End of an Era? Global Economy’s Tectonic Plates Moving Again
October 1987: The U.S. stock market collapsed 23 percent in one day, the largest one-day drop on record. For the rest of that year economists debated how deep the depression would be in 1988. There was no depression in 1988. The reason was that for the first time in central banking history there was a coordinated global response to a visible economic crisis. The leadership attached to that response was provided by U.S. Treasury Secretary James Baker III.
October 1987: The U.S. stock market collapsed 23 percent in one day, the largest one-day drop on record. For the rest of that year economists debated how deep the depression would be in 1988. There was no depression in 1988. The reason was that for the first time in central banking history there was a coordinated global response to a visible economic crisis. The leadership attached to that response was provided by U.S. Treasury Secretary James Baker III.
June 1989: In China a student demonstration referred to as “Tiananmen Square” happened. That demonstration initiated a declaration of martial law by China’s leadership. Over 300,000 communist troops were brought to bear on the demonstrators. The square was cleared of all demonstrators, with hundreds and perhaps thousands of students killed. That event marked the end of Deng Xiaoping’s reforms and solidified those reforms as the basis for a remarkable Chinese economic expansion that has lasted from that moment to the present.
November 1989: The Berlin Wall came down. That event marked the end of Soviet domination of Eastern Europe. It also paved the way for a unification of Germany for the first time in over 40 years. One of the key issues surrounding German unification was how to merge the East German Mark with the West German Mark. Most economists at the time declared an appropriate exchange rate would be anywhere from a minimum of four to as much as 10 East German Marks for one West German Mark. West German Chancellor Helmut Kohl decided that the exchange rate would be one to one. This was seen as a gift from West Germany to East Germany. It also marked the formation of an economic unification that has been prosperous and strong for all Germans from that day to the present.
December 1991: Boris Yeltsin took the leadership role from Mikhail Gorbachev. In short order Yeltsin dismantled the Soviet Union and the Cold War was officially ended.
Viewed collectively as a cluster of events over a short span of four years, these events registered a 9.0 on the Richter scale of geopolitical/economic events. The Reagan/Thatcher economic reforms of the 1980s coupled with this cluster of events moved the global economic tectonic plates and launched the beginning of a powerful wave of economic growth that was sustained right up to the Great Recession of 2008-09.
There is always an ending after a beginning, eventually. The pressing question before us now: Are we at the end of an era of sustained economic growth? To answer the question consider the following:
Following the recent British vote to leave the European Union (Brexit), the pound sterling went into a free fall with lows against the dollar not seen since 1985. A falling currency can mean a lot of things but in this case there is a strong chance that a falling pound sterling means that the British economy may be in recession soon.
$10 trillion (out of approximately $60 trillion) of global sovereign debt is currently trading at a negative yield. The balance of this outstanding sovereign debt is trading at historically low yields of slightly more or less than 1 percent. In an extreme example, a recent 50-year maturity of Swiss sovereign debt traded at a negative yield. There is no precedent for this — none. A consequence of extreme historically low interest rates is that investors that require long-term safe cash flow returns will have none. Savers, retirees, and their pension-fund investment managers will suffer the most.
Two of the largest banks in the world (Duetsche Bank, Credit Suisse Bank), one German and the other Swiss, have stock prices currently trading at historical lows that represent extreme financial stress. This circumstance can be coupled with the entire Italian banking system in desperate need of a capital infusion that will not be coming from private-sector capital markets. Making matters worse for Italy’s banks are Eurozone rules that preclude the Italian government from backstopping their banks with Italian taxpayer funding. The Italian banks alone have about $400 billion of non-performing loans which represent a third of all recognized Eurozone non-performing loans and one-fifth of all outstanding consumer loans in Italy. The recent Brexit vote has spotlighted the EU banking institutions in a position of being the Achilles heel of the entire global financial system.
There are upcoming elections in Italy, German, Netherlands, and France between October 2016 and May 2017. Election results in any one of these countries could be construed as being a referendum on membership in the EU. If a political party hostile to the EU claims a victory, then in all probability that party will dump the Euro. That political event or a failure of any major bank in Germany, Switzerland, or Italy could easily end the EU and the Euro. In turn, the world could easily collapse into a global depression.
If the trip-wires mentioned above fail to cause an economic calamity then there is always the debt minefields of China and Japan coupled with massive global debt accumulation in the rest of the world waiting in the wings to do the job.
Amid all of this, is there a canary in the coal mine? Yes, the canary in the coal mine is the current rising price of gold. After a five-year correction off the high price in 2011, the current trend is solidly up since the beginning of this year. It is an indication that the world’s economic tectonic plates are moving once again.
Only this move will mark the end of an era rather than the beginning of one.
