GnS Economics https://gnseconomics.com GnS Economics Thu, 18 Jun 2020 12:32:01 +0000 en-US hourly 1 https://gnseconomics.com/wp-content/uploads/2019/11/cropped-gns-1-1-32x32.jpg GnS Economics https://gnseconomics.com 32 32 Special report on surviving the economic collapse https://gnseconomics.com/2020/06/18/special-report-on-surviving-the-economic-collapse/ Thu, 18 Jun 2020 12:29:40 +0000 https://gnseconomics.com/?p=7588 The coronavirus has delivered a devastating blow to a fragile global economy. Most analysts, politicians and economists still seem to be in denial about the severity of the economic crisis we are facing. But they are slowly awakening. This crisis has been brewing for some time. We contend that the onset of the crisis occurred… Read More »Special report on surviving the economic collapse

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The coronavirus has delivered a devastating blow to a fragile global economy. Most analysts, politicians and economists still seem to be in denial about the severity of the economic crisis we are facing. But they are slowly awakening.

This crisis has been brewing for some time. We contend that the onset of the crisis occurred on 16 September, 2019, when the “repo”-markets ‘blew up’.

Ever since, the Fed in particular has been engaged in a losing fight to avert the collapse of the global financial bubble which the Fed and other major central banks themselves helped to create. The economic impact on the real economy, delivered by the coronavirus, is almost certain to bring it all crashing down.

This is the fifth report in our Crisis Preparation series. In this issue, we will concentrate on explaining what kind of crisis we will eventually face and how to survive it. We provide guidance for investors, households, and enterprises, but also for governments.

But, what kind of a crisis will we be facing?

Weak, weaker, the weakest

Figure 1 is familiar to all our followers and subscribers. It presents the growth of total factor productivity, TFP, which is the growth in gross domestic product not explained by increases in labor quantity, quality and capital services. It should not, in any circumstances, be in decline during an economic expansion. We have proposed explanations for this several times (see:  Twitter-thread), and most comprehensively in March 2019.

Figure 1. Regional and global growth rates of total factor productivity (TFP) in percentage points. Source: GnS Economics, Conference Board

We have been tracking the unsustainability of China’s economic growth, post-2009, since 2017. China has been driving this business cycle, as it has accounted for over 50 percent of capital investments in large industrialized nations and over 60 percent new money (credit) created globally after 2009. Now, however, China is at the end of the road, as her economy has become plagued by unprofitable investments and a massive debt load (see Figure 2).

Figure 2. The GDP per capita, share of non-financial private sector debt to GDP and the onset of financial crises. Source: GnS Economics, BIS

We have also been issuing warnings regarding the state of the European banking sector for years. It has been under-capitalized to the extent that it is now “fictionally capitalized”.

The deleterious impact of the coronavirus pandemic on the economies with the most fragile banking sectors, Italy and Spain, is very likely to set in motion an European banking crisis, which will become a global issue due to the high concentration of G-SIBs, or global systemically important banks, in Europe.

What this all means is that we will, most likely, soon face a financial crisis of epic proportions.

The black sheep

The U.S. financial markets are currently in a bubble. Valuations are very close to historic extremes (see also this). Leverage in the U.S. financial system has been steadily building over the years, driven in large part by the policies of the Fed.

Low interest rates, quantitative easing, and now the near-complete expropriation of the U.S. capital markets have been feeding the leverage-frenzy across the U.S financial asset universe. When interest rates in the repo-markets exploded in mid-September 2019, this was a conclusive sign that the system could no longer cope with the build-up of leverage and hidden risks.

The Fed was able to avoid collapse then, and again in March 2020, but the cost was the near- socialization of the capital markets of the U.S. However, what the Fed cannot fix is the real economy, which will keep deteriorating beneath the surface of the frothy asset markets. 

We are in a crisis already

In December 2019, we envisaged the five stages of the coming crisis: Onset, Counterattack, Flood, Calamity and Recovery. As mentioned above, we believe that the Onset occurred 16 September, 2019, and the Counterattack began in March of 2020.

In mid-June, we find ourselves in an interim between the Counterattack and the Flood. Many are slowly awaking to the fact that the economy will not see a V-shaped recovery—just as we have been warning.

There is still some time to prepare, but soon enough the focus will shift to survival. Our report will help you to do both. Brace for impact!

More information

Read more on what kind of crisis we will eventually face and how to survive it.

Full report available atGnS Store

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Euro, markka and the exports of Finland https://gnseconomics.com/2020/06/13/euro-markka-and-the-export-of-finland/ Sat, 13 Jun 2020 07:22:09 +0000 https://gnseconomics.com/?p=7565 There has been a lively debate on the effect of national currencies on the economic performance of the members of the Eurozone. In 2012, we published a report, where we simulated the potential development of the export of Finland, if we had remained in our own currency, markka. Now we have updated those simulations. Our… Read More »Euro, markka and the exports of Finland

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There has been a lively debate on the effect of national currencies on the economic performance of the members of the Eurozone. In 2012, we published a report, where we simulated the potential development of the export of Finland, if we had remained in our own currency, markka. Now we have updated those simulations.

Our updated simulations draw a very straight-forward picture. According to them, our export would have been more than 40 percent higher in Q1 2020, if we had remained in markka.

But how did we end up with such a figure?

The background of the simulations

The idea is to construct a statistical simulation model that gives the theoretical values of Finnish markka against euro during the period that Finland has been a member of the Eurozone. Combining these simulated values of markka with other relevant macroeconomic variables we constructed a simulation model which indicates the potential value of the export of Finland during the period in question.

The following assumptions are made to simulate the value of markka after 1999:

  • Everything that has happened in the world economy after 1998 would have happened exactly in the same way even though Finland would not have been a member of the Eurozone.
  • All the current members of the Eurozone would have joined euro even though Finland would have not.
  • Finland would have followed the same economic trajectory before joining the euro at the end of 1998.
  • The Bank of Finland, BoF, would have adopted essentially the same monetary policy as the Riksbanken, i.e. the central bank of Sweden

Since Finland is a small country, we think that the first and second exogeneity assumption are realistic. It should be noted that this assumption would not be realistic in terms of bigger euro zone countries such as Germany. This restricts the usefulness of our counter-factual analysis in terms of the other members.

Third assumption states that we assume that the economic development of Finland would have been the same until the end of 1998 whether she had joined or not joined the euro. We consider this to be a plausible because the Finnish economy and government finances were in a robust state before joining (no alterations were needed).

In history, the monetary policies of the BoF and the Riksbanken have been very similar. It is thus no reason to suspect that the BoF would have deviated from the policy of the Riksbanken to follow the monetary policy lines of the ECB, if we would have remained outside euro.

Our analysis is fundamentally based on the exchange rate between the currency of Sweden, krona, and euro. A historical fact is that the exchange rate between markka and krona followed each other quite strictly several decades until markka was connected to the EMU on the 1st of January 1999. We can thus safely assume that this would have continued if we had not joined euro.

The “theoretical” markka

The starting point for our simulations is to ponder the rate of interest that Finland would have faced if she had not joined euro.  The integration of the world has led to converge of the yields of the long-term government bonds, especially within the EU.

Thus, there is no particular reason to assume that the interest rate of Finland would have systematically been different from that of Sweden or the interest rate within the euro zone.  However, we expose the simulated interest rate to stochastic components such as the average interest rate in Finland is ten basis points higher than in Sweden (or in the Eurozone). 

In the simulation model, we first construct the exchange rate between markka and Swedish krona using their equilibrium association and the interest rate differential between Finland and Sweden as illustrated above. Thus, we assume that the equilibrium association would have remained the same after 1999 when Finland joined euro.

In addition to the interest rate differential, the partially simulated history of the mark-krona exchange rate will affect the simulated markka-krona exchange rate. Figure 1 presents the path of the “theoretical” markka.

Figure 1. The official exchange rate of Finnish markka in terms of euro from 1990 (Q2) to 1998 (Q4) and the simulated exchange rate from 1999 (Q1) to 2020 (Q1). The shaded areas refer to the recession periods in the economy of Finland. Source: GnS Economcs, OECD

So, in our simulations, markka would have depreciated during the 2001-2002 recession and, quite heavily, during the GFC in 2008-2009. Moreover, there would have been a steady depreciation from 2013 onwards. Interestingly, the reaction of the theoretical markka would have been muted during the 2012-2015 recession. This may be due to fact that Sweden did not experience a recession during that period.

 Simulated exports

The simulation model for the export of Finland will consist of the history of the export in Finland, the partly realized and theoretical exchange rate between euro and markka, as well as of economic activity, GDP growth rates, of the U.S. and in the Eurozone.

As expected, according to the estimation results of the statistical model behind the simulations, a depreciation of the (simulated) markka-euro exchange rate and increasing economic activity in the world economy increased the export of Finland, and vice versa. Figure 2 presents the results of the simulation.

Figure 2. The realized and simulated values of the volume indexes of the export in Finland. Source: GnS Economics, Statistics Finland

According to our simulations, having her own currency would have helped the export of Finland to recover from the GFC and also from the long recession of 2012-2015. Moreover, the depreciation of the markka, combined with the strong growth of the world economy in 2016-2018, would have pushed our exports to new heights. At the Q1 2020, if we had remained in markka, our exports would have been more than 40 percent higher than what they are now.

The economy of Finland seems to suffer in the euro

While we, as a firm, do not take any political sides on the matter, our simulations leave no reason for doubt. The euro-membership has probably been very costly to Finland. She may have lost tens of billions worth of export-revenue, which would have contributed very positively on her economic growth, employment and well-being of citizens.

It is almost certain that Finland is not alone in her suffering in the Eurozone. Several countries, including Greece and Italy, have seen their economic fortunes to dwindle or collapse during their euro-membership.

Learn more:

A special report detailing the “end-game” of the Eurozone.

A special report on how the Eurozone breaks.

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The approaching European (global) banking crisis https://gnseconomics.com/2020/05/22/the-approaching-european-global-banking-crisis/ Fri, 22 May 2020 07:03:17 +0000 https://gnseconomics.com/?p=7389 One thing missing from basically all economic analyses of the coronavirus pandemic is the impact of a European banking crisis. We have been warning about the weakness of the European banking sector since June 2015. At that point we identified non-performing loans, or the “NPLs” of European banks as the most pressing threat. However, since… Read More »The approaching European (global) banking crisis

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One thing missing from basically all economic analyses of the coronavirus pandemic is the impact of a European banking crisis. We have been warning about the weakness of the European banking sector since June 2015. At that point we identified non-performing loans, or the “NPLs” of European banks as the most pressing threat.

However, since then two things have occurred. Member nations have successfully lowered the share of bad loans held by banks, but at the same time the profitability of the European banking sector has been decimated by the ill-advised policies of the ECB.

Most worryingly, after the financial crash of 2008, the Financial Accounting Standards Board (“FASB”) in the U.S. relaxed the rules bank could apply to value assets that were not traded publicly (so-called over-the-counter, or “OTC” products). In Europe this was fully embraced by allowing banks to hide the toxic (worthless) assets on their balance sheets and pretend that they had real value.

Alas, the combination of weak profitability, catastrophic policy mistakes and creative accounting has rendered the European banking sector extremely fragile, and it now confronts the massive economic impact of the coronavirus pandemic.

Banking issues and ‘accounting gimmicks’

When the financial crisis hit in full force in 2008, many of the European banks hung on the brink of collapse. The solution European leaders chose was an insufficient financial re-capitalization and reliance on accounting gimmicks.

Only a few banks were allowed to fail and, in total, 114 European banks received government support during the crisis. But, the most destructive policy was for banking regulators to allow Europe’s banks to continue to carry U.S. mortgage-backed CDOs and other exotic—yet nearly worthless—financial products on their balance sheets with imaginary values. This meant, of course, that while many of the OTC products had little or no value, banks could pretend that they did.

This policy approach created the “rotten heart” of European banking system, and it also made the true riskiness of the banks nearly impossible to assess. When the French and German banks were re-capitalized through the agony of Greece’s financial crisis during 2010 – 2012, these issues were left untouched, again.

Then came the Outright Monetary Transactions (“OMT”) program, negative interests rates and Q.E. All these hampered the profitability of European banks further, but also facilitated the flow of cheap credit into Europe’s corporations, creating “zombie companies” (see the Destruction of the European banking sector for more info).

NPLs, the rare success story

However, not all banking policies applied in the Europe have been detrimental. Banks have successfully lowered the share of non-performing loans with the help of national and EU authorities from their peak in 2014-2015 (see Figure 1).

This has been achieved mostly through improving risk management practices and strengthening of the provision of NPLs, but also by selling NPLs to investors.

Figure 1. The share of non-performing loans to total gross loans. Source: GnS Economics, IMF

Yet, at the end of Q2 2019 (the latest data available), NPLs were still considerably above the pre-GFC levels in all three major crisis countries: Italy, Spain and Portugal.

Stressers are in place

The coronavirus pandemic has hit Italy and Spain especially hard. With the summer tourist season likely to be nothing short of catastrophic, the economic effects of the pandemic will keep on building. Moreover, household debt service costs-to-income shares were still very high even before the viral outbreak (see Figure 2).

Figure 2. Household debt service and principal payments to income. Source: GnS Economics, IMF

And, while the total debt-to-equity share of non-financial corporations has drifted down in Spain and Portugal, it’s still considerably higher than the pre-GFC level in Italy (see Figure 3).

Figure 3. Total debt to equity in non-financial corporations. Source: GnS Economics, IMF

Considering all this, Italy is the likely ignition point of the European banking crisis.

“Run for the hills!”

Many consider the relative high capital (Tier 1, etc.) ratios of European banks as a proof of their resilience. However, they are forgetting that such capital is often in the form of government bonds, and that the prices of sovereign bonds are clearly in a bubble in the Eurozone, especially in the crisis countries.

Moreover, if the decision by German’s Constitutional Court forces the ECB to stop the Pandemic Emergency Purchase Program, and the Public Sector Purchase Program, which is clearly within the realm of possibility, the prices of bonds of the crisis countries will crash (yields skyrocket).

This would be a ‘double-whammy’ for the Eurozone.

The crisis countries would be pushed to euro-exits and defaults, while their banks would fall into insolvency. If European leaders are able to agree on the ‘bailout Fund’ currently under negotiation, such euro-exits could be postponed. However, the banking crisis will come, regardless.

Banks in Europe are strong only in an alternative reality. In real life, an unknown but likely large amount of unprofitable assets burden their balance sheets, their profitability is weak, they still have a large share of NPLs, and their customer base is under extreme financial stress—especially in Italy and Spain. These are the building blocks of a banking crisis, which can ignite basically at any moment.

When the European banking crisis commences, it will go global in an instant as Europe holds the largest concentration of global, systemically important banks, or G-SIBs. And, there are very few places to hide.

More information

Learn how to prepare for the ongoing crisis. Order “The Prepper’s Bunker: Coronavirus update II“.

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The economic end scenarios of the Covid-19 pandemic https://gnseconomics.com/2020/05/04/the-economic-end-scenarios-of-the-covid-19-pandemic/ Mon, 04 May 2020 10:01:38 +0000 https://gnseconomics.com/?p=6907 Since we first warned about the dire impact of the coronavirus outbreak in late January, things have deteriorated alarmingly at an astonishing speed. Our “Black Swan” report, published on the 9th of March, laid out bleak economic prospects going forward, but within a week even those proved to be too optimistic. A month later, 2nd… Read More »The economic end scenarios of the Covid-19 pandemic

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Since we first warned about the dire impact of the coronavirus outbreak in late January, things have deteriorated alarmingly at an astonishing speed. Our “Black Swan” report, published on the 9th of March, laid out bleak economic prospects going forward, but within a week even those proved to be too optimistic.

A month later, 2nd of April, we updated our global growth forecasts, and stated that the Covid-19 virus is a “Pillager of the World” as it annihilates economic activity globally in modern, prosperous societies. We regret to report that the economic picture has only gotten worse since.

Although it may be hard for some to believe due to the rally in American stock markets, we are heading to an economic crisis of biblical proportions. Just as we warned in early April, we are only at the early stages of the global economic crisis ignited by the coronavirus pandemic.

Now we must account for the possibility of further waves of the Covid-19 infection. This is something that, among others, leading experts in China have been warning about.

In this Special Issue of our Q-Review series, we take on the unpleasant task of analyzing how badly any possible second or third waves of the pandemic would affect the global economy.

We summarize our the economic end scenarios in this blog. The full report is available from our store.

The “bad” scenario

What has been largely marginalized in all economic projections of the coronavirus pandemic are the effects of an emerging financial crisis.

When one looks at the current horrific economic numbers, one cannot escape the reality that banks will suffer massive losses. This is especially troublesome for European banks as they have been in dire straits since 2008. Their situation has deteriorated even more since then due to the misguided policies of the ECB.

A stress test of the ECB, published in October, showed that half of the biggest banks in the Eurozone would not survive if financial counterparties and some commercial clients pulled their money out. This is, of course, exactly what happens in a recession—which has now arrived.

The economic effects of the pandemic and lockdowns will hit the corporate sector hard across the globe. As we explained in Q-Review 1/2019, the world economy contains a large concentration of so-called ‘zombie corporations’. The term is used to describe a firm that is unable to cover debt expenses from its available income stream. Zombie corporations survive only because weak banks provide cheap credit lines to keep them from failing.

Now, when global demand collapses because of the impact of the coronavirus and lockdowns, these corporations will be unable to maintain operations. They—as well as many “non-zombie” corporations—will fail due to collapsing income flows driven by imploding consumer demand and production. In December 2019 we named this stage of the global economic crisis “The Flood”. When it occurs these weak banks will start failing, leading Europe and then the rest of the world into financial crisis. We are currently very close to this point.

So, in the “bad” scenario we assume that the European banking crisis emerges by summer or fall at the latest. As we have mentioned numerous times, it will go global in an instant due to the high concentration of global systemically important banks, G-SIBs, in Europe. This will again crash global asset markets and push the world economy into a depression.

We also assume that there is only a mild second wave and/or treatments for the illness caused by Covid-19 have improved, and its economic impact is limited.

The “good” scenario

In the “good” scenario, we get the pandemic under control by late May. We establish a breakthrough in virus treatment and we have an efficient vaccine by winter. The virus slowly diminishes and becomes something that resembles a seasonal flu.

Governments issue massive stimulus packages to support ailing economies. Central banks resort to direct financing of government deficits and ‘helicopter drops’ of money on ordinary citizens. European governments issue blanket guarantees for bank liabilities, and depositor bail-ins are enacted to uphold the European banking sector.

The world economy dodges the bullet but emerges itself as a centrally controlled, socialistic “zombie” afflicted by recurring periods of regional and/or national hyperinflations.

The “apocalyptic” scenario

When looking for the worst possible outcome for the current outbreak, there is just one option: the pandemic of 1918-1919, known as the “Spanish Flu”. So, we estimate the economic outcomes of the “apocalyptic” scenario based on the historical progress of the Spanish Flu following recent modeling by CIDRAP.

In the “apocalyptic” scenario, we assume that the devastating flood of corporate bankruptcies commences in May. This leads to bank runs and to a banking crisis, starting from Europe by summer. Alas, there is no real recovery in the global economy.

And then the second wave of the Covid-19 pandemic strikes.  The virus starts to spread rapidly around the world during the fall of 2020 and continuing into the winter, with a possible third wave erupting in the spring of 2021.

Countries across the world are forced to reinstate broad and draconian lockdowns. Supply-chains break down completely and global logistics routes are disrupted by huge numbers of sick (or frightened) employees and the strict closures of both factories and national borders. Nations start to protect vulnerable industries and resources. Food security becomes the main national security issue. Global food transfers are halted or disrupted.

These grim factors, combined with soaring unemployment, business failures and market turmoil topple the global banking sector. Bank losses are so large that though depositor bail-ins are enacted, they are insufficient to keep banks from failing. The European banking sector collapses completely, followed by an implosion of the global financial order. Global commerce evaporates. The world succumbs to utter economic annihilation.

The hit

It’s rather self-explanatory that the resulting medium-term economic outcomes of the aforementioned economic end scenarios range from “mere” stagnation to a complete collapse of the global economic order.

It is utterly impossible to forecast, with any reliable margin, how the course of virus evolves in coming months, but we need to be prepared for the most dire scenarios. The massive blow delivered to the global economy by Covid-19 is already apparent in the leading indicators of the OECD.

the economic end scenarios, economic prospects, scenarios, Covid, pandemic,

Figure. Leading indicators of the OECD for China, euro area, Germany and the US, and the leverage/deleverage cycle of China. Source: GnS Economics, OECD, BIS, PBoC

Also, the IMF has already warned about the negative economic effects of a possible second wave. However, we note that they did not fully account for a probable global banking crisis, and that the second wave of the pandemic can be even more dangerous than the first.

The path forward

It is imperative that  governments be prepared for a collapse of both global supply-chains and economic co-operation and order.

Countries need to be prepared for surviving on their own for at least the fall and winter months of 2020. This means immediately addressing the issue of food security, ensuring that each country has adequate domestic food production or reserves.

Investors must be prepared for extreme events in financial markets and unrecognizable—even lunatic–monetary responses from central bankers. We have outlined appropriate hedging strategies for investors and businesses in “The Prepper’s Bunker: Coronavirus Update II” report.

We are faced by a great unknown. In the worst case, we could see the repetition of “apocalyptic” occurrences not seen in 100 years.  But even if we are spared that outcome, the economic crisis is likely to be severe.  Regardless, we must survive it and see through to better times on the other side.

Crises always provide the opportunity to modify and improve economies and societies. How well we succeed, and how fast we recover, will be determined by our response to the pandemic and the social and economic challenges created in its wake.

Godspeed!

More information

Read more about the economic end scenarios from our Q-Review Special Issue: Apocalypse. Now? Available at GnS Store

Or how to prepare for the ongoing crisis, order “The Prepper’s Bunker: Coronavirus update II“.

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The downfall of the euro https://gnseconomics.com/2020/04/21/the-downfall-of-the-euro/ Tue, 21 Apr 2020 12:25:15 +0000 https://gnseconomics.com/?p=5727 The massive economic blow caused by the Covid-19 will, most likely, bring an end to the European common currency, euro.

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The finance ministers of the Eurozone are negotiating on the implementation of the rescue package agreed two weeks ago. The only problem is that no one seems to know what was actually agreed. The text of the agreement was extremely vague. This is for the simple reason that political cohesion has nearly vanished from the Eurozone.

This is extremely troubling, as political will, or cohesion, is the glue that keeps currency unions together. When it disappears, currency unions break apart. That’s the unanimous lesson of previous currency unions.

In this blog we detail why the Eurozone has reached its present perilous state, and why it’s unlikely to survive the coming crisis.

“The Greeks are coming!”

The unfortunate fact is that if European leaders had let Greece fail and the banking crisis run its course in 2011/2012, most of the problems now haunting the Eurozone would, most likely, have been resolved by now.

In 2011, the balance sheet of the ECB was practically unimpaired, political cohesion supporting the euro was strong, and the world economy was growing relatively fast—since Chinese stimulus was still effective. Now, seven long years later, the balance sheet of the ECB is distended, European political cohesion is under stress, and global growth is stagnant—with Chinese stimulus impotent.

What would have been a regional banking crisis seven years ago has now turned into a monster threatening the whole global financial system. We have described the dire straits of the European banking section in our previous blog.

A likely trigger for the next stage of the ongoing Eurozone crisis will be a bank run in some corner of the Eurozone. It may be either silent (through “repo” markets, etc., as in 2008) or more obvious with savers visibly withdrawing their money.

If the first significant bank failure occurs in a strong euro member, such as Germany, its initial effects may be contained. But it will breed even greater mistrust of the European banking sector, and, at some point, bank runs will commence on a larger scale and in weaker member states where the outcome will be anything but benign.

The options for the euro

The European banking union has the resources to handle the failure of few small-to-medium sized banks, but not a “systemically important financial institution” (“SIFI” in Fed language). That’s why the responsibility for bank recapitalization will, once again, fall on national governments.

This leads us to the crucial questions determining the fate of the Eurozone, which we outlined in Q-Review 3/2019:

  1. Will the ECB be able to provide support for sovereign bond markets through QE and the banking sector, and will it be enough?
  2. Will national authorities co-operate and accept the terms associated with possible bailout loans?
  3. Will national political leaders, in turn, continue to support the euro?

Currently, the ECB is running “unlimited QE”, and so the support for the European sovereign bond markets is in place. This is crucial as many Eurozone countries have a very high sovereign debt burden (see Figure 1).

Euro, Eurozone
Figure. The sovereign (public) debt as a share of GDP in selected countries of the Eurozone. Source: GnS Economics, European Commission

National authorities have also co-operated and agreed, at least on paper, about bailout loans. How strong the current commitment is remains to be seen.

The risk exists that if eventual bailout loans are conditional upon demands for austerity, citizens of bailed-out countries might see EU institutions as oppressors because of such externally-imposed austerity. Citizens of creditor countries, on the other hand, would object to having their taxes used to bail-out banks of other “profligate” countries.

Political mutiny, manifested through radically-populist parties, would almost certainly erupt.  Demands for a euro exit, in Italy for example, could lead to a collapse in political support for the euro more broadly.

The extremely risky “get-out-of-jail” card

If Germany, Finland, the Netherlands, or other “northern” countries agree to significantly increase the budget of the Eurozone in the range of 20%-30% of Eurozone GDP, and to issue Eurozone bonds, they might be able to muster enough firepower to stem the crisis. However, there’s extremely limited support for this in most of the stronger nations, and for good reason, as it would impoverish the whole continent!

For example, in Finland there’s absolutely no support for further federalization. The political backlash would likely be overwhelming.

Realizing a true federal union without the broad and popular support of the citizens of Europe would also be an extremely risky endeavour. It would also violate the constitutions of many member countries as well as Article 125 of the Treaty of the Functioning of the EU, or TFEU, setting the stage for an existential constitutional crisis in the EU. That is why this option continues to be a very unlikely outcome.

Also, if the ECB and/or national governments suffer losses from their loans to other countries of the Eurozone, this would indicate clear violations of Articles 123 and/or 125. This could also precipitate a constitutional crisis in the European Union and make the recapitalization of the ECB far from certain.

The end is near

The unfortunate fact is that the European common currency, euro, has been an ill-conceived project from the beginning. If the history of previous failed currency unions teaches us one thing, it’s that you never ever establish a common currency among countries with very different cultural and political backgrounds without a Federation. It’s unfathomable that we need to learn this lesson the hard way, again!

The massive economic blow caused by the Covid-19 will, most likely, bring an end to the euro. This is something we all should acknowledge and prepare for. It will be the biggest financial earthquake ever, requiring some serious hedging and planning. We have outlined such practices in our Crisis Preparation series.

To end on a positive note, when the euro is gone, former member economies will be ready to accelerate. It will, naturally, not start for a while, but when many export-dependent nations recover their most important macroeconomic stabilizer—their own currency—this will help foster recovery.

And, we should never mourn the passing of those institutions whose time has come!

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Store is open! https://gnseconomics.com/2020/04/20/store-is-open/ Mon, 20 Apr 2020 16:26:27 +0000 https://gnseconomics.com/?p=6079 We have opened our online store. We have extended the opening offers till 3/5! Check our products and offers from our store! GnS Store

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We have opened our online store. We have extended the opening offers till 3/5!

Check our products and offers from our store!

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The worst economic collapse ever? https://gnseconomics.com/2020/04/08/the-worst-economic-collapse-ever/ Wed, 08 Apr 2020 16:01:08 +0000 https://gnseconomics.com/?p=5518 The global collapse would bring in its wake massive unemployment, poverty and the re-structuring of our whole social and economic order.

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Country after country has reported extremely dark economic numbers. The gigantic jobless claims, 6.6 million from the U.S. last week, are just the tip of the iceberg. For example, the service sector PMIs have been simply ghastly across the globe. We are now in a crisis of epic proportions.

But, how massive can the crisis eventually get? Since our inception, in 2012, we have contemplated three scenarios as a part of our quarterly forecasts. While we have not referred to them in each report, we have repeated them periodically. They are: the optimistic, the most probable and the pessimistic.

But at this point our main worry is the approaching realization of the pessimistic, or the worst, scenario. It’s likelihood, while still low, is increasing fast in our estimate.

Underpinning its severity is not the virus, but the fragility of the global economy.

Breeding chaos: failed clean-ups and bad policies

The Global Financial Crisis (GFC) was considered a Black Swan event to many. However, it was no such thing. It was a massive failure of hedging and diversification within the global banking system, most notably in the U.S., and a number of prominent analysts saw it coming. See our blog, 10 years from Lehman. And nothing has been fixed, for an insight view on that crisis.

While banks were wound down and recapitalized in the U.S. after the GFC, an equivalent restructuring did not happen in Europe. Stricken European banks were left to linger in a state of permanent financial distress.

“Outright Monetary Transactions” or “OMT”, negative interest rates, and ECB’s QE program all aggravated the predicament of European banks. The failure to resolve the 2008 crisis ‘zombified’ the European banking sector, a situation which persists today. (See Q-Review 3/2019 for a detailed account).

Another pivotal moment for the world economy came in March of 2009, when the Fed vastly expanded its asset purchase program of U.S. Treasuries and mortgage-backed securities. This became known as the notorious Quantitative Easing or “QE” program, and has persisted in one form or another ever since. (See Q-Review 1/2018 for a detailed explanation.)

Central banks quickly assumed the role of “lender of first resort” in the capital markets, and their balance sheets ballooned. Asset prices rose to never-before-seen heights. Continuous market bailouts, culminating in the ‘pivot’ of the Fed in early January 2019 and its repo-bailout in September, removed all market discipline and incentivized investors to wild speculation (see Q-Review 4/2019 for details).

The giant with (debt) clay feet

Chinese leaders also reacted quickly when the financial crash of 2008 precipitated a global recession.

China initiated a massive infrastructure programs that jump-started the world economy to a renewed upward trajectory. These programs were financed by credit issued by state-controlled banks, which Beijing can compel to lend, and the banks responded by doubling the volume of loans YoY. Between 2007 and 2015, 63% of all new money created globally came from China, and most of this increase was created by commercial banks.

During 2016, China unleashed a never-before-seen credit bonanza, tripling the size of the “shadow banking sector” as a response to a slump in the Chinese housing market, which had become the backbone of the Chinese economy over the past two decades.

By the end of 2017, the assets of the shadow banking sector stood at a mind-boggling 367% of GDP. The commercial banking sector has also become extremely levered, posting over 500% growth in credit since 2008.

Alas, the Chinese banking sector is now totally incapable of coping with any significant shock, and these Chinese economy became riddled with unprofitable investments.

Into the Abyss

These fragilities, combined with the massive economic impact of the coronavirus, leads us to our most pessimistic scenario.

In it we assume that

  • Many governments will not be prudent enough in suppression measures, which will lead to severe global pandemic peaking in summer.
  • Due to the worsening outbreak and delays in containment, suppression measures will eventually be prolonged and they become draconian (“Wuhan style”).
  • The massive stimulus measures enacted by governments and central banks will be ineffective in providing support for the economy, as the tardy application of draconian suppression measures lock people at home in several key countries of the global economy for a prolonged period of time.
  • Global economic activity plunges to never-before-seen lows.
  • European banking sector breaks.
  • Eurozone unravels violently.
  • China ‘lands hard’.
  • Global financial system collapses.
  • A systemic crisis engulfs the world.

A systemic crisis simply means that the banking sector and financial markets collapse. In practice, this implies that most banking services will stop and funding through financial markets will cease. This also means that the monetary system is likely to collapse (see Q-Review 4/2019 for a detailed explanation).

It should be acknowledged that we have never faced such a scenario on a global scale (though the collapse of the Soviet Union could certainly be classified as “systemic meltdown”). That is why the sheer scale of such an apocalyptic scenario will be horrifying. They are presented in the Figure below.

The worst economic collapse ever
Figure. The forecasted (Y-to-Y) GDP growth rates in the U.S. and in the Eurozone in 2020 – 2023. Source: GnS Economics, OECD

Fragilities laid bare

The Covid-19 pandemic will reveal all the fragilities of the world economy. The near collapse of the U.S. capital markets in mid-March was averted only through unprecedented socialization of the financial markets. However, when the Flood of corporate bankruptcies begins, central banks will not be able to withstand the onslaught. Then we will face only extreme economic options.

The global collapse scenario, presented above, would bring in its wake massive unemployment, poverty, misery and the eventual re-structuring of our whole social and economic order. The world would be utterly and permanently changed as a result.

This is something we absolutely need to be prepared for, even though its likelihood is still relatively low.

But it is increasing fast, and that should worry us all.

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Pillager of the world: The economic impact of Covid 19 https://gnseconomics.com/2020/04/02/pillager-of-the-world-the-economic-impact-of-covid-19/ Wed, 01 Apr 2020 21:00:00 +0000 https://gnseconomics.com/?p=5278 The 2019-nCov pandemic has ravaged the world economy since February. On the 9th of March, we published forecasts assessing the likely impact of the outbreak going forward under various scenarios. We will publish updated forecasts in a series of Deprcon Special Issues. This is the first of those updates.

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The Covid 19 pandemic has ravaged the world economy since February. On the 9th of March, we published forecasts assessing the likely impact of the outbreak going forward under various scenarios.

Due to the very fast spread of the Covid 19 and the extreme measures enacted across the world to contain it, our forecasts have become outdated in record time. So, we will publish a series of Deprcon Special Issues updating those forecasts. This is the first of those updates.

“Out of the depths I cry to you”

It’s safe to say that the world economy has “met its maker”. The Covid 19 virus is the perfect weapon designed for maximum economic destruction. It forces decision makers to either shut-down the economy for an extended period of time, at an almost unfathomably severe cost; or try to keep the economy running, at the risk of further contagion and widespread human suffering and death—and then watch as the economy collapses anyway.

The optimal response for the economy and the society seems to be “test early and quarantine”, which was applied most successfully in South Korea. Most of the European countries and the U.S. missed their window of opportunity and were consequently forced to enact draconian suppression measures.

What many seem unable to understand—and what we outlined in the Q-Review 1/2020: The Black Swan report—is that you simply cannot just shut down an economy for a while and then turn it back on like a light-switch.  Yes, after a lockdown, an economy will rebound, briefly. But the massive layoffs now observed in all countries—forced by catastrophic negative shocks to consumption and production—have effects that will accumulate in national and global economies.

The worldwide disruption of commerce and production are unprecedented in at least a century and can only be compared to times of global depression or war. Alas, we are only at the early stages of the economic crisis put in motion by the Covid 19 pandemic!

The (likely) path forward

In our most likely scenario, we expect to see the following:

  1. Some governments will be very prudent and active in suppressing and testing the spread of the Covid 19, while some will drag their feet worsening the global outbreak.
  2. The pandemic will reach its global peak in May.
  3. Global travel restrictions will be slowly relaxed from mid-summer on.
  4. The massive stimulus measures enacted by governments and central banks will provide support for the global economy at the initial stage after the Covid 19 outbreak peaks (late Q2, Q3).
  5. Yet, the flood of corporate bankruptcies, driven by collapsing economic activity, and over-whelming loan losses will push the European banking sector into a crisis by fall, which will metastasize globally due to the high concentration of systemically important banks in Europe.
  6. The Eurozone breakup commences in the fall at the latest.
  7. The Chinese economy will ‘land hard’ due to collapsing global demand and declining economic activity.
  8. The global economy plunges into depression.

As shown in the table below, the Eurozone and Finnish economies, unsurprisingly, will take the worst blow, with GDP crashing by over 20 percent in both. As we expect the Eurozone to fracture, those estimates are naturally only speculative. The US would also take a severe hit, with the GDP plummeting by over 15 percent decline during the next three years.

covid virus economy
Table. Yearly growth forecasts of the real GDP growth for the Eurozone, the US and Finland. Source: GnS Economics, OECD

It is crucial to understand that the estimates presented above are wholly dependent on the assumption that we get the epidemic under control. It should also be acknowledged that if the European banking sector and/or the Eurozone implode already before summer, estimates for the 2020 will be materially worse.

This is it!

We have been warning about the fragility of the global economy since March of 2017. This past January it became obvious that the Covid 19 epidemic would have a severe impact on the global economy and the world’s over-levered and highly speculative financial markets.

The Fed, other central banks, and global governments have basically thrown everything they have against the economic fallout caused by the Covid 19. The Fed has effectively become the financial market as it now backstops not just repo and U.S. Treasury markets, but also corporate commercial-paper and municipal bond markets and short-term money-markets. There is now not much left of the once-great “free markets” in the U.S. 

Of course, European bond markets have been moribund for years after the ECB commandeered them for political purposes in 2012.  Gigantic swap-lines between the Fed and European central banks provide additional dollar liquidity to that banking system. 

While the massive macro response of the U.S. leadership may prove to be excessive, and possibly irreversible, it is at least somewhat understandable, as the consequences of the bursting of the financial bubble would surely be devastating.  But we do wonder whether U.S. leaders realize that they have become their former worst enemy: The (Financial) Socialistic Republic of the United States?

And, in the end, it all is likely to be in vain. When the flood of corporate bankruptcies begin, there is no power in the world sufficient to keep the U.S. financial markets and the European banking sector from collapsing. There just is no escape.

This is it!

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Financial markets are becoming unhinged https://gnseconomics.com/2020/03/17/financial-markets-are-becoming-unhinged/ Tue, 17 Mar 2020 06:18:44 +0000 https://gnseconomics.com/?p=4390 The massive emergency easing measures enacted by the Fed over the weekend to inject liquidity into the global financial system are a sign of sheer panic. Both their sheer scale, and radical extent--including cutting rates to zero, $700 billion in new...

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The massive emergency easing measures enacted by the Fed over the weekend to inject liquidity into the global financial system are a sign of sheer panic. Both their sheer scale, and radical extent—including cutting rates to zero, $700 billion in new QE, and eliminating reserve requirements for U.S. banks—speak vividly to the gravity of the situation financial markets are now facing.

We are on the brink of total collapse.  Monday’s violent negative market reaction—surely the opposite of that which Chair Jerome Powell hoped for—also confirms this.

Yet, like a tsunami visible first on a distant horizon, this economic maelstrom has been looming for quite some time.  As we have argued repeatedly, the crisis most likely started on the 16th of September, 2019, within the repo-markets. The Coronavirus was only the trigger, and now a convenient excuse, for emerging—and unfortunately very real—economic calamity.

We have published a report, Prepper’s Bunker: Coronavirus update, where we detail how investors, corporations and households can prepare for the crisis. We have also made our scenario forecasts on the economic impact of the pandemic freely downloadable. We urge everyone to check them.

But how bad is the situation in the financial markets now?

The beginning (and the end)

There have been at least four recent market bailout operations enacted by the central banks during the last two and a half years.

The BoJ and the PBoC calmed the run on junk bond ETFs in November 2017. The ECB cleared the European corporate markets after they become clogged in March 2018. The PBoC and the Fed bailed-out the credit and stock markets at the turn of the New Year in 2018/2019.

On September 17th, 2019, the Fed enacted a bailout of the repo-markets, which is still very much ongoing. Just yesterday, the Fed provided almost $130 billion worth of liquidity to the repo-markets. And now, the FRA-OIS spread has started to shoot up, indicating that stress in the inter-bank markets is building rapidly.

These all contribute to the same conclusion:  financial markets are extremely stressed.

The Credit market is THE ISSUE

The main problem is presented in Figure 1. Yields in the credit markets (especially in high yield) are spiking aggressively. As the Federal Reserve cannot—at least not yet—buy corporate bonds or common stock, it does not have a direct way to affect rates there.

Figure 1. Yield of bonds of US junk rated (high yield) companies. Source: GnS Economics, St. Louis Fed

This issue is aggravated by the fact that in many countries, as in the U.S., corporate debt is at record highs (see Figure 2), and that capital markets, not banks, are now responsible for a considerably higher share of corporate financing than prior to the 2008 crisis. This, quite simply, means that if and when the credit markets go, we all go with them.

Figure 2. The debt securities of nonfinancial corporate business as a share of nominal GDP. Source: GnS Economics, St. Louis Fed.

We are in a deep hole

The simple and ominous reality is that no amount of central bank induced artificial liquidity can alleviate the impact of the coronavirus on the real economy.

It also follows that no amount of central bank liquidity can stop the stock and credit markets from falling, when the real economy and corporate earnings sour, as is now happening.

It is completely unfathomable to us and will almost certainly be condemned by future economic historians as to why global central banks, led by the U.S. Federal Reserve, first chose endless monetary stimulation and then to exhaust all their traditional monetary stimulus options to uphold the now-collapsing expansion. They fomented an incomprehensibly-large financial bubble that is now imploding before our eyes.

For three years, we’ve been warning that the world economy is desperately fragile. Few have heeded our warnings. Now the chickens have come home to roost.

God help us all.

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Prepper’s Bunker: Coronavirus update II https://gnseconomics.com/2020/03/12/preppers-bunker-coronavirus-update/ Thu, 12 Mar 2020 09:17:13 +0000 https://gnseconomics.com/?p=4289 We have been warning about the impending economic crisis since March 2017. Central bankers and Chinese leaders have been able to postpone the onset of the crisis for...

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Updated 4th of May 2020.

We have been warning about the impending economic crisis since March 2017. Central bankers and Chinese leaders were able to postpone the onset of the crisis for several years, but now the coronavirus pandemic makes any such efforts futile. We are heading to a new global economic crisis.

However, crises are not just doom-and-gloom, and the human costs of dangerous viral outbreaks, like the Covid-19, cannot be measured in money. Still, economic crises do sow the seeds of large potential profits for prepared investors, companies and households. This is because crises will re-price a wide range of assets—which makes a crisis an opportunity as well.

coronavirus prepper bunker

Figure. The confirmed cases of the 2019-nCov virus globally and excluding China from the 22nd January till the 11th of March. Source: GnS Economics, WorldOmeter, Johns Hopkins CSSE

The approaching economic crisis put in motion by the coronavirus pandemic will be exceptional in one important aspect: it will the first-ever global economic crash.

The Great Depression spread across the globe in the 1930’s, mostly because of the gold standard, but it only created serious economic malaise in few countries outside the U.S. The Global Financial Crisis (GFC) was also global, collapsing the global flow of liquidity (credit), but it was quickly contained.

The coming crisis will be a different “beast” altogether, even without the virus outbreak.

The biggest reason behind is the mispricing of risk. When central bankers forced interest rates to zero and below, and began to push artificial liquidity into the financial markets through QE-programs, they started to undermine the ability of markets to allocate resources effectively by distorting market prices.

The world will pay a steep price for the arrogance and errors of global central bankers. The ‘everything bubble’ they have blown has also made hedging especially challenging this time around. We will help you to find efficient hedging positions.

In this Q-Review Special Issue we will explain how investors, households and corporations can protect their assets from both the coronavirus pandemic and the economic collapse it will bring.

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Prepper’s bunker, table of contents:

The tale of four crises

The prepper’s bunker

  Lessons from history

  Depression

  Systemic meltdown

  Bailout/inflation

  General guidelines for crisis investing

Financial hedging against the pandemic

Conclusions

Appendix I: Figures

Appendix II: The best performing stocks during and after crises

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