19 July 2013

Zombie Economics

As the Motor City declares bankruptcy, US equities motor to new highs.

Detroit, also known as the "Motor City" filed for Chapter 9 bankruptcy yesterday in the largest municipal bankruptcy in U.S. history. With a shrinking population, crumbling infrastructure, high crime rate, falling revenues and rising costs (including interest payments on debt totalling $18.5bn), the announcement wasn’t a great surprise – if you are able to see through the slapstick rhetoric spewed by the mainstream media and willing to read between the lines that is.

If not, then the bankruptcy announcement must come as a great shock because the S&P 500 is at a record high (alongside most other U.S equity indices), media coverage proclaims a burgeoning U.S recovery, Ben Bernanke sees the U.S economy “recovering at a moderate pace”, the Fed is on the verge of QE tapering due to “gradually improving labour market conditions”, U.S corporate profits are mushrooming, inflation is low, GDP is resilient and consumer sentiment is optimistic due to the wealth effect induced by the Fed’s award-winning market save back in 2008.

Source: ABC News & US Census Bureau
Once the fourth-largest US city, Detroit has seen its population shrink by more than 50%, from 1.8 million in 1950 to 685,000 in 2013. The majority of the exodus has occurred in the past 5-10 years following the financial crisis and its preceding effects.

As its nickname suggests, Detroit’s history is rooted in the automotive sector. Detroit produces(ed) a huge portion of all cars manufactured in the U.S for decades.

Even after the mammoth bailouts and reorganisation of Chrysler and GM back in 2008/9, the U.S. automotive sector has deteriorated nevertheless, thus slimming Detroit’s prime revenue stream. The miraculous recovery seems to have miraculously missed Detroit.

Detroit's bankruptcy once again refers back to the core issue that is affecting all financial markets, yet not recognised by all market participants: a warped perception of market dynamics, forces and realities.

Perceptions of reality

To illustrate the stunning disconnect between ‘perception’ and ‘reality’, in the financial markets today, one only has to look at the historical background contrasted against today’s market action.

How can the U.S dollar remain a world reserve currency and be considered a ‘safe haven’ with the U.S. deficit close to $20 trillion? How can the Dow Jones Index print new highs while a major U.S. city declares bankruptcy? How can the Fed claim the U.S. economy is recovering when multiple, independent sources of alternative data suggest real U.S unemployment is above 20%, inflation above 6% and experiencing negative GDP growth?

How can the U.S economy be considered in recovery when almost 50 million people receive food stamps and over 100 million receive some form of social security (and growing)? Why do all asset prices collapse at the mere hint of QE removal – only to rise again as QE is put back on the menu?

The answer to all these questions is that the official story supplied by the mainstream media is an illusion - in part coordinated by the elite echelons of the U.S government, Treasury, Lobbyists and Shadow State. The precise modus operandi is secretive and unclear to those on the ‘outside’. For ‘insiders’, market manipulation of LIBOR, gold, silver, food, commodities, government bonds, ISDA, credit, energy, derivatives and equity markets is the norm - used to create astronomical profit and centralize decision making, at the expense of the distracted masses, struggling to survive under crushing economic conditions.

Back to reality

Despite the mirage persisting, the reality is still the underlying truth. Detroit will be bailed out if it needs to be, and most likely forgotten by the press pack in the months to come. However, the U.S debt fiasco is clearly real and likely to weigh on other cities and municipalities in the months and years to come. We expect fearful speculation surrounding other U.S. states to gradually rise over the next few months, possibly culminating in harsher budget cuts, sooner than expected.

This would, of course, weigh on US GDP growth and would be yet another stick in the spokes for the Fed's hopes of going ahead with QE tapering later this year or early next year. The Fed will probably be asked to bail out a plethora of municipal bond markets as a way to "preserve economic stability" and market speculators will probably see such a move as risk-positive (higher equities, lower USD, higher commodities, lower bond yields).

Detroit is located in the state of Michigan. Michigan isn’t the most highly indebted or highest spending state. In fact, it only ranks 9th compared to other U.S states. Gross public debt is expected to rise year on year until at least 2017 while economic growth will almost certainly fall short of expectations. The existing debt will become more difficult to service in real terms as growth slows and fiscal policy is further asked to reel in the slack of impotent monetary policy; already exhausted to a large extent due to the ‘liquidity trap', and eye-watering increases in inequality across the U.S.

Bear in mind, that U.S. federal public debt as a proportion of GDP is at the same level as it was during the 1940’s – a period of World War where the U.S. was understandably ballistic with its spending and debt acquisition. Over the past 30 years, the U.S has burdened itself to the same extent as if it was fighting a World War – a war with its own citizenry at the behest of multinationals and a banking cartel.

Taking this into account, states such as California, Texas, Florida and New York are clearly the next targets for speculators. If Detroit cannot make ends meet ranked 9th worst in terms of its public finances, at least one of the bottom 8 will almost certainly follow Detroit into bankruptcy court over the next 6-12 months assuming worsening economic conditions and denial ridden assessments by the U.S authorities continue.

Commissioned by Think Forex
Written by George Tchetvertakov