2016: Off To A Very Scary Start
The global economic bubble is once again deflating - and it's deflating very rapidly. This is occurring because there is no longer enough monetary and/or fiscal stimulus to keep it inflated. After 2008, Quantitative Easing in the United States was the main source of global stimulus. When the third round of Quantitative Easing (QE 3) ceased in October 2014, the "reflation" ended. Stocks stopped going up and commodities started crashing. It was only a matter of time before air began leaking out from the global bubble and the next downturn began - just as it did after QE 1 and QE 2.
This time, however, there is a new factor that makes everything very considerably worse: China. The great China Boom is now - at long last - giving way to the Bust. China's "Hard Landing" has begun; and there is a real possibility that this hard landing will be radically harder than even the greatest China bears had dared to predict.
You've seen the headlines, but let's quickly review what's been happening this year. By the middle of last week, global equities (as measured by the FTSE All-World index) had fallen more than 20% from their recent peak, officially putting world stocks in a bear market. Oil collapsed to $27 a barrel, its lowest level since 2003, after the International Energy Agency warned that the world risked "drowning in oil". Other commodities also plunged. The Bloomberg Commodity Index fell to its lowest level since at least 1991. Bond yields also slumped all around the world. The yield on the 10-year Treasury bond fell to just 1.96%.
So, what happened? There were plenty of worries to go around, but most of them can be traced back to China's rapidly weakening economy. China's imports contracted more than 10% in 2015 relative to 2014. Remember: as far as the rest of the world is concerned, it doesn't matter how much China's economy grows. What matters is how much China's imports increase. Its 2015 double-digit decline in imports means that China is no longer a driver of global economic growth - far from it. China is now the main cause of a severe global economic slowdown.
Falling demand from China, a surge in supply for many commodities and a strong US Dollar are behind the rout in the commodities markets. This commodities crash is pushing many - perhaps even most - of the commodity producing countries into crisis. Consequently, most Emerging Market currencies are weakening sharply. The Russian Ruble and the Mexican Peso just set new record lows. With their commodities revenues collapsing at the same time that their currencies are weakening, many of these countries are going to find it difficult to repay their foreign, Dollar-denominated debts. Debt defaults and credit rating downgrades are beginning to make the headlines. On top of all these problems, China has begun devaluing its currency, which is certain to make all these matters worse.
As I have explained many times before, it is useful to think of the global economy as a giant rubber raft, but one inflated with credit instead of air. All the world's assets (stock, bonds, commodities, property, etc.) and the world's 7.3 billion people are floating on top of the raft. We have been in crisis since 2008 because this raft is full of holes and the credit keeps leaking out all the sides. This is the case because there is too much credit relative to the income of the world's population. The public just doesn't have enough income to repay its debts. When it defaults, the credit leaks out the sides of the raft and it starts to sink. Each time it starts to sink, the governments of the world have to intervene and pump in more credit in the form of government debt or fiat money creation.
Since the start of 2016, some pretty big gashes have started opening up. Heavily indebted Chinese corporations are in crisis and money has been fleeing China as fast as it can find a way out. Corporations across the commodity-producing world no longer have sufficient revenues to meet their debt repayment obligations. Multinational metals and mining corporations listed in London and Hong Kong are losing their investment grade status. US shale oil producers are going busts. In short, the raft is losing air fast - so fast that it's actually in danger of capsizing.
The only reason not to panic is because there is every reason to expect governments and central banks to come to the rescue yet again. On Thursday, the European Central Bank suggested that it would soon increase its monetary stimulus. The Bank of Japan and, much more importantly, the US Fed are likely to provide similar assurances next week. It will take more than talk to keep the global economy afloat, however. It's going to take another big round of Quantitative Easing in the United States, QE 4. Between now and then, keep your life belts securely fastened. We're taking on water.
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