The International Power Posse

Making their annual pilgrimage to the exclusive Swiss ski sanctuary of Davos last week, the world’s political and financial elite once again gathered without having had the slightest idea of what was going on in the outside world. It  appears that few of the attendees, if any, had any advance warning that 2016 would dawn with a global financial meltdown. The Dow Jones Industrials posted the worst 10-day start to a calendar year ever, and as of the market close of January 25, the Index is down almost 9% year-to-date, putting it squarely on track for the worst January ever. But now that the trouble that few of the international power posse had foreseen has descended, the ideas on how to deal with the crisis were harder to find in Davos than an $8.99 all-you-can-eat lunch buffet.

The dominant theme at last year’s Davos conference, in fact the widely held belief up to just a few weeks ago, was that thanks to the strength of the American economy the world would finally shed the lingering effects of the 2008 financial crisis. Instead, it looks like we are heading straight back into a recession. While most economists have been fixated on the supposed strength of the U.S. labor market (evidenced by the low headline unemployment rate), the real symptoms of gathering recession are easy to see: plunging stock prices and decreased corporate revenues, bond defaults in the energy sector  and widening spreads across the credit spectrum, rising business inventories, steep falls in industrial production, tepid consumer spending, a deep freeze of business investments and, of course, panic in China. The bigger question is why this is all happening now and what should be done to stop it.I was able to see through to this scenario not because I have access to some data that others don’t, but because I understood that stimulus in the form of zero percent interest rates and quantitative easing is not a means to jump start an economy and restore health, but a one-way cul-de-sac of addiction and dependency that pushes up asset prices and creates a zombie economy that can’t survive without a continued stimulus. In the end, stimulus does not create actual growth, but merely the illusion of it.

This is consistent with what is happening in the global economy. China is in crisis because commodities and oil, which are priced in dollars, have sold off in anticipation of a surging dollar that would result from higher rates. The financial engineering that has been made possible by zero percent interest rates is no longer available to paper over weak corporate results in the U.S. Our economy is addicted to QE and zero rates, and without those supports, I feel strongly we will spiral back into recession. This is the reality that the mainstream tried mightily to ignore the past several years. But the chickens are coming home to roost, and they have a great many eggs to lay.

Investors should take heed. The bust in commodities should only last as long as the Fed pretends that it is on course to continue raising rates. When it finally admits the truth, after its hand is forced by continued market and economic turmoil, look for the dollar to sell off steeply and commodities and foreign currencies to finally move back up after years of declines. The reality is fairly easy to see, and you don’t need an invitation to Davos to figure it out.

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