#59. Storm Front – part 4 (of 3)


A long time ago, a certain rock band released an album titled Three of a Perfect Pair. I’ve never heard the album, but I now know the feeling – because here is Part 4 of the Storm Front trilogy.

To explain, I saw Storm Front as a three-part investigation. It would look at why there might be a financial crash in China; at what its broader implications might be; and at what reactions might be appropriate. Since then, readers have made some very important points; the broader debate is accelerating; and market indicators are making my timing look either good or fortuitous.

As we know, the Chinese stock market keeps trending down, even though the authorities have thrown at it, not only the kitchen sink, but the full might of Chinese law. In itself, this isn’t too important. China’s stock market is pretty modest in comparison with the economy and, in any case, the Index has only surrendered part of its earlier gains. Moreover, stock markets themselves are minnows in comparison with bond and forex markets, which is where the really big money is.

What, then, is the important story behind China’s stock market wobbles?

What’s the context?

Since you’ve probably read the previous instalments, here’s a very brief heads-up on the big issue. That issue is debt.

In the years before the 2008 crash, global borrowing (excluding the inter-bank sector) totalled $38 trillion, or $2.20 for each $1 of growth at that time. Since then, we’ve borrowed $49 trillion, or $2.90 for each growth dollar. Moreover, even that growth metric is highly debateable, since this “growth” was really nothing more than the spending of borrowed money.

In other words, far from learning from 2008, we’ve actually increased the rate at which we borrow. One reason for that is that the authorities responded to the banking crisis by making borrowing easier and cheaper. Another is that, aside from spending borrowed money, we seem to have lost the ability to grow the economy.

Where does China fit into this?

Back in 2008, the one bright spot in a pretty dark global economic picture was that China was growing very rapidly indeed. Some argued that a broader group of emerging economies – the BRIC countries – might take over from a debt-shackled West as the main driver of the global economy. Since then, two of the BRICs – Brazil and Russia – have fallen by the wayside, and opinions differ about India.

Until recently, though, China has lived up to its billing as a – indeed, the – global driver of growth. GDP has continued to power ahead. Foreign capital has poured into China, seeking better returns than can be earned in the West. China has sucked in vast amounts of commodities, and of industrial goods. In the space of just three years, China’s consumption of cement exceeded that of America in the whole of the twentieth century. Though China remains a net exporter, its imports have risen rapidly, so that China’s net trade surplus is down to barely 2% of GDP, down from 10% less than a decade ago.

Without all of this stimulus from China, it is debateable whether there would have been any growth at all in global GDP since 2008.

But the weaknesses in what China has been doing are now showing up. For a start, growth has fallen markedly. The Chinese authorities say that growth is now 7% – exactly where they said it would be – but hardly anyone now believes this. Volumetric measures, from vehicle sales to factory output, are dropping rapidly.

And the big snag, as ever, is debt. Since 2007, China’s GDP has grown by $5 trillion, but its debt has increased by $15 trillion, even when we exclude a big ($5 trillion) rise in financial sector indebtedness.

In other words, China since the crash has been doing what the West was doing before it – spending borrowed money and calling this growth. In a sense, this debt-funded growth is real – they’ve got the roads, the factories, the shopping centres and the homes to show for it – but, where such things are concerned, GDP only measures what has happened. It doesn’t tell us whether investment has been worthwhile or not.

What’s the problem?

In the years running up to 2008, real estate was the West’s “idiocy-of-choice”. We poured money into inflating the value of our housing stock, and did this in some very dangerous ways (such as lending to people who could never pay it back, or even keep up the payments after initial “teaser” rates had expired).

Though China, too, has inflated its property market, its main area of excess has been using debt to build capacity that nobody wants. Surplus capacity invariably drives prices down, which is why China’s important local government development vehicles are now earning a return of 2% on assets which cost 6% to service. The clear danger is that China’s debtors cannot keep up the payments on their loans, because surplus capacity has crushed the income on the assets they’ve created with that debt.

Reflecting this, capital is pouring out of China at a rapid and accelerating rate. Forward indicators (such as shipping rates) are pointing unmistakably to a severe economic downturn. That’s a problem for the ruling party, whose “grand bargain” with its people trades liberties for prosperity.

But it’s just as big a problem for the rest of the world. Worries about Greece fade into near irrelevance beside China, to which global banks’ exposure is about 17x greater. Thus, debt going bad in China could hit the global financial system just as the global economy loses its big driver.

Can we, or China, cope?

In short, no.

China’s government debt – about 50% of GDP – is pretty low, but then that was true of America, Britain and the rest before 2008. Government debt ratios tend to soar after a crisis, not before it. China has big reserves, but these consist largely of American government IOUs – so, even if these reserves help China, which is doubtful in itself, they won’t help the global financial system.

In 2008, we responded to a debt problem by borrowing still more. QE (“quantitative easing”) involved buying bonds using money newly created for the purpose. This drove bond prices up, and therefore pushed bond yields – the global market’s interest rate – downwards. This, together with near-zero official (“policy”) rates enabled borrowers to keep up the payments – but it also provided an incentive to borrow even more. This in turn pushed property and other prices up.

Is there a “keystone” problem here?

The really big problem is the disconnect between income on the one hand, and capital values on the other. For example, house prices have soared to very high multiples of average earnings. This has happened across the board, right the way from household debt ratios to the global relationship between GDP and debt. (It has also, by the way, widened the gap between the rich and everybody else, but that’s another issue).

This imbalance is not sustainable. It is the equivalent of an old lady with a big house but little income, who is “asset rich but cash poor”. Unlike that old lady, who could at least sell her big house, the global system has no such possibility. The only people we can sell our inflated assets to are ourselves.

What happens now?

The asset-income disconnect means that we have three options.

First, we could boost our income. Unfortunately, and apart from borrowing yet more, we don’t know how to do this.

Second, we could let asset values crash, but this would be disruptive, and extremely unpopular. Logic suggests that it has to happen, but it will be resisted by all means available.

Third, we could cheat, which means injecting more and more money into the system to keep it going. There are two problems with this. First, this would only buy time. Second, it risks destroying the trust without which “fiat” (mandated) money has no value.

The best guess has to be that policymakers and central banks will try the third option – tinkering – but that it won’t work. There has to be a likelihood that people won’t fall for this a second time.

And in the near-term?

China is the lynchpin, not just because of the sheer scale of its debt, but also because its growth has carried the global economy since 2008.

The likelihood now has to be that the deterioration, in China and elsewhere, will gather momentum. Already, there are reports that China has had to bail out some parts of its huge shadow-banking sector. The economic downturn, traceable in large part to unprofitable surplus capacity, seems likely to gather pace. Even for China, bail-outs might turn out to be like pouring ever more water into a leaky bucket.

These trends tend to have a momentum which gathers pace. Perfectly viable borrowers can become non-viable because of the failures of others by whom they are owed money. As somebody once said, when everyone starts running for the exit doors, those doors get smaller.

What this all means is that a crisis now increasingly seems likelier than not. Short of a crystal ball, it is impossible to know when this will happen. The coming autumn looks a possibility, but – based on the experience of 2007 and 2008 – there might a window of as much as a year before things go wrong.

At least, “forewarned is forearmed”.

67 thoughts on “#59. Storm Front – part 4 (of 3)

  1. This part 4 is the best of your 3 part article, Tim. I guess a summary helps us to envisage a super complex scenario that is the world economy, where ignorance and malfeasance is rife and misinformation the order of the day. Evolution suggests we have big brains in order to cope with deception, and here we see it in full flower!

    • When the world is about to collapse do you not think it is better than the masses are not informed of this, particularly given that there is no solution to this problem?

      Is it not better that they are told things will get better next quarter or next year?

      If the masses were told the truth, which is that we are out of cheap to extract energy and therefore civilization is about to collapse back into the stone ages how do you think they would react?

      The truth shall not set the masses free – all it will do is create panic and the collapse will start immediately.

      Better to kick the can as far as we can. Because when it runs out of road, billions die

    • That is what’s happening already. It’s the default position. Rearranging deck chairs on the Titanic comes to mind except they haven’t heard the news.

    • Whether people should be told the truth or kept in the dark depends on what you believe is happening, and whether you believe that we can adapt. It also depends on whether people can handle the truth. That’s a matter of mind-set as much as anything else.

      My book sets out two key issues. First, the “energy cost of energy” is rising, to the point where further economic growth has become impossible. Second, there are two economies – the “real” economy and the “financial” one – which should be complementary, but have moved dangerously far apart.

      So, we face an ending of growth, and the collapse of the financial system. The latter is a problem that gets worse the longer you put off fixing it. One day – probably soon – asset markets crash, and vast amounts of debt get written off. Vast amounts of paper “wealth” go up in smoke.

      Second, we have to get used to the idea that we’re not going to go on becoming materially “wealthier” – and as I see it, the process of “growth” has been illusory for some years anyway.

      This influences the nature of the truth that we either tell or withold. Here’s the truth as I see it:

      “You’re not going to go on getting materially wealthier – and this hasn’t really been happening for quite some time anyway. It isn’t the end of the world – we can adapt – but it’s the end of a mind-set that says that material posessions are the yard-stick for the quality of life. Vast sums are spent, self-interestedly, on promoting the idea that posessions determine happiness. In future, you will not be able to make easy money by riding the inflation of housing prices, or by moving around pieces of paper in the capital markets. In the future your satisfaction will have to come from other things – family, community, the environment, literature, values such as honesty and integrity – and not from owning the latest gadget. As for asset markets, these are going to collapse from absurdly inflated levels”.

      Some countries (like the UK) may find this change of mind-set difficult to make – but, in the long run, is there any alternative to making this change?

    • Based on the desperate policies being used to keep the system going for as long as possible, surely they understand that when it busts up that means the end of civilization as we know it.

      We are unable to extract oil as it is now because the costs are too high, so we will most definitely not be extracting it when the collapse comes.

      That means billions of people will starve and die.

      The PTB will most definitely be aware of this, otherwise why stick a nuclear bomb into the economy, to try to stop it from blowing up.

      If the masses were made aware of what you wrote here http://ftalphaville.ft.com/files/2013/01/Perfect-Storm-LR.pdf there would be mass panic and the collapse would begin immediately because people would stop spending.

      When the system collapses, civilization collapses.

    • This raises two questions, I think.

      First, can we stop what now looks inevitable? (I refer to the likelihood of a financial crash).

      Second, can we design a new system – or rebuild the existing one on a basis less dependent on speculative finance?

  2. Hi Dr Morgan

    Thank you for a very perceptive summary.

    I think you are right and the “cheating” option is the one that will be taken.

    It seems to me however that there are two contradictory forces at work here: money printing and therefore at least latent (and ultimately real) inflation due to money printing but excess industrial capacity together with a cyclical downturn that should be deflationary. Which will be the greater force?

    • Thanks. I’m sure you’re right about cheating – but will it work?

      And I wonder whether, this time, banks that were “too big to fail” in 2008 become “too big to rescue”?

      Economic pressures are overwhelmingly deflationary – mainly because Chinese demand is weakening so sharply.

      Against this, I think we can always create inflation, using “Ben’s helicopter” to literally drop cash into the system.

      But at some point that could destroy the credibility of money – and ultimately, credibility is all that fiat currencies really have.

    • Dr Morgan, since much of the cash thrown “into the system” effectively got paid to the banks and was held there to stop bankruptcy, won’t the only effective strategy be dropping cash into the streets this time?

      Bob J, my view is that it’s deflation that will win through in the near term, followed by inflation (if we’re lucky). However, I believe – to Dr Morgan’s point – that in the process FIAT could very well be destroyed which is why we are seeing a move from “public” to “private” and why tangible assets will triumph. Farmland, prime property, artworks, diamonds (helpful for airport security), gold has all been favoured by the super wealthy in recent years and one of the fastest growing markets has been in super-luxury yachts as the 0.1% prepare to quite literally become stateless as governments increasingly close down their tax havens. It is interesting to note that in Greece that alternative currencies are flourishing. The creativity and spirit of people is one of our most endearing qualities :).

    • There’s supposed to be a big difference between QE and just handing out newly created “helicopter” money. QE is put into the bond market, and – beyond inflating bond prices, thus lowering yields – isn’t supposed to have broader implications. Obviously it penalises savers and enriches the wealthy (because you can only benefit from inflated asset values if you have the assets to start with).

      If you simply create money and give it out, the risk is Weimar-, Zimbabwe- or Hungary-style hyperinflation.

      This doesn’t mean I don’t think they’d do it, but it would be insane – the medicine would be worse than the disease. We’ve tried to make debt meaningless (in that you never have to pay it back, just roll it over). That hasn’t worked, so then we tried making money ultra-cheap. Now that that’s set to fail, I just hope we don’t go on from there, making money not just “cheap” but “worthless”.


    Remember in 2008, when Iceland was the canary in the coal-mine?

    The Kazakhstan currency fell 25% yesterday – its main trading partners are Russia and China……..

  4. This week’s rout of the stock market seems to indicate that you are right! Time to batten down the hatches.

    • Thank you.

      Of course, the great and the good are already telling us not to worry. My favourite is “it’s only an economic crisis, not a financial crisis” – I look forward to these experts telling us how to service debt when incomes decline sharply….

    • Isn’t it an energy crisis? As in we are out of cheap to extract energy and this is manifesting itself as a financial crisis i.e. the financial crisis is the symptom

  5. Hi Tim

    A lot of the current fall in markets is very similar to about a year ago when markets were getting nervous about the FED pulling the plug on QE. The drop then was halted by James Bullard from the St Louis FED and Draghi and the ECB when they announced their QE programme.

    This time around could be very different in that it will be very unlikely that the FED can ride to the rescue. They have painted themselves into a corner on an interest rate ‘hike’ sometime this year and I can’t see them being able to switch their position entirely and announce QE4 as they are too vain and that would amount to an admission that they had got everything completely wrong. Yet FED QE4 is what it would probably take to stop markets falling further. ZIRP is no longer enough.

    A major problem as far as I see it, is that in addition to problems in China and everywhere else, the liquidity from all those central banks currently doing QE is not finding its way into US junk bond and high yield credit markets. They are tanking and starved of buyers and liquidity.

    I would say that the problem is even worse than it appears. The US has a huge sub-prime student debt problem, a huge sub-prime auto loan problem, a huge sub-prime property loan problem and a huge sub-prime corporate debt problem.

    The worst of the corporate debt problem is in the US oil and gas sector but it extends into all sectors. A lot of the debt isn’t counted as debt as when companies print new shares in themselves to fund CAPEX or just to stay afloat etc – but at the end of the day its still a debt really and in falling markets its worse than holding a debt for shareholders as day by day the value of their effective loans to companies burning through cash falls incessantly. Over the last 7 months a lot of investors have been foolishly buying the ‘dips’ in the oil & gas sector because they didn’t understand the financial dynamics of the oil industry which dictate that because everyone, whether its companies or entire countries, desperately need cash flow, then no-one is in a position to cut production to boost prices, in fact, they have all had to increase production as much as they can to try and make up for the shortfall and keep servicing their massive debts and bills. Oil supply is not elastic period.

    Either way its a massive haircut for investors whether they lose their money through outright default on junk bonds or losses from highly dubious Ponzi share placings and inevitable falls in equity values.

    The FTSE may have lost £130 billion in the last 2 weeks but I counted the loss in market cap over the last 12 months of just 3 shale oil companies in the US as coming in at $65 billion. Come the end of September when Q3 results are announced that’s going to get worse across the industry by orders of magnitude and in October when banks reappraise the value of the collateral and business models that’s going to get worse still.

    Given all of this, I doubt very much that given its current politically awkward position, that the FED can react in time to save the day.



    • Ironically, a new research report from the St Louis Fed says QE doesn’t work!

      I’m sure you’re right that nothing other than QE4 can work – but I doubt if even that would do the trick.

      As I see it, we know that we have too much debt, and have borrowed far too much since 2008. We’ve known this for a while. We also know (though some have been trying to ignore it) that a big chunk of that debt is in China. Bad, but not altogether new.

      What’s new – or at least newly-recognised – is that China’s economy is slowing very sharply.

      This matters because there are two components to debt sustainability – how much debt you have, and where your income is trending.

      Since 2008, the global economy has been a one-trick pony – take Chinese growth, Chinese purchases and so on out of the figures since 2008 and I doubt there would be any growth left.

      China also crystalises a lot of what’s wrong – surplus capacity, rash investment, over-inflated asset markets, and – now – weakening income.

      From here on, we get more bad news than good. Shalecos suffer, and this is part of a broader “flight to quality” (if you can find it), and a process of risk-minimising in investors’ portfolios. Cash is no longer the safe option it once was (ask the Cypriots – tiny, but a precedent).

      The powers that be will try to talk it up – already, I keep hearing that this is “an economic problem, not a financial one” (as though the ability to service debt isn’t related to income!). This “phoney war” is likelier than not to precede a crash – this could happen as early as next month, or drag on for a year. It won’t help if the Fed does raise rates, but may shake confidence if it doesn’t. QE4 – or even the mooting of it – could backfire, by admitting that this is serious.

      And, by the way, Santa Claus has just filed for bankruptcy over a EUR 200k unpaid tax bill.

    • Santa needs to do a placing then. $6 trillion ought to do it. Christmas is not about to go out of fashion even if your business model does involve manufacturing play things for all the children in the world and giving them away for nothing. Isn’t that Facebook’s business model? There is a Santa profit to be made somewhere over the rainbow.

    • Frankly I think there will be a massive loss in confidence whatever the Fed does. I cannot see them raising IRs in anything like the current circumstances and this will be an admission that everything is far from awesome and doing QE4 when they must know it hasn’t worked is an admission of failure (the definition of insanity is doing the same thing again and again and expecting a different result!). I cannot see that the central banks can avoid the “Emperor has no clothes” moment in the next few months; they are in a box, have been for some time, and there is no “get out of jail free” card available.

    • Hi Bob

      ” I cannot see that the central banks can avoid the “Emperor has no clothes” moment in the next few months; they are in a box, have been for some time, and there is no “get out of jail free” card available.”

      I go along with that sentiment. BUT we have all been caught about before by extreme central bank interventions in our musings. As Tim said above and I also think, QE4 could possibly stop the rot but only temporarily. I stand by what I wrote. The FED could possibly save the day in the short term but they are not politically in a position to do so.



    • Simon, apparently children (and adults too) are chipping in to help Santa (and I’m not joking). So much so that he might escape going bust. And I thought the idea was that Santa gave the presents….

      ……it is a truly upside down world…..

      ……..and Donald Trump wants to “rein in” China – oh boy, a trade war with China, that would REALLY help……

    • Bob

      Spot on, I’m sure. If you look at the things that have to go right (as per an email from John Mauldin), it’s pretty unlikely. He reckons, to avoid a hard landing, we need ALL of:

      – PBOC stops interfering with the currency
      – Successful transition in China from exports to domestic consumption
      – Retreat in China equities to realistic levels
      – Debt in China stable or lower
      – Adjustments for countries that hitherto have exported commodities to China

      Of these, I don’t think all five are plausible – in fact the only one that IS plausible is the third, and I’m not sure how that helps.

      I think central bankls have played the “trust me” card, and they only had one.

  6. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

    Ludwig Von Mises

    • Right. These things have a momentum and a dynamic of their own – and the dynamic isn’t even all that hard to predict:

      – You cannot borrow your way out of a debt problem (though you can buy a little time)

      – You cannot make money cheap and expect it to retain value.


  7. Might it be the case that we have too much existing debt, yet, not enough access to new debt to keep our interdependent global economy rolling?

    I’ve been reading Joseph Tainter’s work on societal complexity and diminishing returns. – I almost wish I hadn’t.

  8. Hi Tim

    Another day of market carnage. Where is the good news going to come from to prevent it falling far further? September and October are going to be dire months. The market have probably had some support from people buying the dips in this run down – but how long can they keep doing this within a strongly downward trend that takes out key support levels as if they weren’t there?



    • The great and the good have already resorted to spouting nonsense – this is “an economic problem, not a financial one”, apparently.
      It’s nice to know that falling incomes make debt easier to service…..

  9. “Our leaders do not control the tides of history — they are just surfing them. They are doing their best to keep on top of them. They do not make the tides — the tides of history come from a million different vectors: our advancing technology, our advancing worldview. These are the things that actually make a difference to the flow of history, and our leaders try to sit on top of it, and perhaps try to give the impression that they are controlling it, but history’s history. Time and tide — they don’t pay much attention to any human leader.” Alan Moore

    Last time the credit crunch came out of left field for those in charge. I think they believed their own nonsense – or were surfing the tide of deregulation – which for a politician would be unwise to fight in the 90s and 00s. There have been eight long years for those “in charge” to digesting what happened, and what various measures have and have not achieved. And maybe a painful reminder that busts ALWAYS follow boom.

    There feels to be a change in the air (or the currents). Look at this for example, not just hot air I hope: http://www.bankofengland.co.uk/markets/Documents/openforum.pdf (Carney’s speech is here http://www.bankofengland.co.uk/publications/Pages/speeches/2015/821.aspx).
    Can you imagine the BoE putting out a pamphlet 8 years ago saying “But markets can go wrong.  Left unattended they can be prone to excess, instability and abuse.”?

    At the same time you have Osborne knifing BTL in the back, with the BCBS looking to provide mandatory risk weightings to loan types with Basel III (shove off internal bank risk departments these are your risks and you will apply them ;p ) – which has the added bonus of blowing up BTL SVRs. Unimaginable a few years ago.

    If we such as us that read this blog and other similar sites have been able to produce a coherent and empirically driven narrative of what has and is happening, I am sure those near the seat of power will have too. At the very least they will not want egg on their face. As much as they spin it new-Labour have not got the smell of economic mismanagement off their clothes (nor should they). I doubt the current incumbents want that tag.

    Maybe they will loose their nerve at the last minute, maybe I am being overly optimistic; but I just have a feeling that this time we may get a crash and some proper rebuilding/rebalancing in the aftermath. That is just not possible in the current asset inflated world.

    The tsunami wave is for surfing; not for standing on the shore and yelling at! 🙂

    • I don’t think GO knifed BTL – ordinary buyers cannot offset interest against tax, so logically it makes sense to restrict tax relief available on BTL?
      This could be spun out for up to a year (though personally I doubt that long), using QE, and – as in China today – relaxing bank reserves ratios, thereby both increasing borrowing capacity and increasing risk.
      But I’m pretty sure we’re in the end-game – one month, or one year, but not longer.
      There is one great mystery that no one seems to have addressed – why has growth (other than spending borrowed money) disappeared?

    • I am a biologist – of sorts. I don’t believe in linear growth. Even humans grow in fits and spurts…

      More seriously, once we have met all of our material needs, and then upgraded them, then what? We are social animals, our happiness derives from the quality of interactions with others. Perhaps we can start to move on from the obsession with growth to a “profitable” and stable society. Or maybe I have had to many cans of beer after being at home with a 3 year old for 2 weeks straight!

    • Thanks for the blog Tim.

      Very similar thoughts to Mish Shedlock, Zerohedge etc over the last eight years.

      I think people say that timing is the hardest part of investing and I’ve certainly learnt that.

      I always wonder whether I’m missing something when I read economists espouse lowering interest rates and pumping more money when what is said by you guys makes so much sense (IE more debt isn’t a great way to get over a problem caused by debt, at some point it has to blow up).

      What are your thoughts on how this will all play out? Before and after the fuse finally outpaces people’s rose tinted glasses views and the debt detonates.

      What are the consiquences for FX, bonds, gold, shares, inflation, deflation, politics, wars etc. Will any country escape relatively unscathed?

      A pretty tough question but I’d love to hear your guesses.

      Thanks again.

    • Underscored
      I’ve been accused of being a moralising zealot for saying that material goods are not the only benchmark for quality of life.
      Think of the global advertising spend – about $500bn annually – as propaganda for materialism, and it gives you some notion of what any contrary point of view has to contend with.

    • Thanks Sam.

      We’ve been in a long period of denial, certainly since 2008 and arguably a lot longer. Think of it as two economies – the “real” economy and the “financial” one – becoming decoupled, because the financial economy is predicated on perpetual growth that the real economy can no longer deliver.

      Slashing rates, QE etc are just props trying to hold up a roof that has to collapse. As well as cutting rates, China has relaxed reserve ratios, letting banks lend more off the same capital base, and is also enabling (pushing?) pension funds into the equity market.

      The only way this ends is reset, when inflated asset (including property) markets collapse, there are huge write-offs, and the world’s pile of “claims” (debts etc) on the real economy shrink back nearer to the actual size of the real economy.

    • I don’t think this has taken the PTB by surprise at all.

      They are stage managing everything from the subprime housing medicine (which was a response to the end of growth due to the end of cheap to extract oil)

      They have created more bubbles since 2008 with China being the poster child.

      The PTB are engaged in a life and death desperate battle to keep the wheels on the global economy for as long as possible.

      They are doing exactly what they should be doing. I am surprised that they have delivered 7 collapse-free years.

      I doubt they can get us one more.

  10. Thanks for these articles Tim. We had a storm front go through here a year or two back, gusts of 108 mph brought down several of our trees. One landed on our roof, we were in the kitchen and heard a dull thud, watched a bit of dust drift down and went out to survey the damage. Nothing, not a thing, just several tons of tree resting on my roof. I’d built the roof so strong it could easily withstand that and more. I felt smug as well as warm and dry!

    There is a link to what you’ve been writing about and it’s preparedness. I hope I’ve done enough….

  11. Tim – as you say the fundamental issue is that normal “growth” has vanished. I read and was impressed with Robert Gordon’s article a few years ago making the point that the growth we previously saw was the result of successive industrial revolutions and that the current revolution (IT & computers) while generating some will not provide the same high economic growth (and maybe that ends up in relatively few pockets). You can probably do without your iplayer but it’s tough without hot water/central heating and the like. This seems to have been poo-pooed by may in the economics world but seems to me to be compelling together with the energy/raw material constraints you have so clearly pointed out.

    • David

      Well, of course, my book argues that growth ended some years ago, and everything that’s happened since then has been “wealth” – er, “creation” – through manipulated asset values.

      I’m considering writing about growth. Interestingly, economists have never really tied down exactly where growth actually comes from…….

  12. This would be really interesting – as you say real growth may be hard to find amidst all the manipulation and hype. I’m reminded of what someone said about biotech shares some years ago – promoted as hot investments yet poorly understood by most investors who didn’t understand the science, and that would be better off putting your money into US treasuries.

    • David

      Thank you. There are indeed two sides to this. “Why have we borrowed so much?” isn’t hard to understand. But “why has [non-borrowed] growth stopped?” is harder to answer.

      I’ll have a go at answering it – or, at least, setting up a debate here.

      Ahead of that, if you, or others, can suggest why growth has vanished, please do.

    • Tim

      It’s probably the case that any explanation has a number of layers and one could pose a number of questions:

      – has technical progress slowed? I know we have more computing and the internet but that isn’t everything,
      – Are there institutional reasons which contribute ? Reading Mancur Olson’s “The Rise and Decline of Nations” could one make out a case that growth has slowed due to the further accretion of special interests? In the US this may well be a contributory factor,
      – although you say “non borrowed” growth is in short supply growth itself is a “flow” and might not the secular process be affected by the cumulative “stock” of debt?

      Just a few random thoughts.

    • Is it possible that easy growth produced by easy debt has chased non-debt growth away?

      Why work hard when you can just borrow really cheaply and make money.

      A bit like a gold rush, everyone sees easy profit, rushes to where the money is being made and that sucks everyone away from other productive exploits.

    • Growth has vanished because the cost to extract resources has dramatically increased in recent years.

      Oil is the key one. The answer courtesy of the IMF and OECD:


      According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices.


      Marginal oil production costs are heading towards $100/barrel http://ftalphaville.ft.com/2012/05/02/983171/marginal-oil-production-costs-are-heading-towards-100barrel/

      The marginal cost of the 50 largest oil and gas producers globally increased to US$92/bbl in 2011, an increase of 11% y-o-y and in-line with historical average CAGR growth. http://ftalphaville.ft.com/2012/05/02/983171/marginal-oil-production-costs-are-heading-towards-100barrel/

      Steven Kopits from Douglas-Westwood said the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” he said http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/11024845/Oil-and-gas-company-debt-soars-to-danger-levels-to-cover-shortfall-in-cash.html

      Sanford C. Bernstein, the Wall Street research company, calls the rapid increase in production costs “the dark side of the golden age of shale”. In a recent analysis, it estimates that non-Opec marginal cost of production rose last year to $104.5 a barrel, up more than 13 per cent from $92.3 a barrel in 2011. http://www.ft.com/intl/cms/s/0/ec3bb622-c794-11e2-9c52-00144feab7de.html#axzz3T4sTXDB5

  13. Tim,

    Let’s say the debt bomb blows, then so much money is printed that we have hyperinflation or some other course to economic Armageddon.

    How would you structure the economy, banks, money/money creation etc if we started from scratch?

    Would you have a central bank? Or let markets decide the price of money?

    Are you someone who believes that bankers are paid so much because they have the power to create money and everything that that entails and not because they are all geniuses?

    And lastly, what are your thoughts on Bitcoin/crypto money? I appreciate I might sound like a crackpot to some but I certainly can see at least a role for crypto currency over the next 20-30 years as more and more people see its benefits (ie Micro payments (I’d love to easily pay you a tip for each article of yours that I get something out of), can’t be inflated, can’t be politicised etc).

  14. Picking up on Bob J’s point about technological progress – there is something odd going on here. Whereas we have lots of potential innovation, little of this seems to get through to produce something marketable. An example close to my area of interest are the pharmaceutical companies whose stock of new drugs is vanishingly small to the extent that profits are threatened and growth only achieved by swallowing up other companies with viable products. The so called “block-buster” drugs seem to be a thing of the past. Part of the problem are the enormous costs and regulatory hurdles to be got through in bringing a drug to market and the huge class actions which result if they are found to have side effects. This didn’t happen before – it’s been said that if someone invented aspirin today it would fail all the regulatory tests because of its known side effects. So is the litigious, risk averse culture stopping real innovation? Or is it just that we have picked the “low hanging fruit” in terms of innovation and that future winners are very much harder to identify and develop?

    • David

      I used to work closely with a – perhaps the – top pharma analyst in the City, so I have some limited understanding of the industry. The first issue is cost of approvals, which as you say has soared.

      The second factor seems to be developing “me too” drugs, especially in the US, rather than researching “clinical voids” (conditions for which no treatment exists).

      You’re right about aspirin, but there also seems to be a desire to “do down” some long-established drugs where something newer, less effective and costlier – but capable of being patented – can be offered. Aspirin is a hugely effective drug, I believe, but not promoted because there’s no profit in it.

      Also, big pharma is pretty monopolistic, if you take it on a condition-by-condition basis.

      More broadly, I’m working on why growth isn’t happening – quite a big stats exercise required behind this article.

    • As you say there is huge pressure to turn a quick profit – quarterly accounts etc – and this just inhibits true innovation. Did companies in the past take a longer view on investments. But I shall really look forward to reading your ideas!

  15. Ahead of that, if you, or others, can suggest why growth has vanished, please do.In simple terms is it not that all the low hanging fruit have been picked and there are not enough collective wages to afford the high hanging fruit, which is what the world is now set up to deliver? What is more there is no viable alternative as we have converted the sum energy of fossil fuels into 7+ billion people, half of whom don’t have the skills to survive any other way and the rest who are already in dire straights. Its not that we don’t have the technology or the knowledge to manage a steady state economy, we don’t have the relationships o manage a problem that is much bigger than the group of people we care about and very few are prepared to make significant changes to their live involving a reduction in our standard of living for a very small gain for everyone else. Therefore any necessary political change cannot be supported in a democracy and we do not have acceptable alternatives to democracy, Therefore groth will decline until the system adjusts which will be painful

    • Gordon

      Thank you, and welcome. I’m still working on this – a big stats exercise behind it – but I can give you some thoughts.

      First, my book argues that rising “energy cost of energy”, or EROEI (energy inputs vs energy outputs) is a big problem (and no whit changed by current energy price weakness – a big upturn in growth would very rapidly force prices strongly upwards).

      This being known to readers, the article will try to look at other issues. I believe there are two kinds of output – “globally marketable output (GMO)”, where prices are set or influenced globally, and “internally consumed services (ICS)”, where prices are set locally. There has been a swing away from GMO, and I think this is a factor – $1m of machine tools and $1m of takeaway pizzas have the same notional value in GDP accounts, but the former is more growth-creative.

      We need to look also at business concentration – the Industrial Revolution saw very diverse industries of numerous small competitors, which might be more innovative and growth-creating than the more concentrated “corporatism” of the day. If Google’s markey share was instead divided between 1000 small players, would this be more innovative? I think so. It could also be more suited to “creative destruction”.

      Incidentally, economists generally don’t really know where growth comes from. It turns out that capital investment plus increased labour accounts for only 40% of growth. So they call the “missing” 60% Total Factor Efficiency, and then try to explain it in terms of a huge range of things like law, education, infrastructure – which may well all be true, but can’t really be quantified, I believe.

      The annual Davos report puts a structure and weights to TFE. Dambisa Moyo’s book “How the West was Lost” is very good on this.

    • Re “Incidentally, economists generally don’t really know where growth comes from”.I agree that much of the debate about growth is still stuck in semantics, What are the real indicators of growth, what is included in the economy etc.. Riane Eisler in The Real Wealth of Nations” included both the black and criminal economies and unpaid labour in the total economy which is a start to a realistic framework to model.. What is more the quality of relationships in the economy has an enormous influence on things like productivity, let alone the consumer choices that satisfy both essential needs and psychological needs. However social capital would be almost impossible to model, unless real and useful indicators could be used.I suspect that exploring TFE will require new collaborations between disciplines, much as the “Annales theory of History” challenges conventional historical analysis. The subject is so vast that iti’s hard to do justice in a few sentences.
      I have always enjoyed your writing and look forward to each new post and now your take on the conundrum of growth – all the best.

  16. UPDATE

    Apparently, Chinese government support for the financial system totalled $1,327bn between 29th June and 17th July.

    That is five times larger than America’s 2008 TARP (troubled asset relief program) of $247bn. Additionally, successive reserves ratio relaxations since December have been worth $282bn, and in April China put $62bn into supporting two banks. All-in, this exceeds $1.6 trillion – and that’s just up to 17th July…….so how much more has been injected since then?

    This scale of support drastically exceeds anything in financial history. It may imply that banking and corporate debt problems are deeper than previously suspected.

    • If that is the case, do they have enough reserves to pump in?

      What happens if they just keep pumping fiscally and monetarily?

      I hear they’re selling treasuries? Could this start to impact the U.S. Rates?

    • Not enough, at this rate. I’ve just seen updated figures showing that the $1.3 trillion has risen to $1.8 trillion.

      Questions are also being asked about why dealing in so many big Chinese company stocks is STILL suspended – have they got something to hide?

      On USTs, one analyst has suggested a 200bps (2%) rise in yields – though, alternatively, I think there might be buying on “safe haven” grounds?

    • Thanks John. Climate change isn’t something I often comment on, though I don’t doubt the risks we face. Some day I must explore the EROEI – environment linkage. An optimist might say that deteriorating EROEIs may limit the future harm we can inflict on the planet.

  17. The common man does absolutely nothing! The individual can only mitigate their own environment but if enough did so……?

Comments are closed.