15 March 2009

Perfect Storm for a Balance of Payments Crisis?

As argued in “Road to Ruin: Final stretch” the US is vulnerable to a balance of payments crisis. The cause of that crisis is the convergence of four main crisis events, and we are ready to say that these may occur within the next three quarters:
Epiphany that tax receipts will be dramatically lower than current estimates and expectations, creating a fiscal deficit shock (Timing: Late April or early May?)
Epiphany that demands on the Federal budget are higher than currently expected due to extension of lender of last resort operations to finance current credit market challenges and the inclusion of new rescue operations, such as to support credit card and insurance companies, and a series of funding crises, such as public pensions, and state and local government budget shortfalls. (Timing: Ongoing)
Supply crash meets money supply boom, resulting in rising inflation. All across the supply chain, from raw to finished goods, supply is falling. Starting with raw materials, it is easy to forget that mining is a capital-intensive process, and without credit production has slowed dramatically. Without trade credit shipping and trade have slowed dramatically. In terms of finished goods, the retail trade industry is contracting quickly. Much as occurred starting in 1975, government efforts to reflate the economy by increasing the money supply ran head long into a collapse in goods supply. Looking at trends in goods supply and money supply, a rise in inflation starting with consumer prices may have already begun. (Timing: Q4 2009 or Q1 2010?)
Epiphany that China will as its economy contracts not be able to afford to continue to purchase US Treasury bonds despite the virtually guaranteed result, a collapse in US export demand and value of dollar denominated reserve assets. The situation will be similar to that which the US and UK found themselves in 1930, unable to continue to make payments that maintained capital inflows that the German economy depended on to finance its fiscal and current account imbalances: the German economy collapsed in a Sudden Stop event in 1931. The timing of this event is very difficult because it is political; at what point does the cost of buying Treasuries outweigh the cost of not buying them? (See Economic M.A.D.) Long before the now common warnings from China are acted on, we should see some early signs [See: Headed for a Sudden Stop). One of those signs will be investors hiding out in dollar inflation hedges like commodities and precious metals, and we take the coincidence of falling Treasury yields and rising gold prices as a sign that some investors are preparing for a Sudden Stop event. (Timing: Q3 or Q4 2009?)
The near convergence of these events means they may occur either in sequence or more or less at the same time. For example, if clear evidence of inflation arises soon, that will cause Treasury prices to fall, and in fact may be causing them to do so already. The most likely trigger is a Tax Receipt Epiphany that leads to a Fiscal Deficit Shock and sudden loss of confidence in US sovereign credit quality.

The result in the fabled “Poom” of iTulip’s 1999 Ka-Poom Theory, a theory of the final stage of the disinflation and reflation process of the asset price inflation cycles that began in the early 1980s, began to end in early 2008 with the onset of debt deflation.


1 comment:

Patrick said...

I have a similar prospectus, but with a few twists. As far as I can tell nobody has accurately measured the entire global system in order to adequetely describe how much deleveraging is happening in order to further buoy the dollar. The IMF knows, but they ain't publishing, plus they wouldn't want to ruin their big 2.0 party when they turn into the global trade creditor, also known as a global central bank.

I bet Eastern Europe and hte ensueing dominos show will put this thing on one last leg. They everyone will rush into the dollar and then realize the ship is going down and panic. But it's too early to short the USDX. You should short that instead of t-bonds, because Fed easing will keep the prices inflated. In this manner the deflation will transmute into inflation, and the next episode begins.