Economic Collapse: This Should Keep Investors Up at Night

CollapseAre we on the verge of another economic collapse? It was a crazy idea a few months ago, but now, with bank after bank reporting terrible earnings, investors should be worried about the state of the financial system.

On Wednesday, Goldman Sachs Group Inc (NYSE:GS) reported a 71.8% drop in net income applicable to common shareholders, down from $2.03 billion, or $4.38 per share, a year earlier to $574 million, or $1.27 per share. (Source: “Goldman Sachs posts earnings of $4.68 a share vs $3.53 expected,” CNBC, January 20, 2016.)

Goldman Sachs’ more than 2.6% chute on Wall Street reflected an all-around austere day in the markets as investors have become increasingly concerned by another major market crash. The bleakness affected markets all over the world, with a contagion of red that started in Asia, spreading to Europe and then Wall Street.

Is All Well for the Banking Sector?

The hits just keep on coming for Goldman Sachs stock and the rest of the financial sector.

Market pessimism has exacerbated a crisis that may find its root causes in China’s transition towards a new model of development. It’s generating a whole new set of variables. Or, as former U.S. Defense Secretary Donald Rumsfeld once put it, “unknown unknowns,” as opposed to “known unknowns.”

Some of the questions keeping investors awake in their cozy beds concern doubts over the Chinese government—which tends to intervene with a rather visible hand in its emerging capitalism—and its ability to rule this delicate process. Then there is the matter of oil and the collapse of oil prices, which have pierced through all analysts’ price floors. Soon, there may not even be a foundation left in the house that oil built.

The oil market has taken a rollercoaster ride for over a year, which has now deteriorated into a disorderly rout. It has hurt oil-dependent economies in developing and developed countries alike but also to the Western banks, which have lent to the oil sector.

Then there was the new monetary cycle inaugurated by the Federal Reserve in December, which further strengthened the dollar, creating problems for all those who have borrowed in dollars (sovereign states or companies) around the world.

All of this could translate into big losses for banks.

The Contraction Wars

The combination of these factors is opening the next chapter in the “Contraction Wars,” one which began with the collapse of American finance in 2008 due to the sub-prime crisis and the “Darth Vader” of financial instruments, collateralized debt obligations (CDOs), the very same that Goldman Sachs used to benefit from the general collapse of the property market. The previous chapter, for those following the argument, was the collapse of the eurozone from 2010 onwards.

The oil price collapse was just the beginning of the present chapter, whose climax will develop as many companies’ debts implode.

In other words, Goldman Sachs’s earnings are proof that the U.S. economy isn’t as strong as it seems.