As Predicted, The Global Recession has Arrived, Will Depression Be Next?

A permanent lowering of the interest rate can only be the outcome of increased capital formation, never the result of any technical banking measures. Attempts to achieve a long-term lowering of interest rates by expanding the circulation credit of the banks ineluctably result in a temporary boom that leads to a crisis and to a depression—Ludwig von Mises

In this issue

As Predicted, The Global Recession has Arrived, Will Depression Be Next?

-The Wile E. Coyete Moment: From China to the World

-We Live in Interesting Times! Negative Oil Prices and Worst US Job Losses Since the Great Depression

-The Unseen Consequences from the Uncharted Global Fiscal and Monetary Bailout! Depression Ahead?

-The Bernanke Doctrine in Motion!

As Predicted, The Global Recession has Arrived, Will Depression Be Next?

The Wile E. Coyete Moment: From China to the World

When about 760 million or 50% of China’s population had been immobilized and placed under home quarantine by their government in response to the COVID-19 epidemic, I predicted that this would spur a global recession.

Back then*, I called this China’s Wile E. Coyote moment.

*Batten Down the Hatches! Global Recession Ahead: The New Coronavirus Pushes China’s Economy to a Freefall! February 16, 2020.

Figure 1

In the fulfillment of this watershed moment, last mid-April, China’s first-quarter GDP reported a 6.8% contraction, its first in a few decades!

And considering that the lockdown, which began on the 23rd January in Wuhan, Hubei which spread to over 80 cities in nearly 20 provinces and municipalities that lasted mostly through March, many analysts have come to dispute the reported GDP’s accuracy. The Wuhan lockdown was lifted on April 8th.

Nevertheless, the record economic contraction has prompted the Chinese government to rethink about setting up GDP targets for 2020. According to a report from the Bloomberg/Economic Times, “China’s leaders are considering the option of not setting a numerical target for economic growth this year given the uncertainty caused by the global coronavirus pandemic, according to people familiar with the matter.” Is this a facing saving measure for an embattled ruling class, the CCP?

In the meantime, the rapid transmission of COVID-19 across the globe has eventually prompted the World Health Organization (WHO) to admit on March 11 that this was a pandemic, more than a month after declaring a public health emergency on January 30. Given the speed of transmission, why did it take so long for them to consider?

The pandemic character has been so obvious that even this layman** can distinguish!

**The Coronavirus Pandemic: Who is Panicking? More From the Year of the Rat: Will History Rhyme? February 2, 2020

To “flatten the curve” by social or physical distancing, many countries embraced the authoritarian approach of epidemic containment by forcibly shutting down significant segments of or the entire country, although at varying degrees.

By early April, about 3.9 billion people or half of the world’s population were under home quarantine (house arrests?)!

Figure 2

Hence, the Wile E. Coyote moment wasn’t limited to China; it became a worldwide phenomenon!

As such, in the 1Q, the Eurozone’s GDP shrank 3.8%, its fastest rate on record, while the US GDP reported a 4.8% decrease, its steepest contraction since 2008!

Bloomberg estimates that the Global GDP in April plunged by 4.8%!

But there is more behind the headline numbers.

We Live in Interesting Times! Negative Oil Prices and Worst US Job Losses Since the Great Depression

Things that could not seem to happen—have actually been happening!

And here are just a few of them.

 

Figure 3

With a sharp decline in demand, which came in the face of a dearth of storage space, oil price futures fell to negative in the third week of April! Depressed prices put in peril debt-ridden oil companies and oil-producing nations with untenable welfare systems.

In the US, a record 20.5 million people have lost their jobs last April, sending the unemployment rate to 14.7%, the highest since the Great Depression! Yet, there were 33.5 million people who have filed for unemployment or jobless claims in the last seven weeks!

Minneapolis Federal Reserve Bank President Neel Kashkari in a CNBC interview recently said that though the reported unemployment rate could be as high as 17% — a brutal number, no doubt — but he says the true number may be as high as 24%. “It’s devastating.”

April’s job losses have virtually erased job gains of the last two decades! That’s Nassim Taleb’s Turkey Principle in action!

The US private sector employment-to-population, a measure of the number of people employed against the total working-age population (Investopedia), crashed to a harrowing 51.3% last April, the worst since, again, the Great Depression!

The highest unemployment rate during the Great Depression was 24.99% in 1933, according to the Balance.

Again, that’s only a piecemeal of the overall picture.

And because the great Wile E. Coyote moment has only scratched the surface, governments around the world backed by their respective central banks launched a series of unprecedented measures to bailout both their financial systems and the economies.

The Unseen Consequences from the Uncharted Global Fiscal and Monetary Bailout! Depression Ahead?

Figure 4

Governments around the world have collectively unleashed at least USD 8 trillion worth of subsidies to cushion the impact from the economic shutdown caused by both COVID-19 and the political response to contain its spread. Bank of America’s Michael Hartnett estimates that fiscal spending support has reached $16.4 trillion, about 19% of the 2019’s USD 86 trillion Global GDP!

With depressed economies, spending at this scale translates to massive fiscal deficits, which will require extraordinary amounts of borrowings and or support from the central banks.

And as a result, in 2020, 107 rate cuts have been imposed by about 78 central banks as of May 8th.

And to ensure liquidity, global central banks have engaged in balance sheet expansion by financing their respective governments through asset purchases.

Since surging fiscal deficits signify a global phenomenon, debts and central bank assets have exploded.

Despite the Trump government’s unleashing an accrued $2.4 trillion of spending support for the main street, backed by about $ 2.41 trillion of asset purchases by the US Federal Reserve, which has been faster than the Great Recession or the Financial Crisis (GFC) of 2007 to 2008, the yield of US 2-year Treasury note dropped to a RECORD low, while Fed Fund rate futures turned NEGATIVE before bouncing above zero late last week! The Fed’s balance sheet has soared to a milestone USD 6.712 trillion and has been expected to rocket to $10 trillion by early next year!

The details of the USD 2.4 trillion spending stimulus and the various support programs bankrolled by the US Federal Government can be found here and here.

And rumors of the second phase of support from the Federal Government have been afloat due to the recent job numbers.

Yet the carrying costs of the subsidies from the Great Recession or Financial Crisis of 2007-2008 has been immense. It lowered the trajectory of the rate of economic growth, increased dependency towards leveraging or debt for financing, redirected financial activities from the economy towards debt financed asset speculation, thereby, fueling asset market bubbles, nurtured the rise of zombie firms and industries, which siphoned resources that contributed to maladjustments that decreased economic productivity, promoted the widening of inequality, and entrenched economic structural imbalances, where central bank emergency policies became the norm that ultimately increased systemic global financial and economic fragility. 

Thus, COVID-19 fundamentally exposed such embedded vulnerabilities!

And here is the thing, the US signified the epicenter of the Great Recession or Financial Crisis of 2007 to 2008 (GFC) that spread to the world.  Hence, using domestic policies and international cooperation, much of the world was able to erect defenses against the contamination.

But this time is different.

In 2020, the IMF expects about 170 nations or 90% of its 189 members to register negative per capita income growth! Over 100 countries have approached the IMF for emergency financing. Though the IMF brags that it has USD 1 trillion in lending capacity, the irony is, some of the sources of financing may be from countries that are presently in need of it!

While access to bridge financing for countries undergoing economic stress had been made available from bilateral or multilateral sources during the GFC, that’s unlikely the case today.

Moreover, today's bailouts will be like funding deadbeats, where a financial blackhole exists to continually drain resources. For instance, Argentina received a rescue package from the worth $57 billion in 2018, the biggest loan from the IMF ever. Today, or less than two years from the rescue, Argentina is on the brink of its ninth default!

Furthermore, while it took over 10-years to expose the embedded costs from bailout policies of the GFC, the imbalances built from the present simultaneous fiscal and monetary support will extrapolate to the acceleration of capital consumption.

Besides, the economic shutdown has seriously impaired the availability of capital and capital goods in the global economy!

Yet to surface and be accounted for are the second-, third- and nth order from the current ambit of socio-economic and political events, which means, the current crisis is at its incipient phase!

A prolonged recession could morph into a Depression!

The Bernanke Doctrine in Motion!

Figure 5

And imbalances?

Since the GFC, US Federal Reserve policies have greatly influenced the direction of the US stock market. In a single month, the Fed’s USD 2.4 trillion asset expansion has encapsulated such rescues!

The financial markets have been 'totally' detached from the economy, the Mainstreet, or from “fundamentals”.

Mr. Ben Bernanke penned the below, even as a professor in 2000, or before to his entry to the US central bank. He would eventually assume the highest post as Fed Reserve Chairman from 2006 to 2014:

There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Central bank policies today continue to hallmark the Bernanke Doctrine and throw gasoline to the fire!

And because of this, millions of people have been hurt, and more are to suffer. This policy-induced pain represents its consequence, a somber reality of the business cycle.

Has The Deleveraging Process Culminated? Where’s The Next Bubble?

``Many shall be restored that now are fallen and many shall fall that now are in honor.”- Horace, leading Roman lyric poet in Ars Poetica

Global markets rallied furiously over the week, setting stage for what perma bears call as the sucker’s rally. For all we know, they could be right. But I wouldn’t bet on them. Not especially when central banks start to use the first of its available nuclear option of monetizing government debt. Not when government central banks start running the printing presses 24/7 and begin a Zimbabwe type of operation.

We also don’t know to what extent of the forcible liquidations of the deleveraging process is into, what we do know is that governments are today starting to unveil their long kept ‘secret’ final endgame weapons. We appear to be at the all important crossroads. Will it be a deflationary depression outcome? Will it be a recovery? Or will hyperinflation emerge?

What we also know is that forcible liquidations from the ongoing debt deflation process have been responsible for the “recoupling” saga we are seeing today.

Figure 4 stockcharts.com: Gold leads Rally

In figure 4, compared to the previous failed rallies (2 blue vertical lines), gold, oil and commodities haven’t joined the bullish rebellion in global equities as shown by the US S & P 500 (spx), Dow Jones World (djw), and Emerging Market Index (EEM).

This time we see gold leading a broad market rally. The Philippine Phisix too has obliterated its 10.73% one week loss by surging 11.65% this week. And even our Peso has joined the uprising by breaking down the psychological 49 barrier.

In short, this week’s rally does look like a broad market rally. And broad market rallies usually have sustaining power.

The Philippine Stock Exchange’s market internal tells us that even during the other week’s meltdown, the scale of foreign selling appears to have diminished. It had been the local retail investor jumping ship. This week’s rally came with even less foreign selling even if we omit the special block sales of Philex Mining last Friday.

My ‘fallacy of composition’ analysis makes me suspect that perhaps the issue of deleveraging has ebbed, simply because as the US markets cratered to form a NEW low, just about a week ago, key Asian stocks as the Nikkei 225 ($nikk), Shanghai composite ($ssec) and our Phisix have held ground see figure 5.

Figure 5: Stockcharts.com: Asian stocks Show Signs of Resilience

To consider, even as streams of bad economic news keeps pouring in, as Japan has reportedly entered an official ‘technical’ recession or two successive quarters of negative growth, its main benchmark the Nikkei appear to be holding ground.

It’s been said that once a bear market has stopped being weighed by more streams of bad news or despite this they even begin to rise; this mean that markets may have digested all negative info and may have signaled that a bottom has finally been established. As we quoted Jim Rogers on a video interview, ``When people say it is over and when we you see more bad news and stocks stop going down. But when they go up on bad news, that’s when we are gonna hit bottom. We are not gonna scream I don't know."

Although it could be too premature to decipher recent events as a bottom, we’d like to see more improvement in the technical picture and even more participation from major benchmarks of the region (djp2) aside from sustained rise from the market leader-gold.

Furthermore, if indeed the deleveraging process is beginning to fade, then the next phase should be markets factoring in the repercussions from the recent credit crunch to the real economy. But considering the steep fall during the October-November carnage, it is our impression that most of these had already been factored in.

Moreover, the downturn in the real economy should reflect divergences because not all of the Asian region’s economy will experience recessions see figure 6.

Figure 6 IMF: Emerging Asia Quarterly Growth Forecast

As you can see from the IMF’s regional outlook, except for Industrial Asia (Japan, Australia and New Zealand) which is the only class expected to flirt with an economic recession 2009, the rest of Asia’s economic growth engine is expected to only moderate with the Newly Industrialized Economies (Hong Kong Korea Singapore Taiwan) experiencing the most volatility (steep fall but equally sharp recovery). Most of the Asia is expected to strongly recover during the second half of 2009.

Now if the IMF projection is accurate and if stock markets are truly discounting economic growth to the streams of future cash flows of companies, then we should begin to see today’s rally as sustainable, reflective of these projections and at the bottom phase of the market cycle.

This also means sans further deleveraging prompted liquidations, we could expect some stark divergences in market performances. Unless, of course the headwinds from the collective efforts to inflate impacts every asset class simultaneously, which we think is quite unlikely. But as we earlier said, the bubble structure in the US isn’t going to revive and that any new bubble will come from elsewhere, for example the US dot.com boom bust cycle shifted to the housing industry in 2003 as an offshoot to the inflationary policies applied against a deflating tech industry led market and economic bust.

Boom-bust market cycles always involve a change of leadership. And considering that gold has been the frontrunner during the recent bounce, we suspect that precious metals, energy, commodities, emerging markets and Asia as the next bubbles to blow.

Watching For A Bottoming Confirmation

``For October 10 to be the bottom it is necessary for the sequence to continue. We believe that it will but to raise confidence we need to witness the proof of more credit spreads tightening and bonds rallying. So the best answer we can give today is, it’s likely October 10 was a bottom but it is also too soon to say decisively yes. We will position accounts as if it is the bottom and we will be vigilant and reverse those positions if we see a reason to do so. The Ned Davis database offers some help. They measure 42 global stock markets; all made new lows in recent days before their rallies. All declines qualify as “bear” markets. 11 of their 12 bottoming indicators have reached extremes that suggest October 10 was the bottom. Retests of those lows have been on declining volume; that is a good sign. Breadth indicators suggest it was a bottom. There are many more pieces of evidence in favor of the October 10 bottom conclusion. I will stop listing here.”-David Kotok, Cumberland Advisors, Tinker to Evers to Chance

The global stock markets have remarkably rallied from the lows of last week. But one curious development is that while the many measures of credit stresses seem to be narrowing (see Credit Spreads: Some Improvements But Not Enough), US mortgages appear to be inching higher. These extrapolate to the still significant economic risks to the US economy.

From market action perspective, the present rally could be construed as merely a bounce off from the latest lows than to imply of a BOTTOM yet.

Besides the rollercoaster market action suggests of a mixed message, while we see some semblance of history possibly repeating itself by a significant recoil from its lows typical of the 1973-1974 bear market bottom, the market volatility of over 4% swings in a day seem reminiscent of the actions of the great depressions (see Global Markets: A Wild, Wild October!).

Markets seem to have already priced in the outcome of the US presidential elections considering the tremendous gaps in survey polls and prediction markets months going into November. And as we have stated earlier, the bear markets and deteriorating economic conditions may have even induced the Americans to embrace the opposition as alternative or as a vote against the present administration than for the opposition (Remember, Republican Senator John McCain grabbed the lead from Senator Barack Obama in August-to suggest that it wasn’t totally dominated by the latter-until the US stock markets melted following the Lehman bankruptcy). It now seems likely that the outcome of the Presidential election will be a lopsided affair infavor of the Democrats.

Unless we are considering a return to a new millennium version of the Great Depression, the main focus will be on how the new US president will deal with the woes of US and global markets and the US banking system.

And our guess is that the US markets should probably be in the process of forming a bottom, as they may already have factored in much of the ongoing but unofficially declared recession in the US and elsewhere.

Figure 3: US Global /Credit Suisse: Market Performance During Recessions

The steep drop to the previous recession levels probably points to a possible bottoming out formation in figure 3, albeit we would like to see lesser intraday volatility swings to accompany the coming sessions as a sign of stabilization.

Frank Holmes of US Global Investors also notes of the large chunk of institutional cash waiting at a sidelines as potential drivers of a recovery in the market. But this would actually depend on the scale of losses that has already been priced in, meaning that if there will be less degree of forcible liquidations, then markets may attempt to gradually regain its confidence levels.

It’s a Banking Meltdown More Than A Stock Market Collapse!

``The argument that the government is somehow pumping new capital into the market is absurd. Government is actually borrowing the money from the capital markets that it is in turn injecting into the capital markets. There is no additional source of funding; there is only a diversion of funds from more-productive outlets to less-productive outlets, with government acting as the middleman.” -Scott A. Kjar, University of Dallas, Henry Hazlitt on the Bailout

It’s amusing how many people believe that today’s financial crisis is just a “headline” material. They carry this notion that the meltdown seen in the stock market are just confined to within the industry. They believe in media’s assertion that these are all about just banking related losses and perhaps a prospective recession. Yet, importantly governments will successfully come to the rescue. And that banking deposits will be safeguarded by sanctity of government guarantees. We hope that such smugness is correct and don’t turn out to be chimerical.

From our side, the current global stock market meltdown is like utilizing a thermometer to a gauge the body temperature of a patient. From which the mercury’s position indicates of the degree of normality or abnormality in the patient’s temperature than of its cause. Hence, the thermometer signifies as the medium and the mercury’s position the message. In the stock market we see the same message See Figure 1.

Figure 1: Mercury Indicator: Stock Market Meltdown or Banking System Meltdown?

The Performance chart from stockcharts.com shows that since the whole bubble bust cycle episode unraveled, the losses of world equity markets have been far less than the damage suffered by the housing and the entire swath of financial and banking sector.

True, everyone directly or indirectly involved in the financial sector seems to be afflicted. But some are suffering more than the others. This means that like the thermometer, the public’s attention have been on inordinately transfixed to the freefall in global equities but have glossed over the significance of the ongoing risk dynamics in the US financial sector.

From our point of view, the stock market “meltdown” has been a symptom of a deeper underlying disease: the risks of a US banking sector collapse. And this is not just about your typical banking losses, but a representation of the real risks of a total freeze of the entire global banking network system as we discussed in Has The Global Banking Stress Been a Manifestation of Declining Confidence In The Paper Money System?

As had been pointed out, the US dollar standard monetary system has been anchored upon a global banking system from which operates on a fractional reserve banking platform from where the entire global banking network revolves or interacts upon. In short, deposits, credit intermediaries, clearing and settlement, maturity transformation, asset markets etc… are all deeply interconnected.

Since the US dollar standard banking system has been at the core of our troubles, all the network of banking nodes connected to such intertwined system have likewise been bearing strains, see Figure 2 from the IMF.

Figure 2: IMF’s GFSR: The Evolution of the US Banking System From Deposits to the Shadow Banking

According to the IMF’s Global Financial Stability Report (emphasis mine), ``Banks have been shifting away from deposits to less reliable market financing. “Core deposits” dominated U.S. banks’ liabilities in the past, but have been gradually replaced by other “managed liabilities”…At the same time, near-banks—which are entirely market financed—have grown sharply. This is related to the “originate-to-distribute” financing model that relies heavily on sound short-term market liquidity management. Euro area and U.K. banks also rely more on market financing than in the past, as in the United States. Similarly, the share of deposits by households (defined roughly the same as U.S. core deposits) has been gradually declining over time, while deposits held by nonfinancial corporations, other financial intermediaries, and nonresidents have steadily increased. In addition to these “managed deposits,” financing through repurchase agreements and issuance of debt securities, both in domestic and foreign markets, have expanded, indicating that European banks are also increasingly exposed to developments in money markets. At the same time, the share of household deposits for Japanese banks has been stable and even increasing over time. This may partly reflect the prolonged low interest environment since the late-1990s.”

In other words, from a depository based banking system the US has evolved into gradual dependency on “near banks” or what is known as the “shadow banking system” (we previously featured a schematic chart from the Bank of International Settlements The Shadow Banking System) which basically relies on short term financing or maturity transformation borrow short and lend or invest long.

Thus, when the collaterals backstopping the entire short term financing channels began to deteriorate, whose chain of events included the Lehman bankruptcy, this resulted to a collapse in the commercial paper market (forbes.com) and the “breaking the buck” in the money markets (edition.cnn.com) as banks refused to deal (borrow and lend) with each other on perceived “rollover risks”.

Consequently, major financial institutions dumped the banking channels and stampeded into US treasuries. This exodus or flight to safety set a record yield of .0203% for 3 months bills last September 17^th (Bloomberg), which we described last week as an “institutional run”. And these strains reverberated throughout the network of banks all over the world which raised credit spreads and resulted to a dearth of US dollars and lack of liquidity in the system as banks and companies hoarded cash. Thus as a result to the credit gridlock the liquidity crunch inspired the sharp selloffs.

So while the defensive mechanism for the global banking system has been designed against isolated instances of retail depositors run via a depositors insurance (e.g. FDIC, PDIC etc…), an institutional run has not been part of such contingencies.

Hence what you have been witnessing is an unprecedented monumental development which has a potential risk of a downside spiral.

To consider, the assets of Shadow Banking system was estimated at some $10 trillion dollars which is almost comparable to the assets of traditional banking system. According to a report from CBS Marketwatch (all highlights mine),

``By early 2007, conduits, structured investment vehicles and similar entities that borrowed in the commercial paper market and bought longer-term asset-backed securities, held roughly $2.2 trillion in assets, according to the Fed's Geithner.

``Another $2.5 trillion in assets were financed overnight in the so-called repo market, Geithner said.

``Geithner also highlighted big brokerage firms, saying that their combined balance sheets held $4 trillion in assets in early 2007.

``Hedge funds held another $1.8 trillion, bringing the total value of asset in the "non-bank" financial system to $10.5 trillion, he added.

``That dwarfed the total assets of the five largest banks in the U.S., which held just over $6 trillion at the time, Geithner noted. The traditional banking system as a whole held about $10 trillion, he said.”

So as hedge funds continue to shrink from redemptions, TrimTrabs estimates a record $43 billion in September-liquidity requirements, margin call positions, maintaining balance sheet leverage ratio or plain consternation could risks triggering more negative feedback loop of more forced liquidation.

Besides, risk of a deep and extended recession could imply larger corporate bankruptcies and larger defaults from corporate leveraged loans that could trigger credit events in the CDS market that could give rise to new bouts of forcible liquidations. All these could similarly shrink the capital base of existing banks, even under those buttressed by capital from the US treasury.

In addition, the risks of heavy damages in the asset markets could spread to the insurance and pension funds which risks reinforcing the downside spiral. In short, the shadow banking system poses enough risk to destabilize the entire US banking system.

Global Governments Throws The Kitchen Sink And the House

Governments have virtually thrown not just the proverbial kitchen sink but the entire house to deal with such outsized dilemma. The US government pledged to “deploy all of our tools” as the G7 counterparts have “committed to a global strategy”.

Specifically the US government will earmark some $250 billion for its “capital purchase program” to be infused as capital to the banking system in return for preferred shares of which 9 of the major banks have “agreed” or “coerced” to participate, a temporary guarantee by the FDIC on the “senior debt of all FDIC-insured institutions and their holding companies, as well as deposits in non-interest bearing deposit transaction accounts”, the broadening scope Commercial Paper Funding Facility (CPFF) program which will “fund purchases of commercial paper of 3 month maturity from high-quality issuers” (Federal Reserve) and unlimited swap lines or “Counterparties in these operations will be able to borrow any amount they wish against the appropriate collateral in each jurisdiction” with major central banks as the Bank of England (BoE), the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank (SNB) as “necessary to provide sufficient liquidity in short-term funding markets”. (Federal Reserve)

Figure 3: Wall Street Journal: Europe’s Bailout Package

Of course, it’s no different with the European counterparts which have committed aggressively some €1.8 trillion (US $2.4 trillion)-AFP.

So overall, including the US Congress’ contribution of $850 billion plus the Federal Reserves liquidity infusion via US dollar swaps these should amount to over $3 trillion or over 5% of global GDP (2007) of $54.62 trillion based on official exchange rate-CIA.

Such astounding financial theater of operations reminds us of the D-Day 1944 Normandy Landings. Bernanke’s helicopters have not only been operating on round the clock sorties, but they are also flying all over the globe as the Fed has essentially outsourced its printing press functions to international Central banks!

The Illusions of Government Guarantees

If only those unlimited injections of liquidity can translate to REAL capital.

The unfortunate part is that government guarantees depend on the hard currency that backs the system.

For instance, in the case of Iceland which basically guaranteed deposits of its financial system and nationalized its major banks, the lack of hard currency has precipitated a crisis (See our Iceland, the Next Zimbabwe? A “Riches To Rags” Tale?).

As the Icelandic government operated on a huge current account deficit in the face of a paucity of global liquidity, rising risk aversion, global bear markets, global deleveraging and the monumental debt incurred by its banking system, investors withdrew funding and sold the currency aground. Last October 9^th the Iceland Prime Minister even pleaded to the public to restrain from withdrawals (Reuters).

Now goods shortages have emerged and consumer price inflation has soared. If Iceland can’t obtain the sufficient funding from overseas lenders (IMF or Russia or etc.) soon enough, then it would have to resort to the printing press or our developed country equivalent of Zimbabwe.

In a varied strain, Pakistan’s economy and banking system has allegedly been suffering from “some” depositor’s run (thaindian.news) on rumors that the government might impose withdrawal restrictions. Global volatility has exposed Pakistan’s vulnerability to its heavy dependence on short term debt financing and huge current account deficits (see our Increasing Signs of Pakistan's Depression?). Pakistan is now seeking a bailout package from China.

In both examples, government guarantees won’t serve any good if governments can’t support such claims.

Think of it, government revenues basically derive from three channels: taxpayers, borrowing through debt issuance or the printing press.

Even if your government guarantees deposits or other loans, assets etc…, if taxpayer’s can’t pay up, or if the government can’t raise enough borrowings to fund its present expenditure or settle its liabilities seen via fiscal or current account, your government ends up using the printing press to meet its needs.

This means that in the assumption that your government remains functional under a banking system collapse, whatever money guaranteed by the government will surely have its purchasing power evaporated!

If for instance the Philippine government allows deposit guarantees to increase at P 500,000 per depositor (from the present Php 250,000-PDIC) and our doomsday scenario occurs, such an amount which can momentarily buy a second car will eventually (perhaps in just months) buy up only a bottle a beer! That is if government even allows you to withdraw your money. In Argentina’s case during its 1999-2001 crisis, particularly in December of 2001, the Argentine government restricted depositors from withdrawing money to only a specified amount (BBC).

To Austrian economics, such restriction is equivalent to “Confiscatory Deflation”, which according to Joseph Salerno in his Austrian Taxonomy of Deflation, ``There does exist an emphatically malign form of deflation that is coercively imposed by governments and their central banks and that violates property rights, distorts monetary calculation and undermines monetary exchange. It may even catapult an economy back to a primitive state of barter, if applied long and relentlessly enough. This form of deflation involves an outright confiscation of people’s cash balances by the political and bureaucratic elites…

``Confiscatory deflation is generally inflicted on the economy by the political authorities as a means of obstructing an ongoing bank credit deflation that threatens to liquidate an unsound financial system built on fractional-reserve banking. Its essence is an abrogation of bank depositors’ property titles to their cash stored in immediately redeemable checking and savings deposits.” (highlight mine).

Yet when government mandated money loses trust among its constituents people tend to find a substitute, as example see our previous, The Origin of Money and Today's Mackarel and Animal Farm Currencies.

So as shown above, government guarantees do not constitute as an outright safety net. These will all depend on government’s access of available financing at future costs.

Under the same line of thought, the idea that the US dollar as the international foreign currency reserve with unlimited lending capacity is another mirage.

The US economy has been supported by the financing of its current account deficits by foreign exchange surpluses of current account surplus countries mostly found in Asia and Gulf Cooperation Council (GCC). This vendor financing scheme effectively recycles money earned from exports of EM economies by buying into US financial papers to keep their currencies from appreciating.

Hence, the US economy’s ability to provide unlimited finance is moored upon the willingness of foreigners as China, Japan and GCCs to sustain the present system. Said differently, for as long as these financers continue to buy US financial claims, they automatically provide the wherewithal or the “quiet bailout” to the US government.

So China, Japan and others essentially determines the guarantee provisions the US extends to its financial institutions aside from the world’s faith on its printing presses.

Besides, guarantees in the banking system as we previously discussed represent as “beggar-thy-neighbor” policy which keeps at a disadvantage countries offering less amount of guarantees, like the Philippines, since the former tend to attract more capital or savings because of the higher amount of safety.

Hence, guarantees signify as subsidies to those who apply more and a tax to nations who apply less. Thus, the policy regime of surging guarantees on deposits by Europe and the US tend to put into the downside pressures to the Philippine Peso.

Yet, our discussions above are some examples of isolated banking crisis and not of a systemic banking collapse, a domino effect from a prolonged cardiac arrest of the US banking system, the ultimate recipe for a global depression, where guarantees will just be that- a political rhetoric.

US Banking Collapse: You Can Run, But You Can’t Hide; Revival of Bretton Woods?

We proposed last week that this could mark the beginning of the end of the current form of paper money system or even signify as a harbinger to a new paradigm shift from our present monetary system.

Perhaps European Central Bank’s Jean Trichet heard our whispers and began to talk about the revival of a modern version of a “Bretton Woods” (see Did ECB’s Trichet Fire The First Salvo For A Possible Overhaul Of The Global Monetary Standard? and Bretton Woods II: Bringing Back Gold To Our Financial Architecture?)

So aside from the rapid aggressive policy response (bailouts, liquidity injections, nationalization, blanket guarantees), some European leaders have also raised the idea for a shift in the global financial architecture.

As the Reuters report indicates ``Italy's economy minister said a reform of the Bretton Woods institutions should also review trade, foreign exchange and capital markets and questioned whether the dollar should remain the reference currency under a new system.” (highlight mine) So it won’t be a far fetched idea for a movement among nations to address the need to reform the present monetary system.

Yet as the crisis continues to unfold, everything now seems to depend on how the global markets will respond to the massive stimulus applied and how it will measure up to remedy the apparent weakening of the foundations of the US banking system.

Nonetheless the threat remains real.

This means that should the US banking system collapse, there will probably be no escape for almost everyone dependent directly or indirectly on the global banking system, not even for those who aren’t invested in the stock market. While it is true that alternative sources for financing such as microfinancing and trade finance may be picking up on some of the slack, it won’t be enough for it to replace the rapidly mounting losses in the financial system that risks becoming a financial black hole.

We can only guess what implications of a global depression as an offshoot to the US banking collapse could be: pension, insurance, and other money market funds will perhaps evaporate, stock markets will close, a collapse in the international division of labor means each country will have to fend for themselves or dominant “protectionist” policies will prevail (hence some countries will experience hyperinflation and others will suffer from deflation), a run of the US dollar or the present paper money system, rising crime and security risks, civil wars, return of authoritarianism etc…

On the other hand, some sectors would be quite happy- the extreme left will glee with the resultant equality from a depression, as well as bureaucrats and political leadership who will benefit from more government spending. Outside these sectors, everyone will probably be equally poor!

Sorry for the gloom.

Conclusion

Thus, it is an arrant misguided fairy tale to suggest that today’s stock market meltdown is just seen for its “media feed”.

Today’s stock market meltdown is representative of the real risks of a US banking collapse. While I am not betting that this devastation is gonna happen, a US banking collapse would have deep adverse repercussions to our domestic and global banking system, aside from the global economy which practically means the ushering in of the great depression (version 2008) . Why would global central banks have earmarked over $3trillion of bailout money? Why would Bernanke’s Federal Reserve Helicopters be doing simultaneous missions globally to drop “helicopter money”?

So it is equally myopic to suggest that our banking system will be “immune” to such extreme risk scenario. If the issue is only about banking losses and some disruptions in the system then yes the Philippine banking system will escape with some bruises.

Nonetheless if the US banking industry does collapse, not even those out of the stock market will be spared unless their money is stashed under their pillowcase or buried underground.

That is if street muggers don’t figure them out.