Bank of America’s Michael Hartnett recently came up with a great line to describe America’s current economic environment. He labeled the current situation “bad Goldilocks.” The American economy is not strong enough to lift world growth, but not so weak to necessitate any stimulus.
This dovetails perfectly with my analysis of this weekend’s G20 meeting. Although the finance ministers agreed on all sorts of feel-good platitudes, the end result was nothing changed. And here is the important part - the status quo is not enough to stabilize the markets. The markets had stopped going down on anticipation of G20 coordinated action. Once again the rally on the hopes for a government response has mistakenly convinced finance officials no action is required.
The global economy has entered a self reinforcing negative feedback loop. Credit is being destroyed. Without aggressive policy changes, this trend will overwhelm the both markets and the economy.
The G20 leaders somehow believe the current situation is tenable. They hold out hope “not panicking” and waiting out the current slowdown will somehow be enough. Either that or they understand the monetary stimulus gun is out of ammo and are simply waiting for a crisis large enough to force the next round of fiscal stimulus. Whatever their reasons, doing essentially nothing will only accelerate the trend of lower risk asset prices.
US dollars are all that matter
Although the economic optimists welcome the recent US inflation uptick with hope a regular business cycle acceleration is about to take hold, nothing could be further from the truth.
The global economy is suffering from a shortage of US dollar liquidity. Rightly or wrongly, the world operates on US dollars. Commodities are priced in US dollars, companies borrow in US dollars, business is transacted in US dollars. Of course there are other currencies, but the US dollar’s reserve currency status makes the price and supply of US dollars infinitely more important.
This whole global economic slowdown has been the result of Yellen’s withdrawal of liquidity. The longer it takes for the Federal Reserve to figure this out, the worse the crisis will be.
The US response to the recent global slowdown is to lecture the world about competitive devaluation. That’s easy for them to say when their unemployment is still ticking along at recent low levels. But what about the rest of the world? The pain is brutal. The global economy is plunging off the cliff, and waiting it out is not an option.
Either the US needs to provide the much needed liquidity, or there needs to be dramatic changes in the global financial landscape. Too many countries (such as China) have currencies loosely pegged to the US dollar, and the strength of the past couple of years is too much to handle.
China’s RRR cut is not enough
On Sunday night the markets seemed to have figured this out and the selling was accelerating. But since then China has cut their reserve requirement by another 50 basis points. This has emboldened the bulls.
This is not enough. I have been shorting into strength, and will add to it on this rally.
I don’t buy that the self reinforcing debt destruction cycle can be stopped with a simple 50 basis point reserve requirement cut by the Chinese and some soothing words from the G20 leaders. I agree with Bank of America’s Michael Hartnett - we are in a “bad Goldilocks” scenario. The G20 leaders might want to convince us otherwise, but eventually the reality of the seriousness of the situation will make itself crystal clear.
Thanks for reading,