Stockman is spot on again

Is the end nigh?  Stockman seems to think the tipping point is past.  I think his summary is pretty much spot on.

…the central banks of the world have shot their wad. Accordingly, the 12-year round trip depicted in the chart is not about the end of some nebulous “commodity supercycle” that arrived from out of the blue after the turn of the century. Nor, most certainly, is it evidence of the Keynesians’ purported global shortage of “aggregate demand” that can be remedied by an even more extended spree of central bank monetary stimulus.

No, the Bloomberg Commodity index is a slow motion screen shot depicting the massive intrusion of worldwide central bankers into the global economic and financial system. Their unprecedented money printing rampage took the aggregate balance sheet of the world’s central banks from $3 trillion to $22 trillion over the last 15 years.

The consequence was a deep and systematic falsification of financial prices on a planet-wide scale. This unprecedented monetary shock generated a double-pumped economic boom—–first in the form of an artificial debt-fueled consumption spree and then a sequel of massive malinvestment.

Now comes the deflationary aftermath. Soon there will follow a plunge in corporate profits and collapsing prices among the vastly inflated risk asset classes which surfed on these phony booms.

So it is worth recounting how we got here. In the first phase, central banks engineered a massive wave of household borrowing and consumption/housing spending in the DM economies which, in turn, ignited an export manufacturing boom in China and among its caravan of EM suppliers. This China/EM export boom eventually over-taxed the world’s existing capacity to supply the raw materials required by a booming industrial economy—hydrocarbons, iron ore, met coal, aluminum, copper, nickel etc.

The resulting commodity price boom peaked on the eve of the Great Financial crisis and was crystalized when oil hit $150/barrel in July 2008. During the 2007-2008 initial peak period, the spread between cash costs of production and soaring commodity and materials prices was inflated to unprecedented size, generating vast economic rents that accrued to owners of existing production assets and reserves.

Even though DM consumption spending and demand for global exports was not sustainable, the pre-crisis windfalls naturally generated a surge of capital investment in search of supra-normal returns. But then the central bankers doubled down in the face of collapsing global trade and the liquidation of DM domestic economic excesses in the fall and winter of 2008-2009.

Indeed, the desperate scramble by governments and their central banking branches to dig out from under the plunge in consumer spending and the subsequent liquidation of dodgy mortgages, excess inventories of manufactured goods and over-stocked labor in the DM economies triggered the second artificial economic boom. This time it was manifested in a renewed frenzy of CapEx and  public infrastructure spending in China and the EM economies.

To the pull of windfall profits in global mining, energy, materials, shipping and manufacturing was added the push of dirt cheap central bank enabled credit on an heretofore unimagined scale. In the case of China, for example, public and private credit outstanding at the end of 2007 amounted to just $7 trillion or about 150% of its GDP. During the next seven years—-owing principally to Beijing’s maniacal stimulus of domestic infrastructure investment designed to replace waning exports——China’s now completely unhinged credit machine generated new debt equal to triple the 2007 amount, thereby bringing credit outstanding to $28 trillion or nearly 300% of GDP at present.

Adding fuel to the fire, DM central bankers drove interest rates to the zero bound in a foolish quest to jump-start spending by debt-saturated households. But this did not cause consumers to spend more in the US, England, Spain, Italy, Greece or France because the vast middle classes of these DM economies were already at “peak debt”. Instead, it generated a madcap scramble for yield among money managers and an eventual capital outflow of $4-5 trillion into EM debt markets.

Taken together, the combination of unprecedented financial repression in DM capital markets and the prodigious expansion of domestic business credit in China and the EM elicited a tidal wave of capital investment unlike the world has ever witnessed. This put a renewed round of pressure on commodities that caused a second surge of prices which peaked in 2011-2013.

The torrid demand for commodities during this second wave resulted in part from the need to feed cement, steel, copper, aluminum and hydrocarbons into the maw of China’s massive infrastructure, high rise apartment and commercial building projects and similar construction booms in other EM economies. And on top of that was another whole layer of demand for the raw materials needed to build the ships, earthmovers, mining machinery, refineries, power plants and steel furnaces and mills that were directly embodied in the capital spending spree.

Stated differently, the torrid demand for construction steel in China indirectly led to demand for more iron ore bulk carriers, which in turn required more plate steel to supply China’s shipyards which were given the contracts to build them. In short, a capital spending boom creates a self-feeding chain of materials demand——especially when its fueled by cheap capital costs and the economically false rates of return embedded in long-lived capital assets funded by it.

And therein lies the origins of the deflationary wave now rocking the global commodity markets. Neither the DM consumer borrowing binge nor the China/EM infrastructure and industrial investment spree arose from sustainable real world economics. They were artifacts of what history will show to be a hideous monetary expansion that left the DM world stranded at peak household debt and the EM world drowning in excess capacity to produce commodities and industrial goods.

Read the entire piece at the provided link.

 

 

LEAVE A COMMENT