Category Archives: Fixed Income

Housing Collapse Redux

Take a look at this chart:

2022-11-16_07-05-40_0

That is a collapse in process. An unprecedented collapse in modern times. Perhaps 1346-53 showed something similar. It will take 4-6 months to work its way into the hard data, but it is coming. Recall Stephanie Pomboy’s observation that in July of 2008, inflation was at 5.6%. By July of 2009, it was at -2.1%. There’s a Fed pivot of some kind. Now look at John Hussman’s pivot chart:

Bears follow pivot

Which clearly shows that the real bear market will follow the pivot. Then contemplate another of Hussman’s charts which shows the potential losses from here:

Potential Losses

Now look at the international context. China has its own housing bubble collapse going on, to say nothing of choking its economy with a stupid Covid strategy because a dictator like Xi cannot admit error. Europe is seized with political correctness, internal division over immigration from Africa and an energy catastrophe. Oh and there’s a proxy war with Russia going on and another with China waiting in the wings, to say nothing of a demented President. Just don’t choke on that turkey.

Disintegration

The world is disintegrating. Trust has been lost, both within countries and between countries. Without trust, economic relationships cannot operate.

China

China is a poor country, despite the glitz and glamor of its big cities and its showpiece infrastructure, with a per-capita annual GDP of about USD 11,000.

Chairman Xi presented his plan for world domination at the opening of the party congress. Not going to happen, sir. Your country is an economic and social house of cards that is in the process of collapsing. The housing market, investment of choice for the masses, is a bubble bursting and desperate local governments are even buying their own land use rights from themselves or one another because retail buyers have left the building. So to speak. Your Covid-zero policy has shaken the people’s faith in the benign CCP, while wreaking destruction on millions of small businesses. Unemployment is high and rising, college graduates cannot find jobs. Biden’s withdrawal of support for your semiconductor industry has condemned it to a bleak future without the production technology that your people cannot build. Export demand from the rest of the world is shrinking fast. Sir, your country is likely heading for a deep economic depression and social turmoil. This will further weaken China’s positioning for the world hegemony which you desire.

United States

In the USA, we live in a world now that George Orwell and Aldous Huxley would readily recognize. The state has commandeered the legacy media, as well as the new social media, to not only put out the “progressive” state’s version of reality but to identify, spy on, ostracize and  punish critics and dissenters.

President Biden, your “progressive” policies are not working. Democrat-run inner cities are being abandoned to crime and homelessness. Illegal immigrants are flooding in without any prospects for employment or training. You are continuing to feed the inflation which is mostly damaging the people you claim to represent. Your support for expansion of NATO triggered the invasion of Ukraine, with severe economic and social consequences.

You and your Democratic predecessors, notably Hillary Clinton, have created a deeply divided society, with those who have drunk the purple Kool-Aid and accept the state’s lies and propaganda on one side, and those with a more traditional view of reality on the other. Neither side trusts the other, respects the other’s views, or is willing to compromise. Both sides are preparing for more direct conflict as the sporadic clashes increase in frequency and severity. This is a recipe for a failing state with extremism on both sides. Negative economic consequences are to be expected.

Europe

Neither China nor Europe are democracies – by design. The architects of the European Union claimed that, since democracy had enabled Hitler, it could not be a part of the EU’s structure. As a result, bureaucrats who suffer no consequences for their failures and care little for the fate of the citizenry run the EU. Ursula van der Leyen is no less of an autocrat than Xi. Deep rifts have emerged as democratically elected governments have resisted the orders of the bureaucrats. These rifts are between rich north and poor south as well as conservative east and “progressive” west. It is only a matter of time before a second country leaves the EU, and that will spark a rush for the exits.

The coming winter is going to be hard, as the bureaucrats’ energy policy has been disastrous. Immigration policies have resulted in shocking increases in crime, with many countries reporting zones where the police dare not go in fear for their lives. Mario Draghi’s “whatever it takes” has left a legacy of irresponsible debt, as in the USA. As  interest rates increase, this is going to be a huge problem

Russia and Ukraine

Russia’s invasion of Ukraine has no winners. Regardless of the outcome, the invasion is an economic disaster for both of them. Their economies depend heavily on the export of commodities, such as food, energy and metals. The volumes of these commodities are large, and their absence are also a problem for the countries that have come to depend on them.

Conclusion

I could go on, but it is time to recognize that the future is not bright. Economies will get worse. Much worse. Be careful out there. Don’t focus on the narrative of the “Fed pivot.” The Fed is irrelevant.

The Cash Economy

Large-scale money printing was launched by Alan Greenspan, who believed that additional liquidity would be needed to cushion the shock of the millennium rollover. The shock never happened, but the easy money continued as the dot-com bubble popped, eventually leading to the housing bubble and its culmination with the failure of Lehman and the 2008 financial crisis. The Fed’s response was to turn on the afterburners. The December 2007 monetary base was 0.84 trillion dollars. By December 2019, it had risen four-fold to 3.4 trillion. And the the Fed lit the JATO bottles as well and we got real liftoff, as by December 2021 the monetary base had risen to 6.4 trillion dollars.

This matters because it means the economy is awash in cash. Monetary velocity has fallen from a pre-2009 low of 1.65, set in Q4 of 1964, to 1.15 as of Q2 of 2022. That means that much of the cash is idle, not being spent. All that cash is buying power in the hands of people and institutions. This means that interest rates and availability of credit are less important, and the Fed’s mission to reduce inflation by reducing demand faces an uphill battle. The Fed has begun reducing the monetary base by selling its pile of Treasuries and MBS. This is far more important than raising rates, but it will be a long time before its effects start to be felt because the current position is so extreme.

The poster child of the 2008 crisis was the NINJA (No Income, No Job or Assets) home buyer. The NINJA borrower has been replaced by the US government. Federal debt has nearly quadrupled since 2008.

fredgraph

fredgraph

This is why we have inflation. It is not going away until the deficit spending is reined in. Every dollar of new federal debt becomes a dollar in savings – and potential spending – for the private sector.

Jeff Gundlach Interview

Jeffrey Gundlach is the billionaire founder and CEO of DoubleLine, a Los Angeles based investment boutique mainly specializing in bonds, ranks among America’s highest-profile investors. His bold calls and correct prediction of the 2007 housing crash have earned him a solid reputation. A recent interview is most interesting in that he clearly, if intuitively, understands the instability inherent in the Fed’s attempts to control the economy by hindsight.

The next shock is that we’re having to put in a big overreaction to the inflation problem which we created from our initial reaction of excess stimulus. My guess is that we will end up creating momentum that’s more deflationary than a lot of people believe is even possible.

Of course he is very probably correct. A deflationary economic collapse is very likely to follow the inflationary phase. So long as the Fed is willing to make massive interventions in the economy without understanding the dynamics of control, we are utterly screwed. There comes to mind a well-known class of control systems known as bang-bang control.

That’ll Buff Out

Well I got that one wrong, fortunately my trading system had no dog in the hunt. Yes, Powell did hint at slowing rate increases. But the markets were shocked, shocked I say, by his acknowledgement of the 15 years of futile attempts to curb inflation before Volcker took matters in hand. That an economist should consider history rather than models and calculus is pretty much unprecedented, at least in modern times. His academic credentials may be called into question. The calculus thing was introduced because economists – it was called, correctly, “political economy” at the time – felt they were underpaid, relative to the physical sciences, and therefore needed to emulate them. It helped their prestige but not their forecasts.

Sarcasm aside, it’s a good thing. But the bad thing is there is way too much money in circulation. Consider the following mantra from Milton Friedman in 1963, years before the 1970s inflation.

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Then please consider the following:

fredgraph

money to gdp

That’s going to take a lot of buffing. And yes, Mr Powell, it is the product of years of central bank economic idiocy and arrogance. First chart St. Louis Fed, second John Hussman.

Friday

Friday is the Jackson Hole retreat, where the US taxpayer hosts a gathering of the people who believe they are the masters of the world economies.

Our esteemed Fed Chair, Jerome Powell, is expected to speak about, inter alia, Fed policy. Much digital ink is being spent on speculation about what he will say. So I will join in and spend a little.

It is important to remember that he, and many other attendees, claim to be economists. They are a dangerous species, especially when they attempt to manipulate economies and markets, as the records of booms and busts show.

Chair Powell has stated that he intends to curb inflation by slowing growth, not by slowing the economy, as in the R-word. In my personal opinion, as they say in Japan, we are going to have a deep and dark recession regardless of what Chair Powell says or does. But back to Friday. This means that he will at least hint at slowing rate increases. Of course this is not a “pivot”, more like a “swivel”. But it will be friendly to the stock and bond markets, at least for a little while.

The Price Of Moderation

From my last blog post of 2020:

William Greider, in his book, Secrets of the Temple: How the Federal Reserve Runs The Country, reports Nixon (’69-’74) as saying: “We’ll take inflation if necessary, but we can’t take unemployment.” The nation eventually had to take both. Note that Fed Chair Powell has indicated a willingness to let inflation “run hot” to encourage economic growth. That’s what they thought in the 1960s, too.

Well, inflation is running hot. Too hot for comfort. Discretionary spending is falling rapidly as the cost of essential goods and services takes more of people’s income. Fed Chair Powell is raising interest rates in baby steps, presumably in an attempt to quell inflation without slowing the economy significantly. People seem to think that raising rates to 2 1/2 percent will achieve this result, and are competing to time the “pivot” when the Fed returns to easy money. All I can say is good luck with that. History says that once inflation starts to surge – as it has – it is not easy to stop, as all kinds of feedback loops keep driving prices higher. Weakness now will only make the pain worse.

Perfect Storm Plus

The Perfect Storm began as an extratropical system, absorbed a tropical system (i.e., Hurricane Grace), and ended somewhat uneventfully as an unnamed hurricane. In the process it caused considerable damage on the US East Coast, and sank the fishing vessel Andrea Gail, with the loss of all hands.

We are now living through the early stages of the economic Perfect Storm Plus. The “Plus” is due to the near-simultaneous collapse of four great bubbles – China, Japan, North America and Europe. All are due to central bank monetization of government deficit spending, coupled with over-expansion of consumer and property credit. As Austrian economics teaches, there are only two paths out of these bubbles – stop the credit expansion and accept the resulting recession or depression, or continue to hyperinflation and the destruction of the currency.

The collapse of China began with the cascading failures of property developers, such as Evergrande, when President Xie’s “three red lines” reined in their ability to raise new debt. Then his idiotic “zero-Covid” policy drove a dagger into the beating heart of China’s economy, Shanghai. Then failures in a handful of smaller banks were mishandled by local governments which failed to honor deposit insurance guarantees, instead hiring toughs to beat up demonstrators. This has been followed by a wave of buyers refusing to continue mortgage payments on unfinished properties, especially where cash-starved developers have stopped working on them. A loss of confidence in the CCP government has resulted. It is attempting to stop the collapse with promises of more government funding, but so far success is elusive.

Japan is, so far, following the path of currency destruction. Even though Japan’s central bank now owns virtually all government debt and a very large chunk of the stock market, it continues its path of yield curve control – at zero. This has led to a downward slide in the yen as the US Fed has reacted to inflation, well a little bit anyway. Japan is short of natural resources and must import many commodities, especially energy as the Fukushima disaster has constrained the use of nuclear power. One could easily see a return of the yen to dollar valuations like the pre-1989 mid-200s, compared to 140 today and the 2012 high in the 70s. Needless to say, this would kick off serious inflation in Japan.

North America’s asset bubble, in property and financial assets of all kinds has finally been joined by rapidly inflating prices of consumable goods and services. While Alan Greenspan started the Fed’s monetization addiction around the turn of the century, rapid growth in outsourcing to China, India and numerous other countries kept consumer prices and wages under pressure. Finally the combination of supply chains ruptured by Covid and government payments that put large sums directly in the hands of consumers started to drive up prices, and also allowed large numbers of people to withdraw from the labor force. The coup de grace was Biden’s decision to follow the urging of the climate fanatics and cut off investment in future fossil fuel supply. Anecdotally, a farmer of 1,800 acres in Canada reports that his annual diesel fuel bill has doubled from $40K to $80K, and nitrogen fertilizer (made from natural gas) has gone from $270/tonne to $900/tonne. The Fed’s reaction has been a minor increase in interest rates. A recession is either already underway or set to begin anytime now.

Europe (including the UK) is a basket case. It shares many of the same problems as North America, but in addition climate fanatics and the Russian attack on the Ukraine have conspired to leave it desperately short of energy. EU inflation is running high (8.8%) but the real problem is yet to come. Germany continues to shut down its remaining nuclear plants, while Russia has just notified Germany that it is terminating natural gas deliveries. Germany lacks the terminals needed to import LNG.

A key component of the coming confluence of these storms is the climate mania. This mania is based on bad science, but socialist politicians and activists see an opportunity to disrupt the status quo.

Alchemy

Ancient alchemists – including, amazingly enough, Sir Isaac Newton – strove to transform base metals into gold. Modern alchemy is accomplished by central banks, which transform interest-paying government debt into interest free cash. This alchemy allows governments to borrow unlimited amounts of money, unhampered by the need to pay interest.

We can consult Sir Isaac, as it turns out. “For every action, there is an equal and opposite reaction,” said he, referring to the impossibility of reactionless acceleration. Yes, we are talking about economics here, not physics, but there is a good analogy. The central bankers have attempted the reactionless acceleration of the economy and now follows the reaction.

Looking specifically at the US  Fed, there is a $7 trillion pile of debt that has been processed into cash, representing money that the government has spent beyond the means provided to it by taxes. This money has been sloshing around in the economy, driving up asset prices first of all and now the prices of consumables. Tiny increases in interest rates won’t solve this problem. The fake money has to be destroyed. The Fed can do this by reverse alchemy – selling off the pile of debt – which will drive up interest rates even further. Small problem, even current rate increases will mean that the Fed will become technically bankrupted by the loss of value of the bonds if it sells them. Capital call? Creative accounting? If it continues to hold them it does not have to mark them to market. Alternatively, debt defaults will destroy money as inflation cripples the economy. Your call, Jerome.

Debt

According to the St Louis Fed, from Q1 2000 to Q1 2022, federal debt has expanded from $5.77 trillion or 58% of GDP to $30.4 trillion or 125% of GDP. And the deficit spending continues unchecked. History says that government debt of over 80% of GDP inhibits economic growth.

The interest rate on the debt is currently about 1.5%, but 70% of the debt is due at various dates within 5 years, and will be rolled-over and re-priced at whatever rates are current at its maturity. However, the following chart shows that the highly negative real rates currently in effect do not persist for very long. The red line is the inflation rate, the black line is the Fed funds rate and the blue line is the “real” rate – the nominal Fed rate minus inflation. It seems likely that the Federal budget and interest expense will have a nasty collision in the next few years unless inflation falls rapidly.

Screenshot 2022-06-20 205338