Danger Signals: Economic & Political Outlook (2015) , by Al Martin

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by Al Martin

Danger Signals: Economic & Political Outlook (2015)

(1-8-15) In a recent interview, Bloomberg pundit Marc Faber says we’re in for a year of volatility in the markets and he’s not making any predictions. And that’s what everyone’s saying because it comes down to the same old battle and that is – can the United States be an island of prosperity in a growing tide of foreign red ink? Last year in 2014, the United States remained the only island of prosperity. The question then is – can the United States continue to be that island of prosperity in 2015?

And the answer to that is real easy – No. Why? Because it can’t be the island of prosperity endlessly – although it can be for a year or so. Anything more than that and the rest of the world’s problems begins to weigh on us. The fact is that the rest of the world’s economic problems are driving the dollar higher. The dollar is losing the race to the bottom and that is clearly hurting US exports as we’ve seen in the declining manufacturing numbers in November and will get again in December.

So what can we expect regarding commodities, bonds and equities? Commodities will continue to decline as global deflation continues to build and the US dollar continues to rally. The planet’s principal commodity-producing economies continue to get squeezed because they have to produce more commodities.

This then is a perfect storm that commodities run into at the end of a so-called super-cycle. This is the storm that ends commodity super-cycles. Global deflation, a rallying dollar and emerging market countries who are the principal producers of commodities, i.e. third world nation-states, despite declining prices, simply have to produce more of them because it represents the bulk of the revenue for their economies.

We’ve been in a commodity super-cycle now for the last 10 years or so and it’s coming to an end because its run into the 3 things that have always caused the end of secular bull runs in commodities in the past. A super cycle is when you get enough inflation combined with lower interest rates which are friendly to dollars combined with enough monetary stimulus which is negative to the dollar wherein you get the perfect storm to push commodity prices higher. Now all that is being unwound.

Long bonds, meaning 30-year US Treasuries, are being pushed higher which is an indicator for equities not only in the United States but globally. We are now beginning a cycle wherein foreign retail investors want to own long-dated US Treasuries because they’re buying something that’s denominated in a currency that’s rising in value against their own, that pays a coupon in a currency that is rising against their own and they’re getting to buy that long bond at a yield that’s still 1% or more above the equivalent of their bonds issued by their own countries.

The situation with equities however is changing. You see that the first 5 days of January which has been technically a solid indicator has not worked and that’s because there has been a shift. You are seeing liquidation of equities now in the first week of January which is very unusual. Institutional holders of equities are holding on. Joe Six Packs are the ones who are selling across the world. Why? Because there is one fact that you can’t get around and it upsets all other technical indicators and that is that 2014 was the sixth consecutive year of advancing US equities according to the NYSE composite index. That is the most that equities have ever advanced at one tine in the history of the country. They’re getting out after a big run because people thought that when the S&P; 500 got up in the 2080’s and the shills sold the story that it would come up to 2120 or 2130 in January. However when the first of January came and the next trading day of January (Monday January 5) came and that didn’t happen, some people started to sell. That’s the so-called First 5 Days of January Effect. People know that historically it’s been one of the most solid technical indicators. When that doesn’t work, then you get people retail selling, in other words. And that’s what has happened with equities.

Regarding politics, especially the Greek situation -- that will all play out by the end of January. This is another factor that has been roiling the markets. Will Greece stay or will Greece leave the Euro and return to their previous currency the drachma? This has been exerting downward pressure on the equities and upward pressure on 30 year US Treasuries. The markets are also concerned about the prospects of a far-left government potentially coming into power in Greece, which is just the old repackaged Greek Communist party under a different name. This combined with the news this last weekend – the article in Der Spiegel -- that Germany and Prime Minister Andrea Merkel has done a complete 180 degree turn. The change is that Germany is now prepared to let the Greeks out of the European Union. Why did they change their mind? Part of it was to exert pressure on the other European countries, particularly France and the Netherlands, to grant more generous terms to the Greeks in order to keep them in. This was a very adroit political move by Merkel since the ECB has now extended 373 billion Euros to Greece. The German portion of that – the German economy can handle -- if Germany has to write that off. However no other nation-state in the European Union can make that claim. So she’s in a stronger position to run this gambit of a supposed 180 degree turn and just roll the dice. That’s what she’s doing.

Thus Merkel is doing it to pressure ECB chief Mario Draghi – and particularly France and the Netherlands – into extending easier credit terms to Greece since none of the money is ever going to get repaid anyway. So why not extend them easier terms and try to keep them in? That way if the Communists do come back into power in Greece and they’re running on a platform of we’re just going to pack it in, pull out of the EU and default on their debt and go back to the drachma – and drive Greece into the dirt again which is what effectively they would do. With what Merkel is doing the Communists could claim a political victory by saying that by coming to power they forced the European Union to give Greece more favorable terms. The very threat of the Communist Party coming to power was enough to make the Germans do a 180 and make the ECB and the independent states extend a larger line of credit to Greece.

Greece is a gamble and it might not play out the way Merkel thinks it’s going to. The Communist Party could come into power and they could say we’re going to back out no matter how generous the terms are in which case you get the potential domino effect which is the real risk in the Merkel strategy, wherein the other peripheral EU countries like Portugal and Ireland say – we have nothing more to lose and we won’t be able to pay the money back anyway so why not? This domino effect would extend into all the eastern European states and essentially the European Union would unravel.

And what would be the consequences of the European Union falling apart? What would happen to the ECB debt, which all the member-states are responsible if it becomes worthless? Nobody knows. You hear economists and historians talk about this – does it become another 1955 situation where Germany simply wrote off all of their war debt and all of their remaining debt when they came out of the Marshall Plan.

What if the European nation-states simply wrote off all of their ECB-created debt, they are responsible for? It’s unlikely. They don’t have the economic resources to do it and their economies can not generate the fiscal surpluses necessary to write off the debt. The inherent problem with Social Welfarism is that it provides no mechanism to ever pay down state debt.

If the individual nation states default on their debt to the ECB, this makes all ECB guarantees of which there are trillions of dollars outstanding to European corporations and all of the collateral swap agreements they have with all of the other central banks on the planet – that would all start to unravel. And that is a real threat to the planet’s economy.

The worst case scenario is that it would create a domino effect culminating in collapse. That would be the 1928 scenario all over again – that Europe creates the domino effect.

Everything collapses not only because everything is so interlinked but because all of the other principal nation-states have record debt levels and record debt to GDP levels at the same time. If the ECB unravels on a planet that is already teetering, then it all falls down.

The second biggest threat is what Russia’s Vladimir Putin does because you have the perfect storm setup again in Russia like you had in 1997 when Vladimir Putin defaulted on Russian Sovereign debt. It’s the same setup now. You have a naïve liberal government in the United States combined with naïve left-wing regime throughout Europe as well as Japan and most of the rest of the planet that start to squeeze Russia somehow – this time being done by sanctions. Eventually what Uncle Vlad is going to do once all the friends of the Uncle Vlad Society have moved all of their money expatriated out of Russia. I think that’s the only thing he’s waiting for to issue his threat when he can say – Either lift the sanctions. Or Russia will default on its 678 billion US dollar foreign debt.

The reason that becomes ever more likely is for the same reason it actually happened in 1997 when you had all these liberal governments in power who are pandering to their constituencies.

So who are the primary holders of Russian sovereign debt? Everybody. It is widely held by hedge funds, foreign central banks as well as both European and US plain vanilla foreign bond mutual funds. The problem is that Russian sov debt is so widely held and that’s the other potential domino effect – besides the potential for the EU defaulting. The politics make it more likely since you have the regime in 1997 under Clinton and naïve left-wing regimes in Europe and Japan who are pandering to their constituencies. They don’t know the consequences of what they’re doing. They just want the political sanctions against Russia because they haven’t got the balls to use any type of military option.

In conclusion, there’s a few things to watch. If Chinese GDP continues to decline since the 7% GDP growth target has been abandoned, are they able to even hang on to 4-5% GDP target? China’s economy continues to contract and that is one of the big problems.

In Japan, can Prime Minister Abe launch the much-vaunted “third arrow” i.e. the reform portion of the program? If not, how much can the Bank of Japan apply enough quantitative easing to keep Japan afloat?

Also how many of the emerging (EMI) markets go into defaults like they’ve done before when the prices of oil and commodities fall? Certainly Venezuela would default. Also Argentina. How many other south-of-the-border countries are all going to start to default on their debt because of falling commodity prices?

Stay tuned…

* AL MARTIN is an independent economic-political analyst with 25 years of experience as a trader on NYMEX, CME, CBOT and CFTC. As a former contributor to the Presidential Council of Economic Advisors, Al Martin is considered to be a source of independent analysis for financially sophisticated and market savvy investors.

After working as a broker on Wall Street, Al Martin was involved in the so-called "Iran Contra" Affair as a fundraiser for the Bush Cabal from the covert side of government aka the US Shadow Government.

His memoir, "The Conspirators: Secrets of an Iran Contra Insider," (http://www.almartinraw.com) provides an unprecedented look at the frauds of the Bush Cabal during the Iran Contra era. His weekly column, "Behind the Scenes in the Beltway," is published weekly on Al Martin Raw.com, which also publishes a bimonthly newsletter called "Whistleblower Gazette."

Al Martin's new website "Insider Intelligence" (http://www.insiderintelligence.com) will provide a long term macro-view of world markets and how they are affected by backroom realpolitik.

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