’ conculsion is simple: if the US economy continues on the current track, an economic decline is inevitable, which in turn will crush confidence in the Fed, and make future monetary policy prohibitively costly:

… a recession seems a distant prospect in the minds of most investors. Yet one key precursor for a recession has now fallen into place. Slowing productivity growth means that unit labour costs are now running well ahead of output price inflation. This means a margin and profits downturn is now about to unfold. That typically is a key precursor of recession.

Finally, for those who are will be quick to acuse Edwards of crying wolf, he has a few words for you too:

That confidence in a long cycle comes partly with a high level of certainty that the monetary authorities remain in control of the economic cycle. The doomsayers who predicted that this recovery was on the verge of faltering have been proved wrong, and like the boy who cried wolf, can be safely ignored by the market. Yet that is exactly what happened in 2006 with the US consumer and housing boom, where the voices of caution had been so wrong, for so long, that their Cassandra-like utterances were ignored. Cassandra?s forecasts may have been ignored, but they proved to be correct. Investors demand a sign of when to get out and that trigger may have just arrived.

Crying wolf or not, what Bernanke and his central-planning henchmen are now doing, is simply delaying the inevitable day when realty finally catches up with every cycle, and law of nature that the Fed, courtesy of hundreds of billions of de novo liquidity, has – until this point – successfully deferred. The problem is that perhaps the most important law – that of diminishing returns – is now fianlly breathing down Mr. Chair(wo)man’s neck.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/-M9ngJLC3tk/story01.htm Tyler Durden