THE BEST OF TIMES, THE WORST OF TIMES
It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair…
Charles Dickens, A Tale of Two Cities
What could go wrong? A U.S. economic recovery with lower bond yields. A dovish Federal Reserve and an ECB, which will be forced to implement ‘large-scale’ Quantitative Easing. An abundance of liquidity as far as the eye can see, which the markets somehow will have to absorb. Ultralow interest payments on debt and strengthened balance sheets. A possible comeback of U.S. capital and consumer spending, extending the economic expansion. Today’s Central Banking schemes bring ever greater riches to those, who courageously overcome their fear and forget everything in history. Aren’t markets hitting ‘new highs’ all the time?
What could possibly go wrong? Won’t all the pieces for a sustained recovery of many more years eventually fall into place? Isn’t this ‘a new era’, after U.S. earnings per share have quadrupled, in real terms, since 1992, after being stuck at zero for 30 years? Will the powerful, secular uptrend in U.S. profit margins simply keep growing? Shouldn’t markets be at current valuations and aren’t they headed for even higher valuations?
Questions, questions! This is a ‘false’ economic recovery. Nothing is what it seems. Never in history, has there been such a concerted effort to distort and cover up the truth about the ‘real’ economy. Any meltup, as the world supposedly has found the key to permanent prosperity, will be followed by a meltdown. But during these exciting times, when nothing can go wrong and everything has a backstop and therefore remains under control, the sheep could be seduced to finally behave like animals and take more risk. Once the sheep switch from bonds to stocks, run up their credit card debt and embark on another spending spree, then the world is on track to ‘normalization’. Traumatic busts have become things of the past. Uhh…?
Alas, what’s too good to be true, usually is. In reality, global economic growth is anemic, or not impressive at all. In the next decade, even the possible annual GDP growth in the U.S. could be half the rate of the last 50 years. The economy hitting ‘escape velocity’ any time soon is wishful thinking. Financial engineering (buybacks of shares via debt financing) and Mergers & Acquisitions (take-overs with or without debt financing) , the main reasons for these buoyant markets, are slowing down. The downtrend in chronic low inflation, bond yields and interest rates is secular and will persist for many years. Most deleveraging from overindebtedness is still ahead of us. The ageing of the global population is accelerating, especially in Europe and the BRIC’s, which will affect consumer spending and investment style (shift to bonds is secular). The financial sector will continue to shrink dramatically (much higher liquididity ratios) and financialization is bound to grow less than the real economy, which is the opposite of the last few decades. Therefore, the world faces the ominous prospect of a ‘lost decade’, a global Japan scenario, especially Europe. Deflation will not be prevented by onorthodox monetary policies, because real wages of the middle class will continue to decline (internet, globalization) and the velocity of money will continue to fall (secular weak demand for credit).
There is NO reason to rejoice about Europe! Government bond yields of the weakest members of the Eurozone have been collapsing, as their stagnant economies are likely to remain so. Political uncertainties are bound to rise dramatically again. Why would markets assume, that the ECB could purchase government bonds, which would result in a politically unacceptable redistribution of risk? The Eurozone is NOT a country. How much risk to the taxpayer would the ECB be willing or able to accept, by buying very risky Asset Backed Securities? Or will this be just another bailout for the European banks? Large-scale quantitative easing (QE) could perpetuate Zombie Banking, because the necessary adjustments for a healthy banking system would be postponed. Markets seem to be overly optimistic about the possible impact of any loose monetary policy.
Liquidity-driven markets are unstable. It’s great, while it lasts, but when the tide goes out, the insane Carry-Trades, based on faulty models, of the overleveraged speculators, will prove to be their undoing. And then the world will be back to square one. Another financial crisis, much bigger than the previous one.
RICK SCHMULL
September 4th, 2014
WESTCLIFF-On-SEA, Essex, U.K.
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