Guest Post: The Economy Is On The Ropes And Going Down

Submitted by Tyler Durden
09/28/2011 11:51 -0400
Comments: 117 / Reads: 11,439

Submitted by Chris Martenson

The Economy Is on The Ropes And Going Down

The risk faced by those who are analyzing macro trends is sounding like a broken record. For those younger readers who have no idea what that means, imagine an MP3 song that will stick on and endlessly repeat a random segment of the song you are listening to until you give your device a sharp knock on the side. That's what a broken record sounded like.

The world economy is on the ropes and it won't ever recover. At least not to anything resembling its recent past. Neither the gleeful housing bubble nor the free-flowing credit that enabled that side bubble to emerge will return. The resources simply do not exist to repeat that final orgy of consumption. A new reality is upon us and - while fortunately more and more people are choosing to face our predicament rather than pretend the current risks and challenges do not really exist - the absolute numbers are still small and for the most part don't inlcude any of our political leaders.

The macro trends of worsening public and private debt loads, a looming and unaddressed Peak Oil threat, exponentially increasing global population, resource depletion, and an all-too-human tendency to use the money printing machine to deal with tough economic problems all remain pointed firmly towards an uncomfortable conclusion: There's a future of less in store for most people.

Our best hope is for a negotiated decline to lower levels of economic activity that allow us to gracefully adjust our expectations to a new and lower level consumption that offers an even more enjoyable and purpose filled existence. Our worst fear is that a stubborn insistence on business as usual by our leadership leads to a future shaped by disaster rather than design.

The Fundamental Issue is this: you can't solve a problem rooted in too much debt with more debt. It just doesn't pencil out.

"Here we go again…solving a debt problem with more debt has not solved the underlying problem. ...Can the US continue to depreciate the world's base currency?"

~ Goldman strategist Alan Brazil (Source) http://online.wsj.com/article/SB1000142 ... stpop_read

Yet we now see that both Europe and the US are busily conceding to banker demands and coming up with all manner of fancy schemes to hide the fact that what is happening is simply that old debt is being replaced with new debt.

Consider the confusing news about the European EFSF, the so-called rescue facility for the Eurozone, which is currently conceived to use leverage (to solve a debt problem!) and is thought to look something like this:



(Source) http://macro-man.blogspot.com/2011/09/a ... -plan.html

We could analyze the details of that flowchart and opine on the structure, but that really won't aid anything. Additional complexity and Jell-o redistribution will not change the basic fact that the debts simply cannot be paid back under current terms or out of any imaginable future economic growth.

As far as I can tell the complexity serves one main purpose and that is to baffle enough of the populace for long enough to allow a significant transfer of public wealth to occur in broad daylight into private pockets. In this regard Europe and the US seem to be identical.

A Bad Reaction
On September 21, 2011 the Fed disappointed the world equity and commodity markets by announcing Operation Twist, nothing more than monetary Jell-o being moved from one side of the plate to another, instead of more QE stimulus (which would be additional Jell-o in this metaphor).

The reaction was swift and negative.

Beginning with stocks, we see that a couple of severe down days (the red bars in the green circle) ensued following the operation twist announcement.



We also note that the S&P 500 is down year to date (YTD, blue dotted line) and that it is bouncing between the 1120 and 1220 marks (purple lines) with a lot of volatility but not much direction. The simplest explanation for this is that tensions exists between what the fundamental data is telling us about the state of the global economy (not good, more below) and the hope that more central bank money will soon be flooding the world.

As always, this is not a good sign and any time you read the word "investors" being used in an article about who is driving these price movements I invite you to replace that word with "speculators" as that's what we all are now; speculating wildly about when and how much thin-air money will next be injected by one central bank or another.

Gold had particularly tough going after the Twist announcement getting clobbered for ~$100 on a couple of days (green circle) following the twist announcement:



These price drops had nothing to do with an improved outlook on the viability of the world's fiat money systems or a reduction in overall systemic risk. Neither were appreciably altered by the Fed decision although systemic risk was probably elevated. Without the Fed absorbing additional existing debt the entire system is at greater risk of slipping into a deflationary spiral that could get out of control.

If that happens, you want to be sure to have gold, in hand.

Silver was especially slammed, and was the undisputed loser of the entire commodity complex losing as much as 25% in a single session (before recovering):



I have always held that the risk for silver in this current rout would be that it behaves more like an industrial metal than a monetary asset and therefore could slip in price regardless of systemic stress. For a while there throughout July and August I began to think that silver was displaying some money-like qualities but the recent slam dispelled those thoughts.

I continue to think that this rout is not yet over and am waiting better prices for silver before I remove some of my dry powder and accumulate some more.

The 'off note' in this story is the price of oil:



Until and unless oil, the main lubricant of commerce and a feed-in to the price of everything, slips and plummets a long way from here, I remain bullish on commodities in general. The macro story for oil is simply that a marginal new barrel of oil costs at least $70 in today's world and quite a bit more in some cases.

If oil falls below that $70-$80 level then you can forget about new supply coming on line. In many respects we are living in an 'oil shadow' created by the plunge in oil to $38 in 2009 which delayed a large number of oil development projects that would otherwise be yielding supply today.

Should oil fall below the marginal cost again here in 2011 or 2012 then we'll have another oil shadow to contend with a few years down the line.

Of course I should point out here that the above chart is for US oil only (WTIC) and that the world price for oil is roughly $20 higher as indicated by the price of Brent crude at $104/bbl.

Slip Sliding Away
Presently, the global economy is not doing all that well. There are troubling signs from Japan, the US Europe and now China that the economy is stalling out and in serious danger of slipping back into recession. If that happens, all of the debt rescue plans will both have additional headwinds with which to contend and new debt implosions to rescue.

Any analysis of the global economy has to begin with Dr. Copper, the most trusted source for an accurate economic diagnosis. Used in an enormous variety of commercial applications from houses to cars to electronics to electricity cables, copper prices usually provide a useful early read on the direction of the economy.

That tale is one of weakness:



Copper prices are now back to where they were in 2008, although still considerably up off the lows of late 2008 and early 2009, and are in negative territory YTD by more than 20%.

Consistent with the weakness in copper prices are recent reports of Chinese manufacturing activity slipping into contraction:

China manufacturing data paint weak picture (Sept 22, 2011) http://www.marketwatch.com/story/hsbc-m ... teid=yhoof

HONG KONG (MarketWatch) — HSBC’s preliminary China Manufacturing Purchasing Managers’ Index, or “flashâ€