Article / 04 September 2015 at 13:19 GMT

Macro Digest: The end of global recycling

Chief Economist & CIO / Saxo Bank
Denmark
  • Central banks manufacturing money at breakneck pace
  • The world and its governments are up their necks in debt
  • Only productivity and education can get us out of this negative circle
Capture
 The fashion of our times – central banks printing and printing. Photo: iStock

By Steen Jakobsen

Today I'll follow up on my theory that  the US dollar is leading all cycles. Many people have objected to this idea on Twitter and understandably so – grasping the rationale behind the theory requires a sound knowledge of economic principles and this is something that a generation of day traders has happily ignored since the Great Financial Crisis.

When productivity is collapsing as it is (it's been flat for both 2013 and 2014) the only way to keep the massive debt financed is through lower yields or expansion of the monetary base.

productivity
 
According to a McKinsey report the net new debt issued since GFC is $57 trillion:
debt
 Source: McKinsey

The US dollar-based/linked economy – where the path of least resistance remains a weaker USD:
Black Box

 
So, the world is issuing more and more debt at lower and lower yields in order to pretend-and-extend. This worked until the dollar – the currency denominator – got too strong and recycling stopped:

Here are the new charts:

This is Global Reserves (YoY%) vs. S&P-500 (YoY%). World reserves have dropped close to 5% - (5% less recycling) :
global reserves
Source: Bloomberg, Saxo Bank 

Meanwhile the day traders believe more quantitative easing as promised by European Central Bank chief Mario Draghi yesterday will help and save the day. But, but. but.....
Pretend-and-extend to infinity => stronger USD = lower commodity prices = less recycling = higher marginal cost of capital = lower EM growth = less export and more deflation? If you don’t believe this then take a look at these indicators since the US started QE!
That’s the theoretical argument, which few of you accept, or rather like.. but here are facts:
Central banks’ balance expansion including Japan and the  ECB is flat YoY and both the BoJ and the ECB are expected to undertake more QE later this year.
 
total cb assets assets
 
Conclusion: 
The micro structure of capital markets has changed – forever – the combined lower energy prices plus the China slowdown + lack of productivity + pretend-and-extend + QE and strong USD has forced the market into higher volatility, less leverage, USD-dependence and lower growth because capital consumption is tax on future growth. 

It’s time to get a new playbook which is more flexible, accepts two way directions and a move towards investment in productivity and education, the only two things which can break the negative circle.
Safe travels.

– Edited by Clare MacCarthy

 

Steen Jakobsen is chief economist and CIO at Saxo Bank

3y
Sam Me Sam Me
How shall more QE work??? We are in a "correcting" market and everybody is moving into gov. bonds. So there won't be so much debt left to be monetised by ECB and BOJ. Nobody will be selling "secure" gov bonds in exchange for tumbling stocks. Currently it is just the question if the "119" will hold, otherwise we move to "107" and a lot of carry trades will unwind.
3y
gizmo gizmo
Thx for the post its intresting lets wait day after 17th ti see where the wind will blow ......
3y
Legendoski Legendoski
Nice analysis
3y
Balmeric Balmeric
It seems Mr Jacobsen has caught up with the Radical Left, who knew something was wrong, but couldn't quite put it like he does!

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