New England is stunning this time of year. Just what you’d expect. The leaves turn brown, yellow and red, putting on their best outfits and strutting their stuff in the cool autumn air.
Autumn, especially in New England, is the loveliest time of the year. The sun barely clears the tops of the trees, even at noon. The light, filtered through the coloured leaves, gives the earth the rich and heavy air of a funeral parlour.
Perhaps that is why there are market crashes in the fall. Investors feel the approach of death.
The stock market fell hard on Thursday…and then kept falling on Friday. Before the week was over, investors were worried.
Inflated by Debt
Last week, we talked about the increase in volatility. Our friend and former World Bank economist Richard Duncan predicted this would happen.
As the Fed’s QE comes to an end, he said, so will the EZ money supporting the stock market.
Shrewd investors are looking ahead. Without the Fed behind it, what is the likely return from the US stock market over the next 10 years?
‘Negative,’ says equity analyst Stephen Jones.
Stock prices are high. From these heights, stocks typically fall more than they rise — even without the withdrawal of QE. That’s because stock prices regress to the mean. This could bring 10 years of losses for stock market investors.
Wait a minute, you might say, these prices are supported by earnings.
But Stephen insists that corporate earnings have been inflated by debt. The money had to come from somewhere. And it could only have come from debt. So if the credit expansion stops, those earnings will deflate.
That’s why the feds are so desperate to keep interest rates low and liquidity high. When rates rise, the jig is up. Earnings will fall. Stocks will fall. Credit will contract…and the economy with it. Tax revenues will shrink. Bonds will crash.
Have we forgotten anything?
Oh, yes…the entire model of modern government and finance will collapse, too.
In fact, it will be the end of the world as we have known it.
We (your editor is speaking for himself) were born at the beginning of the biggest boom in history.
In Phase I, that boom was fuelled by output — of babies, autos, TVs and genuine economic growth.
But in Phase II, it was fuelled by credit. From 1964 to 2014, credit in the US increased 50 times, as the economy shifted from manufacturing to finance — that is from making things to buying them with borrowed money.
Now, 66 years later, the leaves are beginning to droop on the whole shebang.
Last week, the IMF announced that the Chinese economy is now larger than that of the US, on a purchasing-power parity basis. In US dollar terms, Chinese output may still be below the US. But when you adjust for what the local currency will buy, China is bigger…and getting bigger all the time.
Another interesting feature of the report: Since the beginning of the financial crisis in 2008, the Chinese economy has grown not twice as fast as the US, but nine times as fast.
But China is not immune to the seasons either. From Chongqing province comes the following news, via the Wall Street Journal:
‘About 1,000 workers at a Foxconn plant in southwest China assembling printers and computers for companies went on strike for several hours this week demanding higher pay.
‘The Taiwan-based company, formally known as Hon Hai Precision Industry Co., said the workers walked off the job for four hours Wednesday at its production site in Chongqing. About 20 workers went on strike Thursday morning but further details on that stoppage weren’t available.
‘Foxconn is working with its labor union and workers to resolve the dispute, the company said Thursday in a statement. The company said the strikes didn’t disrupt production.’
Why is this important?
It’s another leaf turning yellow, says former Reagan budget adviser David Stockman. Chongqing is on the western edge of China’s productive landmass and population centres.
Go further west and you run into the Gobi Desert — lots of sand but few people. If China is running out of cheap labour there, it’s running out everywhere.
Last of the summer wine
A key component of Phase II of the great credit expansion was the entry of about 500 million workers into the international labour pool.
Gradually, as American shoppers went to Walmart, they found more and more ‘Made in China’ labels and ‘Everyday Low Prices’. This phenomenon largely offset the Fed’s inflation.
In short, the US found that it could inflate credit all it wanted without causing an alarming rise in prices or interest rates.
But now, the summer is over. The strikes in Chongqing suggest that, even on the furthest fringes of China, bargaining power is shifting to workers. The well of cheap labour from impoverished Chinese peasants has been pumped dry. If that is so, labour rates will rise in China…and prices won’t be far behind.
Don’t expect an immediate markup of flat-screen TV prices. This is a big boat the Chinese are turning. It will take years to manifest.
Besides, it is just October. There are still November and December ahead. And don’t be surprised if stock market volatility spooks the Fed so that it goes back into QE mode — or worse.
Relax. Enjoy the season. Leaves — like wine and women — can be at their best just as they begin their decline. And as a passenger on the Titanic was heard to remark after the ship hit an iceberg, ‘The band never sounded better.’
For Markets and Money