Stock market futures have triggered circuit breakers this morning, down the maximum they are allowed before the open. The SPX suggests the S&P will open down 9%. Everything is getting hammered in pre-market trading. Japan’s Nikkei was off 10% overnight to 7649. It had been over 18,000 just over a year ago. Britain announced a lower than expected GDP number, off 0.5% in the third quarter.
(Update: at 9:37, the Dow is down a little over 400. And it’s coming back. So who knows, we may actually end up today….though I doubt it.)
People are saying a lot of this is forced selling. There are too many overlevered players that have to sell everything to raise the cash they need to pay back investors. I guess that’s as good a reason as any for the violence in the markets.
The trade out of commodities and into the dollar continues as my college friend Becky Jarvis is reporting on CNBC. Oil is down below $63, the Pound and Euro are getting clobbered as the dollar spikes.
Right now Treasuries and the dollar are a refuge, but what happens when there’s the inevitable reversal out of the dollar and dollar-based assets? Brad Setser published a fascinating piece a couple days back about the fundamental reversal of capital flows that have driven the world’s economies for decades. In a nutshell that relationship has been that they give us stuff, and we give them dollars, which they lend back to us to buy more of their stuff.
But what if they’re no longer benefiting from this trade flow and are forced to reverse it. What if they lose so much money on the dollar assets they’re holding that they decide to stop holding them? In the case of China, for instance, Brad quotes the following:
“Charles Dumas of Lombard Street Research estimates that China makes 1-2 per cent on its (largely) dollar reserves. It then loses up to 10 per cent on the exchange rate and suffers a Chinese inflation rate of 6 per cent for a total real return in renminbi of about minus 15 per cent. That is a loss of $270bn a year, or a stunning 7-8 per cent of gross domestic product.”
When the Chinese decide it’s too expensive to keep recycling their dollars back into the U.S., what then? We could see a spike in U.S. interest rates as the demand for U.S. debt can’t come close to meeting supply. Where do people think the money is going to come from to fund trillions of dollars of bailouts and “stimulus?”
It has to be borrowed, which means we have to sell more Treasury bonds and hope people will buy them. Right now they are, because they perceive Treasuries as a safe haven in a violent market. But it’s my belief that, eventually, the supply of Treasury bonds will vastly outstrip demand to buy them.
That is to say, our need for borrowed money will eclipse the rest of the world’s ability to provide it. That will lead to higher interest rates and possibly a run on the dollar.
It’s been said that the Chinese have to keep this reciprocal relationship going. They have no choice. If you owe the bank a little bit of its money, they own you. But if you owe them all of their money, you own the bank. But that sentiment ignores the obvious truism that unsustainable things do not sustain themselves. We may own the Chinese, but if we go bankrupt, so do they. This Ponzi game we have going with them, where we spend to infinity and they lend to infinity, is just not sustainable forever. It will reverse.
Maybe not today, maybe not tomorrow, but soon and–possibly–for the rest of our lives.