Yves here. Finance people are conditioned to see finance as more important than it is….although financiers have done a remarkable job over the last three decades of making finance more important than it ought to be.
It’s noteworthy when someone who does not see themselves as a finance person to predict that the big story of the upcoming year will be deflation. And that’s more a finance story than a macroeconomic story. It is the result of central banks playing a large role in weakening labor bargaining power, of aggrandizing their role by playing to the fantasy that monetary policy can do more to stimulate growth than it really does, and by backing themselves into the ZIRP/QE corner in their effort, as much as possible, to restore status quo ante in the banking system. Stephen Roach came to similar grim conclusions about how the Fed is choosing to back its way out of ZIRP. However, Roach thinks the Fed might be able to prevent a train wreck if it weans investors of the Greenspan/Bernanke/Yellen put. Even if he were right, I can’t imagine this Fed ever doing that.
By Raúl Ilargi Meijer, editor-in-chief of The Automatic Earth. Originally published at Automatic Earth
No year is ever easy to predict, if only because if it were, that would take all the fun out of life. But still, predictions for 2016 look quite a bit easier than other years. This is because a whole bunch of irreversible things happened in 2015 that were not recognized for what they are, either intentionally or by ‘accident’. Things that will therefore now be forced to play out in 2016, when denial will no longer be an available option.
A year ago, I wrote 2014: The Year Propaganda Came Of Age, and though that was more about geopolitics, it might as well have dealt with the financial press. And that goes for 2015 at least as much. Mainstream western media are no more likely to tell you what’s real than Chinese state media are.
2015 should have been the year of China, and it was in a way, but the extent to which was clouded by Beijing’s insistence on made-up numbers (GDP growth of 7% against the backdrop of plummeting imports and exports, 45 months of falling producer prices and bad loans reaching 20%), by the western media’s insistence on copying these numbers, and by everyone’s fear of the economic and financial consequences of the ‘Great Fall of China‘.
2015 was also the year when deflation, closely linked -but by no means limited- to China, got a firm hold on the global economy. Denial and fear have restricted our understanding of this development just as much.
And while it should be obvious that 2015 was the year of refugees as well, that topic too has been twisted and turned until full public comprehension has become impossible. Both in the US and in Europe politicians pose for their voters loudly proclaiming that borders must be closed and refugees and migrants sent back to the places they’re fleeing due to our very own military interventions.
And that said politicians have the power to make that happen, the power to close borders to hundreds of thousands of fellow human beings arriving on their countries’ doorsteps. As if thousands of years of human mass migrations never occurred, and have no lessons to teach the present or the future.
The price of oil was a big story, and China plays the lead role in that story, even if again poorly understood. All the reports and opinions about OPEC plans and ‘tactics’ to squeeze US frackers are hollow, since neither OPEC as a whole nor its separate members have the luxury anymore to engage in tactical games; they’re all too squeezed by the demise of Chinese demand growth, if not demand, period.
Ever since 2008, the entire world economy has been kept afloat by the $25 trillion or so that China printed to build overleveraged overcapacity. And now that is gone, never to return. There is nowhere else left for our economies to turn for growth. Everyone counted on China to take them down the yellow brick road to la-la-land, forever. And then it didn’t happen.
What 2015 should have made clear, and did in a way but not nearly clear enough, is that the world economy is falling apart due to a Ponzi bubble of over-production, over-capacity, over-investment, over-borrowing, all of which was grossly overleveraged. And that this now is, for lack of a better word, over.
Most people who read this will have noticed the troubled waters investment funds -hedge funds, mutual funds, money market funds et al- have recently landed in. But perhaps not many understand what this means, and where it may lead. These things tend to be seen as incidents, as is anything that diverts attention away from the ‘recovery just around the corner’ narrative.
Not only do the losses and redemptions at investment funds drive these funds to the brink, everything they’ve invested in also tumbles. Add to this the fact that most of the investments are highly leveraged, which means that typically a loss of just a few percent can wipe out all of the principal, and a notion of the risks becomes clear.
Of course, since many of the funds hold the same or similar investments, we can add yet another risk factor: contagion. Things will blow up first where the risk is highest. Then everything else becomes riskier. Low interest rates have caused many parties to chase high yields -junk bonds-, and that’s where risks are highest.
This is the 2015 story of investment funds, and it will continue, and aggravate, in 2016. Ultra low interest rates drive economies into deflation and investors into ever riskier assets. This is a process of unavoidable deterioration, unstoppable until it has played out in full. A 0.25% rate hike won’t do anything to change that.
Why do interest rate hikes pose such a problem? Because ZIRP has invited if not beckoned everyone to be up to their necks in debt. The entire economy is being kept lopsidedly upright, Wile. E style, by debt. Asset prices, even as commodities have now begun to fall in serious fashion, still look sort of OK, but only until you start to look at the amount of leverage that’s pinning it all up.
Once you see that, you understand how fragile it all is. Go one step further, and it becomes clear that this exponentially growing ‘machinery‘ can only be ‘sustained’ by ever more debt and leverage. Until it no longer can.
Commodities prices have nowhere to go but down for a long time to come. These prices have been propped up by the illusionary expectations for Chinese growth and demand, and now that growth is gone. So, too, then, must the over-leveraged over-investments both in China and abroad.
Growth that was expected to be in double digits for years to come has shrunk to levels well below that ‘official’ 7%. China’s switch to a consumer driven economy is as much a fantasy as the western switch to a knowledge economy has proved to be. If you don’t actually produce things, you’re done. And producing for export markets is futile when there’s no-one left to spend in those markets.
Ergo, commodities, raw materials, the very building blocks of our economies, from oil all the way to steel, are caught in a fire sale. Everything must go! Eventually, commodities prices will more or less stabilize, but at much lower levels than they -still- are at present. That we will need to figure this out in 2016 instead of 2015 is our own fault. We could have been healing, but we’ve yet to face the pain.
Trying to guesstimate how low oil will go is a way of looking at things that seems very outdated. It’s interesting just about exclusively for people who ‘invest’ in the markets, but the reality is that the Fed, BoJ, PBoC and ECB have first made sure through QE and ZIRP/NIRP that there no longer are functioning markets, and they are now losing their relevance because of these very ‘policies’.
Price discovery has already started (oil, commodities), and central banks have benched themselves. They could only re-enter the game if they quit interfering in the markets, but they’re too afraid, all of them, of the consequences that might have, not even so much for their economies but for their TBTF banks.
Yellen’s rate hike will mean some extra profits for those same banks at the cost of the rest of the financial world, but with growth gone to not return for a very long time, and with deflation hitting everything in sight and then some, there is no pretty picture left.
And none of this is really hard to process or understand. It’s just that there’s these concerted efforts to keep you from understanding, that keep you believing in some miracle salvation effort. Which would, so goes the narrative, have to come from the same central banks and the same Wall Street banks that put everyone and their pet guinea pig as deep in debt as they are.
If you have been reading the Automatic Earth over the past 8 years and change, you know what this is about. There are a few, but unfortunately only a few, other sources that may have put you on the same trail.
I was impressed with the following earlier this month from David Stockman, Reagan’s Director of the Office of Management and Budget, who now seems to have firmly caught up with the deflation theme Nicole Foss and I have been warning about ever since we started writing – pre-TAE – at the Oil Drum 10 years ago. Stockman today says that we are entering an epic deflation and the world economy is actually going to shrink for the first time since the 1930s. (!)
There has been so much over-investment in energy, mining, materials processing, manufacturing and warehousing that nothing new will be built for years to come. [..] .. there will be a severe curtailment in the production of mining and construction equipment, oilfield drilling rigs, heavy trucks and rail cars, bulk carriers and containerships, materials handling machinery and warehouse rigging, machine tools and chemical processing equipment and much, much more.
It’s good to see people finally acknowledging this. It’s still rare. But there’s another, again interlinked, development that is very poorly understood. Which is that in a debt deflation, the ‘money’ that appears to be real and present in leveraged investments more often than not doesn’t get pulled out of one ‘investment’ only to be put into another, it just goes POOF, it vanishes.
And though it may seem strange, conventional economics has a very hard time with that. In the eyes of that field, if you don’t spend your money, you must be saving it. The possibility of losing it altogether is not a viable option. Or, if you lose it, someone else must be gaining it, zero-sum style.
But that view ignores the entire ‘pyramid’ of leveraged loans and investments and commodity prices, which precisely because that pyramid contained no more than a few percentage points of ‘real collateral’ to underpin everything it kept afloat, should have been a red flag. Because this is the very essence of debt deflation.
Just one little example of how and why this happens comes from this Bloomberg item. The key word is ‘evaporates’:
Colombia is nursing paper losses of more than $100 billion after its oil boom fell short of expectations, wiping out 90% of the value of what was once Latin America’s biggest company. From being the world’s fifth-most valuable oil producer at its zenith in 2012, worth more than BP, state-controlled Ecopetrol now ranks 38th. Its market capitalization has fallen to $14.5 billion, down from its peak of $136.7 billion. “They just haven’t found oil, it’s as simple as that,” Rupert Stebbings at Bancolombia said from Medellin. “The whole oil sector got massively over-bought, and people assumed that one day they’d hit an absolute gusher.”
2016 will be the year when a lot of ‘underlying wealth’ evaporates. Trillions of dollars already have in the commodities markets, but, again, our media don’t tell us about it, or at least they frame it in different terms. They use deflation to mean falling consumer prices, but then insist on calling falling prices at the pump a positive thing. Without recognizing to what extent those falling prices eat away at the entire economy, and at society at large.
To summarize for now: we have elected to deny and ignore what has happened to our economies, our societies and our lives in 2015, only to be forced to face all of it in 2016. That makes the year an easy one to predict. But there are of course a lot of other possible spokes and wheels and other things.
Any government that sees its nation slide down into a deep enough pit will always consider going to war. One or more central banks may opt for a Hail Mary helicopter ride. A volcano may erupt. But none of these things will prevent the bubbles we have blown from deflating. They may divert attention, they may delay the inevitable a bit more, sure. But bubbles never last.
I have a whole list of key words I wanted to use in this, but I think I’ll turn them into a separate article. The main point is you understand the gist of it all. There are no markets, and what has posed as markets is crumbling before our very eyes, inexorably. The best we can do is say ‘see you on the other side’, if we’re lucky.