This is a long post.
Quantitative Easing by the US Fed Reserve, European Central Bank and currency manipulation, by all major economies from 2008 through to 2015, together with China reverting from an export based economy to a consumer based economy, has allowed demand on all commodities to drop significantly.
Growth phase in China has stalled and they themselves will have a depression resulting in even lower demand and prices for Commodities.
All Countries will be affected.
Zero Based Interest Rates (and Negative Interest Rates) have forced capital to seek income earning beyond what is possible in the Bond Markets, thereby increasing exposure to listed stocks, further the lower rates have allowed marginal companies and individuals to borrow in excess, which on all probabilities will result in bankruptcy when the US Fed Reserve increases interest rates. This will cause further world economic gloom, in that there is in excess of USD9 trillion borrowed externally in USD and an interest rate increase by the US Fed will compound the situation of a far stronger USD against borrowers base currencies.
This will result in severe strain on all world Banks and both Bondholders and Depositors will lose monies. Banks will collapse, Countries will collapse. Capital will flee to the Reserve Currency.
Depression is coming.
And yes the US Fed will increase interest rates. It is a matter of the need to sell their bonds to cover excessive US Government debt and offsetting the capital flight into the US Stock markets by all free capital. This capital will seek the safety of the USD status and a better return than the zero or negative interest rates on all other Government Bonds… Those Governments may default themselves as they will be unable to raise capital.
Resulting impact is the US Fed increasing Bond rates. Knock on effect will be a huge increase in USD value against all currencies bringing about the need for another solution, a la’ Plaza Accord.
What do all of these events have in common, why will this lead to a depression?
The opportunity to address all World’s financial problems was evident in 2008 and this was bypassed by all Governments, whereby initially the US Government’s actions on the 2008 financial crisis, was with large financial government cash infusions, to failing banks, on the basis that it would make credit available to both the public and businesses.
To many people (and me included) it seemed strange to supply money to the very institutions which had created the crisis in the first place, instead of using the funds for extended unemployment benefits and public works programs, which in themselves would inject money immediately into the failing economy as had been done under the ‘New Deal’ in the 1930’s.
Note please, that this is a Keynesian approach (See End of Article) and opposite economic opinion to that provided by F Hayek. The reason that I opted for JM Keynes remedy and approach was simple, that if used properly it has a history of working properly, as it did in the 1930’s (albeit at a slow pace then due to the Governments reluctance to implement the plan immediately.)
The 2008 ‘bail out’ was blatant stupidity first and foremost is that no company is too big to fail and as was revealed later, some of this money was used to finance dividend payouts and bank mergers instead of easing credit availability. (One could say that is was a blatant, obnoxious grab for cash for those responsible for the crisis with bonuses in the amount of over 18 billion dollars paid…. God Bless America.)
Then the US Federal Reserve instituted Quantitative Easing 1,2 and 3.
From The Economist
“The effect was to carry out QE the central banks created money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before.
The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence “quantitative” easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans.
The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn boosts investment.
Today, interest rates on everything from government bonds to mortgages to corporate debt are probably lower than they would have been without QE. If QE convinces markets that the central bank is serious about fighting deflation or high unemployment, then it can also boost economic activity by raising confidence. Several rounds of QE in America have increased the size of the Federal Reserve’s balance sheet—the value of the assets it holds—from less than $1 trillion in 2007 to more than $4 trillion now.”
In other words the introduction of lower interest rates… A bloated US Fed Reserve Balance Sheet with toxic assets transferred by the large Financial Institutions.
Forbes Infamous ‘Short’ coming into play March 2015
As Forbes highlights it is only a ‘USD 9 trillion’ short coming in to play..
“After years of accumulating a huge amount of debt in dollars, borrowers will need to figure out how to repay” given the currency’s recent gains, Jen said. “People will either repay early or start hedging actively. There’ll be huge demand for the dollar that is much more than what’s consistent with growth or interest-rate differentials.”
Well guess what?
Forbes has it wrong, the US debt is USD 15.6 trillion
These USD loans are held externally, by all countries and companies and the subsequent USD gains will impact the bottom line, against the devalued currency of the borrowers. This will pressure those that borrowed to no end.
What is paramount in all this, is the need for all World Governments to borrow to sustain the bureaucracy. Who in their right mind would invest in and Country for a negative yield?
With each Countries’ debt who would take a risk investing for a zero or negative return?
There are currency wars being played out by all Countries
This initially started by the Quantitative Easing (QE) policy introduced by the US Fed Reserve to refinance the capital on all of the Banks capital accounts. Near zero interest rates (ZIRP) and a lot of money issued. The knock on effect was that this also devalued the USD on the world stage.
In 2010 we had Brazil crying about currency wars affecting the Real. The stark reality was that the interest rates available in Brazil allowed the currency to strengthen against the USD, it was not only Brazil that was affected, but other commodity export currencies and then those Countries pegged to the USD, main benefactor being China. This allowed Chinese and US export goods to increase, the low USD affected all currencies and commenced a Central Bank and Company borrowing frenzy of cheap USD.
The poorly designed Euro currency and inherent problems of debt exposure in the southern European countries in particular Greece, Portugal, Spain, Cyprus, Italy and Ireland allowed investors, who were seeking higher returns to succumb to the higher interest rates on offer in these Countries. There was no doubt an the illusion that the European Central Bank would implicitly guarantee these debts.
The Greek non default and subsequent investor haircut in late 2010 was a warning, yet investors continued to be attracted to higher yields. If one looks at the influence of ZIRP then it was driving investors to seek far greater yields in riskier Country bonds.
This was covered by an early post on Greece.
With the Euro currency declining in value, Mr Larry Summers did his bit at Davos with the suggestion of Negative Interest Rates (NIRP) which was boldly taken on by those Countries who pegged to the Euro. Those Countries that took this action did so to avoid incoming capital flight and strengthening of their currency against the Euro and to foolishly preserve their own pegs.
Switzerland was one such Country pegged to the Euro and was placed in a precarious situation, to maintain the ‘peg’ during the deflation of the Euro from around 2010 meant that the Swiss Central Bank had to support and preserve the peg.
Then in 2015 the Swiss Central Bank had no alternative (due to the cumulative cost of maintaining the peg against a depreciating currency) but to stop this peg. Technically they bought at Euro high point and where buying Euro throughout its decline against the USD. This cost them dearly (estimates at around USD50 billion).
This decision by the Swiss was no doubt influenced by the ECB’s own QE program, the effect of which was not dissimilar to the US Fed Reserve program and impact on the USD but was also compounded through problems in Greece, Cypress, Italy, Spain and Portugal.
The subsequent stampede by all Central Banks to devalue their currencies from January 2015 was in response to the situation unfolding in Europe and to maintain their own competitiveness against a background of reduced commodity prices.
The speed in which all of these interest reductions were undertaken amazed me and no doubt a lot of investors. All Countries were jockeying to offset their currency strengths.
Was it orchestrated?
This is hard to define, the gains in the USD together with falling commodity prices no doubt instigated a knee jerk reaction from the sidelines. Impact of which was offset by the sheer number of adjustments made and the real effect is no more certain then prior to these interest rate reductions.
What is certain is the strength of the USD. This global knock-on effect will be disastrous.
“The appreciation of the dollar against the backdrop of divergent monetary policies may, if persistent, have a profound impact on EMEs [emerging-market economies]. For example, it may expose financial vulnerabilities as many firms in emerging markets have large US dollar-denominated liabilities. A continued depreciation of the domestic currency against the dollar could reduce the credit worthiness of many firms, potentially inducing a tightening of financial conditions.” BIS.org
Throughout all the currency wars, not one Government has addressed the core issue.
Government debt has not declined (in fact USD debt held by these Countries would have increased through currency devaluation), nor has any benefits of austerity packages put in place by various Governments around the world appear to be working. Citizens are getting a tad tired of austerity measures and this can be seen not only throughout Europe, but Canada, Australia and the US.
That core issue is brought about simply by Government expenditure, taxable income is declining, yet all Governments are bloated and seeking to address tax shortfalls by additional forms of taxation.
So the circular argument with ZIRP and NIRP and the need to raise funds. One wonders at this point, how long all Countries and in particular the US Fed Reserve can raise funds on ZIRP?
I raise this point specifically to cover the fact that with depreciating currencies, capital funds are moving into listed Stocks (note that Central Banks have taken this policy on board since 2008/09).
“The OMFIF research publication, Global Public Investor (GPI) 2014, launched on June 17, is the first comprehensive survey of $29.1 trillion worth of investments held by 400 public-sector institutions in 162 countries. The report focuses on investments by 157 central banks, 156 public pension funds and 87 sovereign funds.
There are worries that central banks may be over-stretching themselves by operating in too many areas.”
Looking at the Dax, S&P, Nasdaq and NYSE each seem to be garnishing support from investors and or Public Institutions looking at riskier investments for yield. Other exchanges appear to be taking the lead from the US, but when will this disconnect?
One assumes when the USD strengthens more and yield is required by investors.
This in itself does not bode well, as the Fed Reserve under Yellen may consider that their inaction (or patience) on interest rates has created a stock market bubble. Personally I feel that Yellen is being influenced on a macro level by BIS and Central Banks to defer any rate increase, so that they themselves can get their act into order.
The problem is what comes first, the global Central Banks desire for the Fed Reserve not to raise rates and increase the value of the USD or the dynamic rise of the US stock exchanges?
The problem with ZIRP and NIRP is that Countries need to fund the bloated Government expenses. The bureaucratic overload of the large Governments.
Current debt is that core issue, which can only be addressed by reduction in Government expenses, primarily as tax collections have reduced markedly and interest rate costs are steady, but an increase of the rates by the Fed Reserve will have that effect of increasing the value of the USD against all currencies and doubling the interest component as well (note that this may quadruple countries interest cost depending on their USD borrowings due to the strength of the dollar). .
No country within the G20 can afford this, with exception to Russia.
Germany is tied to the Euro, Merkel is intent on the Economic Union surviving with austerity measures in place, so when one looks at German Bonds and the Dax, I personally wonder whether the investment in both is misplaced.
France, well nothing more needs to be said (and yes dislike Hollande).
Great Britain as well.
People seem to ignore the actual amount of debt Great Britain has amassed and their stupid financial policies introduced initially by John Major to construct infrastructure and supported by subsequent Governments.
See here http://www.debtbombshell.com
This is ignoring this deferred debt and interest, then again what is GBP 5 billion black hole?
Plus zero inflation (or without sex and drugs that is deflation? Actually subtract only 0.01%)
Great Britain external debt is also a concern, however with the depreciation of their currency it should assist borrowers repayments, not their USD borrowings though.
I expect that in Great Britain the investors will wake up and smell the debt and costs of the bloated Government, NHS shortfall and guaranteed pensions. Borrowing by the Government at low interest rates will not occur at these rates.
The question therefore is further Quantitative Easing by Osborne, or just print the money to repay the debt?
Goodbye GBP ….
What happens then to all other currencies?
Will it be a replay of January 2015 currency wars?
How will they find these funds on ZIRP when Central Banks are investing in stocks and Countries triple A rating is being put to the test.
Now, all things being equal Greece will default, please refer to my other postings on Greece and the fact that they have been bankrupt for 30 years. Yes a long time to operate in deficit bleeding off the ECB and investors.
Then Ukraine, pity that the chocolate king embraces neo nazi’s. This country will end up like Kosovo, assets sold to Soros’ associates and mafia will rule. Refer prior posts on this blog or to Ron Paul ‘Peace and Prosperity’ website.
Those two Countries then will open the way for Austria (Guarantees made to support borrowings by Banks) Spain? Italy? Germany? Portugal?
Two large Austrian Banks are in the spotlight, Hypo Alpe Adria International (which is being wound up in an ‘orderly’ fashion) and Raiffeisen, the international arm of which has recently been under great pressure through large losses in its Eastern Europe investment.
This is a black swan event being hidden, political expediency?
The nature of the Bank debt and manner in which it has been approached is best explained in the Acting Man Blog.
Once other banks start owning up to their losses then the dominoes will keep falling, albeit in very slow motion.
The question on Germany is will the Country allow Deutches Bank to die a derivative debt?
This article is from 2013, so expect it to be a lot worse…
Mind you only 0.5% apparently is for Greece
‘A disaster waiting to happen’
And then German Banks exposure to Austria Heta
It will be a cross border inter-Bank contagion.
The question will be, what will stop this contagion from blowing all Banks in all Countries wide open?
Tier 2 capital invested in which AAA bonds?
Regret that I have seen no Government nor Bank actually address this question recently, particularly with the marked deflation of the Euro.
Note that Tier 2 Capital is undisclosed and unreported capital bonds. A recipe for disaster in the currency wars being played out.
So naturally capital will seek safety, or what is left of the available capital will seek the reserve currency.
Looking at the past and present history when the USD was rampant in appreciating against all currencies.
Commodity price declines were the symptom of sharply deteriorating economic conditions prior to the 1920-21 depression.
To be sure, today’s economic environment is different.
The world economies are not emerging from a destructive war, nor are we on the gold standard, and U.S. employment is no longer centered in agriculture and factories (over 50% in the U.S. in 1920).
In1931, Britain’s devaluation transmitted deflationary pressure to the United States. The
scramble out of the then reserve currency, the sterling was not a scramble into the dollars; rather, it was a scramble into the third reserve asset, gold.
The United States saw its currency weaken, forcing the Fed to raise interest rates.
“Then from 1980 to 1985 a big fall occurred in commodity prices, with the index dropping from 90.7 to 67.8. That coincided almost exactly with the soaring value of the Dollar. The reversal of the policy mix under Ronald Regan included sweeping tax cuts. Marginal tax rates were cut from 70 percent at the federal level to 28 percent for the highest income tax brackets. Corporate taxes were cut from 48 percent to 34 percent and capital gains taxes were also reduced over that period. Big increases in government spending were combined with a tightening of Federal Reserve monetary policy. There was a sharp fall of the price in gold, which dropped from 850 Dollars/ounce in February 1980 to 300 Dollars/ounce within something like two years. This was a period of big deflation or disinflation. The inflation rate in the United States fell from 13 percent in 1980 to 4 percent in 1986. And that period of disinflation was a period of very sharply falling commodity prices.”
“It should be pointed out that despite the weight of the United States economy in the world economy, there is not necessarily a direct causal relationship between the strength of the dollar in currency markets and commodity prices.”
There is no causal relationship even to suggest that commodity prices decline brought about by lower demand was the cause of the prominence of the USD.
Whether it be oil, gold, palm oil or minerals, the simple fact of the matter is that if commodity demand falls, then the price of commodities will fall also.
Currency movements comes down to consumer and investor confidence in the individual Governments. It is obvious that a lower demand for commodities will impact manufacturing exports from China and will impact on economies of the commodity exporters.
Capital needs to invest and why invest in any country in which there will be no returns due to lack of demand. Depending on the Government, confidence is necessary to maintain capital inflows.
So demand is one thing, but confidence is another.
Both dictate and capital safety foremost in times of uncertainty, as is happening now in China (refer to .. https://millermatters.wordpress.com/2015/04/10/china-is-not-the-savior-of-commodity-based-countries/ ) and commodity export countries.
The knock on effect of this decrease in demand, is a recession for Commodity based exporting Countries and the emerging economies. Confidence in Governments then dictates to where capital will flow to take advantage of the situation. Usually away from a Commodity based Country and emerging economies.
So look at the appeal of the USD and US stock markets. A lot more on offer, especially when Countries core problem of debt and bloated Governments (at all levels) is not addressed by the incumbent Governments Treasury, Central Bank or individual finance ministers.
Then we have the situation of debased currencies in Countries and the need to prevent deflation of core assets.
Capital will make up its own mind with the reserve currency being the key target and then with this demand, the strength of the dollar will affect US Companies and impact profits.
If one looks at history the G7 took the step of addressing a rampant dollar by the introduction of the Plaza Accord.
Principally to defeat USD strength and assist a few Countries to escape deflation and recession.
I doubt that this will work this time around.
There are compounding problems that need to be addressed, which will be very difficult to address and the opportunity to address all issues has passed.
The impact will be a global depression of an immense magnitude, due to the stupidity of various Governments and individuals.
Why do I say this?
Well QE in the US, Great Britain and Europe created low interest rates and a bloated balance sheet of bad bank securities. Nothing more, it basically recapitalized the bad Banks at the expense of individuals.
In so doing it deflated currency values, first the USD and now the Euro. Against this backdrop we have currency wars being played out amongst all Central Banks to the benefit of the USD.
With low interest rates and a low USD through the Fed Reserves QE policy, borrowings by Central Banks and large corporations of USD denominated loans increased substantially.
Continued ascendancy of the USD will only increase debt holdings and interest payments.
The core problem is the current debt-load of bloated Governments (world wide) that needs to be addressed. The quick fix of increases of taxes being forced upon the population and ‘austerity’ measures will not resolve the situation.
Governments have to face these facts and with the fact that demand for Commodities is not apparent in China or elsewhere and prices will continue to decline into the foreseeable future. This will only reduce Government revenue further at the same time increasing those monies needed to meet interest commitments and avoid default.
The Banks have continued to seek profits through extraordinary risks and ignorance of good lending / borrowing practices. Under capitalization and the revaluation of assets in Tier 2 and Tier 3 assets will result in a Bank contagion. In 1931 it started in Austria, history is repeating.
Governments are about to implode and default. Greece, Ukraine and thereafter who knows, but the contagion will increase with an increase in the USD.
With the end of QE in the US, the Fed Reserve has nothing within its arsenal to entice investors to invest in US Bonds. They will look at the rise of Equities (and those Central Banks investing) and will need to address the Government expenditure/borrowings for the remainder of the fiscal year.
An increase in rates is inevitable. Yellen’s patience with Central Banks will be tested by the supposed creation of a US stock market bubble through their recalcitrance on interest rates.
This will therefore increase the value of the USD against all currencies.
All Governments interest on debt will basically double overnight with the amount of debt increasing due to the increase of the US currency and the same would apply to the financial institutions. The knock on affect will be to the individual borrowers.
Add to this the Banks failures, which no doubt will be at the taxpayers expense, thereby compounding the effect on the taxpayer.
Money will basically be unavailable. What is left of the investment capital after Countries/Companies and Banks default will flee to the reserve currency and/or gold depending on ones inclination for tangible assets.
A reduction in tax collection, through the reduced demand of commodities and subsequent failure of large and small corporations, thereby increasing the unemployment level, will test every non defaulting Countries low interest rate policy and further, each surviving Countries’ existing debt levels and subsequent higher interest rates will have to be maintained.
Emerging economic countries will default.
This is a complete destruction of capital.
A Keynes type approach by Governments cannot be implemented on the current debt levels without serious ramifications to their USD denominated debt. This cannot be done with that debt accumulated since 2008.
This is a free fall into depression which will not be subject to a quick fix.
Nothing can stop the ascendency of the USD.
A global depression is inevitable, the debt issues worldwide have to be addressed and in a way that allows every Country to re-establish themselves without the debt servitude limitations to the United States.
Good luck on that.
Nothing can reverse the destruction of capital, through Governments stupidity.
Politicians will seek to lay blame elsewhere.
They have no choice as they do not see themselves as the instrument behind this whole situation.
As for Bush, Obama and Bernanke…. Well … history will not be kind.
Note on Keynes:
Keynes proposed increased government spending for such things as relief payments and public works projects during a depression to get the economy rolling again. After a depression ends and prosperity returns deficit spending should then be reversed.
Keynesian economists felt that in order to avoid serious depressions we must avoid extremes in the economic system during prosperity periods. This means that the quantity of check money should not be permitted to increase in a runaway fashion during prosperity, and that the price-fixing activities of monopoly groups should be curbed to avoid upsetting the relationships among the prices for different types of goods.