Category Archives: Debt

Unexpected Outcome

People seem to be surprised that the Fed’s rate hikes have resulted in rates declining. Really? It seems pretty clear that the Fed’s outlook is at odds with reality, and that rates are responding to the real outlook, which is that Fed rate hikes are a negative for an economy that is already tanking.

The Future Is Now

Debt pulls demand forward in time. Borrowers use debt to pay for consumption today and commit future income to service the debt.

The amount available for consumption today represents the present value of that committed income, discounted by the prevailing interest rates.

The further that borrowers reach into the future, the more that discount lessens the amount available today. The Fed wants consumption today, so it attempts to induce inflation in order that borrowers are more confident of their future nominal incomes, while holding interest rates low so that the discounting of that income is minimized.

This strategy has sustained consumption in the short term, at the expense of reducing future income available for consumption.

The problem is that the future is now.

As consumption slows, so does production and inflationary pressure. Defaults rise – just look at the subprime auto loans. Yes, defaults eliminate debt – but only at the expense of the creditor who takes an immediate hit to income, charged against net worth or equity capital. Lenders are forced to reduce their assets.  Borrowers find that debt service takes more of their income than they had expected. Purchasing power erodes and deflation sets in. Spending capacity falls even more rapidly and the economy slides into recession and depression.

The larger the accumulation of debt, the longer it takes to purge the financial system and restore it to stability. Debt – credit – is a necessary and healthy part of the economic system. But the economy cannot depend on consumption funded by the continuous growth of debt. Debt must revolve, expanding and contracting within limits proportional to the size of the economy.

A Bit Of Math

Simon Mikhailovich of Tocqueville Bullion Reserve reminds us of the deadly numbers with a sobering tweet:

A bit of math. With the global debt / GDP ratio at 320% and the cost of average debt service at 2%, it takes 6.4% growth per annum just to service the debt. Not happening.

Same Old

Per Bloomberg, house flippers have pushed the share of sales that are flips, or properties sold twice in 12 months, to its highest level since 2006.

Home flippers, who buy homes as a speculative bet on short-term price appreciation, accounted for 6.1 percent of U.S. home sales in 2016, according to Trulia, which defines a flip as a property sold twice in a 12-month period in arm’s-length transactions. That’s the highest share since 2006, when flips accounted for 7.3 percent of sales.

House prices are, of course, now above the last bubble peak. This is not likely to end any differently than the last time. Thanks, Janet.

Malls Hit The Wall

According to Forbes in 2015, the US leads the world in retail space per capita, with about 25 square feet (roughly 50 square feet, if small shopping centers and independent retailers are added). In contrast, Europe has about 2.5 square feet per capita. Number two is the UK, with about one-sixth the retail space per capita of the US. Now that online shopping is replacing store visits, shopping malls are becoming white elephants.

More mall landlords are choosing to walk away from struggling properties, leaving creditors in the lurch and posing a threat to the values of nearby real estate.

As competition from online shopping batters retailers, some of the largest U.S. landlords are calculating it is more advantageous to hand over ownership to lenders than to attempt to restructure debts on properties with darkening outlooks.

Obviously this is a looming bust for commercial real estate – and of course a wave of defaults on the associated debt.

Going Out On A Limb

I think the end of this bubble is beginning, as yields spike and the dollar soars:

“Our revels now are ended. These our actors,
As I foretold you, were all spirits and
Are melted into air, into thin air:
And, like the baseless fabric of this vision,
The cloud-capp’d towers, the gorgeous palaces,
The solemn temples, the great globe itself,
Yea, all which it inherit, shall dissolve
And, like this insubstantial pageant faded,
Leave not a rack behind. We are such stuff
As dreams are made on, and our little life
Is rounded with a sleep.”

― William Shakespeare, The Tempest

The economy is not strong. There are 100+ million adults not working (“not in the labor force”) out of a total population of 325 million, to say nothing of the myriad of government employees who are employed, but not contributing any value to the economy.

Consumption is being sustained by debt, both private borrowing and government money-printing. By January 2009, the United States had accumulated $10.6 trillion in debt. The gross national debt – just federal government debt – stands at $19.7 trillion as of the end of FY2016. Spending is on a pace to add another $2.4 trillion this fiscal year (2017), surpassing $21 trillion by next September. Krugman applauds, and of course this is Obama, not Trump. Yet.

Debt-funded consumption in excess of income has crowded out savings and therefore investment. As investment has declined, so, logically enough, productivity growth has fallen (see previous post). Simultaneously, government has been growing, making a lethal cocktail for real household disposable incomes, which have been declining for years. Pensioners who think they are in good shape are not noticing that defined-benefit pension funds are already starting to cut benefits and many, especially state and local government funds, are woefully under-funded. Social Security is in negative cash flow, and drawing on the general tax revenue pot to make up the difference. The stock market is ludicrously over-valued and promises zero or negative returns to pension funds for years to come. As Margaret Thatcher notably said “Socialist governments traditionally do make a financial mess. They always run out of other people’s money. It’s quite a characteristic of them.”

Powerful deflationary forces are being unleashed. The world is awash in oil and efforts to keep the price up will eventually fail. OPEC in aggregate will not cut supply because its governments (as well as the non-OPEC ones) depend on the flow of oil money to stay in power. I expect oil to reach the lower $20s if not below. Most of the world is engaged in a race to the bottom, cutting interest rates to devalue their currencies and boost exports. They are therefore exporting deflation to the US. I expect to see CAD in the 0.60s and the EUR in the 0.80s. Consumer price inflation in the US appears comparatively strong due to the inclusion of OER¹ in the CPI, which is not done elsewhere, and due to the uncontrolled rise in healthcare and education prices, funded by government subsidies and debt. These prices end up being a form of taxation by the 0.01%, who are on the receiving end. The protest vote in the US election should be no surprise.

OER, a completely fictional number to start with, is high as a result of low interest rates financing housing bubbles. These will end as badly as the previous lot. I choose not to be a homeowner, largely because I don’t want to face a huge capital loss.

In short, the economy is a Potemkin village. Things are not as they are made out to be. Even a fractional increase in rates may trigger a deflationary crisis, especially considering the shortage of dollar liquidity outside the US.

¹ OER, Owner’s Equivalent Rent, is weighted about 25% of the CPI basket. It is estimated by a telephone survey of selected homeowners, asking them how much they think it would cost to rent their a property like theirs.It has nothing to do with what it actually costs them to own and live in their properties.  I am not kidding. Now do you think CPI means anything?

The Black Hole

Here is a prime example of the kind of nonsense that passes for economic wisdom at the Jackson Hole meeting.

In a lunch address by Princeton University economist Christopher Sims, policymakers were told that it may take a massive program, large enough even to shock taxpayers into a different, inflationary view of the future.

“Fiscal expansion can replace ineffective monetary policy at the zero lower bound,” Sims said. “It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts.”

Ever hear of Abenomics, Mr Sims? Oh I know, not large enough. Please.

I think it is obvious that you can’t finance anything with inflation. Latin America has been trying that for years, with disaster after disaster ensuing. Right now I am looking at a framed Zimbabwean hundred trillion dollar bill. This obsession with creating inflation, obviously intended to devalue the enormous pile of debt that Keynesian policies have created, is possibly the most dangerous and ludicrous aspect of the madness that has seized mainstream economists.

It is a perpetual search for the magic bullet that will resolve the economic failure of liberal socialism, which is playing out around the world. Economists seem to believe that just because the Keynesian free lunch has failed to materialize doesn’t mean that it can’t be teased out by some manipulative action. Sorry folks, it is just a mirage. It will always be out of reach because it does not exist.

Information is lost in both Jackson Holes and black holes.

Heart’s Desire

Well markets got what they wanted today when both the BoE and the ECB indicated that they would be doing “more” – in the case, QE – over the summer.

The Fed did its bit after the close yesterday by authorizing the big banks (except Deutsche Bank, which is probably doomed anyway) to buy back their shares. Of course, they all promptly announced massive buybacks, which they will fund by borrowing from one another thus piling on more debt.

So the debt bubble gets bigger, the banks get worse, the pension funds struggle, the economy slowly dies and it goes on and on. It is becoming farcical.

It is the last day of June, the second quarter and the first half. So much window dressing and manipulation to manage reporting is going on. Notably the (record) Treasury shorts just slammed the bonds as they appeared to be running away to the upside and that wouldn’t look good.

Nothing To See Here


As the market soars this morning, one may wish to take a moment of quiet contemplation and examine the Fed’s chart above. The red circle marks the so-called “Lehman moment” from the last bubble collapse.

This is not supposed to be happening according to the Fed’s models and therefore it is not on Ms. Yellen’s “dashboard.”

So Late We Get Smart

Alan Greenspan, interviewed by Bloomberg Radio, said he was not optimistic about the future: “No. I haven’t been for quite a while. And I won’t be until we can resolve the entitlement programs. Nobody wants to touch it. And that is gradually crowding out capital investment, and that’s crowding out productivity, and it’s crowding out the standards of living where do you want me to go from there.”