JAPAN'S LATEST STUNNER

It came as complete surprise as many had never expected the BOJ to go into negative interest rates. But what would be ramifications? Wall Street seemed to like it as the Dow soared almost 400 points. As an economist, Peter Boockvar puts it, Wall Street liked it a lot when the ECB and BOJ weaken their currencies vs the US$, but seemed to freak out that China would also want a weaker Yuan.

Surely the double standard could not have been more prevalent. Didn't the US devalue its currency when it went on a series of QEs? It's often easy to blame others for the failure of oneself.

Let's explore the ramifications in detail:

1) The way I see it, the BOJ's action changes nothing. The world is still mired in excessive debts, and the global economy is much worse than before. US GDP dropped to 0.7% in the fourth quarter. I would expect 2016 first quarter GDP to be no more stellar than the fourth had been. In fact, I think the first quarter of 2016 will see further distress in the manufacturing, mining and energy sectors. The energy sector could potentially see massive defaults by the shale oil companies, which in turn could unravel the financial derivatives market.

2) Japan's major problem is its diminishing population count. The labour force is shrinking and thus the consumption by the working class. The elderly who have retired consume less than the working class, having to rely only on their retirement funds for their livelihood for the remainder of their lives. And by announcing negative interest rates, the BOJ has certainly made life worse for the retirees as their savings will be impacted by the negative rates.

3) Despite the earlier QE and Abenomics, wage growth has not happened. Without wage growth, how can there be increase in consumption to drive inflation. It is the past decades of failure that is driving the Japanese to save more because the economy is weak. When the economy fails to create wealth, people will avoid spending. Hence the deflationary pressure.

4) The BOJ's action is akin to forcing inflation on the masses. But when there is no wealth creation, the population will just save more, not in the banks, but in their own homes and reduce spending as this form of forced inflation will just make goods and services more expensive. So I anticipate the deflationary pressures will increase after the feel good moment dissipates.

As Peter Boockvar puts it, "Believing that generating inflation is a needed precursor to faster economic growth is nonsense. Inflation reads are symptom of the activity of the underlying economy.

Source of Peter Boockvar's comment: King World News.

5) But didn't the BOJ's action resulted in a massive US rally?  Big deal. Enjoy it while it lasts. As many economists would concur, the action of the BOJ has just unleashed a currency war in a race to the bottom. After the cheer is gone, the US will be faced with the stark reality that its goods and services have just been made more expensive by the strong US$, and this time the Fed will have to response with a possible QE4 with NIRP. The action of the BOJ has also open the gates for China to devalue its currency. Previously, China was trying to defend the Yuan, piling billions of US$ to defend it. The BOJ just has made it easy for China to abandon defending the Yuan, as now they could blame the BOJ for starting a currency war. This will snowball onto the rest of the EM economies, the result of which will be a global deflation.

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THE FED AT NEAR BREAKING POINT?

This is a section of the Fed's Balance Sheet. look at the Total Liabilities vs Capital. The Fed is leveraged 112.6 to 1.0! Several months ago it was just 77.0 to 1.0!

The Fed is almost broke!

There is also an issue of US$19.5B being siphoned off its surplus. Apparently to fund spending after Congress and Senate reached an agreement on the budget (Source: King World News).

WHY US DEBT IS NOT SUSTAINABLE

The following data are taken from www.usdebtclock.org which gives a live count of US debts and tax revenue.

Total US Debt: US$664.7T which include the Government, corporate and citizens debt.
Total US Government Debt: US$18.9T
Interest Paid on Federal Debt: US$0.23T
Total US Federal Spending:  US$3.8T
Total US Federal Tax Revenue: US$3.3T
Total US Federal Deficit: US$0.5T
Total US Interest paid US2.4T

It is interesting to note that the Federal interest paid accounts for 7% of the tax revenue. With a budget deficit of US$0.5T a year, how can the US pay off any of its debt due in any of the years? So US has to take in more debts to repay older debts and this will add further to the burden in interest payments.

WSJ did a projection in interest payment in a report in February 2015, and it does not look good.



Another report by The Daily Signal shows the amount of debt accumulation by the US until 2026:




The above is based on a projection by the Congressional Budget Office.

However, should the economy suffers a slow down, tax revenue is bound to fall short. In such a scenario, the deficit could balloon to higher than projected. Similarly, any increase in interest rates will add to the burden of servicing the debts.

The US debt is clearly unsustainable. it is all just a matter of time when all come back to roost.

A HOST OF UNWELCOME DATA FROM CHINA

GDP 6.8% , 2015 full year GDP 6.9%, the lest since 1990.

Industrial Production in December 2015 grew 5.9% vs 2014. November 2015 was 6.2%.

Retail Sales grew 11.1% vs 11.3% estimate.

Fixed investment grew 10% in 2015, the slowest pace since 2000.

The chart (source: Bloomberg) below is cause for concern:

WILL SHALE OIL DEFAULTS UNRAVEL THE BANKS?

With oil price hovering near the US$30 per barrel range, intense pressure has shifted towards the shale oil producers, once touted as the swing producers, the US shale oil companies are facing the potential collapse, wrought on by years of over leveraging and unabashed borrowings.

According to The Wall Street Journal, total debt among US and Canada oil producers amounted to US$353B for the period from 2010 - 2015.

Bloomberg recently compiled  alist of shale oil producers and where they stand when it comes to their level of debts (source: Zerohedge and Bloomberg):



Notice that the size of the borrowing shave shrunk as banks moved into panic mode? With reduced borrowings and a falling price, it is doubtful these 25 companies listed above can survive past 2016. A falling demand for high yield junk bonds has not helped these companies either as investors shun high yield risky investments.

According to Fadel Gheit, a senior analyst at Oppenheimer & Co, one half of US shale oil producers will not survive the ongoing oil price plummet.

But what about the impact on banks.

So far, several banks have indicated that they will increase their provision for doubtful debts, chief among them:

Well Fargo, which reported a US$17B exposure on energy related loans and currently incurred a loss provision of US$1.2B in its energy related portfolio

BOK Financial Corporation advised its investors that it will be making aprovision for credit losses amounting to US$22.5M

JP Morgan too made similar provision amounting to US$89M.

So as shale oil companies face potential default, could banks be the next victim? We will know in a quarter or two.

I will be looking at a short financials ETF if more banks make further provisions for energy related credit losses.

The above is just my opinion. You advised to do your own due diligence.

CONSUMPTION COULD FALL NEXT?

Walmart to close 269 stores
Kmart to close 27 stores
JC penny to close 7 stores
Macy t close 35 stores

For those who still believe the US will hike interest rates this year, think again. This is a glaring telltale sign that the consumption driven economy in the US is going to fall off the cliff. Earlier I posted that the middle class in the US has shrunk more than 10% compared to the period in 2008 and the next worth is unchanged at the same level of the late 1980s. There is no wealth creation among the middle class in the US despite QE1-3!

The GDP to monetary base is yet another sign that all is not well in the US. When monetary base is enlarged but there is little or no wealth creation, it tells a very damaging story about the state of the US economy.

The Baltic Index gave the first hint when it started towards record new lows.

Buckle up. This is going to be a very tough year.