Are we there yet?
110 weeks ago

Are we there yet? A view of the Quantitative Easing world

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As a business historian who is the middle of writing two business histories, one for a bank and another for a think tank I am taking more than a passing interest in the state of the world economy right now as writing contemporary history is always a challenge and most books finish with the now.

So, as I try and decipher what’s going on in the world of finance, business, politics, nations and peoples I thought I’d share my thoughts to date in layman’s terms via a short chronology.

Week 1, 1-9 Jan

Happy New Year? I think not.

Martin Wolf started out by saying: ‘The US and Europe still live with the legacies of the financial crisis of 2007-09 and the subsequent Eurozone crisis.’ I thought to myself, so do I and plenty of other small businesses.

Wolf goes on to note that: ‘GDP remains far below what might have been expected from pre-crisis trends mainly because of declines in productivity growth.’

Coming from Australia I can understand this. Australians feel that we dodged a bullet during the GFC but all we dodged was fronting up to our own complacency, expecting and getting our governments to bribe voters with cash handouts and no cuts to anything . . .so now we’re in a state of smug delusion. The music has stopped (i.e the resources boom) yet most people are acting like Zombies…denying there’s any revenue problem, demanding their rights to government subsidised health, education and welfare not wanting to face the facts. There’s less money now than there has been even prior to the GFC. Ross Garnaut has captured this brilliantly in his book Dog Days, well worth reading.

Then I get a reminder about 2008-09. The US Government alone spent ‘an initial $US430 billion’ bailing out the ‘troubled’ banks while the UK ‘laid out £133 billion. Of course now there’s all these tougher capital requirements, and that’s supposed to stop the profligacy that occurred in the banking sector leading up to the GFC.

The only problem with this is that CDOs are still out there, derivatives, especially in oil, are way out there, the oil price is tanking (pun intended) and, according to those who know ‘someone is taking a ‘huge position on oil prices’.

Week 2, 10-16 Jan

By all accounts US$159 billion of emerging market debt matures this year but the increase in US interest rates will make this harder for these countries to pay it off.

The S&P 500 looks unimpressive and ‘perhaps a bit concerning’. You’re telling me.

Earnings growth has been negative, profit margins are also declining and firms remain reluctant to invest in capital spending. Well, wouldn’t you if you were a business whose shareholders are demanding their usual dividend payments even though this is unsustainable. I call this the greed of the Baby Boomers. Dam you next generations . . .we’re going to make sure we suck everything we can throughout our lives. Makes sense really. This generation’s parents did the hard yards, they’ve had it easy. It’s my 20-year old son whose got your measure . . .which is why the Millennials don’t trust you at all. Sorry Hillary.

Uberisation is happening everywhere and the S&P is the ‘old world’. Not sure about this? Read on.

 Around 80% of the companies in the S&P500 were in the index in 2011 but this dropped to 50% in 2006 and a mere 30% in 2016. Projections from Koda Capital expect about half the companies currently listed on the S&P500 could be gone by 2021, ‘killed’ by the technology change. Notice they say killed not disrupted. Getting older is never easy.

Week 3, 17-23 Jan

Some of the facts come out.

The week starts with reports about the market having the ‘heebie jeebies’, well at least that I can understand. Then the global chief investment strategist for BlackRock says ‘the market is manic depressive’. That I get too, but in markets? This doesn’t sound good and even he admits they don’t really understand what’s going on with oil. Phew, I thought it was just me.

As it turns out Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate as much as 60% of today’s crude oil price is pure speculation driven by large trader banks and hedge funds. OK, so now I kind-of get this…I’ve learnt a bit having watched The Big Short and 99 Homes recently. It goes something like this. The oil price is, well the oil price but not really. There are ‘players in the market’ (hedge funds) who are speculating on the price of oil through the derivatives market. They’re just placing speculative bets of the price of oil. Because I’ve seen The Big Short I now understand this. If you haven’t, watch it, and watch carefully the scene where Selena Gomez is at the casino and explains what a synthetic CDO is.

Then you’ll get this. Does it make me feel any better knowing that a few derivatives traders are playing the world? Yes. Can I do anything about it? No.

On top of this there are, apparently, covenant -lite loans (which sounds suspiciously like the dodgy CDOs that cause the GFC in the first place) account for more than half of all loans in the leveraged lending space up from 20% 5 years ago. By my reckoning that’s not good.

So, we’ve gone back to loose lending standards which encourage investors to take more risk.

Oh, and now there’s concern about the $200 trillion worth of debt that’s going to ‘unwind’ and this is potentially really bad for the emerging economies, and for the developed world because large emerging markets still account for 70% of global growth. Read: the world economy won’t be growing at anything kind what the projections are for some time to come.

 Oh, (again) and then China stuffed-up its intervention in the market, but it’s under pressure to stop a massive outflow of money. Everyone, including the Chinese are worried about this, other than Australian property developers who LOVE the flow of Chinese investors into the Australian property market and so, secretly do property owners because this has fuelled yet another property boom here in Sydney and Melbourne.

 Week 4, 24-30 Jan

I thought Australia Day (26 January for those not living in Australia) was going to provide some relief I was wrong. Davos –that group-hug for the world’s elite that happens in a small town in the Swiss Alps – made sure my Australia Day was sober in all senses of the word.

 George Osborne (British Chancellor) summed up the start of 2016 succinctly as a ‘hazardous mix of global risks’, while the head of an un-named FTSE company said ‘they were all keeping a watching eye for now to see if it was still a problem come Monday.’ REALLY? Still a problem on Monday? What did he think was going to happen between Saturday and Monday to ‘fix it’?

Not so clearly, I think he was referring to the fact that Moody’s had placed 120 oil companies on a downgrade review. Now the oil story starts to grab everyone’s attention. I thought, just what is the oil story?

And, we were all reminded about the ‘bearish sentiment’ spreading through world markets, $US 7.8 trillion was wiped off the value of global stocks in the first three weeks of the year. Whoo hoo I thought can it get worse . . . apparently a repeat of the 2008-09 recession is a ‘big stretch’. I don’t think soooooo.

Phrases like ‘Latin America and tepid growth’, ‘Russian economy shrinking by at least 2%’, ‘Nigeria needs World Bank support’ and ‘China is struggling to manage lower growth’ are starting to appear with all too regular frequency.

Week 5, 31 Jan-6 Feb

Headline on 4 February: ASX loses $32 billion in worst day of 2016. We’ve only had little over a month of 2016! BP reports a $US6.5billion loss for 2015, Asian markets are down, Nigeria is seeking more funds from the World Bank, sovereign wealth funds are liquidating their assets and the global situation is considerably worse than initially envisaged and central banks are unable to combat deflation.

But lower oil prices are great for consumers, right? Yes, but lousy for the producers and will caused untold damage to the North American energy companies if it goes below $US30 and many will be in danger of default and bankruptcy. Saudi Arabia doesn’t care, it’s pumping out as much of the stuff as it can, Russia is too– it needs the revenue as much as Iran, who is now back in the world market.

Ahh, but the low oil price isn’t really good. Stay with me here. The larger developing countries that rely on oil revenues are under strain and in danger of political upheaval. This is especially so in the Middle East where the social compact between the rulers and their populations has been funded by oil revenue. Several Middle East countries are already being supported by Saudi oil revenues. With young populations either uneducated, under-educated or over-educated and in faux jobs, political unrest across the Middle East is not far away. This is not a good scenario give the parlous state of the Middle East right now.

Week 6, 7-12 Feb

By now I am pretty exhausted.

If losing $36 billion on 4 Feb wasn’t enough the ASX loses another $40 billion on 10 February. There are fears that lenders around the world will be hit by higher funding costs (thanks to all the stuff-ups and rip-offs of the GFC), rising bad debts due to exposure to commodities, slower growth from emerging economies. The whole Deutsche Bank scenario looks really worrying: a €6.89 billion loss for 2015 and €2 billion for the 4th quarter . . .and ‘the market reckons 2/3rds of its loans are impaired’.

 But I am now getting my head around oil thanks to Louis Gave from Gavekal. He says investors could be starting to worry about bank’s exposures to commodity-related derivatives’. He kindly describes what a derivative is for those of you who have not seen The Big Short and then explains that ‘back in 2008 about $US500 billion worth of losses on US mortgages were magnified through the derivatives market resulting in $US 28 trillion being wiped from global equity markets…this raises the question of whether we could see a 2008-like crisis with the catalyst this time being the bankruptcy of commodity companies’.

Hmmm, I think, so is this is also where the so-called covenant-lite loans come in to play. Maybe we’re going to have a ‘lite’ version of the GFC?

Gave’s real humdinger is the following:

‘Looking at market behaviour, it is hard to escape the conclusion that someone is getting one heck of a margin call. Back in 2008, the ‘margin call' was on everything housing-related – this time around, the margin call is likely to be on everything related to commodities.

‘The big difference is that politicians will find it hard to justify using taxpayers dollars to save failed commodity brokers and traders’.

Well, I reckon you’d find that governments and taxpayers haven’t got any more money to bail out anything. They used it all up over the past eight years and it’s done stuff all. In Australia all it’s done is make Australians even more smug and complacent about how we managed to get through it.

And what about the Banks? I am thinking. Oh, and the banks that are the primary ones in oil derivatives trading, Citigroup and JP Morgan Chase, the same two who have warned the market about their increasing loan-loss reserves and problem corporate loans. Remember this is the same Citigroup that lost $US65 billion in the GFC and the same JP Morgan that created Morgan Stanley as an investment bank to enable it to sell CDOs, and the same JP Morgan that lost about $2 billion in 2012 from risky bets on opaque derivatives at a London trading desk. Clearly, not fast learners these guys, or maybe they simply don’t care, or both.

Today, 11 February

I have conflicting thoughts about Valentine’s Day coming up. Part of me thinks of the Valentine’s Day massacre in Chicago, 1929 and pretty much sums up my view of the way the world looks like now. Mayhem and dead bodies literally and figuratively, everywhere. But, I am an optimist at heart and a historian in my head, so I am humming Louis Armstrong’s song, ‘It’s a wonderful world.’

But, I’ve worked why we are where we are and as a business historian this is really critical (and this will help me write the last chapters of the books I am writing).

 The 2015-16 years were when:

  1. The world’s governments realised the music stopped, there were no more chairs left and low growth and low productivity are the norm and rampant speculation by the financial wizards actually runs the world;
  2. Germany atoned for WWII and fundamentally changed the face and composition of Europe, its future growth prospects and cultural make-up forever;
  3. Developed world leaders finally had to deal with the consequences of the carve up of the Middle East after WWI where they installed compliant tribal leaders, funded largely undemocratic rulers in their pursuit of oil security and geo-political control;
  4. Populations around the democratic countries of the world really lost faith in their leaders and trust in the institutions of democracy. Why are we not surprised when 62 people held the same wealth as the poorest half of the global population;
  5. Governments have excelled in stoking fear, uncertainty and racism by enacting even more so-called anti-terror laws that infringe our civil liberties and allow people like you and me to be detained, not arrested, for varying degrees of time because ‘they’ have reasonable cause to do so; and,
  6. Because I live in Australia, we changed our Prime Minister (again) and many of us are now wondering why we did?