If you have followed this blog or even traded during 2015, you must have noticed that price behavior reflected all the typical symptoms of a major deflationary wave. Stocks entered a ghost bear market as breadth collapsed, oil and industrial metals cratered, Treasury bonds held up but went nowhere, corporate bonds reached bubble-level with liquidity drying up by the day, and precious metal prices kept being suppressed by a convenient pair trade involving both paper and physical. While I am not big in economics, I decided to venture into making a few assertions for 2016-2018 since I believe that worldwide currency wars, quantitative currency debasement, and Keynesian doctrine are now approaching their endgame.
To put things into perspective, my belief is that the 2008 subprime crisis started a deleveraging cycle broken down into 3 phases. This cycle, however, could have been shortened to a simple single-phase crisis had Capitalism been allowed to cleanse itself from past excesses as it’s always done through the mechanism of Creative Destruction. We would already be through it and in better shape by now. But authorities knew better. The FED did not allow this process. Instead, imbalances where allowed to remain and grow as the FED expanded its balance sheet to absurd levels to dilute away the damage done to the banking sector.
Now we are left spectating a three-phase crisis that already stole 8 years of economic progress and will only end up magnifying existing bubbles as well as the ensuing crash.
(1) In Phase 1, the FED used gargantuan monetary expansion to prevent the looming subprime-induced deflation which would – and should – have brought about a well-needed normalization in asset prices. To do so, while money supply reached $0.8 trillion over the last 200 years through 2008, that same supply expanded by another $3.1 trillion in just 8 years! The result is that the real-estate, collectibles and stock market bubbles were reinflated in 5 short years. Banks benefited from cheap lending but money sat still on their balance sheets, failing to finance Main Street and fueling further paper speculation. Proof is that money velocity has totally collapsed from 2.2x in 2000 to 1.3x today – and guess what, 1.3x is also the multiple witnessed during the Great Depression. The obvious result is that in the process, after 3 rounds of QE, Ben Bernanke raised the FED’s leverage from 22-1 pre-crisis to 77-1 currently. All the while, each new round of QE has faced the dire law of diminishing returns so that when creating every dollar into existence implied a $2.41 boost in growth during the 1950’s and 1960’s, we are only getting $0.03 right now. That’s right, 3 cents. So here you go, $60 trillion in debt is now sitting on banks’ balance sheets, and this amount is growing 30 times faster than economic growth all the while macroeconomic indicators are starting to roll over!
Despite the above, today is the time the FED finally decided to raise key rates in December by a symbolic 0.25 basis point while they should have already done so in 2009 – 2011 as they were getting an actual economic boost from their QE experiment. The truth is that the FED went out of sync with economic growth and the interest rates cycle. It only raised in December for 3 reasons:
– to maintain credibility as Yellen pinned herself into a corner in 2015, which is unsustainable.
– to let the air out of the asset bubble, which is impossible since bubbles can only crash.
– to be able to cut, which is already forecast by the options market.
The bottom-line is that we stand with an over-levered FED that ran out of ammo, real-estate prices reinflated to 2008 levels which we already know by definition are unsustainable, stock market capitalization that is 203% of GDP (versus 87% right before the Great Depression) and the ticking time bomb of the derivatives market that is said to reach (although it is hard to assess actual OTC exposure) about $710 trillion, that is 10 times US GDP.
So the FED may now only resort to forward guidance to drive the market through alternating tough talk and looser actions. But it can only last for so long.
(2) As the FED is getting caught at its own game, we are entering Phase 2 which is that of natural supply & demand forces trying to take over and rebalance the system. I am expecting the upcoming phase to be that of real deflation in proportions commensurate with the mounting imbalances that were enhanced since 2008. In fact, the process already started in 2015. Last year was characterized as a full-blown deflationary year in asset prices, a year where “nothing worked”. Everything USD lost value, besides the USD itself of course. As I mentioned, macroeconomic indicators are starting to severely roll over already and will most likely collide against a so-called rate hike cycle which is supposed to take us to 3.25% by the end of 2018 – and which will arguably never, ever take place. Who in his right mind can really expect the FED to hike for another 72 months while we have already been in a so-called expansion for 79 months? For the record, the post-1980 expansion, the longest ever, lasted 78 months! Raising rates AND propping up our economic growth are not only out of sync, they render the whole FED rhetoric impossible to apply as we will never make it to 2019 with the economy in its current shape. The FED knows it. It is also aware that it takes on average a 300bp rate cut to thwart a recession. So the fight is already lost. We cannot raise this far to ease again in an economically meaningful manner, and a massive deflationary recession WILL take place before we get so far. This is inevitable.
What will ensue is that everything will go down in price, and cash, no matter how much currency was created since 2008, will be the undisputed king for a few months. All USD-denominated debt abroad will cause multi trillion corporate defaults, starting with emerging markets and taking out most commodity-based businesses. The brutal wave of deleveraging will prove bank reserves insufficient yet and banks will have to be bailed again. Only this time, the FED will not be there anymore to bail them out. Instead, the FDIC will go bankrupt or will issue worthless bank IOUs as banks get bailed IN from ransacking client deposits. If you do not believe that this is possible, try to remember what happened to Cyprus when its government gave his go to depositors confiscation with the benediction of the EU establishment. In a week, people with over €100,000 in deposit lost 47.5% of their assets, erased from their accounts overnight, poof, gone. It created a precedent, a template for future financial stealing. You have to realize that the system we live in and work for is no longer capitalist. In a Capitalist system, failed entities are supposed to go bankrupt and disappear in order to correct the economic imbalance that they created. Today’s government logic is that banks MUST be bailed no matter what violations are perpetrated on individuals and their private property. As a supposed trustee, banks using their depositors assets for indemnifying themselves or worse yet, for claiming ownership of this property is a deliberate and complete act of theft which has been enacted into law. This is a direct negation of Capitalism. Laws were enacted in Canada and many European countries last year without much fanfare or even the media mentioning it. But they are in place. And now the laws are in, lowering the confiscation threshold would be a breeze in case of an “emergency”.
In parallel, new rules are being voted worldwide to wage a global war on your freedom by drastically limiting or banning cash transactions altogether. While anti-terrorism is conveniently being blamed for such enslaving moves, the actual underlying motivation is that governments obviously want to tie you and your resources to the system no matter what. How else would they be able to enforce bail-ins or negative interest rates policy anyway?
So when one takes a step back and starts connecting the dots, it becomes rather forthcoming that the whole picture solely makes sense if governments are well aware that a catastrophic deflationary phase is about to unfold. Assessing things through this very logical prism makes it very clear that in this context, every deposit as well as every paper asset in custody will be severely compromised in the deflationary crash to come.
(3) The issue is that the establishment will never resort to accepting such an outcome. Remember, central banks and governments hate deflation, because it makes them accountable as it enhances the weight of debt by increasing the value of currencies. Once deflation and economic misery set in, I believe that the likely “solution” will be orchestrated by the cooperation between both monetary and fiscal authorities. Central banks will unleash a new wave of panic QE (including negative interest rates) on a scale not even imaginable while working in tandem with governments that will engage in totally desperate fiscal stimulus. Both of which will extend Keynesian theory to final implosion level. So Phase 3 will be that of what Bernanke called “Helicopter Money”. That is monetary creation no longer directed to just banks but also to Main Street. In other words, on top of large-scale debt monetization, people will see currency credits made directly to their accounts in the form of massive tax returns as well as, as absurd as it sounds, currency payments in the form of a universal income, or whatever governments want to call it. If you believe that I am raving, know that blueprints for such insanity were already set forth in some European countries such as the Netherlands or France, and that Finland is readying to issue such “universal income” in the amount of €900 per month later this year. As such credits are being made, people will invariably be deterred from both producing and saving as they lose faith in paper currency. History has proven such a fact many times over.
Phase 3 will bring about the endgame to this multi-decade debt bubble. And there will be only two ways out since it is downright impossible to come out of it by paying debt down.
– Either hyperinflation sets in as people decide to dump their fiat currency once they finally realize that it has become totally worthless. The direct consequence will be the greatest wealth transfer in human history. In just a few days, precious metals will skyrocket to unimaginable levels to account for all the monetary mass created since 2008.
– Or the IMF steps in, bails worldwide central banks out and appoints SDRs as a new world reserve currency. China seems to be playing out this option by covertly hoarding gold for months now. Leaked information from security companies such as Viamat and G4S seem to acknowledge as much. China is indeed trying to introduce the Yuan within the SDRs and may in fact do so by September 2016. With the IMF only leveraged 3-1, it may very well act as the worldwide lender of last resort.
I fully expect an event of monstrous proportions to trigger the exit to phase 3. It may be a war, (false flag) terrorist attack or something else, but it will be an event that will take the blame off central banks and justify political extremism. Its purpose will be to cover up the fact that governments’ decade-long policy of debt binge and social irresponsibility was the root cause that allowed individual rationality to react to these imbalances and build up these bubbles in the first place. As cynical as it may seem, this event will likely bring popular desperation to such level that people will accept whatever governments offer as a solution, no matter how much they are giving up in terms of individual freedom. With a few terrorist attacks, just look how easily governments enacted their so-called State of Emergency and how Obama is now suggesting to take out the second Amendment without actually saying it.
The scenario that I proposed is the one that seems the most likely in the light of what one may observe by trying to look past the filter of mass media. I am mostly issuing a warning that something big seems to be up and that you should prepare yourself for economic and social changes that may very well be of epic proportions in the coming months.
The tragedy is that Capitalism will surely be pointed out as the single culprit once all is said and done. Capitalism has been the only economic system proven to bring prosperity in the history of the world, and yet people have been brainwashed to accept unsustainable government promises and remedies as the easy solution to their lack of self-ownership. Yet again, Capitalism will be blamed while it has been long gone from the actual way our economy is allowed to work.
So with that said, you should remember that with every crisis lies major opportunities. You just have to protect your assets and set yourself on the right side of that wealth transfer to not only survive, but to come out of this phase stronger than you are now. It can be done but it will require a lot of confidence and an ability to stick with your scenario for better or worse.