This Bull is on its Last Legs

ICangles Investment Post…

With the news that China’s central bank is lowering interest rates, the bull market that began in 2009 is likely entering its final stage, which should carry it into at least the next year. Fears that the current global economic recovery is faltering led not just China’s central bank to cut rates, but the European Union to lower rates from 1 to 0.75 percent and the United Kingdom to increase its stimulus efforts. With a weak June jobs report, expectations of further monetary intervention by the United States also grew. But outside of China, monetary intervention is to a large degree pushing on a string. And even if China can give the world a temporary boost, the expansion of its economy will only provide a reprieve from the onset of the next downturn.

So, broken is the current economic paradigm that in the developed world monetary policy is no longer intended to spark healthy economic growth. Rather it is a desperate attempt to forestall another recession. Given today’s near zero interest rate environment and the trillions of dollars in purchased debt now being carried on central bank balance sheets, desperate is exactly the right term for current monetary policy. This reality should give anyone pause, who takes a moment to fully consider its gravity. Today, China is exceptional as the only major economy likely to generate strong growth as a result of monetary policy and its exceptionalism will not last for much longer.

It is abundantly clear that something is very wrong with the current economic paradigm. Many smart observers believe the European monetary union is unsustainable and current measures are simply postponing its inevitable collapse. Meanwhile, the economic recovery in the United States has been remarkably weak with U.S. GDP growth of 3 percent in 2010, 1.7 percent in 2011 and 2012 already posting disappointing results versus an average annual growth rate of 3.4 percent in the 1947-2007 post war period. This outcome has transpired despite the U.S. federal government’s fiscal stimulus and extremely aggressive monetary policy.

Source: Deutsche Bank.

As to Japan, rather than being considered the exception to the rule for its weak economy, as was the case in the nineties, Japan can now more accurately be recognized as a forerunner of what transpires after a balance sheet recession due to asset inflation and a testament to the limits of expansionary fiscal and monetary policy. Although some will certainly try, it is very difficult to argue with any modicum of intellectual integrity that Japan’s problem is that its fiscal and monetary stimulus have not been big enough. Nevertheless, a weak economy remains Japan’s new normal.

Other major economies are now living the Japanese experience, with the exception of China, whose central bank has just cut interest rates. China’s leaders know the risks they are running. But with their political legitimacy tied to delivering prosperity and a transfer of power occurring soon, it is a risk the government evidently feels it must take. Aware of how easy credit led to asset inflation and real estate bubbles in Japan, the United States and other countries, China is taking steps to avoid a similar fate with restrictions on property loans. Unfortunately, China is unlikely to be able to have their economic cake and eat it too, as signs point to asset inflation around Chinese real estate already having created a bubble (see my previous post “China’s Economic Dark Side Part I”).

Pumping money into the economy, even with restrictions, is likely to further fuel speculative excesses, including in the real estate market. Yet, the bubble has not burst yet, asset inflation can run further and China can likely drive some robust growth fueled by malenvistments prior to entering a balance sheet recession—growth that will likely extend the current bull market and forestall another recession for a time. Bubbles tend to last for as long as money is available to fuel further asset inflation, and China in the wake of the global economy faltering and its own economy slowing more than expected, has now taken the step of supplying another round of that money.

Extending the day of reckoning for the global economy will almost certainly make the next downturn worse than would otherwise be the case. And with growth having weakened to the point where China feels the need to embark on expansionary monetary policy despite the obvious risks around asset inflation and bad debts, the timing of the next downturn is now closer. China is the last major economy not pushing on a string. When its central bank pumps money, China’s economy responds, like the world’s other major economies used to prior to their balance sheet recessions. Yet, China is well down the road to repeating the same mistakes as other nations, and when its economy falls the current paradigm will be utterly broken.

A world awash in bad debt, will no longer have the option of creating growth by providing cheap credit. In the coming post asset-inflationary paradigm, we will all be Japanese in the sense that there will be no major exceptions to the new normal of debt-ridden balance sheets, while abundantly available debt financing to fuel government spending is also unlikely to exist. The choice for governments will be on which balance sheets–government, corporate, consumer–the debt is concentrated and how it is worked off in a mixture of defaults, inflation and austerity. The good news is that with no option for further excessive asset inflation, the world will be forced to fashion a new monetary and economic model capable of generating sustainable economic growth. For instance a farewell to floating fiat currencies is very likely.

The bad news is that there is going to be a lot of debt to work off and the breakdown of the current paradigm will extend to debt-fueled government programs in the developed world that have made what appears an economic depression on stock market charts, not feel like one to the benefiting citizenry. In the United States for example the federal government borrowed money and bailed out state governments that otherwise would have needed to retrench, during the last recession, which will be extremely unlikely to transpire again. In the future austerity will not be just for Greeks. As to the timing of the next downturn, I will continue to keep a close eye on monetary policy and will remain especially leery of the period after America’s and perhaps more importantly China’s political power transfers.


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