Wednesday, June 13, 2012

Black Tswanami

When Black Swans meet Tsunamis, it creates Black Tswanamis.
The last time this happened was in 1929-1933 - some people expected a recession, but nobody expected a wipeout. A wipeout which just sucked away demand from the world. The depressed demand created job losses and idle factories. Jobless people scared people who held jobs and depressed demand furthermore. This cycle fed itself for a long time. The world was more or less out of the woods in 3 odd years. 
But 3 years is a long long time in a depression. Luckily, the world was not as interdependent, nor was it as connected, nor was it so indebted.

We are in June of 2012 - and I guess the Mayans were right :)
Herewith, I outline a few reasons why I foresee a global economic upheaval. 

1. Dead money creation has never reached levels such as today's levels.
Here is the link which outlines the progress of US's public debt outstanding.
In Jan 2011 they were at USD 14 Tn
In June 2012 they are at USD 15.7 Tn
I don't have the numbers for the Eurozone or for Japan - but the Eurozone has just been creating Euros out of thin air and lending it to either sovereigns or banks or institutions.
Japan is at 400% + of total debt to GDP

2. The Euro will cease to be shared by as many countries as today (17 at last count)
The fundamental premise of a fiat currency is that the sovereign can control its supply relative to other currencies. When one cannot control its efficacy, hyperinflation such as that in the Weimar Republic or that in Zimbabwe may occur. 'Occur' - because it is difficult to control hyperinflation. On the other hand, deflation is easier to control.
On a side note: Deflation is good because it is a healer. Hyperinflation is bad because it ruins everybody leaving entities with no semblance of what 'value' means.
Coming back to the Euro, Spain can't devalue itself out of its mess - neither can Italy or Portugal or Greece. On the opposite side, the Euro has kept borrowing costs really low for Germany while drastically improving its export competitiveness - therefore it does not want to go back to the DM - but the currency is flawed because in such large economies, it is imperative to be able to control one's foreign exchange based competitiveness. An absurd example of this is: Even in a depressed Greece, a cup of Coffee may cost more than in France. However, if Greece had its own currency, the relative value of the Drachma to the Euro would have made the coffee cheaper. 

What we have in the Eurozone is young people asking 'What did I do to deserve this depressed standard of living?"

3. Coming from the last sentence of the prior point - some Americans are asking the same thing...
Americans have lived with a great standard of living for a long long time - but suddenly, many are jobless. An 8% level of unemployment now seems structural instead of cyclical. So the youngsters are asking why they don't have jobs as thought having a job is an entitlement.

On the other hand, the oldies believe that Pension, Medicare and Medicaid will be provided. To counter this, the youngsters say - "Wait, why should we, the tax payers, foot your inflated bill?"
This creates conditions for a paradigm shift, if you may, in the way the US has conducted its domestic affairs.
I expect higher inflation for a longish time combined with structural unemployment.

4. China.
Numerous non-performing assets in terms of cement factories, steel factories, consumer goods factories, unoccupied buildings, etc. all of which have been funded by the government, and hence funded by the tax payer and hence funded by a depressed purchasing power which is countered through more lending. 
A 2-3% savings rate for a 12%+ nominal growth economy makes no sense.
Feel free to read my earlier China posts for this.

All of this leveraging has been funded by the end of the Bretton Woods Agreement when the gold standard was dropped in favour of a fiat currency regime. America exported its USD worldwide and funded its own exuberance. Japan did the same. The Eurozone tried to do that but has failed. China wants to do that but can't (yet).

To sum this all up.
The world is on the brink of realizing that there is no substance underneath all the potential credit floating about. 
Furthermore, foreign exchange rates are a function of demand and supply - both of which have become enormously variable. 
China's growth will come to an end. The Eurozone growth is already tepid. Our only hope is the US which is still the world's seat of innovation.
The reason why all of this is unlike ever before is that global credit has reached everywhere - something that had never happened before. 

However, irrationality has a way of perpetuating itself.
But when it can't, we have a Black Tswanami.

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