Monday, June 29, 2015


A dictionary definition of “confluence” is “the flowing
together of two or more streams.”

There are, of course, many kinds of stream, including
the literal kind, rivers. Over the earth many rivers, large
and small, converge and flow into each other. These are
obvious confluences.

But there are also less literal streams in our experience,
including political, economic and cultural streams which
also, from time to time, converge or flow into each other,
often with extraordinary consequences.

I would like to call the reader’s attention to one set of
streams, economic streams to be precise, which might, or
might not, now be converging. If they are not converging,
there is not much to say about them other than to note their
particular effects. Yet if they are forming a confluence,
I suggest it might be useful to pay special attention to
them and to any possible unusual consequences their
coinciding might bring.

One of these streams is a very large “river,” that is, the
Chinese economy. With more than a billion persons
composing it, and employing a curious combination of
so-called capitalist free market strategies with ultimately
non-democratic totalitarian controls, the Chinese economy
is perhaps the hottest financial story of the past decade.
Chinese millionaires and billionaires have taken their
places not only domestically in China, but as players on the
international market stage, purchasing foreign stocks, debt,
real estate, art works and other properties. The Chinese
government has taken a serious economic interest in
underdeveloped nations in Africa, South America and Asia.
Accompanying these activities, there has been an economic
“boom” in China. Some say this is an economic “bubble” and
not sustainable, primarily because so much of it, free market
strategies notwithstanding, is controlled by the Chinese
government and its bureaucrats. In any event, the Chinese
stock market has just endured a notable downward slide, at
least in the short term.

A second economic stream of note is the economy of the
European Union (EU) and the state of its common currency,
the euro. As with the economies of the United States and
China, the EU is one of the world’s largest economic forces.
In recent years and months, the EU has made its way through
a chronic series of crises, most of which have been provoked
by the increasing debt and mismanagement of some of its
member states. The latest example is Greece which, as like so
many smaller European economies, has seen unbridled growth
of its debt after decades of creating unsupportable public
expenditures and entitlements (and shortage of revenues to
pay for them). While larger and more stable European Union
members have resisted underwriting this growing debt, and
insisted on government-imposed measures of austerity, the
Greek people have resisted the cut-backs, making the austerity
programs politically impossible. After on-again-off-again
bailouts, the Greek government has closed the Greek banks
and called for a plebiscite. This might not only result in the exit
of Greece from the EU, but precipitate unstoppable larger
crises as the Spanish, Portuguese, Italian and French
economies, also heavily laden with debt, flounder.

A third, and smaller stream, is the bonded debt of the U.S.
territory of Puerto Rico. It amounts to about $73 billion, not
a small amount in itself, but tiny compared to the whole U.S.
economy. The news is that Puerto Rico might not be able to
pay for its public bonds which are not only free from federal
taxes, but state and local taxes as well.  As such, they have not
only been attractive to large investors and many high-earning
middle class investors, but other municipal bond funds as well.
In fact, 70% of all such funds have some investment in Puerto
Rican bonds. The reason for this level of investment is that
Puerto Rican bonds are rated “below” junk level, and since
they have so high a risk, their yield (now above 9%) is so high.
With national interest rates otherwise so low, the high (and
tax-free) rates are especially attractive to investors and funds
which want to improve their yields. No state or territory has
recently defaulted on its bonds. (After the panic of 1837, some
states were unable to pay for their bonds when called in, but
eventually they were paid off after several years.) Recently,
a few U.S. cities have declared bankruptcy, and several others
have admitted they are having difficulty in meeting their
obligations. The governor of Puerto Rico has just warned that
the territory is at the edge of default. If this Puerto Rican bond
crises is not resolved, what effect would this have on the whole
bond market and the U.S. economy?

These three streams are located in the three largest economies
on earth. Is there a chance they could converge into each other?
And what of other financial streams (such as those in Brazil and
other large economies)?

Finally, the Bank of International Settlements (BIS), the central
bank of the world’s individual central banks, has just issued a
report that the world’s banking system has kept interest rates
so low for so long that it has no further ability to deal with the
world’s next economic crisis when it comes. The report was
critical of the banking strategy of prolonged low interest rates,
some of them less than zero, which has fueled short-term
bubble booms followed by busts. In response to these financial
bubble bursts, central banks have lowered interest rates even
further, but as the BIS report suggests, banks now cannot go
any lower to try to revive economic downturns.

All free markets depend on public confidence. If the major
global markets are shaken not only by the crisis in each of the
economic streams I have mentioned, but the loss of confidence
is magnified from a confluence of debt crises in world markets,
what are the consequences?

I am making no predictions, dire or otherwise, but  I do think
current economic events now warrant especially careful and
prudent vigilance.

Copyright (c) 2015 by Barry Casselman. All rights reserved.

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