The turn of the century marked a sea change in the vibrancy of western economies. From that point onwards underlying unleveraged growth and GDPs behaved as if they were swimming through treacle. I would argue that was because America went into the final stage of decline. Interestingly this also coincided with the new inflationary commodity cycle of a new K wave with increased input prices further imposing themselves on a sub dynamic American and western economy. This turning point coincided with 9/11. Which made America feel under attack, such that it encouraged the Fed to print money to safeguard what it perceived to be wartime threats to the US economy. That was the moment when Fed behaviour fundamentally changed as mandated by US politicians and the addiction to money printing took hold. In essence, the Fed moved from the inflationary guardian of the Volker years to a mandate to keep economic wheels on, which would enable re-election of the politicians.
This process continued and inflated the system into the 2007 stock market peak. In this case the excess leverage manifested itself in the bubble in the sub-prime mortgage market, which evolved into a full-blown international banking crisis. Massive bailouts were employed to save the whole financial system from collapse.The European debt crisis followed shortly afterward. The medicine in both cases was to print even more money and become even more addicted. That addition further was driven by the politicians seeking re-election. Today it has increased to the point where it became the new normal, or as the Bubble curve below highlights, this is a new paradigm that is associated with the peak where no one seems to be questioning its sustainability just as disaster awaits.
Reality check: this is not normal and not economically healthy and certainly not sustainable! Let's go back to some basic principles based on the five-stage of an Empire. In two stages of regionalization and expansion the system is expanding and generating real GDPs that by definition expand to make the system bigger. By the time that Empire status has been reached, this equates to a monopoly that repays and loans that have been used to invest in the expansion and leaves the system in a very healthy surplus. Then in the third stage of maturity, the system starts to reduce its GDP and its fixed costs increase to the point of balance. That balance then becomes negative in the over extension phase as new money is borrowed to sustain the system. But hell its an empire that is unassailable so it's a safe bet right? But by the time overextension is reached the system is borrowing excessive amounts of money to keep up with its new competitors. But being a massive empire this decline takes time to build and reach the critical point of collapse as its substantial immune system fights the inevitable.
Images of UK and US debt, related to the empire cycles taken from Breaking The Code of History, shows a very clear similarity. Except Britain had America, its cousin, to pass its baton too. America has no one and as such a debt explosion is all but inevitable.
So let's do another reality check and revert to basic principles to examine if the printing of money and Central Banks can save the day and reverse an underlying trend of Western decline?
Growth X leverage= reported GDP
Zero growth X leverage= zero GDP!
So there comes a point where no amount of leverage can invigorate the system, if it is in a negative growth phase. For a time at the peak, that extra liquidity will go into the stock market to buy companies as it is doing now, but like a man running off a cliff, who for a moment looks to be running on air, gravity will in inexorably hold its sway and the system will fall.
The US Debit Bubble has three components
1. Sovereign debt: which in the case of America has expanded from 55% of GDP in 2000 to over 100% today i.e $22.03 trillion of which 29% is foreign held. The curve of US national debt as a percentage of GDP is given below.
2. Corporate debt: which in the US is $9.95 trillion for Q 2 2019, which is a staggering 47% of US GDP. As compared to £6.6 trillion in 2008 which was 44% of GDP. The burden is such that cash balances are falling, which feeds back into a buyback collapse and the equity market losing one of its current key pillars of support.The next step will be corporate bond defaults and market panic as bond funds who have been seeking yield are forced to sell their good assets to cover the defaulting ones. A situation then exacerbated by inevitable downgrades. Its no wonder that American CEO's confidence is at the same level as the bottom of 2008! PE funds have been a key driver of increasing corporate debt as part of their leveraged model. Both the funds and their investments are likely to suffer heavily in the downturn.
3. Consumer Debt: whilst consumer confidence is holding up, there is evidence that this trend could change swiftly when the US job market changes direction. Both look to be at a key inflection point before a rapid drop.
Today real global demand is dropping due to bifurcation of the American and Chinese spheres of influence, as the US Chinese Trade War rumbles on with no hope of a resolution, as it is driven by strategic competition. This demand drop also coincides with the K wave trough due in the next 12-18 months. The ISM manufacturing index is showing signs of an accelerated decline that will signal a 2008 magnitude event. Additionally the Trump Impeachment proceedings bring a new downside risk to the Stock Markets as the evidence grows against Trump witness by witness. Meanwhile Republicans in the Senate who once would have protected Trump, may now due to the betrayal of the Kurds, have increasing concerns over Trumps judgment in matters of national security.
Our conclusion is that the global Bond market and its trend to zero rates is the accurate measure of the global economy and the market risk, whilst the stock market which regulates overt public sentiment, is lagging that perspective due to the printed money still washing around the system. However, that will only be short-lived. What is concerning is that in all probability the stock bear market will not be like the gradual 2007-2008 decline but in all probability will be more like 1929 with a massive short time frame drop that will just isolate the longs and never allow them to escape.
What is most concerning is that having used the money printing machine to the point of ineffectiveness, what tools do central banks have left in their armoury? None that I can envisage, which leaves governments to restructure their debts and if they can, to then lower taxes. However by then huge amounts of wealth would have been lost in the stock market fall and neither measure is likely to re-stimulate the dead cadaver of an economy for a long time. I have to say that this is a most depressing thought indeed but better to face reality than to emulate the pheasants in my garden who stick their heads in the grass thinking they are not visible!
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