Friday, April 24, 2020

European Banks and the Euro Will Destroy the World

This post is an excerpt of "Rising Risk of Financial and Economic Chaos, Part 2."  It's so important that I felt it deserved to stand alone as a unique post.

The Europeans never allowed any banks to fail during the GFC in 2008, whereas some 157 banks failed and many mergers were arranged in the US during that recession. So nothing was allowed to fail in Europe. No bad debt was eliminated. So EU bank stocks are at 30+ year lows because everyone knows that they are loaded up with bad loans that are papered-over with "mark to fantasy"ratings. The other reason that the EU is faced with a banking crisis is that negative interest rates has effectively crippled the profitability of banks along with profit-killing regulations. The craziest regulation of the EU banking system is the requirement of bail-ins using depositor money should there be a bank failure!  That's crazy! Why would you want to scare away an important source of bank capital???   It's literally insane.  It's the total inverse of our FDIC deposit safety net!

The actions of the ECB to drive interest rates to negative levels is the most irresponsible monetary "experiment" in the history of the world. It's artificially driven up bond prices to truly absurd levels. There are still some $17 Trillion of debt in the EU that have negative yields. It's the biggest bubble in the world! And there's no way out!

But now there's a chorus of "economists" across the world, especially Europe, who are also increasingly critical of negative yields. It's becoming a consensus. It's because QE and negative rates haven't helped; they've hurt and caused damage to retirees, pension funds, insurance companies and most importantly the banking system (especially Europe). Just a week ago, Sweden raised it's interest rate from -0.5% to 0% because of the damage negative rates are causing: housing market price bubbles, bank and pension troubles were cited.

So, we're one populist revolt in a single EU country like Italy or Greece leaving the EU that could begin a real bond rout. Or it could simply be credit markets revolting due to rising risk. What if the ECB, like Sweden, decides to abandon negative rates now that there is consensus that it's actually crazy?

EU banks are large holders of dicey sovereign bonds like Greece and Italy - countries suffering under the yolk of the Euro currency. Germany has loaned 100s of billions to Southern Europe as the Euro currency has imposed a non-stop economic depression on the southern countries. This was predicted long ago by Margaret Thatcher. Such transfers are not sustainable. Even so, economic hardship is causing unrest and populist and/or separatist movements all over the world including Europe. Brexit was first, but who's next? If a country like Italy leaves the Euro currency, it's bonds would drop by about 70% to yield something like 7% from 1.4%. Since European banks are big holders of sovereign bonds, such an event would tip every bank in the EU into insolvency. One hiccup in a EU member's bond market (like Greece or Italy) and say hello to bank failures galore in Europe. Suffice it to say that EU banks are an ongoing problem for the world and probably an existential threat to the world of finance.

The effect could include the instant bankruptcy of nearly all EU banks and this would easily spread to the US and World (like a virus?). The ECB itself would be understood to be technically bankrupt. It CAN go bankrupt unlike our Federal Reserve. Bank runs could easily erupt since large depositors are at risk of losing their money for bail-ins in the event of an EU bank bankruptcy. A flood of money to the US would ensue. The dollar would rocket higher as US causing crises in emerging market countries that have issued dollar-denominated bonds --which is a huge amount.

In my post titled Declining Global Money Supply Taking World Economy With It, I mention that the real dollar money supply for world commerce was found in the Eurodollar markets of European banks. See the graphic.

Essentially all world trade uses the dollar as the core of virtually all international financial and trade transactions, the Eurodollar market therefore facilitates all of the trading and financial transactions for the international and emerging markets and China. Really, it's the "money" supply and lubricant for world trade. 

The "Eurodollar" has developed in past decades as unregulated liquidity that exists on (and mostly off) the large bank balance sheets in Europe and the US. It's really a sort of a "trick" designed to allow banks to skirt regulator's capital requirements. And the regulators, including our Federal Reserve, remain oblivious of what's going on--even now.  

The "Eurodollar,"includes all of it's derivatives. Parentheses around "eurodollar" means it's the aggregate of credit default swaps, interest rate swaps, currency forwards/swaps, repos/reverse repos and other derivatives used mainly to facilitate global and financial trade. "Eurodollars" are only backed by "balance sheet capacity" of the European banks. It's a huge "product" of EU banks and it's designed to bypass and skirt capital requirements set by the government. It'a a way that banks can improve profits through higher-than-permitted leverage.

But there are nearly no dollars backing these instruments. It's nearly pure leverage and very unstable in times of crisis -- as we found out in 2008 (see the graphic above). I'm confident that banks are now attempting to flee these markets again since we're in the Great Financial Crisis #2. But shrinking "Eurodollars" means a shrinking world economy. That's exactly what's happening.

"Eurodollar" liquidity is literally the antithesis of sound money. It's like "internet money." It's pure leverage with no real "backing" except faith in the money center banking system of Europe.  But faith in the European banking system has been dropping for decades. If you didn't know better, you might assume that the EU has been TRYING to ruin their financial system.  Major EU bank stock (equity) prices are at 30 and 40 year lows, indicating extreme lows of faith and high fear concerning these institutions. Fear is rising as indicated by rising LIBOR rates which are considerably higher than the largely irrelevant Fed Funds rate of 0 to .25%.  

Deutsche Bank, one of the largest banks in Europe is at the heart of the EU banking industry.  But the IMF has labeled Deutsche Bank as the world's most dangerous systemically important bank. 

But I'll say it again; there's no dollars in Eurodollars!  There's a high risk that demand for the USD will soar in an acute phase of this 2nd Great Financial Crisis--not unlike GFC1.  Crucially all of this "money" relies on the faith in the EU INTERBANK market and the failure OR EVEN DISTRUST of even one of the EU banks would send the entire Eurodollar market scrambling for the safety of USD securities.  And a rising USD in a crisis is like adding gasoline to a fire, but that's what could happen when the entire world financial system is structurally short of US dollars.  

Shrinking Eurodollars means a shrinking world economy. Shrinking can easily turn into collapse.

Thursday, April 23, 2020

Our Dystopian Future: Recession Without End

I'm sitting at home on Thursday, April 23 and watching the DJIA soar nearly 400 points to nearly 24,000.  We're not far from the Dow peak of 29,000 set just a few months ago.  I'm watching this as another 4.4 million people filed for unemployment claims this week bringing the 5 week job loss total to 26.5 million.  This erases ALL THE JOBS CREATED SINCE 1998.
Figure 1: Cumulative Employment Gains Since 1998

Some folks are saying that 2nd Quarter GDP will be about -35%!  This is incredibly bad.  Remember it takes a 50% increase to reverse a 35% loss.  What are the chances that the US GDP gains 50% in the next few years or even in the next decade?   The chances are slim to none. (NB. 35% down is for one quarter, most expect 2020 GDP to decline by 6 to 8%, but even then it'll take years to recover at 1 or 2% growth.)  Government debt will be soaring further in the months and years ahead, adding artificially to GDP but putting even more of a long term drag on the economy.

In my post Why Our Economy is in Depression and Will Get Worse, and We're Reaching the End of the Road, I mention a number of reasons for why our economy has already been mired in prolonged recessionary conditions and why things won't be improving anytime soon. For instance, I've pointed out that if you subtract government spending that was funded by debt, US GDP has actually contracted since the first Great Financial Crisis (GFC).

US GDP After the GFC in 2008 Shows Organic Contraction
Figure 2 shows that the US GDP has shrunk by $5.9 Trillion if you back out debt-financed spending in the government sector alone. This is Recession Without End (otherwise known as "Depression").

I mention poor demographics, the declining utility of debt, and the effects of reaching the limits of affordable resources, such as affordable oil as some of the causes. All these are true and have caused Central Banks all over the world to "pump-up" the money supply to absurd levels, backstopped all markets to maintain desired "wealth effects"and governments have spent borrowed money like never seen before. These emergency measures have continued for the past 12 years.  

Now these "reality avoidance" measures are ramped-up on steroids!  You could say everything is fake in this country: the news media and news "personalities" are fake, government statistics are faked, politicians are completely phony and fake, GDP and final demand is faked, our country's debt load is faked in that our future entitlement costs are ignored but are really debt,  Our polls are fake. Our stock markets are fake.  Worse, our money is fake! See Extremes of Unsound Money and Finance Lead to Disaster.

From Charles Hughes Smith's "What's Collapsing Can't Be Saved: Our Fraudulent Economy" he says, "The entire stock market rally of the past 20 years is nothing but a gigantic fraud based on stock buybacks funded by debt. Stocks go up because the majority owners of the stock borrow money from a banking sector that gives nearly free money to financiers and corporations. The corporate insiders buy back shares with the borrowed money, and the company services the loan."

Now we're in the Great Financial Crisis #2, the lastest in a series of bubbles and busts spawned by unsound money from the Federal Reserve and government spending bubbles.  The government is working overtime, using whatever spending and debt schemes to prop-up the last bubble.  THEY. MUST. REFLATE.--- or the whole scheme comes falling down. If the all-important stock market crashes, it's over. The desperation is palpable. It's because if stocks crash, so does corporate credit.

And every time a bubble bursts, the resulting recovery becomes more anemic -- especially after the 2000 bubble/bust.

Now we have another bubble bursting. The result will continue to be Recession Without End .

What does this grim future look like? Gail Tverberg has been thinking and warning for some time about the potential of economic collapse as the world confronts limits of affordable energy.  In her most recent post Covid-10 and $1 Oil: Is There a Way Forward, she lists a number of changes that we should expect as much of the world's weakest debt is unwound thru defaults and failure. 

Between her comments and mine, I think I can summarize some of the big themes for the next decade.  
  • the earth's population is unlikely to be sustainable at 7 billion persons. 
  • Starvation will likely be a problem in Africa, the Middle East and in India starting nearly immediately. Population will continue to drop in most of the world and continue to drop in the developed world.
  • The EU and the Euro currency will fail which will likely cause a huge banking crisis in Europe.  
  • This collapse will be especially bad for the world economy because the real money supply to the world, the Eurodollar system and associated derivatives, reside on (and off) the balance sheets of EU banks. This shadow banking system is poorly understood by "Economists" and Central Banks. 
  • Expect political uprisings in many countries like Italy, Spain, Indonesia and maybe the US and China.
  • The entire middle East will collapse. This marks a continuation and conclusion of the collapse that was already underway in that region.  In my post Arab Civilization is Collapsing, I mention that most of the Middle East and North Africa had collapsing cultures most notable after the "Arab Spring."  I then suggested that the entirety of the region will be in collapse once oil prices collapse in a depression scenario.  This is coming true right now.
  • Oil producing countries in Latin America will fail: Mexico, Brazil, Ecuador and Venezuela. Starvation in this region is not out of the question .
  • The EU and Euro will fail. The WHO and UN may disappear.
  • Big cities will become problematic to live in. Big city populations will decline.
  • Most stock equities will be mostly worthless. Quantitative easing in some countries may support stock prices and housing for a few months, but eventually reality will prevail.
  • Supply chains are already breaking. Manufacturing and trade will decline and eventually there will be shortages of goods and food and drugs
  • Manufacturing will be done local and within regions. Globalization will be completely reversed.
  • Nationalization of utilities, banks, oil/gas production and pension plans will be required
  • Education will likely become primarily the responsibility of families, with television or the internet perhaps providing some support. Universities will wither away.
  • International wars and conflicts will erupt

Here's the full text of Gail's post: 

There are clearly parts of the world economy that are not working:
  • The financial system is way too large. There is too much debt, and asset prices are inflated based on very low interest rates.
  • World population is way too high, relative to resources.
  • Wage and wealth disparity is too great.
  • Too much of income is going to the financial system, healthcare, education, entertainment, and travel.
  • All of the connectivity of today’s world is leading to epidemics of many kinds traveling around the world.
In a less connected world, what we think of today as assets will likely have much less value. High rise buildings will be worth next to nothing, for example, because of their ability to transfer pathogens around. Public transportation will lose value for the same reason. Manufacturing that depends upon supply lines around the world will no longer work either. This means that manufacturing of computers, phones and today’s cars will likely no longer be possible. Products built locally will need to depend almost exclusively on local resources.

Pretty much everything that is debt today can be expected to default. Shares of stock will have little value. To try to save parts of the system, governments will need to take over assets that seem to have value such as farm land, mines, oil and gas wells, and electricity transmission lines. They will also likely need to take over banks, insurance companies and pension plans.

If oil products are available, governments may also need to make certain that farms, trucking companies and other essential users are able to get the fuel they need so that people can be fed. Water and sanitation are other systems that may need assistance so that they can continue to operate.

Gail goes on to say:
  • There will be a shake-out of governmental organizations and intergovernmental organizations. Most intergovernmental organizations, such as the United Nations and European Union, will disappear. Many governments of countries may disappear, as well. Some may be overthrown. Others may collapse, in a manner similar to the collapse of the central government of the Soviet Union in 1991. Governmental organizations take energy; if energy is scarce, they are dispensable.
  • Some countries seem to have a sufficient range of resources that at least the core portion of them may be able to go forward, for a while, in a fairly modern state: a) the United States, b) Canada, c) Russia, d) China and e) Iran.
  • Big cities will likely become problematic in each of these locations, and populations will fall. Alaska and other very cold places may not be able to continue as part of the core, either.
  • Countries, or even smaller units, will want to continue to limit trade and travel to other areas, for fear of contracting illnesses.
  • Europe, especially, looks ripe for a big step back. Its fossil fuel resources tend to be depleted. There may be parts that can continue with the use of animal labor, if such animal labor can be found. Big protests and failing debt are likely by this summer in some areas, including Italy.
  • Governments of the Middle Eastern countries and of Venezuela cannot continue long with very low oil prices. These countries are likely to see their governments overthrown, with a concurrent reduction in exports. Population will also fall, perhaps to the level before oil exploration.
  • The making of physical goods will experience a major setback, starting immediately. Many supply chains are already broken. Medicines made in India and China are likely to start disappearing. Automobile manufacturing will depend on individual countries setting up their own manufacturing supply chains if the making of automobiles is to continue.
  • The medical system will suffer a major setback from COVID-19 because no one will want to come to see their regular physician any more, for fear of catching the disease. Education will likely become primarily the responsibility of families, with television or the internet perhaps providing some support. Universities will wither away. Music may continue, but drama (on television or elsewhere) will tend to disappear. Restaurants will never regain their popularity.
  • It is possible that Quantitative Easing by many countries can temporarily prop up the prices of shares of stock and homes for several months, but eventually physical shortages of many goods can be expected. Food in particular is likely to be in short supply by spring a year from now. India and Africa may start seeing starvation much sooner, perhaps within weeks.
  •  History shows that when energy resources are not growing rapidly (see discussion of Figure 3), there tend to be wars and other conflicts. We should not be surprised if this happens again.

Wednesday, April 22, 2020

U.S. Shale Faces Largest Ever Drop in Fracking Activity

The Covid-19 crisis combined with the oil price war is about to trigger the largest ever monthly drop in U.S. fracking activity.

By Rystad Energy, Apr 22, 2020 via

The Covid-19 pandemic has ravaged global oil demand and, coupled with the extremely low price levels brought on by the wide supply surplus, is likely to cause the largest monthly drop in fracking activity ever recorded in the US, a Rystad Energy analysis shows.

We estimate that the total number of started frac operations will end up below 300 wells in April 2020; close to 200 in the Permian and less than 50 wells each in Bakken and Eagle Ford. This translates into a 60% decline in started frac operations between the peak level seen in January to February 2020 and April 2020, as the majority of public and private operators implement widespread frac holidays.

In March we observed an extreme 30% monthly decline in the number of started frac jobs in these three major oil basins, a fall from 807 in February to just 550. Also, nationwide fracking activity, on a completed jobs basis, might have already declined by around 20% in March 2020, according to our estimates.

“With such a rapid decline in fracking already visible, very little activity will be happening in the oil basins during the remainder of the second quarter of 2020. The natural base production decline, which we have seen as an absolute floor for production, therefore becomes an increasingly relevant production scenario,“ says Rystad Energy Head of Shale Research Artem Abramov.

If we assume that no new horizontal wells are put on production from April 2020 onwards, total LTO production will decline by 1 million barrels per day (bpd) by May, 2 million bpd by July and by 3 million bpd by October to November, with the Permian Basin accounting for more than half of nationwide base decline.

US light oil operators, which are now announcing voluntary production curtailments, will try to deliver on these cuts as much as possible from the natural production decline, as opposed to shut-ins of producing wells (though some of the marginal, least economic volumes are being shut in, too).

The magnitude of the base decline for US LTO sounds extreme in the context of what we see for other supply sources globally. But ironically, the steep decline is actually too late to save prices; despite the oversupply issue, standard operation patterns prevent operators from simply turning the faucet off. These days Permian wells require about two months from the moment frac operations start until they produce first oil, and require about three months before they reach peak output.

Hence, the decline in started jobs which began in March will result in a lower number of wells put on production in May, which ultimately will lead to a drop in peak production in June if normal operational patterns are maintained.

“On the demand and storage side, the market is already moving through its toughest challenge yet, and the WTI front-month sell-off emphasized how broken the physical market might be already. We are therefore concerned that significant production shut-ins will be required in the next few weeks to bring the market into the balance in a brutal manner,“ adds Abramov.

By Rystad Energy, via

Thursday, April 9, 2020

Rising Potential for a Financial System Collapse

From Tuomas Malinen on 2020-04-08, from GnS Economics

Country after country has reported extremely dark economic numbers. The gigantic jobless claims, 6.6 million from the U.S. last week, are just the tip of the iceberg (Doug here, and another 6.3 million for the most recent week). For example, the service sector PMIs have been simply ghastly across the globe. We are now in a crisis of epic proportions.

But, how massive can the crisis eventually get? Since our inception, in 2012, we have contemplated three scenarios as a part of our quarterly forecasts. While we have not referred to them in each report, we have repeated them periodically. They are: the optimistic, the most probable and the pessimistic.

But at this point our main worry is the approaching realization of the pessimistic, or the worst, scenario. It’s likelihood, while still low, is increasing fast in our estimate.

Underpinning its severity is not the virus, but the fragility of the global economy.

Breeding chaos: failed clean-ups and bad policies

The Global Financial Crisis (GFC) was considered a Black Swan event to many. However, it was no such thing. It was a massive failure of hedging and diversification within the global banking system, most notably in the U.S., and a number of prominent analysts saw it coming. See our blog, 10 years from Lehman. And nothing has been fixed, for an insight view on that crisis.

While banks were wound down and recapitalized in the U.S. after the GFC, an equivalent restructuring did not happen in Europe. Stricken European banks were left to linger in a state of permanent financial distress.

“Outright Monetary Transactions” or “OMT”, negative interest rates, and ECB’s QE program all aggravated the predicament of European banks. The failure to resolve the 2008 crisis ‘zombified’ the European banking sector, a situation which persists today. (See Q-Review 3/2019 for a detailed account).

Another pivotal moment for the world economy came in March of 2009, when the Fed vastly expanded its asset purchase program of U.S. Treasuries and mortgage-backed securities. This became known as the notorious Quantitative Easing or “QE” program, and has persisted in one form or another ever since. (See Q-Review 1/2018 for a detailed explanation.)

Central banks quickly assumed the role of “lender of first resort” in the capital markets, and their balance sheets ballooned. Asset prices rose to never-before-seen heights. Continuous market bailouts, culminating in the ‘pivot’ of the Fed in early January 2019 and its repo-bailout in September, removed all market discipline and incentivized investors to wild speculation (see Q-Review 4/2019 for details).\

The giant with (debt) clay feet

Chinese leaders also reacted quickly when the financial crash of 2008 precipitated a global recession.

China initiated a massive infrastructure programs that jump-started the world economy to a renewed upward trajectory. These programs were financed by credit issued by state-controlled banks, which Beijing can compel to lend, and the banks responded by doubling the volume of loans YoY. Between 2007 and 2015, 63% of all new money created globally came from China, and most of this increase was created by commercial banks.

During 2016, China unleashed a never-before-seen credit bonanza, tripling the size of the “shadow banking sector” as a response to a slump in the Chinese housing market, which had become the backbone of the Chinese economy over the past two decades.

By the end of 2017, the assets of the shadow banking sector stood at a mind-boggling 367% of GDP. The commercial banking sector has also become extremely levered, posting over 500% growth in credit since 2008.

Alas, the Chinese banking sector is now totally incapable of coping with any significant shock, and these Chinese economy became riddled with unprofitable investments.

Into the Abyss

These fragilities, combined with the massive economic impact of the coronavirus, leads us to our most pessimistic scenario.

In it we assume that
  • Many governments will not be prudent enough in suppression measures, which will lead to severe global pandemic peaking in summer.
  • Due to the worsening outbreak and delays in containment, suppression measures will eventually be prolonged and they become draconian (“Wuhan style”).
  • The massive stimulus measures enacted by governments and central banks will be ineffective in providing support for the economy, as the tardy application of draconian suppression measures lock people at home in several key countries of the global economy for a prolonged period of time.
  • Global economic activity plunges to never-before-seen lows.
  • European banking sector breaks.
  • Eurozone unravels violently.
  • China ‘lands hard’.
  • Global financial system collapses.
  • A systemic crisis engulfs the world.

A systemic crisis simply means that the banking sector and financial markets collapse. In practice, this implies that most banking services will stop and funding through financial markets will cease. This also means that the monetary system is likely to collapse (see Q-Review 4/2019 for a detailed explanation).

It should be acknowledged that we have never faced such a scenario on a global scale (though the collapse of the Soviet Union could certainly be classified as “systemic meltdown”). That is why the sheer scale of such an apocalyptic scenario will be horrifying. They are presented in the Figure below.

Figure. The forecasted (Y-to-Y) GDP growth rates in the U.S. and in the Eurozone in 2020 – 2023. Source: GnS Economics, OECD

Fragilities laid bare

The Covid-19 pandemic will reveal all the fragilities of the world economy. The near collapse of the U.S. capital markets in mid-March was averted only through unprecedented socialization of the financial markets. However, when the Flood of corporate bankruptcies begins, central banks will not be able to withstand the onslaught. Then we will face only extreme economic options.

The global collapse scenario, presented above, would bring in its wake massive unemployment, poverty, misery and the eventual re-structuring of our whole social and economic order. The world would be utterly and permanently changed as a result.

This is something we absolutely need to be prepared for, even though its likelihood is still relatively low.

But it is increasing fast, and that should worry us all.