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lunes, 16 de mayo de 2022

Dimitry Orlov: Financial Collapse, May 2022 Update

1. Crypto and other garbage

Let's start with the truly ridiculous and work our way out. At its height, the cryptocurrency bubble was capitalized at almost $3 trillion. Yesterday it stood at $1.17. Between $110 and $160 billion is leaking out of it daily. Over the past few weeks cryptocurrencies lost between 30 and 99% of their value. The only reason for the recent blossoming of this crypto-idiocy was excess liquidity that resulted from insane fiscal and monetary policies of the US, the EU and the rest of the collective West. It resulted in a loss of faith in fiat currencies and prompted a search for a financial surrogate. When liquidity was spurting out of every nook and cranny, all sorts of contrived mechanisms were need to soak up this impulse of monetary madness. Cryptocurrencies were one of these mechanisms: their fundamental value is precisely zero, yet they prompted the creation of entire analytical centers within investment banks charged with seeking out the best and the most brightest among virtual coins, looking for a kernel of rational sense where none can possibly exist. All of this hastily chewed together digital garbage can only serve a function while a wave of hype and insanity is cresting and investors' brains are in stand-by mode, allowing them to invest in areas where value is nonexistent by definition. That wave of hype and insanity was laden with all sorts of other garbage: Tesla, Netflix, Reddit and other companies that have nothing and produce nothing of consequence were thought to be worth the same as entire industries with multibillion dollar cash flows. And now that's all over. Stricter monetary policy and the forced redirection of financial flows into credit markets all of this bubbly trash, whether actions with 1000 price-to-earnings ratios or crypto-garbage, is getting multiplied by its actual value, which is zero.

2. The US Dollar is Undead

The USD is quickly rising against other world currencies, the Russian Ruble being the stark exception. DXY rose to its highest level in the last 20 years (November 2002 was the last time time DXY stood at 105). The Yen recently dropped through 130—its lowest point since April of 2002. The Euro is heading toward parity with the USD, the Pound is approaching its minimum since 1985. But this is purely a technical issue; it is not as if the USD suddenly became a bastion currency that everyone desires because to do so is correct, modern and fashionable. 

First, the Fed is tightening faster than the rest of the gang (by raising rates and by planning to shrink its balance sheet). Ceteris paribus, that causes financial flows to head toward the dollar zone. Second is a purely technical issue: much of the global debt is denominated in USD and in the midst of a crisis (be it financial, economic or political) there is an inevitable fight to USD simply to continue to service the debt at higher rates of interest. (This trend will, by itself, in due course force various countries into default.) Thus, the growth in DXY is itself a symptom of a crisis and not at all something to celebrate. To get back to reality, compare the USD to RUB which, at 65.5/$, is now the world's strongest currency. The reason for this is that it is not denominated in any sort of financial trash but in oil, natural gas, aluminum, nickel, gold (physical, not manipulated paper gold backed by nothing), coal, fertilizer, grain, enriched uranium and other commodities. Their economic value (in terms of the benefit to society that can be obtained from their use) has remained unchanged (there have been no giant technological breakthroughs lately) but their price in USD and other currencies gone up by leaps and bounds. Their value has not gone up; therefore, it is USD and other currencies have been dropping in value.

3. The US stock market: down, down, down we go!

This is the biggest bubble-bursting episode in the history of mankind. The US stock market has experienced other such episodes (1929 and 2001) but there has been nothing like the bubble of 2021. It is 28% larger than the bubble of 2001. What is happening now is a partial normalization (around 20% off peak): according to the bubble 2001, where excess valuation was 90-100% above the historical average, it is now 70-80%. This may seem reasonable given the current levels of corporate profits and monetary policy, but in medium-term and long-term the situation is bound to worsen significantly. All of these insane valuations only made sense in the context of monetary insanity—significantly negative real interest rates and limitless dollar emission by the Fed. In this context, valuations can be pretty much anything—determined by a combination of mindlessness, irresponsibility and greed. But times are changing and there is a new smell in the air: the smell of roasting buttocks of financial officials. Panic is setting in and they are attempting to normalize monetary policy at a breakneck pace. This attempt is sure to be short-lived and will be over before it has a chance to begin. That is, they won't be able to carry out the normalization, and this will destabilize the markets and worsen the imbalances within the system even more. According to the Fed's latest pronouncements, it plans to take a few stops and then see what happens to the economy and to inflation. Thus, as soon as their pain threshold is exceeded (which has to do with the stock market) the Fed will slam into reverse. This is what it always does. And that means that the breakdown of the dollar system will proceed along the worst possible trajectory. Interest rates will go up regardless because deficits are not going away and will need to be financed. This will force overly indebted zombie companies into bankruptcy and erase corporate profits for the rest because for the past 12 years they have only known how to be profitable in a zero or negative interest rate environment. To stabilize the credit markets, it will be necessary to provoke an outflow of capital from the stock market. If the Fed stops propping up the stock market (or loses the ability to do so), the credit markets will take priority and the pressure on the stock markets will only grow. To finance the deficits, more borrowing will be needed. Previously, the deficits were financed by the Fed and by foreigners, but the Fed is heading for the door while the foreigners are stuck with higher interest rates, dropping currencies and higher energy and materials costs and aren't about to finance much of anything. Does this mean that the US government will be forced to (gasp!) drastically cut spending? Yes, it does indeed! And that is the optimistic scenario; the pessimistic is—What spending?

4. The US can't compete

The competitiveness of US businesses was underpinned by low energy costs (oil, gas, electricity, social spending). But now the cost of energy is rising, reducing profit margins by 2% or so. Meanwhile, labor costs will rise continuously as the labor force degrades (well beyond the over 100 million working-age Americans currently "not in labor force"), placing additional pressure on corporate profit margins. So will the factor of collapsing globalization and loss of access to export markets given the insane foreign policies of the US government which are alienating well over half the planet. But this is a topic for a separate discussion. Back in December 2021 everyone's forecasts were based on record-low taxes, zero interest rates, endless qualitative easing, low labor costs and low energy costs. Throw those forecasts out! This year is different: various bubbles are bursting, the Fed is canceling QE and threatening to shrink its balance sheet, appetites for risk are shrinking rapidly. A new reality is setting in: interest rates are heading higher, taxes are bound to rise, as are operating costs (materials, energy and labor). Corporate margins are headed to zero. Short-term, some bounce-back can be expected after drops of 20% or more; longer-term, there is no lower limit. Do what you can, then concentrate on what's important: hilling potatoes, chopping firewood and stocking up on vodka because is going to be that kind of year.

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