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Musings Report 2020-26 6-27-20 No Safe Haven?
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No Safe Haven?
As longtime readers know, I don't forecast markets or make investment recommendations. What I hope to do is identify trends that will prove consequential. When, where and how these trends might impact asset valuations and financial stability are all unknowns.
That said, I want to share an uneasy feeling I have about the next few months (not to mention the next five years), which reminds me that "cash is a position, too," meaning that just holding cash is an alternative to owning an asset, or asset classes, all of which expose the owners to risk.
Cash is at risk from inflation, of course, but inflation is a glacier, not an avalanche, at least in its initial phase, and so there is time to plan a response to a trend of rising inflation.
But markets can be avalanches, meaning the value of apparently stable assets can plummet dramatically very quickly, catching the unprepared off-guard. The market drop from February 24 to March 23 was a recent example.
As I noted in the blog prior to the February crash, only the first sellers get out without major damage. (When Bubbles Pop, Only the First Sellers Escape Being Bagholders February 21, 2020)
Avalanches of selling can generate "sell everything" dynamics, as stock market margin calls trigger liquidation of other assets and selling begets selling as stops (orders to sell) are hit as people flee to the relative safety of cash.
In this avalanche, even assets considered safe havens such as gold were sold off hard.
To establish some context for my uneasy feeling, let's take a whirlwind tour of the global economy 1946-2020.
Before we start the tour, I want to return briefly to my first Musings of the year which were posted before Covid-19 was officially announced on January 23, 2020. It's not an accident that these Musings were prescient; I was simply drawing upon long-established trends reaching their end-games, i.e. unsustainable extremes.
1-4-20 Instability Rising: Why 2020 Will Be Different:
"Economically, the 11 years since the Global Financial Crisis of 2008-09 have been one relatively coherent era of modest growth, rising wealth/income inequality and coordinated central bank stimulus every time a crisis threatened to disrupt the domestic or global economy.
This era will draw to a close in 2020 and a new era of destabilization and uncertainty begins." This was followed by 1-18-20 What an Extraordinary Moment in History.
My first Musings after the 1/23/20 announcement was a warning against complacency: 1-25-20 Don't Underestimate the Coronavirus.
My February 1 Musings was even more explicit: 2-1-20 Brace for Impact, followed by 2-8-20 Extreme Caution Ahead.
All these long-term trends set up a row of dominoes that the pandemic has toppled. But any puff of air that toppled the first domino would have toppled the dominoes of fragility, instability and unsustainable extremes.
The whirlwind tour of the global economy must include these essential dynamics: energy, currencies, globalization, debt and financialization, which broadly speaking refers to everything that renders finance (lending, leverage, speculation) more profitable than actually generating goods and services.
The "glorious thirty" (Les Trente Glorieuses) years from 1946 to 1975 were decades of rising prosperity in the developed world (Europe, Japan, North America) and rapid development in the first tier of developing countries in Southeast Asia and elsewhere. (Decolonized nations and China struggled with political, social and economic turmoil.)
Costs were low for fuel, housing, food, healthcare, education, etc. as rebuilt industrial bases produced lower cost goods and oil/natural gas were cheap. The global currency market was stable as the U.S. dollar was pre-eminent, enabling Japan and Western Europe to sell their goods to America at discounted prices due to the strong dollar. This policy was explicitly designed to strengthen the economies of allies faced with the threat of the Soviet Union's global ambitions.
The "glorious thirty" were also decades of rising wages and affordable, modestly growing credit and low inflation as the money supply expanded more or less in tandem with the expansion of goods and services and credit.
The wheels fell off in the 1970s as the oil-exporting nations muscled energy prices higher to gain a share of the profits, the gold-backed US dollar regime fell to pieces and inflation skyrocketed, generating a previously unknown economic malaise known as stagflation: high inflation plus stagnant growth.
The external costs of industrial pollution finally came due, and global competition from lower-cost nations (helped by currencies that traded at deep discounts to the US dollar) crushed inefficient industries in the U.S. and Europe.
The 1980s saw a resurgence of growth, but with a different mix of sources. The global postwar Baby Boom generation entered their highest productivity and spending years, boosting global demand, supermassive new oil fields finally came online (Alaska, North Sea, West Africa), dramatically lowered the price of oil while soaring interest rates crushed inflation and wrung bad debt out of the developed economies, Developing nations that had struggled in the 1970s finally found their footing (India, China, South America, etc.)
The steep investment in reducing pollution began paying off and the first wave of financialization boosted mergers, buyouts and asset prices.
The 1980s was capped by the decline and fall of the Soviet Union, eliminating the costly military rivalry of the Cold War, and the collapse of Japan's massive credit/asset bubble in 1989-90.
The 1990s continued the trend of global growth, aided by low inflation, expanding globalization and the mass commercialization of the Internet and computing, as technologies that were once expensive and difficult to use became affordable and accessible.
The Neoliberal ideology--that the way to solve virtually any problem, from poverty on up, is to turn everything into a global market of freely traded labor, capital, goods and services--became the default global economic faith, with some variations (a market economy with Chinese characteristics, etc.)
The 1990s was capped by the emergence of China as the manufacturing hub of the global economy, a role that was institutionalized by China's acceptance into the WTO, and the bursting of the Dot-Com bubble in March 2000.
As globalization and financialization became dominant forces (the natural result of Neoliberalism), instabilities appeared in currency markets (the Thai baht / Asian contagion of the late 1990s) and asset markets (the Dot-Com stock market bubble). Japan's recovery from the credit bubble collapse failed, ushering in 30+ years of stagnation.
As the global economy reeled from these instabilities in 1998-2000, central banks flooded asset markets with newly created currency, the goal being to stave off a recession, which burns off bad debt, marginal investments and companies, reducing credit expansion and consumption.
Rather than accept the risks of a conventional business-cycle recession, central banks pushed financialization to new heights--heights which quickly distorted markets.
As a result, the growth of the 2000s was different: in effect, central banks had created a credit/asset-bubble dependent economy, with growth coming not from lowering costs, improving productivity and rising wages, but from speculations in financialized markets.
This was simply the logical extension of Neoliberalism: if existing markets weren't profitable enough, then create new markets for new exotic financial instruments.
The benefits of these financial instruments were asymmetric: those originating these instruments made billions, while the borrowers taking on the subprime mortgages, etc. were accepting risks they didn't understand. This dynamic fueled soaring wealth/income inequality.
Ultimately, no-holds-barred Neoliberalism led to the Global Financial Crisis (GFC) of 2008-09, as the risks that were supposedly hedged blew up and the markets froze up (i.e. markets became illiquid as buyers vanished).
As former Fed Chair Alan Greenspan admitted, the central banks failed to see that markets are not as self-regulating as the Neoliberal faithful believed: when bubbles pop, buyers vanish and markets go bidless/illiquid: sellers are desperate to sell but there are no buyers at any price.
This was the inevitable end-game of financialized Neoliberalism, and rather than face that reality, central banks and policy-makers double-downed on the same policies that created the 2008 bubble that was destined to pop with horrific consequences to everyone who had a stake in any of the casino's games.
We now come to the 2010s, in which financialization and globalization essentially conquered the global economy, leading to the brittle fragilities that are now unraveling.
With prices rising and wages stagnating, the "solution" was to borrow $10 to get $1 of growth. Since global markets were saturated with debt and risk, lenders cannibalized domestic markets, loading college students with $2 trillion in student loans and enabling a fracking "miracle" that was less an energy miracle and more a financial miracle as companies that lost billions continued to get cheap loans and sell bonds.
The global economy has now been backed against a precipice on every level: energy extraction costs have risen, requiring higher prices for oil, but consumers whose wages have stagnated for 20 years can no longer afford higher prices for oil or anything else.
Globalization has optimized profits at the expense of everything else: ecological sustainability, the security of food and energy sources, etc., while financialization has gutted the real economy in an extraction process that concentrates all the gains into the hands of the few at the top of the financialization/globalization pyramid: a winners-take-most economy that has corrupted and distorted the political and social orders.
All the critical dynamics--energy, currencies, globalization, debt and financialization--have reached extremes that made destabilization--i.e. an avalanche--inevitable.
What happens when the naive hope that the brittle, fragile extremes of the global economy could be completely restored to mid-2019 levels dissipates and is replaced by the sober realization there not only will there not be a recovery, but there can't be a recovery, as those brittle extremes have been lost for good?
One possibility is a "sell everything" move to the lowest risk asset, which many view as cash in a stable currency. If recovery is finally recognized as a pipe dream, what will the response be to the realization that all bets are off?
The rational response to heightened uncertainty, risk and volatility is to move to the lowest possible level of risk available. It is these times of uncertainty, risk and volatility that history leads many to declare that "cash is king."
My uneasy feeling is that this realization that all bets are off could set off an avalanche of risk-reduction that could far exceed the brief decline in March. Everyone holding assets is in essence betting that a recovery to 2019 levels is not only underway but is inevitable.
My understanding of history (sketched above) suggests the opposite: what has unraveled cannot be knitted back together, and since the authorities have no Plan B, uncertainty, risk and volatility could reach extremes few anticipate.
In conclusion, this is not a recommendation for any financial action, nor is it intended to be. My point here is to ask: what trends are in place, what trends are gathering momentum, and where do these accelerating trends lead?
The possibility that there are no safe havens is one of many potential outcomes. As I noted at the start: When, where and how these trends might impact asset valuations and financial stability are all unknowns.
Highlights of the Blog
New Podcasts:
AxisOfEasy Salon #10: Remember when Maximum Pessimism and Irrational Exuberance were mutually exclusive? (54 minutes)
Market Update: Triple Threat! Three major risks the markets are not pricing in yet (39 minutes)
Charles Hugh Smith on the New Normal (37 minutes)
Posts:
The Depression Dominoes Are Toppling 6/25/20
Is Data Our New False Religion? 6/23/20
The Illusion of Control: What If Nobody's in Charge? 6/22/20
Dear Junkies Addicted to Fed Smack: The Monkey on Your Back Is Now a Gorilla 6/20/20
Best Thing That Happened To Me This Week
Made chicken lau-laus with the taro leaves and ti leaves from our yard.
From Left Field
The Obesity Era: As the American people got fatter, so did marmosets, vervet monkeys and mice. The problem may be bigger than any of us.
#175: The Surplus Energy Economy--well worth a read to understand the energy realities....
Can the World Get Along Without Natural Resources? (via Don S.) --laughably, this is what mainstream economics maintains....
The American Press Is Destroying Itself: A flurry of newsroom revolts has transformed the American press
We Are All the Burnout Generation: Fueled by uncertainty and envy, burnout is a condition that is both uniquely human and profoundly misunderstood
Making people aware of their implicit biases doesn't usually change minds. But here's what does work -- sort of...
A rude awakening-- the transition to DeGrowth...
Now Comes the Davos 'Great Reset' -- cui bono--to whose benefit?
WikiLeaks Exposes How Council on Foreign Relations Controls Most All Mainstream Media--no surprise here...
Judging Communism and All Its Works: Solzhenitsyn's The Gulag Archipelago Reconsidered (via Michael M.)
The Second Great Depression: At least four major factors are terrifying economists and weighing on the recovery -- MSM getting nervous...
How We’ve Been Wrong About Healthy Cooking Oils--extra virgin olive oil....
"If the skies fall, one may hope to catch larks." François Rabelais
Thanks for reading--
charles |
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