It’s quaint you know. Analysts faith in the system, I mean. There are a couple of really smart articles out this morning from really smart people about really smart things. And they’re making reassuring noises that there is no recession coming and that you should stay in your trades, that yesterday’s money making strategy is the same as tomorrow’s.
Take Tim Duy, for instance. He’s my favourite Fed blogger. A really bright economist and flexible enough to bend with the data. Today he argues the following:
For what it’s worth, auto sales where up in July, setting the stage for stronger growth in the second half. Thin rope to hold onto, I know. But one inconsistent with recession, arguing instead for a “growth recession,” ongoing tepid growth rates.
This is where the first question bleeds into the second. What kind of recession would we expect? Mild or severe? I think that fears of a deep recession should be highest when the economy is operating at high capacity and/or when significant imbalances have developed. Obviously, in the current environment, the economy is operating at low capacity, with only limited recovery since the recession ended. Difficult to see, for instance, a drop in new housing starts of the magnitude seen in recent years. Impossible, really, given the downside limit. One has to imagine something similar holds true for auto sales. And bank lending. And households are already in the process of deleveraging.
You get the idea. I think combining my thoughts on the first and second questions yields a high probability of slow growth, but a lower (20-30%) probability of mild recession, and a very low probability of severe recession. I was concerned that government spending would come to a standstill, which would certainly plunge the economy into recession, but luckily that fear was not realized.
And then we have the following from J.P.Morgan via Bloomberg:
Investors should retain holdings in commodities even as the global economy expands at a slower pace as raw-material demand is strong enough to support further gains, JPMorgan Chase & Co. (JPM) said, forecasting gold and copper rallies.
Gold may jump to a record $1,800 an ounce by yearend, while copper revisits $10,000 per metric ton, Colin P. Fenton and Matthew Lehmann wrote in a report yesterday. The bank had raised forecasts for both metals, they said, without giving the earlier estimates. The bank can’t release a separate report of full calls, said spokeswoman Polly Leung, citing compliance policy.
Commodities as measured by the Standard & Poor’s GSCI Spot Index fell for a seventh session today, the longest slump since May 2010, on concern that the global economy is slowing. JPMorgan cut its forecast for third-quarter U.S. growth by a percentage point to 1.5 percent, Chief U.S. Economist Michael Feroli said yesterday. The U.S. is the world’s largest user of oil, and is second to China in terms of copper and aluminum.
“Baring a material contraction in global growth, which we do not currently expect, commodities should continue to move higher,” said New York-based Fenton, global head of commodities research and strategy, and London-based Lehmann, a strategist. “Even at a now slower pace, global growth in the second half should be enough to outpace still-constrained supply in the major commodity markets.”
Ah yes, the old supply and demand argument. It’s a beauty and even works sometimes in the real economy. At times like these, however, it’s completely irrelevant.
What makes both of these arguments wrong is the same thing. Markets are far more simple beasts than this. They run on sentiment. Especially so our supersonic, highly sensitive and utterly interconnected modern market. The sophistication of contemporary capital markets – the floating connections between equity, government debt, currencies, private debt, derivatives, assets and liabilities – has no backstop. The intricacies of connection are so finely tuned, so efficient, that there is no buffer in the system.
That only leaves sentiment as the glue that holds it together.
And so, when things are perceived to be good enough, the system inflates. When things are perceived to be poor, such as now, the system deflates.
This system is global and, bizarrely, it is the funding mechanism for the underlying global economy. That is what both of the above articles miss. The interplay of this global market mechanism with the underlying economy guarantees a recession. It does so because things are poor, and so, everyone sells, in case everyone else does, or, can’t pay their bills. Consumers, who own pieces of the market system, see their assets devalue. They retrench. Funding for the real economy becomes scarce. Business retrenches. A recession ensues. The great and global gossamer market leads, it does not follow.
Of course, this ingenious and truly insane system is not completely without supports. As we saw in 2008, when the panic comes, ‘officials’ step in and save the system. There are two types of ‘official’ – fiscal and monetary.
The last two years has seen fiscal ‘officials’ drawn into the madness. Having saved the system with their own Budgets, it has turned upon them. In saving the broken system, they, ironically, broke the rules that make the system tick. Fiscal debt is now the problem not the solution and must be expunged (I’m not going to get into a debate with MMT’s over this. It is an observable fact that these are the rules that the system sets itself).
And after ‘officials’ did so well in 2008, grasping the fleeing fume that is this market, they have been behind ever since. In the US we’ve recently experienced perhaps the most calamitously stupid fiscal policy process of my lifetime, which has resulted in a terrible outcome of fiscal contraction in an economy already sliding towards recession. Along the way, we were offered a debauched glimpse of the end of the world we have known all of our lives, a US default. For no reason whatsoever.
But, as bad as that is, it is in Europe where the collapse of sentiment around fiscal ‘officials’ is greatest. The past two years has been one slow motion effort after another to catch up with failing market sentiment. But ‘officials’ have always been behind and are now falling prey to the same panic. From the President of the European Commission, Jose Manuel Barosso, comes this public letter to his colleagues:
Developments in the sovereign bond markets of Italy, Spain and other euro area Member States are a cause of deep concern. Though these developments are clearly unwarranted on the basis of economic and budgetary fundamentals and the recent efforts of these Member States, they reflect a growing scepticism among investors about the systemic capacity of the euro area to respond to the evolving crisis. Markets remain to be convinced that we are taking the appropriate steps to resolve the crisis.
The 21st of July bold decisions on the Greek package and the increased flexibility of the EFSF (precautionary use, recapitalisation of banks and intervention in secondary bond markets), are not having their intended effect on the markets. Markets highlight, among other reasons, the global economic uncertainties due to both economic growth and the protracted decision on budgetary adjustments in the US but, first and foremost, the undisciplined communication and the complexity and incompleteness of the 21st July package.
Whatever the factors behind the lack of success, it is clear that we are no longer managing a crisis just in the euro-area periphery. Euro-area financial stability must be safeguarded, with all EU institutions playing their part with the full backing of euro area Member States. We need also to consider how to further improve the effectiveness of both the EFSF and the ESM in order to address the current contagion.
Concretely, I would like to call on you to accelerate the approval procedures for the implementation of these decisions so as to make the EFSF enhancements operational very soon. These changes should also avoid introducing excessive constraints in terms of either additional conditionality or collateralisation of EFSF lending. I trust that governments and national Parliaments will rapidly approve these decisions necessary to improve the EFSF flexibility.
I also take the opportunity to urge a rapid re-assessment of all elements related to the EFSF, and concomitantly the ESM, in order to ensure that they are equipped with the means for dealing with contagious risk.
Finally the Commission stands ready to contribute to the improvement of working methods and crisis management in the euro area.
Add to this the total denial, disorder and sheer decadence apparent in Italian leadership and is it any wonder global markets are in a growing disorder?
So, that only leaves us one ‘official’ support: monetary. The ECB has been buying Italian bonds. But as Alphaville pointed out recently, the ECB has neither the brief nor the firepower to quantitatively ease for the eurozone. A major crisis is slouching toward the European Central Bank. And with it a grave danger that we repeat 2008’s loss of faith in the system.
Across the Atlantic, the news is better. There is now no doubt that QE3 is coming. The market rout has at last broken the back of the oil price, blasting it through the $90 support and dropping it almost 6% to $86. I very much doubt it is finished. It’s going lower, along with everything else, and soon.
QE2 was launched with oil around $70. We may not get that low again this time, given everyone knows it’s coming. But I expect to see the price fall at least into the seventies. And when it comes, I have every faith that the great and gossamer global market will reverse and shower us with money once more, for a little while.
The black swan, however, is Europe. If monetary and fiscal ‘officials’ can’t restore faith there soon, then calling bottoms becomes a fool’s game.
