One of the joys of the last financial crisis (it was the best of times if you were in cash or short just about anything) was the evident panic of the powers that be. They hadn’t seen it coming, didn’t know why it happened, had no idea how bad it would get, and as it got worse, threw everything they had at it…to no avail. They would announce some extraordinary measure and if you were short you got your face ripped off for a few days, but then asset prices resumed their descent and soon you were back in the black. The rickety structure that was the world financial system teetered, and should have been allowed to topple, replaced by a far more rational, durable, and honest system. That outcome was not allowed, and the authorities managed to cobble together a bubblegum and baling wire “solution.” They rescued insolvent financial institutions and industrial companies with taxpayer funds, suspended mark to market accounting to mask banks’ insolvency, and issued trillions of dollars in debt, much of which was monetized by central banks as they expanded their balance sheets and suppressed interest rates.
SLL has consistently underestimated the desperation and fear of the powers that be and consequently the stupidity and long-term destructiveness of the measures they will take to rescue themselves. SLL has also consistently underestimated the credulity, the forgetfulness, and the willingness of speculators and markets to play along, at least until the long-term destruction becomes too obvious to ignore. Rallies in financial asset, house, and commodities’ prices that started in 2009 lasted far longer than they should have. The crash had rung the bell on debt. The marginal dollar, yen, euro, or yuan of debt bought less growth than the costs of debt service and repayment; the marginal return was less than zero. However, led by governments and central banks, global debt has expanded the last six years by $57 trillion, to around $200 trillion (see “Debt and (not much) deleveraging,” McKinsey & Company).
Suppressed interest rates not only encouraged more debt, they drove the marginal return on investment down to the abnormally low interest rate. This has promoted more consumption, investment, and production than what would have prevailed under market-determined rates, which in turn fed false signals to capital markets about the value of both government and corporate securities and the creditworthiness of smaller businesses and individuals. Speculators with access to cheap money have elevated asset prices to artificial valuations. Because of the overhang of unresolved debt from the financial crisis and the toll it, and the new debt, exacts on the economy, the latest malinvestment and consumption “boom” has been relatively muted, producing a weak recovery. Nevertheless, until the commodity complex, particularly oil, started falling apart last year, markets and policymakers were happy to pretend that everything was peachy.
SLL identified the commodity bust as the leading wave of a tsunami (see “Oil Ushers in the Depression”) late last year, while most commentators were predicting that 2015 would be the year the US economy would finally reach “escape velocity.” Commodity, oil, and precious metals’ prices have continued to plunge as the Chinese economy, the debt-propelled engine of global growth, christens its not yet acknowledged implosion with a spectacular stock market crash. Crashing with it have been bulk shipping and container rates, sensitive and obvious indicators of the health of world trade.
The Chinese ripples are washing over feeder economies, most notably Australia’s and Brazil’s. Live by China, die by China. The Greece farce demonstrated the vulnerability of the European debt house of cards to the slightest wind, and with the latest non-solution Greece may yet topple it. If not, Spain’s, Portugal’s, Italy’s, or France’s just-as-flimsy debt, singly or in combination, will. Both the Canadian and Japanese economies are close to or are already in recessions.
As the tsunami makes landfall, most US commentators and experts are advising investors to play on the beach. The headlines and hype about the few overpriced stock market darlings making new highs are endless, while an ever-increasing number of stocks quietly falter. Natural resource stocks and debt have cratered and some companies have announced drastic restructuring or declared bankruptcy. The overwhelming force and destructive power of the crashing debt deflation tsunami will render the inane preoccupations of much of the US populace—and the preening, posturing idiocy of their elites—irrelevant, dangerous distractions.
There was panic during the last crisis; this time it will be sheer, unmitigated terror. The powers that be cannot even resort to the faux solutions of more debt (too much debt outstanding—the marginal return is negative), central bank monetization of debt and other securities (with $200 trillion of debt in the world, much of which will collapse in value, central banks would have to expand their balance sheets multiples of their current bloated size to match the magnitude of the implosion), or interest rate suppression (short-term rates are already close to zero). That they have already implemented or considered absurdities such as negative interest rates, depositor “bail-ins,” and outlawing cash shows their desperation, which will increase exponentially as the depression deepens
The frantic and failed efforts of the Chinese government to stop its stock market rout are a preview of coming attractions around the world. SLL has resolved not to repeat mistakes from its past. SLL’s mantra going forward: there will be no lower bound on the depravity, rapacity, and idiocy of governments and only fools will believe otherwise. Falling markets descend a slope of hope; expect occasional rallies, some substantial but all unsustainable, in response to various announcements of inevitably ineffectual measures. Expect each rally to prompt predictions from Washington and Wall Street that “the bottom is in.” At the absolute bottom hope will be extinguished and faith in governments gone (some governments may be gone as well). That will be the “all clear” to start buying cheap assets. Until then, SLL repeats what should by now be unnecessary warnings: be prepared and expect governments to make matters much worse.
“A MASTERPIECE”…A GOLDEN PINNACLE READER