'Marking down Chinese debt to a more reasonable level will leave a gaping hole – in bank capital, in government finances and in household savings. This will set back China’s transformation from production to a services/consumption-based economy by decades..'<blockquote>'Few are yet willing to accept the harsh reality that the world has sunk back into crisis. The VIX ended the week at a somewhat elevated but non-crisis 23.38. Credit spreads have widened meaningfully but for the most part remain at a fraction of 2008 crisis levels. Indeed, markets remain hopeful that “whatever it takes” central banking is waiting in the wings to trigger rallies at the moment things turn disorderly. My view that crisis has reemerged is based on the analysis that de-risking/de-leveraging dynamics have reached a point of self-reinforcing momentum beyond the control of central bank policies. In short, The Adjustment Cycle has commenced and there’s little left at this point to hold it back.
A multi-decade Credit Bubble is coming to an end. The past seven years has amounted to an incredible blow-off top – China; EM; global government debt; “whatever it takes” central bank inflationism; QE infinity; zero and now negative rates; a $3.0 TN hedge fund industry; a $3.0 TN ETF complex; unprecedented global corporate bond excess; historic M&A, stock buybacks and financial engineering; derivatives Bubble resurrection; and tech and biotech Bubbles 2.0 (to name only the most obvious). Importantly, global financial and economic imbalances – already unmatched by 2008 – went to even more precarious extremes.
Bubbles inflate both perceived wealth and future expectations. Meanwhile, in the real economy sphere, myriad Bubble facets work to destroy wealth. Mal-investment, over-investment and associated wealth destruction remain largely concealed so long as financial asset prices remain inflated. This is true as well for wealth redistribution. The unfolding adjustment process will deflate asset prices so as to converge more closely with underlying economic fundamentals.
Marking down Chinese debt to a more reasonable level will leave a gaping hole – in bank capital, in government finances and in household savings. This will set back China’s transformation from production to a services/consumption-based economy by decades. Mark down European debt and asset prices to sensible levels and the banking system is insolvent and Europe’s economy is right back in the ICU. Indicative of a faltering Bubble, European periphery spreads widened significantly this week (Greece, Portugal, Italy and Spain). Europe would be in much better shape today had it taken its medicine in 2012.
..
Candidly, I don’t enjoy writing in these circumstances. It’s reminiscent of the buildup to the 2008 market crash. It wasn’t entirely clear how things would unfold back then, but I knew tens of millions would be badly hurt. Nowadays I fear for hundreds of millions, and the associated geopolitical… So far, the public hasn’t panicked. Why would anyone sell now when stocks always recover? The adjustment process is just getting going.'
- Doug Noland,
The Adjustment Cycle, February 6, 2016</blockquote>
Context<blockquote>
'In terms of the business cycle this confirms that the liquidation phase is indeed beginning..''..the economic analysis of the necessary consequences of intervention in the free market by bank credit expansion.''The collapse of the Soviet Union .. U.S. finance was becoming increasingly state-directed..'</blockquote>