Time for the survivalist kit: Global imbalances herald the coming recession

Listening to the mainstream media in the autumn of 2016, it seems that only two things could put a spanner in the works of the slow, but steady central bank engineered recovery: a Hard Brexit or a Trump White House.

At the risk of sounding the alarm bells, we see the world in a different light: political risks are many and financial imbalances around the world will inevitably lead to recession: years of capital mis-allocation caused by central bank-induced artificial credit expansion needs the corrective effects of recession, to allow the means of production to be re-allocated and applied in a way that is reflective of actual consumer demand. This process is painful, and likely the next phase will be even more so than the 2008 Global Financial Crisis (GFC).

To start with politics and the upcoming US elections: despite the mainstreams fear of a Trump victory, we believe Hilary Clinton poses a greater threat to the world. This is not only because her hawkish stance on foreign policy is much more likely to lead to confrontation with Russia, but also because her domestic platform of higher taxes, more regulation and higher minimum wage is detrimental to an already fragile US economy.

It is of course not only in the US that politics pose a threat to stability. In Europe, the extremes of the political spectrum are steadily gaining power, and while we are certainly no advocates against the inevitable decline inherent in the compromise-seeking social democratic consensus, parties like Italy’s 5-star Movement, Greece’s Syriza, Spain’s Podemos or France’s Front Nationale all pose an immediate threat to the status quo.

But the real source of worry come from large-scale economic and fiscal imbalances building up across the world. We have earlier commented on the bad debt time bomb in China, where a massive, government led credit expansion is bound to lead to a catastrophic end.

Across the East China Sea, the pioneers of monetary extremism in the Bank of Japan have introduced every perceivable measure to kick-start a moribund economy – so far without success, despite a quarter of a century of experimenting. The only tangible results are negative interest rates that allows the government to engage in large-scale, resource-wasting fiscal profligacy.

Closer to home, negative government bond yields are now also commonplace in Europe: even Spain can borrow money for 2 years and get paid to do it. The ECB is creating a massive bubble in government debt, where ultimately the only end buyer will be the ECB itself. Most other market participants are not in it to lock in a loss, but are only looking for a bigger fool to buy at an even lower yield. Even some corporates have been able to borrow at negative rates. The monetary central planners in the ECB have effectively begun to destroy functioning capital markets in Europe. At the same time, they are signing the death warrant of a weak European banking sector, who will struggle to survive in a negative yield curve environment. Deutsche Bank may be the first to buckle.

In the US, the Federal Reserve has for years targeted asset prices in a futile attempt to use wealth effects to jolt the economy into life. US stock markets are massively overvalued, and the only catalyst for further gains is more monetary accommodation from the central bank. A scary chart clearly shows  the reliance of US equity markets on Fed support.

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Despite hawkish talk and market expectations for a December rate hike, we believe the Fed will soon be forced to reverse course and increase accommodating measures, whether interest rate cuts or QE4.

On these shores the Bank of England has followed the new central bank consensus by cutting rates aggressively and implementing a large-scale QE programme. The most obvious effect, and a favourite British topic to rival the weather, is the sky-rocketing property market. After the massive correction (outside London) in 2008, house prices are now almost back where they were before the GFC, even adjusted for the (slow) rise in earnings. London has left pre-GFC levels far behind.

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And even with rock bottom interest rates, in place for more than 7 years, affordability of housing is lower than it has been for most of the last quarter century. It is not hard to imagine what will happen if (when) interest rates eventually rise.

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Nowhere near an exhaustive list, these are just some of the bubbles we have observed being blown up by years of artificial credit expansion across the world. We have quoted Ludwig von Mises before, but it is worth repeating his words that “there is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

If only that was the end of the story. But sadly, for years it has been recognised that the Western world is sitting on a demographic time bomb, as the worker-to-retiree ratio continuously drops without any political will to address the issue of over-generous pension promises. On the contrary, here in the UK, the Cameron government introduced the so-called ‘pension triple lock’ in a blatant bribery of the large, voting and conservative pensioner constituency. It is easy to pretend the problem doesn’t exist, but we can’t run away from ageing…

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Threats abound, yet mainstream media talk is only of recovery, not of renewed recession. Students of the Austrian economic school will know that recession is coming. The depth of the crash will be proportional to the size the bubbles. And the bubbles have never been larger.

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