Three Black Swans

The comments above & below is an edited and abridged synopsis of an article by John Mauldin

We all face economic and financial risk that we need to prepare for. Knowing the risks is the first step toward preparing.

Ten years ago we had a world-shaking financial crisis. By late 2006 we had an inverted yield curve steep and persistent enough to be a high-probability indicator of recession 12 months later.

The losses were over $2 trillion and triggered the financial crisis and Great Recession. Conditions in the financial markets needed only a spark from the subprime crisis to start a firestorm all over the world. Plenty of things were waiting to go wrong, and it seemed like they all did at the same time.

We don’t have an inverted yield curve now, so the only reliable predictor of a US recession is not sounding that warning. But when the central bank artificially holds down short-term rates, it is difficult for the yield curve to invert.

The warning signal has been suppressed, but all is not well in the markets. Today’s global megabanks are much larger than their 2008 versions were, and they are more interconnected. Most Americans are still licking their wounds from the last battle. Many are in worse shape now than in 2008. The crisis-fighting reserves are low.

European banks are still highly leveraged. The shadow banking system in China has grown to scary proportions. Globalization has proceeded apace since 2008, and the world is even more interconnected now. Problems in foreign markets can quickly become problems close to home. And that’s without a global trade war.

There is another recession in our future, and it’s going to be at least as bad as the last one was. The recovery is going to take much longer than the current one has, because the massive debt build-up is a huge drag on growth.

The three black swans that Mauldin discusses in detail are: Yellen overshoots in terms of tightening monetary policy; the ECB runs out of bullets; and a Chinese debt meltdown.