Monday, February 24, 2020

No, The Fed Will Not "Save the Market"--Here's Why

The greater the excesses, speculative euphoria and moral hazard, the greater the reversal.
A very convenient conviction is rising in the panicked financial netherworld that the Federal Reserve and its fellow dark lords will "save the market" from COVID-19 collapse. They won't. I already explained why in The Fed Has Created a Monster Bubble It Can No Longer Control (February 16, 2020) but it bears repeating.
Contrary to naive expectations, the Fed's primary job isn't inflating stock market and housing bubbles, though punters are forgiven for assuming that, given the Fed has inflated three gargantuan bubbles in a row, each of which burst (1999-2000, 2007-08 and now 2019-2020).
The Fed's real job is protecting the banking/financial sector from a richly deserved and long overdue implosion. Blowing speculative asset bubbles is a two-fer, enabling rapacious, parasitic financiers and banks to profit from debt-serfs borrowing and gambling in rigged casinos (take your pick: student loan casino, housing casino, stock market casino, commodities casino, currency casino, etc.).
Blowing guaranteed-to-burst bubbles also generates a bogus PR cover, the Fed's beloved "wealth effect," an idiots' delight belief that the greater the speculative bubble, the more tax donkeys and debt serfs will spend, spend, spend on defective junk and low-value services they don't need--in essence, speeding up the global supply chain from China et al. to the local landfill, all in service of Corporate America profits.
The Fed's secondary interest is maintaining some measure of control over the financial sector and the real-world economy it ruthlessly exploits. Just as the Fed gets panicky if interest rates start getting away from its control, the Fed also gets nervous when its speculative bubbles get away from it via infinite moral hazard:
When punters no longer care whether the Fed actually intervenes or not, so powerful is their faith in eventual Fed "saves," the Fed has lost control and that's not what the Fed wants.
The Covid-19 pandemic is a godsend to the world's central bank, the Fed. Recall that the Fed has a dual mandate: protecting U.S. financiers and banks and global financiers and banks. The Fed thus has the equivalent of Triffin's Paradox, the dual role of the U.S. dollar as a domestic currency and as a global reserve currency.
The two roles are not always compatible and conflicts may arise, requiring sacrifices to keep the entire overheated machine from coming apart.
To re-establish the essential linkage between punters' speculative greed and its actual interventions, the Fed must let the current euphoric faith in its "guarantee" to rescue infinite greed crash to Earth. As noted earlier, the Fed lords are foolish but not stupid. They understand speculative bubbles always pop, and so the Covid-19 pandemic is just the excuse they needed to let the air out of the current grossly unsustainable bubble.
"Buy-the-dip" punters are placing bets on the belief the Fed can't possibly let the current bubble pop. Oh yes they can and yes they will. All bubbles pop. That leaves the Fed with an unsavory choice: either be viewed as responsible for the bubble bursting or engineer some fall-guy to take the blame and give the Fed cover for its self-serving incompetence.
It's also instructive to note, as many have, that the Fed enters this global recession with very little policy ammo. Interest rates are so near zero already that a couple of rate cuts will do very little good in the real economy. As for buying Treasury bonds, this is also overblown; at the rate U.S. Treasury debt is rising, all the Fed will be doing is sopping up fiscal-deficit debt nobody else wants.
For all the brave bleatings of Fed luminaries about negative-interest rates being the "cure" to all that ails the precarious global economy, Japan and Europe have effectively proven that negative interest rates only further cripple the banking sector while doing essentially nothing to boost spending in the landfill economy.
All negative-interest rates accomplished was further boosting speculative bubbles and wealth inequality, which threatens to destabilize the social order--something the Fed cannot control.
Panicky punters expect the Fed to blow its wad on saving their hides, but what would that leave the Fed for the real recession that's just getting underway? Nothing. Would the Fed lords be so short-sighted and stupid to blow their last ammo just to save speculatively-insane punters from the inevitable bursting of a moral hazard-driven bubble? In a word, no.
As I suggested last week, When Bubbles Pop, Only the First Sellers Escape Being Bagholders (February 21, 2020). There is a great deal of recent history on how bubbles arise and burst that's worth studying. The Covid-19 pandemic promises to be much more consequential than the run-of-the-mill financial excesses of the past 20 years, but we already know one important thing: All bubbles pop.
We also know this: the greater the excesses, speculative euphoria and moral hazard, the greater the reversal.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Sunday, February 23, 2020

When Will We Admit Covid-19 Is Unstoppable and Global Depression Is Inevitable?

Given the exquisite precariousness of the global financial system and economy, hopes for a brief and mild downturn are wildly unrealistic.
If we asked a panel of epidemiologists to imagine a virus optimized for rapid spread globally and high lethality, they'd likely include these characteristics:
1. Highly contagious, with an R0 of 3 or higher.
2. A novel virus, so there's no immunity via previous exposure.
3. Those carrying the pathogen can infect others while asymptomatic, i.e. having no symptoms, for a prolonged period of time, i.e. 14 to 24 days.
4. Some carriers never become ill and so they have no idea they are infecting others.
5. The virus is extremely lethal to vulnerable subpopulations but not so lethal to the entire populace that it kills its hosts before they can transmit the virus to others.
6. The virus can be spread by multiple pathways, including aerosols (droplets from sneezing/coughing), brief contact (with hotel desk clerks, taxi drivers, etc.) and contact with surfaces (credit cards, faucets, door handles, etc.). Ideally, the virus remains active on surfaces for prolonged periods, i.e. 7+ days.
7. Those infected who recover may catch the virus again, as acquired immunity is not 100%.
8. As a result of this and other features, it's difficult to manufacture a vaccine that will reliably protect against infection.
9. The tests designed to detect the virus are inherently limited, as the virus may be present in tissue that isn't being swabbed.
10. The symptoms of the illness are essentially identical with less contagious and lethal flu types, so people who catch the virus may not know they have the novel pathogen.
As you probably know by now, these are all characteristics of Covid-19, and this is why it is unstoppable. As we now know, millions of people left Wuhan while the epidemic was raging in January, spreading the virus throughout China and the world via hundreds of airline flights to other nations.
As noted here before--no data doesn't mean no virus. Even in the U.S., facilities do not have test kits, for example: No one in Hawaii has been tested for coronavirus as health officials wait for kits from CDC (2/20/20).
The situation in developing nations is similar: few if any test kits, which are not 100% reliable and so multiple tests may be required, and so there is no means to ascertain who is a carrier. No data doesn't mean no virus.
It's impossible to string together a benign narrative that includes these reports:
If we asked a panel of business executives to imagine a global system optimized for vulnerability to external shocks, they'd likely include these characteristics:
1. Long global suppy chains, four, five and six layers deep, so those in the top layers have no idea where parts and components actually come from.
2. Just-in-time deliveries and limited inventories dependent on complex logistics, so any shock quickly disrupts the entire network as key nodes fail.
3. A global supply chain dependent on hundreds of financially marginal factories and suppliers who do not have the means to pay employees for weeks or months while the factory is idle.
4. A global supply chain dependent on hundreds of financially marginal factories with high debts and expenses that will close down and never re-open.
5. A global consumer economy dependent on the permanent expansion of debt.
6. A global financial system with extremely limited capacity to absorb defaults as suppliers and zombie corporations (i.e. companies dependent on ever-greater borrowing to survive) fail.
7. A global economy burdened with overcapacity.
8. A global economy dependent on "the wealth effect" of rising stock and housing markets to fuel spending, so when these bubbles burst spending evaporates.
These are precisely the characteristics of our precarious global economy, dependent on rising debt, vast speculative bubbles, vulnerable supply chains and marginal consumers and producers.
As noted here before, it doesn't take much to break a system dependent on ever-rising debt and speculation. This chart illustrates the dynamic: when debt loads, speculative bets and expenses are all at nosebleed levels, the slightest decline triggers collapse.
Put another way: the global system has been stripped of redundancy and buffers. A little push is all that's needed to send it over the edge.
Given the exquisite precariousness of the global financial system and economy, hopes for a brief and mild downturn are wildly unrealistic. The global economy is falling off a cliff, and calling it a "recession" while debt and speculative excesses collapse is a form of denial.
When debt and speculative excesses collapse, it's a depression, not a recession. If we can't call things by their real name then we guarantee a wider, deeper cataclysm.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Friday, February 21, 2020

When Bubbles Pop, Only the First Sellers Escape Being Bagholders

Hapless bagholders have two options: buy the dip and be destroyed, or hang on hoping for a reversal and be destroyed.
One often overlooked characteristic of the current stock market bubble is the extremely small exit for sellers trying to avoid becoming hapless bagholders. Bubbles always present small exits because once sentiment turns, buyers vanish and so price goes over the waterfall and crashes on the rocks below (accompanied by the screams of all the punters who reckoned they'd exit at the top).
But modern markets have characteristics which have diminished the exit to a tiny hole in the wall. These include:
1. The dominance of index funds. When shares of the index are sold, every constituent stock gets sold. This triggers cascades of selling that overwhelm "buy the dip" buying.
2. Computers do most of the trading, and the algorithms are set to follow trends with extreme ferocity. Once the trend is "sell," the program selling will self-reinforce the cascade.
3. Central banks have generated a mesmerizing moral-hazard propaganda field that implicitly suggests "we'll never stocks go down again, ever!" Yet the only way central banks can causally intervene is to buy stocks directly in size, i.e. in the trillions of dollars. (Recall U.S. stocks are around $35 trillion, global stock markets about $85 trillion. Yes, buying futures contracts through proxies works in stable markets, but not so much in panic cascades of selling.)
Beneath the illusory stability, modern markets are extremely illiquid, meaning that when the bubble pops and punters/money managers try to sell, there are no buyers at any price.
Liquidity in a crash depends on "buy the dip" bagholders. Once they've been destroyed, there are no more buyers at any price. The "buy the dip" crowd will be wiped out after the first spike higher fails, and then nobody will be left who's willing to catch the falling knife.
It's illuminating to go back to to former Federal Reserve chairman Alan Greenspan's 2014 belated bleatings in Foreign AffairsWhy I Didn't See the Crisis Coming. Greenspan presented one primary reason: the Fed's models failed to accurately account for "tail risk," (otherwise known as things that supposedly happen only rarely but when they do happen, they're a doozy), because guess what--they happen more often than statistical models predict.
"Tail risk" is a fancy way of saying that bagholders willing to buy the dip and be destroyed as the crash gathers momentum are too scarce to stop the waterfall of selling. That leaves everyone with a long position in stocks with a binary choice: either grasp the fleeting advantage of selling out in the first wave of selling--and by the way, there's no advantage unless every single share is sold--or become a hapless bagholder.
Hapless bagholders have two options: buy the dip and be destroyed, or hang on hoping for a reversal and be destroyed. Bubbles always burst, and the confidence that "this isn't a bubble" and "the Fed has our back" are counter-indicators of just how crushing the pop will be: the greater the confidence/euphoria, the greater the crash.
All those drunk on "the Fed has our back" punch might want to ponder the Fed's balance sheet: nine weeks of going nowhere:
12/25/19 $4.165 trillion
1/1/20 $4.173 trillion
1/8/20 $4.149 trillion
1/15/20 $4.175 trillion
1/22/20 $4.145 trillion
1/29/20 $4.151 trillion
2/5/20 $4.166 trillion
2/12/20 $4.182 trillion
2/19/20 $4.171 trillion
Sober up, people. All bubbles pop, and the higher the extreme, the greater the crash. Only the first sellers will escape; everyone who hesitates or "buys the dip" will be crushed at the bottom of the waterfall.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Thursday, February 20, 2020

Covid-19: Global Retrenchment Will Obliterate Sales, Profits and Yes, Big Tech

If you think global demand will rebound as global debt and confidence implode, you better not be making consequential decisions based on Euphorestra-addled magical thinking.
Even before the Covid-19 pandemic, the global economy was slowing for two reasons: 1) everybody who can afford it already has it and 2) overcapacity. One word captures the end-of-the-cycle stagnation: saturation.
Everyone who can afford a smartphone (or can borrow to buy one) already has one. Everyone who can afford an auto loan already has a car. Everyone who could afford an overpriced house already bought one. Everyone who can afford a tablet or laptop already has one. And so on.
This saturation isn't just in the consumer market--the corporate market is equally saturated. Corporations leased too much space, bought more cloud services than needed, increased headcount willy-nilly, and increased capacity just as the market for their goods and services stagnated from global saturation of markets and debt.
Paint-daubed members of the Keynesian Cargo Cult (paging Chief Humba-Humba Paul Krugman) love to claim that "debt doesn't matter" but in their frenzied dance around the campfire they ignore one little feature of debt: interest. In a world in which money is borrowed into existence, all new money issuance and all new debt (the same thing) accrues interest.
And as Japan has proven, even if the interest rate is near-zero, if you borrow relentlessly enough, the interest due even on near-zero interest rates soon dominates your entire income.
The Keynesian Cargo Cult, busy with their rock radios (the dials are painted on), ignore the sad reality that marginal borrowers default because they can't afford to make the principal payments, never mind the interest, and the inevitable result is cascading defaults throughout the financial system.
It's not just marginal borrowers who blow up; marginal lenders also blow up as all the loans they issued to marginal borrowers blow up.
Then there's overcapacity. Yes there are shortages such as pork in China due to the spread of Swine Fever, but in one manufactured commodity after another, there is more capacity than customer demand.
This is a permanent feature of a globalized economy awash in cheap money. On my first visit to China in 2000, TVs were in massive oversupply as production had ramped up just as every household already had a TV. Thin profits turned into massive losses.
Two other features of a globalized economy awash in cheap money are 1) too much debt and 2) complete destruction of discipline. Consumers, governments and corporations have all borrowed and spent on a grand scale, abandoning financial prudence in favor of a euphoric fantasy (encouraged by central banks) that the cycle of expansion would never end.
This global hubris was begging for a comeuppance, and Covid-19 has toppled the world's precarious dominoes. A retrenchment that was long overdue has started, and everyone who works for a company or lives in a nation that does business with China--either relying on China for parts, manufactured goods, tourists, students, etc., or as buyers of imported goods and services--is about to retrench whether they want to or not.
As I explained earlier, desire is a much shakier motivation than need. Aspirational desire for a higher-status good or service to replace the one you already have is a manifestation of confidence and certainty. When certainty dissolves into uncertainty and confidence in the near future melts into air, spending arising from the wispy fantasies of aspirational desire dries up.
The number of people who can't live without a new smartphone, vehicle, tablet, subscription to content, etc. is far, far smaller than pre-pandemic sales. And since profits flow from the marginal buyers of goods and services, profits are about to implode across the global economy.
Big Tech will not be immune to this implosion of profits. Corporate leadership runs in herds just like consumers, and so corporations hired too many people, signed too many leases, rushed into cloud services and borrowed too much money to buy back shares, a.k.a. "create shareholder value."
Just as everyone who can afford a car already has one, every company that wanted cloud services already has cloud services. All the Big Tech giants that have been soaring on expectations of endless 20% quarter-over-quarter growth in their cloud services will find growth crash to 1% or even go negative: as corporate sales and profits plummet, so does the need for more cloud services.
The fat in bloated household and corporate budgets will have to be trimmed, and fast. Headcounts will have to be slashed, marketing budgets burned to the ground, leases on empty space dumped and so on. Does all that online marketing actually work? Well, actually, no, not when consumers retrench.
Households will soon be grabbing their iPhones to delete all subscriptions: settings -> your name -> subscriptions -> cancel, cancel, cancel. People will look at the hundreds of dollars they're blowing on streaming content they rarely use and cancel Netflix et al. en masse. Even sacrosanct Amazon Prime and Costco memberships will be cancelled as people share accounts.
The global economy based on 20% quarter-over-quarter growth in everything will implode as growth slows to signal noise levels (1%) or goes negative. Valuations based on 20% quarter-over-quarter growth forever will flame out and crash to Earth.
Everyone expecting 20% quarter-over-quarter growth to return in the second quarter is going to find that the crash from the crazy high of Hopium and Euphorestra is devastating. Phones last a long time and so do vehicles. Profits that vanished like mist in Death Valley do not start gushing again as the entire world retrenches.
The dominoes have just started to fall: economies dependent on tourists from China are imploding, companies dependent on components made in China are imploding, companies dependent on sales made to Chinese households and enterprises are imploding, and so on.
Do you really think Amazon fulfillment warehouses have 12 weeks of every item in inventory? Are you joking, or just delirious from a high-ball of Hopium and Euphorestra? The global supply chain has been disrupted four layers deep: you think that assembly plant in Vietnam is unaffected, when 50% of the parts being assembled are sourced from China?
If you're confident the containers from China will soon be offloading at Long Beach in two weeks, you better check your meds. And if you think global demand will rebound as global debt and confidence implode, you better not be making consequential decisions based on Euphorestra-addled magical thinking.
My COVID-19 Pandemic Posts


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