An Emerging Global 'Perfect Storm?' 4 Key Trends To Watch

by: Jack Rasmus

Much like a "perfect storm" at sea is the consequence of converging bad weather fronts, significant global trends have begun to intensify, and converge, on the global economy during the past week. That convergence has already begun to "come ashore" and impact US equity markets, and could likely do so even more intensely in the weeks to come. Effects on the US real economy and policy in the short to medium term are also inevitable. The convergence is still in its early phase, but its initial US "landfall" is already evident.

1. In Europe the new catchword has become deflation. Although the Eurozone economy in aggregate terms is no longer in decline and that region's recent "double dip" recession appears to have stabilized for the moment, the data show that prices for goods and services in the region continue to slow or decline. The IMF, the European business press and other sources - private and official - are now all warning of the growing risks of deflation on the horizon. When deflation occurs, a host of nasty things economic follow: consumers slow their spending (already a problem in Europe), businesses reduce investment causing unemployment to stagnate or even further rise (another nagging Euro condition), and debt actually rises in real terms (and we know all about Euro debt). Deflation is probably a better indicator of a weakening "real" economy longer term than is GDP, given the limits of that latter term in measuring real trends. With no true banking union, the Eurozone continues to focus on austerity - recently shifting its austerity focus from targeting government spending to wages and productivity more directly under the topic of so-called "labor market reform." So prospects for the Eurozone having a "V-shape" recovery are still quite low and the region remains a decided "weak economic sister" globally, notwithstanding all the hype about its alleged recovery. It could slip back into recession (this time a "triple dip") without too much of a push. Although Germany remains afloat in the storm, it does so largely at the expense of exports to the rest of the Eurozone as well as due to exports to Asia and China, upon which the entire Eurozone is also still heavily dependent. Which leads to the convergence of the Euro "storm front" with the other two.

2. A second major development of the past week in terms of the emerging global economic storm is China itself. Last week it released its latest report on manufacturing output, which is now clearly slowing, actually turned negative, while the magnitude of the drop also exceeded expectations. Behind the signs of a slowing China economy lay that country's intensifying fight with global shadow banks that have penetrated its local economy and firmly implanted themselves in recent years, in particular in local real estate, finance and local government investment project markets. China has been playing a cat and mouse game for more than a year now to try to reign in its shadow in an effort to cool off its construction sector inflation bubble. But whenever it tries to do so by reducing credit, its economy slows. Meanwhile credit from non-government finance sources continues to surge. China for more than a year thus seesaws back and forth between contradictory goals of bringing its shadow banks to heel, slowing the economy, only to back off and witness the renewed refueling of the property bubbles by the global shadow banks once again.

What the case of China shows is that central bank monetary policy has declining effect on restraining asset price bubbles, and more unintended effect on slowing the real economy when that policy aims at slowing economic activity - just as, conversely, central bank monetary policy (e.g. QE) has had declining effect on stimulating the real economy while having more unintended effect on stimulating asset price bubbles.

China thus appears mired in its own kind of "stop-go" economic trajectory longer term, during which its economic growth rate progressively (and unevenly) will continue to slow - a scenario in some ways similar to Europe's stop-go real economic long term trend, as evidenced by the latter's drift toward deflation.

The two region - China and Europe - are connected in their mutual economic drift. Both heavily export dependent economies are locked in a mutual embrace and slowing. The two in turn are joined to the third global economic storm involving key emerging markets elsewhere in Asia and Latin America. As Europe deflates and China slows, the eminent contraction of emerging market economies is a third front converging on the other two, raising the prospect of an intensification of the Euro-China trade slowdown connection.

3. Barometric pressure is rising in the emerging market front as a result of the general leak in the business press last week that the US Federal Reserve may plan to reduce (taper) its QE monthly spending another notch at its upcoming January 29, 2014, meeting. The equity markets didn't want to hear that. They no doubt thought the Fed's December "token taper" (reducing its monthly QE buying by only $10 billion, from the previous $85 billion a month) was the endgame for a while. To hear more taper may be on the agenda so soon raises uncertainty about what may lie ahead. And when the Dow and S&P are already at "bubble highs" of their own, it doesn't take much to spook the stock market herd into taking their money and running to the sidelines, which is also exactly what began to occur at the past week's end. The worst than expected data out of China and growing talk about deflation in Europe further tipped the herd psychology scales in the equity markets last week. And there was yet a fourth development, which will potentially have a greater impact in the short run that spooked the markets last week and may do so even more in the weeks to come short term.

4. Directly related to the Fed policy, the emerging markets problems have begun to intensify once again. Already volatile and wobbly from 2013's "on again-off again" Fed taper indecision, currencies have begun falling again from Asia to Latin America to Turkey and other points east, as it becomes clearer that more tapering is coming. Even though the Fed has given the emerging markets nine months to prepare since last May, they have been able to do much in preparation. Consequently, the massive dose of cheap capital that flowed into emerging markets after 2008, made possible by the Fed and central banks worldwide in the form of QE and near zero interest money policies, is now reversing rapidly and flowing back to the US and the "west" again. Falling emerging market currencies are the consequence, not only due to accelerating capital flight but to declines in capital "inflows" as expectations of rising interest rates (and slowing economies) in the emerging markets redirects global investment away from emerging markets. Emerging markets' slowdown mean less demand for both US and European exports, and fewer profits for western corporations in those markets that have been so lucrative since 2009.

In other words, a perfect storm may be brewing that will slow global trade in 2014, with consequences for mega-regional domestic economies like the Eurozone, China and Emerging Markets. The Eurozone's nascent "recovery" may be challenged, China may slip below its strategic 7.2% GDP threshold, and Emerging Markets' real contractions may prove more serious than anticipated. The question is how will the US economy perform in the face of the "worst case" scenarios, and as the Eurozone-China-Emerging Markets feed off each other in a negative way?

One predictable consequence will be the effects on US equity markets, already looming large. Already the events in China and Emerging Markets have begun to take a toll, as the "herd" runs for cover. And that run may just be beginning.

A correction of 1000 points or more in the US Dow average will have a negative impact on the 10% wealthy households' consumption levels, which has buttressed a consumer sector in the US that has been overly dependent on that group, on credit growth in general, and on retail and auto discounts in particular.

Considering the real side of the US economy, the housing market in the US has clearly lost its early 2013 momentum and will no longer in 2014 provide even the mild contributing factor to US growth it did last year. Questionable as well is US retail sales, which turned in a poor fourth quarter 2013 when adjusted for retailers' last minute discounting. Auto sales in particular performed poorly at year's end and are questionable going forward. And the exceptional gains in business inventory investment that occurred in the last half of 2013 will almost certainly not repeat in coming months.

Neither positive or negative, entering 2014 the US government at least decided not to shoot itself in the "fiscal foot" again for the coming year-backing off from austerity during the 2014 election year as it did in 2012, another fiscal contraction will wait until the next "odd" year, 2015, before Congress reloads its austerity gun and shoots its other economic foot once more.

On the positive U.S. growth contribution side, there's oil and shale gas production that will keep industrial production from falling and will subsequently boost US exports as Congress lifts quotas later this year. And the government can rely again on its 2013 redefinition of investment in its GDP calculations that provides a fictitious additional $450 billion a year R&D spending boost to US GDP numbers. Meanwhile, on the jobs front, benchmark revisions to the US jobs picture next in early 2014 should statistically smooth out December's disastrous low 74,000 job creation - even though it won't represent real jobs creation while hundreds of thousands more in the US will likely continue to drop out of the labor force altogether.

In short, the picture for the US is mixed at best, as it has been for four years past. It is not a scenario in which the US current, historical sub-par "recovery" is strong enough to successfully offset the "perfect global storm" brewing elsewhere now in China, Emerging Markets, and the Eurozone's real economy. It may even result in the US once again slowing in terms of growth, thus continuing its "stop-go" economic recovery trajectory of the past four years-i.e. what this writer has analyzed and predicted elsewhere as an "epic" (as opposed to "great") recession.

Explanations of new emerging trends are not to be found in past historical events or metaphors, as is so much the tendency of mainstream economists of late. The explanation of Europe's current economic weakness does not lie in trying to impose some kind of "Japan Balance Sheet Recession" of 1990-2001 model on a European template. Nor can what's reoccurring again in Emerging Markets be explained by resort to the "Asian Meltdown" events of the late 1990s. Nor is China's current struggle with its shadow banks a replicate of the US experience in 2007-08. Economists, like generals, are too apt to look at the last war as a way to fight the next.

But as Europe slow slides further toward deflation; as China output, exports, and growth slows; and as emerging markets enter a phase of accelerating capital flight, plummeting currencies, rising rates and slowing economy, it will be interesting to watch how the Federal Reserve responds to it all next week and in coming months under the new Janet Yellen Fed (and her "Richilieu-like" partner, newly appointed vice-chair, Fischer). Will it choose to take another bite out of its QE poison apple in its final meeting with Fed chairman Bernanke before he retires at the end of this month? Will it introduce another "toe in the water" taper, as last December? Or will the Fed retreat once again, as it did last September and June 2013, in the face of rapidly unwinding equity markets, increasingly volatile emerging markets, and slowing consumer spending in the US?

Meanwhile the real global economic perfect storm outside the US will continue to build momentum - converging the respective problems in emerging markets, China and the Eurozone that will almost certainly become increasingly interdependent.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.