Friday, July 3, 2015

Hard-landing Scenario Is Not Out Of The Question

Will You Be Able To Walk Away?
The game of life is both confusing and complex, this is especially true when it comes to the financial part of our lives. Those who watch closely will notice that even small changes in the laws and rules can have a big impact. A lot of strange almost bizarre theories are floating around. If we step back, take a deep breath, then try to sort out what is really happening in the economy we find great uncertainty. Many of the investments people make are predicated on the idea that if the economy fails we will have a soft-landing, or if it does crash the result will not be fatal.

The idea the economy will simply be able to adjust and grow its way out of our current funk and muddle along is based on a view of history that often overlooks the many who have "lost it all" in prior periods of economic chaos. As we focus on the fact the system always moves forward we tend to forget how it has a way of sacrificing many investors for the "better good", this is fine if you are not one of those being sacrificed. This means we should not be blind as to other less optimistic scenarios concerning our economic future. A key assumption of the current "escape velocity" mantra is that we have all the time in the world to deal with our problems, it discounts the notion that forward progress may at any time be fouled by events often beyond our control. This feeling all is well is strengthened by the government's optimistic projections and numbers that fail to recognize how another recession could skew future tax revenue and cause spending to soar.

Computer Screen Of Inaccessible Sites!
To the left is an image posted on a web site on the morning of Monday June29th, this was at a time concern over a default by Greece ran high. It shows dozens of servers as being "inaccessible" and is an indication of how fast things can lock-down when things turn ugly. Take this as a warning and solid reminder that we must not allow ourselves to become complacent and think we have plenty of time to take action. In our modern world of instant communication  it is becoming increasingly common that options can vanish in a blink of an eye. If we wait too long we may find all doors close and there is no place to hide.

A person watching closely as the deadline approached for Greece renegotiating its dept with the Euro-zone noted that many people reading about money coming out of the Greek banks were wondering why any money was still even left in these accounts. He went on to say "It is simply another Greek tragedy that so many of the local depositors were merely waiting until just after the last minute to withdraw their funds before joining those already busy hoarding fuel and food." The financial default of Greece could be the thing that fuels the fire that finally brings down the house. If it does not, the light from the flames will surely illuminate and expose the fact that similar flaws and massive debts exist in many other countries across the world.

The more and more I study derivatives it now appears the main goal of QE may have been to hold up the underlying value of assets that feed into and support the massive derivative market more than help the economy. QE has up to now stopped an implosion of derivatives and the resulting contagion and shock that would have spread throughout the financial system. The irony is how little of this money has reached Main Street in a constructive way while the damage to savers has been massive. While the Fed has essentially abolished the most basic rules of macro-economics do not be surprised if the natural laws of economics show their dominance over Yellen and others who dare to toy, tinker, and write a new script.

It appears complex and strong crosscurrents may be about to converge and knock the implicit assumption of the escape velocity off its axis. The theory that we have plenty of time and that another recession does not loom anytime in the future is rooted and based on the momentum model of economic growth.  It rests on the idea we will experience a trend of ever growing year over year increased production. The problem we face today is much of this recovery has been constructed on the unstable base of false demand. The easy money policies and artificially low interest rates of the last seven years has simply moved demand forward and created a slew of economic activity that is unsustainable in what would be considered a normal economic environment. This tends to distort prices and lead to overbuilding that often abruptly comes to a painful end.

Just how far off course we have moved becomes clear when we look at the service trades which cater to the top 10% of consumers which account for 40% of total consumption spending and 85% of financial assets. Please note jobs reports should be viewed as a lagging indicator, but in the present US business world that is dominated by stock market obsession it has been elevated much as it was in the run-up to 2008. Many people are "over-inventorying" labor by believing that the stock averages are forecasting higher sales and demand around the corner. We are currently at the highest ratio of business inventories to final sales since October 2008 in part because low interest rates make it easy to stock more goods with little carrying cost. When the markets finally break, we may again witness a hard landing driven by the dual liquidation of excess labor and stockpiled goods.

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