Unpublicized Risks to Global Economy and Financial Markets
by Victor Sperandeo with the Curmudgeon
Introduction:
Victor identifies several risks that the mainstream print and
on-line media have either ignored entirely or have not objectively disclosed
and discussed. The Curmudgeon notes the
problems US banks are facing as they add to loan loss reserves and continue to
experience profit pressures from low interest rates (yes, the Fed is way behind
the curve). Victor concludes with words
of wisdom for your portfolio and a conundrum of a quote for all of us to
ponder.
Analysis of Unpublicized Risks:
1. Derivative Exposure:
This is perhaps the biggest risk to the world economy, yet it's
rarely if ever mentioned by the mainstream media. Why not? From the excellent July 21st
presentation by Greg Weldon, "Understanding the Real Value of Gold in
Today's Market" (subscription required):
"The International Monetary Fund /The World Council
(IMF/TWC) estimate of the (worldwide) Gross Derivative Notional value ranges
from a low of $630 Trillion to a high of $1,200 Trillion.”
Curmudgeon Notes:
1. As of March 31, 2016,
Citigroup alone had over $55.6 Trillion in total derivatives according to this post.
2. According to a CBS Marketwatch blog
post by Sue Chang:
"Funds invested in derivatives alone total
$1.2 quadrillion. In fact, there is more money in derivatives than in all the
stock markets combined, which is a comparatively paltry $70 trillion.
As for money owed by every single person and
country in the world, the grand total is $199 trillion, with some 29% of it
borrowed since the 2008 financial crisis."
Who will cover the losses if derivatives blow up and cause a
chain reaction? The FDIC (US) couldn't even cover 0.0001% of the low estimate!
The high estimate is $1200 trillion or $1.2 Quadrillion. Do you get the picture?
Any mistakes by global governments and/or central banks would
make the 2008 financial crisis look like a picnic. In particular, Lehman Brothers could have
been saved with “only” $60 Billion? What
would it take now to “fix” an avalanche of derivative blow-ups by large global
banks?
Also note that total world debt is $199.0 Trillion, according to
IMF/TWC. How much of that might be
defaulted on? One can see that a small
problem with debt and/or derivatives could have monstrous ramifications for the
global economy.
2. The China built
Islands in South China Seas:
These are manmade islands that China claims as their own,
despite territorial claims from other Asian nations. The Hague international court tribunal ruled
against China, but Beijing's rejected the ruling.
So what is the end result? Economic, or a “hot war” seems like
the only possible outcomes. As the
latter is not likely, the West vs the East could be involved in an arduous
economic battle.... That seems like the endgame.
A boycott of China goods by the Western countries would be
horrendous for world trade and might result in a depression. What else can
global governments do against a nation with 1.4 billion people and an estimated
260 nuclear warheads?
→China island building and its control over disputed
territories could turn into a world problem of horrendous significance at any
time on any day.
3. The EU will likely break-up:
Another European nation that asks for a referendum to
"leave" will cause turmoil as contagion of Brexit spreads.
Consider the next French presidential election which is
scheduled to be held in April and May 2017. The current front runner is Marine Le Pen (who
thinks like Donald Trump), head of France’s far-right National Front party. Le Pen has said she will ask the French
people to vote on pulling out of the EU if she is elected president in
2017. With an approval rating that's
almost triple incumbent President Francois Hollande, Le Pen is likely to be
elected France's next president.
The French people are applying for gun licenses at never before
seen rates (they don't have a 2nd Amendment like in the US).
If France leaves the EU, there will not be an EU anymore. Thereby, it is highly likely the EU experiment is a dead nation
walking within a year. How that might affect the global economy is anyone's
guess, but it's not likely to be a pretty picture.
4. ECB (Euro-zone
Central Bank) Public Backstop for Non-Performing Loans:
The ECB is buying all kinds of debt within Europe at the rate of
80 billion euros per month. When ECB
President Draghi was asked if it included NPL's (Non-Performing Loans), he said
"if they would follow the rules."
Draghi told
reporters last week that a public backstop for NPLs would be
“very useful,” laying out a potential three-pillar approach that would include
regulatory supervision, legislation that would allow the development of a
“fully functioning NPL market” and the possibility of a public backstop.
So the ECB will be buying debt that is in default? The world is
burning, and being destroyed, and we can now see similarities to Nero (Rome
Emperor in 64 AD who played the fiddle when 70% of Rome was destroyed by fire).
It should also be noted that all the countries in the EU will
now have to pay more in taxes to belong to “CLUB EU.” This is why other EU
country departures will result in government budget problems.
5. US Dollar Rises:
As yields of 10 year notes hit all time historic lows (e.g.
Germany sold a 10 year note at a negative yield on July 13th), the
US still has a positive yield on its sovereign debt. Therefore, foreign investors are buying
dollars to buy US Treasury notes and bonds.
The rise in the dollar is causing commodities to decline along with
emerging market (EM) debt.
Curmudgeon Note: US multinational company profits will be hurt
by a stronger dollar. And that's after
five consecutive quarters of NEGATIVE year over year earnings reported by
S&P 500 companies (most of which are multinationals).
6. 1920 Germany-like set-up:
Talk of a "cashless society" and "negative
interest rates" continues unabated, even though those policies have
effectively failed. When something
doesn't work, why keep trying more of same? Isn't that one definition of
insanity?
Also, "Helicopter Money" and/or Perpetual Bonds
(non-marketable bonds with no maturity date and no yield have been bought by
the BoJ from the Japanese government).
The Curmudgeon noted that in last week's post: “I have
never seen such a mania in global government bonds (especially the $10T in
negative yields, BoJ buying perpetual JGBs, and 30 year US T bond yielding <
½ of its pre-financial crisis all time low yields).”
These and similar schemes are all listed in the history of world
manias, best chronicled in the famous book "Extraordinary Popular
Delusions and the Madness of the Crowds," by Charles McKay. To understand today's economic environment, I
suggest you read/re-read this book.
7. The Middle East
Wars:
This problem has improved somewhat, but the area is still a
tinderbox that could explode at any time.
Curmudgeon Note: There are regional conflicts or civil wars
ongoing in Syria, Iraq, Yemen, Libya, Egypt (despite military strong man
President el-Sisi's iron grip on that nation). Let's also not forget hostilities due to
Hamas' control of Gaza and recent Palestinian attacks in Israel.
Turkey is a more recent example of flare ups. The NATO member
country is now in a state of emergency after a failed coup attempt that left
many dead and scores more injured. That
followed a meticulously planned ISIS
terrorist attack at Turkey's principal airport in Istanbul. Turkey holds
~50 Nuclear Bombs owned by the US.
-->What would happen if those bombs were to fall into the hands of
a terrorist inspired group?
8. Italian Banks on
the brink of collapse?
Italian banks are in terrible shape. They are struggling with a burden of bad debt
and loans that are unlikely ever to be repaid fully. Any recession, due to Brexit or other causes,
could bring down a big Italian bank.
At his most recent monthly press conference, ECB head Draghi
(formerly Italy's finance minister) backed a public bailout of Italy’s troubled
banks “in exceptional circumstances.”
That's even as he hailed the Euro-zone for its resilience in the
aftermath of Britain’s decision to quit the EU and left interest rates on hold.
Curmudgeon Comment: Draghi continues to talk the talk that the
ECB will do “whatever it takes to save……..???”
9. Central Bank
Incompetence:
Goldman Sachs former employees are running Central Banks in
England (BoE's Mark Carney), the Euro-zone (ECB's Mario Draghi), and the New
York Fed (Bill Dudley). These Keynesians are all thinking alike. As we have
seen recently, they’ve guessed very wrong on monetary policy. The UK has voted to leave the UK, the
Euro-zone is not growing despite massive ECB QE and negative interest rates,
while the Fed has been whipsawed on "raising rates" vs not
"raising rates.”
Are all these bankers going to be wrong at the same time? We'll
see, but if one fails they all will in my humble opinion.
…………………………………………………………
Curmudgeon Add-on Risk -- Deteriorating Health of US Banks:
It's been said that a strong economy and financial markets
depend on a solid banking system. It's
ironic that US financial markets have soared to epic mania proportions at the
EXACT time that the US banking system is getting weaker!
The Saturday, July 23rd Wall Street Journal (on-line
subscription required) reported that US big banks are putting more money away
to cover possible losses on consumer loans. Lenders including JP Morgan
Chase & Co., Wells Fargo & Co., Capital One Financial Corp. and
Discover Financial Services said on earnings calls this month that they have
bolstered their reserves—in some cases for the first time in years—to prepare
for an uptick in loan losses.
Capital One said Thursday that it added $290 million in reserves
for its domestic credit-card business, a move that was driven both by growth in
customers’ outstanding balances and by the expectation that more would
default. The bank also added to auto-loan reserves, partly because of
growth in loan volume that included a higher portion of sub-prime borrowers.
The bank said that this year it has increased auto lending to borrowers with
lower credit scores.
Saturday's Journal also noted that US banks’ profit
margins on loans are falling again after a brief boost from the Federal
Reserve’s rate increase late last year. Net
interest margin, a measure of how much a bank earns from the difference
between what it pays on deposits and what it takes in on loans and investments,
fell at all six of the largest US retail banks by assets that reported 2nd
quarter earnings this month. At those
lenders— JP Morgan Chase, Citigroup, Bank of America, Wells Fargo, US Bancorp
and PNC Financial Services Group —the profitability metric or the most
comparable figure dropped to 2.62% in the 2nd quarter from 2.67% at
the end of 2015. The figure is at or below where it was at all but one of the
banks when the Fed announced its rate increase in the fourth quarter.
Regional banks’ profitability is expected to stay under pressure
if rates remain low. The Curmudgeon has
repeatedly stated that ultra-low short term interest rates hurt banks, savers,
retired folks living off interest income.
They also encourage all sorts of financial engineering by companies
to artificially boost their stock prices.
Richard Davis, CEO of Minneapolis- based US Bancorp, last year
likened his bank’s situation waiting for interest rates to rise with the last
few grueling moments of a gym-class test, hanging on a pull-up bar for 90
seconds.
Last week, on a call with investors, Mr. Davis extended the
bar-hang analogy further, saying that with rates staying lower for longer, the
bank is now “grimacing like crazy. Both the knuckles are white. But we’re
hanging in there.”
The Curmudgeon wonders how long banks can “hang in there,”
before one or more fails and needs another government bail-out or “bail-in?”
…………………………………………………………
Victor's Conclusions:
Many other risks (to the global economy and financial markets)
are present, but those described above are the most important currently. At least as far as I'm concerned. However, information alone won't help your
portfolio -only diversification and Gold.
Let's end with the brilliant words
of Ruben Blades- Panamanian singer, song
writer, actor and activist:
"I think we risk becoming the best informed society that
has ever died of ignorance."
Good luck and till next time...
The
Curmudgeon
ajwdct@sbumail.com
Follow the
Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has
been involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a
historian, economist and financial innovator who has re-invented himself and the
companies he's owned (since 1971) to profit in the ever changing and arcane
world of markets, economies and government policies. Victor started his Wall Street career in 1966
and began trading for a living in 1968. As President and CEO of Alpha Financial
Technologies LLC, Sperandeo oversees the firm's research and development
platform, which is used to create innovative solutions for different futures
markets, risk parameters and other factors.
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Curmudgeon and Marc Sexton. All rights reserved.
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