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Are We Entering an Earnings/Sales Recession?
Are We Entering an Earnings/Sales Recession?
Are corporate profits due for a retest of the lower channel line? If so, what happens to equity valuations when corporate profits plummet?
Is the U.S. economy in recession? Is it heading for recession? These questions can only be answered in hindsight, but it’s worth looking for clues to what might be just ahead.
Longtime correspondent B.C. recently submitted a chart of corporate earnings and one of real demand and time deposits (a measure of money) and real final sales.
(Explanation of demand deposits).
Unsurprisingly, all three of these metrics tank in recessions.
Corporate profits have been hugging the upper line of a long-term channel for years.
While real final sales have not yet plunged to recession levels, the annual change in real demand and time deposits has fallen into negative territory.
While the annual change in demand and time deposits has swung between positive and negative for decades, the annual change in real final sales only enters negative territory in recessions.
While the two series don’t align perfectly, there is a clear correlation between the expansion of money supply and sales.
For this reason, the recent decline in demand and time deposits might serve as an early warning of an impending drop in real sales to recession levels.
Corporate profits have remained in a rising channel for 85 years, with one exception: the Global Financial Meltdown of 2008-09.
Interestingly, all three recent equity bubbles–in 2000, 2007 and the current bubble–align with corporate profit peaks above the upper channel line.
Are corporate profits due for a retest of the lower channel line? If so, what happens to equity valuations when corporate profits plummet? These questions may be answered later in 2016.
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Money Velocity Is Crashing–Here’s Why
Money Velocity Is Crashing–Here’s Why
The inescapable conclusion is that Fed policies have effectively crashed the velocity of money.
That the velocity of money has been crashing while the money supply has been exploding doesn’t seem to bother the mainstream pundits. There is always a fancy-footwork explanation of why whatever is crashing no longer matters.
Take a look at these two charts and tell me money velocity doesn’t matter.First, here’s money supply: notice how money supply leaped from 2001 to 2008 as the Federal Reserve pumped liquidity and credit into the economy, and then how it exploded higher as the Fed went all in after the Global Financial Meltdown.
Now look at a brief history of the velocity of money. There are various measures of money supply and various interpretations of velocity, but let’s set those quibbles aside and compare money velocity in the “golden era” of the 1950s/1960s and the stagflationary 1970s to the present era from 2008 to 2015–the era of “growth”:
Notice how the velocity of money remained in a mild uptrend during both good times and not so good times. The inflationary peak of 1979-1982 (Treasury yields were 16% and mortgages were 18%) generated a spike, but velocity soon returned to its uptrending channel.
The speculative excesses of the dot-com era pushed velocity to unprecedented heights. Given the extremes in velocity, it is unsurprising that it quickly fell in the dot-com bust.
The Federal Reserve launched an unprecedented expansion of money, credit and liquidity that again pushed velocity up in the speculative frenzy of the housing bubble. But note that despite the vast expansion of money supply, the peak in the velocity of money was considerably lower than the dot-com peak.
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Is This How the Next Global Financial Meltdown Will Unfold?
Is This How the Next Global Financial Meltdown Will Unfold?
In effect, a currency crisis is simply the abrupt revaluation of the currency to reflect new realities.
I have long maintained that the structural imbalances of debt and risk that triggered the Global Financial Meltdown of 2008-2009 have effectively been transferred to the foreign exchange (FX) markets.
This creates a problem for the central banks that have orchestrated the “recovery” by goosing asset bubbles in stocks, real estate and bonds: unlike these markets, the currency-FX market is too big for even the Federal Reserve to manipulate for long.
The FX market trades roughly the entire Fed balance sheet of $4.5 trillion every day or two.
Currencies are in the midst of multi-year revaluations that will destabilize the tottering towers of debt, leverage and risk that have propped up global growth since 2009.
Though the relative value of currencies is discovered in the global FX market, there are four fundamental factors that influence the value of any currency:
1. Capital flows into and out of the currency (and the nation that issues the currency).
2. Perceived risk, specifically, will this currency preserve my global purchasing power (i.e. capital) or erode it?
3. The yield or interest rate paid on bonds denominated in this currency.
4. The scarcity or over-abundance of the currency.
If we dig even deeper, we find that currencies reflect the income streams and assets of the issuing nation. Consider the currency of an oil exporting nation that has seen both its income from selling oil and the underlying value of its oil in the ground fall by more than 50%.
Why shouldn’t that nation’s currency decline in parallel with the erosion of income and asset valuation? As a nation’s income and asset base decline, there is less national income to pay interest on sovereign bonds, less private income to tax, and a reduced asset base for additional borrowing.
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The Next Financial Crisis Won’t be Like the Last One
The Next Financial Crisis Won’t be Like the Last One
It seems increasingly likely the next Global Financial Meltdown will arise in the FX/currency markets.
Central banks are like generals: they tend to fight the last war. The Great Financial meltdown of 2008 was centered in too big to fail, too big to jailtransnational banks and other financial entities with enormous exposure to collateral risk (such as subprime mortgages), highly leveraged bets and counterparty risk (the guys who were supposed to pay off your portfolio insurance vanish in a puff of digital smoke, leaving you to absorb the loss).
In response, the central banks and treasuries of the major economies “did whatever it took” to save the private banking sector from insolvency and collapse. In effect, central banks launched a multi-pronged bailout of banks and other financial heavyweights (such as AIG) and hastily constructed a clumsy and costly Maginot Line to protect the now-indispensable private banks from a similar meltdown.
The problem with preparing to fight the last war is that crises arise not from what is visible to all but from what is largely invisible to the mainstream.
The other factor is what’s within the power of central banks to fix and what’s beyond their power to fix. Correspondent Mark G. and I refer to this as the set of problems that can be solved by printing a trillion dollars. It’s widely assumed that virtually any problem can be fixed by printing a trillion dollars (or multiple trillions) and throwing it at the problem.
Yes, the looming student-loan debacle can be fixed by printing a trillion dollars and paying down a majority of the existing student debt.
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A Major Bank Just Made Global Financial “Meltdown” Its Base Case: “The Worst The World Has Ever Seen”
A Major Bank Just Made Global Financial “Meltdown” Its Base Case: “The Worst The World Has Ever Seen”
When it comes to the epic bubble in China’s economy, it really boils down to one – or rather two – things: a vast debt build up (by now everybody should be familiar with McKinsey’s chart showing China’s consolidated debt buildup) leading to a just as vast build up of excess capacity, also known as capital stock accumulation. And/or vice versa.
It is how China resolves this pernicious, and self-reinforcing feedback loop, that is a far greater threat to the global economy than even what happens to China’s bad debt (China NPLs are currently realistically at a 10-20% level of total financial assets) or whether China successfully devalues its currency without experiencing runaway capital flight and a currency crisis.
One bank that is now less than optimistic that China can escape a total economic meltdown is the Daiwa Institute of Research, a think tank owned by Daiwa Securities Group, the second largest brokerage in Japan after Nomura.
Actually, scratch that: Daiwa is downright apocalyptic.
In a report released on Friday titled “What Will Happen if China’s Economic Bubble Bursts“, Daiwa – among other things – looks at this pernicious relationship between debt (and thus “growth”) and China’s capital stock. This is what it says:
The sense of surplus in China’s supply capacity has been indicated previously. This produces the risk of a large-scale capital stock adjustment occurring in the future.Chart 6 shows long-term change in China’s capital coefficient (= real capital stock / real GDP). This chart indicates that China’s policies for handling the aftermath of the financial crisis of 2008 led to the carrying out of large-scale capital investment, and we see that in recent years, the capital coefficient has been on the rise. Recently, the coefficient has moved further upwards on the chart, diverging markedly from the trend of the past twenty years. It appears that the sense of overcapacity is increasing.
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Future Shock and the Greening of America
Future Shock and the Greening of America
What I find fascinating is our limited ability to make sense of trends unfolding in real time.
During our recent breakfast meeting in Berkeley, author/blogger Jim Kunstler suggested that the coherence of eras waxed and waned, and the present era was incoherent. By this he meant the narratives being propagated by the status quo no longer align with reality, and often conflict with one another, resulting in incoherence.
There is a time lag of many years between fast-changing events and our ability to make sense of them, i.e. construct a coherent account or narrative of what we collectively experienced.
Each era has its Big Events and trends, but the last era with truly ground-shifting changes that affected virtually everyone in the nation in one way or another was the 1960s. 9/11 increased airport security but other than that, the changes wrought by the Global War on Terror (GWOT) only heavily impact narrow slices of the state and populace–the armed forces and security agencies.
The same can be said of the Global Financial Meltdown of 2008-09: the Zero Interest Rate Policy (ZIRP) destroyed the yield on savings, but the daily-life effects on most people have been relatively restrained compared to far more disruptive eras; some have seen their portfolios skyrocket in value, but most households have seen their real net worth decline. Social welfare did its job of providing a safety net for those who lost their jobs in the recession.
The 1960s visibly changed society in a few short years, and less visibly, the economy. Two books published in 1970, at the end of the tumultuous 1960s, attempted to weave a coherent narrative of what everyone was experiencing: Future Shock and The Greening of America.
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