Events have turned suddenly around the world in a way that promises to spawn macroeconomic disruptions. Basically, several powerful deflationary pressures now grip the global economy. Let me simply survey the worst storms that seem to be emerging around the world:
1) Greece and the possibility of a Grexit from the Euro Zone is back in the news. The Greek Prime Minister has called a snap election that could derail the bailout of Greek debt. The Athens financial markets literally crashed in the wake of this development. The Parliament in Athens will vote first on December 17, and if the government loses there then a general election will follow shortly thereafter. Worst case scenario: months of uncertainty followed by catastrophe.
2) The Euro Zone is in terrible shape and appears to be worsening. The ECB appears totally sidelined by the Germans at this point. It would be hard to imagine that the Euro Zone could withstand an event like a Greek exit from the Euro Zone. Even without an exit, it seems destined to suffer a recession and to export deflation worldwide. This is a key reason commodity prices are crashing.
3) China apparently racked up a mountain of bad debts that initially helped fuel its stellar growth but now leaves it with a massive hangover of underutilized assets and loan defaults. The future is not looking good across the Pacific. China is also exporting deflation as its slowdown (of unknown proportions) is clearly causing commodity prices to plunge across the world.
4) In fact, the Bank of International Settlements recently warned that many nations (Russia, Venezuela and a host of others) and private firms face declining revenues and soaring debt burdens because commodity revenues are shrinking as dollar-denominated debt increases in cost due to a surging dollar that is a natural outcome of the commodity bust. This could lead to a rash of defaults.
5) Meanwhile, in the US a dramatic fall in oil prices poses an existential threat to the highest growing part of our economy--energy. Jobs in the oil patch account for virtually all job growth in America over the past five years and new jobs beyond energy pay little. Much of the American high yield debt market is centered in the oil patch. With oil in a literal free fall this sector of the US economy may well be doomed. Can the US economy withstand the job losses and loan defaults implicit in very cheap energy?
There are more threats. Banks across the world still need to deleverage, raise capital and therefore reduce lending. Ukraine faces financial collapse. These problems are manageable alone. The above issues are in combination far more dangerous.
All of this suggests that despite an apparently buoyant US stock market (now standing at 17,411) caution must temper any optimism. "This week's financial headlines sound like a recap of the horror stories of the last six years." There is an increasing probability that a major financial crisis looms as deflationary pressures overwhelm an increasingly fragile global economy.
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