Saturday, August 29, 2015

Financial Crisis Dead Ahead

We have already seen two financial crises in the past 15 years and it appears that we are on the verge of another one right now. The magnitudes of each crisis are increasing. Since debt is even higher, it should be expected that the 2015 crisis will be worse than 2008 -- maybe even catastrophic.

World-Wide Debt Higher Than Ever
We're on the verge of the 3rd financial crisis in 15 years and here's why there is no way out now:
  • If the China story is finished, then the emerging market story is finished.
  • The 33 year period of steadily falling interest rates is over interest rates at near zero. Even when interest rates stop falling, this represents a trend change that removes the "wind at our back."  Interest rates may actually start to rise even in the government sector. Financial distress is already causing corporate interest rates to rise. High yield corporate bonds are slowly sinking (and yields rising).  Expect this to continue.
A kick-off to the next financial crisis could be huge decline in the stock market when a financial firm has some kind of financial distress or failure. (that's what happened with Lehman Brothers and that almost brought down the world financial system).  It could be a failure of a highly indebted commodity trading institution like Glencore that deals in commodities. It could be a "blow-up" in the $1,200 billion derivatives market. It could be defaults of a company like Petrobras or a default of a country like Venezuela, Argentina, Brazil, Ukraine or Russia that starts a chain reaction in the banking sector. The near-default of Greece nearly caused a financial panic in Europe. That's why they were bailed-out again.

Financial panics tend to morph into deep recessions. But this time I don't see a way out of the next recession.  China (or any other country) will not be able to spend like they did in 2009 to 2011 since their debt levels are already high.  No other government will be able to offset the equivalent of the 2008 shock like China did. The US will not build ghost cities and high speed railroads to nowhere. They can't. They don't know how. Despite all the disingenuous rhetoric, there are no infrastructure projects ready to go (just like in 2009).  If we need infrastructure projects now, those projects should have commenced (ie., planning, budgeting and engineering) about 5 years ago. But nothing has happened. Nothing is ready. The US won't have the shale fracking boom either. Oil prices have collapsed and may collapse further.

If we have a world-wide financial/banking crisis, world trade will stop again like it did in 2008. In 2008 and 2009, when confidence in banks was widespread (no one knew who had too much bad debt), the entire basis of international trade, ie., letters of credit, were not accepted. World trade stopped.  It happened once in 2008 and could happen again. Global trade and global supply chains could be impaired for longer next time.

With such a shock, stocks will crack-up, Almost certainly the world economy will crack-up. Derivatives may blow-up. Banks/Financial institutions will fail. Adding to the downward pressure will come defaults in commodity producing countries (including countries like Russia, Venezuela and Nigeria). Resource companies will go bankrupt. Hedge funds and financial entities will fail dramatically.  Pensions will crater, unemployment will rise.

Even though Quantitative Easing has been discontinued in the US as it's been deemed to cause more problems than it solves, it is likely to make a comeback here and everywhere when a crisis hits. Not only does it lower the cost of borrowing by the government, it is about reducing the value of your currency in the world markets.

Already every government in the world has tried to debase their currencies faster than all the others in a grotesque "beggar thy neighbor" currency war. This currency war is a de facto trade war and it's already under way. Trade wars were the very thing that lead to downward spiral of world trade in the 1930s causing the prolonged Great Depression. This time, it probably won't be tariffs (like the Smoot Hawley Act) but competitive devaluations that have the same effect of chilling global trade (although Trump has proposed tariffs!). Global trade is already contracting. If everyone is devaluing at the same time, how can anyone get more than a temporary advantage?

QE will likely make a comeback in the US. I can see a situation where government receipts collapse but government spending increases. I could see prolonged income tax holidays -- meaning that government revenues drop to nearly nothing and all government debt is bought by the government itself (the Federal Reserve) which is the very definition of QE.  US deficits could rise to $3 or $4 Trillion per yr or so and funded entirely by the Federal Reserve money printing.  The rub comes when people that are receiving income support find that there is little to buy due to the global trade collapse and certain prices begin to rise. Then you might see a burst of hyperinflation and then a final collapse.

I guess we might see nationalizations of banks all over the world to restart trade. But this entire scenario is about as akin to the end of the world as ever imagined.

Modern civilization is likely entirely at risk.

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