Thursday, February 6, 2014

HERE'S A PREDICTION THAT'S APT TO COME TRUE:

Ambrose Evans-Pritchard

Ambrose Evans-Pritchard has covered world politics and economics for 30 years, based in Europe, the US, and Latin America. He joined the Telegraph in 1991, serving as Washington correspondent and later Europe correspondent in Brussels. He is now International Business Editor in London. Subscribe to the City Briefing e-mail.

SocGen bear growls: deflation shock-wave from Asia to trigger global recession

By Ambrose Evans-Pritchard Economics Last updated: February 6th, 2014

69 Comments Comment on this article

The Soc Gen bear is in a foul mood (Photo: Reuters)

Albert Edwards from Societe Generale has returned from two weeks holiday in a completely foul mood.

"The ongoing emerging market debacle will be less contained than sub-prime ultimately proved to be. The simple fact is that US and global profits growth have reached tipping point and the unfolding EM crisis will push global profits and thereafter the global economy into deep recession."

What we are seeing is a "direct replay" of the East Asia crisis of 1997 but on a bigger scale. A strong dollar/weak yen world is an "incendiary mix" for emerging markets. It tightens liquidity while delivering a trade shock to weaker economies.

Analysts are slashing their forecasts at an "all-time record rate – this is wholly inconsistent with talk of economic acceleration".

"The dire profits situation will only get worse as EM implodes and waves of deflation flow from Asia to overwhelm the fragile situation in the US and Europe."

This week's slump in America's ISM manufacturing gauge is the "straw in the wind" of what is to come. "Even if the Fed resumes massive QE at some point as the world melts down, and markets desperately attempt their return to the dream trance, they will instead find themselves locked into a Freddy Krueger-like nightmare in which phase 3 of this secular bear market takes equity valuations down to levels not seen for a generation."

Albert and SG's Andrew Lapthorne say profits have already slumped to near zero growth if you use MSCI reported earning rather than the "made-up" pro-forma IBES data. .

EM profits have been negative for two years already. The global equity rally has been driven by QE fumes.

I hate to think what would happen if Albert were right. The world cannot take such an outcome in its present enfeebled condition.

It would push China into a dangerous crisis, greatly raising the risk a diversionary military clash with Japan, which would in turn embroil the US in a Pacific War.

It would doom any chance of recovery in southern Europe, sending debt trajectories and jobless rates through the roof. The European Project would disintegrate in acrimony, with a chain of sovereign defaults pushing Germany into depression.

Britain would spin into another financial cataclysm, this time having to rescue banks with huge exposure to emerging markets and China (through Hong Kong). This would be hard to explain to long-suffering British taxpayers a second time. The retribution that bankers deftly avoided post-Lehman would be crushing.

Much of the world would revert to capital controls, locking down trillions of foreign wealth much as the Bolshevik revolution wiped out French investors. Western pensioners would face a greatly impoverished old age.

It would cause the further implosion of Argentina, risking a fresh Falklands War with Britain. It would endanger Brazil's democracy, and tempt military coups in several Latin American states.

It would lead to the economic collapse of Russia, with fearsome implications for Ukraine and ex-Soviet sphere.

I could go on,

But in the end I am not as gloomy as Albert  — though I share his fears over the gravity of the EM crisis, and the implications of Fed tightening.

The financial world is ultimately smoke and mirrors. Debt is a mirage. Creditor claims can be "re-arranged" at the point of a bayonet if need be, and often are.

You can conjure all kinds of tricks, and wave all kinds of magic wands. A determined central bank – backed by a credible government and a cohesive society – can achieve miracles. Any deflationary shock can overpowered.

Political will can always triumph over these setbacks. To borrow from the Habsburgs, the situation may be desperate but it is not serious. So waltz on, and keep the champagne flowing.