Is time running out for developed-world economies?

AS AUSTRALIA’S miracle economy chugs along at twice the clip of its developed-world counterparts, markets remain absorbed and unnerved by events overseas – and as easily spooked by Armageddon scenarios as they were during the financial crisis.

The latest Armageddon theory hails from Raoul Pal, a hedge fund whiz kid who retired to the Valencian coast in 2004 at the age of 36 to pen a newsletter on macro-economics.

As a former alumni of the ”giant vampire squid” Goldman Sachs, Pal enjoys some degree of market cred, though it should be said that his conjecture about the future is just that, conjecture.

According to Pal, it’s time to plant the vegie patch, shovel out the bomb shelter in the backyard and stockpile the tinned beans. The banking system will collapse in months, sovereign states will default like dominoes and paper money will be rendered worthless.

”The problem is not government debt per se,” he says. ”The real problem is the $70 trillion in G10 debt is the collateral for $700 trillion in derivatives.”

Besides some perspectives on the terrifying leverage in the financial system – there is no secret in that – the presentation shows some foreboding-looking charts, with distinct head-and-shoulders formations – often a sign for technical analysts of an impending crash.

The failed policies of governments and central bankers since the GFC have sown fertile ground for Pal and the purveyors of Armageddon.

Constant protestations from European leaders, among others, that everything is just about to be resolved only lend further credibility to the super-bears every time official assurances are found wanting. The opinions of the market machine – banks, institutions and bureaucracies – and the mainstream finance media likewise.

During earlier cycles – during every economic cycle in history, to be precise – information had been controlled by the establishment. At the same time as the economic mainstream hopelessly failed to see the GFC coming, internet penetration was hitting its straps.

Now it is mainstream. Now contrarian viewpoints are ubiquitous. This has brought an erosion in confidence, which is not so much a bad thing as an inevitable thing. Thanks to the market machine, asset prices and leverage had run too high. Prices had to burst.

It would be hard to break it out, or quantify it mathematically, but share prices no longer carry the premium they did for good news. There is more bad news about, not simply because of the upheaval in financial markets, but because contrarian opinions are so prevalent.

Ten years ago it would have been anathema – the domain of crackpots only – to criticise the US Federal Reserve. Alan Greenspan was beatified as a hero of the markets for his low interest rates, in retrospect a foolish approach which sparked the bubble in the first place.

Now the crackpots of the boom call themselves the realists; indeed their predictions have proven more correct than the economists, and the Fed is subject to daily excoriation online. Chairman Ben Bernanke might be called ”Helicopter Ben” in the mainstream. In the blogosphere he is ”Chairsatan”.

It is now game-on between the sheep of the establishment – with their forecasts huddled in a herd – and the wolves of the hedge funds talking up their short positions and pointing out the negatives.

The revolution in information technology will draw out any recovery as confidence is now so easily undermined. The other thing to have changed since the GFC is that leverage has been transferred from banks to sovereign states and it is Europe’s banks in biggest trouble. Moreover, the economic fortunes of the big developing nations, China and India, are on the slide.

Since Pal delivered his The End Game Armageddon thesis in Shanghai last month, further economic data has corroborated the bearish trend in China and India. And the banking crisis in Spain, as Pal predicted, has got worse.

As investors are now more timid than ever, nursing their bruises from the latest share ructions, market sentiment is as susceptible as it ever was to Armageddon scenarios. They are whipping anxieties to a point only felt during the financial crisis four years ago.

The truth and the reality, as always, will fall somewhere between the wolves and the sheep – somewhere between Armageddon peddlers and the cusp of the bull-market scenarios expounded so tirelessly by the mainstream rhetoreticians.

The world is deleveraging and can’t rely on expanding credit to fuel the same rate of recovery as in previous cycles. The sweet paradox is that the markets can either go up or down, yet despite this elementary choice which daily bewitches the world’s most highly paid pundits, they always get it wrong. The direction may be a 50-50 but nobody can ever predict the timing.