The dominoes are falling thick and fast now

It’s almost impossible to exaggerate the speed with which economic collapse is bearing down on us.  The daily news headlines are filled with individual facts that, to anyone with any knowledge at all of business and economics, are nightmarish to behold:  yet those same news headlines seldom put two and two together, and warn their readers of what those individual facts mean when taken in conjunction with others. I’d like to think that I can help at least some readers by making connections between such headlines, putting them together, and showing the ‘big picture’ they represent.  I hope you find that useful – if not exactly happy or pleasant reading!

Here’s what’s come down the pike in the past few days.  Each headline is followed by an excerpt from the relevant article;  click on the link to see the full article.

1.  Global slump alert as world money contracts

Growth of the world money supply has dropped to the lowest level since the financial crisis of 2008-2009, heralding a severe economic slowdown later this year unless authorites rapidly take action.

The latest data show that the real M1 money supply – cash and overnight deposits – for China, the eurozone, Britain and the US has been contracting since the early Spring. Any further falls risk a full-blown global recession.

Clear signs of trouble are emerging in the US, until now the last bastion of strength. The New York Institute of Supply Management said its ISM business index – a proxy for business demand – flashed a “screeching halt” in May, crashing to 49.9 from 61.2 in April, where anything below 50 denotes contraction. Unemployment is rising again after grim jobs data for April and May, indicating that the economy may have fallen below stall speed.

Central bank governors and finance ministers from the G7 bloc are to hold an emergency teleconference call on Tuesday to grapple with Europe’s escalating crisis. There is mounting anger in North America and Asia over the failure of the Europeans to use their vast resources to contain the brushfire in Spain.

The world money data collected by Simon Ward at Henderson Global Investors show that real M1 for the G7 economies and leading E7 emerging powers peaked at 5.1pc in November and has since plunged to 1.6pc in April. The data explain why commodity prices are falling hard, with Brent crude down to a 16-month low of under $97 a barrel.

China’s money data are falling at the fastest pace since records began. The gauge – six-month real M1 – gives advance warning of economic output half a year ahead.

2.  Asia’s $6.4 trillion in foreign reserves a threat to stability

The relentless build-up of foreign reserves by China and Asia’s export Tigers has become a threat to financial stability and risks setting off inflation across the region, the Bank for International Settlements has warned.

. . .

The reserves are mostly in dollars and euros. They top 100pc of GDP in Hong Kong and Singapore, and 50pc in China, Malaysia and Thailand. The BIS said reserve accumulation on this scale distorts the credit system. In China it has led to negative real interest rates and growth of a “shadow banking system” that is hard to control. It causes banks to boost lending beyond safe levels and can “push the expansion of monetary liabilities beyond the ability of the financial system to absorb them”.

. . .

China has amassed $3.3 trillion, or more than 5pc of global GDP. Professor Michael Pettis from Beijing University said this was what the US did in the 1920s, and Japan in the 1980s. Both episodes ended badly.

The combined reserves of Asian powers and oil exporters now exceed €11 trillion. This money is recycled into the global economy through bonds – making credit too cheap, and fuelling asset bubbles – and may have been a key cause of the global crisis in 2008-2009.

(Note what this means for the USA.  Over 40 cents out of every dollar the US government currently spends is financed through borrowing – and over the next 15 years, the federal government’s total debt is expected to double.  US government borrowing to fund that debt takes the form of bonds sold to investors.  Until recently, the biggest among those investors were the Far Eastern nations mentioned above, who were investing their foreign currency surpluses in US treasuries.  Over the past year or two, that’s ground to a halt as the dollar looks less and less like a safe haven for their money.  Today the Fed is buying something like 70% of all US treasuries, because there simply isn’t enough foreign investor interest in them.  That may change in the short term as desperate European investors seek safe havens for their money, but it won’t last.  It’s virtually certain that in the medium to long term, the foreign investors on whom the USA has relied to purchase its bonds won’t be in the market for them any longer.  That being the case, how will the USA fund its ongoing excessive expenditure?)

3.  ‘Zombie’ companies holding back UK economy

Britain’s recovery is being held back by a wave of “zombie” companies that should be allowed to fail but are instead undermining capitalism, according to Ernst & Young.

The accountant said that the financial crisis had created an environment where it is “too difficult to fail”, with businesses being kept afloat to the detriment of the broader economy.

As a result, so-called “financially undead” companies are clinging on, despite the recession, making markets and the economy inefficient.

. . .

Alan Hudson, E&Y head of restructuring in the UK, said while zombie companies were still operating, they were taking market share from viable companies that should be growing and boosting the economy.

. . .

Alan Bloom, head of global restructuring at Ernst & Young [said] … “It means that businesses which probably should fail, don’t fail. In a capitalist economy you get winners and losers,” … Mr Bloom added that the US government’s rescue of GM Motors appeared to be the “high watermark” of the state bailing out private sector companies, essentially re-writing capitalism.

Note that last sentence in bold print.  That’s been a disastrous element of the present economic crisis, not only in the USA, but across Europe as well.  Governments have essentially prevented business failures by taking insolvent debt levels onto national balance sheets, thereby relieving companies of the burden but imposing it on taxpayers.  The USA did it with General Motors and Chrysler.  Spain has just done it with Bankia, and has begged for European Union assistance to raise sufficient funds to bail out other banks, because it can’t afford to pay the interest rates demanded by private investors.  Ireland did it for its own banks.  The list goes on and on . . .

Remember that much emergency state assistance to failing companies is directed towards the political allies and supporters of those in power.  For example, the Greek financial bailout was not intended to provide money to Greece, for that country’s needs:  it provided funds to reimburse the banks to which Greece owed money.  It was, in effect, a European Union subsidy to European Union bankers.  The latter were – and are – ‘in bed’ with Europe’s politicians, who will do whatever it takes to bail out those who bribe them ‘finance their (re-)election campaigns’.  That’s also why the Obama administration made sure its political cronies and allies – the UAW and other unions – got far more out of the bailout of GM and Chrysler than other investors and creditors.  The interests of the public at large, or of the nation as a whole in the medium to long term, are seldom a factor of importance when such decisions are made.

* * * * *

I don’t know exactly how the present mess will look in a few months’ time, once more financial and economic dominoes have fallen;  but I’m sure it won’t be pretty.   It’s possible that massive government intervention will be able to keep the lid on the boiling economic pot, but in my opinion it’s more likely that the pressure has already built up to such an extent that the lid’s going to get blown off, no matter what anyone does.

Two commentators have provided what I consider to be ‘worst-case scenarios’ in the past couple of days.  In order to demonstrate how bad things might get (although they aren’t guaranteed to become that bad), I’ll cite them both at length.  This is what we may be facing in the short to medium term.

A.  Zero Hedge:  Systemic Risk: Why This Time IS Different and the Central Banks Won’t Be Able to Stop the Crisis

Europe will collapse before the end of the year and very likely before the end of the summer. When this Crisis hits it will be worse than 2008. And the world Central Banks will not be able to control the damage.

. . .

  • According to the IMF, European banks as a whole are leveraged at 26 to 1 (this data point is based on reported loans… the real leverage levels are likely much, much higher.) These are at Lehman Brothers leverage levels.
  • The European Banking system is over $46 trillion in size (nearly 3X total EU GDP).
  • The European Central Bank’s (ECB) balance sheet is now nearly $4 trillion in size (larger than Germany’s economy and roughly 1/3 the size of the ENTIRE EU’s GDP). Aside from the inflationary and systemic risks this poses (the ECB is now leveraged at over 36 to 1).
  • Over a quarter of the ECB’s balance sheet is PIIGS debt which the ECB will dump any and all losses from onto national Central Banks (read: Germany)

So we’re talking about a banking system that is nearly four times that of the US ($46 trillion vs. $12 trillion) with at least twice the amount of leverage (26 to 1 for the EU vs. 13 to 1 for the US), and a Central Bank that has stuffed its balance sheet with loads of garbage debts, giving it a leverage level of 36 to 1.

And all of this is occurring in a region of 17 different countries none of which have a great history of getting along… at a time when old political tensions are rapidly heating up.

As bad as the above points may be, they don’t even come close to describing the REAL situation in Europe. Case in point, regarding leverage levels, PIMCO’s Co-CIO Mohammad El-Erian (one of the most connected insiders in the financial elite) recently noted that French banks (not Greece or Spain) currently have 1-1.5% capital relative to their assets, putting them at leverage levels of nearly 100-to-1.

And that’s France we’re talking about: one of the alleged key backstops for the EU as a whole.

To be clear, the Fed, indeed, Global Central Banks in general, have never had to deal with a problem the size of the coming EU’s Banking Crisis. There are already signs that bank runs are in progress in the PIIGS and now spreading to France (see El-Erian’s comments in the article above).

I want to stress all of these facts because I am often labeled as being just “doom and gloom” all the time. But I am not in fact doom and gloom. I am a realist. And EU is a colossal mess beyond the scope of anyone’s imagination. The World’s Central Banks cannot possibly hope to contain it. They literally have one of two choices:

  • Monetize everything (hyperinflation)
  • Allow the defaults and collapse to happen (mega-deflation)

. . .

In simple terms, this time around, when Europe goes down (and it will) it’s going to be bigger than anything we’ve seen in our lifetimes. And this time around, the world Central Banks are already leveraged to the hilt having spent virtually all of their dry powder propping up the markets for the last four years.

There’s more at the link.

That last paragraph is important.  The world’s central banks (including the Federal Reserve) have engaged in quantitative easing programs until the world was awash in freshly-printed money.  All they’ve succeeded in doing is postponing the inevitable reckoning.  When the chickens finally come home to roost, those central banks will have almost nothing left in their financial arsenals to deal with the situation.  They’ve already used almost every ‘weapon’ at their disposal.

B.  Business Insider:  Raoul Pal calls the present situation ‘The End Game‘.

The world has no engine of growth with most of the G20 countries approaching stall speed at the same time.

. . .

The problem is down to one thing:


The ten largest debtor nations on earth have total debts of over 300% of World GDP.

. . .

We don’t know exactly what is to come, but we can all join the very few dots from where we are now, to the collapse of the first major bank …

With very limited room for government bailouts, we can very easily join the next dots from the first bank closure to the collapse of the whole European banking system, and then to the bankruptcy of the governments themselves.

There are almost no brakes in the system to stop this, and almost no one realises the seriousness of the situation.

The problem is not Government debt per se.  The real problem is that the $70 trillion in G10 debt is the collateral for $700 trillion in derivatives

Yes, that equates to 1200% of Global GDP and it rests on very, very weak foundations.

From an EU crisis, we only have to join one dot for a UK crisis of equal magnitude.

And then do you think Japan and China would not be next?

And then do you think the US would survive unscathed?

This is the end of the fractional reserve banking system and of fiat money.

It is the big RESET.

From a timing perspective, I think 2012 and 2013 will usher in the end.

You have to understand that a global banking collapse and massive defaults would bring about the biggest economic shock the world has ever seen.

There would be no trade finance, no shipping finance, no finance for farmers, no leasing, no bond market, no nothing …

The markets are at the frankly terrifying point of realising that LTRO, EFSF, QE etc are not going to prevent this collapse.

The next phase as Spain and Italy go, will be to see nationalisation of banks and the assumption of the bank debts on Government balance sheets.

Then expect to be shut out of financial markets …

. . .

I wish I could see another outcome with an equally high probability, but I can’t …

Again, more at the link.  Bold print is my emphasis.

As I said earlier, those two are ‘worst-case scenarios’.  I hope and pray things won’t get that bad . . . but in the light of the present mess, as outlined in preceding articles above, I can’t be sure of that.  No-one can.

What to do?  As far as financial and economic preparations are concerned, the inimitable Karl Denninger posted ‘Ten Things You Must Do‘ in 2010, and updated the list in 2011 and again today.  I recommend reading all three articles, and then acting in accordance with his advice (not all of which will be applicable to everyone).  In the coming elections, I also recommend voting against any politician who’s voted to get us into this mess, or who fails to demonstrate both an understanding of it and a willingness to work to solve our economic problems!



  1. I still basically don't understand any of this at all. How can there even be that much debt? And as long as the businesses involved are still making product and providing service, how are they unable to maintain the status quo?

    Or is the problem mostly due to many of these very rich people having most of their wealth actually just be virtual, theoretical wealth tied up in investments that have a supposed value that doesn't match reality, and they're going to be pissed when it turns out that they made bad investments?

    I dunno. I just can't wrap my head around it. People want stuff, the companies that make stuff want to sell it… it just seems like the pressure to trade should keep things moving. Maybe this is chauvinism borne of a life spent entirely in the United States, where the money system has been, if not rock steady, at least pretty close to unassailable, at least in my lifetime.

  2. @Perlhaqr: I've had a couple of e-mails asking basically the same question. I'll respond to it in a separate blog post tonight – perhaps two or three of them, spread over a few days.

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