Warren Buffett's classic aphorism "You only see who's swimming naked when
the tide goes out" is being tossed around more frequently these days, as the
world gets yet another deflation scare. Zero Hedge just published a
great piece on this topic, which should be read in its entirety. In the
meantime here's a summary of the story with a few added bits.
Let's begin with the common sense premise that overly-easy money sends a false-positive
signal to market participants, leading them to buy and build things that maybe
shouldn't be bought or built. Then, when money goes back to a more reasonable
price, the bad decisions (malinvestment in economist-speak) are revealed and
financial turmoil ensues.
Today's situation has its roots in the 1980s, when the developed world got
too lazy to live within its means and started borrowing way too much money.
It then tried to inflate away its debts by creating a tidal wave of new currency
and pushing interest rates down to unnaturally low levels. Flush with extra
cash and cheap credit, consumers (especially in the US) bought huge amounts
of imported junk. This in turn led China -- the main producer of said junk
-- to go on an infrastructure/factory building spree of epic proportions, which
shifted into hyper-drive after the 2008 crash. Chinese demand for industrial
materials like copper, iron ore, and oil soared, pushing their prices far above
historical averages.
This in turn led miners and drillers to mine and drill on an unprecedented
scale, which caused the supply of industrial materials to surge. The flashiest
case in point is the US shale oil boom, which sent domestic oil production
back to levels not seen since Texas' blockbuster oil fields were young.
But it was all a money illusion, and every part of this process has recently
hit a wall. Consumers refuse to go more deeply into debt to buy non-necessities,
even when money is nearly free. Faced with lower demand and poor cash flow
from the past decade's overbuilding, China has tapped the brakes on its infrastructure
build-out. The US is trying to stop monetizing its debt, which has sent the
dollar through the roof on foreign exchange markets, thus making life even
harder for about half the world's population.
As a result of the above, demand for basic materials is returning to normal
levels, which, in the face of inflated supply, is tanking prices across the
commodity complex.
In other words the tide has gone out, leaving a whole beach full of naked
(and unfortunately not very attractive) bodies. Specifically:
Shale oil junk bonds. Back when oil was over $100 a barrel, everybody
wanted to lend to drillers, especially in the exotic (and as it turns out fatally-flawed)
shale oil sector. $170 billion of energy-related junk bonds are now outstanding,
and they are tanking along with the price of oil.
Emerging market economies. These countries and their major
companies have accumulated about $6 trillion of dollar-denominated debt, and
with the dollar up more than 10% in the past year, the aggregate losses on
those loans could exceed half a trillion dollars. Suddenly, the emerging market
miracle looks disturbingly like the Asian
Contagion that nearly brought down the 1990s global economy.
Mining/drilling firms. These guys ramped up in response to soaring
oil, copper, iron ore, gold, and silver prices. Now many of them are earning
less per unit of product than it costs to mine/drill it. Massive bankruptcies
and consolidations are coming. One dot-comish sign of things to come is Civeo,
which provides living quarters for workers pouring into oil fields and mines
in Canada, Australia, and the US. With people pouring out instead of into these
suddenly non-viable fields, the company's services are no longer required.
The Texas economy. Texans are cool. But a big source of their cockiness
vis-a-vis the rest of the country was due to the fact that the price of their
main export -- oil -- was at historically high levels. Now that it's not anymore,
the Texas economy -- like those of Brazil and Russia, is falling back to earth.
JP Morgan Chase predicts a recession in 2015.
The US economy. It turns out that most of the full-time jobs gained
in the past five years have come from the energy sector. Otherwise, it's been
part-time secretarial/fast food/temp work that no one actually wants and in
any event can't support a family. Reverse out the oil patch jobs and the $10
or so trillion it took to engineer the "recovery" will look like just another
piece of money-illusion malinvestment.
Anyhow, that's just a sampling of the badly-maintained bods suddenly on display.
Most are now running for cover, which is an amusing sight for anyone not directly
affected by their problems. Trouble is, it's hard not to be affected by energy,
debt and deflation.
