The world is at the event horizon of the black hole of debt, the point of no return in which the gravitational pull of imploding debt makes escape impossible. Debt has allowed the world’s command and controllers to pretend they could control many important variables, but debt reaches a point where debt service costs outweigh putative benefits. It is then only a matter of time before it collapses, and it doesn’t matter where that collapse begins. The world has $200 trillion of debt, almost three times world GDP, and most financial assets are in fact someone’s debt, or, further down the priority ladder, equity—unsecured ownership claims on corporations. In a world as indebted as ours, an impairment of even a small percentage of debt reverberates globally, as the impairment entails asset mark downs, impairing the debt service capabilities of those asset owners, which means mark downs by their creditors, jeopardizing their debt payments, and so on. Once the black hole forms and exerts its pull, its event horizon expands, sucking in financial instruments, entire companies, and governments.
Back in the days when the Federal Reserve was engaged in Quantitative Easing (QE), depreciating the dollar, countries who wanted to maintain their exports had to depreciate in tandem to maintain their currency’s foreign exchange rate against the dollar. The US was exporting QE, which had all the attendant consequences we’ve come to know and love for the importers: artificially lower interest rates, artificial economic “stimulus,” debt promotion and expansion, and a currency that either kept pace with the dollar’s depreciation or out-depreciated it. QE presented a rare bonanza for the financially connected: borrow US dollars at near zero interest rates, speculate with the proceeds on anything that potentially presented a positive return, and pay back the loan in depreciated dollars. It was a trade that drove equity markets higher, bond yields lower, funded fracking and other low-quality debt, and was the foundation of unknown trillions in all manner of derivative speculation.
Using borrowed dollars meant these trades were short dollars. The end of QE and the dollar’s rally are inflicting massive pain and prompting the unwind of many of them. A 5 percent loss hurts when the speculator has put up the full price, at 10 times leverage it becomes a 50 percent loss, at 20 times the speculator’s equity is wiped out. Putting up full price in modern financial markets is quaintly anachronistic. Almost everyone is leveraged, and 20 times or more is not anomalous. The unwinds contract the debt used to fund the underlying trades, shrinking total debt. In other words, much of the world’s speculative activity is running smack into the event horizon.
What is happening to those countries, many of them emerging market nations, who imported the Fed’s QE? They no longer have to manufacturer their local currencies to buy dollars to depreciate their currencies; the market is taking care of that for them. This serves as an implicit monetary tightening, with the reverse consequences of imported QE. Money becomes less plentiful; interest rates rise and the currency appreciates, which slows or stops export growth and consequently economic expansion. Importantly, it also prompts debt contraction, or more debt at the event horizon.
China is in a league of its own. Its currency, the yuan, has a “soft” peg to the dollar, consequently the yuan has roughly moved with the dollar. When the dollar was weak, China weakened its currency to keep up, accumulating almost $4 trillion as it bought dollars and sold yuan. Selling yuan increases the Chinese money supply—Chinese QE. Exports dominate the economy, promoting a rising standard of living and acquiescent quietude to Communist domination among the Chinese masses. When China’s export markets contracted during the financial crisis, China went on a debt binge, funding unnecessary domestic infrastructure and redundant housing developments. Since 2008, total Chinese credit has quadrupled, reaching 282 percent of GDP.
To maintain the yuan-dollar peg now that the dollar is rising, the Chinese must sell dollar reserves to buy yuan, tightening the domestic money supply. This handicaps Chinese exports, shrinks China’s foreign exchange reserves, and retards economic growth and debt expansion. The yuan is slipping against the dollar, but because the dollar is rising and the world is hell-bent on competitive currency devaluation, the yuan is rising against most other currencies. If the Chinese abandon the peg and let the yuan fall against the dollar and other currencies, they will see an acceleration of already serious capital flight. If they don’t: slowing exports, economic contraction, and potential social unrest. The Chinese leadership has responded as most command and controllers respond when confronted with hard problems that have no easy solutions: it has grown increasingly repressive (see “The Endgame Of Communist Rule In China Has Begun,” by David Shambaugh, The Wall Street Journal, 3/7-8/15, SLL, 3/9/15). Whether or not the peg is abandoned, the Chinese economy is slowing and has a rendezvous with unsustainable debt. Maintaining the peg will only hasten the day.
Debt began collapsing in on itself with last year’s commodity bust. In the fracking “miracle” oil patch, the collapse is well advanced (see “‘Default Monday’: Oil & Gas Companies Face Their Creditors,” by Wolf Richter, SLL, 3/5/15), and will eventually draw non-oil debt into the no-escape vortex. The financial world is holding its breath, waiting to see who the dollar short carries out on a stretcher; who draws the short stick on Greek, Ukrainian, and Austrian debt, (see “Ukraine unofficially has 275 percent inflation!” from The Burning Platform, SLL, 3/10/15, and “Austria is fast becoming Europe’s latest debt nightmare,” by Jeremy Warner, SLL, 3/8/15), and how China will maintain a strong and weak currency at the same time. Now that the event horizon has been breached, the black hole of debt is expanding, exerting its increasingly powerful gravitational pull.
ONCE UPON A TIME THERE WAS NO CENTRAL BANK!