Category Archives: Financial markets

Could Big European Banks Drag the World Economy Down? by Peter Schiff

The European banking sector may be where the next financial crisis starts, but all of the world’s banks have assets and liabilities far in excess of their capital, and they are all interlinked, so once the crisis starts it will spread quickly. From Peter Schiff at schiffgold.com:

Humans are by nature somewhat myopic. We tend to focus primarily on what is right in front of us and filter out things further removed. As a result, we can sometimes overlook important factors.

As Americans, we generally devote most of our attention on American policy. We follow political maneuverings in Washington D.C., study the Fed’s most recent pronouncements and track the US stock markets. But we also need to remember there is a whole wide world out there that can have a major impact on the larger economy and our investment portfolio.

One factor that could potentially rock the world economy that a lot of American may not be aware of is the mess in the European banking system.

In a recent podcast, Peter Schiff talked about the impact the European Central Bank could have on the economy. Mario Draghi’s comments indicating he plans to hold interest rates at zero for another year roiled the markets. But that’s not the only issue facing the eurozone. As economist Dr. Thorsten Polleit noted in a recent article published by the Mises Wire, many euro banks are in “lousy” shape.

So what? you might ask. Well, the European banking system is huge. It accounts for 268% of gross domestic product (GDP) in the euro area. If the sector collapses, that’s bad news for the broader world economy.

One of the biggest problem children in European banking is Deutsche Bank. As of March 2018, the German giant had a balance sheet of close to 1.5 trillion euro, accounting for about 45% of German GDP. Polliet described this as an “enormous, frightening dimension.”

Beware of big banks — this is what we could learn from the latest financial and economic crises 2008/2009. Big banks have the potential to take an entire economy hostage: When they get into trouble, they can drag everything down with them, especially the innocent bystanders – taxpayers and, if and when the central banks decide to bail them out, those holding fiat money and fixed income securities denominated in fiat money.”

To continue reading: Could Big European Banks Drag the World Economy Down? 

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The Smart Money Gets Ready for the Next Credit Event, by Wolf Richter

The vultures are gathering, hovering above the credit markets. From Wolf Richter at wolfstreet.com:

“It feels like we’re about 12 months away, but we could get into extended innings.”

As corporate indebtedness in the US has reached precarious heights, and as risks are piling up, in an environment of rising interest rates and a hawkish Fed, the smart money is getting ready.

The smart money is preparing for the moment when the air hisses out of the exuberant junk-bond market, when liquidity dries up for over-indebted companies, and when their bonds collapse. The smart money is preparing for the arrival of “distressed debt” – it’s preparing now because these preparations include raising billions of dollars for their funds, and that takes some time.

“Distressed debt” is defined as junk-rated debt that sports yields that are at least 10 percentage points above equivalent US Treasury yields.

Distressed-debt investors can make a killing by buying bonds for cents on the dollar during times of economic stress, of companies that they believewill make it through the cycle without defaulting. In this scenario, a distressed bond might sell for 40 cents on the dollar, and two years later, the company is still intact and the credit squeeze is resolved, and now the bond is worth face value. For those two years, the bond paid a huge yield to investors that bought at 40 cents on the dollar – and the profit might be 200% in capital gains and interest.

The thing is: The junk-bond market has been booming. There’s no credit squeeze yet. And the riskiest end is flush as the “dumb money” is still chasing yield. And for the smart money, there’s not much to pick at the moment; but down the road, the future looks bright.

S&P Global tracks distressed debt in its US High Yield Corporate Distressed Bond Index. The index peaked in early July 2014, on the eve of the oil bust. Over the next 18 months, it plunged 56% as the oil bust was wreaking havoc on oil-and-gas bonds. But on February 11, 2016, the index bottomed out. New money began flowing into the oil-and-gas sector. Banks started lending again. The surviving bonds soared. And the index skyrocketed 113% in 28 months:

To continue reading: The Smart Money Gets Ready for the Next Credit Event

The Pension Train Has No Seat Belts, by John Mauldin

Pensions are the same unsustainable trajectory as the rest of our debt-saturated world. From John Mauldin at mauldineconomics.com:

In describing various economic train wrecks these last few weeks, I may have given the wrong impression about trains. I love riding the train on the East Coast or in Europe. They’re usually a safe and efficient way to travel. And I can sit and read and work, plus not deal with airport security. But in this series, I’m concerned about economic train wrecks, of which I foresee many coming before The Big One which I call The Great Reset, where all the debt, all over the world, will have to be “rationalized.” That probably won’t happen until the middle or end of the next decade. We have some time to plan, which is good because it’s all but inevitable now, without massive political will. And I don’t see that anywhere.

Unlike actual trains, we as individuals don’t have the option of choosing a different economy. We’re stuck with the one we have, and it’s barreling forward in a decidedly unsafe manner, on tracks designed and built a century ago. Today, we’ll review yet another way this train will probably veer off the tracks as we discuss the numerous public pension defaults I think are coming.

Last week, I described the massive global debt problem. As you read on, remember promises are a kind of debt, too. Public worker pension plans are massive promises. They don’t always show up on the state and local balance sheets correctly (or directly!), but they have a similar effect. Governments worldwide promised to pay certain workers certain benefits at certain times. That is debt, for all practical purposes.

If it’s debt, who are the lenders? The workers. They extended “credit” with their labor. The agreed-upon pension benefits are the interest they rightly expect to receive for lending years of their lives. Some were perhaps unwise loans (particularly from the taxpayers’ perspective), but they’re not illegitimate. As with any other debt, the borrower is obligated to pay. What if the borrower simply can’t repay? Then the choices narrow to default and bankruptcy.

Today’s letter is chapter 6 in my Train Wreck series. If you’re just joining us, here are links to help you catch up.

To continue reading: The Pension Train Has No Seat Belts

America’s Greatest Crisis Upon Us…Debt-to-GDP Makes It Clear, by Chris Hamilton

The current trajectory of US government spending and debt growth is unsustainable. From Chris Hamiton at economica.blogspot.com:

America in the midst of the greatest crisis in its 242 years of existence.  I say this based upon the US federal debt to GDP (gross domestic product) ratio.  In the history of the US, at the onset of every war or crisis, a period of federal deficit spending ensued (red bars in graph below) to overcome the challenge but at the “challenges” end, a period of federal austerity ensued.  Until now.  No doubt the current financial crisis ended by 2013 (based on employment, asset values, etc.) but federal spending continues to significantly outpace tax revenues…resulting in a continually rising debt to GDP ratio.  We are well past the point where we have typically began repairing the nation’s balance sheet and maintaining the credibility of the currency.  However, all indications from the CBO and current administration make it clear that debt to GDP will continue to rise.  If the American economy were as strong as claimed, this is the time that federal deficit spending would cease alongside the Fed’s interest rate hikes.  Instead, surging deficit spending is taking place alongside interest rate hikes, another first for America.

The chart below takes America from 1790 to present.  From 1776 to 2001, every period of deficit spending was followed by a period of “austerity” where-upon federal spending was constrained and economic activity flourished, repairing the damage done to the debt to GDP ratio and the credibility of the US currency.  But since 2001, according to debt to GDP, the US has been in the longest ongoing crisis in the nation’s history.

But what is this crisis?  The chart points out the debt to GDP surges in order to resolve the Revolutionary war, the Civil War, WWI, and WWII. But the debt to GDP surges since 1980 seem less clear cut.  But simply put, America (and the world) grew up and matured, but the central banks and federal government could not accept this change.  Instead, the CB’s and Federal government wanted perpetual youth…growth without end.  The chart below shows the debt to GDP ratio but this time against the decelerating growth of the total US population as a percentage (black line) but also against the faster decelerating growth of the 0-65yr/old population (yellow line).

To continue reading: America’s Greatest Crisis Upon Us…Debt-to-GDP Makes It Clear

Mr. Trump Attacks Aluminum, Russia Attacks the Debt, by Tom Luongo

Is Russia selling its US government debt to retaliate against US sanctions? From Tom Luongo at tomluongo.me:

Looking at the unfolding trade war between Donald Trump and the world the phrase that should come to mind is “One good turn deserves another.”

In the case of the insane sanctions on Oleg Deripaska and Russian Aluminum giant, Rusal, back in April, we finally got some clarity as to how Russia can and will respond to future events.

In yesterday’s Treasury International Capital (TIC) report, we saw clearly that Russia activated its nearly half of its $100 billion in U.S. Treasury debt to buy dollars in April.  More than $47 billion in U.S. debt was dumped into the market to cover the chaos engendered by Trump’s overnight diktat for the world to stop doing business with Rusal.

TIC Report.png

Also of note, U.S. ally Japan continues to shed Treasuries at around 8-10 billion per month.  Ireland dumped $17 billion and Luxembourg nearly $8 billion.

While China dropped $5 billion this is noise, ultimately as its holdings of U.S. debt have been stable for over a year now.  What is interesting is Belgium, the home of Euroclear, seeing a $12 billion inflow.  Likely that’s where some of the Russian-held debt was traded to.

The Russians likely sold from their balance on reserve with the Federal Reserve.  Here’s the latest iteration of the chart I keep for just such an occassion.

USTs Treasury

Rusal’s shares and bonds went bidless but the damage wasn’t contained there as major Russian banks like VTB and Sberbank were hit hard as well.   So, while Rusal didn’t have much in the way of dollar-denominated debt.  It did have major dollar-related obligations as accounts receivable on its balance sheet because of the sheer size of its trade conducted in dollars.

And that’s why there was such an outflow from Russia’s stock of Treasuries.  But, here’s the thing.  It didn’t matter one whit.  Why?  It didn’t undermine Russia’s Foreign Exchange Reserves.

Russia Forex Reserves

No Dip in Russia’s Foreign Exchange Reserves During Rusal Crisis

Russia just sold Treasuries into the market, raised dollars and swapped out Rusal’s bonds, holding them as collateral for a Repo.

Bank of Russia debt.png

The Bank of Russia Intervened to keep Rusal and Other Banks Solvent by Dumping U.S. Treasuries

This went on for most of the month and into May.  Zerohedge’s reporting on this leads the way. 

To continue reading: Mr. Trump Attacks Aluminum, Russia Attacks the Debt

 

Living Dangerously, by Alasdair Macleod

Suppressing interest rates, encouraging debt, and discouraging savings generally does not end well. From Alasdair Macleod at goldmoney.com:

Regular readers of Goldmoney’s Insights should be aware by now that the cycle of business activity is fuelled by monetary policy, and that the periodic booms and slumps experienced since monetary policy has been used in an attempt to manage economic outcomes are the result of monetary policy itself. The link between interest rate suppression in the early stages of the credit cycle, the creation of malinvestments and the subsequent debt dénouement was summed up in Hayek’s illustration of a triangle, which I covered in an earlier article.[i]

Since Hayek’s time, monetary policy, particularly in America, has evolved away from targeting production and discouraging savings by suppressing interest rates, towards encouraging consumption through expanding consumer finance. American consumers are living beyond their means and have commonly depleted all their liquid savings. But given the variations in the cost of consumer finance (between 0% car loans and 20% credit card and overdraft rates), consumers are generally insensitive to changes in interest rates.

Therefore, despite the rise of consumer finance, we can still regard Hayek’s triangle as illustrating the driving force behind the credit cycle, and the unsustainable excesses of unprofitable debt created by suppressing interest rates as the reason monetary policy always leads to an economic crisis. The chart below shows we could be living dangerously close to another tipping point, whereby the rises in the Fed Funds Rate (FFR) might be about to trigger a new credit and economic crisis.

 

living danger 1

Previous peaks in the FFR coincided with the onset of economic downturns, because they exposed unsustainable business models. On the basis of simple extrapolation, the area between the two dotted lines, which roughly join these peaks, is where the current FFR cycle can be expected to peak. It is currently standing at about 2% after yesterday’s increase, and the Fed expects the FFR to average 3.1% in 2019. The chart tells us the Fed is already living dangerously with yesterday’s hike, and further rises will all but guarantee a credit crisis.

The reason successive interest rate peaks have been on a declining trend is bound up in the rising level of outstanding debt and loans, shown by the red line on the chart. Besides a temporary slowdown during the last credit crisis, debt has been increasing over every cycle. Instead of sequential credit crises eliminating malinvestments, it is clear the Fed has prevented debt liquidation for at least the last forty years. The accumulation of debt since the 1980s is behind the reason for the decline in interest rate peaks over time.

To continue reading: Living Dangerously

Trump’s Not Like Ike, by Bill Bonner

Bill Bonner wishes Trump were like Ike. From Bonner at bonnerandpartners.com:

Yesterday came word that the European Central Bank followed through, just like the Fed.

After $2.7 trillion in “stimulus,” it has officially taken its foot off the pedal.

No more bond purchases by the end of the year.

It follows the Fed in returning to “normal” monetary policy.

The announcement scarcely made the headlines. The media knows what keeps the public engaged – reality TV and fake news, mostly. Not central bank monetary policy.

Trump Show

On the front pages, it’s the Trump Show, 24/7… and performances are always sold out.

Many of our readers love it. They’re convinced that America’s president is a genius who will Make America Great Again. No need to read the back pages or wonder exactly how he’ll do it.

Typically, they write to say that we “don’t understand him.” Or that “he has done more in 18 months than Obama did in eight years.” Or that, since the other choice was Hillary, our only hope is to “get behind the president.” Or, “Finally, our side is winning… What’s wrong with you?” [Read more in today’s Mailbag.]

It must be as puzzling to readers as it is to us. How could we resist the charm of The Donald? How could we fail to fall under his spell?

Some readers think that there must be a hidden agenda. “You’re a closet liberal…” wrote one. “You’re one of the swamp critters,” wrote another, while a third accused us of “being part of the Deep State.”

The puzzlement goes both ways. While they can’t imagine why we don’t see the halo over his head, we can’t quite figure out what they see at all.

So to gain perspective, we put the old jalopy in reverse… and try to take another look. We’ll back up to those golden green days… of Gunsmoke and I Love Lucy… back when America really was great.

To continue reading: Trump’s Not Like Ike