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 a
its 2007 record of $14.1 trillion. Specifically, Business debt during that
timeframe 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.
