The bad smell hovering over the global economy

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All is calm. All is still. Share prices are going up. Oil prices are rising. China has stabilised. The eurozone is over the worst. After a panicky start to 2016, investors have decided that things aren’t so bad after all.

Put your ear to the ground though, and it is possible to hear the blades whirring. Far away, preparations are being made for helicopter drops of money onto the global economy. With due honour to one of Humphrey Bogart’s many great lines from Casablanca: “Maybe not today, maybe not tomorrow but soon.”

But isn’t it true that action by Beijing has boosted activity in China, helping to push oil prices back above $40 a barrel? Has Mario Draghi not announced a fresh stimulus package from the European Central Bank designed to remove the threat of deflation? Are hundreds of thousands of jobs not being created in the US each month?

In each case, the answer is yes. China’s economy appears to have bottomed out. Fears of a $20 oil price have receded. Prices have stopped falling in the eurozone. Employment growth has continued in the US. The International Monetary Fund is forecasting growth in the global economy of just over 3% this year – nothing spectacular, but not a disaster either.

Don’t be fooled. China’s growth is the result of a surge in investment and the strongest credit growth in almost two years. There has been a return to a model that burdened the country with excess manufacturing capacity, a property bubble and a rising number of non-performing loans. The economy has been stabilised, but at a cost.

The upward trend in oil prices also looks brittle. The fundamentals of the market – supply continues to exceed demand – have not changed.

Then there’s the US. Here there are two problems – one glaringly apparent, the other lurking in the shadows. The overt weakness is that real incomes continue to be squeezed, despite the fall in unemployment. Americans are finding that wages are barely keeping pace with prices, and that the amount left over for discretionary spending is being eaten into by higher rents and medical bills.

For a while, consumer spending was kept going because rock-bottom interest rates allowed auto dealers to offer tempting terms to those of limited means wanting to buy a new car or truck. In an echo of the subprime real estate crisis, vehicle sales are now falling. 

The hidden problem has been highlighted by Andrew Lapthorne of the French bank Société Générale. Companies have exploited the Federal Reserve’s low interest-rate regime to load up on debt they don’t actually need.

“The proceeds of this debt raising are then largely reinvested back into the equity market via M&A or share buybacks in an attempt to boost share prices in the absence of actual demand,” Lapthorne says. “The effect on US non-financial balance sheets is now starting to look devastating.”

He adds that the trigger for a US corporate debt crisis would be falling share prices, something that might easily be caused by the Fed increasing interest rates. .

So that’s China and the US. How are the other two members of the “big four” – the eurozone and Japan – faring? The answer is not so well.

Europe’s big problem, over and above the fact that the euro was a disastrously flawed concept, is that the banking system is not fit for purpose. As the IMF noted last week, a third of eurozone banks have no prospect of being profitable without urgent and meaningful reform. That requires two things: to reduce the number of banks and to do something about the €900bn (£715bn) of bad loans sitting on their books at the end of 2014.

There is no immediate prospect of either happening, which makes it much harder for Draghi to get any traction with his stimulus package. The plan is that negative interest rates and quantitative easing will increase the incentives for eurozone commercial banks to lend more. The banking system, however, is badly impaired and the normal channels for creating credit are blocked.

The same applies to Japan, where the financial markets have responded badly to the announcement of negative interest rates earlier this year. As in Europe, the idea was that the banks would lend more if they were penalised by negative interest rates for hoarding money. Higher lending would lead to higher levels of investment and consumption, which would in turn feed through into higher prices.

The plan has not worked. There has been little impact on interest rates, banks have not increased their lending and the yen has risen on the foreign exchanges – the opposite of what was planned – because investors fear that the Bank of Japan is fast running out of ammunition. They have a point.

Central banks, of course, swear blind that they are fully in control and that there is nothing to worry about. Perhaps not, but something doesn’t smell right. The fact that economists at Deutsche Bank published a helpful cut-out-and-keep guide to helicopter money last week is a straw in the wind.

As the Deutsche research makes clear, the most basic variant of helicopter money involves a central bank creating money so that it can be handed to the finance ministry to spend on tax cuts or higher public spending. There are two differences with QE. The cash goes directly to firms and individuals rather than being channeled through banks, and there is no intention of the central bank ever getting it back.

It will take some time to get the helicopters into the air. Central banks can muddle through for the rest of this year, beefing up their QE programmes and driving interest rates deeper into negative territory. The underlying softness of the global economy, however, means that it is quite easy to envisage a downturn in 2017, the 10th anniversary of the start of the financial crisis.

In those circumstances, the unconventional would quickly become conventional, as it did after the collapse of Lehman Brothers. The only question would be which central bank would move first. Hardline resistance from Germany means it certainly would not be the ECB, although the case for helicopter money in the eurozone is strong.

Instead, it would be a toss up between the Fed, which is normally prepared to experiment with something different if the situation is desperate enough, or the Bank of Japan, where – as the Deutsche research reminds us – helicopter money was used successfully in the 1930s to help the country escape the Great Depression with far less damage than to other western nations. So give it a few months then listen hard. The choppers are coming.


Dollar will Blow Up and Collapse

072212_Sullivan_WilliamsEconomist John Williams says it is not a matter of if, but when, there is panic dollar selling. Williams says the Fed would try to slow it down. Williams explains, “The Federal Reserve would step in and slow the pace to make it not appear like a panic. If you start to see a panic selloff (in the dollar), that’s a real bad sign. It means they are losing control of the system, and I think that is coming. The initial effect on the system for people living in the United States, as the dollar crashes, you will see inflation beginning to surge, particularly from oil and gasoline prices. Those effects will begin to spread in the system. It will change the way people look at things and will start the process that will eventually be a hyperinflation. The Fed does not have a way out of this circumstance. They have backed themselves into a corner. They have been keeping things reasonably stable, but they can’t get things going in the economy. . . . The economy is in terrible shape.”

Williams also says, “The dollar will blow up, and when I say blow up, it will collapse. There will be panic selling of the dollar, and that will intensify the inflation. The problem is they don’t have a way of avoiding it. If they could somehow get the economy back on track, they would have some room to work, I think, but the economy has never recovered.

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Central Banks may soon start buying silver

silver-storageIn case of emergency, central banks go back to what they know and to what works. Once silver was a monetary commodity for central banks, today only investors buy silver. Central banks have little to none silver, but things can change – fast. In case of emergency, silver can reclaim its monetary status.

Most investors will see you as a fool when you say central banks can start buying silver even when they aren’t interested in gold. But when you think a little further, it’s not a crazy idea after all. But first you must understand the meaning of money.

Money is …

  • Divisible: should be divisible in smaller units
  • Portable: able to carry it around
  • Homogenous: one unit should be the same as any another unit
  • Durable:  should not be able to be easily destroyed or eroded
  • Valuable: should have intrinsic value

Centuries ago people chose gold as the best to be money. That’s why all over the world gold is considered money, in every county on earth gold is the same and it has intrinsic value. That’s also the reason central banks love gold (yes they do).

Investing in silver before central banks heat up the price

But silver is also divisible, portable, homogenous, durable and valuable. A long time ago central banks had silver in their vaults as a safe haven. But now silver is almost entirely demonetized.  Bretton Woods killed silver definitely when the world embraced gold and the US Dollar as true money.

While central banks were still holding gold as part of their reserves, silver was sold off. That’s why some see gold as money but silver only as a commodity.

Many would say that central banks hate gold, based on the majority of their actions over the last 100 years, at least. However, it is not that central banks hate gold per se, but they hate it when it is in their interest to do so, and they love it when they need it.

In the seventies central banks bought gold because there wasn’t much faith in fiat currency. Faith stabilized in the eighties so gold reserves stayed the same. From the nineties till the financial crisis fiat currency was king and gold a barbaric relic.

But things changed in 07/08. Central banks were net buyers for gold again, especially emerging countries. But in the future it may be more difficult to buy gold at a reasonable price as faith in fiat currencies fades away. So at some point, central banks can embrace silver again because silver has the same properties as gold.

The only reason they were not interested in silver is because it was in their interest to hate it. But for how long? After all, it is not like having silver is new thing for them.

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