The signs of deflation are now flashing all over the globe. In our estimation, the possibility of an associated financial crisis is now dangerously high over the next few months.
As we’ve been saying for a while, our preferred model for how things are going to unfold follows the Ka-Poom! Theory as put out by Erik Janszen of iTulip.com.
That theory states that this epic debt bubble will ultimately burst first by deflation (the “Ka!”) before then exploding (the “Poom!”) in hyperinflation due to additional massive money printing efforts by frightened global central bankers acting in unison.
First an inwards collapse, then an outwards explosion. Ka-Poom!
We’ve been tracking the deflationary impulse for a while, and declared deflation the winner back in July of this year.
A Failed Strategy
What exactly do we mean by deflation? Back in 2008 the central banks of the developed world, as well as China, had a choice:
- admit that prior policies geared towards encouraging borrowing at a faster rate than income growth were a horrible idea, or
- double down and push those failed policies even harder
As we all know, they chose option #2. And so here we are, just 8 years later, with nearly $60 trillion in new debt piled on top of the prior mountain — while GDP grew by only $12 trillion over the same time period:
In other words, instead of saying to ourselves: Hmmm…. it was probably a terrible idea to pile up debt at 2x the rate of income growth, what the world did instead was to double down on that terrible idea and pile on more debt at 5x the rate(!) of nominal GDP growth.
Talk about not learning from your past mistakes….
So here we are. What are we to make of it all? It’s our view that the financial markets are important to monitor because they will signal to us when sentiments has shifted, and events start unfolding at a faster pace.
Judging from the market action over the past month, we think that shift has happened. And we’re increasingly concerned that this next ‘correction’ could be pretty rough for a lot of folks.
Bright Red Warning Lights
The global economy is downshifting fast, and there are lots of flashing red warning lights indicating as much.
Doug Noland has captured the emerging market pain caused by the hot money that is now flooding out of those territories, as well as provided a great explanation of the bubble dynamics in play:
The Federal Reserve is flailing and global currency markets are in disarray. Notably, the Brazilian real dropped more than 10% in five sessions, before Thursday’s sharp recovery reversed much of the week’s loss. This week the Colombian peso dropped 3.0%, and the Chilean peso fell 3.1%. The Mexican peso dropped 1.9%.
The Malaysian ringgit sank 4.5% for the week, with the South Korean won down 2.7% and the Indonesia rupiah losing 2.2%. The Singapore dollar fell 1.8%. The South African rand sank 4.4% and the Turkish lira fell 1.4%.
Notably, market dislocation was not limited to EM. The Norwegian krone was hit for 4.4%, and the Swedish krona lost 2.0%. The British pound declined 2.3%. The Australian dollar also lost 2.3%.
The global Bubble is bursting – hence financial conditions are tightening. Bubbles never provide a convenient time to tighten monetary policy. Best practices would require central bankers to tighten early before Bubble Dynamics take firm hold. Central bankers instead nurture and accommodate Bubble excess. It ensures a policy dead end.
As the unfolding EM crisis gathered further momentum this week, the transmission mechanism to the U.S. has begun to clearly show itself. While “full retreat” may be a little too strong at this point, the global leveraged speculating community is backpedaling. Biotech stocks suffered double-digit losses this week, as a significant Bubble deflates in earnest. It’s also worth noting that the broader market underperformed.
What does it mean when we see currencies in retreat across the globe? It means that the hot, speculator money is rushing out of weaker economies and back towards the stronger center. This is consistent with a liquidity crisis, one where all the borrowed money used to spark all those heady asset gains and falling yields on the way out do the exact opposite on the way back.
And Doug is exactly right – there’s never a good time to pop a bubble. So the central bankers just sits, paralyzed, afraid to even raise rates by a token amount for fear that the daisy-chain of global bubbles will burst as a result. They needn’t fear: the bubbles will burst no matter what the Fed does.
Full article: Deflation Warning: The Next Wave (Peak Prosperity)