Category Archives: Debtonomics

Why the Coming Wave of Defaults Will Be Devastating, by Charles Hugh Smith

Posted on September 22, 2016 | Leave a comment

The global economy is more leveraged than at any time in history, which means this next debt bust is going to be one for the ages. From Charles Hugh Smith at oftwominds.com:

Without the stimulus of ever-rising credit, the global economy craters in a self-reinforcing cycle of defaults, deleveraging and collapsing debt-based consumption.

In an economy based on borrowing, i.e. credit a.k.a. debt, loan defaults and deleveraging (reducing leverage and debt loads) matter. Consider this chart of total credit in the U.S. Note that the relatively tiny decline in total credit in 2008 caused by subprime mortgage defaults (a.k.a. deleveraging) very nearly collapsed not just the U.S. financial system but the entire global financial system.

Every credit boom is followed by a credit bust, as uncreditworthy borrowers and highly leveraged speculators inevitably default. Homeowners with 3% down payment mortgages default when one wage earner loses their job, companies that are sliding into bankruptcy default on their bonds, and so on. This is the normal healthy credit cycle.

Bad debt is like dead wood piling up in the forest. Eventually it starts choking off new growth, and Nature’s solution is a conflagration–a raging forest fire that turns all the dead wood into ash. The fire of defaults and deleveraging is the only way to open up new areas for future growth.

Unfortunately, central banks have attempted to outlaw the healthy credit cycle.In effect, central banks have piled up dead wood (debt that will never be paid back) to the tops of the trees, and this is one fundamental reason why global growth is stagnant.

The central banks put out the default/deleveraging forest fire in 2008 with a tsunami of cheap new credit. Central banks created trillions of dollars, euros, yen and yuan and flooded the major economies with this cheap credit.

They also lowered yields on savings to zero so banks could pocket profits rather than pay depositors interest. This enabled the banks to rebuild their cash and balance sheets– at the expense of everyone with cash, of course.

Having unleashed tens of trillions of dollars in new credit since 2008, the central banks have simply increased the likelihood and scale of the coming default conflagration. Now the amount of deadwood that’s piled up is many times greater than it was in 2008.

Very few observers explore what happens after defaults start cascading through the system. Defaults mean loans and bonds won’t be paid back. The owners of the bonds and debt (mortgages, auto loans, etc.) will have to absorb massive losses.
Recall that banks rarely own the debt they originate: mortgages and auto loans are bundled and sold to investors such as pension funds, insurance companies, mutual funds, etc. So banks aren’t the only institutions at risk: every institutional owner of debt-based assets is at risk.

Two things happen in a default/deleveraging conflagration. One is that lenders get very wary of lending more money to anyone or any entity other than those with the lowest-risk profiles. That constricts lending to the bottom 95% who are already over-indebted.

To continue reading: Why the Coming Wave of Defaults Will Be Devastating

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Negative Interest Rates and the War on Cash (Full Article), by Nicole Foss

Posted on September 11, 2016 | Leave a comment

Nicole Foss has published an epic, four-part tome on negative interest rates and the war on cash. It’s a valuable edition to the topic. SLL published Part One and then decided to wait until the comprehensive edition with all four chapters, and links to each idividual chapter. Here then, is the full article and links, from Nicole Foss at the automaticearth.com:

This article by Nicole Foss was published earlier at the Automatic Earth in 4 chapters.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

Part 4 is here: Negative Interest Rates and the War on Cash (4)

Nicole Foss: As momentum builds in the developing deflationary spiral, we are seeing increasingly desperate measures to keep the global credit ponzi scheme from its inevitable conclusion. Credit bubbles are dynamic — they must grow continually or implode — hence they require ever more money to be lent into existence. But that in turn requires a plethora of willing and able borrowers to maintain demand for new credit money, lenders who are not too risk-averse to make new loans, and (apparently effective) mechanisms for diluting risk to the point where it can (apparently safely) be ignored. As the peak of a credit bubble is reached, all these necessary factors first become problematic and then cease to be available at all. Past a certain point, there are hard limits to financial expansions, and the global economy is set to hit one imminently.

Borrowers are increasingly maxed out and afraid they will not be able to service existing loans, let alone new ones. Many families already have more than enough ‘stuff’ for their available storage capacity in any case, and are looking to downsize and simplify their cluttered lives. Many businesses are already struggling to sell goods and services, and so are unwilling to borrow in order to expand their activities. Without willingness to borrow, demand for new loans will fall substantially. As risk factors loom, lenders become far more risk-averse, often very quickly losing trust in the solvency of of their counterparties. As we saw in 2008, the transition from embracing risky prospects to avoiding them like the plague can be very rapid, changing the rules of the game very abruptly.

Mechanisms for spreading risk to the point of ‘dilution to nothingness’, such as securitization, seen as effective and reliable during monetary expansions, cease to be seen as such as expansion morphs into contraction. The securitized instruments previously created then cease to be perceived as holding value, leading to them being repriced at pennies on the dollar once price discovery occurs, and the destruction of that value is highly deflationary. The continued existence of risk becomes increasingly evident, and the realisation that that risk could be catastrophic begins to dawn.

Natural limits for both borrowing and lending threaten the capacity to prolong the credit boom any further, meaning that even if central authorities are prepared to pay almost any price to do so, it ceases to be possible to kick the can further down the road. Negative interest rates and the war on cash are symptoms of such a limit being reached. As confidence evaporates, so does liquidity. This is where we find ourselves at the moment — on the cusp of phase two of the credit crunch, sliding into the same unavoidable constellation of conditions we saw in 2008, but on a much larger scale.

To continue reading: Negative Interest Rates and the War on Cash (Full Article)

 

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America The Debt Pig: We Are A ‘Buy Now, Pay Later’ Society – And ‘Pay Later’ Is Rapidly Approaching, by Michael Snyder

Posted on September 4, 2016 | Leave a comment

Consume more than you produce and sooner or later you will go broke. SLL is going broken record, saying it over and over again. We’ll continue saying it until the US goes broke, and undoubtedly beyond that sad day of reckoning. From Michael Snyder at theeconomiccollapseblog.com:

If you really wanted to live like a millionaire, you could start doing it right now. All you have to do is to apply for as many credit cards as possible and then begin running up credit card balances like there is no tomorrow. At this point, I know what most of you are probably thinking. You are probably thinking that such a lifestyle would not last for long and that a day of reckoning would eventually come, and you would be exactly right. In fact, anyone that has ever had a tremendous amount of credit card debt knows how painful that day of reckoning can be. To mindlessly run up credit card debt is exceedingly reckless, but unfortunately that is precisely what we have been doing as a nation as a whole. We are a “buy now, pay later” society, and our national day of reckoning is approaching very, very quickly.

Often we like to focus on our exploding national debt, but household debt is out of control too. In fact, the total amount of household debt in the United States is now up to a whopping 12.3 trillion dolllars…

In the second quarter, total household debt increased by $35 billion to $12.3 trillion, according to the New York Fed’s latest quarterly report on household debt. That increase was driven by two categories: auto loans and credit cards.

We throw around words like “trillion” so often these days that they often start to lose their meaning. But the truth is that 12.3 trillion dollars is an astounding amount of money. It breaks down to about $38,557 for every man, woman and child in the entire country. So if you have a family of four, your share comes to a grand total of $154,231, and that doesn’t even include corporate debt, local government debt, state government debt or the gigantic debt of the federal government. That number is only for household debt, and there aren’t too many Americans that could cough up their share right at this moment.

Do you remember when I wrote about how credit card companies are specifically targeting less educated and less sophisticated consumers? Well, that is where much of the credit card debt growth has come lately. Just check out these numbers…

Now, credit cards are returning among individuals with low credit or subprime credit scores below 660. Among people with credit scores between 620 and 660, the share that had a credit card rose to 58.8% in 2015 from a low of 54.3% in 2013. Among those with scores below 620, the number of people with a credit card increased to 50% from a low of 45.6% two years ago. Both figures for 2015 are the highest since 2008.

In America today, we are enjoying a standard of living that we do not deserve.

We consume far more wealth than we produce. The only way we are able to do that is by going into debt.

Debt takes future consumption and brings it into the present. In other words, we are damaging the future in order to make the present a little bit better. On an individual level, we may enjoy the big screen television we buy with a credit card today, but we are taking away our ability to spend money later. And on a national level, what our unprecedented debt binge is doing to future generations of Americans is beyond criminal.

To continue reading: America The Debt Pig: We Are A ‘Buy Now, Pay Later’ Society – And ‘Pay Later’ Is Rapidly Approaching

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Why A Crisis Is Coming—–Two Charts Which Explain It All, by Eugen Von Bohm-Bawerk

Posted on September 3, 2016 | 1 comment

The government’s tax receipts are trending down, but employment has been holding up. Why? From Eugen Von Bohm-Bawerk at davidstockmanscontracorner.com:

The great “science” of economics once discovered an empirical relationship between GDP and unemployment that has been dubbed Okun’s Law. It simply states that the unemployment rate rises as GDP contracts, or vice versa, as production shrinks less people will be employed. It is not exactly rocket science.

However, this made us think about another relationship we have observed lately. US government real tax receipts have been trending downwards while employment has kept up remarkably well. If we draw a chart of US withholding taxes (smoothed from all the short-term noise) and overlay that with employment growth, we find a worrisome divergence that has historically not been there.

If we plot the same chart, but using annual change in real GDP instead of the annual employment growth, everything seem to fall into place though.

What can explain this dichotomy? The most obvious explanation is the increased employment of low paid workers with lower productivity relative to what we have seen in previous recoveries. Substituting $50 – 100k full time breadwinner jobs with barmaids and waiters is certain to drive down wages (and hence taxes) and GDP as the marginal productivity of each additional new hire is lower than the previous. Both productivity statistics and the monthly labour market report substantiates our view.

Years of capital consumption have led to peak debt whereby each additional unit of debt reduces economic growth instead of artificially stimulating it. There is only one way out of this, and that is a wholesale admission that current policies of extend and pretend is no longer working; unfortunately only real crisis seem to focus minds enough to implement necessary changes. Until then, the painful slog will continue. Our dire prediction for the future is simply one where the confluence of a struggling middle class and politics jointly forces through some sort of structural change. These usually makes things much worse before the system reset toward a more sustainable path. Upcoming elections in Italy, the US, the Netherlands, France, Germany and Spain in a post-Brexit environment provide ample opportunity for radical change.

http://davidstockmanscontracorner.com/why-a-crisis-is-coming-two-charts-which-explain-it-all/

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We’ve Reached the “Zero Point” of Debt Creation, by Harry Dent

Posted on September 1, 2016 | 1 comment

We’re getting less and less incremental GDP per dollar of debt. SLL argues that the marginal value of debt has already gone negative. Harry Dent says the zero point arrives next year. Either way, expanding debt only compounds our economic travails. From Harry Dent at wolfstreet.com:

Forty-five years and counting: We’ve been on a debt spree since the early 1970s when we went off the gold standard, covering every possible angle. Trade deficits, government deficits, unfunded entitlements, private debt – you name it! Our total debt has grown 2.5-times GDP since 1971.

How could economists not see this as a problem? How is this the least bit sustainable?

It isn’t. We’re hurtling toward a massive financial crisis, and all we have to show for it are financial asset bubbles destined to burst. And when they do, they’ll wipe out the artificial wealth they’ve created for many decades… in just a few years, as they did from late 1929 into late 1932!

The chart below shows the common-sense truth.

As with any drug – and debt is a financially enhancing drug – it takes more and more to create less and less of an effect. Eventually, you reach the “zero point” where there is no effect and the drug kills you from its very strain and toxicity.

We’re rapidly approaching that zero point, after every dollar of debt has produced less and less GDP steadily since 1966:

Note that the anomaly in the chart after 2008 was due to the impact of unprecedented QE. Ever since that disruption, the trends have pointed back down – making a beeline toward that zero point again.

Back in 2002, Swiss investor and market prognosticator Marc Faber published a similar chart. His findings showed the zero point for debt creation would occur around 2015. With updated data, we now see that the zero point will hit around the beginning of 2017.

In other words – right about NOW!

This is why central banks around the world have failed to spurn inflation despite endless money-printing. The more money they print, the less effect it has.

Just ask Japan. They’ve been doing this since 1997 with zero GDP growth and zero inflation, on average. Lately it seems like any time they get out of a recession they’re thrown right back into one!

But there is another ramification to all this money-printing…

When central banks create money out of thin air – through the fractional reserve banking system and through QE – it has to go somewhere.

When the economy is so indebted that consumers and companies can’t take on any new debts, the money can’t go there. So, it winds up going into financial speculation, especially as investment firms can lever up at little cost due to zero or negative interest rates. Stock prices bubble instead of inflation as the economy keeps sucking wind!

Sure enough, this next chart shows that debt and equity prices go hand-in-hand:

In the 20 years between 1995 and 2015, debt grew at a rate of 4.2-times GDP, and stock prices followed at 4.3-times. Total U.S. sector debt now stands at 348% of GDP, with stocks at 214%.

All told, these two combined are 588% of GDP, far more than any time in history.

To continue reading: We’ve Reached the “Zero Point” of Debt Creation

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Why Helicopter Money Won’t Push Stocks Higher, by Charles Hugh Smith

Posted on July 12, 2016 | 3 comments

The wonder is why anybody would think that government debt monetization would push stocks higher, because all the effects on the real economy of such monetization are negative. From Charles Hugh Smith at oftwominds.com:

In effect, helicopter money turns the entire economy into a Ghost City.

The possibility that Japan might launch helicopter money stimulus sent global stock markets soaring in a paroxysm of pleasurable anticipation. But exactly what is helicopter money and what connection does it have to stock valuations, if any?

Broadly speaking, helicopter money is government deficit spending that is directed to households rather than the financial sector. Deficit means the government doesn’t have extra cash to pay for the stimulus program–it borrows it by selling government bonds.

With interest rates near-zero or even negative, it doesn’t cost governments much to borrow huge sums from future taxpayers. All bonds are borrowed from future taxpayers, because somebody will have to pay back the principal, even if there are no interest payments due.

Typically, bonds that mature (i.e. the principal must be returned to the owner of the bond) are replaced with newly issued bonds. In other words, government debt never declines, as new debt is issued to replace bonds that come due AND to fund additional spending.

The nearest household analogy is a mortgage which you “pay off” by borrowing an even larger sum every few years. The debt just keeps getting larger as time goes on.

The assumption here is that there will be more of everything in the future: more taxpayers paying more taxes, more consumers consuming more, more workers being even more productive, more corporations earning even more profits, and so on: more, more, more, more.

More of everything means it will be easier to pay the debt we borrowed from future taxpayers. The economy will be larger, tax receipts will be higher and productivity will drive profits and consumption higher.

This assumption worked for a few hundred years, but now it doesn’t. In Japan (and many other nations are soon to tread the same path), population is declining and GDP, profits, productivity and tax receipts are all stagnating.

This raises the terrifying prospect that there won’t be more of everything in the future. If there is less of everything, sacrifices must be made to roll over the mountain of debt accumulated in the past, and it soon becomes impossible to do so.

Here’s the magic part of helicopter money: to avoid all the problems of ever-rising debt in a stagnating economy, the central bank creates money out of thin air and buys the government bonds with the newly created money.

This is called monetizing the debt as new money is created out of thin to buy the debt. No tax revenues are needed, and so no sacrifices must be made to accumulate more debt. All the helicopter money is in effect free money because nobody has to pay anything for it.

To continue reading: Why Helicopter Money Won’t Push Stocks Higher

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Bernanke’s Black Helicopters Of Money, by David Stockman

Posted on July 11, 2016 | Leave a comment

There is almost no idiocy to which Japanese politicians and central bankers have not resorted during Japan’s twenty-six years of economic stagnation. Now, apparently, under the tutelage of Benjamin Bernanke, they are about to engage in the ultimate idiocy: helicopter money. From David Stockman at davidstockmanscontracorner.com:

Ben Bernanke is one of the most dangerous men walking the planet. In this age of central bank domination of economic life he is surely the pied piper of monetary ruin.

At least since 2002 he has been talking about “helicopter money” as if a notion which is pure economic quackery actually had some legitimate basis. But strip away the pseudo scientific jargon, and it amounts to monetization of the public debt—–the very oldest form of something for nothing economics.

Back then, of course, Ben’s jabbering about helicopter money was taken to be some sort of theoretical metaphor about the ultimate powers of central bankers, and especially their ability to forestall the boogey-man of “deflation”.

Indeed, Bernanke was held to be a leading economic scholar of the Great Depression and a disciple of Milton Friedman’s claim that Fed stringency during 1930-1932 had caused it. This is complete poppycock, as I demonstrated in The Great Deformation, but it did give an air of plausibility and even conservative pedigree to a truly stupid and dangerous idea.

Right about then, in fact, Bernanke grandly promised during a speech at Friedman’s 90th birthday party that today’s enlightened central bankers—led by himself—-would never let it happen again.

Presumably Bernanke was speaking of the 25% deflation of the general price level after 1929. The latter is always good for a big scare among modern audiences because no one seems to remember that the deflation of the 1930’s was nothing more than the partial liquidation of the 100%-300% inflation of the general price level during the Great War.

In any event, Bernanke was tilting at windmills when he implied that the collapse of the US wartime and Roaring Twenties boom had anything to do with the conditions of 2002. Even the claim that Japan was suffering from severe deflation at the time was manifestly false.

In fact, during the final stages of Japan great export and credit boom, the domestic price level had risen substantially, increasing by nearly 70% between 1976 and 1993. It then simply flattened-out—–and appropriately so—-after the great credit, real estate and stock market bubble collapse of 1990-1992.

So even by the evidence of Japan, there was no basis anywhere in the world for Bernanke’s fear-mongering about deflation at the turn of the century.

Instead, Bernanke was already showing himself to be a dangerous academic crank with no compunction about dispensing among democratic politicians the most toxic ideological poison known to history. Namely, an invitation to plunge the public fisc deep into the red so that the central banks would have bonds to buy in their fight against the purported scourge of deflation.

To continue reading: Bernanke’s Black Helicopters Of Money

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It Took $10 In New Debt To Create $1 Of Growth In The First Quarter, by Tyler Durden

Posted on June 10, 2016 | Leave a comment

Distressing, and depressing (in both the emotional and economic senses of the word) statistics on debt, from Tyler Durden at zerohedge.com:

When the Fed unexpectedly stopped reporting the data for Total Credit Market Instruments in September 2015, the most comprehensive series of total credit in the US economy, there were many screams of disappointment and frustration from US debt watchers. However, this was unnecessary, as all the Fed did was break up the series into its two constituent components: total debt (found here) and total loans (found here).

So today we had a chance to update the total US credit following the release of the Fed’s Flow of Funds (Z.1) statement, which is usually parsed for its tracking of changes to household wealth. And while it showed that in the first quarter the net worth of US residents, mostly the wealthy ones as the bulk of financial assets is held by a small fraction of the total population, rose by $837 billion to $88 trillion mostly as a result of a change in real estate holdings, we were more interest in the aggregate picture.

It wasn’t pretty.

As a reminder, according to the latest BEA revision, nominal Q1 GDP was $18.23 trillion, an increase of just $65 billion from the previous quarter or an annualized 0.7% rate, the question is how much credit had to be created to generate this growth. Well, according to the Z.1, total credit rose to a new record high $64.1 trillion. This was an increase of $645 billion from the previos quarter. It means that in the first quarter, it “cost” $10 in new debt to generate just $1 in new economic growth!

And here are the two other key charts: the first, showing total credit (debt and loans) vs GDP growth since 1950. The trend is hardly anyone’s friend, except for those who create the debt out of thin air to pocket the ever lower cash flows associated with it (and await the next inevitable bailout):

More importantly, on a leverage ratio basis, the US economy is now at a level of 352% total credit/GDP, the highest since Q1 2013, and a level which has been relatively flat since it peaked at 380% just before the crash. One way to read this chart perhaps is that the “carrying debt capacity” of the US economy is roughly 380% at which point something “unexpected” happens. At the current rate of surging credit relative to slowing GDP, the US economy should be there in the not too distant future.

http://www.zerohedge.com/news/2016-06-09/it-took-10-new-debt-create-1-growth-first-quarter

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Pity Poor China: There’s No Easy Fix to the S-Curve, by Charles Hugh Smith

Posted on June 9, 2016 | Leave a comment

The S-Curve is an exponential growth and decay function. The downward curve can be, and usually is, a lot sharper than the upward curve, which means it’s not a truly symmetrical S. China’s down is probably going to be a lot sharper than its up has been. From Charles Hugh Smith at oftwominds.com:

This decline is inevitable in fast-expanding economies that depended on export growth and investment booms.

The fundamental context of China’s economy is that it has traced out an S-Curve–as did previous fast-developing nations such as Japan and South Korea.

Gordon Long and I discuss why there’s no easy fix to the S-Curve in our new video discussion Bull in the China Shop (35:25).

The S-Curve can be likened to a rocket’s trajectory: first, there’s an ignition phase, as the fuel of financialization, cheap labor and untapped productive capacity is ignited.

The boost phase lasts as long as credit-fueled production and consumption expand rapidly.

In the boost phase, investors and financial authorities can do no wrong. The high growth rate of credit and production overwhelms all other factors, as the virtuous cycle of expanding profits and production increases wages which then support further expansion of credit and consumption which then supports more production, and so on.

A vast tide of foreign investment fuels an equally vast expansion of fixed capital assets such as factories and new homes. (The chart below depicts the astronomical amounts of new square footage constructed in China every year.)

But then the fuel of financialization is consumed, and the previously fast-growing economy slows to stall speed. Depending on how much leverage, corruption and wealth has piled up in the boost phase, this phase may last a few years. This is the top of the S-Curve.

As the economy weakens, everything that worked in the boost phase no longer works: expanding credit no longer boosts growth, inflating yet another real estate bubble no longer generates a widespread wealth effect, and every effort to shift from being an export-dependent economy to a self-supporting consumer economy fails to achieve liftoff.

This decline is inevitable in fast-expanding economies that depended on export growth and domestic investment booms fueled by exploding credit and leverage. In the decline phase of the S-curve, doing more of what succeeded spectacularly now fails spectacularly.

To continue reading: Pity Poor China: There’s No Easy Fix to the S-Curve

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The Five Stages of Central Bankers’ Failure, by Charles Hugh Smith

Posted on May 31, 2016 | Leave a comment

Unfortunately, we are probably a long way from the Kubler-Ross acceptance stage where central banks admit that they’re useless, they’re counterproductive. Charles Hugh Smith analyzes where we are on the famous continuum at oftwominds.com:

Central bankers must accept the complete and utter failure of their policies if we are to move forward.

Central bankers are now in the denial and anger stages of Kubler-Ross’s famed stages of loss: denial, anger, bargaining, depression and acceptance. Central bankers are in denial that all their trillions of dollars, euros, yen and yuan have completely and utterly failed to achieve the desired result: “organic” (i.e. unmanipulated by central states/banks) expansion of productivity, investment and household earnings.

Central bankers not only continue to insist their free money for financiers will eventually “trickle down” to the masses–they’re angry that the masses aren’t buying it. Central bankers are now blaming the masses for maintaining a perverse psychological state of disbelief in the omnipotence of central banks and their policies.

Central bankers are raging at the psychology of hesitant households, which they finger as the cause of global weakness: if only people believed everything was great, they’d borrow and blow tons of money, and the ship would leave port with a full head of steam.

The central bankers have spent seven years constructing “signals” that are supposed to create a psychological state of euphoria that leads to more borrowing and spending. The stock market is at all-time highs–don’t those stupid masses get it? That’s the “signal” that all’s well and they should get out there and borrow more money to enrich the banks!

Central bankers’ anger is not directed at the source of the policy failures–themselves–but at the masses, whose BS detectors suggest all the signals are manipulated and therefore worthless. The skeptical psychology of the masses is akin to the mark at the 3-card monte table: the crooked dealer (in this case, the central banks) has let the mark win a few rounds to “prove” the game is honest, but the mark remains skeptical.

This is infuriating central bankers, who counted on the marks falling for the rigged game. This wasn’t supposed to happen, they rage; the Keynesian bag of tricks was supposed to work. Stage-managed perception (i.e. rising markets mean the economy is healthy and vibrant) was supposed to trump reality (i.e. the economy is sick, dependent on the dangerous drugs of debt and speculation).

Next up: bargaining. Central bankers are kneeling at the false gods of the Keynesian Cargo Cult and saying that they’ll offer “helicopter money” (more fiscal stimulus) if only the financial gods restore “growth.”

They hope that by being “good central bankers” the gods will delay the inevitable destruction of their empires of debt.

To continue reading: The Five Stages of Central Bankers’ Failure

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