China’s central bank governor warns of ‘Minsky Moment’ risk

The world is coming to the end of probably the greatest financial bubble ever seen.  Since the financial crisis began in 2008, central banks in China, the USA, Europe, the UK and Japan have created over $30tn of debt.

China has created more than half of this debt as the chart shows, and its total debt is now around 260% of debt.  Its actions are therefore far more important for global financial markets than anything done by the Western central banks – just as China’s initial stimulus was the original motor for the post-2008 “recovery”.

Historians are therefore likely to look back at last month’s National People’s Congress as a key turning point.

It is clear that although Premier Li retained his post, he has effectively been sidelined in terms of economic policy.  This is important as he was the architect of the stimulus policy.  Now, President Xi Jinping appears to have taken full charge of the economy, and it seems that a crackdown may be underway, as its central bank chief governor Zhou Xiaochuan has been explaining:

  • Zhou first raised the issue at the National Congress last month, warning of the risk of a “Minsky Moment” in the economy, where debt or currency pressures could park a sudden collapse in asset prices – as occurred in the US subprime crisis.  “If there are too many pro-cyclical factors in the economy, cyclical fluctuations are magnified and there is excessive optimism during the period, accumulating contradictions that could lead to the so-called Minsky Moment.  We should focus on preventing a dramatic adjustment.”
  • Then last week, he published a warning that “China’s financial sector is and will be in a period with high risks that are easily triggered. Under pressure from multiple factors at home and abroad, the risks are multiple, broad, hidden, complex, sudden, contagious, and hazardous. The structural unbalance is salient; law-breaking and disorders are rampant; latent risks are accumulating; [and the financial system’s] vulnerability is obviously increasing. [China] should prevent both the “black swan” events and the “gray rhino” risks.”

We can be sure that Zhou was not speaking “off the cuff” or just in a personal capacity when he made these statements, as his comments have been carried on both the official Xinhua news agency and on the People’s Bank of China website.  As Bloomberg report, he went on to set out 10 key areas for action:

  • “China’s financial system faces domestic and overseas pressures; structural imbalance is a serious problem and regulations are frequently violated
  • Some state-owned enterprises face severe debt risks, the problem of “zombie companies” is being solved slowly, and some local governments are adding leverage
  • Financial institutions are not competitive and pricing of risk is weak; the financial system cannot soothe herd behaviors, asset bubbles and risks by itself
  • Some high-risk activities are creating market bubbles under the cover of “financial innovation”
  • More companies have been defaulting on bonds, and issuance has been slowing; credit risks are impacting the public’s and even foreigners’ confidence in China’s financial health
  • Some Internet companies that claim to help people access finance are actually Ponzi schemes; and some regulators are too close to the firms and people they are supposed to oversee
  • China’s financial regulation lags behind international standards and focuses too much on fostering certain industries; there’s a lack of clarity in what central and regional government should be responsible for, so some activities are not well regulated
  • China should increase direct financing as well as expand the bond market; reduce intervention in the equity market and reform the initial public offering system; pursue yuan internationalization and capital account convertibility
  • China should let the market play a decisive role in the allocation of financial resources, and reduce the distortion effect of any intervention
  • China should improve coordination among financial regulators”

Clearly, Xi’s reappointment as President means the end of “business as usual” for China, and for the support provided to the global economy by Li’s stimulus policies.  Xi’s own comments at the Congress confirm the change of direction, particularly his decision to abandon the idea of setting targets for GDP growth.  As the press conference following the Congress confirmed, the focus is now on the quality of growth:

“China’s main social contradiction has changed and its economic development is moving to a stage of high-quality growth from a high-rate of expansion of the GDP,” said Yang Weimin, deputy head of the Office of the Central Leading Group on Financial and Economic Affairs. “The biggest problem facing us now … is the inadequate quality of development.”

Companies and investors should not ignore the warnings now coming out from Beijing about the change of strategy.  China’s lending bubble – particularly in property, is likely coming to an end.  In turn, this will lead to a bumpy ride for the global economy.

 

US tax cuts will fail as Trump’s demographic deficit replaces Reagan’s demographic dividend

No country in the world now has a top quality pension system.  That’s the conclusion from the latest Report by pensions consultants Melbourne Mercer.  As the chart above shows:

  • Denmark and The Netherlands have fallen out of the top category
  • In the G7 wealthy nations: Canada is in category B; Germany and UK in C+; France, US and Italy in C; Japan in D
  • In the BRICS emerging economies: Brazil is in category C; India, China and S Africa are D; and Russia’s system is so poor it is unclassified

Unsurprisingly, the cause of the problems is today’s ‘demographic deficit’, as the authors highlight:

“The provision of financial security in retirement is critical for both individuals and societies as most countries are now grappling with the social, economic and financial effects of ageing populations. The major causes of this demographic shift are declining birth rates and increasing longevity. Inevitably these developments are placing financial pressure on current retirement income systems. Indeed, the sustainability of some current systems is under threat.”

These problems have been building for years, as politicians have not wanted to have difficult conversations with voters over raising the retirement age.  Instead, they have preferred to ignore the issue, hoping that it will go away.

But, of course, problems that are ignored tend to get worse over time, rather than go away.  In the US, public pension funds saw their deficits jump $343bn last year to $3.85tn – making it almost certain that, eventually, pension benefits will have to be cut and taxes raised.

The issue has been that politicians preferred to believe central bank stimulus programmes could solve the deficit by cutting interest rates and printing large amounts of virtually free cash.  And unfortunately, when it became clear this policy was failing to work, the banks “doubled down” and pursued negative interest rates rather than admitting defeat:

  • Currently, 17% of all bonds (worth $8tn), trade at negative rates
  • Swiss bond yields are negative out to 2027, as the Pensions Partners chart shows
  • Most major European countries, and Japan, suffer from negative rates

2 years ago, Swiss pension experts suggested that its pension system would be bankrupt within 10 years, due to the requirement to pay retirees an annuity of 6.8% of their total savings each year.  This rate is clearly unaffordable with negative interest rates, unless the funds take massive risks with their capital.

The US faces similar problems with Social Security, which is the major source of income for most retirees.  The Trustees forecast its reserves will be depleted by 2034, when benefits will need to be cut by around a quarter.  Medicare funds for hospital and nursing will be depleted by 2029.  And as the Social Security Administration reports:

173 million workers are covered under Social Security.  46% of the workforce in private industry has no private pension coverage.  39% of workers report that they and/or their spouse have not personally saved any money for retirement.”

Rising life expectancy is a key part of the problem, as the World Economic Forum (WEF) reported in May.  Back in 1889, life expectancy was under 50 when Bismarck introduced the world’s first state pension in Germany.  Today, the average baby born in the G7 countries can expect to live to be 100.  As WEF conclude:

“One obvious implication of living longer is that we are going to have to spend longer working. The expectation that retirement will start early- to mid-60s is likely to be a thing of the past, or a privilege of the very wealthy.” 

Sadly, politicians are still in denial, as President Trump’s proposed tax cuts confirm.

Today is not 1986, when President Reagan cut taxes in his October 1986 Tax Reform Act and was rewarded with higher tax revenues.  30 years ago, more and more BabyBoomers were entering the wealth creating 25 – 54 age group, as the chart from the Atlanta Fed confirms:

The issue is the ageing of the Boomers combined with the collapse of fertility rates:

  • The oldest Boomers left the Wealth Creator cohort in 2001, and the average Boomer (born in 1955) left in 2010
  • The relative number of Wealth Creators is also in decline, as US fertility rates have been below replacement level (2.1 babies/woman) for 45 years since 1970

Inevitably, therefore, Reagan’s demographic dividend has become Trump’s demographic deficit.

As I warned back in May, debt and demographics are set to destroy Trump’s growth dream.  And without immigration, the US working age population will fall by 18m by 2035, making a bad situation even worse.  Instead of tax cuts, Trump should instead be focused on 3 key priorities to:

  • Design measures to support older Boomers to stay in the workforce
  • Reverse the decline that has taken place in corporate funding for pensions
  • Tackle looming deficits in Social Security and Medicare”

Future retirees will not thank him for creating yet further debt headwinds by proposing unfunded tax cuts.  These might boost GDP in the short-term.  But they will certainly make it even more difficult to solve tomorrow’s pension deficits.

Interest rates and London house prices begin return to reality

10 yr rates Sept17

Global interest rates have fallen dramatically over the past 25 years, as the chart shows for government 10-year bonds:

  UK rates peaked at 9% in 1995 and are now down at 1%: US rates peaked at 8% and are now at 2%
  German rates peaked at 8% and are now down to 0%: Japanese rates peaked at 4% and are now also at 0%

But what goes down can also rise again.  And one of the most reliable ways of investing is to assume that prices will normally revert to their mean, or average.

If this happens, rates have a long way to rise.  Long-term UK interest rates since 1703 have averaged 4.5% through wars, booms and depressions.  If we just look more recently, average UK 10-year rates over the past 25 years were 4.6%.  We are clearly a very long way away from these levels today.

This doesn’t of course mean that rates will suddenly return to these levels overnight.  But there are now clear warning signs that rates are likely to rise as central banks wind down their Quantitative Easing (QE) and Zero Interest Rate stimulus policies.  The problem is the legacy these policies leave behind, as the Financial Times noted recently:

In total, the six central banks that have embarked on quantitative easing over the past decade — the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England, along with the Swiss and Swedish central banks — now hold more than $15tn of assets, according to analysis by the FT of IMF and central bank figures, more than four times the pre-crisis level.

“Of this, more than $9tn is government bonds — one dollar in every five of the $46tn total outstanding debt owed by their governments.  The ECB’s total balance sheet recently topped that of the Fed in dollar terms. It now holds $4.9tn of assets, including nearly $2tn in eurozone government bonds.”

The key question is therefore ‘what happens next’?  Will pension funds and other buyers step in to buy the same amount of bonds at the same price each month?

The answer is almost certainly no.  Pension funds are focused on paying pensions, not on supporting the national economy.  And higher rates would really help them to reduce their current deficits.  The current funding level for the top US S&P 1500 companies is just 82%, versus 97% in 2011.  They really need bond prices to fall (bond prices move inversely to yields), and rates to rise back towards their average, in order to reduce their liabilities.

The problem is that rising yields would also pressure share prices both directly and indirectly:

  Some central banks have been major buyers of shares via Exchange Traded Funds (ETFs) – the Bank of Japan now owns 71% of all shares in Japan-listed ETFs 
  Lower interest rates also helped to support share prices indirectly, as investors were able to borrow more cheaply

Margin debt on the New York Stock Exchange (money borrowed to invest in shares) is now at an all time high in $2017. Ominously, company buy-backs of their shares have already begun to slow and are down $100bn in the past year.

London House Sept17

House prices are also in the line of fire, as the second chart shows for London.  They have typically traded on the basis of their ratio to earnings

  The average ratio was 4.8x between 1971 – 1999
  But this ratio has more than doubled to 12x since 2000 as prices rose exponentially during subprime and then QE

The reason was that after the dotcom crash in 2000, the Bank of England deliberately allowed prices to move out of line with earnings. As its Governor, Eddie George, later told the UK Parliament in March 2007:

“When we were in an environment of global economic weakness at the beginning of the decade, it meant that external demand was declining… One had only two alternatives in sustaining demand and keeping the economy moving forward: one was public spending and the other was consumption….

“We knew that we had pushed consumption up to levels that could not possibly be sustained in the medium and longer term. But for the time being if we had not done that the UK economy would have gone into recession, just like the economies of the United States, Germany and other major industrial countries. That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out.”

Of course, as the chart shows, George’s successors did the very opposite. Ignoring the fact that a bubble was already underway, they instead reduced interest rates to near-zero after the subprime crisis of 2008, and flooded the market with liquidity. Naturally enough, prices then took off into the stratosphere.

Today, however, the Bank is finally recognising – too late – that it has created a bubble of historical proportions, and is desperately trying to shift the blame to someone else.  Thus Governor Mark Carney warned last week:

“What we’re worried about is a pocket of risk – a risk in consumer debt, credit card debt, debt for cars, personal loans.

Of course, the biggest “pocket of risk” is in the housing market:

  Lower interest rates meant lower monthly mortgage payments, creating the illusion that high prices were affordable
  But higher prices still have to be paid back at the end of the mortgage – very difficult, when wages aren’t also rising

The Bank has therefore now imposed major new restrictions on lenders.  They have ordered them to keep new loans at no more than 4.5x incomes for the vast majority of their borrowers.  And lenders themselves are also starting to get worried as the average deposit is now close to £100k ($135k).

Of course, London prices might stay high despite these new restrictions.  Anything is possible.

But fears over a hard Brexit have already led many banks, insurance companies and lawyers to start moving highly-paid people out of London, as the City risks losing its “passport” to service EU27 clients.  Over 50% of surveyors report that London house prices are now falling, just as a glut of new homes comes to market.  In the past month, asking prices have fallen by £300k in Kensington/Chelsea, and by £75k in Camden, as buyers disappear.

The next question is how low could prices go if they return to the mean?  If London price/earning ratios fell back from today’s 12x ratio to the post-2000 average of 8.2x level, average prices would fall by nearly a third to £332k.  If ratios returned to the pre-2000 level of 4.8x earnings, then prices would fall by 60% to £195k.

Most Britons now expect a price crash within 5 years, and a quarter expect it by 2019.  Brexit uncertainty, record high prices and vast overs-supply of new properties could be a toxic combination, perhaps even taking ratios below their average for a while – as happened in the early 1990s slump.  As then, a crash might also take years to unwind, making life very difficult even for those who did not purchase when prices were at their peak.

Investors ponder further shocks after North Korea jolt

Interviewed for this Reuters articleI suggest today’s low levels of market volatility could be “the calm before the storm” 

Wall St Aug17Saikat Chatterjee and Vikram Subhedar, AUGUST 11, 2017 / 5:06 PM

LONDON (Reuters) – After this week’s war of words between the United States and North Korea triggered the biggest fall in global stocks since the U.S. presidential election, investors are wondering what other off-radar shocks may be waiting to rock world markets.

Although there is little sign so far that investors are protecting themselves against a major sell-off, some say the current environment masks latent risks.

“Every day, our risk models tell us to take more risk because of falling volatility but with markets being where they are, we have to be very careful in not following them blindly,” said James Kwok, head of currency management at Amundi in London.  ”So we try to project scenarios on what can go wrong and where are markets not looking.”

Such has been the extraordinary period of stability in financial markets in recent years that world stocks have hit a series of record highs while gauges of broad market volatility have plunged to record lows.  That benign investment environment has been fostered by central banks which have pumped vast sums of cash into economies since the global financial crisis that began a decade ago, lifting asset prices globally.

Flows into most asset classes have already overtaken peaks reached before the financial crisis.  For example, inflows into active and passive equity funds have nearly doubled to $10.9 trillion at the end of June 2017 from a September 2007 peak, according to Thomson Reuters Lipper data. Inflows into bonds have meanwhile increased nearly three-fold to $4.1 trillion in that period.

Broad market gauges of risk, such as the CBOE Volatility Index .VIX, better known as the VIX, and its bond market counterpart, the Merrill Lynch Option volatility index .VOL remain pinned near record lows despite a spike this week.  But analysts say low market volatility masks the heavy weight of options written on these gauges by investment banks betting that the calm conditions will persist for a long time.

That has been accompanied by the growing popularity of inverse-volatility ETF products, which have doubled in value this year as market volatility has cratered.  Morgan Stanley strategists say the volume of bets on volatility remaining low means even a small increase in price swings could force some of these leveraged bets to unwind, triggering shock waves in the financial system and sending stock markets tumbling.

Daily percentage changes are important in the volatility world because a lot of these exchange-listed products and notes are rebalanced daily based on these changes, so that any large change would automatically trigger selling pressure elsewhere.

“This is why lower volatility creates higher risk,” said Christopher Metli, a Morgan Stanley quantitative derivatives strategist in a recent note.  He estimates that a 12 point rise in the VIX could send the S&P 500 index down by 3.5 percent. A move of that magnitude was last seen after Britain’s shock Brexit vote in June 2016.

But a spike in volatility is not the only scenario worrying investors.

Other risks markets may be ignoring include the implications of a messy British exit from the European Union and the risks that the Qatar crisis could spiral out of control in the Middle East and hit oil prices. Even the prospect of a newcomer at top of the U.S. Federal Reserve when Janet Yellen steps down in 2018 could prove unnerving.

“Today’s low volatility is the calm before the storm and doesn’t reflect the real world in which companies are operating, or the major uncertainties that are developing,” said Paul Hodges, chairman at International eChem, a consultancy.

Another variable is the expectation that central banks will soon start unwinding their massive post-crisis stimulus measures, with unpredictable results.  One of the biggest risks seen lurking is the rise and growing influence on the world’s stock markets of passive funds, which aim to track rather than beat benchmarks and charge lower fees than their more actively-managed peers.

The proportion of stocks on the main U.S. benchmark equity index that are now owned by such passive investors has nearly doubled since the 2008 crisis to 37 percent.  But redemption pressures on large passive investors could exacerbate any market selloff.

Apple Inc (AAPL.O), a stock market darling, has a fifth of its outstanding stock held by index funds with Vanguard, BlackRock and State Street making up the top three holders, according to latest Thomson Reuters data.  The head of sales of a large British-based bond fund said some of its clients are trying to put together pools of money with which to snap up beaten-down stocks if a large emerging market-focused ETF is faced with sudden redemption pressures.

“We get a lot of queries on what are some of the risks that markets may be overlooking, and that is what keeps us up at night,” he said.

 

Reporting by Saikat Chatterjee and Vikram Subhedar, Graphic by Saikat Chatterjee and Ritvik Carvalho; Editing by Catherine Evans

London housing market hit by Brexit, China’s capital controls

Nine Elms Mar17

London’s housing market was always going to have a difficult 2017. As I noted 2 years ago, developers were planning 54,000 new luxury homes at prices of £1m+ ($1.25m) in central London, which would mainly start to flood onto the market this year.

They weren’t bothered by the fact that only 3900 homes were sold in this price range in 2014, or that the number of people able to afford a £1m mortgage was extremely limited:

□ The idea was that these would be sold “off-plan” to buyers in China and elsewhere
□ They had all heard that London had now become a “global city” and that it offered a safe home for their cash
□ There was also the opportunity to “flip” the apartment to a new buyer as prices moved higher, and gain a nice profit

Of course, it was all moonshine. And then Brexit happened. As I warned after the vote, this was likely to be the catalyst for the long-delayed return of London’s house prices to reality:

□ “Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
□ There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
□ This will also undermine the London housing market by removing the support provided by these high-earners
□ In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven””

Confirmation of these developments is now becoming evident. A new study from the Bruegel research group suggests up to 30,000 bank staff and £1.5tn of assets could now leave London, as it becomes likely that the UK will not retain the vital “passport” required to do business in the Single Market after Brexit. This would be around 10% of the estimated 363k people who work in financial services in Greater London.

They will also likely be more senior people, able to afford to buy London homes with cash from their annual bonuses, rather than the more junior people who need to rely on a mortgage based on a multiple of their income. And there is no shortage of tempting offers for these bankers, with Frankfurt, Paris, Amsterdam and Dublin all lobbying hard for their business.

Now, another threat has emerged to prices, in the shape of China’s new capital controls. China has seen its foreign exchange reserves tumble by $1tn over the past 18 months, due to its revived stimulus programme. January data showed they were now just below $3tn, perilously close to the $2.6tn level that most observers suggest is the minimum required to operate the economy. As we have reported in The pH Report:

□ China has now banned the use of the annual $50k foreign currency allowance for foreign real estate transactions
□ It has also banned State-Owned Enterprises from buying foreign real estate valued at $1bn+

The rationale is simple. The country can no longer afford to see money disappearing out of the country for purposes which have nothing to do with the real needs of business. And the impact on London’s property market (and that of other “housing bubble” cities such as New York, Singapore and Sydney) could be huge, as Chinese have been the largest buyers of new residential homes globally according to agents Knight Franks – and were responsible for 23% of commercial deals in central London last year.

Central London prices fell last year by 6%, and by 13% in the most expensive areas according to agents Savills. And now London’s Nine Elms development (pictured) at the former Battersea Power Station has just revealed a serious shortage of new buyers.

It was intending to build 3800 new homes, and originally found an enthusiastic response back in 2013 when the first 865 apartments went on sale. But 4 years later, just 1460 homes have been sold in total – and yet residents are supposed to be moving into the first phase later this month. Even worse, 116 of these original sales are now back on the market from buyers who no longer wish, or can afford, to take up residence.

Some of these buyers have already taken quite a hit on price. As property journalist Daniel Farey-Jones reports, one anxious seller originally listed his apartment for sale at £920k. Having failed to sell, he had cut the price by Friday to £699,995 – a 24% reduction.

Nine Elms is just one of many sites where developers are anxiously watching their cash flow, and hoping a flood of new buyers will rush through the doors. Sadly, they are not the only ones who may soon be panicking.

In recent years, large numbers of home buyers – many of them relatively young and inexperienced – have been persuaded to buy unaffordable homes on the basis that London prices could never fall. I fear that, as I have long warned, they are now about to find out the hard way that this was not true.

Chart of the Year: US$, 10-year US interest rates begin to rise

US Dec16Last year it was the oil price fall.  This year, there is no doubt that the US dollar has taken centre stage, alongside the major rise underway in benchmark 10-year interest rates.  As 2016′s Chart of the Year shows:

  The US$ Index (black) has risen 12% since May against other major currencies (euro, yen, pound, Canadian dollar, Swiss franc, Swedish krona), and is now at its highest level since 2003
  Benchmark 10-year US interest rates (red) have almost doubled from 1.4% in July to 2.6% today.  They are back to 2013-4 levels, when the Fed proposed “tapering” its stimulus policy

Clearly something quite dramatic is now underway.

In currency markets, investors are voting with their feet.  It is hard to see much upside in the European, Japanese or Canadian economies in the next 12 – 18 months.  Europe is going to be gripped by the unfolding crisis over the future of the euro and the EU itself, as it moves through elections in The Netherlands, France, Germany and probably Italy. By March, the UK will be on the Brexit path, and will leave the EU within 2 years. Japan is equally unattractive following the failure of Abenomics, whilst Canada’s reliance on commodity exports makes it very vulnerable to the downturn underway in the BRICs (Brazil, Russia, India, China).

Investors are also waking up to the uncomfortable fact that much of today’s borrowed money can never be repaid. McKinsey estimated global debt at $199tn and 3x global GDP at the start of 2015, and the total is even higher today.

As I warned a year ago in “World faces wave of epic debt defaults” – central bank veteran), there is no easy route to rescheduling or forgiving all this debt.  Importantly, central banks are now starting to lose control of interest rates. They can no longer overcome the fundamentals of supply and demand by printing vast amounts of stimulus money.

This is the Great Reckoning for the failure of stimulus policies in action.

THE RISES WILL CREATE “UNEXPECTED CONSEQUENCES” FOR COMPANIES AND INVESTORS
These moves are critically important in themselves as the dollar is the world’s reserve currency, and US interest rates are its “risk-free” rates. Unsurprisingly, interest rates are already now rising in all the other ‘Top 15′ major economies – China, Japan, Germany, UK, France, India, Italy, Brazil, Canada, S Korea, Russia, Australia, Spain, Mexico. Together, these countries total 80% of the global economy.

The rises are also starting to create unexpected “second order impacts”.  For example, many companies in the emerging economies have large US$ loans, which appeared to offer a cheaper interest rate than in their home country. Suddenly, they are finding that the cost of repayment has begun to rise quite rapidly.

This happens in almost every financial crisis:

  People become excited by the short-term cost of borrowing – “Its so cheap, just $xxx/month”
  They totally forget about the cost of repaying the capital  -”I never thought the dollar would get that strong”

There were $9tn of these loans last year, according to the Bank for International Settlements.  Many were to weak companies who are likely to default if the dollar keeps rising along with US interest rates.

In turn, these defaults will also have unexpected consequences.  Lenders will suffer losses, and will be less able to lend even to stronger companies.  Higher borrowing costs will force consumers to cut back their spending.  This risks creating a vicious circle as corporate interest costs rise whilst revenues fall.

China 10yrChina is the obvious “canary in the coalmine” signalling that major problems lie ahead.

  The Wall Street Journal chart shows 10-year rates have risen despite central bank support
  Its total debt is around $27tn, or 2.6x its GDP, due to housing bubble and other speculation
  The central bank now has to sell its US Treasury holdings to support the domestic economy
  In turn, of course, this pushes US rates higher, as rates move inversely to bond prices

China used to hold around 10% of US debt, and was the largest foreign holder. Japan holds similar amounts, and is also stepping back from purchases due to the growing exchange rate volatility.

Nobody else has the financial firepower to take their place.  The only possible replacements – Saudi Arabia and the Gulf countries – have seen their incomes fall with the oil price, whilst their domestic spending has been rising.  This means interest rates and the US$ are likely to carry on rising.

Higher rates will further weaken the US economy itself, particularly if President Trump launches his expected trade war.  In the important auto market, GM has just announced production cutbacks next month due to falling sales, despite the industry having raised incentives by 21% to nearly $4k/car. GM’s inventories are now 25% higher than normal at 86 days versus 69 days a year ago.  Housing starts fell 7% last month, as mortgage rates began to rise.

And then there is India, the world’s 7th largest economy and a leading oil importer.  Its rates are now rising as shocked investors suddenly realise recession is a real possibility, if the currency reform problems are not quickly resolved.

These risks are serious enough.  But they are very worrying today, due to the steep learning curve that lies ahead of all those who began work after the start of the Boomer-led SuperCycle in 1983.

  They assume that “recessions” are rare and last only a few months as central banks always rescue the economy.
  Only those who can remember before the SuperCycle know that markets and companies should have long ago taken fright as these risks began to develop

This is why the rise in the US$ Index and US 10-year exchange rates is 2016′s Chart of the Year.