An Increasingly Dangerous World

Update: The UK announced a Brexit referendum vote for June 2016, much earlier than 2017. This decreases the chance of the UK leaving the EU to about 50%, given the European financial problems won’t climax yet by then.

 

I thought I’d write down a list of major geopolitical and economic risks that could inflame at any moment and cause serious market worries.

At the end I also talk about how I see the pending crisis unfolding and the global economic risks. This new crisis will last for a decade or more. And it will be a process like nothing we’ve ever seen.

There is only thing holding back the world fromĀ  utter calamity. And that are the central banks. So the entire thesis is centered around the idea, can they save us? Again. Do they have the tools left, after nearly 8 years of radical experimental fiscal policy?

Can they erase the tens of trillions in bad loans and toxic debt? Can they neutralize the negative effects of the historic growth of global debt – from governments to corporations to individuals. Can they overcome the self-induced over-investment and over-capacity brought about by their own policies, which resulted in the greatest commodity and oil wealth destruction in the history of the world? Can they prevent the asset bubbles they have inflated through over 7 years of zero and now negative interest rate policy, coupled with the nearly $10 trillion in new quantitative easing money printing globally?

Looking at the tools they have, plus historic and creatively imagined new ones, I don’t see how they can prevent this calamity from unwinding itself. It’s easy to inflate balloons. It’s infinitely more difficult to prevent them from popping and deflating. Eventually all bubbles burst. And neither God nor the Fed nor any central bank or government can prevent it from happening.

The objective, mathematical definition of a bubble is defined by exponential growth, without underlying exponential support. That is what a bubble is.

And based on this definition, we have (some have burst already) bubbles in global real estate, stocks, corporate bonds, commodities, government debt, even art and expensive collectibles, plus I’m sure I forgot some. Because all of these exponential asset growths have not occurred with a corresponding exponential growth in GDP or underlying fundamental demand. They were merely caused by free easy money. And too much of it.

People will use all kinds of metrics to say this or that isn’t a bubble. Use simple mathematics of exponential growth being supported by underlying exponential fundamentals. They don’t exist. Economists have all kinds of silly metrics that always fail to see the true nature of bubbles. That’s why we constantly get them. And only afterwards do they say, “Gee, nobody saw that coming.” Yeah, sure.

Fool me once, shame on you. Fool me twice, shame on me, as the old saying goes.

Geopolitical Hot Points

Anyway, here are the major geopolitical risks I see moving forward. We will cover the economic risks later.

1. Turkey/Kurds/Syrian Kurds

The developments in Turkey and Syria as it relates to the Kurdish region is alarming. Turkey is a key NATO ally so it has massive significance to the world.

The domestic violence and terrorist acts (depends on whose perspective as far as labels) in Turkey, no doubt backed by the separatist PKK or Kurdish political wing within Turkey, have been escalating for several months now. And now with the growing power and influence of the Iraqi Kurdish population – largely due to US backed support to help fight Iraqi insurgency and ISIS – has created problems within Turkey. The fear of a Kurdist separatist movement to unite the Kurds living in Turkey with those in Iraq is growing stronger. Turkey fears this greatly and will do anything to stop it.

This fear, which is largely founded given the Kurdish goal, is resulting in a very high risk of complicating the situation in Iraq and fight against ISIS. On the one hand, we have US backed Iraqi Kurds, who have largely been the only group to show any success againsy ISIS, getting stronger politically and militarily. And the probability of a unification effort with Turkish Kurds seems quite high in the coming years. Yet, on the other hand, Turkey is a key member of NATO and essential to this war against ISIS. But Turkey’s priority is the Kurds, not ISIS. And given the unusually direct and un-toned down political speak coming from the Turkish president and leadership, being extremely critical of US actions, it seems this conflict of interest is about to blow up.

Turkey is getting ready for a ground invasion and offensive in Iraqi to combat the very Kurds the US is supporting and enabling. Indirectly, this means Turkey is acting with hostility toward US goals, trumped by their own vital domestic interests. This new chapter in the conflict has the real potential to escalate into an outright civil war in Turkey and with an exponential increase in terrorist attacks. It could really put NATO in a strange untenable situation. This could also completely destroy any success the West has been having in the fight against ISIS.

To me, this is the biggest geopolitical risk given Turkey is a key part of NATO and a part of Europe. They are vital to Europe’s security through the control of borders, and a Muslim bridge to the more radical elements in the Middle East.

2. UK leaving EU

I foresee about a 90% chance of the UK leaving the EU.

By the time the “Brexit” vote comes around, likely in 2017, Europe will be a mess. We will talk more about the European banks and economic issues later. But economically, the EU will be in shambles at that time.

Furthermore, the open borders is a serious issue for the UK, and greater euro-zone. It is the most fundamental issue, even more important than the economic side. The heavy migration of middle east refugees throughout Europe, as well as the huge influx of Eastern European immigrants westward is creating intense nationalist feelings. These won’t go away, but will only intensify.

Add on top of all this the ISIS and terrorist threats, and it seems almost certain Brexit will happen. As ISIS experiences greater defeat in Syia, they will do 2 things. First, the will move to other regions such as Southeast Asia and Africa, and other tumultuous Middle East countries. Second, they will export terrorism to the West in far greater numbers. And the West will be largely powerless to prevent these attacks, because the style and sophistication is impossible to prevent.

All these factors together spell the beginning of the end of the EU and the unification experiment. Greece and the southern Europe crisis was just a prelude to a much greater problem down the road.

Essentially, the fundamental premise of the EU was flawed. It never had a chance to succeed as originally structured. Too vastly different countries, cultures and economic systems, ruled by a single institution and system. It would only create two extremes, the northern countries would flourish at the expense of southern European members.

And yet, the loss of border integrity is at the heart of national sovereignty. So the EU structure essentially disabled sovereign nations’ ability to protect and maintain its borders. Economic interests can only override political and national needs for short periods of time. In times of peace and prosperity, the time following the Cold War, these issues weren’t primary. The world has changed and is going to continue to change in the opposite direction moving forward. Under this reality, the EU structure has no chance at survival. The Brexit vote is merely a symptom of a much larger fundamental problem in Europe.

3. North Korea vs South Korea/Japan

Kim Jung Un is a bit crazy. At least his father, Kim Jung Ill was older and wise enough to know how to push the west – to bend but not break the strange relationship between North Korea and its neighbors and the West.

I used to think the situation in North Korea didn’t matter politically or economically. It was merely an global side show. I’ve recently changed my opinion on this. It is has now become one of the most threatening theaters of geopolitical risks. This is largely due to the convergence of nuclear capabilities of the North, coupled with enhanced delivery systems, and all led by a growingly unpredictable and more unstable leader.

One day, I would not be surprised to wake up and hear that the North has started artillery shelling of Seoul. I used to think this was unimaginable. No longer. The devastation this would cause cannot be overstated. Both physically and economically, globally.

The chance of real conflict, perhaps war, within the Korean peninsula is at the highest it’s ever been since the truce following the Korean War in the 1950s.

And I am increasingly skeptical over the world’s view that China has nearly complete control over North Korea. I think even China has lost most of its influence and control. The other day, I read that China is preparing to send troops near thr Korean border in case of an outright war.

4. Ukraine/Russia

Escalation could be damaging to both countries. But at a time when there is growing talk of sanctions relief for Russia, driven mostly out of fear their economy may collapse (which is bad for the world), this would force the West to tighten sanctions or become more involved militarily from a NATO perspective, via arms sales or even military advisers to Ukraine.

Plus the recent aggression by Russia to all its European neighbors, particularly the former Soviet Baltic states, could create a lot of instability in the region, affecting Europe as well as the entire West.

Russia is a wild card. Their increased hostility is strange. And as their domestic economy teeters on collapse over the next 2-3 years, God knows what Putin may do. He is calculating and never arbitrary. Which is exactly what concerns me. He will not stand idly by as his country crumbles, and everything he has worked hard to build up over the past 2 decades, to reestablish Russia as a global power and influence, falls apart. He will not stand by and watch this without something drastic. War. Expansion of aggression. Territory expansion.

When a lion has been backed into a corner, never underestimate its potential for ferocity.

5. Brazil political instability

Brazil is in the throws of the worst recession in the past 2 or 3 decades. It’s bad. Brought about due to the commodity collapse and post China boom. It’s not going to end.

Inflation is double digits. The economy is shrinking fast. The currency is weaking rapidly. And the Zika virus couldn’t have come at a worse time. Even if the “bite” isn’t as bad as the reality, the psychological element of this virus, just prior to the critical Olympic summer games, is going to be devastating.

I was planning on going to Brazil and South America later this year as part of my global tour. I’ve changed my mind. The Zika virus terrifies me more than AIDS. Having deformed babies is worst than death to me. And God knows how much mosquitos love me.

All of these things are converging to create immense political and social instability. Brazil will go bankrupt. The economy will only get worse. And the end result is likely a very leftist socialist government siezing power.

Brazil is important because it’s the largest economy is South America. And they are owners of a lot of foreign debt – American and European, Chinese, etc. What happens in Brazil will affect the world greatly.

6. Saudi Arabia vs Iran proxy battle

The transformation of the Middle East is happening. The ending of Iran sanctions couldn’t have come at a more tumultuous time. The timing of this event is curious and stupid.

Iran will emerge as the regional super power, changing the region and the world in unforseen ways. Obama is an idiot to enable an a vowed enemy of America to become the most significant player in the most violent and critical region in the world. Oil will still be vital for the world for decades to come.

Saudi Arabia will fall. The kingdom is doomed. The rise of Iran will ensure this. I’ve said before this oil price war is about far more than market share. It is at the heart of this proxy war with Iran and Russia (allies) for regional dominance. It will fail and end up crushing the Saudis.

Saudi Arabia is running huge deficits. And they are saddled with a heavy burden of large handouts and welfare to its citizens to maintain social stability. They are rapidly dipping into their oil sovereign wealth fund. It will be all gone in as little as 2 years. Faster if this war with Syria and Yemen intensifies. And this in a world of low oil prices, likely for the next several years at least, spells doom for the Saudis.

Iran has learned how to survive under harsh economic conditions due to the sanctions. Saudis are completely dependent on oil wealth to maintain power.

Once the Saudis fall, American influence in the region becomes a shell of itself. Chinese and Russian influence will be the new order. It will create global economic uncertainty. Keep in mind the entire American Middle East policy was due to the energy shock of the 1970s which destroyed our economy and sent inflation up to high double digits. And because of this influence and willingness to even wage war for this national interest, we’ve been able to maintain consistent access to the lifeblood of our economy – oil.

Just because oil is down a lot and will be for 2-3 years possibly, doesn’t diminish the importance longer term for the commodity. We have undone what we have won through multiple wars, countless loss of lives, and trillions of dollars spent.

Why? is still the biggest mystery of this Obama objective. I cannot fathom this policy decision. I believe it is the worst foreign policy decision since WWII and allowing Russia to sieze and control East Berlin and much of Eastern Europe. We will rue the day. The world will one day regret this decision immensely.

7. Greek being kicked out of EU Shengen zone

The EU members who have been trying to oust Greece from the Eurozone, due to their fiscal irresponsibility, now have siezed on the opportunity to cut them out of the passport free Shengen zone. This is the beginning of the end for Greece as part of the EU.

It also begins a new chapter for the 28 member bloc. Instead of growing and adding members, this trend will reverse, as members begin to be expelled or voluntarily leave.

The EU experiment is near death. Immigration, banking crisis, huge disparity between countries was just too much to bring under a single umbrella for too long.

The ECB and their irresponsible monetary policy will ultimately undue the entire union. The handling of the 2011 southern European crisis was the nail in the coffin that didn’t become visible until years later. The toxic debt on the balance sheet of the ECB, as they purchased every type of toxic European debt possible it seemed, will bankrupt the institution. And the political backlash will be too difficult to overcome to further fund this dysfunction institution.

The ECB will die together with the Euro.

8. China and South China Sea

As China’s economy deteriorates further over the coming years, this regional issue will become much more significant. It is China vs Japan, Taiwan, Thailand, Malaysia, India, Indonesia, pretty much every Southeast Asian country who has some claims to the territorial disputes. Increasing military abrasion could eventually lead to something much worse. The Chinese leaders will grow desperate as their economic miracle is in shambles in the coming years, and the unspoken contract with the people is severely strained. This coupled with a lessening trade dependency on China, will create more hostility in the region toward a much more asssertive and poweful China military presence.

At some point, China WILL challenge American military supremacy in the region. How we react depends on who the residing president will be.

As Japan’s economic woes deteriorate further, their movement toward greater military strength and assertiveness in the region will also play a huge role. Both Japan and China will need economic distractions. How this plays out, I don’t know. But there are a lot of variables, and a lot of different ways it could end badly.

9. ISIS attacks in Europe

There are going to be many ISIS terrorist attacks in Europe over the coming year. As the war in Syria gets more desperate, and as losses mount against the Western coalition, the exporting of terrorism will increase. This will create economic fear and uncertainty. This isn’t a black swan event because it is almost certain to occur. The breadth and frequency of attacks will be the concern.

When I was in Vienna, I saw the demographics of the Syrian refugees. There were hundreds of refugees, mostly from Syria. The overwhelming majority of these refugees were young, single Middle Eastern men. Not families or women and children. There are hundreds of thousands of such refugees throughout Europe now. While I personally support the Syrian refugees due to humanitarian responsibilities we all share, we are being naive if we don’t understand that many of these men are ISIS plants. It has been discovered to be fact. But the numbers uncovered doesn’t reflect the true scope of the problem in my opinion. I saw first hand.

Trust me on this. I know exactly what I’m talking about because I saw it with my own eyes and the demographics were so obvious. I saw these men every single day for 2 weeks. Most were good people.

9. Spain Catalina secession movement

The relevance of this is really about prosperous regions disconnect with underperforming regions. Really in a greater context, it’s about North vs South. East vs West. And Catalina epitomizes this struggle within a single country. The greater fear is as conditions deteriorate globally, taxes and wealth transfer will become a hotter issue. It will lead to protectionism and secession talk. Secession of Catalina with greater Spain. Of northern Europe from the south. UK from the EU.

For the past 3 decades the global trend has been closer integration and globalization via free trade and the removal of barriers. This movement is largely stalled and will soon begin a vicious unwinding cycle.

We can see this in Europe. We can see this in America, with the popularity of non-establishment presidential candidates. As the currency wars heat up, protectionism will become the mantra. Globalization is about to soon begin a sudden reversal. The nail in the coffin was the end of the China golden age and the growth of international trade, leading to escalating currency wars now starting.

Mark my words, it is the beginning of a new phase in global economics.

10. The Southern EU Banking and Sovereign crisis

This crisis is hardly over. It may have been removed from the front page headlines, but the situation is actually more critical now than it was in 2011. The only difference is that the ECB has been buying periphery sovereign bonds to keep rates artificially low. In the meantime, sovereign debts have continued to rise appreciably, the banks are in horrible condition, and the ECB is now saddled with toxic junk debt backed loans. This will eventually, at some point, create a political backlash in Northern and Eastern European countries, as the European economy slows in 2016 and recession hits, bringing clarity to the scope of the disaster at hand.

Global Economic Hot Points

On top of all of these geopolitical worries, of course we have economic problems festering and growing larger:

1. China is a mess and slowing every month. Their debt has grown at record historical rates. It’s never grown so much, so fast. And banks are saddled with too much bad debt. Much worse than the western banks in 2008.

This will not end well. This affects the entire world obviously.

The currency will depreciate massively starting in the second half of this year. By end of the year, it will become clear China doesn’t have the foreign reserves to continue propping up the yuan. It will be forced to free float the currency. And this, together with the fact China has started a new policy of massive money printing to try and stimulate their economy, it will lead to RAPID depreciation of the yuan. It will create a new Asian currency crisis, similar to 1998, but about 100 times worse, because this is China, the world’s second largest economy, and not tiny inconsequential Thailand. It will be the nail in the coffin for the world economy.

In 2014, Russia started to free float their currency. Today, with the collapse in oil, and speculators betting against the ruble, the currency has fallen from about 30:1 to around 80:1 dollar.

The Chinese RMB could devalue by half in 2017. It will change the world.

2. Japan’s problems can no longer be ignored. They are getting to a moment of desperation with this failed Abenomics policy. I’ve said from day one it would end in disaster, and it’s becoming clear the end game is not rosy for Japan. But this desperation is going to be a problem for the world. They will become the most aggressive in this ensuing currency war. And it will create imbalances throughout the world. We can see the strains today.

Japan is engaged in the largest quantative easy program in world history (relative to their GDP as the world’s 3rd largest economy). Their QE program is 3X the size of the US Fed. It is also more aggressive, with the BOJ (Bank of Japan central bank) buying up virtually every kind of Japanese asset: Japanese government bonds (JGBs), exchange traded funds (ETFs), Japan real estate investment trusts (J-REITs) and corporate debt issued by Japanese companies. The BOJ currently owns $2.6 trillion, or 34% of all Japanese government debt. It will far exceed 50% by the end of 2017, as the BOJ steps up even bigger QE. The BOJ also owns about 60% of all Japanese ETFs!

It’s completely nuts. And the end result has been utterly the opposite of what the BOJ and Japanese government hoped for. The yen is much stronger. They wanted to weaken it to increase exports. GDP is in decline and another recession starting. GDP declined 1.4% in Q4 of 2015. Exports fell by over 12%! Japan is completely dependent on exports. And despite the BOJ buying Japanese stocks through ETFs, the stock market is down over 20%.

Nothing has worked.

Essentially, the BOJ or Japan central bank is the only buyer of newly issued government debt now. They have bought so much, it is approaching the size of their entire GDP or economy!

Plus Japan has long had the world’s highest debt to GDP already and an ever shrinking work force and severely aging population. They have the worst demographics from an economic standpoint.

With the slowdown in China, Japan will experience large economic contraction, exports will fall, and this perpetual QE program will fail. It hasn’t worked at all but they don’t know what else to do. It’s the moment of desperation.

3. Emerging economies are in near total collapse with the plunge in oil and commodities. Their fiscal situation is dire. The political situation desperate. The longer oil stays low and these huge deficits persist in a recessionary local environment, together with high inflation due to weakening currencies, this spells trouble for developed nations who export to these countries and also have huge foreign currency loans outstanding. The potential for social unrest due to economic suffering increases the odds of Leftist governments seizing power, increasing the probability of sovereign defaults and privatization of foreign corporate assets. It’s Venezuela and Hugo Chavez spread to greater regions.

4. Europe and the European banking crisis is just starting to come to the spotlight. But this has been brewing for years, since the last crisis. It is getting to become a serious problem globally. The bank profit models globally are in ruin. Moving forward, in this zero to negative rate environment, persistent slow growth and rising loan defaults, there is not a lot of good news to latch onto to.

The next crisis will likely be precipitated by failure in a major European bank. Eventually all major global banks will be pressured from collapsing assets they hold, and skyrocketing defaults from excess toxic debt.

5. Oil and commodities implosion will only get worse. There is no chance of a recovery. It must get worse before it gets better. This means massive bankruptcies over the next 6-12 months. Huge multi-billion dollar bankruptcies. I’ve said before 50-60% of energy companies will go bankrupt (much higher than estimates of 30%). And the bank exposures, through both the direct loan defaults, bond holdings, and insurance exposure through these credit default swaps, will destroy even the most well capitalized banks.

It won’t be just oil and commodities companies that will go bankrupt. Globally, there will be trillions in defaults. Non-performing loans will hit an ALL-TIME record, much higher than 2009. Barely a 6% non-performing loan ratio will destroy banks, as we saw in 2008. It will be much higher this time. It will be well over 10%. Enough to wipe out even the strongest and well capitalized banks.

6. Sovereign debt to GDP ratios of developed Western nations will become a problem in the downturn. They have only grown significantly since 2008. As they accelerate upward, coupled with a new awareness suddenly (soon) that these debt levels in the context of a slow growth global economy for decades are unpayable, a sovereign debt crisis will be the final leg. And the table will utterly collapse. This final leg will be in 3-7 years.

This ensuing crisis isn’t going to be a one year blip like 2008-9. This one will be long and painful. It will span many years. We are just now in the first inning of this crisis starting to unfold. There will be many phases. Many ups and downs. Many policy and government experiments – all trying to solve the problem with more debt and spending. They will all fail this time. Because there is no more headroom left. I suspect this crisis will endure for 1 to 2 decades. And we have a long way down to go.

There’s a lot to be rightfully worried about, and very few positive things we can latch onto in this moment.

But the real problem is that virtually all of these problems and risks are converging simultaneously. There is more risk and potential for “badness” today than I have ever seen in my lifetime. Which is why it’s so surprising for me to see how clueless the markets are to shrug everything off, pretending there isn’t a thing to be worried about.

This truly is a far more scary moment than 2008, or ever before in my lifetime.

Save this post, and one day you can pull it out and say, “Holy shit! That crazy bastard was right.” It’s not something I want to be right about.

Nobody likes downers. And gloom and doom is never popular. But sometimes we have to be realists, and adults who face the problems and risks, and hopefully prepare.