Here’s another speculative question that maybe no one on the planet can answer:
I’ve read that there are trillions of dollars worth of derivatives and credit swaps that are expected to explode the economy in some really horrific ways. How would that whole scenario play out in a deflationary economy?
In a deflationary cycle, particularly where there is asset price deflation, derivatives necessarily will lose value. As synthetic assets predicated on the values of other securitized assets, the loss of value on the underlying assets cannot help but transmit that loss of value into the derivatives markets.
We saw a microcosm of this when the 2003-2007 housing bubble burst sparking the GFC: as home prices fell and mortgages became unaffordable, the value of the securitized mortgages underneath the ginormous amount of derivatives generated by Wall Street collapsed, and took the derivatives with them. The resulting margin calls and liquidity crises destroyed first Bear Stearns then Lehman Brothers.
With a notional aggregate value of all derivatives on all financial markets around the world estimated to be in excess of a quadrillion dollars (no that is not a typo), a period of prolonged deflation is almost mathematically guaranteed to create fresh liquidity crises and rapid unwinding of derivatives positions at steep losses.
When the GFC hit, and news pundits were compelled to explain what happened, I remember that I was shocked to hear about collateralized debt obligations- because I was hearing of their existence for the first time! “CDOs! Why haven’t I ever heard of them before, and WHAT ELSE DON’T I KNOW ABOUT?”
I hope you will help keep us informed, Mr. Kust, of the financial shenanigans before they happen. Thank you!
That being said, I still encourage everyone to do as much of their own reading and research as possible--there's not a snowball's chance in Hell I am going to capture every crucial detail or even most of them.
Isn’t this at least partially related to the cheap money-created and Covid-worsened banking and interest rate crisis? The global economy was flooded with Covid relief dollars printed out of thin air and we are paying for it now with high prices . Totally predictable.
However, the origins of China's malaise predate COVID by decades in some respects. The One Child Policy which has destroyed China's demographics is from 1979. China's real estate bubble was a response to weaknesses in their export-oriented economy during the 2010s: Beijing and local governments responded by boosting revenues via land sales to developers, while easing credit conditions so they could develop said land.
China's export-oriented economy began deteriorating in the 2010s not just because of the global financial crisis, but because in that same time frame China reached the "Lewis Turning Point", that point in a developing economy where all surplus rural labor has been absorbed, and from which point manufacturing wages are forced to rise due to labor scarcity.
Interesting, thanks for the information . Communism and capitalism don’t go together . I foresee continuing difficult times ahead for the average worker as the global economy adjusts to new conditions from inflation, crash in commercial real estate due to the remote workforce , aging population, declining birth rate, culture wars, and artificial intelligence . The investor class will prosper. Government and taxes will grow. Do you have any predictions ?
Not specific ones. Global deflationary events are truly a "one in a century" phenomenon. It's been nearly a full century since the onset of the Great Depression, and the Long Recession of the 1870s was a full half century before that. These things just don't happen as often as regular recessions and inflation episodes do.
There is also the additional issue of demographic collapse in China and Russia particularly. China ran out of children some 20 years ago and is now running out of young workers (and the ones they have are increasingly choosing to "lie flat", according to some accounts). Russia is already at a point where has to choose between putting its young men to work and sending its young men to war.
These demographic crises (and similar crises in countries such as Germany) coupled with economic stress could quite easily precipitate a political crisis in those nations. The CCP could be facing an internal rebellion if can't make good on its post-Tienanmen Square promise to the Chinese people to keep them pacified while under totalitarianism. Putin potentially could have to stave off multiple coup attempts if his war in Ukraine goes seriously south on him
If the regimes in these countries fall, I'm not sure anyone can accurately assess what comes after. If things deteriorate sufficiently in China especially, we are looking at a geopolitical singularity with no real clue what lies on the other side.
You always include so much current, hard, factual data in your Substack that it makes the main-stream media look pathetic. I like to speculate and extrapolate (it’s a sickness, I know). So, even though I realize that this would be uncharted territory, I’d love to hear your opinion:
If China goes into a long deflationary period, would that increase the likelihood of the U.S. economy also becoming deflationary? If so, how quickly would it likely occur, and would the severity also be increased? Or maybe China collapsing would be to our economic advantage in some ways (market share, brain drain to the US, stimulus for us to innovate, etc.). During the Great Depression, when our economy tanked, so did much of the rest of the world’s. But that era had some different financial fundamentals, and so I have no idea how things would play out now. Would one major country’s deflation lead to other countries going into deflation?
My suspicion is that the global economy as a whole is already sliding into a deflationary period that could prove to be distressingly long. I do not believe it is an "if" or even a "when", but rather a "now".
For obvious reasons, I will not be disappointed to be proven wrong by subsequent events!
Both during the Great Depression of the 1930s and the Long Depression of the 1870s, deflationary impulses were transmitted globally. As we saw with the serial liquidity crises during the Great Financial Crisis of 2007-2009, contagion is a real phenomenon. I believe current global conditions reflect a contagion effect by which deflation is being transmitted once again globally , even though we have not had a seismic event (yet) in financial markets to put a marker on the beginning of the contraction.
Here’s another speculative question that maybe no one on the planet can answer:
I’ve read that there are trillions of dollars worth of derivatives and credit swaps that are expected to explode the economy in some really horrific ways. How would that whole scenario play out in a deflationary economy?
In a word: badly.
I've explored the surface of this issue somewhat already.
https://newsletter.allfactsmatter.us/p/powells-paradox-curing-inflation
In a deflationary cycle, particularly where there is asset price deflation, derivatives necessarily will lose value. As synthetic assets predicated on the values of other securitized assets, the loss of value on the underlying assets cannot help but transmit that loss of value into the derivatives markets.
We saw a microcosm of this when the 2003-2007 housing bubble burst sparking the GFC: as home prices fell and mortgages became unaffordable, the value of the securitized mortgages underneath the ginormous amount of derivatives generated by Wall Street collapsed, and took the derivatives with them. The resulting margin calls and liquidity crises destroyed first Bear Stearns then Lehman Brothers.
With a notional aggregate value of all derivatives on all financial markets around the world estimated to be in excess of a quadrillion dollars (no that is not a typo), a period of prolonged deflation is almost mathematically guaranteed to create fresh liquidity crises and rapid unwinding of derivatives positions at steep losses.
If that happens, it will not be a pretty sight.
News like a punch to my gut.
But jeez, you’re smart and knowledgeable! Thanks!
When it comes to the economy, it seems my fate is to be Cassandra warning against the treachery of the Greeks!
When the GFC hit, and news pundits were compelled to explain what happened, I remember that I was shocked to hear about collateralized debt obligations- because I was hearing of their existence for the first time! “CDOs! Why haven’t I ever heard of them before, and WHAT ELSE DON’T I KNOW ABOUT?”
I hope you will help keep us informed, Mr. Kust, of the financial shenanigans before they happen. Thank you!
I mean to publish all the information I can.
That being said, I still encourage everyone to do as much of their own reading and research as possible--there's not a snowball's chance in Hell I am going to capture every crucial detail or even most of them.
"When everything is heading south there can be no thought of economic recovery by definition."
You just keep handing us quotes like this we can use.
Fantastic work!
Edwin
Thanks! I haz mad skillz sometimes! :D
Isn’t this at least partially related to the cheap money-created and Covid-worsened banking and interest rate crisis? The global economy was flooded with Covid relief dollars printed out of thin air and we are paying for it now with high prices . Totally predictable.
It's fair to say the two crises are intertwined.
However, the origins of China's malaise predate COVID by decades in some respects. The One Child Policy which has destroyed China's demographics is from 1979. China's real estate bubble was a response to weaknesses in their export-oriented economy during the 2010s: Beijing and local governments responded by boosting revenues via land sales to developers, while easing credit conditions so they could develop said land.
China's export-oriented economy began deteriorating in the 2010s not just because of the global financial crisis, but because in that same time frame China reached the "Lewis Turning Point", that point in a developing economy where all surplus rural labor has been absorbed, and from which point manufacturing wages are forced to rise due to labor scarcity.
https://ebrary.ifpri.org/utils/getfile/collection/p15738coll2/id/1737/filename/1738.pdf
China's situation certainly has not been helped by the COVID lunacies, nor its own lockdown "Zero COVID" policies.
https://newsletter.allfactsmatter.us/p/xi-jinping-leading-china-over-a-zero
Still, with China moreso than with the rest of the globe, their current economic ills have far deeper roots than COVID and the ensuing Pandemic Panic.
Interesting, thanks for the information . Communism and capitalism don’t go together . I foresee continuing difficult times ahead for the average worker as the global economy adjusts to new conditions from inflation, crash in commercial real estate due to the remote workforce , aging population, declining birth rate, culture wars, and artificial intelligence . The investor class will prosper. Government and taxes will grow. Do you have any predictions ?
Not specific ones. Global deflationary events are truly a "one in a century" phenomenon. It's been nearly a full century since the onset of the Great Depression, and the Long Recession of the 1870s was a full half century before that. These things just don't happen as often as regular recessions and inflation episodes do.
There is also the additional issue of demographic collapse in China and Russia particularly. China ran out of children some 20 years ago and is now running out of young workers (and the ones they have are increasingly choosing to "lie flat", according to some accounts). Russia is already at a point where has to choose between putting its young men to work and sending its young men to war.
These demographic crises (and similar crises in countries such as Germany) coupled with economic stress could quite easily precipitate a political crisis in those nations. The CCP could be facing an internal rebellion if can't make good on its post-Tienanmen Square promise to the Chinese people to keep them pacified while under totalitarianism. Putin potentially could have to stave off multiple coup attempts if his war in Ukraine goes seriously south on him
If the regimes in these countries fall, I'm not sure anyone can accurately assess what comes after. If things deteriorate sufficiently in China especially, we are looking at a geopolitical singularity with no real clue what lies on the other side.
You always include so much current, hard, factual data in your Substack that it makes the main-stream media look pathetic. I like to speculate and extrapolate (it’s a sickness, I know). So, even though I realize that this would be uncharted territory, I’d love to hear your opinion:
If China goes into a long deflationary period, would that increase the likelihood of the U.S. economy also becoming deflationary? If so, how quickly would it likely occur, and would the severity also be increased? Or maybe China collapsing would be to our economic advantage in some ways (market share, brain drain to the US, stimulus for us to innovate, etc.). During the Great Depression, when our economy tanked, so did much of the rest of the world’s. But that era had some different financial fundamentals, and so I have no idea how things would play out now. Would one major country’s deflation lead to other countries going into deflation?
My suspicion is that the global economy as a whole is already sliding into a deflationary period that could prove to be distressingly long. I do not believe it is an "if" or even a "when", but rather a "now".
For obvious reasons, I will not be disappointed to be proven wrong by subsequent events!
Both during the Great Depression of the 1930s and the Long Depression of the 1870s, deflationary impulses were transmitted globally. As we saw with the serial liquidity crises during the Great Financial Crisis of 2007-2009, contagion is a real phenomenon. I believe current global conditions reflect a contagion effect by which deflation is being transmitted once again globally , even though we have not had a seismic event (yet) in financial markets to put a marker on the beginning of the contraction.
“Now” = wow. I literally got a chill down my back!