I must confess a certain fondness for the apocalyptic sort of financial writer, provided they don’t lose anchoring with reality and fall into the tinfoil hat category. Nouriel Roubini is the case example of an economist who favors a baroque, melodramatic style, and despite sounding more than a tad unhinged at points, he has proven to be the most accurate seer of our unfolding financial mess.
Another writer who almost seems to relish describing how bad things can get is Ambrose Evans-Pritchard of the Telegraph. Pritchard has been proven correct, despite catcalls on this blog, in his assessment that the oil price runup was overdone and his early recognition that deflation, the product of deleveraging, and not inflation, was the pressing economic risk.
Evans-Pritchard put up two articles this week, the first “Germany takes hot seat as Europe falls into the abyss” and “Russia and Brazil crumble as commodity prices crash.” Both are suitably bone chilling, First, excerpts from the EU piece:
During the past week, we have tipped over the edge, into the middle of the abyss. Systemic collapse is in full train. The Netherlands has just rushed through a second, more sweeping nationalisation of Fortis. Ireland and Greece have had to rescue all their banks. Iceland is facing an Argentine denouement.
The US commercial paper market is closed… The interbank lending market has seized up….. Healthy companies cannot roll over debt….
As the unflappable Warren Buffett puts it, the credit freeze is “sucking blood” out of the economy. “In my adult lifetime, I don’t think I’ve ever seen people as fearful,” he said.
We are fast approaching the point of no return. The only way out of this calamitous descent is “shock and awe” on a global scale, and even that may not be enough….
Yves here. That turn of phrase is not off target. Paul Krugman has said that interventions in large liquid markets are too small to force a change in valuation by virtue of the sheer weight of buying. They instead serve as a slap in the face, to (hopefully) make investors realize that they are caught in a funk. But Krugman also acknowledged that in this case, the markets may not be irrational.
The lesson of the 1930s is that any country trying to reflate in isolation will be punished. The crisis will ricochet from one economy to another until every one is crippled. We are seeing it play again in this drama as our leaders fail to rise above their narrow, parochial agendas.
The European Central Bank – which raised rates into the teeth of the crisis in July – has played a shockingly destructive role in this enveloping slump. Its growth predictions this year have been, and still are, delusional. Neglecting its global role, it has vastly complicated the fire-fighting efforts of Washington.
It could have offered “cover” to the US Federal Reserve this spring when Ben Bernanke was forced by events to slash rates to 2pc. It could at least have signalled an end to monetary tightening. That is how an ally ought to behave.
Instead, it stuck maniacally to its Gothic script, with equally unhappy consequences for both sides of the Atlantic, as well as for China, Japan, and India. The euro rocketed yet further, which it turn set off an oil shock as crude metamorphosed into an anti-dollar with leverage.
The ECB policy was self-defeating, even on its own terms. It merely drove headline inflation even higher, while deeper forces of underlying debt deflation pulled the real economies of Germany, Italy, France, and Spain into a recessionary vortex.
Far from offering reassurance, the weekend mini-summit of EU leaders served only to highlight that nobody is in charge of this runaway train. There is still no lender of last resort in euroland. The £12bn stimulus package is risible.
Angela Merkel has revealed her deep limitations. It was she who vetoed French efforts to launch a pan-EU rescue package, suspecting that any lifeboat fund would prove to be Trojan Horse – a way of co-opting German taxpayers into colossal transfers of wealth to Latin Europe.
In that she is right, but it is too late now for dysfunctional EU political games. By demanding that those who caused the damage should pay for it, she crossed the line into caricature, or worse.
Her comments echo word for word the “we’re alright Jack” attitudes of Euro-pols during the first US banking crises in 1930-1931, until the storm hit Europe and the entire cast was swept away by furious electorates, or simply shot. Thankfully, this EU stupidity is at last drawing serious criticism….
As for the US itself, it has not yet exhausted its policy arsenal. It can escalate further up the nuclear ladder. The Fed can cut interest rates from 2pc to zero. If that fails, it can let rip with the mass purchase of US debt.
“The US government has a technology, called a printing press,” said Fed chief Ben Bernanke in November 2002. (His helicopter speech).
In extremis, the Treasury/Fed can swoop into any market to shore up asset prices. They can buy Florida property. They can even buy SUV guzzlers from the car lots in Detroit, and mangle them in scrap yards. As Bernanke put it, the Fed can “expand the menu of assets that it buys.”
There is a devilish catch to this ploy, of course. It assumes that foreign creditors will tolerate such action.
Japan entered its Lost Decade as the world’s top creditor, with a vast pool of household savings to cushion the slump. America starts its purge with net external liabilities of $3 trillion, and a savings rate near zero. Foreigners own over half the US Treasury debt, and two thirds of all Fannie, Freddie, and other US agency bonds.
But the risk of a dollar collapse is one for the distant future. Right now the world faces the opposite problem. There is a wild scramble for dollars as a $10 trillion pyramid of global lending based on dollar balance sheets “delevers” with a vengeance.
This is a key point missed in many analyses.
This is a “short squeeze” on those who have used the dollar for a vast global carry trade. International banks are facing margin calls on their dollar leverage. It is why the Fed is having to provide $1.25 trillion in dollar liquidity for the entire global system, according to estimates by Brad Setser from the Center for Geoeconomic Studies.
The crisis engulfing Europe, Asia and emerging markets, makes life easier for Washington. The United States is becoming a safe-haven again.
The Fed can now hope to pursue monetary stimulus “a l’outrance” without being slapped down by the currency, debt, and commodity markets. Take comfort where you can.
And now to key bits from the commodities article:
Oil, grains, and industrial metals all crumbled as the week began despite the passage of the Paulson bail-out plan in Washington and dramatic moves by European governments to shore up their banking systems, compounding the steepest commodity crash in over half a century.
The big exception yesterday was gold, which surged $34 to $864 an ounce on safe-haven buying as the markets came face to face with the unsettling reality that the euro is no healthier than the dollar, and perhaps sicker…
Hans Redeker, currency chief at BNP Paribas, said investors fear that no one is in charge of Europe’s monetary union. “Who is Mr Europe? What is his telephone number? There is no such thing. We have a cancer eating at the system because even healthy companies cannot roll over their debts, yet the politicians still don’t understand the risk,” he said.
The sudden shift in commodity sentiment has led to a massive withdrawal of funds from frontier markets, triggering stock market routs across Latin America, Asia, and Eastern Europe. The MSCI index of emerging markets fell 11pc yesterday in its worst day ever.
Russia suspended trading after Moscow’s Micex index crashed 19pc in its biggest one-day drop since the 1998 default…Brazil shut the Sao Paulo exchange after the Bovespa index crashed 15pc in panic trading…Mexico’s Bolsa was off 7pc; India’s Sensex was off 6pc.
The Goldman Sachs Commodity Index has tumbled a third since May. Chartists say it is now perched precariously on its seven-year line, threatening to challenge the “supercycle” thesis that became so fashionable at the top of the bubble.
“The boom was fuelled by massive speculation,” said Charles Dumas, chief strategist at Lombard Street Research.
“Commodity derivatives in the spring had a face of $10 trillion, so it doesn’t take many bulls to sell and send prices crashing. Remember all those clever bankers saying this was the new investment medium, ‘uncorrelated’ with either assets? Well, it’s correlated now – downwards,” he said.
The Australian dollar, the beacon of commodity sentiment, went into near-meltdown yesterday, dropping 9.7pc against the yen in the largest one-day drop on record as Japanese investors dumped their Uridashi bonds and scrambled to close bets on high-yield economies – known as the carry trade…..
Albert Edwards, global strategist at Société Generale, said China depends on exports to US and Europe for its lifeblood, and could face banking problems of its own.
“I think China is going into recession as well. This is going to catch investors off-guard.”
Yves here, Note most forecasters call for China’s growth to slow from its recent pace of 12% to 8%. The idea that it could have a contraction is on just about no one’s radar right now.
Stephen Jen, currency chief at Morgan Stanley, said the “glowing reputation” enjoyed by emerging markets during the global boom was a deception caused by the easy-money largesse of the credit bubble. Strip that away, and the picture looks very different.
“They are very vulnerable to a U-turn in capital flows,” he said….
There are fears that Russia could slip into a downward spiral if oil drops to $50 a barrel, which is now the lower end of Merrill Lynch’s forecast.
Moscow has become addicted to the oil bonanza, ratcheting up spending so quickly that it may now need prices to stay above $90 to fund spending plans. Veteran analysts say they have seen this movie before.