The next Crisis.

Recession is in the air.... latest news is German economy stagnates in 2nd quarter.

German inflation has hit 8.5% as food prices jump. On top of that, even more pressing is the Energy crisis they will be facing in coming winter days. There will be blood in the streets in coming days, if this stupid economic war of sanctions between Nato and  Russia is not properly managed and stopped immediately.

The German city of Hanover has turned off the heating and switched to cold showers in all public buildings because of the Russian gas crisis. It's the first big city to turn off the hot water after Russia dramatically reduced Germany's gas supply.

Germans have been told to expect sweeping gas reduction measures and extra charges on their energy bills.  And the EU has agreed to lower demand for Russian gas this winter by 15%.  The policy is in line with announcements from Berlin last week, as Germany races to build up its reserves ahead of the winter. 

Other cities - such as Augsburg in Bavaria - have already introduced their own measures such as turning off public fountains. The 15% reduction target in Hanover matches the EU-wide goal to reduce reliance on Russian gas.

And on Thursday, Germany confirmed that a planned gas surcharge on customers could be much higher than previously expected, to try to ensure energy companies do not go bankrupt in the coming months. 

And all this is just in one country within the Eurozone. 

Annual consumer price inflation across the 19-member euro area hit a fresh record high of 8.1% in May 2022.

Given Europe’s proximity to the war in Ukraine, energy  and trade interdependence with Russia and therefore state of economic peril,the concern that we should have is that there are so many negative shocks coming from the war, sanctions, uncertainty, that the economy is going to slow down even without raising rates.

Meanwhile, over in the US of A... the Federal Reserve recently began shrinking its massive balance sheet, unwinding trillions of dollars worth of bond purchases that it started making during the depths effort to offset the effects of the Covid-19 pandemic. It’s not the first time that the Fed has undertaken ‘quantitative tightening,’ as the process is called. But this time around is different. 

The central bank is withdrawing stimulus at an unprecedented speed. The big question for markets now is what the impact of this liquidity withdrawal will actually be, and whether differences in the size and composition of the Fed’s more recent market operations make this bout of ‘QT’ different to previous episodes. 

So, those are troubles that beset countries that are far away from us, correct? 

What's it to do with us over here in Asia? 

What does all this fears indicate?

Two words...Money Liquidity / or a Repo Market crisis.

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. The difference between the selling and purchasing price of the security is the repo rate.

In short, Business/Trade needs cash. 

Banks provide cash. 

So, what happens when banks are low on cash because of increased interest rate hikes by European Central Bank trying to reduce Inflation? 

You see, When we need cash , we go to banks to meet our financing needs. When banks need cash, they borrow money on the repo market.

● What is the average leverage ratio for banks?

In banking, a common ratio is 95:5 (and that can be before off-balance sheet exposures are taken into account). Meaning they take your savings, govt bond purchases, securitised assets we put as collateral for loans as pajak for cash in the repo market between banks. 

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two parties, buys them back shortly afterwards, usually the following day, at a slightly higher price.

These days, the repo market is an important source of funds for large financial institutions in the non-depository banking sector, which has grown to rival the traditional depository banking sector in size. 

Large institutional investors such as money market mutual funds lend money to financial institutions such as investment banks, either in exchange for (or secured by) collateral, such as Treasury bonds and mortgage-backed securities held by the borrower financial institutions. 

An estimated $1 trillion per day in collateral value is transacted in the U.S. repo markets...okay, so far, so good..... so what is the problem?

The problem is the Eurozone banks balance sheet leverage ratio is getting too big. If it gets so big that they can't carry it  forward anymore, the whole global market is in danger of contagion ...ie collapsing at some point and those fears spills over and causes another Global Financial Crisis.

What is balance sheet leverage?

Balance Sheet Leverage Ratio means, as of any day, the ratio of Consolidated Total Liabilities as of such day to Consolidated Gross Asset Value as of such day. 

In other words, a Balance Sheet Leverage Ratio means, at any date of determination thereof, the ratio of (a) Consolidated Total Liabilities to (b) Consolidated Net Worth.

● What is a good balance sheet leverage ratio?

Leverage in the context of investments simply means borrowing capital for an investment, and expecting the profits to be amplified. A figure of 0.5 or less is ideal. 

In other words, no more than half of the company's assets should be financed by debt. 

In reality, many investors tolerate significantly higher ratios.

In summary:

Effectively, what we are seeing today in the West is the US govt's interest rate fiscal policy tightening is selfish acts of trying to suppress the INFLATION their own money printing folly created which has cascaded into real govt shaking crisis for the rest of the world.