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Why Citi Is Worried: "This Is The Tipping Point"

In his latest must read presentation, Citigroup's Matt King continues to expose - and be very concerned by - the increasing helplessness (and cluelessness) of central bankers, something this website has done since 2009, fully aware how it all ends.

Take Matt King's September 2015 piece in which he warned that one of the most serious problems facing the world is that we may have hit its debt ceiling beyond which any debt creation is merely pushing on a string leading to slower growth and further deflation.

Or his more recent report which explained why despite aggressive easing by the BOJ and ECB, asset prices continue to fall as a result of quantitative tightening by EM reserve managers and China, which are soaking up the same liquidity injected by DM central banks.

Or his February 2016 report, in which his bearishness was practically oozing from every page, and which started off with the stunned observation, that "none of this is "supposed" to be happening" - inflation and economic growth are supposed to be rising in a world as manipulated by central bankers as this one. Instead, the opposite is taking place." He then went on to say that "maybe it will all fizzle by itself"... "but if it doesn't, then we have a problem."

It wasn't just one problem: as we laid out it was at least 8 problems, of which the last one was the most dire one: "if there is a next phase, it's likely a crisis of confidence in central banks." Because if central bank confidence goes away, so do the asset price gains of the past 7 years, all of which have been on the back of an unprecedented push by central banks to preserve the system if only that much longer.

Sure enough, central banks appear to have heard his ominous warning, and starting with the January Shanghai Accord, and the concurrent Beijing debt firehose which unleashed $1 trillion in debt in the first quarter, managed to stabilize if not the world, then certainly stock markets for a few months, courtesy of another epic credit-impulse driven push.

* * *

Over the weekend, King released his latest must read presentation, dubbed aptly enough "When the wisdom of crowds becomes the blundering herd", in which he no longer laments the failure of central planning - we assume it's taken for granted - and instead proceeds to highlight some of the direct consequences of living in a world in which extreme events are becoming increasingly more common, in everything from elections and polls (for which Trump is especially grateful)...

 

... to historic polarization in politics...

 

... to polarization in geography...

 

... even to polarization in weather...

 

... and of course, record polarization in the economy...

... in wealth and income...

 

... and markets...

 

... King then goes on to show just how senseless is any attempt to centrally-plan complex systems... 

 

... in which the longer central planners push the world away from an equilibrium point...

 

... pushing the system into a state of increasing fragility, defined by homogeneity, extensive interconnection, critical linkages, and slow, violent feedback...

 

... the more violent the snapback will be, and the greater the probability of breaching the critical tipping point beyond which the world will devolve into full blown systemic chaos, from which there is no return even with full central bank intervention.

Matt King's question is also the $64 quadrillion one: "at what point does behavior become nonlinear?"

Neither we, nor King knows the answer - Janet Yellen most certainly does not - but looking at the gallery of unprecedented swings from one extreme to another, and of record divergences, we can't help but think that we are very close, which is also why King is worried.

* * *

So until that one critical moment, in which central banks finally do push the world's "complex system" beyond the tipping point of no recovery, here are Citi's views on how to live, adapt and what to expect in world in which extreme events are now the norm, and in which complex systems have been hijacked by central planners.

First, the implications for politics: Direct democracy + disaffected populations = increased chance of extreme outcomes, as seen in election outcomes both in Europe and the US over the past year.

 

Then, the implication for profits, where it is increasingly a "winner takes all" outcome, especially if the winner has access to zero-cost debt with which to fund an expansive, monopolistic rollup.

The implication for jobs is well-known to regular ZH readers: "only the wealthy benefit from wage growth." Now, even Citi admits it. To all other workers, better luck next time.

 

Then the one thing that nobody in power ever dares to mention: that near-record debt (the only time total US debt was higher as a % of GDP was just before World War II), merely amplifies the cycle and adds to the probability of tipping points.

 

Meanwhile, with defaults set to soar coupled with tumbling recovery rates, this means that whoever is the creditor on the hook, will suffer major losses now that the default outlook is even more binary than usual.

* * *

Finally, the two most important observations for market participants: market liquidity continues to deteriorate as a result of leverage constraints which imply lower diversity, and which together with central banks buying up increasingly more debt and equity securities, it means ever greater clustering of volatility, leading to periods of extremely low volatility punctuated by the occasional session of historic vol which forces exchanges to shut down the very measurement of the VIX as happened on August 24, 2015.

 

And then, finally, the implication for market levels is the most ominous: with the leverage cycle near - and in some cases beyond - its tipping point, equities are increasingly jittery as shown in the chart on the right.

 

Citi's conclusion: the world is now much closer to a tipping point that what is implied by rates, which in turn merely represent what central banks want them to represent, which as we have said over many years, has nothing to do with the underlying reality.

In summary:

Extreme events are becoming more common, which is an intrinsic feature - not external shock - in a system that is fast approaching its "centrally-planned" tipping point. Citi's suggestion: position for tipping points, and stay away from the conventional, fake optimistic forecasts that all shall be well as propagated by the financial media. This is why Citi is now very worried.