by Michael Pento,
1/19/16
The S&P 500 has begun
2016 with its worst performance ever. This has prompted Wall Street apologists
to come out in full force and try to explain why the chaos in global currencies
and equities will not be a repeat of 2008. Nor do they want investors to
believe this environment is commensurate with the Dot.Com Bubble that caused
the NASDAQ to plummet 78% and the S&P 500 to shed 35% of its value. In
fact, they claim the current turmoil in China is not even comparable to the
1997 Asian Debt Crisis: when dollar-denominated debt loads couldn’t be repaid
and the Thai baht lost half its value, and the stock market dropped 75%.
Indeed, the unscrupulous
individuals that dominate financial institutions and governments seldom predict
a down-tick on Wall Street, so don’t expect them to warn of the impending
global recession and market mayhem. But a recession has occurred in the U.S.
about every five years on average since the end of WWII; and it has been seven
years since the last one-we are overdue. Most importantly, the average market
drop during the peak to trough of the last 6 recessions has been 37%. That
would take the S&P 500 down to about 1,300; if this next recession were to
be just of the average variety.
But this one will be
worse. A major contributor for this imminent recession is the fallout from a
faltering Chinese economy. The megalomaniac communist government has increased
debt 28 times since the year 2000. Taking that total north of 300% of GDP in a
very short period of time for the primary purpose of building a massive
unproductive fixed asset bubble. Now that this debt bubble is unwinding, growth
in China is going offline.
The renminbi’s falling
value, cascading Shanghai equity prices (down 40% since June 2014) and
plummeting rail freight volumes (down 10.5% y/y), all clearly illustrate that
China is not growing at the promulgated 7%, but rather isn’t growing at all.
The problem is China accounted for 34% of global growth, and the nation’s
multiplier effect on emerging markets takes that number to over 50%. Therefore,
expect more stress on multinational corporate earnings as global growth
continues to slow.
But the debt debacle
in China is not the primary catalyst for the next recession in the United
States. It is the fact that equity prices and real estate values can no longer
be supported by incomes and GDP. And now that QE and ZIRP have ended, these
asset prices are succumbing to the gravitational forces of deflation. The median
home price to income ratio is currently 4.1; whereas the average ratio is just
2.6. Therefore, despite record low mortgage rates, first-time home buyers can
no longer afford to make the down payment. And without first-time home buyers,
existing home owners can’t move up.
Likewise, the total
value of stocks has now become dangerously detached from the anemic state of
the underlying economy. The long-term average of the market cap to GDP ratio is
around 75, but it is currently 110. The rebound in GDP coming out of the Great
Recession was artificially engendered by the Fed’s wealth effect. Now, the
re-engineered bubble in stocks and real estate is reversing and should cause a
severe contraction in consumer spending.
Nevertheless, the solace
offered by Wall Street is that another 2008 style deflation and depression is
impossible because banks are now better capitalized. However, banks may find
they are less capitalized than regulators now believe because much of their
assets lie in Treasury debt and consumer loans that should be significantly
underwater after the next recession brings unprecedented fiscal strain to both
the public and private sectors. But most importantly, even if one were to
concede financial institutions are less leveraged; the startling truth is that
Businesses, the Federal Government and the Federal Reserve have taken on a
humongous amount of additional debt since 2007. Even Household debt has
increased back to its 2007 record of $14.1 trillion. Specifically, Business
debt during that time-frame has grown from $10.1 trillion, to $12.6 trillion;
the Total National Debt boomed from $9.2 trillion, to $18.9 trillion; and the
Fed’s balance sheet has exploded from $880 billion, to $4.5 trillion.
Banks
may be better off today than they were leading up to the great recession but
the government and Fed’s balance sheets have become insolvent in the wake of
their inane effort to borrow and print the economy back to health.
As a result, the Federal
Government’s debt has now soared to nearly 600% of total revenue. And the Fed
has spent the last eight years leveraging up its balance sheet 77:1, in its
goal to peg short-term interest rates at zero percent.
Therefore, this
inevitable, and by all accounts brutal upcoming recession, will coincide with
two unprecedented and extremely dangerous conditions that should make the next
downturn worse than 2008.
First off, the Fed will
not be able to lower interest rates and provide any debt service relief for the
economy. In the wake of the Great Recession Former Fed Chair, Ben Bernanke,
took the overnight interbank lending rate down to zero percent, from 5.25%, and
printed $3.7 trillion and bought longer-term debt in order to push mortgages
and nearly every other form of debt to record lows. The best the Fed can do now
is to take away its 0.25% rate hike made in December. Secondly, the Federal
Government increased the amount of publicly traded debt by $8.5 trillion, an
increase of 170%, and ran $1.5 trillion deficits to try to boost consumption
through transfer payments. Another such ramp up in deficits and debt-which are
a normal function of recessions after revenue collapses–would cause an interest
rate spike that would turn this next recession into a devastating depression.
It is my belief that in
order to avoid the surging cost of debt service payments on both the public and
private sector level, the Fed will feel compelled to launch a massive and
unlimited round of bond purchases. However, not only are interest rates already
at historic lows, but faith in the ability of central banks to provide
sustainable GDP growth will have already been destroyed given their failed
eight-year experiment in ZIRP and QE. And adding $1.5 trillion dollars per year
to the $19 trillion U.S. debt won’t be taken well by the bond market either.
Therefore, the ability of government to save the markets and the economy this
time around will be extremely difficult, if not impossible. Look for chaos in
currency, bond and equity markets on an international scale throughout 2016.
Indeed, it already has begun.
http://affluentinvestor.com/2016/01/this-is-not-2008-its-actually-worse/
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