Economic Risks Are Growing Fast
There are more risks to our economy right now than we have ever seen
The weight and breadth of potential economic risks have never been quite so great for our economy. This is true even when you compare our current situation to some very difficult times in our past, such as the Great Depression, the popping of the Dot Com bubble, and the mortgage meltdown of 2007/2008.
There is a big difference between earlier cycles of hardship and the situation we find ourselves in now. Back in each of those dark periods in our economy, the individual American consumer had less debt, the federal government was in a much stronger financial position, and the Federal Reserve had the capacity to boost the economy through measures such as quantitative easing and by lowering interest rates.
Right now, the American government is tapped out in terms of potential responses to any recessionary or economic risks. There is little they can do which has not already been tried (and failed).
We find ourselves in a situation where we are much more vulnerable and exposed. After the regulatory bodies such as the Federal Reserve have run out of bullets, it becomes anyone's guess as to how they may attempt to handle future risk events, and even whether or not those tactics will eventually prove successful.
Recently, there has been an overall changing of the focus and beliefs of the masses in many locations worldwide. This fact has manifested itself in many recent events which we have all borne witness to: the 'Brexit;' the election of our new President; the rise of far-right political groups all across Europe and worldwide; potential tariffs and trade wars.
Now in this new world order, we are staring right in the face of many scenarios which could lead to increased risk, if not act as detrimental forces to our economy and the economies of other nations around the globe. Some of the potential landmines which everyone should be keeping an eye on include, but are not limited to:
The "Q Ratio"
Simply put, the Q Ratio takes the value of all the assets of companies on the stock market, compares that to the cost to replace all those assets. By its nature, the Q Ratio should never be above 1.0, and any such levels will be unsustainable.
In the six times where the queue ratio hit 1.0 or higher, it was followed very soon by a significant stock market correction. The crumbling prices decrease the value of the stocks on the market until their Q Ratio drops as low as 0.3.
In other words, a Q Ratio above 1.0 is heavily overvalued, and it typically responds by returning to highly undervalued territory of 0.3 or so. This wouldn't even be an issue or concern whatsoever, except for the fact that right now the Q ratio is at 1.01.
Velocity of Money
The velocity of money will show you how many times a single dollar spent through the economy per year. If the restaurant owner pays the handyman, and that handyman uses that dollar to buy groceries, and the grocery store owner uses that dollar to go to the restaurant, that will be a velocity of 3.
Any time that the velocity of money falls significantly enough, implies that we may be in for a recession.
The velocity of money reached a peak of 10.67 in 2007. Since then, it has endlessly slid to 5.7, the lowest we've seen since the recession began in 1974. This may imply a stock market crash is on the way.
Weak Dollar Policy
For the first time in several decades, the President has indicated a bias towards a weaker dollar. The nation who has a stronger currency finds it harder to sell their products and services overseas, while those with weaker currencies tend to see increases in their export trade balance.
The problem is not a weak dollar policy on its own. In fact, it does make some logical sense, and could potentially be helpful to some corporations and individuals.
The issue is that the announcement came suddenly. Any time a policy shift is indicated to occur over a sudden or very short time period, there will always be growing pains for the nation involved.
Companies which manufacture goods in America will benefit from a weaker dollar policy. However, if they buy supplies and resources from overseas, even the U.S.-based corporations will see their costs rise at the same time.
It is too soon to tell exactly how weak dollar policy will play out in effect all the corporations here in America. We can know is that it will help some while hurting others, and the most we can hope for is that the net result is an overall positive one or that it is a negative one.
Prime Minister Modi in India has recently embarked on a campaign of demonetization. The government canceled certain currency bills, without warning—the 500 and 1,000 rupee banknotes instantly and officially lost their status as recognized currencies.
New Rs 500 and Rs 2,000 rupee notes were introduced, which were given to owners of the demonetized bills as exchange/bank credit. Individuals could trade in their demonetized notes for the new ones, but only at low transaction volumes, subject to daily maximums.
The idea was that this would be very detrimental for counterfeiters and people engaging in illicit activities, and in that since the demonetization process would very likely be successful. Of course, there is the potential unintended consequence of the Indian economy dropping to its lowest productivity level in recent years.
As well, there are massive lineups at banks and civil confusion and mild unrest. The world's most highly cash-based economy will take a while to adapt to the surprising change.
This is not the first time that India has demonetized portions of its currency. The country took similar actions in 1954, and in 1978 as well.
While the act of demonetization will undoubtedly be very problematic for many in the population of India, on balance it should be a good thing to fight counterfeiters and criminals, who store large portions of their wealth as cash. Unfortunately, most of these negative actors keep as little as 6 percent of their wealth in cash, according to the Central Board of Directors Taxes, who argue that this process will not hurt illicit activities as much as it will be detrimental to the average Indian citizen.
While it sounds like it's a world away, and certainly is not our problem on first glance, it could become an issue if the economy of India slows as a result. At a time where the world needs growth from all of the major economies, it could become problematic and potentially exacerbate other situations if the nation's growth rate drops. According to CNBC, India is going to see its lowest growth since 2011, in the shadow of demonetization.
There are never any winners in war. Likewise, there are never any winners a trade war.
The potential for a trade war between the United States and other nations around the world has increased significantly since the election of the new American president. Already there is a discussion of tariffs on goods made in countries such as Canada, Mexico, China, and several others.
The list grows by the day. So too does the list of countermeasures which nations such as China have already expressed that they will take in response.
Just like worldwide currencies war started a few years back, we are now entering a period of trade wars. These economic conflicts of already begun, but they will almost certainly increase in intensity going forward.
Negative Interest Rates
Something which has not happened in our world's economy ever before has quickly become much more commonplace. There are now negative interest rates in Switzerland, the Euro Zone, Sweden, Japan, and Denmark.
Basically, you are paying the bank for the right to keep your money with them. Based on the depth of the negative interest rate, when your bond matures you will receive the majority, albeit only a portion, of the amount of money you put in in the first place.
You may buy a $1,000 bond which matures in five years, and when the asset reaches maturity, you are only returned $950.
Early on, the biggest concern with negative interest rates was that there would be a run on the banks. Since this did not occur, many nations have become emboldened to follow the same path.
In addition, they also may push their current interest rates into even deeper negative territory, as they see fit. Even already negative interest rates can get even more negative.
Part of the "logic" is that if savers know their money in the bank is slowly declining, they would be more likely to take that money out and go spend it on things. This, in turn, would be expected to boost the economy.
It is actually a known fact (but apparently not equally understood among decision-makers of economic policy), that negative interest rates backfire. The practice tends to spook consumers about the economy, who in turn are more likely to hold onto their money for longer and put off significant purchases.
Most banks, especially in the European Union, are in much worse shape than the majority of people realize. Deutsche Bank, for example, has more money in derivatives than the entire GDP of the German nation. Italian banks are just as bad off, and there are similar concerns with institutions in Spain, Portugal, and Greece, among others.
If any of these banks fail or are forced to default on what they owe, it could potentially set off a domino effect between other closely-connected banks due to the resulting contagion forces which would be experienced. If Bank A cannot pay bank B, then Bank B cannot pay Bank C, and so on.
As the fiscal situations of many of these banks deteriorate, they have fewer options and actions which they could take to ensure the stability of the various underlying and connected economies. Any single credit event could potentially lead to a "grass fire" of further similar credit events, which potentially could span and impact the entire world's economic system.
Fracturing the European Union
The "Brexit" (United Kingdom leaving the EU) was the first crack in the European Union, but there will probably be more to come. For example, the "Grexit" (a Greek exit from the EU) is growing more likely by the week, and there potentially could be other nations pulling out of the European Union, such as Italy, Spain, and Portugal.
All of these nations have populations who are increasingly more open to leaving the Euro behind and reverting back to their original currency. As well, these countries are in extremely weak financial shape, and only survive economically be getting massive loans, and subsequently becoming even more indebted.
What to Do?
Opportunities will come out of these situations as possible downsides play out. And if that happens, confidence in currencies might drop and shift towards precious metals like gold. This could make commodities more attractive investments for storing wealth and protecting wealth against global shocks to the economy. In the meantime, if you want to be cautious, it could be good to limit exposure to assets at potential risk—including luxury products, retail, restaurants, and consumer discretionary stocks.