Sunday, June 26, 2016

Brexit is Bear Stearns

Waiting for Humpty Dumpty
Brexit is a Bear Stearns moment, not a Lehman moment. That’s not to diminish what’s happening (markets felt like death in March, 2008), but this isn’t the event to make you run for the hills. Why not? Because it doesn’t directly crater the global currency system. It’s not too big of a shock for the central banks to control. It’s not a Humpty Dumpty event, where all the Fed’s horses and all the Fed’s men can’t glue the eggshell back together. But it is an event that forces investors to wake up and prepare their portfolios for the very real systemic risks ahead.

There are two market risks associated with Brexit, just as there were two market risks associated with Bear Stearns.

In the short term, the risk is a liquidity shock, or what’s more commonly called a Flash Crash. That could happen today, or it could happen next week if some hedge fund or shadow banking counterparty got totally wrong-footed on this trade and — like Bear Stearns — is taken out into the street and shot in the head.

In the long term, the risk is an acceleration of a Eurozone break-up, which is indeed a Lehman moment (literally, as banks like Deutsche Bank will become both insolvent and illiquid). There are two paths for this. Either you get a bad election/referendum in France (a 2017 event) or you get a currency float in China (an anytime event). Brexit just increased the likelihood of these Humpty Dumpty events by a non-trivial degree.
Die Welt Calls For Merkel's Resignation, Slams "EU's Gravedigger"
Britain leaves the EU because a majority no longer wants to tolerate the union's political failure. One key factor contributing to that is the German chancellor's solo attempts in the refugee policy.

...Europe has neglected its citizens -- not the other way round. When those citizens can watch the EU, the spin-off and replacement of the traditional nations, doing badly on a daily basis, its leaders should not be surprised when an increasing number of people prefer the somehow functioning original to the shaky innovation. This is the real reason, rather than stupidity and backwardness, that made nationalism, already on the way out, fashionable again in the middle of Europe. The narrow outcome, which would have been impossible one year ago, also shows clearly that Angela Merkel's laissez-faire in the refugee crisis has ruined David Cameron's political career -- and estranged Britain from the EU for good. It was the pictures of the Balkans and the excesses of Cologne, which UKIP [United Kingdom Independence Party] leader Farage loved to refer to with relish, that decided the Brexit.
Almost the entire world is insolvent. The demographics don't work. The immigrants brought in to fix the demographics, don't work either. Even the ones who work, don't work because they consume more in resources. A solo illegal doing roofing is adding to the economy even if subtracting a job from a local, but an illegal with two or three anchor babies and their mother is running up $20-$30,000 in educational costs alone. Tack on welfare and it's a monetary sinkhole.

It's possible that illegals and their welfare benefits, along with increased food stamps and such, is near 100 percent of economy "growth." U.S. federal government debt alone was about 2.5 percent of GDP in FY2015, the smallest in years, yet economic growth will be lucky to exceed 2 percent in 2016 and has been running at about 2 percent since the 2008 crisis.

Public and private debt combined is multiples of GDP. There's no room left for debt driven growth unless you find new borrowers. China was that borrower and they went hog wild on debt for about 4 years, and now they're going hog wild on debt to keep from defaulting on trillions of dollars worth of debt from the last binge.

Meanwhile Boomer pension funds are all assuming 6-8% returns in the stock market. Medicare costs are projected to become 100% of the budget in about 10-15 years, and the U.S. has better demographics and better finances than Europe. (U.S. debt to GDP is higher, but the banks were bailed out. Countries such as Germany have yet to experience their banking crisis.)

Long story short, there's no financial wiggle room. Aside from slashing non-cash expenses such as the regulatory state (which would have positive impact), it's difficult even for a fiscally strong, free market policy to have positive effects without crippling levels of inflation.

Nearly every currency, including the U.S. dollar, is at risk of significant devaluation. Or asset prices will collapse amid deflation. If the U.S. dollar crashes, then every other currency crashes with it because a 40% crash in the U.S. dollar is the economic equivalent of President Trump announcing a 40% across the board tariff. More likely, as we've been seeing and has played out historically, is foreign currencies will devalue first. The yuan is tottering, the pound is below 2008 lows, 2001 lows. The euro is above its 2000 of $0.85, but even a return to parity at this point would be a crisis for financial markets.

The Cathedral has wrecked the economy. There is only the final settlement remaining. If I had to bet, it will be European politics or Chinese economics that undoes the world, and if one happens, the either will follow. Yet one alone is enough to blow up the world economy.

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