Will the Federal Reserve Destroy the World in Two Weeks?

When people using different models come to the same conclusion as myself, I pay attention:

I'm overdue on updating the fed pivot indicator, and frankly it's showing we have arrived already

We are at the point where the fed would usually halt rate hikes and begin easing again

As they gear up for 75bp in a couple weeks, they would be knowingly blowing up the system pic.twitter.com/u20NsnvhNH

— TheHappyHawaiian (@ThHappyHawaiian) July 11, 2022

He's using debt financing for government. I look at it from the view of inverted yield curves and the breakout in the U.S. dollar versus the yen in particular. Here's the spread between the 10-year and 2-year yield. Back to the line where rate cuts begin.

Here's the same chart with the effective funds rate (DFF on FRED) inverted.

This makes me very nervous:

If I was in Powell's shoes, I'd be scared of hiking 75 bps and the market interpreting policy as hawkish. The markets are on a knife's edge. In 2018, the Fed reversed course and stopped a stock market decline. I'm not sure they can reverse a collapse in the yen if they knock that domino over. Crashes beget crashes:

Coming into 2022, the Fed was trapped because the market would crush stocks and bonds whether they hiked or not, therefore they had to hike. Now they are in a different trap. They have a new threat: deflationary collapse. 

If they hike too slowly and the CPI stays high, they may have to hike more later. My hunch is recession will kick in eventually and solve this risk. Still, if it is a risk, it is a manageable one. They could signal hawkishness in September if August gets too inflationary for their tastes, but my hunch is any bounce in speculation and commodities will burn out in a couple months at most. 

If instead they push global markets into a major crisis, they will have to backtrack on tightening at all. They also might have to do it within days, weeks at most. That will harden the idea that the Fed is trapped for good and can never hike rates or has no idea what it is doing, setting up a repeat of 2022's decline as soon as whatever animal spirits they stir up fade away.

My view: the Fed has a lot of leeway on what constitutes a pivot. Markets are now pricing in a 75 bps hike with the gamblers betting on a 100 bps hike. This looks like lunacy to me given developments in commodity and currency markets, plus incoming economic data. Odds of a 50 bps hike were at 50 percent a month ago (before the market priced in more hawkishness). Since then commodities have cratered, gold-copper screams deflation, U.S. dollar is breaking out again and Fed models show a recession and rapid disinflation. Everything is telling me 75 bps will be a coup de grâce for inflation and financial markets.

At this point, a 50 bps hike would both be economically excessive in my opinion, but also perhaps necessary given Fed guidance. It would cause a "dovish" reaction in markets. If the Fed plays the markets, then 50 bps looks like the right number. Or the Fed could deliver 75 bps as expected, but signal a far more dovish footing for September, perhaps even no hike being on the table if the "data warrants" with the Fed statement discussing the rapid cooling in various markets. Whatever they do, they are at high risk of overshooting on the hawkishness and should consider how they want to climb down. A slower pace of hikes is the obvious choice because it leaves open the possibility of more hikes.

At least one Fed official sees the risk. Esther George today (PDF): Tightening Monetary Policy in a Tight Economy

The main role of the Federal Reserve is bailing out the banking system, not controlling interest rates. It mostly follows the market, and it ignored the market screaming inflation in 2021. It waited too long to hike rates and the economy is doing the work of raising rates and killing inflation for them. It's no surprise that recession fears are here so soon because the Fed should have started hiking rates at least 15 months ago when inflation was obviously manifest and financial assets were still in a speculative frenzy.

It is rare to say, but here a Federal Reserve official gets it. The Fed can communicate hawkishness while dialing back the speed of hikes. See if market forces start taking inflation down for them. The 1970s were a mess because the Fed cut rates in the recessions. If the economy is going into recession and commodities continue selling off, rates are probably already too high. Inflation will come down on its own without any push from the Fed. 

Contra 2021 screaming inflation, markets are screaming caution and deflation here. Maybe it's a momentary fit of madness and will pass. The Fed can't afford to take that risk though. If the markets are right, they're saying something very large could break. Better to wait and see, then to be the impetus for triggering a global meltdown.

If Unemployment Looks Like This Forecast, Depression

Peak of unemployment in the early 1980s was around 1 million (4wk average, population adjusted). If this forecast from BMO is right, the economy is doomed. It will be stuck at the 1980s peak for weeks on end.
ZH: The Magnitude Of The 2nd Round Of Job Losses Won't Be Apparent Until After The Election

These ambitions are consistent with reemploying as many workers displaced by the pandemic shutdown as possible, but the fact of the matter is a large number of the jobs lost during the second quarter simply are not going to return. This isn’t to suggest that an elevated unemployment rate will be a permanent feature in the US, rather that the snap-back scenario is unlikely given the dizzying array of uncertainties that persist. The October 31 expiration of the payroll protection program has undoubtedly kept the ranks of the unemployed lower than had the initiative not been deployed; even if a more cynical interpretation implies that another round of job-shedding has only been delayed to the final two months of 2020. The fact the magnitude of the second-round losses won’t be evident until after voters go to the polls on November 3 isn’t lost on us; but was it ever going to be any other way? We digress.

The stock market is either insanely overvalued or pricing in insane amounts of inflation (in which case crypto/precious metals related plays are insanely undervalued). Industrial commodities and real estate are less certain since high long-term interest rates and a stagnant economy will crush consumer demand.

I previously discussed post-coronavirus employment in Depression Versus Recovery in Employment. I looked at the most recent initial and continuing claims data in Extended Unemployment Benefits Stall Recovery

About That 1998 Analog and Y2K Scenario

Action in the forex and commodity markets is echoing with 1997-1998.

Nasdaq peaked at 2028 intraday on July 31. It fell to a low of 1475 on August 31, a drop of 27 percent. It rallied nearly 17 percent, then sold off again. It lost 23.6 percent in the second wave. The total drawdown at intraday low was 33 percent. The bottom was in early October, making for a nine-week crisis.

Few are thinking about a positive outcome, but there was real panic in summer 1998. The Federal Reserve organized a bailout of Long Term Capital Management. If coronavirus were a similar situation in time (with larger percentage moves), the bottom might come around the last week of April or first week of May. I'm not proposing that is going to happen, but it's worth keeping in the back of your mind. The final leg up was caused by Fed liquidity and also the destruction of the bears. Skeptics were calling the market a bubble before 1998, they were betting against Internet and tech stocks. The euphoria rally that followed was in part driven by the failure of a bear market in the face of a 33 percent correction.

The economy isn't heating up into a cyclical peak this time. Growth has been terrible for 11 years. Social mood isn't climbing into a major peak. It is arguably expressing a depression on par with the 1930s and even 1920s Weimar Germany. But the potential for an explosive bull move is not out of the cards yet, not until the virus pushes the economy into a clear recession that will not lift with the virus.

Update:

1930s Depression vs 2010s Depression

In The Booming Depression, Jeffrey Snider shows that economic growth in this depression is weaker than in the 1930s depression.

Today, it is the reverse. Not the “us” versus “them” part, that’s the same. Only now the whole global economy is swept up in a deflationary pit from which it again seems unable to transcend. It is not deflation in the 1930’s sense, rather it is a slow squeeze, an unceasing downward (monetary) drag that intermittently ensnares the global economy keeping it from taking off at just those moments it looks best able to.

As a result, the last decade plus actually underperformed the Great Depression. Think about that.

The Dow Jones Industrial Average closed at 381 at its 1929 peak. Eleven years later, it was trading at 150, or 60 percent below the peak. That also includes a dollar devaluation from $20 per ounce of gold to $25 dollars. In other words, the 1929 Dow peak bought you 19 ounces of gold, but 11 years later it bought only 4.3 ounces, or 77 percent below the peak.

The U.S. stock market peaked at 14,165 in 2007. The dollar went off gold in the 1970s, but for reference, it was about $750. The Dow bought about 18.9 ounces of gold. Eleven years later, the Dow traded at 29,551. Gold was around $1650 per ounce or 17.9 ounces per Dow Jones Industrial Average. In nominal terms, the Dow soared to more than double its 2007 peak even amidst an economy performing as badly as the 1930s economy. Of course, the past decade-plus saw slow, grinding growth. There was no collapse of the banking sector thanks to central bank and government intervention. Stocks tumbled more than 50 percent from peak to trough, far better than the nearly 90 percent drop post-1929. Measured from bottom to eleven years later, the Dow gained nearly 250 percent in the Great Depression. It advanced more than 350 percent off the 2008 low.

The question I'm asking right here is: did the inflation end? Are central bankers out of bullets? Will the 1929 scenario begin in earnest this time, but with stocks starting from a far more overvalued position? Or is the depression closer to its end, and the devaluation of fiat currencies about to begin, crushing the Dow/Gold ratio back below 10? If the latter, I still believe emerging markets will collapse first- as is happening right now. My thesis remains that fiat burns from the periphery to the core, with USD likely the last currency to implode. Neither Japan nor Europe is equipped to take on the role of global consumer, neither can handle the destruction of the manufacturing sector that would come from ripping higher versus the greenback. Perhaps the USD, EUR and JPY will all collapse together, but if not, I maintain the USD falls last. Also, I believe some rising percentage of capital fleeing emerging market currencies will flow into gold. I anticipate the U.S. dollar will "rise" versus many foreign currencies, even if they are all losing value against gold. A superior trade is long gold and short any number of non-U.S. dollar currencies.

My conclusion: the 1930s depression was far harsher at the start, but it enjoyed a far more equitable inflationary response. The economy boomed in FDR's first term. Inflation in the current depression has flowed mostly into financial assets. It has pushed up costs for consumers, but not wages. A "settlement" between financial assets, wages and gold is coming and these measures, among others, will be more balanced in the future.

Bonus depression charts:

France Gives Warning of Inflation Riots to Come

The French stock market peaked in 2000. The 19th year of a bear market has recently begun as the market likely achieved its second bear market rally peak. Mood is turning down again within this overall negative trend.

Evening Standard: Paris riots: 133 people injured in France and over 400 arrested as protesters rage at rising cost of living

In the United States, President Trump was elected to reverse falling living standards falling life expectancy, porous borders, and low employment. He is not succeeding on any of these issues. Most of his challengers (in both parties) want to make these problems worse by doubling-down on existing policies that created the mess. Even if the establishment unleashes a major reform effort to solve these issues, the situation hitting France is coming anyway because the U.S. dollar will eventually succumb to revaluation along with all the fiat before it.

Another lesson from France: even regime opponents are lumped in with the establishment. Le Pen is as likely to go the way of the dodo as the establishment of France because they go together like yin and yang. The collapse of the GOP establishment along with the Democrat establishment in 2016 was a small taste of what is brewing.

Macron was the poster boy for the globalist establishment. He was a sign in 2017 that populism could be stopped. Instead, he has ignited a more violent response to globalist, establishment thinking. It is better to have reform come early and be successful than to deny "populists" power. If Trump fails in the U.S., the result will not be pretty. Parties shut out of power in Europe are more likely to win total control over political power when the public finally revolts. Those in power, such as 5-star and the League, are as likely to be tossed as anyone unless they take bold steps to change course.

If the central bankers of the world hadn't convinced enough people that they'd solved the crisis, right now we'd all be calling this The Greater Depression. Social mood is very negative and the establishment is still pushing more extreme versions of the very policies that ignite public rage. Immigration should have been restricted after the year 2000, but politicians are calling for open borders and mass migration. Banking should have been reformed after 2008, not rebooted. In the U.S., healthcare should have been reformed, instead Obamacare was a giveaway to insurance companies and made the IRS their enforcers.

Finally, a key to the French riots is they are leaderless. It's a genuine mass movement. There's no one to negotiate with. When this comes to the U.S., there will be completely different groups and ideologies rioting in the cities and rural areas. These groups will have 180 degree opposite demands. The center is already collapsing, but when the riots hit, it will be gone. If establishment centrists hold power at that time with a puppet like Macron, they will be powerless.

Tick Tock: Toronto Home Prices Plummet

Financial Post: Toronto home prices see biggest drop in almost 30 years

The high-end of Toronto’s housing market is bearing the brunt of declines from last year’s dizzying growth, with prices falling and unit sales slumping by almost half.

Sales of detached homes in and around Canada’s biggest city fell 46 per cent in March from the same month a year ago, while the average price fell 17 per cent to $1.01 million, according to data released Wednesday by the Toronto Real Estate Board. That dragged down the average selling prices for all housing types by 14 per cent from a year earlier to $784,558, the biggest drop since 1991.

“Detached home sales, which generally represent the highest price points in a given area, declined much more than other home types,” the board said in its monthly report. “In addition, the share of high-end detached homes selling for over $2 million in March 2018 was half of what was reported in March 2017, further impacting the average selling price.”

The U.S. housing market peaked in 2006. The recession hit in 2008. Canada's housing market peaked in 2017.

What is Trump Afraid Of? China Answers: Made in China 2025

iFeng: 特朗普到底在怕什么？

What is the United States worried about?

According to public information, the United States imposes tariffs on China's products mainly in these major areas: high-speed rail equipment, aviation products, new energy vehicles, a new generation of information technology, industrial robots, agricultural machinery and equipment, new materials, bio-medicine, high-performance medical machinery Wait.

There are many types, but it can be summed up in one sentence: almost all involve the strategic tasks and priorities of "Made in China 2025". For example, a new generation of information technology, new materials, biomedicine, rail transportation equipment, large aircrafts, and so on.

In these areas, China has clear goals and plans. If all goes well, it means that by 2025 China will enter the top rank in these fields.

At present, the United States is still the leader.

Bai Ming, deputy director of the International Market Research Department of the Ministry of Commerce Research Institute, told the China News Agency that it was a through train. Trump imposed tariffs on China in 2018, apparently putting the roadblocks on the front.

"Fearful that China's industry will develop to a certain stage in the future, it will replace the dominant position of the United States in the international division of labor," said Bai Ming.

What is behind the status?

In the past, the United States has used its dominance in the international division of labor to obtain large excess profits and even supported the status of the US dollar.

China’s move in the manufacturing industry clearly caused Trump’s concern.

As a result, trade frictions between China and the US have frequently appeared.

Related background from January 2018: Top-level design of Made in China 2025 completed, ministry says

According to Miao, a group of key landmark programs and projects have been launched in areas such as manufacturing innovation, intelligent manufacturing and green manufacturing, and the country has climbed to a new level in building a manufacturing powerhouse.

On August 30, 2016, the Ministry of Industry and Information Technology (MIIT) announced China will set up around 40 national manufacturing innovation centers by 2025, according to Xinhua.

Miao said five national manufacturing innovation centers have been completed so far and 48 provincial manufacturing innovation centers have been nurtured, which has formed a manufacturing innovation system that takes the national innovation center as the core node and the provincial manufacturing innovation centers as important supplements.

In priority areas such as large aircraft, integrated circuit, new material, aircraft engine and gas turbine, 5G as well as new energy vehicles, positive results have also been achieved, Miao said.

Back to the iFeng article:
How does China-US trade friction end?

The U.S. proposal for the return of manufacturing industries not only reflects that the United States simply wants the return of manufacturing, but also reflects the United States’ desire to maintain its position in global politics, economy, and international affairs.

However, China is not the same poor China.

For China-US trade friction, China’s attitude is cautious and firm.

I didn't paste the parts that recite free trade talking points such as importing solar panels creates jobs. The issue isn't employment but the types of jobs and the supporting industries, research and development, that accompany high-tech manufacturing.

Bai Ming believes that China will not lose the bottom line when it comes to principles.

In other words, this is a game and negotiation process between the two parties.

At the same time, we must also see how the United States' deterrence against China compares with China's deterrence against the United States, its dependence on China, and its anti-dependence and strength.

Last time, China responded to the “232 Measures for Imports of Steel and Aluminum Products of the United States” and intended to impose tariffs on some products imported from the United States to balance losses.

In the face of the United States' tariff increase on China’s 60 billion U.S. dollars, what measures China will have? We are not aware of this.

However, it is certain that China will take all appropriate measures to firmly defend the interests of the country and the people.

The aforementioned report believes that China and the United States should transform themselves from globally competitive competitors into global winners, and truly create products from "Made in China" to "Made in China and the United States," creating a new situation for win-win development in manufacturing.

China wants to draw the United States into a dependent bilateral relationship. It wants to knock the United States off its perch as the premier global economic power. The people in charge on the United States have through malice or stupidity, chosen to give away the nation's advantage. Structural issues are in play that restrict policy maker choices. Good luck winning an election based on entitlement reform and slashing debt-fueled consumer. However, coupling mass unskilled immigration with a free trade policy that is premised on the need to obtain cheaper labor overseas destroy's a nation's middle class by crushing its wages.

As for a trade war, the key point missed by nearly everyone is that the calculation changes dramatically if we are talking about sovereignty and political power instead of economics. Even though a trade war could be long-term beneficial for the United States by forcing reforms that politicians will never vote for, it will have a short-term economic cost. There will be major disruptions even if there are winners (as happened with free trade, but condensed into a few years instead of forty). Those decrying Trump's actions on economic grounds are on shakier ground than they believe, but they are on relatively solid ground when it comes to disruption and risk. If all you care about is GDP, a strong case can be made against trade war. The higher your time preference, the stronger the argument.

If the issues at stake go beyond economics, the calculations change. We don't yet know how serious Trump is about confronting China. He might want a simple deal that lowers the trade deficit by $100 billion and then claims victory, but does nothing to reform the economy. But he might have advisers from the Pentagon who argue an economic recession is a small price to pay if it can cause a depression that sets China back a decade.

The stock market was not worried that the drop in international trade would tank the US economy. International trade was small as a percentage of the US economy, roughly 4% total. But, that 4% of international trade was servicing the accumulated lending that amounted to anywhere from 30-50% of the value of the entire US economy. The tariff meant that firms would not be able to service the money lent to them by Americans and, thus, lead to massive bond defaults.

Luttwak argued for reducing China's growth rate through restrictive trade policies in The Rise of China Vs The Logic of Strategy. China is vulnerable because of its monster debt growth that far exceeds the 1920s U.S. A major financial crisis was possible well before Trump took office. A modest level of tariffs that creates secondary and tertiary effects in the financial markets could be enough to push China into a serious slowdown.

Growing Signs of Distress in the Market

I would be surprised if a recession kicked off now, but between China and the central banks, there's definitely a disinflationary wind blowing since late 2017 it will continue into 2019. It looks like the technology sector is giving up leadership as social media comes under scrutiny from the public and government, the hope of driverless cars is shattered, cryptocurrency prices prepare to return to Earth and tech valuations and inflows mean revert. Whether this signals a stock market top or merely a changing of the guard in the bull market remains to be seen, but I expect at least something similar to 2015-2016 before all is said and done if only because of China.

Macro Man: AN EXERCISE IN CONNECTING THE DOTS: THE LIBOR-OIS SPREAD

I wonder if we might be closer to a downturn than the market expects, with market participants starting to sell liquid assets, but in a slightly different fashion, as we are still in a very low yield environment. They might have started liquidating some very expensive government bonds between end of 2017 and beginning of 2018, but, after a certain level of yields was reached, moved into selling short-dated corporate paper. If this trend in low beta corporate paper selling should continue (which is a big if), together with a continuation of the increase in T-bills yields (driven also by an increase in issuance and higher Fed rates), it could create pressure at funding level. This would potentially translate (at a certain point) to a shortage in Dollar funding, which could theoretically be supportive for USD itself (like in 2008, with the USD bouncing only after Bear Stearns at the beginning of the year), which would be in line with the view of a potential tactical bounce.

I think one of the scenarios the market is not pricing is that the Fed might have already tightened (or it is very close to) financial conditions too much, but other elements may have hidden this, especially in 2017 (i.e. Chinese liquidity injections). Something like what I tried to explain above might be one of the canaries in the coal mine. I understand it is a bit of a far-fetched hypothesis, but I would appreciate any thoughts or feedback, especially those that go contrary to my view.

While on the subject of a potential recession, there's also the 1962 analog that saw stocks drop 25 percent from mid-March through the end of May. The economy experienced a recession in 1960-61 and the stock market drop froze hiring for several months. A dip in economic activity today would push GDP growth below 2 percent and possibly below 1 percent.

My spidey-sense isn't tingling as in late 2015 when credit spreads widened near their 2011 highs and importantly, to a level associated with bear markets and and recessions, but there is elevated risk of a significant market decline. The Dow Transports missed triggering a Dow Theory sell signal intraday by 1 point before rallying at the close.

In sum, signs of distress are piling up. VIX blew out in February. Technology is being taken down in March. I give the bears the benefit of the doubt on funding stress because this is Year 10 of a deflationary/disinflationary depression punctuated by outright deflation in 2011 and 2015-16. The Hong Kong dollar is still on the verge of hitting the peg limit and forcing HKMA intervention. I do not know if this signals immediate trouble, but I strongly suspect there will be trouble in 12 to 18 months at the most.

Collapse Narratives Return

As social mood turns at the bear market peak and heads towards a new low, the collapse narratives will intensify. The big question is whether they are correct, rather than popular due to current mood. If you believe a grand super cycle top is underway (Prechter), or you read Tainter (see this presentation), or you read Turchin, or Strauss & Howe, or Roman history, there are a lot of collapse narratives all pointing in the same direction.

Financial Sense: Peak Civilization

Two millennia after the battle of Teutoburg, we can see how useless it was that confrontation in the woods soaked with rain. A few years later, the Roman general Germanicus, nephew of Emperor Tiberius, went back to Teutoburg with no less than eight legions. He defeated the Germans, recovered the standards of the defeated legions, and buried the bodies of the Roman dead. Arminius, the German leader who had defeated Varus, suffered a great loss of prestige and, eventually, he was killed by his own people. But all that changed nothing. The Roman Empire had exhausted its resources and couldn't expand any more. Germanicus couldn't conquer Germany any more than Varus could bring back his legions from the realm of the dead.

Civilizations and empires, in the end, are just ripples in the ocean of time. They come and go, leaving little except carved stones proclaiming their eternal greatness. But, from the human viewpoint, Empires are vast and long standing and, for some of us, worth fighting for or against. But those who fought in Teutoburg couldn't change the course of history, nor can we. All that we can say - today as at the time of the battle of Teutoburg - is that we are going towards a future world that we can only dimly perceive. If we could see clearly where we are going, maybe we wouldn't like to go there; but we are going anyway. In the end, perhaps it was Emperor Marcus Aurelius who had seen the future most clearly:

Nature which governs the whole will soon change all things which thou seest, and out of their substance will make other things, and again other things from the substance of them, in order that the world may be ever new.

Marcus Aurelius Verus - "Meditations" ca. 167 A.D.

It is difficult to know the right path, but it is possible to understand the wrong path from history. Complexity, centralization and inefficiency must be ruthlessly destroyed. An example comes in healthcare and education. If you look at spending and outcomes in those two industries, there is one clear step that would improve overall efficiency in the U.S.: slash spending. The marginal return on education and healthcare spending is negative and has been for 30 years or more. It doesn't matter what you do with the smaller sum of money, it could be wasted in the existing system or the cuts might trigger new efficiencies, but by reducing spending, resources are conserved.

Complexity destroyed retirement. Before social security, many people prepared for old age by having at least two children, in the expectation that they would care for their parents in old age. A government run system is complex and individuals do not see the need for youth to support them. Some might argue that you can save and invest if you have no children, but how would that work if everyone did the same thing? There's no one to sell financial assets to in the future. Boomers are in trouble because of low fertility rates, in addition to the fact that Millennials are more interested in cryptocurrencies and are so debt burdened that they cannot afford marriage, families and homes. Comfortable Boomer retirement could disappear starting tomorrow if the 1987 and 1929 market analogs hold up. If they manage to avoid a financial decline, they will leaves ashes in their wake.

Complexity is destroying the West, but recognizing that fact is close to impossible because the society is built on complexity, those institutions that are least needed are the most powerful and revered. Staving off collapse requires a "pre-collapse" retrenchment of economic, military and political power. The very symbols of American power, such as the wealth of Wall Street, the powerful military and ever growing Washington bureaucracy (reflected in the wealth around Northern Virginia) is a sign of American collapse. When Rome collapsed, the standard of living in many parts of the former empire went up, not down, because the farmers and hinterlands were no longer financing an empire.

What A Depression Looks Like

Depressed people don't get out of bed. Similarly, a depressed society doesn't go out shopping, but instead stays home to shop online. There are other major factors at work such as technology and central bank policies propping up asset prices, but if technology and inflated asset prices occur during an economic recovery, people go out and shop. We'd see a decline in retail, but not a collapse. This is a depression and right now we are near a peak in post-2008 economic activity. The bottom is still ahead.

ZH: Starbucks Chairman: "We Took A Walk On Madison Avenue. It Reminded Me Of The Financial Crisis In 2008"

Now, as a result of what we're witnessing, we're also seeing something else and that is, there is a proliferation around the country right now of empty storefronts. We took a walk in New York two weeks ago from 59th street to 79th on Madison Avenue, and we lost count of how many empty storefronts there were in Manhattan. It reminded me of the cataclysmic financial crisis in 2008. But what's happening is very simple, the rent structures for the last 5 to 10 years, have been rising at historic rates and retailers do not have the amount of customers they had during these last 5 to 10 years and could no longer economically survive.

So they're closing stores and as a result of this, I can promise you just like I predicted in 2014 that rents are coming down and landlords are going to have to get religion, or else their stores are going to stay empty. And we're already beginning to see a different level of reception in terms of what we believe the cost of occupancy should be. And this is going to bode extremely well, specifically for us. We're adding almost 700 new Starbucks stores a year. And so we are going to take full advantage of the economic reality of this situation. And as we go forward two, three, four, five years out even though labor is going up in terms of cost of labor, we believe rents are going down and the economic model of Starbucks is going to be enhanced as a result of this macro situation. And we're just at the beginning of this trend.

Federal Reserve: Revise Potential GDP and Declare Victory

Jeffrey Snider at Alhambra explains how America experienced a "lost decade," yet the Federal Reserve is ready to hike interest rates because it declares current conditions the new normal.

It is a gross dereliction of duty, especially where central bankers are now declaring both a deeply unsatisfactory and dangerous future as well as how that is the proper economic state. It is entirely nonsense, as the answer lies in the very place that central banks refuse to consider – the global money system. The results you see above are not unique to the United States, having been replicated all over the world. As discussed here, it is endemic in Europe as well, and can be spotted all over the emerging market world. There is nothing proper about it.

...Like it or not, we are in a depression having lost already one decade to it. The Fed raising rates is a wholly disastrous outcome because it means officials will no longer even try to do anything about it! It’s not that we want them to do more QE or come up with the next useless program, rather we require at the very least an honest and open discussion about what happened and further why it was and is unacceptable.

China's stimulus provided the global recovery and it ended in 2011. It's possible the rebound in 2016 was also the work of China's money printers. With credit tightening in China now, either the U.S. steps up credit growth or the reflation trade will likely run into the brick walls of the Marriner Eccles Building.

How the Fed Sees Itself

Alhambra: What It Means That The Fed Declares That It Is Done

That leaves the second rate hike after all that has happened, and more so what didn’t (2016 was supposed to have been a remarkable economic improvement over 2015), projecting recovery that is in no way faithful to the word – nor, I am sure, what the mainstream is still claiming about it. The FOMC just added its two cents (in the format of idle, useless bank reserves, of course) that it agrees 15 months of contraction in IP is by these orthodox definitions as good as the Fed can make it, the new baseline trend for the US economy. Despite all the wreckage that remains after almost a decade of clearly broken promises, including how malaise has infected so far as to break out in social and political unrest, they are done.

On the Edge of Historic US Dollar Bull Market

Jeffrey Snider at Alhambra has been doing the yeoman's work of explaining the global dollar deflation. His latest is here: ‘Rising Dollar’ Again To Start This Week

At FT Alphaville, Izabella Kaminska digs into how dollar shortages affect global trade financing in: Dollar shortage *alert* (plus global trade *alert*)

She relays a recent speech by Hyun Song Shin, Economic Adviser and Head of Research at BIS. The first chart below pretty much says it all though. The collapse in leverage at U.S. securities firms is the collapse in eurodollar funding which has been Mr. Snider's focus. To boil it down into the most simplest of terms, the money supply is made up of money and credit. Credit far outstrips money as a share of total money supply in nearly all modern economies. The credit created on U.S. securities firms and mega bank balance sheets in the form derivatives such as credit default swaps was the outer edge of credit supply. It collapsed in 2008.

Look at that first chart of leverage compared to this chart of credit default swaps posted by Snider in The Eurodollar Decay

Money "printing" by central banks was a drop in the bucket compared to total deflation.

The Trump win takes ongoing economic trends in the global economy and steps on the gas. Even if Trump does nothing but pursue a pro-American domestic agenda, he will achieve his trade goals because the Federal Reserve won't stop the dollar deflation. Higher interest rates, higher U.S. dollar, lower energy imports and more domestic manufacturing. If there's even a little bit of trade balancing, we could see an incredible rally in the U.S. dollar and a collapse in emerging market currencies before the cycle completes.

The index to watch is the U.S. Dollar Index. It hit a multi-year high today, intraday. We'll see if it holds or not. I expect it will based on everything I've been blogging about the past several years, but the market is final evidence. A short-term pullback in the dollar is likely, a possible handle on a large saucer bottom.

The Asian Dollar Index has broken it's long-term uptrend, fell below 105 in the past week. ADXY is calculated the opposite way of DXY, falling ADXY shows USD strength.

US dollar also consolidated for 2 years after early 1997 breakout. We are approaching 2 years of consolidation following the 2014 breakout. The long-term chart of the dollar also shows a similar pattern stretching bank 18 years. An upside breakout is imminent assuming the analog holds.

Global Dollar Shortage aka Deflation

Carmen Reinhart at Project Syndicate: The Return of Dollar Shortages

But, because numerous countries employed the same tactics in an environment in which a broad array of capital controls was in place and official exchange rates were pegged to the US dollar, a parallel currency market flourished. The black market’s premium (relative to the official exchange rate) in most European countries (and in Japan) skyrocketed through the early 1950s, reaching levels that we now tend to associate with “unstable” emerging markets.

Today, seven decades later, despite the broad global trend toward more flexibility in exchange-rate policy and freer movement of capital across national borders, a “dollar shortage” has reemerged. Indeed, in many developing countries, the only thriving market for the past two years or so has been the black market for foreign exchange. Parallel currency markets, mostly for dollars, are back.

This time, the source of the dollar shortage is not the need for post-conflict reconstruction (though in some cases that is also a contributing factor). Rather, countries in Africa, the Middle East, Central Asia, and Latin America – most notably Venezuela – have been hit very hard by plunging oil and commodity prices since 2012.

Jeffrey Snider of Alhambra comments in What Progress Looks Like

The world is finally waking up to its dollar problem, though in reality it is much, much more than that; it is a full “dollar” shortage. What will likely be most shocking to those who had subscribed to the Bernanke view is that this “dollar” condition is nearly a decade old, actually explaining why Bernanke should have been dismissed at least by the time Bear Stearns failed. The FOMC in every way demonstrated conclusively its utterly criminal incompetence because money wasn’t what they thought it was – even though that was the one task they were supposed to be totally unchallenged by.

...Central banks, especially the Fed, don’t have a printing press in their “toolkits.” They had been using the myth of the money tree to some effect for decades, Alan Greenspan the most prominent accidental “genius” maybe in world history because of it. When it counted the most, however, meaning since August 2007, a money tree has proven exactly as useful as it sounds. The “rising dollar” is and has been a euphemism for “dollar” shortage but only the latest stage of it, finally proving even to (some of) the previously obstinate orthodox faithful they have no idea what they are doing.

The next step is appreciating that they never did.

Take this view of the U.S. dollar system in deflation since 2007-ish. Then consider the renminbi has been inflating almost non-stop since then. A shortage arises when demand outstrips supply, but there are large dollar reserves in places such as China. China created massive amounts of credit all of which acts a a potential conduit for U.S. dollar flows out of China. The world needs dollars, China has them, the dollars flow, the renminbi depreciates.

Not Yuan Weakness, Dollar Strength

I expected a breakdown in the yuan not only because of inherent imbalances between credit inflation and accumulated reserves, but also due to U.S. dollar strength. Weakness in the yuan is due to the latter at the moment.

First on the imbalances. There was enough inflation baked into the Chinese monetary system for a double-digit depreciation several years ago. The situation only grows worse with the Chinese economy growing at 6 percent and credit growth at double-digits. The theoretical target price (as opposed to market price) for USDCNY is ever rising until these trends change.

China is pouring credit into a saturated market,. Like pouring water into an already filled bowl, the overflow goes somewhere, in this case into housing and outflows. As the U.S. dollar rises in relative value against other fiat currencies, the yuan rises with it. The valuation gap between Chinese assets and foreign assets widens as the currency appreciates versus much of the world, and this is on top of the high domestic inflation of prior years which has yet to be accounted for in the currency market.

The outflows to date are still mostly the result of fundamentals. Chinese investors are buying overseas assets because they're cheap and they will keep buying as long as they remain cheap. Depreciation expectations have yet to play a major role in outflows. The PBoC would like to keep it that way, but the wildcard is the U.S. dollar.

China has effectively said currency appreciation is over. The yuan flatlined versus the euro following the adoption of the currency basket at the end of 2015, and the two move in near lock-step since, albeit with less volatility for the yuan.

The U.S. dollar is fully in control here. An appreciation of less than 1 percent will push USDCNY past 6.83, erasing all yuan appreciation since the re-peg ended in 2010. Depreciation expectations have not played a large role in the market to date, but once 6.83 is taken out, technical traders will look for a breakdown. Even without any shift in expectations, if the U.S. Dollar Index moves past 100 and on to new highs, USDCNY will climb past 7. A move towards 105, 110 or even 120, and the yuan could be down 5, 10 or 20 percent without any need for depreciation expectations.

Note that if Trump wins the presidency, China will not be able to count on the U.S. export market and will have little incentive to hold down USDCNY appreciation.

Related: ‘Something’ In ‘Dollars’; August

Saudi Bleeding Dollars

Be it China or Saudi Arabia or Deutsche Bank. they are all running into problems that can trace back to the U.S. dollar.

Jeffrey Snider at Alhambra: The Dollar Perspective Matters

The Kingdom’s problem is withdrawal, as in dollars not riyals. The Interbank Offered Rate surged to its highest in seven years last week, as the government prepares to borrow under extraordinary circumstances. The placement of that debt offering is telling; it is to be a $10 billion or so Eurobond flotation. In the mainstream, Saudi Arabia’s problems are pitched as oil prices, and thus quite understandable as being their own.

When the TIC figures were updated for July, even the media began to notice that central banks including Saudi Arabia had been selling consistently for some time. In this Bloomberg article, the authors cite this trend as a risk to UST prices as perhaps another sign that “rates have nowhere to go but up”; a cliché that has been constantly deployed since 2011 and has yet to be done so appropriately.

Selling is happening in a buyers market as demand for low risk assets is high. Rates will have nowhere to go but up once the cycle bottoms and investors have better opportunities.

The same can be said of Saudi Arabia, China, and the primary dealers who are not holding bonds as their sacred American duty but hoarding collateral in a repo system that is increasingly unstable. The mainstream is going to great lengths to avoid putting the words “dollar” and “shortage” together because orthodox ideology means that cannot possibly be the case. Therefore, every financial problem around the world that can be otherwise easily distilled by just recognizing the “dollar shortage” is instead chopped up and isolated as if individual anomalies of idiosyncratic circumstances.

It’s Not Really About Deutsche Bank

As has been the typical mainstream reaction, Deutsche Bank is being written about right now in a vacuum as if the actions and behavior (and losses) of last year were left only to last year. When global illiquidity first popped up (again) in the second half of 2014, it was regarded in the same way – a series of purportedly random, unrelated events. They had to be strung together in a benign chain of distinct actions because convention still holds QE to be money printing. Ditching that convention has the effect of connecting all these dots as a logical and ongoing progression of a “rising dollar” that is really a euphemism for “dollar shortage.”

And it really doesn’t take too many dots to connect. This isn’t to say that Deutsche Bank is in danger of a wholesale liquidity run, only that the bank is perhaps far closer to it than anyone in the mainstream will ever admit. As I wrote last year, it really isn’t even about Deutsche Bank.

U.S. Oil Demand Overstated By 16pc

ALhambra: More Bad Economic News From The Oil Patch

When oil prices first crashed starting in late 2014 and really January 2015, commentary was filled with the words “supply glut.” Particularly related to US fracking as the biggest contribution to non-OPEC growth, the intent in using those words almost exclusively was to downplay the possible negative implications of a serious commodity crash (especially what was causing it) given that such crashes are monetary by nature. At most, there would be some words expressed about economic “concerns”, but for the most part oil prices were purported to be the victim of too much success.

A year and a half later, supply remains a problem but focus has finally shifted toward demand, though not by choice. And it is here that the IEA’s latest forecasts have hit oil views hard. First, OECD oil inventories continue to climb, hitting a new record of 3.11 billion barrels in July even though, “refinery activities reached a summer peak, crude oil inventories refused to decline.” Now, however, refineries are starting to reject additional crude supplies, forcing the IEA to reduce its 2016 forecast for coming refinery runs to the “lowest rate in a decade.”

Depression: Hanjin Goes Bankrupt

Reuters: Hanjin Shipping files for receivership, as ports turn away its vessels

South Korea's Hanjin Shipping Co Ltd (117930.KS) filed for court receivership on Wednesday after losing the support of its banks, setting the stage for its assets to be frozen as ports from China to Spain denied access to its vessels.

Banks led by state-run Korea Development Bank (KDB) withdrew backing for the world's seventh-largest container carrier on Tuesday, saying a funding plan by its parent group was inadequate to tackle debt that stood at 5.6 trillion won ($5 billion) at the end of 2015.

Hanjin Shipping, South Korea's biggest shipping firm, announced the filing for receivership and a request to the court to freeze its assets, which the Seoul Central District Court planned to grant, a judge told Reuters, declining to be named.

Slowdown in Private Investment a Long-Term Trend

Bloomberg: No Need to Be Alarmed by China Private Investment Crash, Say Analysts

Investment numbers this year aren’t completely comparable with 2015 because they include firms that recently migrated from the private to the state sector, says Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington. Research firm Rhodium Group and economist Louis Kuijs at Oxford Economics Ltd. have spotted the same discrepancy.

“Policy makers and the market should not worry unnecessarily about misleading data purportedly implying a scary sudden divergence in 2016 between private and non-private investment,” Kuijs said in a report last week.

Response:

Even if you wave away the increase in SOEs as a statistical blip not caused by government stimulus efforts, you still have the long-term trend. Total FAI was growing at 20 percent in July 2013, 16 percent in July 2014, 10 percent in July 2015, 4 percent in July 2016. All trends come to an end, but right now this one says July 2017 FAI growth will be below zero.

The slowdown in Chinese investment matches the persistent deterioration in global economic data. Here's U.S. total vehicle sales, monthly, year-on-year change. The slowdown and trend looks very much like the China and global commodities slowdown.

Retail sales are one of the bright spots in the U.S. economy:

The argument from the bulls is that the collapse isn't accelerating, but they have yet to say when the now 5-year slowdown will end.

Chinese Real Estate Sector Has Turned, Economy to Follow

An article from the China Finance 40 Forum covering China's real estate market has lots of good charts. The second one below is the most important. It shows real estate investment as a share of GDP, falling and then picking up. In 2015, real estate investment slowed to 1 percent and in 2016, it is slowing a again, down to 5.3 percent YTD. Real estate investment grew faster than GDP at the start of 2016 though, to reach its highest share of GDP since 2013. This propped up Chinese GDP in the first half, but a downturn is already underway.

This next chart shows the turn in sales growth and then price (dotted line, NBS 70-city survey) clearly. The second shows real estate area under construction and prices (dotted line, NBS 70-city survey).

This chart shows the Chinese real estate cycle. A decline in prices should begin in the next month or two, followed by a drop in investment. Real estate investment fell to 1.4 percent growth in July 2016 and the slowdown hasn't even really begun yet.

And former three different cycles, 2015 to start sales and housing prices do not rise quickly bring new construction area. Until the end of 2015, new construction area is still negative growth year on year, real estate development and investment amount are at historic lows.

This is partly due to the country's overall housing stock market is still in the accumulation of business prospects for the real estate industry to determine differences, on the other hand is due to lack of developer's own investment capacity.

By the end of 2015 the real estate industry, the average asset-liability ratio of 70%, far higher than other industries. Excessive leverage at developers make operating conditions more difficult in the market downturn. The real estate industry average ROE of 8% in 2010 fell to 5% in 2015, interest coverage fell from 4 to 2.5 times. Even after sales picked up in 2015, Days sales outstanding also largely used to repay debt rather than invest further.

Until the end of 2015, real estate companies listed on the current ratio and quick ratio have rebounded, showing short-term debt burden eased. 2016 first quarter real estate development funds grew 15%, ending two consecutive years of single-digit growth in real estate investment rebound quickly, the performance of new construction area in April cumulative increase of 21.4%, real estate development and investment in the amount of the cumulative increase of 7.2%.

Speaking of the relationship between credit and real estate:

As the real estate investment plays an important role in GDP growth, while real estate prices and rental costs will be passed to end enterprise thus affecting the overall price , thus creating a mutual feedback effects (Figure 7 between the real estate cycle and interest rates in the credit cycle shown). When monetary policy easing, buyers get a boost demand for new loans and rising sales area, within a few months of real estate investment and housing prices rose, led directly to GDP and is conducted to the overall price.

According to experience, the CPI within six months after the formation of the inflection point of monetary policy began to shift, interest rates (or interest rates) cycle lasts several months to a year (Figure 8). When the CPI upward for some time, monetary policy tightening, the incremental credit contraction, real estate sales and prices, real estate investment decline put pressure on economic growth, price slowdown (or even deflation), then trigger another round of currency policy easing. Overall, since 2006 behind the wheel of the real estate cycle is the credit cycle.

The message is a stark warning for China:

Summary and Outlook

After the export-led economic growth mode is terminated, the role of real estate investment in China's GDP growth in the increasingly prominent. The real estate cycle is driven by credit policy since 2008, including the total amount of the monetary policy and macro-prudential policies for the real estate. Although the short term do not see the CPI and monetary policy shift upward signs, but the downside is the interest rate has also been limited. Considering the skyrocketing housing prices in some cities and residents purchase loans surge, macro-prudential policy for the real estate market has clearly turned.

In the medium term, to the economic downturn and expected future revenue growth slowdown does not support a substantial increase in the household sector continued to leverage, which means increased demand for home loans is likely to have peaked.

Whether from the policy level or demand perspective, the real estate market turning point has come, the last two quarters of promoting economic stability factors will soon disappear. Real estate investment growth will slow or even negative growth in the fourth quarter and bring downward pressure on the economy next year.

iFeng: 机构：房地产市场拐点已经到来 投资增速或负增长

This was exactly the warning sent by Liaoning in 2014. It relied on real estate investment to drive economic growth following the commodities slowdown (which began in 2011), but once that market slowed too, it was game over. Liaoning Shows Path to Chinese Recession, Global Depression

There's nothing particularly special about Liaoning beyond its reliance on basic industries. Instead of a slowdown spread out nationally, it is concentrated in a few provinces. Yet in its use of real estate and government-led fixed asset investment, Liaoning is like most provinces. The same strategy is deployed all over China, it simply wasn't enough in Liaoning because the slowdown in the "real" economy was so great and so long, now running into its 5th year.

If I am wrong, then Liaoning is a special case of a long-term concentrated slowdown. Other provinces will not see a similar economic depression and will be able to paper over their recessions with real estate and fixed investment for a few years, by which time the economy will have recovered.

If I am correct and the slowdown works through the rest of the economy, many provinces will end up in a situation similar to Liaoning because fixed asset and real estate investment was the only play in the stimulus playbook since 2008. Provinces with more diversified economies can manage for a time, but eventually they too will see the core economy weaken and investment collapse.

We are months away from seeing the effects of the latest real estate slowdown and Liaoning sends a stark warning for any province relying on real estate to make up for real economic shortfalls. Once real estate investment declines, the bottom drops out:

The world is in the middle of a slow motion depression unfolding over years instead of months. There's no evidence any of the current trends are reversing. China's national real estate investment will eventually follow Liaoning and move into contraction, followed by fixed asset investment, followed by GDP. It could take another couple of years to unfold if the markets continue discounting the decline in global economic activity, but eventually the moment of realization arrives. The central bank created fog will lift, revealing the global economic depression.

Related posts on Liaoning.