Category Archives: Saving & Investment

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.

Where The Fugawi?

The flightless Fugawi bird lives in the tall grass of the African savannahs. Unfortunately, this bird is not as tall as the grass that surrounds it, hence its mournful call. The mavens of Wall Street seem to share the bird’s frustration as they focus on fractional changes in economic data, in the hope that they will foreshadow a return to the peaceful, sunlit uplands of free and flowing money.

Alas, it is not to be. We are fated to do battle with the multi-headed Scylla of inflation and, if we win, it is only to be sucked into Charybdis’ whirlpool of depression. Massive increases in government debt have, inevitably, increased private sector savings and pulled consumption forward in time. If these increases continue, Scylla will dine well as hyperinflation ruins the dollar. If they do not, consumption will, of necessity, fall as the credit impulse reverses. Charybdis’ whirlpool is a fine metaphor for the negative feedback cycle that will result from bankruptcies and defaults. If I do say so myself.

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.

Pivot – To What?

It seems as if every financial writer has no more important subject to opine upon than the exact date of the Fed “pivot,” when the Fed will be “forced to” resume supporting wild speculation.

Such opinions may be successful clickbait, but any such pivot is economically meaningless. Just look at the last employment report. The number of jobs increased significantly, but the number of employed persons hardly moved. People are taking on more jobs in order to, as President Bush put it, “put food on their family.” This can only go so far, for obvious reasons, and it means there are insurmountable limits on the economy’s ability to grow. Production equals labor hours times productivity. Productivity is slow and hard to improve, so not any help. Labor hours are pretty close to the wall, as shown by the average workweek which has flatlined at 34.6 (FRED). This all means that the economy cannot grow in response to stimulus. Easy money and/or a return to QE will simply result in more inflation, which will do as much or more damage to the economy and corporate profitability than higher interest rates. I cannot believe that the Fed is unaware of this reality. There is no free lunch. Pain is coming, regardless of what the Fed may or may not do. Look back at the Great Depression when the Fed thrashed around, trying everything because nothing “worked.”

Just One Chart

When you buy shares in a company, you are really buying a share of the stream of profits yet to come. This chart from John Hussman shows what is going to happen as labor reclaims its share of company income.

labor costs vs profits

The extra profits in the early 2000s were financed by the housing bubble, while the recent spike is mostly the result of massive government deficit spending on subsidies and handouts of various kinds. These are coming to an end despite the best efforts of the Dems to blow up inflation.

Rate Shock

The median price of a new home has fallen by -11.9% over the last 2-month period,

Image

Thanks to Liz Ann Sonders.

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

The Digital Economy

Zuckerberg said that Meta (Facebook) will make significant losses in coming years as it invests heavily to build “the digital economy”. He implied that the excess expense would include subsidizing the virtual reality headgear needed to experience Meta’s virtual world(s).

We have something of a digital economy today. Crypto tokens, NFTs that include digital avatars and clothing for them, digital real estate and even digital yachts presumably navigating digital seas. Most of what you need in a digital world. Fortunately mundane things like food and water or fuel are not required, just a lot of imagination.

Will it make the kind of huge business needed to pay out those billions to be invested? I don’t know, I like my life real. Even it is dangerous and challenging. Zuck’s vision seems to me to be a sad imitation of reality.

 

Wishful Thinking

Financial advisers are falling over themselves to roll out the bullish case for the stock market. Perhaps the Fed will get scared and resume pumping the stock market. Perhaps the Fed will engineer a “soft landing”. Perhaps the economy will grow fast enough to avoid a recession. Perhaps a recession will abolish inflation. The first is possible. The others are not.

Perhaps the reality is that we are facing a perfect storm. I’ve written about some of the issues here and specifically about energy policy here. 

Perhaps most important but unmentioned is the impact of the Biden administration’s spendthrift and socialist policies. This is an administration that is completely dominated by wishful thinking. That it can print and spend money without concern for the effects of excessive debt on growth, or the impact of inflation on households with little margin for error. That it can grow an economy already short of labor by spending money. That the US can support a level of military spending which exceeds the total military spend of the rest of the world. That pandering to racial and transgender political correctness is more important than taking care of basic necessities such as food and energy. That opening the borders to crowds of uneducated and unskilled refugees fleeing socialist regimes will not overload the US social safety net.  That the US can afford to export democracy when there is precious little left at home.