'Today we will summarize something I’ve been thinking about for a long time. Exactly how will we get from the credit crisis, which I think is coming in the next 12–18 months, to what I call the Great Reset, when the global debt will be “rationalized” via some form of nonpayment. Whatever you want to call it, I think a worldwide debt default is likely in the next 10–12 years.'
- John Mauldin,
Train Crash Preview, May 18, 2018
'I know it sounds crazy - pure heresy - to most. But there's a shot that the world has commenced a crisis that will unfold into something more comprehensive and challenging than 2008. And at least in the U.S., financial crisis is the furthest thing from people's minds. Not even on the radar. Not possible.
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We've created a Bubble economic structure that will function especially poorly come faltering markets and a tightening of financial conditions.''It's worth repeating (from above): "Outstanding debt securities from developing nations have ballooned to $19 trillion from $5 trillion a decade earlier." Analysts this week were keen to note that EM market tumult has been less disruptive than the (soon passing) 2016 episode. Give it time. We're still in just the initial phase of Risk Off. Only a few weeks back it universal bullishness held sway over the emerging markets and economies. Buy one ETF and own them all!
It's worth recalling that the 2016 de-risking/de-leveraging episode was nipped in the bud by an upsurge in global QE (especially courtesy the ECB and BOJ) and a corresponding extension of easy money by the Federal Reserve. And let us not forget the commanding contribution from Beijing policymaking. After a modest slowdown in 2015, China's Credit growth surged in 2016 and that acceleration continued well into 2017. Two additional fateful years of surging global Credit and financial flows are now coming home to roost.
Today's backdrop is more conducive to a protracted EM crisis backdrop, along with, I would argue, an especially destabilizing global market liquidity crunch. For one, the overheated U.S. economy has the Fed rather hamstrung. Their timid baby-step approach has worked to sustain excessively loose financial conditions. And while central bankers dilly-dallied, extreme fiscal stimulus coalesced with extreme monetary stimulus - creating a most potent concoction way too late in the economic cycle. Between fiscal stimulus, a capital investment boom and reenergized housing inflation, the Fed today confronts extraordinary uncertainty as it attempts to gauge the amount of economic stimulus and inflationary juice in the pipeline.
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China would not face today's degree of fragility had it not fatefully resuscitated Bubble Dynamics back in 2016. EM, as well, would be in a sounder position if it had begun to deal with excess and mounting vulnerabilities. Instead, for both China and EM it's been a case of extending Terminal Phase Excess, with an additional two years of rampant Credit expansion, extraordinary international "hot money" flows, and even deeper structural impairment.
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From my vantage point, EM contagion has reached critical mass. There will be ebbs and flows, but we're now on Crisis Watch. De-risking/De-leveraging Dynamics have attained momentum, and the focus will be on waning global market liquidity and the next domino. The process of unwinding EM "carry trade" leverage has commenced. I ponder how much leverage has accumulated throughout Asian debt markets. Hong Kong's Monetary Authority has significant international reserves (over $400bn) to support its faltering currency peg. But I would expect the reversal of "hot money" flows to accelerate, pressuring central banks throughout Asia and EM more generally. To fund outflows, central bankers will be forced sellers of Treasuries (and other sovereign debt). It's worth noting that custody holdings held by the Fed for foreign Treasury holders have dropped $63bn over the past five weeks.
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China appears increasingly vulnerable to EM contagion effects. Finance is tightening in EM, in China and globally. Over recent years, China has developed into the prevailing source of EM finance and trade. China and EM interdependency has been instrumental to their respective booms. Now comes the downside. I suspect "hot money" has begun exiting EM at least partially in anticipation of waning trade and financial flows from China. And a faltering EM Bubble certainly has negative ramifications for the increasingly fragile Chinese Bubble. If there is a big "carry trade" in Chinese Credit instruments, it's susceptible.
Previous problems have not gone away - they've instead festered and metastasized. EM debt, the China Bubble, Italy and euro monetary integration, to name just a few. This week was clearly an escalation in de-risking/de-leveraging dynamics. How much speculative leverage has accumulated (since 2012) in Italian, Greek, Portuguese and Spanish debt? ECB rate manipulation and "money printing" stoked an artificial boom. It's come at a very steep price. Myriad problems associated with a deeply flawed monetary integration are waiting to resurface, as we're witnessing in Italy.
I know it sounds crazy - pure heresy - to most. But there's a shot that the world has commenced a crisis that will unfold into something more comprehensive and challenging than 2008. And at least in the U.S., financial crisis is the furthest thing from people's minds. Not even on the radar. Not possible.
..to one that has been chronicling the "global government finance Bubble" now for over nine years, I really worry. Excess became systemic. Deep structural maladjustment - systemic. Global imbalances - unprecedented. The amount of global debt - previously unfathomable. And, deeply concerning, the world has become so much more divisive and hostile over the past decade.
Come the next international crisis, it will not be the U.S. and a group of likeminded global central bankers coordinating a unified policy response. Expect a disparate group of bankers, politicians and strongmen autocrats pointing fingers, making threats and demanding action from others. If they can't after months successfully negotiate trade deals, how are they to respond to crisis dynamics that they are wholly unprepared for.
But I'm getting ahead of myself. The U.S. economic boom has a head of steam. The small caps traded to record highs this week. To the naked eye, things look sound and sustainable. If only it weren't a Bubble Illusion. The NYT's Kevin Roose this week penned an insightful article, "The Entire Economy Is MoviePass Now. Enjoy It While You Can."
"I've got a great idea for a start-up. Want to hear the pitch? It's called the 75 Cent Dollar Store. We're going to sell dollar bills for 75 cents - no service charges, no hidden fees, just crisp $1 bills for the price of three quarters. It'll be huge. You're probably thinking: Wait, won't your store go out of business? Nope. I've got that part figured out, too. The plan is to get tons of people addicted to buying 75-cent dollars so that, in a year or two, we can jack up the price to $1.50 or $2 without losing any customers. Or maybe we'll get so big that the Treasury Department will start selling us dollar bills at a discount. We could also collect data about our customers and sell it to the highest bidder. Honestly, we've got plenty of options. If you're still skeptical, I don't blame you. It used to be that in order to survive, businesses had to sell goods or services above cost. But that model is so 20th century. The new way to make it in business is to spend big, grow fast and use Kilimanjaro-size piles of investor cash to subsidize your losses, with a plan to become profitable somewhere down the road. Over all, 76% of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to… Jay Ritter, a professor at the University of Florida's Warrington College of Business. That was the largest number since the peak of the dot-com boom in 2000, when 81% of newly public companies were unprofitable. Of the 15 technology companies that have gone public so far in 2018, only three had positive earnings per share in the preceding year… The rise in unprofitable companies is partly the result of growth in the technology and biotech sectors, where companies tend to lose money for years as they spend on customer acquisition and research and development… But it also reflects the willingness of shareholders and deep-pocketed private investors to keep fast-growing upstarts afloat long enough to conquer a potential winner-take-all' market."
We've created a Bubble economic structure that will function especially poorly come faltering markets and a tightening of financial conditions.'
- Doug Noland,
Crisis Watch May 19, 2018
Context'..over time, debt stops stimulating growth..' - '..The mother of all bubbles exists and it is in the debt markets..'