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Karl Denninger is an extremely gifted investor, businessman and technologist.  When he speaks about the economy I listen.  His latest video issues a dire warning to Americans.  I believe everything he has said is correct and aligns with projections I’ve made in the past.  Please give his video a view and consider the implications of this irresponsible monetary policy.

I would like to pose an important societal question to any banker that is willing to answer it:

Why are bankers increasingly hesitant to lend, even drawing back lines of credit, yet at the same time allocating a lot of funds in to commodities, especially oil?

Isn’t it true that oil and consumer consumption are closely correlated?

Are they seeing something that I am not or is this a bit of a logical paradox?  How can the banks create the growth they need for their trade (or investment) to be profitable if they refuse to lend to those that would spend it on consumables?

There has to be more than just dollar weakness factored in to this equation.

There are no shortage of credit problems to navigate through with mortgages (both subprime and now prime), credit cards and commercial lending, potentially indicative of a deflationary credit squeeze for the everyday person who will no longer be able to borrow to buy everything based off their future earnings or assets.  This contraction could also have very negative effects on small business growth and hiring, too.

It’s because consumers and small businesses account for the majority of the US economy that I think we are wise maintain a defensive posture as most of the multi-month rally’s asset allocation haven’t taken this matter in to focus yet.  I believe we are well out of bounds of realistic equity valuations and the dollar is being sacrificed by the printing press of the Federal Reserve, Treasury and Congress to temporarily support financial markets.

Once this liquidity flood induced euphoria wears off there will be severe consequences to the US currency, bond and equity markets that most investors don’t seem to be aware of or have not positioned themselves for.

Sources:

http://market-ticker.denninger.net/uploads/KeyCharts/Credit-y-o-y-large.png

http://www.federalreserve.gov/releases/g19/Current/

http://econompicdata.blogspot.com/2009/09/consumer-credit-freefall.html

http://www.marketwatch.com/story/troubles-shift-to-prime-borrowers-wsj-2009-09-04

http://www.boston.com/realestate/news/blogs/renow/2009/09/mortgage_market.html

http://www.reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSN0829660420090909

http://www.reuters.com/article/newsOne/idUSTRE58752720090908

At this point there is some distortion between energy and metals which have a direct relationship as energy must be expended to mine the metals. usually the ratio is 10x the price of a barrel of oil for an ounce of gold, but now it’s been in a range of 12.5x-15x.

Either oil is very undervalued (which is unlikely) or gold is overbought at these levels.

Today’s close of the stock markets and oil seems to indicative of a risk repricing that began last week.

960 (around the 50 day moving average) on the S&P 500 and $65 a barrel on light sweet crude are my downside targets short term, but if either breaks we could trade to much lower support levels.

In addition, when examining the huge sell off in natural gas prices, it’s near certain that energy has more negative catalysts than positive because industrial utilization continues to lag despite the green shoots propaganda that we keep hearing.

Finally, there are a growing number of bears calling for a shake out of March’s lows coming this fall because of a new leg down in commercial real estate that will bleed liquidity out of the equity markets and REITs.

With deflation continuing despite long-term zero interest rate policy, how does the new Japanese government plan to expand its efforts to revive economic growth and lower unemployment?

Is this our future?

Japan paints a very sobering picture of what the future of the United States may be facing in the future should this loose monetary policy continue unabated. Zombie banks, real estate bubbles, deflation and stock market collapses are all themes very familiar to the Japanese economy in the 1990s.

Unfortunately the circumstances are all too similar here at home. Adding to that Japan also has a large aging population that will soon outnumber its workers, akin to the situation we face in the United States. All of these reasons and more are why it’s important to pay attention to where the Japanese economy is heading.

Severe economic routs have no easy cure

Every time a massive speculative bubble implodes it leaves behind a tremendous amount of credit destruction, which in turn absorbs liquidity and pressures equities, corporate bonds and derivatives like credit default swaps. All of these circumstances potentially create deflationary forces that can shrink the capital base of a country and even create a banking panic. After all, debt is money in many modern economies. As that monetary base shrinks each unit becomes more valuable.

Mitigating the risk of severe economic contraction requires an innovative and careful approach to the underlying cause with attention to stimulating the next catalyst. Green energy is one of many appropriate catalysts for a non-speculative sustainable global economic evolution. Others include technology, infrastructure, education and health system improvements.

Japan must lead or become obsolete

For many years Japan has enjoyed the status of second biggest economy in the world, but that status is quickly fading as Japan’s export-based economy contracts in the face of a global recession and slumping industrial production.

The new government in Japan has an opportunity to reverse policy mistakes of the previous ruling party and create a sustainable economic model that is more focused on durable growth rather than speculation. This would prove to be a model for the rest of Asia if Japan can take the lead.

If Japan’s economy can not evolve and take the next step forward, China and other neighbors will gobble up the industrial production for exports that was once taken for granted.