Author : John E. Charalambakis
Date : December 8, 2014
We live in a delusion. We face a sea of risks and we contemplate if we need more debt. This is like asking a diabetic if he needs more sugar. The global economic system faces a good chance of collapse in the foreseeable future and we are wondering if Draghi’s moral suasion can turn the tables, or if a 25 bps increase in short term rates could kill the growth prospects. This is just absurd. I am looking for existential disruptors that can awaken us all.
Since the financial crisis a temporary ceasefire has been set that resembles the demarcation line; however the real causes (see numerous previous commentaries on the subject) have not been addressed. We resorted to measures that ballooned central banks’ balance sheets and now we believe that through more monetary manipulations (reverse repos) we can buy more time. We may, but a drunk driver going at 140 mph also faces a destiny, which is not bright. The dizzy heights of the dream world called debt-creation are ultimately consuming the life out of the markets.
Unencumbered by that height we have created a nightmare of endless hunger that has no boundaries. As Polish poet Jacek Dehnel wrote: “Specters rise outside in the shadows, darkness comes to visit at my windows.” This is not about secular stagnation – as we have noted before – but rather about such a fragile system (geoeconomically and geopolitically) destined to inflict such bitter pain whose dawn mist will be glowing with tears converted into waterfalls. The time is coming to start preparing and checking spare tires. At least this is what we (Blacksummit) plan to do, especially after the second half of 2015, without of course sacrificing potential measurable gains.
I would dare to say that we live in an era of distorted market nationalism. As Isaiah Berlin wrote: “nationalism seems to me to be the strongest force in the world today…nationalism enslaved its rivals, and reduced them to relative impotence. German romanticism, French socialism, English liberalism, European democracy were compromised and distorted by it. They proved powerless against the torrent of nationalist pride and greed…Those who discounted its strength and especially those who thought that they could harness it to their own purposes, failed to predict events, and their adherents were punished accordingly.” A distorted market nationalism where central banks are thought to be omnipotent and the ultimate deus ex machina will bring exactly what extreme nationalism has done to geopolitics, i.e. destruction.
In the last several weeks we observe efforts to be made to move the demarcation line of the distorted market nationalism. Those efforts can be seen in energy prices as well as in shaky currency markets led by the Russian ruble. Both have lost about 40% since the start of the year, and there are doubts that they have seen the bottom yet. Currency turmoil is historically associated with political instability. Thus we should not be surprised if Venezuela, Nigeria, Mexico, Brazil (among others), experience political turmoil while Russia reverts to a policy of escalating confrontation with the West.
On one hand, lower energy prices reduce production costs and act as a booster to incomes. From that perspective they are positive contributors to growth prospects. On the other hand, they can become market disruptors. We only hope that the disruption they are causing will enhance the stability of the disequilibrium, which is the objective while it will also encourage addressing the causes of the fragile system. Lower oil prices can become effective and productive market disruptors in a few ways. Let me name just five:
First, they can financially squeeze developing nations which depend on oil prices to the effect that they suffer from Dutch disease that has distorted their economies and created capital misallocations while enhancing political regimes that only care for cronies. Of course, fiscal crisis may lead to much needed political change but with Russia things could be unpredictable. The squeeze also on their corporate and financial institutions may have effects on the western lenders and the complex world of counter-party risks. If those risks can be managed, declining oil prices could contribute to the disruption desired.
Second, exuberant oil revenues will not be recycled to support unsustainable asset prices. Hence, market distortion and capital misallocation through artificial valuations may be reduced given that credit overextension supported through energy contracts’ collateralization will be reduced. I expect this to be a lower risk and much healthier (than the one above) market disruption.
Third, the lower volume of petrodollar recycling will affect the trading of bonds (the big bubble of private and public debt), and thus it may assist in rates normalization and the beginning of the end of financial repression.
Fourth, the US growth locomotive could be assisted by EU and Chinese growth prospects due to lower energy prices. The market disruptions described above, may even force the bureaucracy of the EU and of the Chinese to some market reforms and deregulations that could unleash entrepreneurial activity.
Fifth, the drop in oil prices changes the dynamics in the Middle East. Production and budget estimates of Middle East countries show that at current levels only Saudi Arabia may be able to sustain its programs in the short to medium term. Knowing that the area is a cup of turbulence, the disruptions brought by lower oil prices may bring desired changes in the sense of weakened regimes. However caution is needed in case that despots in Moscow and Tehran join forces.
We believe that 2015 will be a watershed year for the markets that need more than one disruptor which will shake things up, rock the boat of debt creation and superficial valuations, and allow the causes of the crisis-to-come to be addressed.
Soren Kierkegaard chose for his epitaph the words “that individual.” The existential philosopher wanted to distinguish the individual from the stereotypes that characterize the masses. Kierkegaard desired to understand the individual existence within a conceptual scheme where the former is not secondary to the concept/scheme. Universal schemes represent inadequate attempts to grasp individual existence which always evades complete conceptualization. What exists comes first. In a similar manner we cannot lose sight of the individual risks engineered by monetary manipulations. All these individual risks culminate into a debt-bomb and any metaphysical rationalization by the central banks cannot wave its existence that threatens to unravel financial and economic systems unless we return to anchors that can guide our sailing.