GLOBAL ECONOMY – DOWNCLIMBING IS MUCH MORE DANGEROUS THAN UPCLIMBING

JANET YELLEN IS RIGHT.

In “Global economy – Quagmire & Quicksand” published in January 2015, http://www.tremeritus.com/2015/01/21/global-economy-quagmire-quicksand-part-13/

http://www.tremeritus.com/2015/01/22/global-economy-quagmire-quicksand-part-23/

http://www.tremeritus.com/2015/01/23/global-economy-%E2%80%93-quagmire-quicksand-part-33/

 I warned

•   of stormy global economy and financial markets looming ahead.
•  The strength of US recovery is running out of stamina moderated by rising US dollar.

And despite the strength of the US dollar, I asked this pertinent searching question in closing comment – why is gold price so strong?

This is now playing out to full illumination – turmoil, fear and even panic, griped financial markets since the beginning of 2016. Two sudden Chinese Yuan devaluations in August 2015 and the bursting of the Chinese equity market bubble since last June set the triggers. Sharks roaming financial markets smell blood in the water. In just over 3 weeks since January, over $8 trillions of asset values were wiped out in global equity market rout. http://www.reuters.com/article/us-usa-economy-recession-idUSKCN0V01IF . This bloodbath is continuing. Bank of America Merrill Lynch warned of elevated risks of another US recession looming.

In Congressional testimony on 10 February 2016, Fed Chairwoman, Janet Yellen, warned of these risks ahead for the US economy – rising borrowing costs, plummeting stock prices waiting to discover a bottom. http://money.cnn.com/2016/02/10/news/economy/janet-yellen-testimony-congress/index.html. In fact, she spoke not once but twice on the subject-matter of risks adversity strength of the US dollar undercutting the fragile US economy recovery. http://www.federalreserve.gov/newsevents/testimony/yellen20160210a.htm. Yellen’s cautionary stance blamed “subdued foreign growth” and “appreciation of dollar restrained net exports”. The Fed’s estimated US 2015 GDP growth at a tepid 1.75%. Financial conditions within US have become “less supportive of growth”.

What most market analysts missed, perhaps forgotten, (but not financial market traders who dashed for the “sell” door) are these dreaded foreboding words of last September ...“slowing Chinese growth” and depressing commodities prices could “trigger financial stresses in commodities exporting economies, particularly in vulnerable emerging economies”...their flow-on effects pose detrimental risks to US economy forward. This is precisely what is already happening now. Yellen in Sept 2015 press conference after her Congressional testimony – in refusing to raise US interest rate – spoke of “China” 16 times in less than an hour. http://money.cnn.com/2015/09/18/news/economy/china-yellen-global-economy-worry What has changed since September 2015?

Arguably, worsen global economic conditions after a baby-step hike in US Fed fund rate last December. And the US Dollar index, DXY, actually hit exhaustion close to 100 after the fact of event. Coincidentally, spot gold closed at US$1,071.81 an ounce, near its lowest 2015 levels, on the relevant market day – thus rising from charred disenchantment & transforming itself into a raging bull. Was that a mistake of US Fed monetary policy of Yellen’s first stumble on a dangerous terrain? At minimum, she either lost track of her September 2015 Congressional testimony or now preferred silence of that when the she testified slowing China’s growth prospect has become the epicenter of global growth narrative within the Fed, IMF, OECD, World Bank etc. http://www.tremeritus.com/2015/10/20/china-bond-market-are-quicksands-part-1/ and http://www.tremeritus.com/2015/10/22/china-bond-market-are-quicksands-part-2/ and http://www.tremeritus.com/2015/10/23/china-bond-market-are-quicksands-part-3/. This is the first time Yellen acknowledges

•  Fragility and timidity of US economic recovery below trend line benchmarks
• China and emerging economies pivoting play and negative feedback loops from these economies will be central to the sustainability of US economic recovery
•  leaving US to be the last remaining bastion of global economic  fortress
•  US economy decelerated rapidly in the December qtr, the Fed mostly treading on the quicksand of US dollar appreciation & navigating increased volatility in financial market against a background of persistent weakness abroad, exacerbated concerns about global growth outlook.

WHAT ARE THE REALITIES?

Yellen spoke of “higher borrowing rates for riskier borrowers” in the US – it is NOT an entirely new phenomena. Nor is it unique to the US. Take a look at US corporate BBB grade investment bond yield – it has been rising for nearly a year now despite ample availability of near zero interest rate liquidity. It is now slightly higher than 4.46% compared to 3.4% in March 2015. https://ycharts.com/indicators/us_corporate_bbb_effective_yield. Zero interest rate policy (ZIRP) has not worked and central banks, globally, are in damage control. Chinese have slowed down their money printing of stimulus spending. Chinese President Xi warned at year beginning that “economic stimulus is ‘not the answer to nation’s challenges....... China cannot rely on extensive development and strong stimulus to achieve these targets, otherwise the country will repeat the old path, and then create new contradictions and problems.  Expanding investment could help boost growth, but ineffective investment that brought no returns would eventually become bad debts, posing financial risks to corporations and fiscal risks to the country.”http://www.scmp.com/news/china/policies-politics/article/1897719/chinas-president-warns-economic-stimulus-not-answer

Janet Yellen has yet to find a more confident footing in pushing for normalisation of the Fed’s monetary policy. Credit is tightening in some sectors such as housing and energy and no one knows who is lending what amount to emergent economies, big oil or mining houses as commodities prices got crushed. Recent equities sell-off slammed European banks particularly hard, with banking shares diving deeper relative to broad market indices fall. The sell-off in financials reflects investor’s risks adversity flight to safe havens - investors preferring preservation of capitals rather than trying to catch the bounce of earnings which slow economic growth finds hard to discover. The iTraxx Senior Financials index tracks the cost of credit default swaps (CDS) has risen steeply last week though not quite to the level of fear-grip panic seen in the Euro crisis. http://blogs.wsj.com/moneybeat/2016/02/09/surging-credit-risk-for-banks-is-becoming-a-major-issue-in-european-markets/ CDS which protect the investors buying them against a company’s default, and this will add to the costs of equity for European financial institutions. In an environment of negative interest rate for deposits with central banks, the earnings of European banks will be crushed notwithstanding risks of lending expanding. The risk-return trade-off paradigm weighs against return.

Negative rate, set by central banks in Europe, has spread to Japan. Banks across the globe suddenly woke up to the realities that instead of providing liquidity in tough times, protecting their own equity and capital must now take priority. On razor thin margin spread between deposits and lending rates, banks find their margins squeezed further having to pay central bank negative interest rate penalty for their reserves deposits. Before that, risk across all asset classes is already mispriced in unprecedented accommodative monetary policy as money influx from quantitative easing finds its way into stock markets and other asset bubbles. Banks know they have no backstop protection from central bankers from financial market volatility when bubbles deflate. Corporate bonds saw their prices falling but safe-haven bonds issued by UK & US government found support. Plenty of money around, but fear of capital loss overrides in a sea of overpriced assets.

GOLD’S STELLAR SURPRISE SURGE

Gold turned up a euphoric performance in the face of global volatility. My last check at goldprice.org as of February 11, 2016 reveals the gold price performance in different currency mixes.

Against the weakening US dollar, physical gold rose 17.7% since January 3. The yellow metal climbed 20.9%, 18.1%, 18.7% and 12.4% against the Australian, Canadian dollar, Chinese Yuan and even the stronger Euro respectively. Gold stocks fared much better taking analysts and market punters by surprise. A look at the price charts of this list of Canadian gold stocks reveals a majority of gold stocks bottomed-out well before this 2016 price spike. http://www.miningfeeds.com/gold-mining-report-canada. Financial markets have appetite for gold stocks LONG BEFORE this sudden forceful upturn in the bullion market – the strength of gold was something which I alerted to in Global Economy – Quagmire & Quicksand some 12 months ago. This is something Janet Yellen kept silent on.

Fundamentals alone cannot justify bullish gold sentiment even as World Gold Council reported 4% growth in consumer demand, central bank demand up 25% in the December 2015 qtr and for the first time since 2008, gold production has fallen. In prior years of 2014 and 2015, geopolitical events underpinned rally in gold price in the first qtr before it fizzled out. We saw Russia’s annexation of Crimea in 2014 and Greece’s brinkmanship of “Grexit” in 2015. In 2016, is it going to be flight to “safe haven” in gold as even the US dollar wilting, stock indexes worldwide collapsing over the concerns of health of the global economy, hints of banking systemic contagion spreading, and safe-haven 10 yr US Treasury hitting their low since 2012?

Or there might be no safe haven at all – merely the rotational play of asset bubble bursting might see gold as the last bet on the gambling table evaporating of its euphoric spasm of stretched valuations as investors adjust to the realities of global recession. Unlike oil and gas, gold production can’t be escalated modestly to meet with sudden surge in its underlying commodity price. Stock price surge among some Australian gold producers appears to defy logic and explanation. Bullion rise is too fast, too steep of climb and stands in polar contrast to base metals and energy. Question must be asked – is this sustainable much longer from here?

If one is to believe oil price is a good predictor of gold price but not vice versa, the scripture written on the wall says deflation pressure is stronger than inflationary pressure. That is the gold price rise is temporary and global economy is, more likely than not, walking down the pathway of subdued economic activity. At 1.75% annual growth rate of the US economy, the FOMC cannot be sanguine of its targeted annual inflation rate of 2% over the medium term. There is no demand pressure and declining energy prices is another drag on inflation expectation in the short-term. Yellen testified in her Congressional testimony that the US labor market, though much-improved, is still operating below potential and housing demand is still significantly short of demographic prediction.

GLOBAL ECONOMY DECELERATING TOGETHER IN LAST QUARTER

Economy activity in the world’s three largest economy decelerated in the final qtr of 2015 and it was second shrinkage in 3 qtrs for the Japanese economy. http://www.marketwatch.com/story/japans-economy-shrinks-again-abenomics-in-doubt-2016-02-14 . The economic credentials of “Abenomics” are in tatters. Shinzo Abe has been monkeying around with his unorthodox economic policy construct since December 2012. Economists may point to a “better” Eurozone growth of 1.5% last year compared to 2014 but that had the benefit of weaker Euro/dollar exchange battering US exports and economy. The Eurozone economy demonstrated no “escape velocity” of growth recovery long past ECB President, M. Draghi’s brave threat in July 2012 of “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” in dealing with the debt crisis and turning its economy around. http://www.telegraph.co.uk/finance/financialcrisis/9428894/Debt-crisis-Mario-Draghi-pledges-to-do-whatever-it-takes-to-save-euro.html.

So there you have it – “Abenomics” is a failing demand-side economic experiment since December 2012, moving into new experiment with negative interest rate supply-side economics. And “Draghi-nomics” is sinking with this admission to the European Parliament this week from its principal architect, no less. http://www.kitco.com/news/2016-02-15/ECB-chief-parts-of-Europe-banking-system-face-challenges.html. In a week of violent swings in the stock prices of major European banks including Credit Suisse, Deutsche Bank and Societe Generale, the European parliament was reminded that some EU banks are still battling with challenges from litigation and restructuring costs as well as working off soured investments. Of course, Draghi spoke nothing of rising credit defaults swaps and market pressures on major EU banks to buy back their “contingent convertible bonds (also known as “cocos”” bonds) underlining investors’ growing fear of these banks lending exposures to commodities business, commodities export-dependent emerging economies, financially-strapped EU sovereigns and vulnerability to even risks of sell-off among sovereign wealth funds of their investment holdings. I believe Draghi’s European parliamentary testimony understated the extent and balance sheet risks of EU banks’ exposure to “soured investments”.

Post the GFC period, monetary policy from the ECB is the only truly stimulative policy over the last 4 years – Draghi noted. And, in the case of the US and China, monetary stimulus, prevailing over the last 7 years. Draghi was silent that monetary stimulus is proven ineffectual of its intended objectives. Yet, he has already hinted of even more dosage of quantitative stimulus in March in the face of destabilised global stock market, Chinese slowdown and continued tumbling of commodities prices. http://www.ft.com/cms/s/0/1bf80430-c03d-11e5-846f-79b0e3d20eaf.html#axzz40Kox5VMR. “We are not surrendering in front of these global factors” evidenced how defensive ECB has become of a failed macroeconomic policy construct. Meantime, Morgan Stanley warned that negative interest rate experiment is dangerous. http://www.marketwatch.com/story/negative-interest-rates-are-a-dangerous-experiment-warns-morgan-stanley-2016-02-17?dist=beforebell

ANOTHER EUROPEAN BANKING CRISIS LOOMING?

Who knows if another EU banking crisis is lurking on the horizon – no matter what the ECB promises to do of “whatever it takes”? A little known besieged Portuguese bank, Novo Banco, could have lit the proverbial prairie fire.  With the ease of keyboard stroke precision, it simply deleted the “pari passu” (equal footing) ranking of all creditors to unilaterally decide who gets what back of its debt borrowing. http://www.derivalert.org/news/?Tag=Novo+Banco+SA . The fear that creates must be who are the next “Lehman Brothers” ghosts of re-incarnation among EU banks. It is hard to know who is exposed to who and what amount and “cocos bond” of European banks might be just another worthless piece of sanitary paper i.e. the legal document defining the terms of the bond issue might count for nothing – the debtor decides the fate of all those who invested – just like Novo Banco’s fait accompli. http://www.forbes.com/sites/petertchir/2016/02/06/what-is-happening-to-european-banks/#172f5cf05b2f The GFC of 2008 tells us no bank is too big to fall – the bigger the bank, the heavier of fall of impact, perhaps.

The latest dismal EU banking results speak volume of intense margin pressures and that will intensified as negative interest rate set by central banks adding to their woes. In distressed environment, EU banks are absorbing the cost of negative interest rate - too fearful to pass on their increased costs of equity to customers. Since February 2015, most highly-rated non-financial corporate like Nestle can easily offer “negative yield” bond rather than seeking bank financing. http://www.ft.com/intl/cms/s/0/4b5c16a8-abcb-11e4-b05a-00144feab7de.html#axzz40Kox5VMR Over in the US, Anheuser-Busch InBevNV did a US$46 billion bond issue in January 2016. Apple plans to issue US$10 to US$12 billion to finance share buybacks and dividends. http://www.marketwatch.com/story/apple-to-issue-10-billion-to-12-billion-of-bonds-to-finance-share-buybacks-dividends-2016-02-16 . Other corporate like IBM are next in the queue. The inevitable follows must be crushed earning for banks aggravated by intensified risks lending to financially-weaker borrowers. 

Negative interest rate policy is a desperation “crisis policy” of paying your banker to save because traditional tools of monetary policy no longer work.

By the end of 2015, roughly one-third of the debts, some as long as 6 yrs duration, issued by EU sovereigns had negative yield. http://www.bloombergview.com/quicktake/negative-interest-rates  The Bank of Japan surprised the world on January 29 by adopting a negative interest-rate strategy. It is uncharted waters of monetary policy in experimentation. A sea change in the banking world is evolving with commercial banks finding no support of refuge from central banks navigating macroeconomic monetary policy of its sovereign in command. Banks used to be a warehouse of assets (good, bad or doubtful values) and a provider of liquidity in distressed financial market conditions but they can no longer afford or able to – this is the ultimate damage of negative interest rate strategy. EU banks might be too fearful to lend. http://www.smh.com.au/business/markets/what-the-experts-wont-tell-you-about-last-weeks-market-turbulence-20160213-gmtijz.html

With investors’ support diminishing of prospective capital raisings of lower quality bond issuers evaporating, which banker is stepping forward to fill this credit shortage? And, after Nova Banco, who is going to be the next investor buying EU banks’ next “cocos bond” offering, in distress of their collapsed share prices? What if negative interest rate strategy backfires, sending EU banking system into a tailspin and its economies tumbling into a deflationary spiral?

IS THE US ECONOMY QUITE SOUND?

Janet Yellen was more “confident” of survival probabilities statistical analysis on December 16, 2015 (when the Fed raised 25 basis points on its lending rate)…… “but the underlying health of the U.S. economy I consider to be quite sound. I think it’s a myth that expansions die of old age. I do not think that they die of old age. So the fact that this has been quite a long expansion doesn’t lead me to believe that it’s one that has—its days are numbered…….. a lot has changed since pre–financial crisis in terms of the financial system…” http://www.federalreserve.gov/mediacenter/files/fomcpresconf20151216.pdf. I didn’t see Yellen so confident on February 10, 2016, less than 2 months later. What has changed?

For one thing, the sustainable long-term growth rate pre-financial crisis is 3% GDP growth per annum, the US struggled to reach 1.75% in 2015. And the US economy quite sound if you believe the soothing assurances of Yellen of December 16 last year? Lumber price is languishing at the bottom, back to 2012 levels. http://www.nasdaq.com/markets/lumber.aspx?timeframe=7y. Weyerhaeuser (WY) reported on February 5, 2016 a lower 2015 sales turnover and forecasting a modest-to-lower outlook forward. http://investor.weyerhaeuser.com/2016-02-05-Weyerhaeuser-reports-fourth-quarter-full-year-results.  WY is bellwether of US housing sector. https://www.youtube.com/watch?v=udjyZ9F6qn8  Toll Brothers Inc, the largest builder of luxury homes in US, reported stagnant gross margin - excluding interest and impairments - was 25.9% in 2015, compared to 25.3% for FY 2014. http://globenewswire.com/news-release/2015/12/08/793702/10158087/en/Toll-Brothers-Reports-4th-Qtr-and-FYE-2015-Results.html?parent=792696. There is no price leverage even for builders of luxury homes. This is despite lower unemployment, increasing home equity, rising real personal income attribution made by Janet Yellen.

With US nationwide housing starts currently running at 1.1 million units annually, it is still a long way from historical past. http://www.federalreserve.gov/mediacenter/files/fomcpresconf20151216.pdf Yellen is correct in February on her assessment of the “progress” in US new homebuilding since pre-financial crisis period .It “remains well below the longer-run levels implied by demographic trends” she said.

Bank of America analysts noted that the fourth-quarter earnings season, currently wrapping up, is shaping to be the worst quarter for earnings growth since the financial crisis. http://www.marketwatch.com/story/this-is-the-worst-quarter-for-company-earnings-since-2009-2016-02-16?dist=tbeforebell  The recovery in US economy is feeble, shallow, its interest-sensitive housing sector remains fragile and the strength of the US dollar adding to external vulnerability more than the positive offset of cheaper import prices including energy. Already, the 10-yr treasury yield is flashing warning signs of a US looming deep recession – unless this security is “significantly mispriced”. http://www.marketwatch.com/story/heres-why-the-fed-not-the-market-might-be-right-about-a-recession-2016-02-18. That is to say, the collective financial market is wrong and the Fed’s (read Yellen’s) optimism is right.

GOLDMAN SACHS – BETTING GOLD OR ECONOMY?

High profile market watchers are rethinking their assumptions and reworking their economic calculus of the US economy. Goldman Sachs (GS) for one is a case in point. GS backs away from 5 of its 6 big market calls so early in the year. http://www.marketwatch.com/story/how-to-react-when-a-goldman-sachs-backs-away-from-its-big-calls-so-early-in-the-year-2016-02-10?siteid=bigcharts&dist=bigcharts one need to remember GS had been over extended of its optimistic forecast on the US economic recovery in both 2014 and 2015 – for two consecutive years. Betting against gold in 2014, Jeffrey Currie, Global Head of GS commodities research, confidently asserted... “Our view there really is driven by the expectation of the U.S. economy reaching escape velocity.” http://www.cnbc.com/2014/01/13/gold-to-tank-in-2014-goldman-sachs.html  In 2015, GS’s Jan Hatzius forecast a US GDP growth of at least 3% “above trend” as the Fed moves to exit the economy’s dependency on QE. http://qz.com/316118/macroeconomic-outlook-for-2015/. We know and Janet Yellen have pencilled in a US GDP growth of 1.75% for 2015 – well below trend line.

GS was bearish on gold in 2014/2015 but again both were “wrong” of its bearish bias. The Crimean war in 2014 and “Grexit” down to the wire challenge defeated GS’s bearish forecast. Of course, GS is still stoic of its bearish conviction on gold in 2016. They are recently forecasting the Fed will raise interest rate 3X by 25 basis point each time and maintaining their analysts’ December 2015 forecast that bullion will trade at US$1,000 per oz by end of 2016. http://www.bloomberg.com/news/articles/2016-02-09/goldman-is-no-believer-in-gold-rally-as-fed-to-hike-three-times. So far, up to the date of this writing, bullion staged an unprecedented euphoric rise contrary to most high profile market watchers. Uncertainty of how hawkish then of the Fed will be in raising interest rate sidelined confidence in gold – warned Barrons on 2 January 2016. http://www.newsmax.com/Finance/StreetTalk/Barron-s-Gold-Likely-to-Stay-Tarnished-in-2016/2016/01/02/id/707918/ Many fast-paced traders short found themselves short-covering in panic and this rally is without any help from any specific geopolitical event unlike 2014/2015 except the global stock market rout hitting hardest on banking stocks and what appears to be a potential forming systemic crisis of confidence ravaging banks in EU, US and parts of Asia. This turmoil is continuing.

Yet GS adamantly said this week yet again – sell gold now as recent rally isn’t justified - of irrational fear entrapment. Its global head of commodities, Jeffrey Currie,  urged -  “As we maintain our view of rising U.S. rates and hence lower gold prices with a 3-month target of $1,100 an ounce and 12-month target of $1,000 an ounce, we are recommending shorting gold,” – it is fascinating. http://www.marketwatch.com/story/sell-gold-now-as-recent-rally-isnt-justified-says-goldman-sachs-2016-02-16?dist=lcountdown . This writer took a quick check on VIX - CBOE volatility index – as a proxy barometer of market fear factor – it has spiked up twice since December 2015 and has already subsided. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=vix&insttype=&freq=1&show=&time=6.

Is GS too late of this gold (but not gold equities apparently) shorting recommendation? The extreme price volatility of Australian gold stocks in positive territory this morning (17 February, 2016) contrasting the extreme negative volatility of Canadian gold stocks overnight speaks volume of deep global divisions among gold equity investors in this narrow investing space. Bullion price had declined 2.94% and silver fallen 3.45% overnight in North American trading. It is to be remembered that bullion is “spot” trading and gold equities investing discounts forward of much further outlook years out of both gold price and the gold miners. Glencore recently raised over US$800 million in funding from Franco-Nevada selling its future precious metal streams. http://www.mining.com/glencore-to-sell-gold-and-silver-to-franco-nevada-in-500-million-deal/ and Evolution Mining (EVN) in its December qtr sold forward 726,394 oz of its 2016 budgeted 800,000 oz production at A$1,589 per oz contrasting last week’s peak A$1,753 per oz. http://www.asx.com.au/asxpdf/20160127/pdf/434l5rdsj8gzrn.pdf. EVN’s market capitalisation (exceeding a staggering A$3 billion last week) had been rising strongly signalling that its buyers are expecting gold price to reach beyond A$1,753 per oz (or US$1,245 per oz) in 2017 and beyond. St Barbara Mines, unhedged of FY 2017 production and beyond, also showed up a stellar performance despite having its share price already risen 20X since November 2014 without the benefit of any exploration success. https://sg.finance.yahoo.com/echarts?s=SBM.AX#symbol=SBM.AX;range=5y Either GS or investors of gold equities in Canada and Australia are right of their gold forecast but it can’t be both. Is GS betting on a stronger recovery despite turbulence in destabilised financial markets and global economies decelerating in synchronisation?

NEGATIVE INTEREST RATE POLICY – AN EXCHANGE RATE DISGUISED DEVALUATION?

Beyond GS’s pessimistic look at gold relative to global economy bet in contrast, other bankers/economists are searching hard for angles to interpret economic statistics. Intense deep division of conflicted opinions exists even within same financial institution flood the debating space. Citigroup’s William Lee, Head of North American economics, views any talk of possible US recession is “ridiculous” as market, in his informed opinion, can no longer appropriately allocate risks. https://sg.finance.yahoo.com/video/citigroups-lee-u-recession-fear-115734669.html;_ylt=AuqFPDSbBaGRsXA_drJF. Only 5 days earlier, global strategists within Citigroup in contrast warned the global economy seems trapped in a “death spiral”. http://www.cnbc.com/2016/02/05/citi-world-economy-trapped-in-death-spiral.html.

Jose Vinals, Director - monetary and capital markets – IMF told Bloomberg news that negative rates could even go lower. http://www.bloomberg.com/news/videos/2016-02-11/imf-s-vinals-interest-rates-could-go-even-more-negative. The danger is the spread of negative interest rate strategy degenerate into a capricious tool of disguised competitive currency devaluations destabilising global banking system. The impact of currency intervention via negative interest rate policy tool is similar to monetary easing. As Jose Vinals warned correctly it is a struggle of choice of two lesser evils – without quantitative easing, we might not even have today’s global financial architecture though barely working and with the accommodative monetary policies since post-financial crisis, we now have to handle its unfathomable moving consequences in the aftermath. There is big tantrum ahead looming for global financial stability – EU, Japan, China and US included. http://journal.georgetown.edu/the-outlook-for-global-financial-stability-five-minutes-with-jose-vinals/ China is the key for the world, according to Jose Vinals.

 

2016 – CHALLENGING YEAR FOR CHINA & “MUDDLING THROUGH”?

2016 will be a challenging year for China – ardent China bulls agree on this forecast even as they battle to outdo each other of rationalising soapy sell of what is really a dismal outlook forward – their colliding logic offered (to me at least) is as bewildering as unconvincing. Look at this from Yale economist, Stephen Roach – “The slowed growth rate is a reflection of the structure shift in the Chinese economy, away from manufacturing and construction to services. For any economy, it means a slower growth; China is not an exception........ The growing service sector can't completely compensate the declining industry sector. The important thing is service sector can compensate a large portion of reduced employment from industry sector. It's more important than GDP”. http://en.ce.cn/main/latest/201602/13/t20160213_8825037.shtml. As Stephen Roach acknowledged correctly, Chinese industry, being restructured, had been hit by weak global demand and lagged impact of the Yuan’s appreciation. Chinese exports to Australian, Canadian, Brazilian, S.African and even EU markets are challenged by huge devaluations of these currencies relative to the strong US dollar which Chinese currency closely pegged to.

In similar parallel of observations, Song Yu, Beijing-based chief China economist at Goldman Sachs Gao Hua Securities - the best overall forecaster of China's economy according to Bloomberg Rankings for the past two years - spoke of overvaluation of the Chinese Yuan, predicting a 7% devaluation in 2016 and another incremental adjustment of 0.3% for 2017. http://www.smh.com.au/business/markets/no-need-to-panic-as-china-growth-slows-says-goldman-20160217-gmwy6a.html This writer is unconvinced of the magnitude of the suggested slightly over 7% plus Yuan adjustments forward for many reasons. Relative to major currencies, the US dollar have appreciated close to 20% in two years as measured using the US Dollar Index. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=dxy&insttype=&freq=1&show=&time=9 . The Chinese has a lot of devaluation catch-up to do to restore its former competitive equilibrium. Slump in factory gate prices extends to record length of 47 months as China’s economy slows. http://www.scmp.com/news/china/economy/article/1913819/slump-factory-gate-prices-extends-record-length-chinas-economy The alternative is Chinese industries, going through restructuring, might collapse faster than the restructuring process allows them of continued survival fight. The risk is incomplete restructuring imbalance with grave enduring consequences for China and the rest of global economy.

As if not enough of complexity - to make the Chinese elephant rhythmically dancing according to the restructuring tune of global economy in turmoil is a big difficult ask. Like I often said in blog comment, completion of a successful mammoth restructuring of this scale and complexity requires a deft hand of economic expertise and a miracle global economy backdrop. http://www.tremeritus.com/2016/02/05/chinas-fall-and-the-hard-landing-in-singapore/. The former I am less confident because of China’s lack of long experience in full opening-up and Chinese comprehension of the intricate processes of continual adjustment, integration and adaptation to a fast shifting globalized economy. And the latter, a haunting ghost, in rebuke of what is really now a world economy in violent turbulence. Negative interest rate, a giant monetary experiment, is wreaking havoc to banking systems and global economy.

The pressure is right at the doorstep - as Chinese imports plunged 18.8 per cent in January from a year earlier in US dollar terms and exports dropped 11.2 per cent. Song Yu confessed as much of difficult synchronisation of structural re-balancing from industry/infrastructure dependency to a consumption-led counterweight, and in Song Yu’s optimistic words - even though full-year growth will drop to 6.4 per cent in 2016 as wages, employment and consumption "take a hit" - but it won’t leave dire consequences. In equal confidence, UBS’s Wang Tao poured cold waters on China’s “super bears” presumably George Soros, Kyle Bass, Jim Chanos and the likes of those adherents shorting the Chinese Yuan believing the gloomy predictions of impending collapse of the Chinese banking system. Dr. Wang Tao, has this confident retort and prediction....... While we acknowledge the seriousness of challenges facing the Chinese economy and exchange-rate regime currently, we don't think it as bad as some believe. http://www.marketwatch.com/story/ubs-thinks-super-bears-are-wrong-about-china-2016-02-16. Wang Tao’s bottom-line assurance to all grizzly bears – China, according to her, will simply “muddle through” as its economy slows but there won’t be a cataclysmic meltdown that some China bears will be counting on will materialise. It is interesting that economist Wang Tao also disputed the size of risks insolvency exposures within the Chinese banking system – offering two divergent amounts of derivations. Dr Wang Tao also denied the relevance of FX transaction should China’s need to use of its huge financial reserves in bailing out its banking system.

Acknowledging these wide divergent views, this writer does not comprehend why the Chinese foreign reserves dwindled in recent months to US$3.23 trillion in January – it’s lowest since 2012. http://www.scmp.com/news/china/economy/article/1912819/central-bank-neither-god-nor-magician-chinas-central-bank-chief  Haven’t PBOC been active, selling its US treasuries and for whatever reason/s? If the Yuan is not overvalued needing adjustment which Song Yu agrees with China bears, in contrast, one would find it difficult of explanation of Chinese off-shore banking activities in relation to supporting the Yuan exchange rate like this. https://www.bullionvault.com/gold-news/yuan-squeeze-020520161. These defensive exercises, even if temporary, are expensive and pundits in the gold market have noticed.

China face three bubbles – stock market bubble, real estate bubble and a debt bubble infecting its banking system. The stock market bubble has burst and another economist has this warning of real estate bubble bursting. https://sg.finance.yahoo.com/video/chinas-economy-real-estate-export-100602943.html.  Can the Chinese economy sustain a twin bubble bursting in quick succession? As China's manufacturing sector stalls, is the world's second-largest economy relying on a more dangerous growth engine: debt? http://money.cnn.com/2016/02/17/investing/china-debt-gets-bigger/index.html?iid=obnetwork. Piling debt on top of debt is easy upclimbing of fabricating a risks mountain of glossy infrastructure and urbanized architecture but the deleveraging downclimbing when the economy slows to grinding slowdown is far more dangerous of risks consequences. You often can’t see the terrain and the bottom on the way down except knowing the steep slope is likely to be treacherous. Is it going to be as Dr Wang Tao put it – the art – of simply “muddling through” the unknown and uncertainty?

Central Banks watch helplessly as global equity market rout intensified since January – not even keeping the global financial system on an even keel if it can’t solve economic woes. BOJ Governor, H. Kuroda called on major economies to find ways to stabilize financial markets when they due to meet later this month. http://www.marketwatch.com/story/bojs-kuroda-calls-for-global-action-on-volatility-2016-02-18. In breaking his silence on Yuan’s external parity, PBOC Governor, Zhou Xiaochuan, set the perspective right – central bank is neither god or a magician who can turn uncertainties into certainty. Global growth in 2015 is at its weakest growth in 5 years. http://business.financialpost.com/investing/oecd-downgrades-global-growth-says-worlds-economy-needs-urgent-fiscal-response-from-governments

Central banks cannot change the dynamics of business cycle nor can government. Never mind the Keynesian economic corpses or the monetarist “devils” or variants of those adherents, Professor Krugman’s  “liquidity trap” formulation  did captured how excessive debt leverage have imprisoned the recovery of the Japanese economy for decades leaving a trail of enduring damaging impact. http://www.marketwatch.com/story/2-things-we-havent-learned-since-the-2008-financial-crisis-2016-02-17. Monetary policy just isn’t as powerful of macro-economic tools as many economists once believe. We witnessed an unprecedented level of monetary expansion post GFC. The result of this gigantic monetary experiment?  A stagnant global economy and arguably the most feeble, uneven, volatile recovery in modern economic history. In finality of glaring clarity, the Fed and the ECB have been around for decades, haven’t we seen enough of recessionary cycles in their presumed watchful nursing care?

THE PERILS OF NEGATIVE INTEREST RATE POLICY

Stephen Roach wrote an incisive piece on how negative interest rate policy is setting the stage for the next financial crisis. http://www.marketwatch.com/story/negative-interest-rates-set-stage-for-next-crisis-stephen-roach-says-2016-02-18. In it, he itemised two serious complications.

•  Central banks ignored the risks of financial instability
• Politicians drawing false comfort from frothy asset markets are less inclined to fiscal policy measures in supplement, closing the last escape route of failed accommodative monetary policy.

Central banking, having lost its way, is in crisis. Can the world economy be far behind? He asked. I believe Stephen Roach have answered his own question already. The world, in his words....

— remain stuck in an eight-year quagmire of just 1.5% average real growth. Even worse is the eurozone, where real GDP growth has averaged just 0.1% over the 2008-2015 period.

PUMPING OXYGEN TO RESUSCITATE A GLOBAL ECONOMIC CORPSE?

Are central bankers pumping oxygen to resuscitate a global economic corpse? This question crosses my mind for the following reasons.

•  Negative interest rate policy and its spread are toxic.
•  Sell-off of EU banking stocks is endangers the prospect of EU economic recovery.
•  PBOC’s Governor, Zhou Xiaochuan publicly “threatened” no Chinese devaluation left me bewildered which central bank governor will publicly admit to impending market-driven devaluation.
•   Accommodative monetary policy failure obscured structural economic imbalance not yet addressed in political governance but for how long more(?)
•  The end of Merkel era and Presidential election due must mean at least a temporary loss of determining political will and direction in EU and US.
•  Chinese addiction to debt-laden carbon-heavy growth needs to find a new engine beyond consumption spending, itself dependent on the former.
•  Too many global investment banks have revised their 2016 gold price and global economic outlook forecast so fast and soon.
•   Desperate, besieged and deeply divided central banks are discovering the tidal wave of massive liquidity flow after unprecedented accommodative monetary policy is proving unmanageable of risks containment.
•  Negative interest rate is not yielding positive results in EU countries and already stumbled in Japan.

 OMINOUS SIGNS OF DESPERATION

There are ominous signs of desperation elsewhere. The inexplicable gold price surge, perhaps its best since 2011 gold price decline, speaks loudly of financial market instability risks, loss of confidence in the US dollar, and more specifically loss of faith in central banks and their failed monetary policies of gravitating from ZIRP, to quantitative easing to now negative interest rate policy. Draghi’s stern public warning to market speculators that “we are not surrendering in front of these global factors” found similar echo of desperation in PBOC’s Zhou Xiaochuan’s promise that “China would not let the market sentiment be dominated by these speculative forces.” Central bankers are besieged of solution wanting when none is readily apparent or available, if negative interest rate policy fails. A proxy currency war is now underway via negative interest rate but in BOJ’s case it ended up in failure as the Yen surged instead. http://www.cnbc.com/2016/02/18/bojs-governor-kuroda-defends-negative-rates-says-weaker-yen-wasnt-the-aim.html

Most frightening of all is how violently the mobility of massive flood of liquidity from accommodative monetary policy since the GFC is coming back to haunt policy makers in the manner of incapacitating nightmare that inflicts on central bankers i.e. its apparent intensity/ferocity of reactions – totally unanticipated and perhaps yet incomprehensible to governments. Before the GFC, the Fed fund rate was 5%, it fell to nearly zero for 7 years and financial markets partied on a feast of cheap money not on productive investment but casino bets on asset bubbles. And now, a mere lift of only 25 basis point on December 16 changed the world completely even though after this lift-off, interest rates is still in the extremity depth of low relative to long historical past. The ominous hint of that is financial market is addicted to the tiger of ZIRP. Ride this tiger and shift it a little, it will bite back at you mercilessly and if you got off, you may be eaten alive for a quick meal.

The global economy is plagued by paltry growth and unsettled financial markets – that is the glass ceiling. BOJ invited itself on 29 January 2016 joining a failed ECB experiment right at its own critical moment of failure of monetary experiment. H. Kuroda, BOJ Governor denied a lower Yen exchange rate objective was the unspoken intent of Japan to lift its exports and GDP growth. He got a huge slap as the Yen surged upwards instead, making imports cheaper. The contagion systemic risks are now set to implode if either one or both BOJ/ECB negative interest rate policy backfired if others come to the same buffet. We are in uncharted water of financial risks experimentation – big tantrums waiting, regardless.

WATCH OUT THE GOLD PRICE.

I made a reference to gold in my January 2015 publishing, and I shall repeat it here again – why is gold suddenly so strong when energy and base metals so weak? And, perhaps, is gold likely to be massively volatile going forward from this point as one gold technical analyst forecasting? http://www.marketwatch.com/story/expect-gold-prices-to-be-massively-volatile-2016-02-19 Or is physical gold price evolving into a reliable contrarian forward indicator of global economy outlook ahead as negative interest rate in recession-ridden economies destabilises the global financial system?

Zhen He

THE GLOBAL ECONOMY – CHINA & BOND MARKET ARE QUICKSANDS

In my January 2015 write-up, Global economy – Quagmire & Quicksand, I alluded to 2015 will see a more stormy global economy and volatile financial markets than the year preceding.

http://www.tremeritus.com/2015/01/21/global-economy-quagmire-quicksand-part-13/.  Goldman Sachs (GS) preferred a much more benign positive outlook, forcasting global growth poise to accelerate and US striking above-trend growth – China slowing.  http://www.goldmansachs.com/our-thinking/archive/2015/ . GS was slightly more positive of gold raising its 2015 average price forecast for gold to US$1,262 per oz.  http://www.reuters.com/article/2015/01/23/metals-goldman-forecasts-idUSL1N0V21PS20150123. By July, GS’s Jeffrey Currie, Head of Commodities Research, took a decisively bearish stance  to gold, predicting that the metal is likely to trade below US$1,000 per oz. “Going forward if we continue to see improvement in U.S. economic growth we tend to maintain downside risk in gold," he added http://www.cnbc.com/2015/08/26/not-seeing-weak-deamand-in-energy-goldmans-currie.html . The presumption is that gold value as an asset class with no interest yielding is countercyclical to economic strength.

Gold, in fact, turned out to be far more resilient till now, in spite of a much stronger dollar, and the US economy actually turning softer than expected – evident in patchy manufacturing, weaker employment data, and recent months declining retail sales, and more tellingly, housing starts/building permits. http://www.tradingeconomics.com/united-states/housing-starts... The Fed Reserve growth forecast for US economy this year is only 2.1% and 2.3% for 2016 – far below the long-term growth rate of 3.2 in recovery phase. http://www.marketwatch.com/story/imf-trims-global-forecast-as-brazil-canada-outlooks-deteriorate-2015-10-06 With only one qtr remaining, it is stunning that IMF has revised global growth for 2015 (and 2016) forecast by 0.2%  to 3.1% from its July revised forecast of 3.3% against a year beginning forecast of 3.5% - noting of weakened conditions in China, Brazil – both heading for their fifth straight year of declining growth. http://www.imf.org/external/pubs/ft/weo/2015/02/index.htm  Both GS and IMF have been more optimistics of global economic outlook than warranted.

THE YEAR TO DATE IN RETROSPECT

Volatility in the global economy and financial market, indeed, proved to be far more pronounced this year than 2014. Right from the beginning, we saw a 42% sudden rise in Swiss franc in January followed by steep fall of the Euro. By early March, the Euro sank to the 12-year low against the US dollar – no thanks to the Greece contagion effect and the declared divergent strategies intent of the US Fed Reserve to raise interest rate. http://www.theguardian.com/business/2015/mar/11/euro-12-year-low-gainst-the-dollar  Then came next is a mini crash of the German bund (bond) in May (the steepest upward climb in a quarter of a century). The yield on Germany’s 10-year bunds was a mere 0.059% on 17 April rocketed up to 0.70% by the first week of May. By historical standards, yields were still incredibly low, but the spike up was visible even with a long-term 10-year view on the chart. http://www.businessinsider.sg/germanys-bund-yields-boomed-at-the-fastest-pace-in-a-generation-this-week-2015-5/#.Vg0rZeyqooI .That sent shivers to peripheral eurozone bond markets, the euro, 10-year US treasury yield and commodities market.

 http://blogs.ft.com/gavyndavies/2015/05/10/bund-tantrum-warns-of-future-accidents/. The bund tantrum caught financial market by surprise –  10-year bond yields had seen steep decline since January in the wake of collapsed oil price, raging firestorm warning of deflationary threats, euro us dollar exchange rate saw continuing pressure. There was no expectation that the European Central Bank QE to taper off in such dismal economic outlook prevailing. Nominal yields of Bunds below 7 years duration was negative – suggestive of a bubble in the bond market. Was the shock rebound a “psychologically triggered”, not wholly explained by fundamentals – other than a fear of exit illiquidity?

Fear of illiquidity left financial market prone to evaporation of values. IMF’s Global Financial Stability Report warned of this. http://www.imf.org/external/pubs/ft/survey/so/2015/pol092915a.htm Regardless, there is strong evidence of hard assets mispricing of risks which brings with it risks of sudden extreme volatility that this writer predicted to erupt in 2015.

Risk is, to my mind, a volatility construct, rather than financial construct – much harder of estimation quantification & forcasting despite the academic finance teachings - much debunked now. The impact is necessarily financial, and at times, really huge.Indeed IMF warned of this - If financial conditions worsen or investors become weary of a particular asset class or financial market, market liquidity and value can quickly evaporate. We saw the shares in Glencore PLC tanked 29% in a single day on Monday 28 September but rebound within the next 5 trading days enjoy a bounce-back to more than recover all the losses. http://www.cnbc.com/2015/09/28/glencore-tanks-another-25-whos-next.html. What is less capable of explanation in this strength of confident rebound is why Glencore’s US$36 billion bonds were then being traded at pricing akin to junk bond in financial market. http://www.cnbc.com/2015/09/30. With deeply contentious view of the group’s equity might be worthless unless commodity pricing picks up swiftly, one side could be badly wrong as the gyrations in commodity pricing continues to escalate in growing uncertainty.  The mystery unresolved is this – is the equity market in Glencore shares ‘deceiving” the commodity market feeding its volatility or the volatility and downward pressure in the commodity market misleading the equity valuation and debt borrowing costs of Glencore in the equity market. The focus of deeply divided perspective on Glencore is on China and implicitly the global economy –specifically the state of its economy as the key driver.

There is little doubt in my mind that China is in deep trouble. Few would have predicted the quagmire China found itself in since late June.  It stock market saw a meltdown in June and August  with the Shanghai Composite Index now standing at 3052 points compared to its peak of 5166 of 12 June 2015 – an awesome bloodbath of 40% loss of bubbly value. China claims 7% GDP growth in the first half but not everyone is convinced.  Some of the evidence is anecdotal inside China – foreign businesses are complaining of slower economy than China officially admits. With imports falling and declining PMI manufacturing consistently in negative territory for most of 2015, scepticism about the accuracy of official data has intensified.  China’s factories are still struggling. The government's official purchasing managers' index hit 49.8 in September. http://money.cnn.com/2015/09/30/news/economy/china-pmi-manufacturing/index.html?iid=obnetwork. Any number below 50 represents a deceleration in the manufacturing.Caixin and Markit showed manufacturing PMI dropped to 47.2 in September, a slight decline from 47.3 in August and 6.5-year low, now been below 50 for seven consecutive months. The Caixin China services purchasing managers index fell to a 14-month low of 50.5 in September. http://www.marketwatch.com/story/china-caixin-services-pmi-falls-to-14-month-low-2015-10-01?link=MW_home_latest_news  Dragged by the insipid property sector, growth in China's fixed-asset investment, one of the crucial drivers of the economy, slowed to 10.9 percent in the first eight months of 2015 - the weakest pace in nearly 15 years. https://sg.finance.yahoo.com/news/china-august-factory-output-6-054640890.html. Barclay Bank economists cut China’s GDP growth rate to 6.6% this year and 6% for 2016. http://www.smh.com.au/business/markets/china-is-leading-us-into-a-global-recession-says-citi-chief-economist-willem-buiter-20150915-gjms00.html. Finance Professor Michael Pettis at Peking University reckons the attainment of GDP growth target in the coming years beyond 3% - 4% is practically impossible. http://news.sky.com/story/1559985/china-faces-lost-decade-of-economic-growth. Considering a revised downward GDP growth in 2014 to 7.3%, the weakest in 24 years, any decline in 2015 GDP growth to the predicted 6.6% must be viewed with increasing concern. Remember, the PBOC has cut interest rate 5 times since last November besides reducing reserve requirements three times for most banks to support lending. https://sg.finance.yahoo.com/news/china-grapples-risk-economic-hard-landing-044131334--finance.html  It would signal the ineffectiveness of quantitative easing in juicing up the economy, pointing to the apparent acceleration of descent of sustainable growth for China and suggestive of increased risks of a hard landing next year.

China faces 3 bubbles and a long shadow of weak manufacturing – the stock market bubble, the real estate bubble and the debt bubble – the first two have imploded or at least freezing and the debt bubble still being expanded by monetary easings to contain the adversity impact of the two formers.There is very little buffers left of policy adjustments in managing the mother of all bubbles. Activity in China’s factory shrank again in September with new orders dwindled. http://www.reuters.com/article/2015/10/14/us-china-economy-inflation-idUSKCN0S804H20151014. Consumer inflation is subdued and producer prices declined for the 43 consecutive months raise concern of deflationary pressures unabated. Weichai Power, China's largest manufacturer of engines for heavy-duty trucks used in mining and construction warned its nine-month net profit could fall 75-85 percent due in part to the weakening economy.

OUTSIDE CHINA – THE OUTLOOK FORWARD ADVERSELY -INFECTED

Outside China, the evidences of eroded weaknesses are staggering. South Korean industrial export of intermediate goods to China is fizzling out. http://blogs.wsj.com/korearealtime/2014/08/21/south-koreas-exports-to-china-game-over/ Australian dollar hit a 6-year low against the US dollar on China fears. http://www.smh.com.au/business/markets/currencies/australian-dollar-hits-sixyear-low-on-china-fears-20150901-gjczj9.html Yet given this competitive currency leverage, throughout Australia’s heartland, factories are closing and China is not buying minerals exports like coal, iron-ore and other commodities no matter how cheap the prices are. http://www.smh.com.au/business/markets/australia-pays-the-price-for-relying-on-china-20150924-gjulu2.html  Brazil suffers the most from China’s recent devaluation as 50% of its iron ore, oil and other commodities landed in Chinese ports. http://www.businessinsider.sg/china-devaluation-hurts-brazil-most-2015-8/#.Vg1IEOyqooI . Exports to China tumbled by 19% in the first 7 months of 2015. http://www.wsj.com/articles/how-brazils-china-driven-commodities-boom-went-bust-1440728049 The Brazilian Real came under intense pressure hitting the all-time low at R$3.9901 to the dollar recently. http://www.ft.com/intl/cms/s/0/88903fac-6081-11e5-9846-de406ccb37f2.html#axzz3nKEGGDDZ. The falling Real prompted the Brazilian Central Bank to publicly state that it is willing to use the country’s US$370 billion foreign-currency reserves to defend the Brazilian currency. http://www.wsj.com/articles/brazils-real-strengthens-against-dollar-1443125945. Brazil is not the only deeply troubled by falling currency amidst growing fears of Chinese slow down. Among emergent economy facing high inflation or huge foreign currency debt, falling currency spells disaster. Indeed there is carnage out there, notably in South Africa, Turkey, Indonesia and Malaysia. http://www.cnbc.com/2015/09/25/its-carnage-out-there-for-emerging-markets.html. During her press conference on 18 September decision not to raise interest rates, Fed Chairwoman, Janet Yellen invoked China 16 times in one hour. This is how serious China’s diminishing growth prospect has become the epicentre of global growth narrative within the Fed, IMF, World Bank, OECD etc. http://money.cnn.com/2015/09/18/news/economy/china-yellen-global-economy-worry/. This is in spite of the fact that US-China trade account for less than 1% of the US GDP statistics but it is China’s trading relationship with the rest of the world is alarming. A recent Brooking-FT index report warned of "sharp divergences in growth prospects between the advanced economies and emerging markets, and within these groups as well", notably resourcess rich economies like Russia, Canada  and Brazil already mired in recession. The danger is that emerging economies ‘leading the world economy into a slump.” http://www.cnbc.com/2015/10/04/emerging-market-turmoil-flashes-warning-lights-for-global-economy.html

Janet Yellen spoke of these words – it is no secret that China’s economy is slowing….. The question is how much it will impact the rest of the world, including the United States….. Canada, a major U.S. trading partner, is already in a recession, largely because China is no longer buying commodities like it once did. Many emerging markets like Brazil are also struggling for the same reason.”  The truth is that China’s growth cannot be independent of protracted subdued conditions in the developed world and the emergent world even more vulnerable to downward pressures. Many of these economies are severely leveraged on China’s continued growth but now exhausted. It is a vicious self-reinforcing circle.

Alcoa slashes its outlook for China's production of cars & heavy duty trucks are good bellwhether. http://www.marketwatch.com/story/alcoa-slashes-it-outlook-for-chinas-production-of-cars-heavy-duty-trucks-2015-10-08?dist=tbeforebell  The “macro softening” in China’s economy is taking hit on US corporates, suddenly souring their outlook of Yum Brands, even Nu Skin Enterprise Inc. - China accounting for 26% of its revenue base. http://www.marketwatch.com/story/china-could-become-a-big-problem-for-us-stocks-again-2015-10-07 . The fear forward is weak consumer demand inside China will infect US /global corporate earnings alongside a weakening Chinese services sector. No where is this Chinese economic slowdown more clearly felt as in Caterpillar Inc. http://www.marketwatch.com/story/10-worst-sp-500-stocks-led-by-caterpillar-decline-2015-09-24 Caterpillar planned to cut its global work force by some 10,000 through to 2018.With sales declining for three straight years so far, Caterpillar CEO Doug Oberhelman said Caterpillar was facing “a convergence of challenging marketplace conditions” in mining and energy – implicitly all mining & oil and gas jurisdictions from Canada, Australia, Brazil, South Africa, Middle East, China and USA itself. Mining provides the raw material for construction and manufacturing and energy is needed to drive production, distribution of input/output and consumption – without recovery of both adversity of challenging convergence  of market conditions, Caterpillar Inc. at the forefront,  is telling us no economic recovery forward  is in sight for the next 3 years. The World Bank sees China slowing for the next 2 years. http://www.marketwatch.com/story/world-bank-sees-china-slowing-over-next-2-years-2015-10-05.  Some Asian currencies are plummeting to multi-year lows including Singapore, Malaysia and Indonesia. Corporate Indonesia is likely to face enormous pressure in 2016 to roll over US$42 billion of foreign currency denominated debts – an ominious reminder of possible repeat of the 1997 Asian Currency Crisis. http://www.cnbc.com/2015/10/04/indonesia-inc-faces-tough-time-rolling-over-debts.html. IMF’s Global Stability Report warned the “excess” of emergent market corporate sector over-leveraging to the tune of US$3 trillion in the last decade. A wave of default in a credit crunch of higher interest rate environment could imperil an already weak global economy. Policy-makers has no margin of error in  navigating through the inevitable normalisation of interest rate and market conditions, any miscalculation risks wiping out economic growth for the next 2 years.  http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html Export-dependent Germany, eurozone’s key economic engine, is also sputtering.  http://business.financialpost.com/investing/global-investor/germany-the-eurozones-economic-engine-is-sputtering-as-its-biggest-companies-struggle.  A steep decline in manufacturing orders over summer from outside the eurozone tells of bleaker economic outlook ahead – the advantage of 20% depreciation of euro against US dollar through 2015 notwithstanding.Anaemic conditions in EU & Japan depress their currencies, juice up their economies but little to show even short term  growth. IMF warned that the euro depreciation will restrain US and China for years, reducing 1% of the US GDP and China by 2% respectively.http://blogs.wsj.com/economics/2015/04/14/imf-euro-depreciation-will-restrain-the-u-s-and-china-for-years/. The mighty US dollar in a decade has already sent its August exports to a 3-year low. http://www.marketwatch.com/story/us-exports-fall-in-august-to-three-year-low-2015-10-06  World trade volume grows modestly, slower than global real GDP – hinting of weak demand compounded by growing uncertainty and turmoil in financial and currency markets. http://www.gbm.scotiabank.com/English/bns_econ/forecast.pdf  The downside risks to growth still dominates outlook going into 2016.

WHAT DOES THE COMMODITIES MARKET TELLS US?

I would say – lots, and mostly grim statistics. Glencore PLC, the mining and natural resources trading behemoth lost 57% of its traded value this year and survived a death-defying plunge in late September. It is shutting down its Eland platinum mine in South Africa, zinc production at Lady Loretta In Australia,  Iscaycruz in Peru, cutback the same at George Fisher and McArthur River in Australia and at various locations in Kazakhstan and suspended all its copper/cobalt production in Katanga Mining Ltd in DRC and at Mopani in Zambia. http://www.bloomberg.com/news/articles/2015-09-07/glencore-zambian-move-to-halt-26-of-country-s-copper-output. Seven out of 10 worst performing S & P index stocks this year are in commodities-related business. http://www.mineweb.com/articles-by-type/analysis/commodity-collapse-has-more-to-go-as-goldman-to-citi-see-losses/. Out of 21 major financial benchmarks tracked by Reuters, only two – US dollar and 10-year US Treasury bonds – have yield positive returns this year.
http://www.smh.com.au/business/markets/investors-brace-for-stocks-to-fall-again-ahead-of-us-earnings-20151003-gk0hdw.html . It is hard to argue for a strong case for a price recovery in commodities in 2016. Only 3 commodities – rice, cocoa and cotton – all agricultural and supply shortfall-induced escaped the 2015 carnage and the worst deflationary price decline was lumber. http://www.marketwatch.com/story/only-3-commodities-have-managed-to-escape-2015-carnage-2015-09-29. Industrial metals like aluminium, copper, platinum and energy -relevant Brent crude featured on the top end of price fall. Together with rubber, they tell a compelling story of underlying economic fundamental also told by Caterpillar Inc. & Alcoa. Historical natural rubber price chart showed a steep declining secular downtrend since February 2011 http://www.indexmundi.com/commodities/?commodity=rubber&months=60 and on a 12-months chart read, it exhibits a sharp cyclical decceleration in price since June 2015. http://www.indexmundi.com/commodities/?commodity=rubber&months=12. China’s January-August rubber imports down 4.4 per cent to 1.66 million tonnes. India’s natural rubber imports slumped 32 per cent on YoY basis to 33292 tonnes in August http://globalrubbermarkets.com/37258/geofin-comtrade-daily-report-on-natural-rubber-september-28-2015.html. India and China account for roughly 30% of the world’s automobile production. Nearly 70% of the natural rubber is used in automotive industry. Growth of Chinese car sales slowed right from the start of CY2015 compared to CY 2014 as slowing economy weighs on the world’s largest auto market. http://www.wsj.com/articles/china-car-sales-get-a-tap-on-the-brakes-1425972198. That trend continued weaker for the rest of 2015 – purchase in July was a 17-month low after the steepest rout in Chinese stock market since 1996. http://www.bloomberg.com/news/articles/2015-09-09/china-auto-sales-rebounded-in-august-as-discounts-lured-buyers. Given these weak numbers and supply/demand imbalance, it is no surprise of the lagged fall in crude oil price, behind the deteriorating weakness in rubber. The evidence pointed to incipient investing class lost a lot of money and reduced capacity to spend on consumption forward. http://fortune.com/2015/09/09/china-economy-trouble/.  China’s and global economy are in deep trouble navigating in uncharted waters.Caterpillar Inc knows that and retrenching 10,000 through CY2016 – citing a convergence of challenging conditions in mining and energy markets. http://www.miningweekly.com/article/caterpillar-restructuring-to-see-more-than-10-000-retrenchments-by-2016-2015-09-25

Until I see a rebound in rubber, platinum & lumber prices, I cannot see a rebound in the global economy. Some 70% of natural rubber found its use in tyre and platimum – outside jewelry market – is largely consumed in catalytic converters in car manufacturing. Other than Japanese, China already accounts for more than two-thirds of platinum jewelry globally and further consumer penetration might be limited – therefore it is most unlikely for platinum price to recover without a recovery in the auto sector. http://www.kitco.com/news/2015-09-02/Barclays-Foresees-Strong-Chinese-Imports-Of-Precious-Metals-Over-Next-Several-Years.html  If consumers in EU and China cannot afford to buy cars (and rubber & crude oil), how can they afford to buy mortgage-financed real estates in an environment of higher interest rate forward?

Lumber price is a good forward proxy of the housing and construction sector – notably in US and China – and it is falling since year beginning. http://www.nasdaq.com/markets/lumber.aspx?timeframe=3y. US new housing starts near an 8-year high in July but permits fall. Weyerhaeuser (WY) reported deteriorating Chinese & Japanese housing markets in summer aggravated by stronger US dollar aggravating its export volume – China is its biggest export market.   http://www2.laufer.com/falling-west-coast-exports-dampen-loggers-sales.html . (WY), one of the world’s largest owner timberlands, saw its share price collapsed. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=wy&insttype=&freq=&show=  New home orders by builders like D.R. Horton & Lennar Corp trend upward, but the annual rate for new single-family houses sold is not at pre-recession high. http://www.wsj.com/articles/homebuilding-industry-after-the-recession-1443671769 - Their share prices appear to have peaked.The US housing sector recovery since the last GFC has been shallow and could tipping over ahead of rising interest rate.

The simple truth revealed in falling lumber prices is that the Asian economies of China and Japan are slowing. Japan’s industrial output dropped by 1.2% in August over July, far steeper than earlier anticipated 0.5%. http://www.marketwatch.com/story/japans-factory-output-slumps-hints-at-recession-2015-10-15  The US recovery story is sluggish at best, marked by tepid consumption, slower consumer inflation and falling producer’s price index in September, even as gasoline prices at multi-year low. http://www.cnbc.com/2015/10/14/consumers-shutting-down-as-us-economy-deflates.html  Buried in the minutes of the Fed’s meeting of 16-17 September disclosed a pessimistic economists forecast within the Fed of a much subdued economic growth averaging only 1.74 % over 2015 – 2020. http://www.marketwatch.com/story/buried-in-the-fed-minutes-is-another-downgrade-to-the-us-economy-2015-10-09. Chinese Finance Minister Lou Jiwei over the weekend at the International Monetary Fund's annual meeting of 9-10 October 2015 warned that the US “is not yet in the condition for an interest rate hike”- indicate Beijing's unease about the impact that the move might have on the Chinese economy. http://www.marketwatch.com/story/chinese-finance-minister-says-us-shouldnt-raise-rates-yet-2015-10-12.  China’s imports collapse in September, exports remaining weak. http://www.cnbc.com/2015/10/12/china-exports-imports-continue-to-fall-in-september.html. Any interest rate rise in US will lift its dollar (indirectly the Yuan) and its tailwind likely to undermine the Yuan’s competitiveness relative to the rest of the world. Relative to rest of major competitive currencies like the Euro, Yen, and Chinese Yuan depreciates less against the muscular US dollar in the last 20 months.

SO WHAT IS THE OUTLOOK FOR CHINA & GLOBAL ECONOMY?

Notwithstanding the weaker crude, bulk commodity prices & Yuan’s August devaluations, September trade figures in Yuan-denominated terms, indicate weak domestic demand and tepid external conditions. The downward pressure on the Chinese economy has intensified. The Chinese, for political and strategic calculations wants a stronger Yuan, but economically can’t afford that. Chinese policy-makers have been lobbying hard for the Yuan to be included in the IMF’s “Special Drawing Rights” basket which now comprises only four currencies – namely, the US dollar, Japanese Yen, Sterling Pound and Euro. That would confer the Chinese Yuan as de facto as “reserve currency” status – a decision IMF could make in November. http://www.marketwatch.com/story/china-will-be-able-to-support-the-yuan-for-a-long-time-2015-10-07. Yet we saw two small quick sudden Yuan devaluations in 11 & 12 August – they underscore the capacity of & for shift in Chinese policymaking paradigm - in response to shifting external conditions taking global financial market by surprise. It is a strategic move and tactically well executed. The Chinese could not have taking a bigger cut in August – if they want to - for fear of triggering a global currency war and provoking a capital outflow in panic fear.

THE CHINESE DEVALUATION  CONUNDRUM

My suspicion is that these are not the end of the Yuan devaluation, never mind the Chinese Central Bank have been burning its foreign reserves to prop up the Yuan and hold on to its US dollar currency peg. Bigger shocks are ahead, once Chinese Yuan is internationalized, if any. Foreign Central Banks are likely to re-balance their foreign exchange holdings of the Yuan, the buying of Yuan could drive Chinese Yuan higher, severely undercutting Chinese exports’ global competitiveness and raising import prices fueling domestic inflation, risking further erosion of domestic consumption demand. In a weak growth environment, that spells big trouble for China’s external competitiveness and the rest of the world of shrinking Chinese demand. China is by far Australia’s biggest trading partner. Investment banks warned of overly-inflated property bubble burst leaving worst damaging consequences than recession triggered by further fall in demand for Aussie commodities exports in the event of a Chinese hard landing. The Yuan’s exchange rate volatility will have major impact on Australian property investment. http://www.smh.com.au/business/the-economy/housing-bust-now-the-greatest-recession-risk-say-investment-banks-20151012-gk6pjz.html. Australia don’t want a hard landing of its economy accompanied by a hard landing in its property market as strong demand by cash-rich Chinese had been a big factor driving economic actvity as mining slowed. China’s economy is in a much weaker state than it publicly acknowledged officially. Adjusted for inflation-fueled stimulus spending impact on construction and consumption – which China cannot engage in these periodic timely fiscal stimulations to boost spending demand forever – the underlying real growth in Chinse GDP is probably closer to 3% or 4% at most.  Falling commodities prices cannot alone explain the entire decline in recent Chinese Yuan-denominated imports and despite almost uninterrupted falling producer’s price index (ex-factory prices) since 2012; Chinese exports have not soaring in tandem. That tells me that China’s transition from a heavily investment and export-driven dependency to a domestic consumption economy had been excruciating more difficult of balancing achievement than economic modelling and theorising had predicted. The takedown of this economic rebalancing can be seen in falling official GDP growth since the GFC. Overcapacity keeps reinforcing and further fiscal stimulus will only adds to this weight – all too apparent to global mining industry. In most recent times, we read of Glencore shutting  or reducing production  in South Africa, Peru, Kazakhstan, Peru, DRC following other big mines closures such as NMG’s huge Century zinc mine in Australia and Irelan’s Lisheen, owned by India’s Vedanta. For the first time in a decade, Chinese steel production has contracted.  http://www.reuters.com/article/2015/09/11/us-china-steel-ahome-idUSKCN0RB20I20150911  Industrial overcapacity is "the largest problem facing the Chinese economy now," according to Xu Shaoshi, chairman of powerful state planning body the National Development and Reform Commission.We see a persistent trend of negative Chinese PMI manufacturing statistics, punctuated by brief spikes, have worsen of late, and recently, this downtrend accelerating since the June stock market swoon.

THE LUNACY OF MERGERS & ACQUISITIONS – ASSETS FINANCIALISATION MANIA

Directly or indirectly, the developed economies consumed most of the world’s production of commodities. Plummeting prices across industrial metals, even foods, speak of soft demand in weak advanced economies. Consumer deleveraging is continuing, matched by even greater excess of corporate leveraging binge salivating on cheap money made readily available through successive quantitative easings in all major economies. We saw big mergers and acquisitions, perhaps a record in 2015, in value terms often cemented by paper valuation rather than the discipline of cash from past retained earnings – the eye is on burning redundant competition and squeezing efficiency to uplift profits in the face of stagnation of demand revenue flow. Carl Icahn pooh-poohed these mergers & acquisitions as “financial engineering at its height,” http://blogs.wsj.com/moneybeat/2015/09/29/carl-icahn-is-skeptical-of-the-ma-boom/ . These combinations create no wealth but ultimately destroy the acquiror’s balance sheet when the acqusition fails to deliver of expectations. In practical world, most acquisitions turn out to be costly failures. Clearly what is missing of this economic equation is one word – production and its lack stems from weak demand. In the next downturn, what would you be selling? An inflated asset valuation in circumstances of insolvency? Economists forgot this tragic fact – while the world’s Central Bank’s money printing have staunched losses in the financial sectors, they failed to achieve the final objective of creating credit to stimulate demand and re-ignite the global economic engine of recovery. Post GFC quantitative easings only inflates asset price, lower exchange rate in parts of global economy (and uneven), bails out banks, foster financial interest differential arbitrage of carrying trade and resolves no underlying overcapacity.

THE PSEUDO-GLOBAL ECONOMIC RECOVERY QUAGMIRE

Post-GFC of 2009, US’s real GDP growth was 2.2% at an annual rate, eurozone barely limping at half that rate at 1.2% annual growth and Japan’s start-stop economy hardly reaching 1%. – all sub-par recovery rates after a recession. Note that these dismal rates of growrh start from a low recessionary base and fertilized by unprecedented mountain of quantitative easing manure for all economies except in US where QE 3 ended in 2014.If the US economy is strong, how come the strongest listed entities are buying back their own shares instead of investing in new/growth businesses and also retrenching employees at the same time? http://www.marketwatch.com/story/companies-are-cutting-jobs-and-buying-back-stock-at-the-same-time-2015-10-02 There is practical no self-sustaining life in developed economies. China has failed to reverse or at least support from falling its own economic slowdown after 5 interest rate cut and repeated easing of its required reserve requirements since November 2014? http://www.bloomberg.com/news/articles/2015-10-02/oil-bulls-lose-faith-in-recovery-as-russia-adds-to-global-glut China is the main prop supporting emergent economies – now found itself sinking at a time when the rest of the world is trapped with  sinking commodities prices, currency depreciations and US$3 trillion of corporate credit crunch of “over borrowing” over a decade according to IMF study . http://www.telegraph.co.uk/finance/economics/11916485/3-trillion-corporate-credit-crunch-looms-as-debtors-face-day-of-reckoning.html  With interest rate rise looming, they are facing the prospect of another financial crisis not disimilar to the Asian currency crisis of 1997. In the event of mass defaults, global economic growth will be imperiled as no economy – be it China’s manufactured exports or developed economies will be spared of this mayhem. In the best of circumstances, the global economy is locked into a gear of modest to moderate growth. The Singapore Government Investment Corporation, in its 2015 Annual Report, warned of modest global growth and even negative return on some asset investments for the next 5 to 10 years. http://www.gic.com.sg/report/report-2014-2015/?confirmeng=1

Former Fed Chairman, Alan Greenspan warned in October 2014 that he does not believe the normalisation of interest rate to market conditions can be achieved without turmoil in the financial market, after years of extraordinary stimulus. http://www.bloomberg.com/news/articles/2014-10-29/greenspan-sees-turmoil-as-qe-boost-to-markets-unwinds. I agree with him. There will be economic tantrums in different parts of the global economy and Janet Yellen faced exactly that in September this year.

CHINA'S STOCK MARKET BUBBLE BURST – SIMMERING IMPACT

Few people would be aware of this Bloomberg news leak - Zhou Xiaochuan, governor of China’s central bank, said three times to a G-20 gathering that a bubble in his country had “burst,” Japanese Finance Minister Taro Aso said. http://www.bloomberg.com/news/articles/2015-09-04/china-s-zhou-kept-repeating-the-bubble-burst-at-g-20-meeting. This was before the US Fed reserve meeting of 16-17 September to decide on US interest rate. The PBOC, China’s Central Bank, came up with clarification that Zhou was referring to the Chinese stock market, not the economy. I believe the fate of the Chinese stock market is indeed hanged in suspended animation – the real blood will spill once all the restrictions on securities trading are lifted. It could be really ugly if global conditions spiral downwards – just like Malaysian stock market found post the 1997 Asian currency crisis. A lot of cash strapped entities disappeared from listing while others severely financially- impaired, unable to raise new capital in lost market confidence, were taken over in rescue restructuring. I will watch the Chinese banks closely.

A CNNMoney survey among economists has penciled a third-quarter GDP growth of 6.7% and for 2015 as a whole at 6.8%. http://money.cnn.com/2015/10/13/news/economy/china-economy-growth-survey/index.htm. Next year, the outlook is dimmer at 6.5%. Germany’s sputtering economy have just reported its August exports fell by 5.2% compared to July – its biggest monthly decline in 6 years and that was before the outbreak of Volkswagon debacle and much cheaper Euro notwithstanding. German economist identified soft emergent market, especially China – another sign of burst stock market bubble hurting Chinese domestic consumption. German manufacturing output and new industrial order also slowed in August. IMF forecast German economy to grow by 1.5%, slightly lower to Eurozone growth of 1.6% in 2015 – its growth momentum as an economic power house has evaporated.  China, like Japan in the 1980s, the exports-led high rate of savings has contributed to China’s real estate and stock market bubbles.  The Japanese economy suffered the wreckage of its real estate and stock market bubbles and unable to recover since by exporting its way out of malignancy. The Chinese stock market bubble burst leave it little option but also exports its way out of this guagmire and quicksand. The harder it struggles, the deeper it will sink in the quicksand faster and drowns Japan and the rest of the world – this is what I fear most. The signs are already there to see - China is Japan’s second-largest trade partner, accounting for 18.3% of exports in 2014, closely behind the U.S., at 18.6%. The volume of Japan’s exports to China fell 9.2% in August from a year earlier, and available indicators for July — industrial production and machinery orders — have also come in much weaker than expected. http://bruegel.org/2015/09/chinas-woes-could-derail-abenomics/. So who is lifting the world out of this sinking guagmire? Countries with big current account surplus, small budget surplus and price deflation – Japan, Germany and China could fit this descript. http://www.cnbc.com/2015/10/11/who-can-rev-up-the-world-economy-china-germany-or-japan.html  Germany is sputtering, drag by the rest of Eurozone and now its weakest link, Abenomics is falling apart at its core pilllars and China is riddled with stock market bubble burst and debilitating real estate bubble – no one can afford any more fiscal stimulus on the scale prevalent in the last GFC and since. The quarter just past was marked by the worst global equities performance in 4 years, notably Chinese stock market crash. http://business.financialpost.com/investing/global-investor/global-stocks-rally-on-final-day-of-worst-quarter-in-four-years My bet on the gambling table is a recession waiting in 2016 – coming out of China, this time.

NEGATIVE INTEREST RATE POLICY - PARASITIC SPECULATION, NOT PRODUCTION

And even if pessimism is overdone & China escapes the worst fate, its de-acceleration will be painful for the rest of global economy. Canada, Brazil, Argentina, South Africa, Australia are either in recession already or in feeblest growth rate since 2009. Post GFC, China is the main prop of global economic resilience for emergent economies and faltering.  Within sickly EU, Germany is sputtering. Abenomics is about the taste the best medicine of derailment and the US Fed fearful to even raise a modest token of its Fed fund rate –almost 6 years since the GFC.  What is scary is this – even the Fed is in quiet contemplation of delving into negative interest rate to fight any further downturn of the US economy. “Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” said William Dudley, the president of the New York Fed chapter. http://www.marketwatch.com/story/fed-officials-seem-ready-to-deploy-negative-rates-in-next-crisis-2015-10-10. What a shocker of monetary devils residing inside the Fed. It is not the question of the costs – if at all clearly measurable in isolation but its ineffectiveness but leaving a continuing trail of future unknowns that all the quantitative easings already damaged the global economy structure. In Europe, the massive ECB bond buying of “whatever it takes” mantra has no impact on asset price, consumer spending ,  or business lending as EU banks continue shrinking,  economic resuscitation but adding to volatility in currency, bond, commodities and equities market.  The commonality of adversities includes growth in financialisation, parasitic speculation than production. Even former Fed Chairman, Ben Bernanke admitted as much – it wouldn’t be a panacea but a support to a weakened economy. The tantalizing prize – illusory as it may be – is that aggregate demand is no longer a scarcity. There will be no savers, more spenders.

BOND MARKET QUICKSAND

The biggest danger is that money flows away from negative yield investments into junk bond and highyield corporate bonds of equivalent junk bond grade. Added to that risk is the likely drag of downward pull of longer-dated 10-yr treasury bonds yield, fueling a bond market rally that is unsustainable. Retail investors don’t understand that bond investments are the trickest investment risks. http://www.neamb.com/finance/bonds-risky-investment.htm. The bond market is thin, institutions-dominated and Central Bankers the main sellers and buyers – everyone else is peripheral. Such financial instruments are illiquid, mispricing is dangerous because yields might spike when everyone rushes for the exit door in a panic when there is no buyer except Central Banks. We saw the bond market collapsed in May & June this year. http://business.financialpost.com/investing/why-no-one-should-be-surprised-by-the-bond-collapse-that-has-wiped-out-2015-gains. As one fund manager put it this way - “What we’re seeing is a repricing of the ultra-low interest rates to where they should be….the new normal is going to be price discovery — figuring out where bond yields are actually supposed to be, because at zero or even negative yields is obviously not right as the market has realized.” And the consequences of bond market collapse? Norway’s $900 billion sovereign wealth fund announced on April 29 that it would exit long-term euro bonds in its $328 billion bond fund. This was after it degraded its European bond exposure to 40% from 60% the preceding October. Obviously their clients demand higher rate of return than zero or worst still negative returns. In conditions of extreme volatility, which Central Bank will step in to buy?  What about those managed funds which face disgruntled retail investors seeking redemption in extreme market volatility in the bond market?  In those circumstances, fund managers sells equities – the era of cheap, even negative interest rate, is going to end up in a bubble burst crashing bang!
The easy money of falling interest rate to near zero on risks asset investment in equities and real estate is behind us, the page that is facing investors forward is fraught with sudden dangers of inmense severe impact. Quantitative easing has NOT worked for US, EU, Japan or China. Huge trillions were printed thrown at the economy and disappeared without a trace. Central bankers have lost control over monetary policy and fiscal stimulations have limited life-span of safety-net support as economies dip in rotation. In China, it simply adds to overcapacity way overloaded, exacerbates the crisis of economic instability and financial turbulence in rotation – transmitting from the equities to the bond, commodities and currency markets and recycling within this closed loop. Government bond rates are stubbornly low in the sea of deflationary pressures and credit spread, as a measure of default risk, is silently rising. Very few retail investors in the high-yield bond market understand the financial calculation involved in risks pricing implied of capital loss in the event of actual default.

Investors are aware of the extent of corporate/institutional debt leverage but not the earnings base to justify this risks escalation, notably in some sectors  like shale gas and  industrial metals which are the most economically sensitive to downturn. Corporate high yield bonds are really junk bonds. A 5% default rate implies investors expect to average a 5% loss of 5 cents in each dollar of principal invested. Adjusted for time value of money – if the 7-yr “risks free” US Treasury rate is 2% - the lenders (bond buyers) are assumed the risks that he/she is going to get a capital return equivalent to 70% of invested capital. That is to say, a 7-yr low quality high-yield bond offered by a corporate issuer at 7% return is NOT an attractive return at all for the investor. If the corporate bond offers at a higher rate than this – it means the risks of default and bankruptcy is much higher than 5% default risks.  Glencore corporate bond, otherwise is blue chip investment, is priced as junk bond grade risks pricing. How many of the shale gas entities in the US are staring at death now unable to generate cash flow to fund even on-going drilling/fracking operations, forget about interest and loan repayments? Banks in China exposed to overcapacity sectors are riddled with huge non-performing loans. Without the implicit but unsustainable guarantee of support against insolvency, how many of the behemoth Chinese State-owned enterprises riddled with over-capacity will survive the next downturn and credit life line from Chinese Government? In a slow-growth environment, you can’t grow earnings and financial reserves to pay off your ballooning debt. IMF warned of “sudden evaporation” of asset values in emergent economies, notably China where corporate debts borrowing including high-yielding (read junk) bonds far exceeded their market capitalisation. http://www.telegraph.co.uk/finance/economics/11898936/World-set-for-emerging-market-mass-default-warns-IMF.html  China’s 42.2 trillion yuan ($6.7 trillion) bond market was flashing red hot in August when its equity market crashed. Investors practically shifted from one bubble to another bubble even as corporate earnings shrinking. http://www.bloomberg.com/news/articles/2015-10-08/if-you-thought-china-s-equity-bubble-was-scary-check-out-bonds. Overall corporate debt as estimated by Commerzbank is 161% of its national GDP base in the first quarter of 2015. http://www.marketwatch.com/story/are-bonds-markets-telling-us-that-gloom-over-china-is-overdone-2015-10-12?page=2.  Interest rate cut is ineffective in lifting a debt-heavy Chinese economy.

Low interest rate and worst still, negative interest rate policy, pursued by central bankers, are toxic inducement of flawed economic policy. Because of excess supply and cheap availability, borrowers arbitrage for gains in sectors of easy over-supply to seeming escalating demand. Like power surges damaging electrical appliances, supply surges of money in oversupplied markets (the global iron & steel, oil and gas sectors for example in the fast receding commodities super-cycle) is dangerous. They kill the industry, kills the borrowers/investors, the economy and society.

THE WORLD OF PSEUDO-RECOVERY, DEBT TSUNAMI AND DEFLATION THREAT

The world is in that precarious brink now, can’t afford any misstep.  We are living in a new era of pseudo-recovery, swimming in a sea of debt tsunami, volatile bond/commodities market, inflated asset bubbles of equities and real estate, financial fragility in emerging economies and a real threat of deflation. Imprudent debt leveraging beyond financial affordability can take a lesson from this Fed’s instruct – “.It is appropriate for monetary policy to take a step back from the emergency measure of zero interest rates.” http://www.marketwatch.com/story/feds-mester-says-economy-can-handle-rate-hike-2015-10-15?link=MW_home_latest_news  Even the Fed Reserve Chief agrees the risks around China and global (read China) outlook is daunting – she said “The situation abroad bears close watching,”. Never before have the Fed mentioned of these heightened concerns of growth in China & frailty of emerging market economies its deliberations of interest rate policy. The Fed knows that China has been a major contributor of low-inflation global growth for nearly two decades – that is gone or will be gone soon.

China and/or the bond market are quicksands which can tip us over into a deep recession.  Beyond the temporary false prosperity boom fed by the steroid of quantitative easings globally which must end, what comes next behind these dark shadows?  

Zhen He