Tag Archives: speculation

The Illusion of Getting Rich While Producing Nothing, by Charles Hugh Smith

You can steal someone’s production, but you can’t steal the source of production and wealth—the human mind. From Charles Hugh Smith at oftwominds.com:

By incentivizing speculation and corruption, reducing the rewards for productive work and sucking wages dry with inflation, America has greased the skids to collapse.

Of all the mass delusions running rampant in the culture, none is more spectacularly delusional than the conviction that we can all get fabulously rich from speculation while producing nothing. The key characteristic of speculation is that it produces nothing: it doesn’t generate any new goods or services, boost productivity or increase the functionality of real-world essentials.

Like all mass delusions, the greater the disconnect from reality, the greater the appeal. Mass delusions gain their escape velocity by leaving any ties to real-world limitations behind, and by igniting the most powerful booster to human euphoric confidence known, greed.

Lost in the mania of easy wealth from speculative trading is the absence of any value creation in the rotation-churn of moving bets from one table to the latest hot game: in flipping houses sight unseen, no functionality was added to the house. In transferring bets on one cryptocurrency to another or from one meme stock to another, no value to the economy or society was created.

In the mass delusion that near-infinite wealth can be generated without producing anything, creating value has no value: the delusion is that I can get rich producing nothing but speculative gains, and then I can buy all the stuff somebody else is making.

The fantasy powering the speculative frenzy is once I get rich, I’ll stop working and live off my wealth. It’s interesting, isn’t it, how everyone can get rich via unproductive speculation, quit their jobs and then live off the productive work of somebody else who failed to get rich off speculation.

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Doug Casey on Why Almost Nothing is Cheap

Doug Casey muses on how to survive the impending financial collapse. From Casey at internationalman.com:

nothing is cheap

Stocks, bonds, and urban property—conventional investments—aren’t cheap in today’s investment world.

Because of the trillions of currency units that governments all over the world have created since the start of the crisis in 2007, financial assets are grossly overpriced. Meanwhile, real wages are slipping rapidly among those who are working, and—regardless of what official figures say—a large portion of the population is unemployed or underemployed. The next chapter in this sad drama will include a rapid rise in consumer prices.

We are in a financial no-man’s land. That said, what you should do with your time and money presents some tough alternatives. “Saving” is compromised because of depreciating currency and artificially low interest rates. “Investing” is problematical because of a deteriorating economy, unpredictable and increasing regulation, and rising taxes. “Speculation” is the best answer, of course, and I cover what that means elsewhere. But it may not suit everyone as a methodology.

There are, however, several other alternatives to dealing with the question, “What should I do with my time and money now?” They include active business, entrepreneurialism, innovation, “hoarding,” and agriculture. There’s obviously some degree of overlap with these things, but they are essentially different in nature.

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Seven Things Nobody Talks About that Will Eventually Matter–A Lot, by Charles Hugh Smith

When the only thing that matters is that the stock market is going up, it’s time to ask yourself what could go wrong. From Charles Hugh Smith at oftwominds.com:

Nobody seems to notice the ‘diminishing returns’ on Fed manipulation, oops, I mean ‘intervention’.

Perhaps it shouldn’t surprise us that everything that will eventually matter is ignored until it does matter–but by then it’s too late. Here’s a short list to start the discussion:

1. The Federal Reserve has transformed the American populace into a nation of dismayingly over-confident gamblers. I’ve been writing about moral hazard–the separation of risk from consequence–since 2011. Punters who are insulated from risk will have an insatiable appetite for risky bets, which is precisely what we see on a mass scale, as the confidence that the Fed will never let markets drop is 99.99% because the Fed has indeed reversed every decline, no matter how modest, month after month, year after year.

The Fed has perfected moral hazard: everyone from the money manager betting billions to the punters gambling their stimmy money is absolutely confident I can’t lose because the Fed will always push the market higher. Hence the advice to never sell and keep increasing the size of one’s bets because losing is transitory (heh).

2. The Fed’s perfection of moral hazard radically incentivizes increasing debt and leverage to maximize one’s bets because the bigger the bet, the bigger the payoff–the Fed guarantees it! Margin debt is at extremes, and many wildly successful stock and options punters have reaped fantastic gains by maxing out their Robinhood margin as their winnings increase.

Since the Fed guarantees that anyone holding until the Fed gooses markets higher will be a winner, maximizing leverage is completely rational: hedging is a foolish waste of money that could have been placed on a sure winner–any long bet.

Margin and shadow-banking leverage is through the roof, but nobody sees any risk from this extreme expansion of debt and leverage. Never mind that leverage unwinds faster than it builds…

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Is the 9-Year Long Dead Cat Bounce Finally Ending? by Charles Hugh Smith

Charles Hugh Smith calls the last nine years in financial market just a dead cat bounce, because fundamentally nothing has been fixed. SLL is not arguing with him. From Smith at oftwominds.com:

Ignoring or downplaying these fundamental forces has greatly increased the fragility of the status quo.
The term dead cat bounce is market lingo for a “recovery” after markets decline due to fundamental reversals. Markets tend to bounce back after sharp declines as participants (human and digital) who have been trained to “buy the dips” once again buy the decline, and the financial media rushes to reassure everyone that nothing has actually changed, everything is still peachy-keen wonderfulness.
I submit that the past 9 years of market “recovery” is nothing but an oversized dead cat bounce that is finally ending. Here is a chart that depicts the final blow-off top phase of the over-extended dead cat bounce:
Why are the past 9 years nothing but an extended dead cat bounce? Nothing that’s fundamentally broken has been fixed, and none of the dynamics that are undermining the status quo have been addressed.
The past 9 years have been one long dead cat bounce of extend and pretend, i.e. do more of what’s failed because to even admit the status quo is being undermined by fundamental forces would panic those gorging at the trough of the status quo’s lopsided rewards.
This 9-year dead cat bounce was pure speculation driven by cheap central bank credit and liquidity. Demographics, environmental degradation, the decline of middle class security, the erosion of paid work, the bankruptcy of public and private pension plans, the global debt bubble, soaring wealth and income inequality, the corruption of democracy into a pay-to-play bidding war, the destruction of price discovery via market manipulation by those who have turned markets into signaling devices that all is well, the laughable distortion of statistics to mask the real world decline in our purchasing power (inflation is near-zero–really really really), the perverse incentives to leverage up bets in financial instruments that have no connection to the real-world economy–none of these have been addressed in the market melt-up.

Consensus Forming: China Heading Back Into Financial Crisis, by John Rubino

At the end of debt binges, there is a massive increase in speculation, because that’s one of the few uses of borrowed funds that still offers the prospect (always overstated) of a positive return. Such is the case now in China. From John Rubino at dollarcollapse.com:

China’s historic post-2009 debt binge flew largely under the radar — fooling most observers into thinking the global economy was recovering rather than just re-leveraging.

Now Beijing is back at it, borrowing over $1 trillion in this year’s first quarter, buying up commodities and creating the illusion of global growth. But this time the scam hasn’t gone unnoticed. Reporters, editors and money managers seem, at last, to be catching on. Some representative headlines: [see original article for links]

George Soros warns of credit crisis in China

Chinese cities dive back into debt to fuel growth even as defaults rise

China debt climbs to US$25 trillion

China’s banks cut bad debt buffer as profits flatline

Doug Noland, meanwhile, goes to the heart of the problem in last night’s Credit Bubble Bulletin:

I recall an early-1998 Financial Times article highlighting the explosive growth in Russian ruble and bond derivatives. Not only had the “insurance” market for risk protection grown phenomenally, Russian banks had become major operators in what had evolved into a huge speculative Bubble in Russian debt exposures. That was never going to end well.

There was ample evidence suggesting Russia was a house of cards. Yet underpinning this Bubble was the market perception that the West would not allow a Russian collapse. With such faith and the accompanying explosion in speculative trading, leverage and a resulting massive derivatives overhang, any break in confidence would lead to illiquidity, panic and a devastating bust. Just such an outcome unfolded in August/September 1998.

From a recent Financial Times article: “The [Chinese] market for pledge-style repos — short-term, bond-backed loans — is currently bigger than the stock of outstanding debt”. Within this undramatic sentence exists the potential for a rather dramatic global financial crisis. And, to be sure, seemingly the entire world has operated under the assumption that Chinese officials (and global policymakers in general) have zero tolerance for crisis – let alone a collapse. So Credit, speculation and leverage have been accommodated – and they combined to run absolute roughshod.

The Financial Times article includes a chart worthy of color printing and thumbtacking to the wall: “China’s Use of Bonds as Loan Collateral Rises Sharply”. The pink line shows “Onshore Market Bonds” having almost doubled since mid-2011 to about 40 TN rmb ($6.17 TN). The Red Line – “Pledge-Style Repos” – has ballooned four-fold since just early 2014 to surpass 40 TN rmb. So basically, in this popular market for inter-bank borrowings, borrowing banks have pledged bond positions larger than the entire market as collateral for their (perceived safe) short-term borrowing needs.

To continue reading: Consensus Forming: China Heading Back Into Financial Crisis

China And The New World Disorder, by Raúl Ilargi Meijer and Nicole Foss

The title is somewhat misleading. This is an article about the global economics of debt, deflation, and depression. SLL could have written it, and if you put all of SLL’s articles about the 3 Ds in one place, it would look a lot like this. Importantly, the authors understand the diminishing and eventually negative returns from debt growth, and the deflationary consequences when debt growth becomes debt contraction. Like SLL, the Automatic Earth has been warning of impending doom for years. Those in that camp have no need to apologize. The world has inflated its largest debt bubble in history. It’s been going on for decades, and any economic analyst worth his or her salt should have seen this inevitable bust coming years before it happens. The apologies will be owed by those analysts who are either surprised by the bust or who go back to their own archives and cite vague statements, rather than the quite clear warnings of the bust-is-coming camp, to “prove” they knew it all along. This article by Raúl Ilargi Meijer and Nicole Foss is very long, but it’s a great compendium of the inter-workings of debt, deflation, and depression and has some revelatory charts. Even if you don’t read it all, bookmark it for future reference. From Meijer and Foss, at automaticearth.com:

Nicole Foss: Our consistent theme here at the Automatic Earth since its inception has been that we are facing a very powerful deflationary depression, following on from the bursting of an epic financial bubble. What we have witnessed in our three decades of expansion and inflation is nothing short of a monetary supernova, and that period has been the just culmination of a much larger upward trend going back many decades at least. We have lived through a credit hyper-expansion for the record books, with an unprecedented generation of excess claims to underlying real wealth. In doing so we have created the largest financial departure from reality in human history.

Bubbles are not new – humanity has experienced them periodically going all the way back to antiquity – but the novel aspect of this one, apart from its scale, is its occurrence at a point when we have reached or are reaching so many limits on a global scale. The retrenchment we are about to experience as this bubble bursts is also set to be unprecedented, given that the scale of a bust is predictably proportionate to the scale of the excesses during the boom that precedes it. We have built an incredibly complex economic system, but despite its robust appearance it is over-extended, brittle and fragile after decades of fuelling its continued expansion by feeding on its own substance.

The Automatic Earth, December 2011: The lessons of the past are sadly never learned. Each time the optimism is highly contagious. In the larger episodes, it crescendos into euphoria, leading societies into a period of collective madness where risk is embraced and caution is thrown to the wind. Sky-high valuations are readily rationalized – it’s different here, it’s different this time.

We come to believe that just this once there might be a free lunch, that we can have something for nothing. We throw ourselves into ponzi finance, chasing the mirage of speculative gains, often through highly questionable and outright fraudulent practices. Enron, Lehman Brothers, and recently MF Global, are but a few egregious examples of what has become an endemic phenomenon.

The increasing focus on chasing speculative profits parasitizes the real economy to a greater and greater extent over time. After all, why work hard for small profits in the real world, when profits on money chasing its own tail are so much greater for so little effort?

Who even notices the hollowing out of the real economy, or the conversion of large amounts of capital into waste, or the often pointless depletion of non-renewable resources, or the growing structural dependency trap, when there is so much short term material prosperity to pursue?

In such times, the expansionary impulse drives the development of multiple engines of credit expansion. The reserve requirements for fractional reserve banking (already a ponzi scheme) are whittled away to almost nothing. Since the reserve requirement effectively determines the money supply multiplier effect, that multiplier becomes almost infinite.

The extension of credit through the shadow banking system removes the semblance of central bank control over monetary expansion. Securitization and financial innovation also create putative wealth from thin air, using underlying collateral to derive layers of additional illusory value. In this way, excess claims to underlying real wealth are created. The connection between the rapidly expanding virtual worth of the derivative instruments and the real value of the underlying collateral becomes ever more tenuous.

Shadow Banking and Phantom Wealth

Since 2011, in our desperate attempt to avoid the consequences of an imploding bubble, we doubled down on the doomed strategy of ponzi credit expansion. In doing so, we have only succeeded in digging ourselves into a deeper hole, and have done so on a massive scale. While the aggregate balance sheet of the world’s central banks grew exponentially from $3 trillion to $22 trillion over the last 15 years, the expansion in the shadow banking sector has been even more dramatic, and its role in fostering the overall credit hyper-expansion has become increasingly clear:

Shadow banks are that exploding growth segment of global finance capital that share the following characteristics: they are largely unregulated, they invest primarily in financial asset securities of various kinds (i.e. stocks, government and corporate junk bonds, foreign exchange, derivatives, etc.) instead of real asset investment (plant, equipment, software, etc.), they target high risk-high return opportunities based on asset price appreciation and volatility to realize financial capital gains, their investments are highly leveraged and debt driven, their investment targets are highly liquid financial markets worldwide that enable a quick entry, price appreciation, and subsequent just as quick short term profit extraction.

Their client base is predominantly composed of the global finance capital elite – i.e. the roughly 200,000 worldwide ultra and very high net worth individuals with net annual additional income from investment flows of $20 million or more—for whom they invest individually as well as for themselves as shadow bank institutions.

Shadow bank ‘forms’ include private equity firms, hedge funds, asset and wealth management companies, mutual funds, money market funds, investment banks, insurance companies, boutique banks, trust companies, real estate investment trusts – to note just a short list – as well as dozens of other forms and newly emerging initiatives like peer to peer lending networks, online investment funds, and the like.

Shadow banks have been estimated to have investable assets (i.e. relatively short term and liquid) of about $75 trillion globally as of year end 2014, a total that does not include revenue from ‘portfolio’ shadow-shadow banking. That is projected to exceed $100 trillion well before 2020.

The exponential growth of both central banks and shadow banking during the long global boom constitutes a gargantuan increase in the supply of money plus credit relative to available goods and services, which is inflation by definition. This huge supply of virtual wealth has acted to push up asset prices, creating a plethora of asset price bubbles and a cascade of malinvestment based on those price distortions. The explosive growth of shadow banking in particular, following the 2009 bottom, was accompanied by a return to extreme risk complacency and rock bottom interest rates, leading to a frantic search for investment returns in riskier and riskier places.

To continue reading: China And The New World Disorder

Valuation and Speculation: The Iron Laws, by John P. Hussman

There are three primary long-term investing decision parameters: market, investment, and price. John Hussman makes a strong case that the US equity market is one investors are best advised to avoid right now. From Hussman’s weekly market comment at hussman.net:

There are two central considerations in investing that, when used in combination, have been the source of virtually every major success I’ve had in 30 years as a professional investor, and when inadvertently missed or underappreciated, have been the source of virtually every significant disappointment.

The first is what I’ve often called the Iron Law of Valuation: every security is a claim on an expected stream of future cash flows, and given that expected stream of future cash flows, the current price of the security moves opposite to the expected future return on that security.The higher the price an investor pays for that expected stream of cash flows today, the lower the return that an investor should expect over the long-term. Particularly at market peaks, investors seem to believe that regardless of the extent of the preceding advance, future returns remain entirely unaffected. The repeated eagerness of investors to extrapolate returns and ignore the Iron Law of Valuation has been the source of the deepest losses in history (see Margins, Multiples, and the Iron Law of Valuation).

The second consideration, however, is equally important over any horizon other than the long-term. It deserves its own name, and I’ll call it the Iron Law of Speculation: The near-term outcome of speculative, overvalued markets is conditional on investor preferences toward risk-seeking or risk-aversion, and those preferences can be largely inferred from observable market internals and credit spreads. In the long-term, investment outcomes are chiefly defined by valuations, but over the shorter-term, the difference between an overvalued market that becomes more overvalued, and an overvalued market that crashes, has little to do with the level of valuation and everything to do with investor risk preferences (see A Better Lesson than “This Time is Different”).

If you have the long-term available to you, there’s nothing particularly wrong with being a value investor. Over the long-term, disciplined, historically-informed, value-conscious analysis pays off. But over shorter horizons, I promise from personal experience that it will periodically be the bane of your existence. I’ve learned that lesson twice: once during the late-1990’s valuation bubble, when I developed our methods of inferring risk preferences from market internals, credit spreads, and other risk-sensitive factors, and then again – as the inadvertent result of our awkward transition from our successful pre-2009 methods to our (hopefully equally or more successful) present methods of classifying market return/risk profiles. The simple fact is that the ensemble methods that came out of our 2009-2010 stress-testing against Depression-era data included all of those risk-sensitive measures, but not sufficiently to deal with a central bank bent on intentionally fomenting the third valuation bubble in 15 years. We ultimately imposed those bubble-tolerant considerations as an overlay to our methods in mid-2014.

So if you genuinely want to learn something from our experience during the recent half-cycle, it’s not to discard the Iron Law of Valuation, but to couple your awareness of valuation with an understanding of where investor preferences toward risk are from the standpoint of the Iron Law of Speculation. I had very vocal concerns about valuation during the tech bubble and the housing bubble, well before they burst. But it was a specific combination: extreme valuation coupled with fresh deterioration in market internals – the same combination we observe presently – that provided us with timely evidence that market conditions had shifted to urgent risk at what in hindsight turned out to be the very beginning of the 2000-2002 and 2007-2009 collapses. Those collapses wiped out the entire total return of the S&P 500 – in excess of Treasury bills – all the way back to May 1996, and June 1995, respectively, despite aggressive Fed easing in both instances. Don’t imagine that the current bubble will avoid a similar completion.


To continue reading: Valuation and Speculation: The Iron Laws

The Economics of Debt, Deterioration, Deflation, Depression, and Disorder, by Robert Gore

Economies are analogous to ecosystems. Environmentalists’ base state is an ecosystem in a state of nature, unsullied by man. Economists’ base state is an economy in which, other than establishing and maintaining essential conditions—protection of property and contracts rights and physical security—the government is absent. Both systems rely on the autonomous actions of their constituent elements, organically adapting to the myriad stimuli and signals around them. Analyzing the changes and distortions caused by humans on ecosystems is a big part of environmental science. Similarly, much of economics analyzes the perturbations caused by governments in economies.

Money can be broadly defined as whatever enjoys widespread acceptance as a medium of exchange and store of value—a means of saving—within an economy. Demonstrably more efficient than barter, money plays a central role in any advanced economy. A distortion virtually every government has introduced into their economies has been the production of fiat money—money not backed by and therefore not exchangeable into a set weight of a metal or other good—whose acceptance is compelled by legal tender laws.

The ostensible reasons advanced for fiat money are mostly specious; governments do it because they benefit from doing so. Money buys things, and if government is the source of money, it also has an issuer’s advantage. While monetary depreciation eventually leads to price inflation, the government is ahead of the curve. It purchases goods and services with the money it is creating and debasing before the resultant inflation sets in (this issuer’s advantage is known as seignorage).

Fiat money has another benefit for governments, dwarfing seignorage: it supports deficit financing. A government that cannot borrow must extract taxes or fees from its populace, which is never popular and often resisted. Monetary depreciation allows the debtor to repay with money that is worth less than it was when the debt was incurred. If government is a debtor, it realizes that benefit, which is why inflation has been called a hidden tax.

More insidiously, a government can either issue its debt directly as money, or—the more modern approach—a central bank can “monetize” the government’s debt by buying that debt with money it creates. The central bank buys debt either with currency it produces or by increasing the selling counterparty’s account with the central bank (the latter practice is far more prevalent). With fiat money, a government’s debt represents a promise of repayment with either more debt or fiat money, and nothing more.

The central bank is a large, interest-rate insensitive buyer of its government’s debt. Its buying pushes the rate the government pays below what would prevail if there were only interest-rate sensitive private buyers in the market, and lowers most other rates, which are often benchmarked to the interest rates on government debt. A below-market interest rate increases borrowing and decreases saving below what would have prevailed at a higher rate. It is a misleading signal for investment; a lower cost of capital leads to more investment, and consequently more production, than if the economy had a true market cost of capital. Mis-priced money also encourages consumption and speculation in excess of what would have prevailed under higher rates.

Governments and central banks around the world have stretched ultra-low—or in some cases negative—interest rates, sovereign debt, debt monetization, and the promotion of consumption and speculative bubbles to historic extremes (see “A Skyscraper of Cards,” 10/19/14). Metaphysically, just stating the idea that value and real economic growth can be created by governments borrowing money, creating money, and using that created money to buy their own debt casts heavy suspicion on the whole enterprise. It sounds like magic, and it is. Reality confirms the skeptics. While these policies can produce short-term increases in growth and goose financial markets, in the long run those effects are reversed and the net effect is contractive rather than expansionary.



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No nation has practiced this “magic” longer than Japan, whose economy has cycled from recession to anemic recovery to recession since the early 1990s (it just reentered recession). The Japanese once had one of the world’s highest savings rates, but the government has been drawing down its citizens’ savings on a two decade debt binge. Now it is the most indebted government, in terms of debt-to-GDP ratios (227.20 percent), in the developed world. Ultra-low interest rates (the Japanese 10 year interest rate is .47 percent) make saving an exercise in masochism. The central bank owns most of the government’s debt, and has expanded its purchase to private financial assets, including equities.

Japan offers ample proof that in the long term, debt and money magic retard production and growth. Despite a five-year rally, the Nikkei 225 stock index is not even half of what it was in 1989. As for a telling economic indicator, nothing captures people’s assessment of economic prospects and the future so well as the decision whether or not to have babies. Reflecting dwindling opportunities, Japan has one of the world’s lowest birthrates; its rapidly aging population now buys more adult than baby diapers. The elderly cohort will be yet another drain on Japanese savings as it pays for retirement. “Magic” economics requires running ever harder just to stay in place. The world’s financial markets got a Halloween treat when the Japanese central bank announced a 60 percent increase in asset purchases with funny money, but the prior, already massive, purchases have not stopped Japan from sliding back into recession.

Japan has been the pacesetter, but Europe and the United States are not far behind. Despite mammoth expansions of the European Central Bank’s and the Federal Reserve’s balance sheets in pursuit of unprecedented asset monetization, growth rates have been far below historical trend. European growth in 2013 was .1 percent, and the continent currently has either no growth or is in recession, depending on how many statistical angels are dancing on which pin heads and who is doing the counting. In the US, 3 percent plus growth used to be routine; 2 percent is the new normal. The last time the US saw 3 percent annual growth was 2005.

The labor market demonstrates the ongoing deterioration of the US economy. Taking the seasonally- and business-birth-and-death-adjusted, subject-to-future-revision employment statistics as offering a passable approximation of reality (perhaps a heroic assumption), there has been job growth, but the labor force is shrinking. However, it is the qualitative aspect of the labor market where the real story is told. David Stockman recently did a masterful analysis. Since the turn of the century, jobs in what Stockman terms the Breadwinner Economy: construction, manufacturing, white collar, finance, insurance, real estate, transport, information, and trade, have shrunk, replaced by much lower-paying jobs in hospitality, food service, and medical care. Readers are referred to Stockman’s article for a full analysis and explication (http://davidstockmanscontracorner.com/the-feds-paint-by-the-numbers-delusions-about-the-labor-market/ ). During the greatest Federal Reserve balance sheet expansion in history, labor market fundamentals and the economy have deteriorated. It’s no mystery why a plurality of voters in the last election cited the economy as their chief concern, despite the much ballyhooed “recovery.”

Adding to labor’s pain: below market interest rates have promoted the substitution of capital for labor, and by promoting consumption, have fueled the US’s perpetual trade deficits, which create jobs in foreign countries. In a world where money is not the whimsical creation of central bankers, no country would be able to run trade deficits in perpetuity. Pressure on the currency and withdrawals of whatever stands as the government’s reserves backing it would force a deflationary price adjustment, including in wages, and an increase in interest rates to make the country’s economy more competitive in world markets.

No such adjustment is necessary when the world must accept an ever expanding supply of dollars, the so-called “reserve” currency, backed by no reserves but redeemable for more dollars or treasury debt. The usual do-gooders lament the state of the labor market, but champion a higher minimum wage. However, wages in this country must come down relative to wages in other countries—the flip side of years of living beyond our means—before the employment situation can meaningfully improve.

The liquidity that is not promoting economic growth is promoting bubbles in select financial markets, primarily sovereign debt and equities. Paraphrasing President Nixon, we are all speculators now. Central bankers have been candid about one of their motivations for microscopic interest rates: they want to push savers farther out on the risk spectrum, forcing them to buy either lower quality or longer-dated bonds, or equities. Everybody is speculating, from retirees switching money out of money market funds to stocks or bonds to earn a return, to corporations, who can find nothing better to do with their cash than buy their own stock. The expected rate of return on productive investment has equilibrated with the corporate cost of funds—close to zero—due to many years of overinvestment and overproduction. The theory has been that rising asset prices, particularly stock prices, produce a wealth effect, which prompts beneficiaries to go out and spend, in turn producing economic growth.

If, in light of dismal economic growth, that sounds like holding a lit match to a thermometer to heat up a room, it is—more magic. It reverses causality, trying to put the stock price cart before the economic growth horse. Thus, after a four-year rally, in 2013 the US stock market gained almost 30 percent (S&P index) while economic growth was 2.3 percent. Even if one buys the theory that stocks are a discounting mechanism, or predictor of future economic trends, last year’s strong rise has “discounted” growth so far this year of 2.2 percent, or slightly less than last year. Since the turn of the century, neither the wealth effect nor debt “magic” have produced the kind of trend growth during expansions that most of the developed world had taken for granted for at least four decades prior.

Central bankers have been less than candid about two other motivations for microscopic interest rates. Although some central banks are ostensibly independent, like the Federal Reserve, even the Fed can be considered an arm of the government when to comes to the government’s debt. Low rates ease the government’s debt service burden, and central bank monetization provides a ready buyer of debt.

However, the primary reason for easy money is to promote inflation, which devalues governments’ massive debts. If unfunded pension and medical liabilities are added to nominal debt, it is clear that the only way governments can hope to keep their many promises is by substantially devaluing them through monetary depreciation. The 2 percent inflation mantra that central banks around the world chant as a policy goal has nothing to do with the real economy, and everything to do with a hoped-for escalation of inflation governments so desperately need.

That central banks have been unable to achieve even 2 percent inflation is another indication of their policies’ ineffectiveness. The marginal return of an additional unit of debt-based liquidity is actually negative. It is not producing inflation or economic growth, and the debt carries an obligation to pay back an amount greater than the original loan. Underlying the oft-expressed fear of deflation is recognition that it would crucify governments. Just as inflation devalues debt, benefitting debtors, deflation makes debt more expensive to pay back. Deflation would make governments’ mounting debt loads that much more onerous, thus the almost hysterical fear of it.

Part and parcel of shrinking private-sector opportunity is expanding public-sector rapacity. Although taxes and fees keep rising, governments keep running deficits. The productive have been increasingly milked for the vote-buying benefit of the unproductive, with the state taking its cut. Its dead-hand grip on economic activity is tightening, not for the purported public-benefit justifications, but to increase economic rents to the government and its officials. Individuals and businesses lobby, curry favor, donate, and bribe to get subsidies, tax breaks, and regulatory dispensations. It speaks volumes that the Washington D.C. metropolitan area is now the nation’s wealthiest. Obamacare promises bounteous new opportunities for payola, taxes, and regulatory extortion, which was the real reason it was passed.

When “magic” economic nostrums can no longer keep an economy running in place, it falls backwards, painfully. In “non-magic” economics, debt growth well in excess of economic growth for an extended period, rising taxes, and increased regulatory sand in the gears and government rent-seeking eventually produces an economy that not only stops growing, but contracts. Almost immediately, debt in the most leveraged sectors of the economy starts unravelling, and in a debt-saturated economy that unravelling spreads quickly, because virtually every financial asset is someone else’s debt (or equity, which occupies an even lower rung on the priority-of-payback ladder). In 2008, it started with mortgages and mortgage-backed securities and engulfed the world’s financial system with frightening speed.

For years the world has looked one way down the railroad track, watching for the inflation locomotive, oblivious to the deflation locomotive coming from the other direction. There are always quibbles about the accuracy of price indexes, but the just-around-the-corner outbreak of skyrocketing inflation has remained just around the corner, despite years of massive central bank balance sheet expansion. Debt has become the medium of exchange (even the US currency, which is not usually thought of as debt, bears the title: Federal Reserve Note) and the global economy runs on debt. When debt plays such a central role and the gross amount starts to shrink, the result has to be economically contractive and deflationary. Debt shrinkage acts as a margin call: assets are sold, economic activity curtailed, and debts repudiated as debtors try to reduce their debt burdens. Their creditors must write off assets, sell other assets, curtail their economic activity, and repudiate their debts as the vicious cycle gathers steam.

The collapse of the world’s skyscraper of debt will take prices and economic activity with it. If the crash is proportional to the debt build up that preceded it (and it wouldn’t be wise to assume that it won’t be), it will take down governments as well. The Orwellian nightmare of totalitarian government, amplified by the Edward Snowden revelations, may be another case of the world fixating on the wrong fear. Come the crash, most governments will be flat broke, unable to borrow except at prohibitive rates. Command and control—monitoring, repressing, incarcerating, and torturing the populace—is expensive and stifles economic activity. Destitute governments will have their hands full maintaining the barest semblance of public order.

The smart money bet for what emerges from the rubble is chaos and anarchy, not government-maintained order. Which suggests that investments in self-sufficiency and self-protection, including firearms and training in their use, are prudent (There are a multitude of organizations and internet sites that provide guidance and sell provisions.) The people who have made those investments have been derided as the fringe, but events will probably give them the last laugh, if anyone is laughing in such a world.