Ashok Dhillon
Sep 9, 20185 min
For a long time, we have been very sceptical of the path that the U.S. Federal Reserve (the 'Fed') has steered the American and the major global economies onto. Those readers that are familiar with our previous economic analysis, know us to be somewhat of ‘perma-bears’, ever since the Fed’s multiple Quantitative Easing initiatives went, from an absolute necessity to save the tanking American and global financial markets in 2008, to actively inducing artificial asset price inflation to recreate the recently lost ‘wealth effect’.
The insanity of such actions (to us) was that it had been this kind of easy money policies of the past decades that had been responsible for the crazy speculations in insanely valued assets that had brought on the financial crashes of the recent past in 2000, and then 2008. And here we are in 2018, and the Fed has again led the other Central Banks (CBs) to create stability threatening asset prices bubbles that will once again pop to devastating effect. And in this mix now, is the craziness of Donald Trump.
The Fed and the other CBs undertook these unprecedented inflating exercises in their attempt to save crashing economies and to resurrect stalled economic growth world-wide. And they have been able to do that very well. The current economic expansion, particularly in the United States, is one of the longest in history. And the rise of the American stock markets is the longest in history. But it is coming with a steep price as there is nothing natural or organic about any of it. Which means that it is dependent on perpetual and heavy intervention of governments and CBs to be sustained, and therefore it is not sustainable. It is not even a shadow of the ‘Capitalism’ that is touted so aggressively in America, and the Western economies; it is in fact a massive cynical subsidization of the wealthy, at the cost of the rest of the populations.
And because only a fraction of the top 10% get the majority of the benefits from programs like repeated Quantitative Easing and near-zero interest rates, the long albeit slow expansion of this last recovery is ‘bought’ by un-precedent global credit, expanding at a rate faster than global Gross Domestic Product (GDP) growth. In other words, global debt has increased at a far faster rate than economic growth.
Since 2008, there was no slow solid fundamental rebuilding of battered economies after their decimation from previous excesses - through a reversion to financial prudence, the wholesale shedding of built up debt and unnecessary fat, the return to higher efficiencies and increased productivity, innovation, investment, and savings - instead, the Fed and the rest of the major CBs chose to unleash the printing presses and pumped Trillions of Dollars into the economies to achieve their rebound. According to McKinsey, approximately an additional $72 Trillion of debt has been added to the global total, since 2007, and, most of the countries never did deleverage since the last crisis.
The reckless pumping of steroids-like ‘easy-money’ into the financial blood stream of global economies, to induce a Frankenstein-like resurrection, resulted in a recovery alright, but one that has been entirely dependent on the constant force-feeding of endless cheap debt. That flow is still running in most major economies, with the Fed toying with reducing the flow gingerly – as incredibly, after 9 plus years of this special force-fed liquidity diet, the economic recoveries are still not robust enough to take the shock of any tightening, without them risking a full retraction.
In the meantime, this collective and constant ‘accommodation’ has driven the global debt to almost $250 Trillion.
Why is any of this important? Because, the U.S. Federal Reserve is seeing the U.S. economy going into overdrive, and to stay with the driving metaphor, overheating and causing serious damage to the hot-rod. So, this year, the Fed started to raise interest rates, albeit cautiously, and started to reduce its $4 Trillion balance sheet, and almost immediately sent some of the Emerging Market (EMs) currencies into cardiac-arrest, as dollar denominated debt laden countries came under severe pressure with dollars fleeing back into the U.S. for safety.
The rising interest rates in the U.S. strengthened the U.S. Dollar against the other currencies, precipitating a rush by traders and institutional investors to get out of EMs, back to the perceived safe-haven shores of the U.S.
Additionally, a number of the EMs that have had very significant devaluations in their currencies, have also been the victims of traditional mismanagement by their leadership, which seems to be a requirement of the Third World Countries to maintain their Third World Status. But others have seen their currencies devalue as a direct result of the Fed starting its tightening cycle, and the advent of a mega trade disruptor, the current U.S. President, Donald Trump. High corporate debt in developing countries, denominated in U.S. Dollars, coupled with disruption in trade could see default rates rise of stressed companies that are vulnerable to devaluing local currencies and rising repayments in a strengthening Dollar.
The following quote is attributed to General John Kelly, the White House Chief of Staff, about his boss, the 45th U.S. President, Donald J. Trump:
"He's an idiot. It's pointless to try to convince him of anything. He's gone off the rails. We're in Crazy town."
The economic ‘craziness’ started well before Donald Trump became the President, but he is certainly doing everything to make it ‘in your face!’.
Donald Trump’s unorthodox methods (to be kind) are destabilizing a fragile economic system that isn’t robust enough to stand repeated and diverse blows in rapid currency devaluations, trade and relationship disruptions, and resurgent populist political kamakaziness that wants to take the countries and the economies down with them in flames of division, threats-counter-threats, suspicions and fear.
Venezuela, Argentina, Brazil, Turkey, India and China are experiencing serious currency devaluations, with some like Venezuela’s in total collapse. Numerous African countries are also teetering on currency collapses, while others like Russia and Iran struggle with their respective devaluations, to stay above the water due to ever-tightening sanctions by the U.S. and the West. In China, the seriously over-extended real estate markets, with their accompanying non-banking lending institutions, are walking a fine line between status quo and a dangerous fall that would test the Chinese government’s ability, and resolve, to bail out the entire unstable system. China’s Stock Markets significant retraction (Chart below) is reflecting the dangers inherent in the leveraged financial industry and the escalating trade war with the U.S. To make the Chinese government’s task a tad more difficult Trump has been threatening punitive tariffs on all imports into the U.S. In other words, a full-fledged trade war.
In the North American arena, Donald Trump has held the possible cancellation of NAFTA (North American Free Trade Agreement) gun to Mexico and Canada’s head. While saner heads seem to have prevailed and the three countries are apparently close to an amended NAFTA, yet Trump’s penchant for threats, as the preferred method of negotiations, are having a negative ripple effect through all three economies.
Additionally, dangerously inflated real estate markets in Australia, Canada and pockets of the U.S. are starting to deflate as interest rates rise, bringing with them the renewed possibilities of popping real estate bubbles that have grown relentlessly since the last crisis. And considering how stretched households are in general, it would not take much in rise of servicing costs to up the rates of default.
Over and above all the threatening geo-political, trade and financial clouds, are the relentless laws of economics that have a nasty habit of reasserting themselves when confidence climbs to the ‘this time is different’ note, and the feeling that this time it all can be controlled by greater awareness, as a result of the past crisis. This economic expansion cycle and the accompanying financial markets rise is very long in the tooth, and is teetering with old age and weakening fundamentals in the Emerging Market stocks and bond markets, global currencies, disrupted international trade, relentlessly rising debts, growing geo-political tensions and uncertainties, and last but not least, the ‘crazy’ chaos in the Trump White House. It all bears watching, as it portends the coming stall.