When you read a lot, you eventually stumble upon something really different. The poster above is a good example. I took it out of a very interesting read, pondering no less than the quantic side of our existence (not to be confused with our “dark side”). Now, that is indeed a subject (one in thousands), in which my knowledge is zero (getting closer and closer to the value of Fed thinking).
Not that the matter bothers me at all. My fate is death, and I am almost certain it will come well before those cosmic events take place -if they do at all. In the meantime, I plan to keep sailing every important race I can attend. So I really don’t care. It was just nice, thought provoking, reading. I love reading.
Giving things a second and third thought (using the inner female we all have), I recalled a vexing issue I do care about. It is something that will happen in the immediate future. Something beyond my control, not cosmic (just global), that will -if I am not extra careful- affect my sailing (unless the cost of my carbon membrane sails is cut down to a fourth. Hey can anybody get me a discount at quantum sails?). Let’s give it a fancy name: “the galactic debt meltdown”.
A couple of economists, bloggers and presumed pundits keep on saying the world is broke, and debt will never get paid back. I am one of them. Nobody knows when this will be “official”, and, to make things worse, nobody knows how debt will be reduced as a percentage of global (non-cosmic) GDP. Meaning, we don’t know if it’s going to be real GDP growth, GDP deflator growth, or debt write downs (a bookkeeping entry), that will allow us to get rid of the problem. Lastly, nobody knows the schedule of events to take place. In sum, a “helluva” lot of “unknowns”. The road map is far from the accuracy of differential GPS positioning (the one we use for race-sailing starts).
We have desperately tried to grow ourselves out of debt for the last seven years. We have tried to outgrow debt in real terms, or at least nominally, to no avail. Escape velocity has been a “chimera” in Keynesian groupthink for as long as I can remember (in fact most of Keynesian groupthink is plain, small talk broadcast, wishful thinking). By all means, I am not saying “escape velocity” will not finally come to pass -I just find this outcome included in the category of “infinitesimal probability”. Similar to that of the cosmic events we talked about above.
That leaves us with just two statistically significant alternatives: deflate debt, or hyperinflate GDP (we have already tried to reflate ourselves gently out of the problem). And it is -deep sigh- no other but a Central Bank decision that will orient us, for once and for all, in one or the opposite direction. When is (as with death), the vital question. It should be over the next couple of months, but it could take years if we can chronify the desease. We should urgently hire some oncologists for the politburos: we are going to need them. Kicking the can forward is requiring, as we reiterate it time and again, an increasingly high level of expertise (and luck!!).
Yes, this can go on further for longer. But, what if we can’t chronify cosmic Keynesian groupthink? What if the whole set up melts down earlier than we think? For a time now, we have had two main drivers of instability: debt and inequality. Both are getting more powerful every day, even as I write. As I said in my post “debt sustainability and/or inequality will end the show”, one of them is likely to end the CB’s show. I humbly stand by everything I said in November. Time will say. I am aware that even a broken watch is right twice a day.
Of course ZIRP -and its upgraded high-octane form (NIRP), money printing, currency wars, and credit creation (57 trillion extra since 2007 and counting), are factors of instability in themselves. They show up in market behaviour (markets keep on “losing their cool”). But the ultimate reason for their existence is related to the omnipresent fictitious/phony asset of global debt (unpayable, and thus unreal) in our global non-consolidated balance sheet. In fact, and underlying all those monetary and fiscal measures, there is only one driver, the debt overhang (regardless of the multiple strategies and measures implemented by Central Banks). One thing I must say. They have seriously improved their implementation techniques. POMO desks are doing a good job -in the wrong direction, and for the wrong reasons- but a very good job indeed. They have almost “mastered” the markets.
Not to forget is the inequality factor, that manifests itself sporadically, in different forms and places. On the surface, the problem looks well contained. But under the surface it is alive and well, and ugly social developments are taking place. I am not a social anthropologist, but I am positive that tremendous and explicit (media broadcasted) inequality, is percolating most souls in distressed situations (unemployed, underemployed, sick with little or no health insurance …).
Forget about ISIS, Syriza, nationalisms, other terrorists, and similar dissonant social clusters (more or less violent). They are only the tip of the iceberg. Inequality is seriously degrading our global social tissue. In due time, we will pay for this as well because, as I always say, there are no free lunches (Hi Larry don’t get too upset please). In economics, as in life, you pay dearly for your mistakes. Sooner, … or later (and if it is much later, with a hefty interest rate surcharge -late error payback is not subject to ZIRP)
Fast forward and, with a higher debt load ratio, markets somewhat more unstable, and more inequality, the question continues to be what “gives” first. And in order to respond with a minimum degree of precision, we need to know what the politburos at the main CB’s are going to do next. Depending on their decisions, and on the calendar of events, I see two possible outcomes.
1.- A deflationary bust that could be ignited by market or social instability, or by the consequences of Central Bank tightening. They don’t have to tighten much for that. It can come with associated violence, or not (most likely with some degree of violence or street protests in one form or another). I think this is the most likely initial outcome. As soon as politburo members find themselves cornered by financial instability, and sense a whiff of cost inflation (demand side inflation is about to be reclassified as an obsolete concept), they will gently touch the brakes. Markets will then collapse as soon as the tightening “bites” our brainless investors (or maybe sooner if they anticipate the outcome).
It is realistic to think that we shall try this outcome first, and maybe, later on, under pressure, concede to Weimar printing. Central Bankers save face initially, but finally pensions and entitlements have to be paid, and the printing presses will have to get started again. I will be honest here. I would do it myself if I had an angry mob pounding on my door. Maybe they will not concede and stay the course. But I doubt it: social pain will be unbearable. And social violence could be nasty.
2.- A reflationary boom, ended Venezuelan style (empty supermarket shelves with price controls). In this scenario, fiat currencies (most of them) end up as useful paper waste to be recycled. That was the obvious solution before we created “independent central banks”. Now, it is unlikely to be the first solution. “Independent Central Bank” politburos will try to reign in the monetary orgy, at least initially. But it very well could not be the case. If Stanley Fisher can’t get it his way in September -or at least before year end, risks will increasingly tilt to the market instability/hiperinflationary direct outcome. The question is how long would the central bank independence “chinese wall” last for, before countries engaged in physical printing greek style (all euro notes begining with a Y have been printed in Athens, and are a liability against the ECB of their central bank)?
And, further down that road yet, when would Weimar style printing take over?
Both deflationary or reflationary outcomes (we have run out of alternative options to decrease debt to decent relative levels) could be more or less sanguinary. I sincerely hope not. If this is the case, we will see a similar result to the Mugabe “final white farmer/afrikaner solution”, the nazi “final jew solution” or the stalinist “czar solution”, not to mention the french 1789 “guillotine”. The rich, the Zimbabwe Afrikaners (white farmers), the jews, the czars, Louis XV, or the economic elite, were all guilty of treason against the mob. Only Krugman and Bernanke will get a “sauf-conduit” when they argue they printed and spent as much as they could (good for them). As for the rest (me included), they will just get rid of us directly, or allow the crowds to do so on their own -authorities will be looking the other way.
Behavioural economics has it that, if this outrageous extend and pretend farce implodes, it has to be somebody else’s fault. Crowds will want to take revenge. I see myself as one of the likely candidates. The problem (apart from the obvious near cosmic hemorrhage of a Guillotine at work 24 hours a day), is that, just after you get rid of the last farmer (Zimbawe style), your crop production collapses and the problems get even worse.
Ask Robert Mugabe, (a nice guy, peace nobel -prize candidate, and fair man of principles if there is one). Tree pruning requires some constraint, or else you get rid of both the good and the bad branches. Try and explain that to angry “Syriza” or “Podemos” radical left wingers. I wish you all good luck with that. The Zimbabwe farmers tried to do so with the Mugabe paramilitary SS troops, and it didn’t work.
The reader might think I am forgetting about the “troika” military games as a factor of instability. In truth, I don’t even want to talk about the absurd games being played by China, Russia and the US (and NATO allies). I am not a geopolitical strategist (another area of zero knowledge), and decline to noodle around the chances of something going wrong in this stupid, absurd, dumb, masculine contest of who has the biggest … (sorry ladies, but that’s the only way I can accurately describe what’s going on between those three). Ridiculous. Whatever the outcome, I find it impossible to include these musings into the prescription for the likely evolution of our economic woes. I have to leave all their posturing, bullying, and bluffing, as a wild card in the global order of events.
Central Banks will have to pick their poison soon. The Fed will have to raise rates and use the reverse repo facility first in this easy money global environment. They were the first to print (OK, the BOE did it first, but sterling is not a significant reserve currency). So it’s clearly their turn to turn the tap off. It will take courage, intelligence, and political strength to do that. If they don’t, we are definitely entering the reflationary scenario. It is key to see if they will have the guts to tighten up, ever so carefully. Or, to be more precise, if the situation will allow them to do so.
You ought to be surprised to read this. After all, for a very long time (an eternity in fact), we have been able to print money, and increase debt (seven years since the GFC and counting) with no significant negative consequences -other than the wealth transfer and market price distortions. A precipitous descent in the velocity of money has allowed CB’s to get away with it. Some think it will go on for ever.
In truth, this is an exceptional situation, and other factors have contributed to this temporary nirvana:
- Excess capacity has ensured that supply always outpaced demand, covering the flank of demand driven inflation.
- Technology productivity increases also contributed to deflation (or at least to prevent reflation) in the easy money environment. And technology helped simultaneously allowing for disintermediation, and optimizing production processes (lowering production costs).
- ZIRP and NIRP have ensured a low cost of capital -in fact so low, that we may run out of free float equity soon. Why hold equity liabilities in your balance sheet if you can ensure money availability at near zero rates? The result is low financial costs, increased leverage, and increased eps (all the rest being constant -ceteris paribus).
- Competitive country taxation for multinationals has leveraged after tax profit, even though at the cost of multinationals parking capital all over the world.
- And salaries? They are down somewhere around 10% of GDP for the OECD countries (workers have been massacred, but labor costs have been brought down significantly)
I sense this is more or less the end of the road for this easy money, easy rates, easy printing, easy gearing up, easy bubbly capital gains model. Side effects are soaring. The Fed has to move (I don’t care if it is September or October, if it’s gradual or one off, etc). The real issue is “will they tighten up?” and stick to their guns whatever happens next? If they do, it is the beginning of the end via a deflationary bust (sooner or later). If they don’t, inflation, and financial instability will propel us into the Weimar style environment. It is easy to begin to print. It is outstandingly difficult to stop doing so. Interesting times once again.
My problem: the investment strategies for the reflationary and deflationary scenario are antithetic. I have a strong conviction tactical play for the sanguinary outcome, whether it comes with deflation or reflation -buy a nice farm in New Zealand.
The other two scenarios also signal clear tactics once their outcome is clear. In the bust scenario, it is “risk off”, portfolio all in cash, and solid currencies and investments (my actual stance). In the reflationary scenario, it is simply “all in” to equities and hard assets. It will be hard for me to do that at current prices. But, when and if the time comes, we must not hesitate. I’ll do my best.
Aa I said before, in my view, they will at least try the first alternative for a time. But I could easily be wrong, and the issue is crucial. The pressures on the Fed by the establishment will be monumental. Another possibility is that the Greek haircut or any other credit or equity event anticipates a market bust. The deflationary scenario will then be the byproduct of that situation, and politburos will not have to tighten money base or interest rates. But given that scenario, they could still opt for restarting their printing press.
On Sunday I am beginning the ORC sailing world championship. I plan to enjoy myself. I feel guilty of upsetting you with this crude post. In order to compensate, will give you the best message I could think of; Don’t worry, be happy. Make sure you enjoy the full video, and not just the music. The lyrics are just great. Things may look awful, but in the meantime we have to enjoy life. Have a great time, and take care. I will be back around mid july.
PS. I would love to see Drachma notes with a María Callas image (no pun intended). Aren’t they beautiful? Better than euro notes beginning with Y in their serial number. By the way, I find her adequate even for the new USD notes. We should all try to think global. Who cares where she or Pavarotti were born!