Category Archives: Debtonomics

Why The Flyover Zone Is Hurting——–Bubble Finance Is Strictly For The Bicoastal Elites, by David Stockman

Posted on May 22, 2016 | 1 comment

Even if you don’t like Donald Trump or Bernie Sanders, it should be no great mystery why they have done so well in their presidential primaries. From David Stockman at davidstockmanscontracorner.com:

We are now in month 83 of this so-called recovery. Yet there are still 45 million people on food stamps——one out of every seven Americans. The median real household income is still 5% below its level in the fall of 2007. There are still only 71 million full-time, full-pay “breadwinner” jobs in the nation—–nearly 2 million fewer than when Bill Clinton was packing his bags to vacate the White House.

At the same time, we have had monetary stimulus like never before. There has been 90 straight months of virtually zero interest rates. The balance sheet of the Fed has been expanded by $3.5 trillion. For point of reference, that is 4X more than all the bond-buying during the entire first 94 years of the Fed’s history.

So something doesn’t parse, and that’s to put it charitably. The truth is, the Fed’s entire radical regime of ZIRP and QE constitutes a monumental monetary fraud.

It has not “stimulated” a wit the struggling main street economy of flyover America. Instead, it has showered Wall Street speculators with trillions of windfall gains and gifted the bicoastal elites with a false prosperity derived from financial inflation and government expansion.

Herein follows an initial bill of particulars. We show that the “recovery” narrative endlessly trumpeted by the Fed and its fellow travelers on Wall Street and in the financial media does not remotely reflect on the ground economic reality; it derives almost entirely from a narrow band of badly flawed and thoroughly misleading labor market indicators and other faulty “incoming data” from the Washington statistical mills.

To begin with the most obvious example, consider the graph below on industrial production of consumer goods. The whole point of ultra-low interest rates is obviously to induce households to borrow and spend, and thereby trigger a virtuous cycle of rising demand, increasing production, more jobs and income and even more consumer spending. That’s Keynes 101.

Yet after seven years of massive monetary stimulus, domestic production of consumer goods is still 9.1% below its pre-crisis peak, and at a level first reached in early 1999!

Never once in its post-meeting blather about a steadily “improving” domestic economy has the Fed noted this fundamental rebuke to its entire ideology.

After all, if you are priming the pump with trillions of inducements for households to borrow and spend, why has consumer goods production remained in the sub-basement of its historical trend line and “recovered” at such a tepid rate?

The disconnect between the mainstream recovery meme and the chart above is implicit in the latter’s construction. That is, the industrial production index is a physical measure of output, and as such is not distorted by the flaws in the primitive measures of inflation published by the BLS.

To continue reading: Why The Flyover Zone Is Hurting——–Bubble Finance Is Strictly For The Bicoastal Elites

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Why $19 Trillion In Debt IS a PROBLEM, by Lance Roberts

Posted on May 2, 2016 | Leave a comment

Debt service, even with ultra-low interest rates, becomes a burden that weighs on an economy. From Lance Roberts at davidstockmanscontracorner.com:

According to the World Economic Forum, the United States has achieved a new TOP 10 ranking. Tell us what we’ve won Bob:

“Coming in at #10 – the United States, at 104%, gets nothing but the privilege of being on the list of countries with the highest debt/GDP ratios.”

So…it’s just $19 Trillion? A mere doubling of the national debt in eight years isn’t really a problem, right? According to Bob Bryan at Business Insider, that answer is – no.

“Debt is an issue only if you can’t repay it or if other people believe you can’t repay it. And, as Business Insider’s Myles Udland has noted, the US can literally print the money it needs to repay its debt, and it still maintains a high credit rating.”

Bob is correct. The “fear mongering” over debt levels, and President Obama’s threats of default if we “shut down the government,” are just that – fear mongering. Entitlements and interest payments are mandatory expenditures of the government which get paid regardless of whether the Government is shut down or not.

However, what Bob misses is the much bigger point which is the impact on debt levels as it relates to economic prosperity.

According to Keynesian theory, some microeconomic-level actions, if taken collectively by a large proportion of individuals and firms, can lead to inefficient aggregate macroeconomic outcomes, where the economy operates below its potential output and growth rate (i.e. a recession).

Keynes contended:

“A general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”

In other words, when there is a lack of demand from consumers due to high unemployment, the contraction in demand would force producers to take defensive actions to reduce output.

In such a situation, Keynesian economics states:

Government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment and deflation. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

Keynes’ was correct in his theory. In order for government deficit spending to be effective, the “payback” from investments being made through debt must yield a higher rate of return than the debt used to fund it.

The problem is that government spending has shifted away from productive investments that create jobs (infrastructure and development) to primarily social welfare and debt service which has a negative rate of return. According to the Center On Budget & Policy Priorities nearly 75% of every tax dollar goes to non-productive spending.

To continue reading: Why $19 Trillion In Debt IS a PROBLEM

 

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The Keynesian House Of Denial, by David Stockman

Posted on April 16, 2016 | Leave a comment

SLL has written what probably amounts to a book now on the futility and counterproductive stupidy of intervention by governments and central banks in economies and markets (see Debtonomics Archive). Here’s David Stockman at davidstockmanscontracorner.com with a nice refresher course:

We use the term “Keynesian” loosely to stand for economic interventionists of all schools. The followers of JM Keynes and Milton Friedman alike fit that category. So do some of the more rabid supply siders who claim the power to stimulate ultra-high economic growth with the tools of tax policy alone.

The common denominator is economic statism. That is, the assumption that the state, including its central banking branch, is indispensable to economic progress and prosperity.

As the various denominations of the Keynesian economic church have it, capitalism is always veering toward the ditch of under-performance and recession when left to its own devices and natural tendencies; and, if neglected by the wise policy-makers of the central state too long, it lapses toward outright depression and collapse.

Our purpose here is not to correct the particular philosophical and analytic errors associated with each of these Keynesian or statist variants. On any given day we make it pretty clear the central banking based mutation of modern Keynesian is predicated on two cardinal errors. Namely, the myth of demand deficiency and the false presumption that central bank pegging of interest rates, yield curves and other financial prices will enhance macro-economic performance while not harming the efficiency, stability and efficacy of money and capital markets.

That’s completely wrong. The very worst thing the state can do is meddle with and falsify financial market prices. Sooner or later cheap debt, repressed volatility, stock market “puts” and artificially inflated asset prices drain the genius of markets out of capitalism. What remains in the financial system is raw speculation for the purpose of rent gathering and leverage for the purpose of supercharged gambling.

On the other hand, what gets lost is true capital formation, honest price discovery and allocative efficiency. These are the building blocks of true macroeconomic expansion and rising wealth.

The irony is that the theories of Keynes and Friedman were designed to enable exactly that. Yet after having been morphed and melded into the cult of central banking in recent decades they have become a generator of main street stagnation and impoverishment.

In that regard, we have frequently pointed out that behind all the pretentious jargon and faux economic science of the likes of Yellen, Bernanke, Dudley and Fischer is little more than the “D” word. They believe that an economy can never have enough Debt.

At the end of the day there is no other purpose for the lunacy of 78 straight months of ZIRP and the fraud of $3.5 trillion worth of QE/bond-buying with digital credits conjured from nothing. It’s all designed to get the primary economic agents—households, business and governments—-to borrow and spend.

The contemporary central bank based mutation of the old Keynesian and Friedmanite fallacies is rooted in this debt-centric economics but is far more dangerous. Owing to his anti-gold standard worldview, Friedman failed to realize that fiat money was nothing more than debt, but at least he swore an oath of restraint in the form of a fixed rule (such as 3% per annum) for the growth of credit money.

To continue reading: The Keynesian House Of Denial

 

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The Root of Rising Inequality: Our “Lawnmower” Economy (hint: we’re the lawn), by Charles Hugh Smith

Posted on April 12, 2016 | 1 comment

In a global economy in which debt is the foundation (see Debtonomics Archive), it should come as no surprise that debt merchants have done better than most. It should also come as no surprise when myriad debt bubbles eventually pop and the global economy is put through the wringer. From Charles Hugh Smith at oftwominds.com:

This predatory exploitation is only possible if the central bank and state have partnered with financial Elites.

After decades of denial, the mainstream has finally conceded that rising income and wealth inequality is a problem–not just economically, but politically, for as we all know wealth buys political influence/favors, and as we’ll see below, the federal government enables and enforces most of the skims and scams that have made the rich richer and everyone else poorer.

Here’s the problem in graphic form: from 1947 to 1979, the family income of the top 1% actually expanded less that the bottom 99%. Since 1980, the income of the 1% rose 224% while the bottom 80% barely gained any income at all.

Globalization, i.e. offshoring of jobs, is often blamed for this disparity, but as I explained in “Free” Trade, Jobs and Income Inequality, the income of the top 10% broke away from the bottom 90% in the early 1980s, long before China’s emergence as an exporting power.

Indeed, by the time China entered the WTO, the top 10% in the U.S. had already left the bottom 90% in the dust.

The only possible explanation of this is the rise of financialization: financiers and financial corporations (broadly speaking, Wall Street, benefited enormously from neoliberal deregulation of the financial industry, and the conquest of once-low-risk sectors of the economy (such as mortgages) by the storm troopers of finance.

To continue reading: The Root of Rising Inequality: Our “Lawnmower” Economy (hint: we’re the lawn)

 

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The Global Bubble Has Burst – “Will Tear At The Threads Of Society” by Doug Noland

Posted on April 10, 2016 | Leave a comment

Doug Noland understands debtonomics. From Noland at creditbubblebulletin.blogspot.com, as excerpted on zerohedge.com:

Bubble Economy or Not?

“The US economy has made tremendous progress in recovering from the damage from the financial crisis. Slowly but surely the labor market is healing. For well over a year, we have averaged about 225,000 jobs (gains) a month. The unemployment rate now stands at 5%. So, we’re coming close to our assigned congressional goal of maximum employment. Inflation which my colleagues here, Paul (Volcker) and Alan (Greenspan), spent much of their time as chairmen bringing inflation down from unacceptably high levels. For a number of years now, inflation has been running under our 2% goal, and we are focused on moving it up to 2%. But we think that it’s partly transitory influences, namely declining oil prices and the strong dollar that are responsible for pulling inflation below the 2% level we think is most desirable. So, I think we’re making progress there as well. This is an economy on a solid course – not a bubble economy. We tried carefully to look at evidence of potential financial instability that might be brewing and some of the hallmarks of that – clearly overvalued asset prices, high leverage, rising leverage, and rapid credit growth. We certainly don’t see those imbalances. And so although interest rates are low, and that is something that can encourage reach for yield behavior, I certainly wouldn’t describe this as a bubble economy.”

-Janet Yellen, April 7, 2016, International House: “A Conversation with Janet Yellen, Ben Bernanke, Alan Greenspan and Paul Volcker”

From my analytical perspective, unsustainability is a fundamental feature of “Bubble Economies.” They are sustained only so long as sufficient monetary fuel is forthcoming. Over time, such economies are characterized by deep structural maladjustment, the consequence of years of underlying monetary inflation. Excessive issuance of money and Credit are always at the root of distortions in investment and spending patterns. Asset inflation and price Bubbles invariably play central roles in latent fragility. Risk intermediation is instrumental, especially late in the cycle as the quantity of Credit expands and quality deteriorates. Prolonged Credit booms – the type associated with Bubble Economies – invariably have a major government component.

Japanese officials in the late-eighties recognized the risks associated with their Bubble economy and moved courageously to pierce the Bubble. Outside of that, few policymakers have been even willing to admit that Bubble Dynamics have taken hold in their systems. Apparently, only in hindsight did U.S. monetary authorities recognize the Bubble component that came to exert pernicious effects on the U.S. economy in the late-eighties, later in the nineties and again in the 2002-2007 mortgage finance Bubble period. I would strongly argue that the U.S. has been in a “Bubble Economy” progression for the better part of thirty years, interrupted by financial crises relatively quickly resolved by aggressive governmental reflationary measures. And each reflation has been more egregious than the previous, with resulting booms exacerbating underlying financial and economic maladjustment.

Chair Yellen stated that the U.S. “is an economy on a solid course – not a bubble economy” – “we tried carefully to look at evidence of potential financial instability that might be brewing.” That the Fed has for seven post-crisis years clung to near zero rates and a $4.5 TN balance sheet (with reassurances that it can grow larger) argues against such claims. That the Fed rather abruptly backed away from its 2011 “exit strategy” and repeatedly postponed “lift off” due to market instability rather clearly demonstrates the Fed’s underlying lack of confidence in the soundness of the markets and real economy.

I have argued that the more systemic a Bubble the less obvious it becomes to casual observers. By the late-nineties, the “tech” Bubble had turned rather conspicuous (although the Fed and the bulls still rationalized with claims of New Eras and New Paradigms). While having quite an impact on the technology, telecom and media sectors, these relatively narrow Bubble distortions had yet to cultivate more general structural impairment throughout the economy.

The mortgage finance Bubble was a much more powerful Bubble Dynamic, clearly in terms of Credit expansion, economic imbalances and systemic impairment. Alan Greenspan nonetheless argued that since real estate was driven by local factors, a national housing Bubble was implausible. Only in hindsight was the degree of systemic “Bubble Economy” maladjustment recognized.

It’s now been seven years since my initial warning of an inflating “global government finance Bubble” – the “Granddaddy of All of Bubbles.” This Bubble did become systemic on a globalized basis, ensuring the strange dynamic of a somewhat less than conspicuous global Bubble of historic proportions. Over the past eight years, global Credit growth has been unprecedented – driven by an extraordinary expansion of government borrowings. The inflation of central bank Credit has been simply unimaginable. Global asset inflation has been extraordinary – especially in securities markets and real estate.

The expansion of Chinese Credit has been greater than I previously imagined possible. Hundreds of billions – perhaps Trillions – have flowed out of China, with untold amounts flowing into the U.S. (real estate, securities and M&A). For that matter, I believe huge inbound flows have been inflating U.S. securities and some real estate markets, especially “money” fleeing bursting EM Bubbles.

Indeed, extraordinary international financial flows are fundamental to the global government finance Bubble thesis, flows that I believe are increasingly at risk. Along with Bubble flows from China and out of faltering EM, I believe speculative flows grew to immense proportions. And, importantly, the massive global pool of destabilizing speculative finance has been inflated by the proliferation of leveraged strategies. Chair Yellen may not see “high leverage,” yet on a globalized basis I strongly believe speculative leverage reached new heights over recent years. “Carry trade” speculation – borrowing in low-yielding currencies (yen, swissy, euro, etc.) – has proliferated over recent years, especially after the 2012 “whatever it takes” devaluations orchestrated by the European Central Bank and Bank of Japan.

To continue reading: The Global Bubble Has Burst – “Will Tear At The Threads Of Society”

 

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An Exponential Decay Function, by Robert Gore

Posted on April 4, 2016 | 4 comments

For a long time, economic policy in affluent, developed countries has attempted to end-run reality. While there have been isolated remnants of intellectual integrity that stood in opposition, much of what passes for the field of economics has provided cover. Delusions being more comforting than reality—and often more profitable in the short term—financial markets have fully endorsed them. Evading reality doesn’t make it go away, and evasion makes the eventual consequences that much more severe. Governments and central banks have postponed and ameliorated the consequences, but the mounting long-term costs are staggering. Now, the end run is no longer possible.

A phrase used to sell the Federal Reserve Act in the early 1900s—“an elastic currency”—denotes its foundation in fantasy. When money is left to private actors, choices, and markets, it is neither elastic or inelastic. Just like other goods and services, it’s acquisition and use is governed by the dynamic forces of supply, demand, and the price mechanism. Money has obvious functions and usefulness, so there is a demand for it. It will be, if government has no role, something tangible that requires resources to produce, probably a precious metal, or something directly convertible to that intrinsically valuable medium (see “Real Money”). Its supply will be governed by the same factors that determine the supply of other tangible items. Its price is its exchange value relative to other goods and services. In a system where government has no monetary role, debt is not money, although it may sometimes fulfill monetary functions, and is tethered to production. Its quantity can not long outrun the means to repay it.

The welfare state—theft from those with productive ability to the government and those it deems “in need”—is a self-evident attempt to abridge reality. Ability and its fruits are limited, needs are not. Governments now meet “needs” for income, pensions, shelter, medical care, child care, weaponry, military bases, corporate subsidies, bailouts, mass transit, crop price supports, education, and anything else those running the governments judge necessary, or more correctly, politically expedient. In most if not all welfare states, the “needy” now outnumber the able. Not surprisingly, economic performance has deteriorated for decades. Economies are sputtering around the zero growth line, depending on the abstruse calculations underlying seasonal adjustments and price indexes, on their way to destinations well below zero.

Debt delays reality and its attendant pain. Both public and private sectors have been going deeper into debt. The growing debt service burden bears a significant share of the responsibility for deteriorating economic performance. Debt is the last refuge of the delusional, but now each additional dollar, yen, yuan, and euro of debt exacts a cost greater than any putative benefit. Debt expansion has slowed and may have stopped altogether. If it hasn’t it soon will, on its way to contraction, because the benefits of reducing debt are now greater than the benefits of additional debt.

The debt overhang—not just stated, on-the-books debt, but governments’ unfunded pension and medical promises—is the salient feature of the global economy; everything else pales in significance. Governments and central banks are engaging in absurd stratagems: monetizing government fiat debt with central bank fiat debt, negative interest rates, and perhaps helicopter money drops, to force already over-indebted individuals and businesses to spend more and take on additional debt. These stratagems are distractions, totems on which financial markets can affix whatever optimism they can still muster.

Financial markets are exercises in crowd psychology. Extremes in either optimism or pessimism give way to reactions the other way. Governments and central banks fighting debt deflation with more debt and low interest rates have delayed the deflation but are, by increasing debt, making it worse. Deflation is everywhere. Despite a weak rebound in some prices propelled by overly exuberant shorts covering ill-timed bets, the collapse in commodities continues, with markets glutted and demand shrinking as economies shrink. Commodities are no longer a leading edge anomaly; gluts and weak prices characterize much of the rest of the global economy: intermediate and finished goods, transportation, retail, and services. Most of the remaining pockets of inflation and supposed economic activity reflect the inefficient hand of government: housing, medical insurance and care, and education.

The reality of debt contraction and deflation has not changed since commodities heralded their arrival in 2014, and will not change until a huge chunk of the world’s $225 trillion in debt is paid down, repudiated, or written off. Even those who focus only on financial markets and pronouncements and statistics from Wall Street and Washington must notice that something is amiss. While central bank machinations have a lot to do with negative interest rates, they couldn’t get away with it in anything but a deflationary environment. With occasional interruptions credit spreads have been widening and bank and other financial companies’ share prices have been declining for months. Legitimate, GAAP-compliant S&P 500 earnings peaked in the third quarter of 2014 and are down 18.5 percent since then. Incidentally, the gap between GAAP-earnings and companies’ dressed up, “adjusted” earnings reached an all time high this latest quarter. The Atlanta branch of the Federal Reserve is predicting just 6 tenths of 1 percent annualized growth in the first quarter, a seasonal adjustment or inflation index tinker away from outright contraction.

The resolutely bullish must ignore the real economy and the growing list of financial and statistical indicators, leaving only central bank faith, hope, and pixie dust, which has been in full florescence since early February. Debt contraction and deflation are exponential decay functions. They start slowly, gather steam, reach a point of inflection, and drop dramatically, approaching or reaching zero. Recall in the last crisis that the housing market topped out about a year-and-a-half before the headline stock market indices did in October of 2007, and most of the financial damage came in a few-month span a full year after that.

The train has left the station. Asset values have been reduced, mountains of IOUs await rescheduling and write-offs, debt-based wealth shrinks, economic activity deteriorates, and reverberations multiply throughout the extensive interlinkages of the global economy. Fools will pay attention to the stratagems and pixie dust. The rest of us don’t have that luxury. The inflection point looms: the unavoidable can no longer be avoided.

This is Crisis Progress Report 17. For the first 16 CPRs, see the Debtonomics Archive.

EXPONENTIAL PROGRESS:

ROBERT GORE’S NOVEL OF THE INDUSTRIAL REVOLUTION

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2016: The End of the Global Debt Super Cycle, by Etai Friedman

Posted on April 1, 2016 | Leave a comment

Excellent history of the global debt super cycle, from Etai Friedman at palisade-research.com:

After the stock market crash of 1987, The Federal Reserve embarked on a path that led to the biggest debt bubble in the history of the world. The day after the 1987 crash (Oct. 20, 1987) Alan Greenspan, Chairman of the Fed, announced to the world that The Fed stood ready to provide whatever liquidity was needed by the banking system to prevent the crash from turning into a systemic financial crisis. That was the day the Fed “put” was born.

A put is an option that allows its owner to sell a specified amount of a particular asset at a predetermined price by a specific date. As an example, if an investor had a February 90 put on Apple’s stock that investor would have the right to sell 100 shares at 90 a share until the third Friday in February when the option expired. An investor would only exercise that put if Apple’s stock price dropped below 90 a share before expiration. As it stands Apple’s stock price is 94.02 as of Friday’s close so no rational investor would exercise that put. But if on Monday Apple’s stock crashed and was trading 60 a share than the investor would exercise his put and gladly sell his stock at 90 a share to the person who sold him the put. So in effect after 1987 The Fed was acting as a giant put for the financial markets, a role it had heretofore not played.

In September of 1998 Long Term Capital Management, a highly leveraged high profile hedge fund, sustained losses that threatened its solvency. The fund with a few billion in equity had $80 billion in assets and all of its trades were going against the firm. LTCM’s equity was going to be wiped out within days. Warren Buffet and a consortium of investors offered to bail out the fund by paying fire sale prices for the assets and shutting down the fund. LTCM’s management balked and looked to The Fed for a better solution. The Fed engineered a bailout by numerous banks that left LTCM’s management in place with some of their wealth to spare. Once again, The Fed intervened in a market calamity and this time bailed out an extremely reckless hedge fund that should have been allowed to fail. The Fed’s put engendered moral hazard in the hedge fund community by allowing reckless and destabilizing behavior to go unpunished.

In December of 1999, The Fed injected enormous amounts of liquidity into the banking system to fend off any potential problems from the Y2K problem. If you recall, The Fed was worried that banking computer systems might erroneously register 1900 as the year on January 1, 2000 due to perceived deficiencies in banking software. To avert any panic, The Fed stuffed money into the banking system to make sure no calamities ensued. The stock market which was already in the midst of a mania in the tech sector effectively had kerosene poured on the fire. The extra banking liquidity found its way into the stock market and sent the tech bubble into overdrive. After the new year passed without so much as a hiccup The Fed withdrew the excess liquidity and the tech bubble peaked in March 2000 and then collapsed.

To continue reading; 2016: The End of the Global Debt Super Cycle

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The Seven Countries Most Vulnerable To A Debt Crisis, by Steve Keen

Posted on March 28, 2016 | Leave a comment

Steve Keen demonstrates an excellent grasp of debtonomics. From Keen at forbes.com:

For decades, some of the most important data about market economies was simply unavailable: the level of private debt. You could get government debt data easily, but (with the outstanding exception of the USA—and also Australia) it was hard to come by.

That has been remedied by the Bank of International Settlements, which now publishes a quarterly series on debt—government & private—for over 40 countries. This data lets me identify the seven countries that, on my analysis, are most likely to suffer a debt crisis in the next 1-3 years. They are, in order of likely severity: China, Australia, Sweden, Hong Kong (though it might deserve first billing), Korea, Canada, and Norway.

I’ve detailed the logic behind my argument too many times to count, and I won’t repeat it here (if you want to check it out, try this Forbes post on Krugman, this one on money, this one on the Fed, or this one on our dysfunctional monetary system). The bottom line is that private sector expenditure in an economy can be measured as the sum of GDP plus the change in credit, and crises occur when (a) the ratio of private debt to GDP is large; (b) growing quickly compared to GDP. When the growth of credit falls—as it eventually must, as growing debt servicing exhausts the funds available to finance it, new borrowers balk at entry costs to house purchases, and numerous euphoric and Ponzi-based debt-financed schemes fail—then the change in credit falls, and can go negative, thus reducing demand rather than adding to it.

This is what caused the Global Financial Crisis, and the simplest way to simply substantiate my argument—which virtually every other economist on the planet will advise you is crazy (except Michael Hudson, Dirk Bezemer and a few others)—is to show you this data for the USA. The crisis began as the rate of growth of credit began to fall, and the Great Recession was dated as starting in 2008 and ending in 2010. As you can see from Figure 1, the sum of GDP plus credit growth peaked in 2008, and fell till 2010—at which point the recovery began.

To continue reading: The Seven Countries Most Vulnerable To A Debt Crisis

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S&P Gets Bearish, Sees “Spike in Defaults,” Blames Fed, by Wolf Richter

Posted on March 27, 2016 | Leave a comment

From Wolf Richter at wolfstreet.com:

“Hangover from years of lenient credit may become painful.”

Credit rating agencies, such as Standard & Poor’s, are not known for early warnings. They’re mired in conflicts of interest and reluctant to cut ratings for fear of losing clients. When they finally do warn, it’s late and it’s feeble, and the problem is already here and it’s big.

So Standard & Poor’s, via a report by S&P Capital IQ, just warned about US corporate borrowers’ average credit rating, which at “BB,” and thus in junk territory, hit a record low, even “below the average we recorded in the aftermath of the 2008-2009 credit crisis.”

The one-year average default rate for US companies with a credit rating of B- is 9.8%, according to Standard & Poor’s. That’s a 1-in-10 chance that the company will default over the next 12 months. Companies getting downgraded deep into junk and issuing more low-grade bonds are precursors to soaring defaults.

The signs have been piling up. S&P Capital IQ:

In 2015, Standard & Poor’s downgraded 5.54% of the U.S. speculative-grade nonfinancial corporate borrowers it rates — the highest level since 2009.

The average credit rating for U.S. nonfinancial corporate issuers has fallen to a record low due to the continued rapid rise in lower-quality borrowers.

As a result, nonfinancial corporate borrowers’ net negative bias is at a post-recession high and the speculative-grade downgrade rate is at the highest level since 2009.

We believe a more conservative lending environment, where more limited capital market access enables lenders to better dictate terms and conditions, could spark liquidity challenges, accelerate downgrades, and ultimately lead to a spike in defaults.

And in a delicious bit of irony, in its more or less subtle manner, it blamed the Fed for the coming “spike in defaults”:

After the financial crisis, quantitative easing-induced low interest rates enabled companies across the credit spectrum to borrow at attractive pricing and terms in the capital markets. And, until recently, investors were willing to accept the heightened risks associated with speculative-grade (rated ‘BB+’ and lower) debt in return for higher yields.

However, the residual hangover from years of lenient credit may become painful for lower-quality issuers, especially when lenders become more selective and discerning. As borrowing costs rise with market volatility and uncertainty, lower-quality borrowers, who opportunistically were able to tap the capital markets, will most likely feel a credit pinch in a more subdued and conservative borrowing environment.

The Fed’s policies since the Financial Crisis have systematically destroyed the possibility to earn a visible real yield on low-risk corporate bonds or US Treasuries. So investors have embarked on a frantic search for yield, wherever they could find it, and they found it in junk bonds, and in chasing after junk bonds, they pushed those yields down too, and companies took advantage of it.

To continue reading: S&P Gets Bearish, Sees “Spike in Defaults,” Blames Fed

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The ECB and John Law, by Alasdair Macleod

Posted on March 18, 2016 | 1 comment

From Alasdair Macleod at cobdencentre.org:

Last week, the ECB extended its monetary madness, pushing deposit rates yet more negative. It is extending quantitative easing from sovereign debt into non-financial investment grade bonds, while increasing the pace of acquisition to €80bn per month. The ECB also promised to pay the banks to take credit from it in “targeted longer-term refinancing operations”.

Any Frenchman with a knowledge of his country’s history should hear alarm bells ringing. The ECB is running the Eurozone’s money and assets in a similar fashion to that of John Law’s Banque Generale Privée (renamed Banque Royale in 1719), which ran those of France in 1716-20. The scheme at its heart was simple: use the money-issuing monopoly granted to the bank by the state to drive up the value of the Mississippi Company’s shares using paper money created for the purpose. The Duc d’Orleans, regent of France for the young Louis XV, agreed to the scheme because it would provide the Bourbons with much-needed funds.

This is pretty much what the ECB is doing today, except on a far larger Eurozone-wide basis. The need for government funds is of primary importance today, as it was then.

In Law’s day, France did not have a central bank, such as the Bank of England, managing the issue of government debt, let alone a functioning government bond market. The profligate spending of Louis XIV had left the state three billion livres in debt, which was the equivalent of 1,840 tonnes of gold. This was about 85% of the world’s estimated gold stock at that time, at the livre’s conversion rate into Louis d’Or. John Law would almost double that by June 1720, with unbacked livre notes issued by his bank.

Today, the assets being overvalued for the governments’ benefit are government bonds themselves, but the principal is the same. There is no need to use a separate, Mississippi-style vehicle, because there is a fully functioning government bond market.

Banque Generale created the bank credit for France’s upper and middle classes to buy Mississippi Company shares, driving up the price and making yet higher prices a certainty. Law had set up a money-making machine for those with a modicum of wealth, but the ten per cent down-payment required to subscribe for Mississippi shares made speculation available to the servant classes as well. The result was virtually everyone in Paris was caught up in the speculative fever, and Mississippi shares increased from the 15 livres deposit to 18,000 livres fully paid at the peak in June 1720. The term “millionaire” dated from that time.

Today, the ECB is doing things a little differently, creating money to buy government bonds from the banks, enabling governments to continue to spend without the threat of a funding crisis. Basel III banking regulations, which exempt banks from having to apply a risk weighting to government bonds, ensures that the bonds are also in great demand as collateral, further guaranteeing that the banks will continue to buy them.

However, in common with Law’s scheme, the ECB needs new suckers all the time to keep the market from stalling, so the ECB is extending the scheme beyond sovereign debt by buying up investment grade bonds as well. And since it can conjure up money out of thin air, it will also pay the commercial banks interest to borrow from it, ensuring the yields on all bonds purchased with this finance will continue to fall in line with negative interest rates.
To continue reading: The ECB and John Law 

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