The Long Wave “Winter of Discontent”!

Chris Vermuelen

 

At the present time, ‘Deflation’ is the greatest and most urgent concern throughout the global economy. Over the past couple of years, producer prices have fallen throughout the developed economies. Consumer prices have been falling for the last consecutive six months in France, Germany, Hong Kong and China. Japanese wages have actually fallen by 4 percent, over this past year.

 

‘Deflation’ is a widespread global problem. The Global Central Bankers had believed that printing more money would be the answer. And yet, ‘deflation’ is now a more serious threat, as Global Central Bankers are presently realizing that it cannot be prevented or reversed.

 

These ‘academic pinheads’ have failed to realize that we are in the ‘contraction phase’ of a much larger business cycle which can NOT be eliminated. We are currently experiencing “excess capacity” with crashing “aggregate demand”. All that the Central Banks have managed to accomplish was the “wealth effect” which, in turn, created an “artificial” rise of global equity markets and nothing more.

 

The global economy is now experiencing the “Kondratieff Winter”! In March of 2000, the start of the imploding tech shares ‘bubble’ marked the beginning of “Kondratieff’s Winter Correction Wave”.

 

After 1971, money creation became limitless and debt kept on growing, despite entering “Kondratieff’s Winter”. This system by the Central Banks is doomed to fail before the end of the cycle which will occur sometime between 2020-2021.

 

When gold is part of the monetary system, excessive debt is always eliminated from the system during “Kondratieff’s Winter” (deflation).

 

Since that time, the Fed has fought by all possible means the installation of the “Correction Wave” since the amount of debt is so high that allowing ‘deflation to occur’ would lead to a never before seen ‘catastrophe’. As a matter of fact, we have long passed the point of no return and the only solution that the FED has is to devaluate the dollar, regardless if that means creating a new currency.

 

The FED is systematically keeping “Kondratieff’s Winter” from taking hold and feeding a series of ‘speculative bubbles’. It is my view that the debt margin, for playing the stock market, is linked to the euphoria as seen at each peak period of time (2000, 2007, 2014). In both peaks of 2000 and 2007, the FED’s ‘easy money’ fueled speculation (stocks and real estate) during each time and thereby marked the start of a new ‘crisis’. Those three pivotal periods, 2000-2001, 2007-2008 and 2014-2015, are each separated by a seven-year period.

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The unsung genius, Kondratieff, and his ‘economic business cycles’ will, in fact, ‘play out’. We will witness a debilitating period of ‘contraction and crisis’. This period is most likely to appear obvious to “Main Street”, very soon, and will continue to persist for an additional three to five years! I am titling this as “The Great Reset”.

 

 

The FEDs’ balance sheet will continue to grow. Public debt will never be paid back.  In fact, there is legislation pending that currently avoids any debt cap. The FED is looking out for Wall Street and, most certainly, not the general public.

 

The collapse in global economic activity is a direct result of too much debt. Debt was intended to increase consumer consumption, but there was a total lack of global “aggregate demand”.

We are currently in the bust of a classic “boom/bust cycle”, however, this is the key point; it is not only companies and individuals with excessive debt, but, countries, as well.  

 

Whatever the trigger point is, failing is inevitable, according to IMF’s Managing Director Christine Lagarde, (http://www.imf.org/external/np/omd/bios/cl.htm), who herself states: “the crisis isn’t over”, and no real economic recovery will occur without this crisis “finishing the job” it has started.

 

Just like all major long-term/big picture trends and cycle changes, nothing happens quickly. Its very much a process and the market will continue to move in a direction that makes no sense longer than most traders and investors think. Just like those who warned about the 2001 market crash, 2008 financial crisis, real estate crash, and now the 2016 stock market crash… most of these big picture analysts like myself see these things coming well in advance sometimes 1-2 years before they happen.

 

We warn about these events happening and slowly position ourselves to not only avoid the crashes but to profit from them. But these take time to unfold as these are multiyear cycles and they do not turn on a dime.

 

Things are maturing and many asset classes are starting to make moves as expected but US stocks have not fully topped just yet…

Climbing Gold and Silver's Wall of Worry

By: Clint Siegner
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Confidence is slippery, even when you are a metals investor sitting atop the best performing assets of 2016. It doesn't help when 4 years of a miserable bear market remains fresh in our memories. Any weakness in prices and it can feel like markets are getting ready to plunge right back to $13 silver and $1,000 gold.

That feeling is called the "Wall of Worry", and bulls are going to have to climb it by staying in the market even if their emotions are telling them to bail. Let's review the last 6 weeks because they are quite instructional.

June 1st: Silver closed at $15.97 and gold at $1,213. Precious metals prices stood well below the highs put in at the end of April and plenty of people declared the end of metals bull run.

There was plenty of reason to worry. At the time, markets were obsessed with Federal Reserve policy and sentiment was darkening.

The year had opened with turmoil in the stock markets. The S&P 500 was plummeting in response to a December rate hike with the expectation of more hikes to come. Precious metals surged as investors sought refuge from crumbling stocks.

In mid-February Fed officials responded to the collapse in stock prices by reversing their rhetoric on interest rates. They reaffirmed their undying commitment to growth and prosperity through freshly printed cash!

Metals got another boost and the S&P 500 took off like a rocket.

So much so that, by June, schizophrenic officials had reversed direction once again. They sounded an economic "all clear" and began jawboning about raising rates. Some thought they might even get around to hiking as soon as the FOMC meeting in the middle of the month.

June 3rd: The Bureau of Labor Statistics (BLS) released a disastrous jobs report for May, missing even the most conservative estimates by a mile. The consensus on more rate hikes simply blinked out of existence. Forget higher interest rates, investors began wondering if Negative Interest Rate Policy would soon be making its U.S. debut.

Gold prices jumped by $80/oz to $1,299/oz over the following 2 weeks. Silver raced ahead by $1.50 to $17.54/oz.

Then, in the days leading up to the Brexit vote, metals prices take a beating. Everyone is watching, but no one expects the British to vote "Leave."

June 23rd: United Kingdom voters shock people everywhere. Stock markets crash, there is turmoil in the foreign exchange markets and people wonder if Brexit represents the kick-off for the next worldwide financial crisis.

Not only were interest rate hikes back off of the table, central bankers stood out front and did what they do best: they assured markets that no one need pay for their sins. They stood at the ready to provide "liquidity," also known as unlimited cash to prop up overleveraged and mismanaged banks and hedge funds who lost bets they couldn't afford on Brexit.

The turmoil and safe haven buying drove the gold price from $1,257 to $1,367 by July 8th. Silver jumped from $17.32 to $20.31 over the same period.

July 8th: Stock markets shrugged off the turmoil following the Brexit vote. Two days of heavy selling immediately after Brexit were followed by relentless buying.

Only investors were split. Some bought risk assets like stocks, figuring the hysteria surrounding Brexit was overdone.

Others bought safe haven assets including Treasuries and metals. They saw European banks in a lot of trouble. Italian banks needed a bailout and much larger banks - Deutsche Bank and Credit Suisse - were signaling the possibility of collapse as their share prices traded below the 2008 crisis lows.

Cue the next U.S. employment report. This time the BLS puts out a blockbuster number that beats expectations by a mile. That report and the continuing rally in stocks undermine interest in safe haven assets. People once again start whispering about the Fed raising interest rates.

Metals and bonds both drifted lower.

So what have we learned? World events are unpredictable - perhaps even more so lately. And, in bull markets some of the biggest moves happen suddenly, when people least expect it. Blink and you've missed it. So you just have to hang on to your convictions, and your position, even when worry sets in.

The Revenge of Turkey’s Erdogan

The coup deserved to fail, but his purge will cause further turmoil.
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China Is Now Driving Drunk - And You're The Passenger

by: The Heisenberg

- The party: global growth. The liquor: debt.

- The life of the party: China.

- Why did you agree to go along on a beer run?
 

- It's Thursday afternoon.

 

- Your phone rings.

 

 

You hesitate, but you pick up.

 

"Hello?" (as if you don't know who it is).

 

"It's me. I'm having another party tomorrow. You're coming right?"

 

You try to hide your trepidation. You feign enthusiasm. "Yeah man, what time is everyone showing up?"

 

"Eight." Click.

 

Now you've RSVP'd. You have to show up. Crap.

 

It's not so much that you didn't have a great time at the last party, it's just that there towards the end, the host looked like he might have had one too many tequila shots and you, like most of the other partygoers, were scared of what might happen next.

 

("Once it hits your lips...")

 

Fortunately, he stumbled to his room and passed out. He didn't drive anywhere. Or fight anyone. But he could have. Who knows what's going to happen this Friday.

 

For those unfamiliar with the analogy, China is the drunk party host. The tequila is debt.

 

In all kinds of ways, China is the host of the global economic party. They're all at once the engine of growth and the barometer for demand. They're "behind the wheel," as it were. And make no mistake, they're drunk. Drunk on debt.

(Chart: Goldman)

 

Now the thing is, we don't know for sure where all the debt is. We don't know the extent to which 260% of GDP even captures it all. We don't know which sectors owe what to who. We don't know how much is obscured via banks' exposure to channel loans. We don't know what the real non-performing loans numbers are. Basically, we don't know anything. We're in the passenger seat, China is driving, China is clearly drunk, but we have no way to assess how drunk.

 

I'm not going to run through the mechanics behind China's sprawling shadow banking complex here.

 

If you want to know the details, it's covered here and here, among other places. Rehashing it takes forever, but I will say that in order to fully understand what follows, you need to read those linked pieces. Sorry. It's a pain, but diverting new readers to those is preferable to subjecting veterans to repetition and redundancy.

 

So China's mid-tier local banks are in deep. Like, waist deep. Recall the following from Reuters:

At China's mid-tier lender Industrial Bank Co, for example, the volume of investment receivables doubled over the first nine months of 2015 to 1.76 trillion yuan ($267 billion). 

This is equivalent to its entire loan book - and to the total assets in the Philippine banking system, filings showed.

Remember, "investment receivables" is a line item Chinese banks have created to obscure the extent to which they're taking credit risk that doesn't show up as tradition loans. Here's what UBS financial analyst Jason Bedford, a former bank auditor in China told Reuters back in January:

These are now the fastest growing assets on the balance sheets of most listed banks, excluding the Big Five, not just in percentage terms but absolute terms. The concern is that the lack of transparency and mis-categorization of credit assets potentially hide considerable non-performing loans.

Precisely. Well, Deutsche Bank (whose work on China banking risk is unparalleled on the sellside) went looking for systemic risk at local banks in struggling provinces and guess what they found? Nothing good. Here are some excerpts from their latest:

An economic hard landing has already happened in north-eastern China and Shanxi province, with combined nominal GDP growth slowing to 1% yoy in 2015 and further to -0.4% in 1Q16. 

In contrast, local banking asset growth remained strong at 16% yoy, with city/rural commercial banks and policy banks the key funding providers (assets up 26% for each type), while the big- five banks in the local market only grew their asset base by 6%. The 17 unlisted local banks, which made up 12% of local banking assets, recorded asset expansion of 22% yoy, mainly driven by fast-growing, higher-risk shadow credit (up 78% yoy). We think that these banks are likely providing "evergreen" lending to weaker corporates and hence are associated with higher credit risks.

 

When Deutsche talks about "evergreening", they're talking about companies that borrow just to service their existing obligations. In other words: these companies have reached their "Minsky moment."

 

And don't think this is just local banks. The policy banks are there too:

 

(Chart: Deutsche Bank)

 

Not to put too fine a point on it, but Deutsche's takedown is devastating. Here's more:

The 17 local banks grew their asset balance by 22% yoy in 2015. If including the three listed banks in these four provinces, their asset growth registered at 28% yoy in 2015. This compares to the Chinese banking system as a whole at 15.7% yoy, nearly twice as fast. Furthermore, it is also stunning when compared with only 1% nominal growth in regional GDP. In our view, one explanation would be that these banks were extending "evergreen" credit to weaker corporates, in order to prevent unemployment and corporate bankruptcy. 

The strong asset growth was mainly driven by shadow credit (58% of new assets), which was packaged in the form of receivable investments and available-for-sale (AFS) investments. Their receivable investments were up 85% yoy and accounted for 13% of total assets.

And finally, this:

With a relatively small loan book of c.Rmb50bn per bank, these 17 banks are more exposed to riskier sectors and also have a higher concentration of large customers. 

As shown in Figure 18, they have notably higher exposure than listed banks to the manufacturing, wholesale & retail trade and mining sectors, which include the major overcapacity sectors (e.g. steel, cement, coal and non- ferrous etc.).

In short, one (or more) of these local banks is going to collapse. It's just a matter of time. And when it does, the question becomes whether that sends shockwaves through the rest of the system.

Remember, Kyle Bass's entire short thesis on the yuan (NYSEARCA:CYB) rests on the idea that Beijing will need to embark on a massive recap of the banking sector. Will a local bank be the first domino? Here's what I said last month:

If just one of these banks (even one of the country's 130+ city commercial lenders) goes under, it could send shock waves through the whole system and cause a crisis of confidence. It only takes one domino to trigger a collapse. That's when Bass's thesis comes into play. When it comes time to plug the holes, there's really no where to go but down for the yuan for the four reasons outlined at the outset.

If the Chinese banking system collapses (which it will), there's no alternative for the PBoC.

 

They'll have to deploy their balance sheet. And you know what that means, right? A sharply lower renminbi. You might as well take risk assets - including US equities (NYSEARCA:SPY) - into the back alley and execute them now. Show some mercy for God's sake.

 

And on that note, I'll close with an updated version of a chart I've shown many times previous:

 

 

A Trump Economy Beats Clinton’s

His plans that would get the U.S. back on track include the biggest pro-growth tax cut since 1981 and repeal of ObamaCare.

By Andy Puzder and Stephen Moore
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Remaking Britain

Gordon Brown



LONDON – Britain will have a new prime minister today – but the country’s post-European Union future remains uncertain. Indeed, prolonged delays are likely in implementing the voters’ decision to leave the EU.

China, International Law and Reality

The South China Sea case proves that laws mean nothing if there is no enforcement mechanism.

By George Friedman


A court in The Hague ruled in favor of the Philippines in a dispute over islands in the South China Sea earlier this week. The Chinese told the court, the Philippines and anyone who cared to listen that they couldn’t care less about what the court said. This has led some to assert that tension is increasing in the South China Sea. If only because people seem to care a great deal about the topic, we need to address it.

First, a lot is said about the rule of law. Thomas Hobbes, an English philosopher, pointed out that law can only exist when a Leviathan exists. What he meant is that the law only exists when there is something enormously more powerful than the individual actors who feel compelled to obey the law. Therefore, international law doesn’t exist because there is no global Leviathan that can enforce the law. It exists only in the sense that there are treaties, agreements and academic volumes on the subject. And there are people who want international law to exist.

But there is no Leviathan, no force that can compel nations to comply with rulings they disagree with. Some may wish international law existed. But it does not. It is as if there were a law against theft, and the thieves were more powerful than the police. In that case, there is a law, but the thieves determine what will and will not happen. There are places like that in most countries, and some countries have only that.

It is similarly the case with the international legal system. Individual states will not capitulate to the legal findings of international courts unless they choose to. And when they choose not to obey, nothing can be done about it. Some nations, like the United States, are wary about signing international agreements that give international courts jurisdiction. In the United States, a treaty has the force of law and a domestic court may enforce the ruling of an international court. In contrast, other countries are happy to sign treaties, knowing perfectly well that if they object to a particular ruling, they will ignore it.


The only countries where international law has meaning are weak, fragmented countries where major powers will support court rulings because they do not affect their national interests. And supporting international law makes major countries look good. African states have complained bitterly that their leaders are subjected to scrutiny and prosecution that would never be applied to major powers. This is undoubtedly true and indicates the arbitrariness of the international legal system. International courts prosecute who they can and pass rulings that they know will be ignored.

China’s rejection of the ruling was no surprise, because the Chinese said they would reject the ruling long before it happened, and they never participated in the trial. The trial happened anyway, China lost and the headlines are filled with stories that imply that this matters. The Chinese aren’t embarrassed because internally they can use this to show that the world is against them, and that all of China should come together. In the Philippines, there will be celebration because a court has said that the Philippines was right about something. In the rest of the world, this will be forgotten in a week.

The question is, what does this mean for the South China Sea? The answer is that it changes nothing. All sides will continue to make military movements that the others will denounce as aggressive. No side will actually engage in significant military action against the others. We define significant military action as, at a minimum, shooting something meant to hit the other guy. The others will not fire on Chinese vessels because they are not actually interfering with anything important, and also because firing on Chinese vessels is a non-trivial action by a country like the Philippines. The Chinese will not fire for effect on anyone, because they have to assume that the United States would intervene with its massive naval and air forces, and China is not ready for such a confrontation.

This is not to say that the South China Sea is trivial. It is encircled by islands from Indonesia to the Philippines. Those islands create choke points that could be readily blocked by the United States – with submarines and aircraft from carriers at a distance and from even more distant bases. China is a trading nation and the fear of being blockaded by the United States is real.

The Chinese, like many other countries, see the United States as powerful and, therefore, unpredictable. They believe that in the long run they will have to confront the United States on the periphery of the South China Sea. They hope the U.S. will give them the time needed to build a force that can challenge it. One way to do that is to make themselves appear reckless and dangerous, without triggering a war. Sending warships hither and yon and building islands, all without actually engaging in combat, is their best move. They appear to be more capable than they are, while carefully avoiding a test of strengths.

The ideal Chinese solution would be to to convert Taiwan, the Philippines or Indonesia into an ally. That would solve China’s blockade problem decisively. The United States has worked intensely with these nations and with Vietnam to prevent this from happening. If a conversion cannot be done diplomatically, it is always possible to do it by subversion or invasion. The Chinese had such a subversion program in 1965 in Indonesia but it ultimately failed. The Chinese attacked Vietnam but it did not go well. Conducting an amphibious assault against Taiwan would be very difficult, and generating a pro-Beijing program there in the middle of President Xi Jinping’s purges is not likely. The Philippines might prove vulnerable, but making an incursion would take a great deal of time and risk.

When we talk of the South China Sea and China, international law is an interesting idea. But the likelihood of China capitulating on major issues of national interest because a court in the Netherlands directed it to is low. In the meantime, the strategic discussion has far more meaning than the legal one. Some may wish it weren’t so, but it is. It is not that there couldn’t be an international government, but having seen Britain rail against the majority for daring to vote to leave the EU, we must be careful what we wish for. A global democracy and police force would leave the Chinese with a lot of votes and power. We might prefer an impotent court to one created by a genuinely global democracy. Leviathans can come in many flavors.