We’ve spent our entire life in a credit expansion. “Hey, we’ll pay you later,” we said. But what if “later” is now?
By Bill Bonner, Chairman, Bonner & Partners:
When we left off yesterday we were worried. What if we have seen the highs in US stocks and bonds – not just for the next five or 10 years… but for the rest of our lifetimes?
Yesterday, the Dow fell 272 points. No big deal, of course. But what if it continues? Just six years ago it fell 51%. It could easily do so again – back down to, say, 8,000. There would be nothing unusual about it. Fifty percent corrections are normal.
You know what would happen, don’t you?
Ever since the “Black Monday” stock market crash in 1987 it has been standard procedure for the Fed to react quickly. But what if Yellen & Co. got out the party favors… set up the booze on the counter… laid out some dishes with pretzels and olives…. and nobody came? What if the stock market stayed down for 30 years, as it has in Japan?
A Special and Unusual Time
It seems almost unbelievable. Every time US stocks have gone down since World War II they’ve bounced back… and hit new highs. We take it for granted that they will always go up over the long run.
But why should they?
The time between 1945 and 2007 is starting to look less and less like the “way things always are”… and more and more like the “way things were during a special and unusual time.”
It was more of an outlier than an average. The world was recovering from World War II. Populations were growing. New markets were emerging. People were starting new families and new businesses.
And perhaps most important, the world was just beginning the greatest credit expansion in its history.
Gold – which had kept the US dollar honest for almost two centuries – was taken out in two steps.
First, in February 1968, when President Johnson asked Congress to end the requirement that dollars be backed by gold. Second, in August 1971, when President Nixon ended the direct convertibility of dollars to gold.
Thenceforth, the flimflam began. We’ve been over the numbers before. No point in repeating them. Besides, the point we are making is obvious: When it comes to multiplying a society’s debt by a factor of 50… or increasing its debt-to-GDP ratio from 140% to 350%… we pass this way but once in a lifetime.
Credit can continue to expand for one… two… even 10 years. But not for 50 years. Not without trouble hot on its heels, at least.
Of course, the future includes a potentially infinite number of days. And we don’t know what will happen on even a single one. But if half a century goes by… and we wake up one fine day and discover that debt has risen to 1,000% of GDP… won’t we be surprised!
Pockets Full, Head Empty
Meanwhile, look what is happening to the Treasury market. The Fed is supposed to withdraw from bond auctions this month. There goes one of the Department of the Treasury’s biggest and best customers. His pockets full and his head empty.
You’d think you’d see Treasury bond prices would fall. But no! They’re going up.
This curious trend has confounded analysts all over the world. If the US economy really were recovering, it should mean higher yields (and lower bond prices, which move in the opposite direction) as interest rates rise.
So, what’s going on? Are bond buyers making a mistake? Or is the economy really weaker than the recent jobs report would make it appear?
We’ll go with the bond market on this one. Low Treasury yields are consistent, after all, with sluggish growth.
And who can expect the same growth rate as we had over the last 50 years? From “bond king” Bill Gross:
Growth in the US and elsewhere has been facilitated in the past 30 years by the expansion of credit and leverage. Once capitalists recognize that they can’t continue to accumulate leverage at the same pace, growth slows. Demographics also are contributing to diminished economic growth. The boomers aren’t booming. They are getting older and retiring.
Most boomers need health care, but they don’t need another house or a third car. The aging of our society is putting curbs on economic growth. Thirdly, technology is a boon and a wonder, but it also has eliminated jobs that aren’t being replaced at the same pace. Apple is a wonderful company, but it doesn’t hire as many people as the old General Motors.
Finally, globalization is an issue. The US has been the world leader in globalization since the end of World War II. We have benefited from mercantilistic expansion, and because the dollar has been the reserve currency. Now things are turning sour elsewhere. When you fly into headwinds, you fly at a different speed.
We’ve spent our entire life in a credit expansion. We began life when the cork came out of the credit jug. We’ve all been pulling hard on it ever since.
Credit juiced up the economy… and the stock market. Heck, we’ve lived on it. We’ve taken TVs from China. Autos from Japan. Wine from France and Italy.
“Hey, we’ll pay you later,” we said.
What if “later” were now?
By Bill Bonner, Chairman, Bonner & Partners:
This is not to say that it won’t go on longer or won’t get wilder. There are already people with lampshades on their heads. And girls are dancing on the tables. Read… The Party Has Gotten out of Hand Thanks to the Fed’s Free Booze. Time to Look for the Car Keys
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So, on Wednesday the stock market “recovered” Tuesday’s losses – on the “news” that the Fed was looking for ways to reassure Wall Street that it wasn’t going to raise interest rates any time soon.
A few weeks ago I laid out my view that interest rates were going exactly nowhere for the foreseeable future. I suspect that maybe I was right about that.
Assuming I was right, I’ll go a step further and proffer the view that this so-called economic “recovery” is nothing but a statistical mirage.
As Wolf pointed out a few days ago, the net addition to the national debt over the past year was over $1 trillion, while just a day or two ago the lying statisticians at the Congressional Budget Office claimed the 2014 deficit was “only” $486 billion.
I submit that the US economy “looks good” only because of massive Federal deficits that far exceed the reported figures, student loans that are increasing at a phenomenal rate even though there are no “good-paying” jobs for college graduates, an out-of-control war machine, and sub-prime auto loans that are written at 130% loan-to-value.
One day we are going to run out of tricks and flimflams to make the economy “look good.” Then the whole sorry edifice of bad debt and accounting fraud is going to blow up. That will be a real sight to behold.
The truth is, the Federal Reserve cannot withdraw from anything where it has injected cash to stimulate the “financial markets”; over these last few years, without crashing the US financial system. The Federal Reserve always double speaks: – If it says that it is going to or not to do something, it has always done the opposite! When it officially tapers or withdraws quantitative easing, it has always used a proxy government or third party to – should we say – “take up the slack”.
You are right about the ” economic recovery is nothing but a statistical mirage.”
Most people do not realise that the Federal Reserve “is the market.”
Oops! Let me state that again: Most people do not realise that the Federal Reserve “IS THE MARKET!” -That’s better.
It is not just a question of tricks, it is a question about the sources of “real money.”
Have a look at this example of Trace Meyer’s great credit contraction image: –
http://www.creditcontraction.com/images/affiliate/Great-Credit-Contraction-Liquidity-Pyramid-Large.jpg
What most economist do not realise when looking at this representation of the downward trend of money, is that we are witnessing – without realising it – how the Federal Reserve’s policies of quantitative easing is specifically designed to send a vast flood of “virtual money, to wash out as much “real money” as possible, into the financial system. It is just like what Gold panners do!
http://www.pmt.net.au/wp-content/uploads/2011/09/gold-panning.jpg
The problem is, fewer people are being fooled by the grandiose fireworks. If there was real growth why would the US need to use the Foreign Account Tax Compliance Act (FATCHA) to pursue US citizens abroad?
Or why would the US government be putting legislation into place to seize retirement pensions 401k’s and IRAs by nationalising all pensions – including private – with Government bonds?
Why is the Federal Reserve making new proposals on an exit fee tax to prevent capital flight from US Bonds?
Unfortunately, that day is right in front of us; That day is almost here.
Bob, I can’t help but point out the irony that Bill wrote this piece after Tuesday’s downdraft. As you then pointed out, the Fed on Wednesday was able to goose the market via the publications of the minutes. But on the Thursday – 12 hours after you posted the your comment – the bottom fell out. Is it that the Fed’s magic seems to lose its power?
Concerning the deficit, someday I’m going to take a 5-year course in government accounting to figure out how they’re doing it. Because for the life of me, I cannot reconcile the official “deficit” and the official increase in the debt – and the big difference between the two.
It is off balance sheet expenditures. Similar to Level 3 used by most major corporations. The only logical reason it is allowed is that neither the government nor the large corporations, especially banks, would be shown to be insolvent if they didn’t use this type of fog and mirror accounting. No way that could be allowed as then they couldn’t borrow money at ZIRP. The gig would be up.. Or not …. because the sheeple only care that their house and their car is bigger/better than their co-worker. Self worth is not what’s on the inside but what you show off to the other shallow people. For the most part, the USA sold out and there aren’t many left with real insight, integrity and ethics. Our government reflects ourselves, in debt and scared.
Don’t learn “government accounting” unless you plan on holding a government job forever. It doesn’t “work” anywhere else, like where there is reality.
Government is the only sphere where reality doesn’t matter.
Credit has been expanding for 575 years not fifty. Johannes Gutenberg lost his printing business to his creditor, he certainly wasn’t the last … borrower to do so.
Credit expands exponentially, an inflection point is reached where expansion becomes non-linear. This point of non-linearity is where we are today: the doubling of credit every few years shifts from annoyance to absurdity, creditors are no longer simply foolish but incompetent.
Incompetent lenders = loss of confidence. Hello, world!
Debt is either paid off or defaulted. It seems like the whole world has been busy kicking the debt can down the road with freshly minted FIAT currency as well as refinancing the the principal with artificially low interest rate thanks for money printing. Add to this bigger than life derivatives scene.
Alas what if something triggers the seemingly small defaults globally which snowball into something sinister when derivatives needs to unwind in this highly leveraged market? I suppose only solution is to print more FIAT currency resulting in mother of all global inflation (not to mention currency wars in bid to improve export leading to trade wars) and unintended consequences of people rioting everywhere. Next up in the Twilight Zone will be messy wars as this is only way the politicians can maintain power and whip up nationalism to counter anti-government protest.
We indeed are living in interesting times…
The S&P broke from the top of the channel it had been in since the first part of 2013 downward out of a megaphone pattern at the top. Then we broke below it. Now we have broken the lower channel line it was running in. The market closed near its lows for the day. Not a good sign. Should bounce in the morning back inside the channel but this is the 3 time it penetrated the bottom of the channel line and the first time it closed below it.
All this and I don’t think we are even close to FEAR yet. We were in GREED so long I think most people have forgotten what FEAR was. This may not be the BIG one yet but …. If this keeps up, margin calls will start to play a bigger roll. and FEAR will enter again into the market.
When Chaos rules, anything can happen. We are indeed living in Interesting Times!
We’ll just have to see what tomorrow brings us.
There is a longer term channel that started in 2009 at the bottom of this cycle. The S&P was in that channel until July 2013 when it broke out to the upside in a new steeper channel which is the one we just broke down out of and closed below. We will enter the original channel (depending on time) some where around 1865 (channels go up or down so are time dependent). At this time the lower line of that channel is around 1625. Currently the channel we broke below is resistance because we closed below it.
Will we go all the way down to the original channel? We should. Will the S&P remain in that old channel? I haven’t a clue.
There was a lot of debt created and not a lot of income distribution since the bottom. Which means to me that the advance was all accounting and not real. The debt from before the crisis wasn’t resolved for most corporations and was just added to or refinanced. The stock market should reflect the actual health/wealth of the economy. I could make and argument that this at some point could/should retrace or exceed the lows of 2009.
We’ll just have to wait and see what rabbits can be pulled from the Magician’s hat behind the curtain. Maybe Dorothy will pull the curtain down? Lots of unknowns.
We sure do live in interesting times.
Bond prices will remain high as long as buyers are most convinced that Treasuries represent the highest likelihood of being able to “get their money back.” This comparison remains favorable when looking at the world as a whole.
When all that confidence is eventually used up, Treasuries, too, will fall. They will fall (as Prechter has stated) when the concern changes from return ON money to return OF money. When that day comes, people will again refer to bonds as certificates of guaranteed confiscation.
My hat is off to anyone who even attempts to figure out the convoluted mess that is the Fed’s balance sheet. I assume that they have hundreds of ways to rig things, most of which can’t even be determined. It is about perception management, and yes, panning for gold (flooding fake in to get real money back). The IRS tax code has become so ridiculous that it is directly contradictory in many places, and that was BEFORE Obamacare. I suspect and hope for a tax revolt, sooner rather than later. This ponzi scheme cannot continue forever. Once corruption has weakened the trust of the people in all matter of leadership, large numbers stop paying into the system. This causes ever more onerous regulations on those who still try to play by the rules, which quickly disenchants the remainder. The lower the water level the faster the remaining water circles down the drain. Are there any “good” jobs left that aren’t complicit in the bureaucracy in some way?The high stock market returns was the only thing keeping a lot of retirement plans safe…