World bond bloodbath

 Bonds are being heavily sold off.  (Reminder:  yields rise as prices fall)

It's because of :

• the Iran war, and its effect on oil prices and inflation.  
• ballooning US deficits
• concern that the Fed won't fight inflation
• Japan's economic unravelling
• stubborn inflation, not just in the US, but in Europe and elsewhere.
• the beginning of Central Bank tightening.
• strongly rising commodity prices — it's not just oil.

When bond yields rise, it's a signal of tightening credit.  The riskier the borrower, the bigger the rise in the interest rates they must pay to obtain credit. (That's why national government bond yields haven't risen by equal amounts over the last 2 years). At some point, the elastic snaps, and companies and possibly countries start going bankrupt.  Which leads, inevitably, to a recession.

The AI bubble is dependent on credit and circular financing.  When outside credit flows dry up, it will pop, taking down the economy and share markets with it.

Every previous oil crisis has been followed by a recession, and the bigger the relative increase in prices, the deeper the recession. 

Record car loan delinquency

 From Barchart

Not good.  If recession bites in the US --- and that seems increasingly likely --- this indicator suggests strains on consumer spending and banks' loan books, worsening the downturn.

Note strong seasonality.
I don't have the data, so I can't seasonally adjust them for you.

China's slump

 The last time China's inflation was so negative was during the GFC (global financial crash), and before that in 1998/99 (the Asia crisis)  And yes, inflation is negative, i.e., consumer prices are falling.  This is called deflation, and is a sign of extreme economic weakness, but is also very dangerous in an economy with as much debt as China's.  Deflation means incomes and turnover are falling, but debt doesn't fall.  The only way to cut debt is to repay it from your profits or income, and as income/sales fall, this gets progressively harder, leading to more bad debt, more defaults, and further declines in the economy.   When this happens, it's called a debt-deflation, and it was a key factor in the collapse during the Great Depression from 1929 to 1933.

In the past, China has always averted this by encouraging investment in plant and equipment and in housing.    But her population is falling, so housing stimulus is unlikely to work.  House prices are falling, and housing investment is collapsing, leading to spectacular bankruptcies by giant property developers.  Many people have bought houses "off the plan" and are now paying mortgages for flats which will never be built.  Meanwhile, erratic policy towards the private sector is discouraging foreign investment, while domestic fixed asset investment continues to slide.   And it seems that until very recently, Xi doesn't appear to have been concerned. 

China matters.  Even though the official GDP data are very rubbery, it is prolly the world's second-largest economy with ~15% of world GDP, and it is also the world's largest importer of raw materials.

Falling prices in China is a clear sign that economic growth is much less than stated, and that the economy is in a slump.   

Half of America's banks insolvent

From The Age

The twin crashes in US commercial real estate and the US bond market have collided with $US9 trillion ($13.5 trillion) uninsured deposits in the American banking system. Such deposits can vanish in an afternoon in the cyber age.

The second- and third-biggest bank failures in US history have followed in quick succession. The US Treasury and the Federal Reserve would like us to believe that they are “idiosyncratic”. That is a dangerous evasion.

Almost half of America’s 4800 banks have already burnt through their capital buffers and are running on negative equity. They may not have to mark all losses to market under US accounting rules, but that does not make them solvent. Somebody will take those losses.

“It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.”

The full shock of monetary tightening by the Fed has yet to hit. A great edifice of debt faces a refinancing cliff-edge over the next six quarters. Only then will we learn whether the US financial system can safely deflate the excess leverage induced by extreme monetary stimulus during the pandemic.

A Hoover Institution report by Professor Seru and a group of banking experts calculates that more than 2315 US banks are currently sitting on assets worth less than their liabilities. The market value of their loan portfolios is $US2 trillion lower than the stated book value.

These lenders include big beasts. One of the 10 most vulnerable banks is a globally systemic entity with assets of over $US1 trillion. Three others are large banks. “It is not just a problem for banks under $US250 billion that didn’t have to pass stress tests,” he said.

The US Treasury and the Federal Deposit Insurance Corporation (FDIC) thought they had stemmed the crisis by bailing out uninsured depositors of Silicon Valley Bank and Signature Bank with a “systemic risk exemption” after these lenders collapsed in March.

The White House baulked at a blanket guarantee for all deposits because that would look like social welfare for the rich. Besides, the FDIC has only $US127 billion of assets (and less very soon) and may ultimately require its own bailout.

The authorities preferred to leave the matter vague, hoping that depositors would discern an implicit guarantee. The gamble failed. Depositors fled First Republic Bank at a fast and furious pace last week despite an earlier infusion of $US30 billion from a group of big banks.

White knights probing a possible takeover of First Republic recoiled once they examined the books and discovered the scale of real estate damage. The FDIC had to seize the bank, wiping out both shareholders and bondholders. It took a $US13 billion subsidy along with $US50 billion of loans to entice JP Morgan to pick up the pieces.

“No buyer would take First Republic without a public subsidy,” said Krishna Guha from Evercore ISI. He warns that hundreds of small and mid-sized banks will batten down the hatches and curb lending to avoid the same fate. This is how a credit crunch begins.

The share price of PacWest, the next on the sick list, fell as much as 60 per cent in after-hours trading on Wednesday. That will be the bellwether of what happens next.

The US authorities can contain the immediate liquidity crisis by guaranteeing all deposits temporarily. But that does not address the greater solvency crisis.

The Treasury and the FDIC are still in the denial phase. They blame the failures on reckless lending, bad management, and over-reliance on footloose uninsured depositors by a handful of banks. This has a familiar ring. “They said the same thing when Bear Stearns went down in 2008. Everything was going to be all right,” said Seru.

First Republic lends to technology start-ups, but it chiefly came unstuck on commercial real estate. It will not be the last on that score. Office blocks and industrial property are in the early stage of a deep slump.

“Where we stand today is a nearly perfect storm,” said Jeff Fine, real estate guru at Goldman Sachs.

“Rates have gone up 400 to 500 basis points in a year, and financing markets have almost completely shut down. We estimate there’s four to five trillion [US] dollars of debt in the commercial (property) sectors, of which about a trillion is maturing in the next 12 to 18 months,” he said.

Packages of commercial property loans (CMBS) are typically on short maturities and have to be refinanced every two to three years. Borrowing exploded during the pandemic when the Fed flooded the system with liquidity. That debt comes due in late 2023 and 2024.

Could the losses be as bad as the subprime crisis? Probably not. Capital Economics says the investment bubble in US residential property peaked at 6.5 per cent of GDP in 2007. The comparable figure for commercial property today is 2.6 per cent.

But the threat is not trivial either. US commercial property prices have so far fallen by just 4 per cento 5 per cent. Capital Economics expects a peak to trough decline of 22 per cent. This will wreak further havoc on the loan portfolios of the regional banks that account for 70 per cent of all commercial property financing.

“In a worst-case scenario, it could create a ‘doom loop’ which accelerates a real estate downturn that then feeds back into the banking system,” said Neil Shearing, the group’s chief economist.

Silicon Valley Bank’s travails were different. Its sin was to park excess deposits in what is supposed to be the safest financial asset in the world: US treasuries. It was encouraged to do so under the risk-weighting rules of the Basel regulators.

Some of these debt securities have lost 20 per cent on long maturities – a theoretical paper loss only until you have to sell them to cover deposit flight.

The US authorities say the bank should have hedged this Treasury debt with interest rate derivatives. But as the Hoover paper makes clear, hedging merely transfers losses from one bank to another bank. The counterparty that underwrites the hedge contract takes the hit instead.

The root cause of this bond and banking crisis lies in the erratic behaviour and perverse incentives created by the Fed and the US Treasury over many years, culminating in the violent lurch from ultra-easy money to ultra-tight money now under way. They first created “interest rate risk” on a galactic scale: now they are detonating the delayed timebomb of their own creation.

Chris Whalen from Institutional Risk Analyst said we should be wary of a false narrative that pins all blame on miscreant banks. “The Fed’s excessive open market intervention from 2019 through 2022 was the primary cause of the failure of First Republic as well as Silicon Valley Bank,” he said.

Mr Whalen said US banks and bond investors (ie pension funds and insurance companies) are “holding the bag” on $US5 trillion of implicit losses left by the final blow-off phase of the Fed’s QE experiment.

“Since US banks only have about $US2 trillion in tangible equity capital, we have a problem,” he said.

He predicts that the banking crisis will keep moving up the food chain from the original outliers to mainstream banks until the Fed backs off and slashes rates by 100 basis points.

The Fed has no intention of backing off. [It raised rates further this week to the highest level in 16 years, and chair Jerome Powell warned not to expect any rate cuts this year]. It continues to shrink the US money supply at a record pace, with $US9 billion of quantitative tightening each month.

The horrible truth is that the world’s superpower central bank has made such a mess of affairs that it has to pick between two poisons: either it capitulates on inflation, or it lets a banking crisis reach systemic proportions. It has chosen a banking crisis.

 

The rise in the US discount rate from 1% in 2004 to 5.3% in 2006
led to the GFC.  The rise this cycle has been even larger.

A debt crunch is looming

 From Bloomberg

Just when it seemed the US regional banking strains were starting to ease, First Republic Bank has leaped back into headlines, reigniting concerns of rising pain in the lending system.

Banks increased emergency borrowing from the Federal Reserve for the second week in a row in a sign of the ongoing stress in the system. Last week, the New York Fed reported that financial conditions in its region had deteriorated sharply.

The trouble is rekindling concern that a credit crunch is underway. And it further complicates the plan for next week’s Fed policy meeting, where officials have to figure out how to balance the risks of tighter borrowing conditions against stubbornly high inflation.

Below are six charts that help explain why and how borrowing is getting harder in vast parts of the economy:

Lending Contraction

“Lending from U.S. banks is poised to contract over the next few quarters,” Amanda Lynam, head of macro credit research at BlackRock Financial Management wrote in a note on Thursday. Headwinds to profitability including higher deposit costs have seen bank spreads underperform relative to non-financials, she wrote.

Money Supply

The blow to credit availability comes as the money supply shrinks, a sign that the spike in interest rates by the Fed is causing money to exit the banking system, shrinking the availability of loans. That could slow the economy, with monetarist economists suggesting it could herald a crash and deflation.The Dallas Fed and the San Francisco Fed last week reported pressure on funding in their geographic regions, with projects being canceled and nonperforming loans expected to increase.

[See my piece about money supply, here]

Consumer Headwinds

Banks that posted quarterly results this month said they boosted provisions on bad consumer loans to levels not seen since the early days of the pandemic. For example, Capital One Financial Corp. increased its provision for credit card losses by more than 300% to $2.26 billion compared with a year earlier. The firms have generally said the rising provisions are just consumers returning to pre-pandemic norms.

Office Woes

Capital One also set aside more money to cover souring office loans, as vacancies rise and many workers choose to work from home. Morgan Stanley has previously estimated that office property valuations could fall as much as 40% from peak to trough, increasing the risk of defaults.

Another emerging source of stress in credit is the leveraged loan market as corporate borrowers with floating-rate debt struggle to keep pace with higher borrowing costs.

Higher Defaults

The amount of loans trading at distressed prices, defined as below 80% of face value, has jumped 26% to about $127 billion since the end of February, according to data compiled by Bloomberg. That compares with a 10% increase for bonds to about $488 billion.

“We believe the loan market, which has historically had a lower default rate than the high yield bond market, will record a higher rate during this cycle,” Armen Panossian and Danielle Poli, managing directors at Oaktree Capital Management LP, wrote in a memo last week. “This is due to the covenant-lite nature of most loans and the rising prevalence of loan-only capital structures.”

Credit Chatter

Company executives worldwide, meanwhile, are talking about credit on conference calls at the highest rate since the pandemic hit, according to data compiled by Bloomberg News. Some mentions include Evercore Inc.’s Chief Executive Officer John Weinberg noting an increase in restructuring and liability management business and Peabody Energy Corp. investor relations vice president Karla Kimrey saying the company has positioned itself to avoid uncertain credit markets.

Household debt flashing red

 This is important because in the past high levels of household debt relative to income/GDP have subsequently led to recessions, as happened in the US before the GFC (global financial crisis)

From a tweet by Phil Oliver

“Our risk map identifies ten countries where the danger from household debt is flashing red and the threat of this leading to financial crisis”

“The countries where we found the greatest specific concern meanwhile were Australia, Canada….” 

See his source.

 

US debt default

 A cartoon by Ann Telnaes

Not so grande

Evergrande Center

 From The Age

The crisis engulfing Evergrande, China’s second-biggest property company, is the greatest test yet of President Xi Jinping’s effort to reform the debt-ridden behemoths of the Chinese economy. It could also be the most significant test that China’s financial system has faced in many years.

As angry protesters occupied the headquarters of the troubled property developer in recent weeks, some analysts have described the Evergrande crisis as “China’s Lehman Brothers moment”. Only this time it’s a credit-fuelled housebuilder that suddenly can’t pay its $300bn debts, rather than a blue-chip investment bank that many assumed was too big to fail but was instead thrown to the wolves 13 years ago.

Although there may be some parallels, the more extreme prophecies of doom for China may be no more correct than the assumption that Beijing will simply step in and bail out Evergrande to make sure the fallout from the failure of a property giant does not spread to other areas of the Chinese economy.

“It seems that we may have already started the financial distress process. As the risk of insolvency increases, the behaviour of sales agents, homebuyers, suppliers and other stakeholders changes in ways that further undermine revenues and raise expenses,” said Michael Pettis, a professor of finance at Peking University. “Once that process begins, conditions can quickly spiral downwards unless someone like the government steps in to guarantee payments.”

As Evergrande’s turmoil continues to brew, the pressure on China’s real-estate sector is being felt far beyond a single developer. August data released on Wednesday suggested that national home sales by value had tumbled by 19.7% year-on-year, the largest drop since April 2020. Growth in home prices had slowed, too.

The question is how Beijing is to intervene – if it is going to do so at all. Some analysts think it will try to save part of Evergrande with a “politicised hierarchy” of creditors headed by the small investors and homebuyers who marched on Evergrande offices this week to demand their money back. Such public protest is rare in China and Beijing cannot risk it escalating into a narrative about the elites enriching themselves at the expense of ordinary people.

Starting on Tuesday, when the firm founded by the former steel executive Xu Jiayin 24 years ago is widely expected to default on two key bank repayments, big banks and financial institutions face the prospect of a drastic haircut of more than 75% as the price of saving the little guys.

But the key question is: will that work? The company shocked the market this week by admitting that it cannot offload its assets quickly enough to stop the bleeding. Its share price is collapsing and trade in its bonds has been suspended. It could get messy, analysts say.

“The nightmare scenario is a fire sale of Evergrande assets that transforms a healthy market correction into a rout,” said Gabriel Wildau, a China political risk specialist and a senior vice-president at the advisory firm Teneo.

The potential time bomb has been ticking for some years. China’s housing market has become hugely bloated by years of cheap credit and is reckoned by conservative estimates to account for 16% of GDP, although some estimates put that figure at 25% – far more than the proportion in western economies.

But the low-hanging fruit of debt-fuelled growth has long gone. In 2007-08, about 6.5tn yuan ($1tn) of new credit was needed to raise GDP by about 5tn yuan a year, according to the IMF. In 2015-16, it took more than 20tn yuan in new credit for the same growth.

This means it is becoming much more expensive to repeat the trick, as more credit is pumped into the system for an ever-decreasing impact. In the end there has to be a reckoning and the crisis at Evergrande suggests that the cycle has finally caught up with the poster child of China’s property-market miracle.

“It is an intractable problem. As long as Beijing for political reasons selects GDP growth targets that exceed the underlying growth rate of the economy, it needs surging debt to achieve those targets, and this surging debt requires implicit guarantees, or moral hazard,” said Pettis. “They can’t really get one without the other.”

This is perhaps the biggest headache for Beijing when it tries to make a reformed economic model work. Shortly after he came to power in 2013, Xi said that China needed to “shift the focus to improving the quality and returns of economic growth … to pursuing genuine rather than inflated GDP growth.”

Since Xi’s speech, a slew of regulations were introduced for various sectors of the Chinese economy, for example the so-called “three red lines” for selected developers in 2020 which severely limited their capacity to borrow.

Experts agree that this was where the rot finally set in for Evergrande because, as property prices began to cool in the wake of the regulatory crackdown, the company could no longer borrow so much to cover losses. Some say that the way Xi handles the implosion at Evergrande will be the “most serious test” of his determination to see through his reforms.

Damien Klassen, who manages millions of dollars at Nucleus Wealth in Melbourne, Australia, said Xi should be applauded for trying to make serious change to an unbalanced economy. The problem is that it could spiral out of control.

“Xi may be thinking that: ‘If I have to break a few eggs, I break a few eggs.’ I’m sure he would prefer if 25% of the economy was not devoted to the housing industry. Xi wants to change society, make property more affordable. That’s not a bad thing. But can he pull it off? He could end up with a debt crisis.

“The problem is that the banks have lent to every developer in the same way so you could see contagion across the whole sector. There will be uncertainty about who takes on the bad loans and then it will be the whole sector that won’t get any credit, not just Evergrande. No one knows what’s going on, so you don’t know which property companies will fall over next.”

Most observers agree that the state will be able to orchestrate a softer landing than western governments managed 13 years ago. Wildau points out that China’s banking system survived a stress test this month by regulators that factored in defaults on both home mortgages and developer loans in excess of the likely impact of an Evergrande collapse. Evergrande’s liabilities of $305bn are around half of Lehman’s and the west did not have the kind of regulatory control at Beijing’s disposal to defuse the situation.

However, whatever happens, and even if Evergrande lives to fight another day, the Reorg analysts say that the Chinese property market is already in a crisis as companies race to offload debt.

“The impact is already being felt in industry – it is deleveraging very rapidly. Companies are finding it much harder to raise money which is shown by very high yields for their bonds,” they said.

Capital Economics agrees that even if a soft landing is engineered, the property sector that has driven China’s growth for 25 years is entering a period of decline that could have a profound effect on the world’s second-biggest economy.

Even reversing the red lines would not make much difference, they argue, because sales of land and homes were already falling, partly because China’s slowing population growth is acting as a natural break on the housing market. There are fewer young adults than there were 10 years ago, something shown by a 31% drop in marriages from 2013 to 2019.

“Relaxation of regulatory controls on the sector wouldn’t change this fundamental constraint,” said Mark Williams, Capital’s chief Asia economist. “Construction, a key engine of China’s growth and commodity demand, will slow substantially over the next few years, whether or not the economy escapes the current crunch unscathed.”

A wave of debt could swamp the world economy

From the Australian Broadcasting Corporation (ABC):

The World Bank has warned the largest and fastest rise in global debt in half a century could lead to another financial crisis as the world economy slows.

The 'Global Waves of Debt' report looked at the four major episodes of debt increases that have occurred in more than 100 countries since 1970 — the Latin American debt crisis of the 1980s, the Asian financial crisis of the late 1990s and the global financial crisis from 2007 to 2009.

The bank said during the fourth wave, from 2010 to 2018, the debt to GDP ratio of developing countries has risen by more than half to 168 per cent.

That was a faster increase on an annual basis than during the Latin American debt crisis.

Problematically, the rise in debt has been across both private companies and governments across the world, amplifying the risks if there is another global financial crisis.

China accounted for the bulk of the increase, with its debt-to-GDP ratio rising by nearly three-quarters to 255 per cent since 2010, now totalling more than $US20 trillion.

However, most emerging economies saw their debt rise over the eight years.

The report said the latest wave of debt was more challenging than the previous three waves because of the build up of both private and public debt, new types of creditors including foreign investors and the big rise in borrowing, which was global and not limited to one or two regions.

Poorer countries have also increasingly borrowed from non-traditional lenders such as China, which offer less favourable loan conditions, including higher interest rates and requiring stakes in projects as collateral.

The new report has upped the pressure on governments to prevent another debt crisis.

It found that of 519 cases of debt surges in 100 emerging and developing countries since 1970 roughly half ended in financial crises.

"75 per cent of them now have budget deficits, their foreign currency denominated corporate debt is significantly higher, and their current account deficits are four times as large as they were in 2007.

"Under these circumstances, a sudden rise in risk premiums could precipitate a financial crisis, as has happened many times in the past."

Leveraged loans: the big risk for the US economy

What made the GFC (Global Financial Crisis, 2007-2008) much worse was unrestrained and ill-advised lending by the banks in the years before the crisis.  Banks lent profusely to home buyers, with low buyer deposits and "liar loans", and packaged these loans into bundles (Collateralised Debt Obligations, or CDOs) which remarkably inept rating agencies rated AAA.  When the downturn came, the defaults on the mortgages and the CDOs took down the banking system and with it the world's economies.  In the years after the GFC, banking regulators increased required capital standards and tightened regulations.

Now something very similar is happening again, and the tightened standards and regulations imposed after the crisis have been loosened by the US government.  It seems no lesson is too serious to be unlearned by the Right.

[From The Washington Post]

Actions by federal regulators and Republicans in Congress over the past two years have paved the way for banks and other financial companies to issue more than $1 trillion in risky corporate loans, sparking fears that Washington and Wall Street are repeating the mistakes made before the financial crisis.

The moves undercut policies put in place by banking regulators six years ago that aimed to prevent high-risk lending from once again damaging the economy.

Now, regulators and even White House officials are struggling to comprehend the scope and potential dangers of the massive pool of credits, known as leveraged loans, they helped create.

Goldman Sachs, Wells Fargo, JP Morgan Chase, Bank of America and other financial companies have originated these loans to hundreds of cash-strapped companies, many of which could be unable to repay if the economy slows or interest rates rise.

“This means that the next downturn that we have could be more serious and longer-lasting and more difficult to deal with than it would have been if we had constrained these practices,” former Federal Reserve chair Janet L. Yellen said in an interview.

The lending boom was precipitated, in part, by the rush to water down regulations at the start of the Trump administration. That’s when newly minted regulators — many with close ties to the financial industry — sought to strip away post-crisis financial rules and find ways to juice the economy by encouraging more lending.

One of their top targets was leveraged loans. These are giant loans that banks make to heavily indebted — in financial speak, highly leveraged — companies. Bankers often have little assurance that the loans can be repaid, which can make them particularly risky. Bankers earn large fees off these products, and many banking executives say their institutions are sheltered from losses because they sell the loans to other investors such as hedge funds, mutual funds and insurance companies.

As regulators scaled back scrutiny, bankers began to binge.

Financial companies issued a total of $1.271 trillion in leveraged loans in 2017 and 2018, 40 percent more than in 2015 and 2016, according to S&P Global Market Intelligence. More than 80 percent of the loans made in 2018 were made with fewer restrictions on the borrower and fewer protections for the lender in the event the loan falls into default.

[Read more here]

It seems very likely that the US will enter a recession this year—I would say an 80% chance.  At the same time, the yield curve (the spread between short-term rates and long-term rates) has gone negative in the US, reducing bank profits. 

Source: Business Insider

There is also a pending crisis in auto loans.  Just as happened with mortgages before the GFC, when default rates on mortgages reached record highs even before the recession began, so it is with car loans now.   What will happen when unemployment starts to rise?  It's obvious, isn't it. 

As I pointed out here, PMIs for the world are sliding.  The only good news is that Chinese re-stimulation measures are having some effect.  Meanwhile, in Europe and Japan, Central Bank discount rates are already at zero, and the banking systems remain parlous.  How will the authorities counter if growths slows any further and debt defaults explode? 

If the world goes into recession, will we experience a crisis as severe as the GFC, with even fewer tools to avert the disaster?  My concerns are rising.

Too much debt

When debt levels are high, even a small downturn cascades into a deeper one.  Debts can't be repaid because income/cash flow deteriorates.  Companies default on their debt.  Banks have to write off bad loans.  This reduces their free capital and their ability to lend even to sound businesses.  Workers get laid off, and the debt burden increases.  The doom loop continues.

The world has been on a massive spending spree.  Outstanding debts levels have more than doubled.  If there is a significant slowdown in the US, there is a high risk that the world economy will have a recession.

The carbon bubble

(Source: Your Pension and the Carbon Bubble)

A recent analysis reported in The Guardian argues that the carbon bubble will burst before 2035.

Plunging prices for renewable energy and rapidly increasing investment in low-carbon technologies could leave fossil fuel companies with trillions in stranded assets and spark a global financial crisis, a new study has found.

A sudden drop in demand for fossil fuels before 2035 is likely, according to the study, given the current global investments and economic advantages in a low-carbon transition.

The existence of a “carbon bubble” – assets in fossil fuels that are currently overvalued because, in the medium and long-term, the world will have to drastically reduce greenhouse gas emissions – has long been proposed by academics, activists and investors. The new study, published on Monday in the journal Nature Climate Change, shows that a sharp slump in the value of fossil fuels would cause this bubble to burst, and posits that such a slump is likely before 2035 based on current patterns of energy use.

Crucially, the findings suggest that a rapid decline in fossil fuel demand is no longer dependent on stronger policies and actions from governments around the world. Instead, the authors’ detailed simulations found the demand drop would take place even if major nations undertake no new climate policies, or reverse some previous commitments.

That is because advances in technologies for energy efficiency and renewable power, and the accompanying drop in their price, have made low-carbon energy much more economically and technically attractive.

[Read more here]

For coal, it's going to happen long before 2035.  At the end of 2017, solar provided 1.9% of the world electricity, wind 5.6%.  Solar has been growing at 40% per annum for nearly 3 decades, and there seems every reason to believe that it will continue to grow at that rate for the next 10 at least.  Perhaps it could even accelerate as the cost of storage declines.  Wind is growing more slowly (20% per annum) , but will likely continue to grow because (a) wind gives power 24/7, (b) a grid with a mixture of wind and solar is more stable and requires less backup/storage than a grid dominated by solar and (c) wind is still one third the price of coal and continues to decline in price, though more slowly than solar.  Hydro provided 16.4% of total demand in 2018.  Hydro (though not pumped hydro) is unlikely to grow rapidly.  All the best big dam sites have been taken.  So I've assumed only modest growth in hydro (3% per annum).

World electricity demand is growing at 3-ish % (there's no demand growth in developed countries, even declining demand, but varying demand growth in developing countries).  I've increased that by 1% in 2022 and 2023 and by 2% in 2024 and 2025 in my forecasts to allow for the growth of electric car charging.

Using these assumptions, fossil fuel demand for electricity generation (i.e., mostly coal, because gas will still be used for firming and peaking power for a couple of years longer) peaks in 2020, falls slightly in '21 and '22, and then starts to plunge.  By 2025 the supply of electricity generated from fossil fuels will be falling by 8% per annum.  Which means demand for fossil fuels for electricity generation will be falling as fast.

What about demand for petroleum and diesel for land transport?  That's a bit slower.  Cheap EVs will only be available from 2020 on.  As a quick and easy estimate, petrol/diesel demand will fall by 1% per year for every 10% share of new sales EVs have.  But EVs could make up 50% of sales by 2025.

Markets look ahead.  By '21 or earlier  it will be obvious to everybody in the market place what's happening and what's going to happen.  At that point share prices will start to plunge, debt defaults by fossil fuel producers will rise, hitting the banks, and the carbon bubble will pop.  Long before 2035.

Gird your loins.

Untamable debt

A cartoon by Scott Stantis of the Chicago Tribune

Credibility

Default cretinism

This is the consequence of ill-advised austerity

Trenchant cuts to government spending and large rises in taxes don't balance the budget, because they cause the economy to go into recession or to deepen the existing recession.

The Greek unemployment rate is now at a new record high of 25.4%.  A year ago it was bad enough: 18.4%.  But it has risen an incredible 7% points in one year, and this isn't the first year of the recession.  It's the fifth.  And its prospects of repaying its debts are no better than they were at the beginning of this whole sorry fandangle.

This is higher than the unemployment rate reached during the Great Depression in the US.  And it is still rising!   Holy ninniebarn!

What a shameful spectacle of gross incompetence by those in charge; incompetence made worse by the fact that not only has it not achieved its target, but it has inflicted scars on Greece which will last a generation.  Pointlessly.

Meanwhile, the same tired old remedy is being proposed to solve the budgetary difficulties of all the other deficit countries (Spain, Italy, the UK, Australia....), and of course we face a "fiscal cliff" in the US where the rabid right cling desperately to their failed nostrums.  Like medieval blood-letting: if the treatment doesn't work you just repeat it until the patient dies.

(You might also want to read Lessons from History)

Dr Gloom

Nouriel Roubini, who correctly forecast the GFC, more or less alone amongst his econorat colleagues(apart from a among others Gerard Minack at Morgan Stanley and yours truly), gives a deeply gloomy and reasonably convincing interview pointing towards a very bad 2013.  A double dip in the US, probable war with Iran, a slow-motion trainwreck in Europe speeding up, and an absence of government weapons to stop the economic and fiscal crisis.  He points out that the banks haven't changed, as evidenced by the Barclays Libor scandal.  And they haven't in respect of their behaviour, but they are far better capitalised now than then.  Some lessons have been learned.  Personally, I think the banks' proprietary trading should be split from the traditional banking business of borrowing short and lending long.  That's risky enough itself.  Add corrupt trading desks manned (and it's usually manned not womanned) by testosterone-high bullies interested only in short-term wins, still too low genuine capital (long term debt is NOT capital) and you have a toxic mix which will blow up again one day.  Maybe not in 2013, though.

The Greek Debt Crisis (again)

Once again, markets are being roiled by concerns that Greece will default on its debts.  For some time now it's been obvious that a restructuring of Greek debt is inevitable, but bureaucrats and politicians have continued to pretend that austerity will be enough to guarantee payment.

The Greek government’s debt to GDP ratio exceeds 100%.  This means that the interest paid on this debt will be a significant percentage of GDP.  If interest rates are low, say 1 or 2%, as they are in Japan, the interest cost of the debt will also be low.  But if doubts arise about the ability or willingness of the government to repay the debt, then interest rates start rising, and the interest burden starts to rise as markets increase the risk premium applied to that country’s debt, thus increasing the risk that the debts won’t be paid.  This doom loop has hit Greece.  10-year bond yields are now above 17%. 

The burden on the Greek population is insupportable.  It is likely that the government will fall today or in the next few days and Greece will default.

Does this crisis mean you should switch into defensive investments such as cash?  No (though it's close) for 6 reasons:

1. Chinese growth will continue. China is the world’s second largest economy (and is the world’s largest consumer of raw materials).   Chinese growth is now driven by internal forces rather than exports.
2. Though US growth is slowing this has much to do with natural disasters – the tsunami in Japan stopped car part production which affected US car production and sales; and floods in the mid-west also impacted output and sales.  Outside the PIGS (Portugal, Ireland, Greece, Spain) growth in Europe is strong.
3. Share markets are a lot cheaper than they were--though they're still not screaming buys.
4. The markets have seen this crisis developing over the last year, and most of the bad news is now “in the price.”  Nobody now believes Greece will avoid default except bureaucrats and politicians.
5. Policy makers are extremely aware of the dangers and will move aggressively to ease liquidity on any sign that the crisis is spreading.  If necessary, central banks can buy bank bonds or lend banks unlimited cash on the security of government paper or even lend them money directly.
6. Unlike the situation at the beginning of the GFC, when economies were ripe for a cyclical downturn, now we are still in the middle of the upswing from the trough of the recession.

But it's hard to see share markets booming on this, isn't it?