Collapsing Dollar Liquidity Sends Dire Signal For Stocks

With the ECB today confirming that its bond purchase program will end in less than three weeks, it is worth reminding readers that the world is now crossing that critical threshold where the consolidated global central bank balance sheet is shifting from a source of liquidity to a drain on the global (and fungible) monetary system. And as the chart below shows, every single time the total change in net central bank assets has dipped into the red, it lasted only briefly before some financial crisis typically ensued, forcing central banks to resume liquidity injections to maintain market stability.

Yet while much of the investing public appears to have forgotten about the danger from balance sheet shrinkage, instead focusing on such interim distractions as trade war, peak earnings or rising rates, it is only a matter of time before the need for continued "flow" (not "stock)" of liquidity manifests itself in sharply lower asset prices.

Confirming this, is a new note by Nedbank, whose analysts Neels Heyneke and Mehul Daya warn that "equity markets are vulnerable" and caution that "it is time for central banks or governments to step up to the plate to help these markets" reminding readers that "in 2008, the Fed underestimated the size of the shadow-banking system, and the rest is history."

To underscore this point, the analyst duo shows the following key chart which makes it unambiguously clear that there is a strong relationship between the change in global USD-liquidity (in the form of M1) and the performance of the global stock market, where liquidity leads the stock market by an average of eight months.

And since the rate of change in liquidity is now the lowest it has been since the financial crisis, absent a fresh boost to global $-liquidity, Nedbank expects this relationship to hold and "as a result the risk of further downside potential for stock markets across the world remains intact."

One place where the shortage of liquidity is already manifesting itself, Nedbank claims, is in the rising spread of USD-denominated Emerging Market corporate debt, where the spread is close to a breakout level. To Nedbank,"this is the "canary in a coal mine for risk assets."

To be sure, the numbers are staggering and suggest a continued need for liquidity injections as USD-denominated debt of EM corporates has grown from $650Bn in 2009 to the current $3.2Trillion and, as the IMF has pointed out, there are significant mismatches i.e. USD-denominated debt as a percentage of GDP is 70% and as a percentage of reserves is 75%.

What about equities?

Here too the picture is quite bearish, and not only from a fundamental liquidity standpoint, but from a technical one as well as the failure by markets to remain above the (red) resistance line through the tops is in itself a sell signal. According to Nedbank, "if the world index remains below the (blue) support line at 1,984 over the coming days, it will likely be just a matter of time before the bear trend accelerates."

Injecting a little more chart analysis, Daya notes that according to Elliott wave rules, the correction after the completion of a five-wave structure should retrace the entire fifth wave. This would indicate a correction to the 50% retracement level at 1,454.

If that forecast is accurate, and if the S&P reconverges with the MSCI World, from which it decoupled for much of 2018, it would imply that the S&P500 has to drop over 700 points, sliding as low as 1900.

One thing is certain: whatever the "Powell Put" is today, it will certainly be triggered should the stock market crash by that much, not only ending any Fed tightening plans, but also launching a new round of QE.

Fonte: qui

Market Crash? Another 'Red Card' For The Economy

A few months ago I wrote this article at the World Economic Forum called “A Yellow Card For The Global Economy“. It tried to serve as a warning on the rising imbalances of the emerging and leading economies. Unfortunately, since then, those imbalances have continued to rise and market complacency reached new highs.

This week, financial markets have been dyed red and the stock market reaction adds to concerns about a possible impending recession.

The first thing we must understand is that we are not facing a panic created by a black swan, that is, an unexpected event, but by three factors that few could deny were evident:

1. Excessive valuations after $20 trillion of monetary expansion inflated most financial assets.
2. Bond yields rising as the US 10-year reaches 3.2%
3. The evidence of the Yuan devaluation, which is on its way to surpass 7 Yuan per US dollar.
4. Global growth estimates trimmed for the sixth time in as many months.

Therefore, the US rate hikes – announced repeatedly and incessantly for years – are not the cause, nor the alleged trade war. These are just symptoms, excuses to disguise a much more worrying illness.

What we are experiencing is the evidence of the saturation of excesses built around central banks’ loose policies and the famous “bubble of everything”. And therein lies the problem. After twenty trillion dollars of reckless monetary expansion, risk assets, from the safest to the most volatile, from the most liquid to the unquoted, have skyrocketed with disproportionate valuations.

(courtesy Incrementum AG)

Therefore, a dose of reality was needed. Monetary policy not only disguises the real risk of sovereign assets, but it also pushes the most cautious and prudent investor to take more risk for lower returns. It is no coincidence that this policy is called “financial repression“. Because that is what it does. It forces savers and investors to chase beta and some yield in the riskiest assets.

Three examples of the market lunacy: Iraq, a country that has been all but devastated and in constant turmoil, issues a 2028 bond at 5.8% yield, lower than some developed markets only six years ago.

Argentina issued a 100 year bond  with an 8.5% yield. A country that in the previous 100 years before issuing this bond defaulted more than eight times. The $2.5bn issue was oversubscribed 3.5 times, which shows how credit investors are more than hungry for any kind of yield, as global negative yield bonds currently surpass the $6.5 trillion figure. With Europe and Japan giving negative nominal and real yields, and central banks buying a combined $200 bn a month of assets, there was massive real demand for some yield.

None of the eurozone countries’ sovereign debt yields show a realistic combination of risk and return. With 19 countries yielding negative real returns, the evidence that there is no real demand for those bonds at these levels is that the ECB is considering an “operation twist” to avoid the inevitable reckoning of rising real yields as the quantitative easing unwinds.

In Europe, no investor would buy bonds of the eurozone states with these coupons in a normalized environment. This has led to higher risk assets in fixed income discounting a spread of only 290 basis points over a sovereign bond that is already massively inflated. That is the creation of a huge bubble instigated by central banks with its reckless policy of ignoring the risks that they encourage in the markets.

With more than 6.5 trillion dollars in bonds with a negative yield, the global bubble remains huge. Stock markets on fire, infrastructure multiples soaring, junk bonds at the lowest yields in thirty-five years… 

And it burst. 

China reminded us that the tale of synchronized growth was false and that what we have been seeing in recent years has been synchronized growth … of debt .

(courtesy IIF)

When China devalues the yuan and introduces the biggest tax cut in 38 years and a constant monetary stimulus to bail out its banks, what is it really telling us? That everything is fine? No, that things are not going well with the Asian giant  No economy launches a massive undercover bailout of the financial sector, cuts rates and implements huge tax cuts as well as devaluing if everything goes smoothly.

The realization of the fallacy of synchronized growth has also brought down expectations of global growth. And with it, corporate profit estimates.

Markets, suddenly, look as expensive as many have warned when the combination of China devaluation and soaring US yields shows the extent of the accumulation of risk of the past years.

The cracks in the building always appear first with currencies. Countries that have become accustomed to the idea that “this time is different” and that debt does not matter, started to multiply their indebtedness in foreign currency. Debt in dollars from emerging countries soared to 41% of their total debt.

In the first three months of 2018, global debt rose 11% to a record of 247 trillion dollars (according to the IIF), and that of emerging markets soared by 2.5 trillion to an all-time high of 58.5 trillion. .

When the lowest risk bond, the United States 10-year, went to 3.1%, the synchronized growth and complacent veil lifted, and t many assets showed how risky they truly are.

Markets woke up to a reality that we had decided to ignore. That rates do rise. And if the safest bond gives a return of 3.2% … Am I willing to buy bonds from much riskier countries with negligible spreads?

Add to that “sobriety” effect, another one. The inevitable devaluation of the yuan , which soared to almost 7 against the dollar. Am I willing to buy emerging markets and commodities when China exports its imbalances sending disinflationary pressure to the rest of the world?

One, the US 10-Year, shows us the risk in the assets that we perceive as “safe”. And the other, the yuan, reminds us that China exports global disinflation and warns of impossible growth expectations.

This reminds us that this time is not different. It is the same as all the previous ones. A bubble created from monetary policy gives way to a deep hangover .

The US technology sector, which soared thanks to very low rates and high liquidity began to show signs of weakness, and the US market reacted by losing support levels as a continuation of the five-year lows in China and emerging markets as well as ongoing weakness in Europe, showing that the United States was not immune to the problem of excesses in other markets and that “value” in Europe or emerging markets was inexistent. These markets fell with the US -and more in some cases-. The US market might be expensive, but others are optically cheap but very expensive in reality, and as such, they fall in tandem.

What is the problem?

If we look at the 180 most important economies in the world, only six have in their estimates of 2018, 2019 and 2020 an evident improvement of their fiscal and commercial imbalances. In other words, almost no government in the world plans to reduce the rate of debt increases. If we look at the corporate sector and families, the situation is much better, because private debt is somehow more contained -except in China- and especially in terms of solvency, compared to profits and assets.

Given that it is more than likely that central banks will continue to Japanize the economies through financial repression, these “red cards” are becoming more frequent and, in addition, there comes a point at which the saturation of monetary and debt measures stops working even as a placebo.

Governments and their central banks always start from a wrong diagnosis. They always believe that the problems of their economies are due to lack of demand and that turmoils are caused by external enemies, not by their policies. By appointing themselves as a solution to the problems they create, they only perpetuate the imbalances, and the solution is increasingly complex

Above all, the tools that central banks and governments have always used (lowering rates, increasing liquidity and increasing spending), generate very evident diminishing returns. In the past eight years, for every $1 of GDP, there were $3 of debt created. 

This week’s tantrum will probably recover because the incentive to continue inflating the risky assets is high. But we already have had several warning signs and we keep ignoring them . Even worse, episodes of volatility are being used to increase imbalances and generate further problems in the long-term.

When societies are based on incentivizing spending and debt and not saving and prudent investment, we are always going to throw ourselves into a bigger problem based on the conviction that nothing is happening. When it bursts, governments and central banks will blame anyone except themselves. And repeat.

Authored by Daniel Lacalle via DLacalle.com

Has “It” Finally Arrived?

With the recent plunge in the S&P 500 of over 5%, has the long-anticipated (and long-overdue) market correction finally begun?

It’s hard to say for certain. But the systemic cracks we've been closely monitoring definitely got an awful lot wider this week.

After nearly a decade of endless market boosting, manipulation and regulatory neglect, all of the trading professionals I personally know are watching with held breath at this stage. The central banks have distorted the processes of price discovery and market structure for so many years now, that it’s difficult to know yet whether their grip on the markets has indeed failed.

But what we know for certain is that bubbles always burst. Inevitably. Each is built upon a fallacy; and when that finally becomes apparent to enough people, the mania ends.

And today, there are currently massive bubbles in stocks, bonds and real estate. Every one courtesy of the central banks (as we have written about in great detail here at PeakProsperity.com over the years).

And with no Plan B in place to gracefully exit the corner they have painted themselves -- and thereby the global economy -- into, the only option available to them is to double-down on the pretense that we'd all be screwed without their stewardship. They have to do this I suppose. To admit the truth would throw the world into panic and themselves out of a job. 

Who knows what they think privately? But in public, they give us real gems like these:

Williams Says Fed Rate Hikes Helping Curb Financial Risk-Taking

U.S. interest-rate increases will help reduce risk-taking in financial markets, Federal Reserve Bank of New York President John Williams said.

"The primary driver of us raising interest rates is just the fact that the U.S. economy is doing so well in terms of our goals,” Williams said Wednesday in a reply to questions after a speech in Bali, where the annual meetings of the International Monetary Fund and World Bank are taking place. “But I would also add that the normalization of monetary policy in terms of interest rates does have an added benefit in terms of financial risks.”

"A very-low interest-rate environment for a long time does, at least in some dimension, probably add to financial risks, or risk-taking, reach for yield, things like that," he said.

"Normalization of the monetary policy, I think, has the added benefit of reducing somewhat, on the margin, some of the risk of imbalances in financial markets."

(Source)

And with that, our award for “Finally closing the barn door after the horse left 8 years ago,” goes to John Williams of the US Federal Reserve.

Come on, Mr. Williams. Your historic 'very-low interest-rate environment' didn't merely lead to a slight degree of higher risk at the margins here.

Instead, it has lead to an explosion of excessive risk everywhere today, including:

• Junk bonds trading near their most expensive prices ever
• Covenant lite loans out the wazoo
• The highest levels of corporate debt ever
• The most expensive stock markets ever, by several measures
• The highest margin debt on record
• Real estate bubbles across the globe
• Pensions highly exposed to the stock market

And the central banks' policy over the past decade hasn't merely been to create a “very low interest rate environment”. It has been nine long years of intense and deliberate financial repression.

The resultant risk-taking didn’t happen “in some dimension”. It happened right here on Planet Earth, in real time, and in public and private portfolios alike, across the globe.

Pensions have been monkey-hammered by this policy, forced to throw away 100 years of accumulated investment wisdom and flip from traditional allocations of 60/40 bonds-to-stocks to the opposite in a desperate chase for yield.

The mathematically-certain insolvency of much of the pension system lies on your shoulders Mr. Williams. And those of your other Fed colleagues. 

Moreover, the other malignant market responses to the Fed’s distorting policies didn’t “probably add to financial risks”. It absolutely guaranteed a future crisis -- one that will dwarf any prior.

In my assessment, the biggest crime of the Fed was the decision under Greenspan to try to eliminate the business cycle by replacing it with a credit cycle. Here’s what that looks like in chart form:

If you can't clearly spot the absurd Fed-blown asset bubbles in the above chart, you may as well stop reading here. With that kind of blindness, nothing can help you plan for what's coming next.

Now, why would central banks prefer credit cycles? Easy! They're a lot more fun. When they're expanding, everybody loves you. You get invited to Davos and people love celebrating you at parties.

Just as good, when the bubbles burst, as they always must, you get to ride to the rescue and play the role of savior. And when the dust settles, you get feted as a “hero” by the mainstream media (even though you were no better than an arsonist putting out his own fire).

Case in point:

Yes, I blame the central banks for the breakdown about to come. They are the villain to blame for their horse-whipping of stocks, bonds and real estate into dangerously over-valued asset price bubbles. Nobody else.

Former Fed chairs Greenspan, Yellen and Bernanke have to shoulder nearly all of the culpability. It remains to be seen what Powell does, but so far he seems less interested in bailing out stock market declines than his predecessors. If indeed so, he’s an enormous improvement.

Already, under Powell, for the first time in a decade, we are emerging out from underneath the miserable thumb of financial repression, the key cornerstone of which is having to accept negative real yields on saved money.  Today the rate of interest on a 3-Mo T-bill is higher than the (stated) rate of inflation. It’s also higher than the dividend yield on US equities. So savers finally have an option that doesn't unjustly punish them.

If we can thank Powell for that, then he’s already done more good than all three of his predecessors combined. And if he allows this last ill-conceived credit cycle to finally die of its own accord, he'll actually deserve that "hero" accolade. Especially because doing so will not only be the right thing to do, it will be deeply unpopular with the Powers That Be, and require an inordinate amount of courage to effect.

Heck, Trump was already gunning for Powell on Wednesday after just the first -3% decline:

“The Fed is making a mistake, they’re so tight. I think the Fed has gone crazy.”

~ Donald Trump, 10/10/18

But if Trump was concerned on Wednesday, he must have been spitting nails on Thursday as the market carnage continued:

Is this really it?

Has the worm really turned?  Is it not possible that the authorities will once again rescue these “markets” driving them ever higher in their quest for printed-up prosperity?

Again, anything is possible, but our view is that until and unless the central banks decide to reverse their QE wind-down operations the faux gains that resulted from the money flood will evaporate as well.

Our view is that things progress from “the outside in” reflecting the fact that it is always the cash strapped zombie company that fails before the AAA rated company, and it is the weaker emerging market economy that suffers before the core OECD economy.

This table of various year to date stock market returns perfectly illustrates that the “outside in” dynamic has been in place for a while.

It’s not a perfect detection mechanism certainly (Germany is down 4x more than Portugal?) but the pattern is more than directionally adequate.  The money flood has reversed and we’re seeing that in the losses that have been mainly concentrated at the periphery --  but are fast rippling into the strongest "core" markets

Time For Safety

Admittedly, we’ve been mostly out of the markets for a long while, preferring cash, gold, some core real estate holdings; while slowly building a small short position.

Our main strategy for surviving bubbles is to not get caught up in them in the first place. We've long advocated the wisdom of amassing cash, to have 'dry powder' capital to deploy at much better valuations after the bubble's bursting. In our opinion, everyone should be working on ‘buy list’ for that day.

Sadly, the expansion of the Everything Bubble has gone on for far too long as the central banks have all but destroyed true price discovery and well-informed capital allocation. Heck, most Millennial adults weren't old enough to experience the 2000 and 2008 episodes -- to them, today's Frankenmarkets are 'normal'. Most seem to have exactly zero clue of the role of the central banks have played in fostering the lion’s share of the stock and bond market gains that have occurred during their short adult lives.

The investment chat sites I lurk through to gauge the mood are awash with folks telling each other to “buy the dip” and “stand firm.”  Many are parroting the Wall Street/CNBC mantra that "This time is different!", so it’s best to just keep putting money in, staying long and fully invested.

We disagree. And we think those blindly marching to Wall Street's tune will be the first and worst victims when the next major correction hits.

Which is why we encourage everyone reading this to crash-test their portfolio with their professional financial advisor. If indeed we're entering another 2008-style correction, how will your current holdings fare? How risk-managed are your positions? Are your potential losses hedged to the downside? And once the dust settles, what's your plan for re-entering the market?

These are critical questions to be asking right now. And the time to address them may indeed be very scarce (the Dow has dropped another 100 points as I've been writing this).

If you don't have a financial advisor, or are having difficulty finding one willing to address the risks discussed here, consider scheduling a portfolio crash-test consultation (it's completely free) with the advisor Peak Prosperity endorses.

Just please, whatever you do, make sure you've taken prudent steps to prepare for a major market downturn. Don't leave your hard-earned wealth exposed, unless that's an intentional decision on your part.

Conclusion

The recent market sell-off was not at all unexpected by us. We began observing the first tremors at the periphery many weeks ago.

Last week, on October 5^th, we sent out a market warning to our premium subscribers under the banner The Markets Are Suddenly Looking Very Sick.

Whether the central banks blink here and ride to the rescue is the big question.

While we'll have to wait and see to learn the answer, in all of our interviews with experts (e.g. Axel Merk) who know the Fed and its staffers personally, the consensus is that Powell is a different animal from his predecessors. He'll tolerate quite a lot of stock weakness before he's moved to act.  Is his line in the sand -20%?  -30%? 

Whatever it is, it’s likely a lot more than the -6% we’ve seen so far.

Further, the ECB is in a bind because it, too, are publicly committed to tapering its balance sheet expansions to zero by the end of 2018. And as the EU is also locked in a budget battle with Italy, and it would be very politically difficult for the ECB to both play dove and hawk at the same time by bailing out the markets with more QE while also not buying any more Italian government debt or helping Italian banks.

The Bank of Japan is pretty much done, too. It has recently even (gasp!) shrunk its balance sheet a few times in recent months.

China is busy fighting its own battles with slowing growth and history's largest ever-real estate bubble. It's also in very delicate trade negotiations with the US, complicated enormously recently with the revelation that the Chinese PLA had a role in inserting hardware hacks (chips) onto high tech products supplied to the US.  So the PBoC is probably not going to be in the business of doing anything dramatic in terms of balance sheet expansion right now.

Add it all up, and the “outside in” contagion we’ve been observing over the past few months seems to have finally reached the core.

12/10/2018

Fonte: qui

In Part 2: Preparing For The 'Big One' we examine what a true market "crash" would look like.  We’ll be looking at bonds, stocks, gold, the gold miners, currencies as well as discussing potential candidates to consider for your post-crash 'buy list'.

Ready or not, developments are escalating. Be as ready as you can for what's coming.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access

Mauldin Warns "This Debt Train Will Crash"

We are approaching the end of the debt Train Wreck series. I’ve spent several weeks explaining why I think excessive debt is dragging the world economy toward an epic crash. The tracks ahead are clear for now but will not remain so. The end probably won’t be pretty. But there’s good news, too: we have time to get our portfolios, our businesses, and our families prepared.

Today, we’ll look at some new numbers on just how big the problem is, then I’ll recap the various angles we’ve discussed. This problem is so big that we easily overlook key points. I hope that listing them all in one place will help you grasp their enormity. Next week, and possibly a few after that, I’ll describe some possible strategies to protect your assets and family.

Now on with the end of the train.

Off the Tracks

Talking about global debt requires that we consider almost incomprehensibly large numbers. Our minds can’t process their enormity. How much is a trillion dollars, really? But understanding this peril forces us to try.

Earlier in this series, I shared a 2015 McKinsey chart that summed up global debt totals. They pegged it at $199 trillion as of Q2 2014. Note that the debt grew faster than global GDP. Everything I see suggests it will go higher at an ever-increasing rate.

Source: McKinsey Global Institute

Last month, McKinsey published a very useful online tool for visualizing global debt, based on Q2 2017 data. It shows a total of $169T, which is less than McKinsey said in 2014. Is debt shrinking? No. The new tool excludes the Financial debt category, which was $45T three years earlier. A separate Institute for International Finance report said financial debt was $59T at the end of 2017. These aren’t quite comparable numbers, but in the (very big) ballpark range we can estimate total debt was somewhere between $225T (per McKinsey) and $238T (per IIF) in mid-2017. (IIF’s latest update last week says it is now $247T).

Source: McKinsey Global Institute

That would mean world debt grew something like 13% in the three years ended 2017. If so, it would be a slowdown comparable to the 2007-2014 pace McKinsey showed in the chart above—but still faster than world GDP grew in those three years. McKinsey says global debt (ex-financial) grew from $97T in 2007 to $169T in mid-2017.

Importantly, households aren’t driving this. Governments accounted for 43% of the increase McKinsey cites and nonfinancial corporate debt was 41%. That is where I think the coming train crash will originate. Governments have more debt than corporations, but also more tools (like taxing authority) to manage it.

On the other hand, governments also have massive “unfunded liabilities” that don’t show in the numbers above. So, they aren’t in a great position, either.

Bottom line: There’s going to be a train wreck here. Which train will go off which track is unclear, but something will. And we’re all going to feel it.

Woes to Come

We launched this journey in my May 11 Credit-Driven Train Crash letter. I described my friend Peter Boockvar’s perceptive statement: “We no longer have business cycles, we have credit cycles.”

His point is subtle yet critical. Post-crisis growth, mild as it’s been, has been largely a function of debt, which central banks encouraged and enabled. The result was inflated asset prices without the kind of “recovery” seen in previous business cycles. Interest rates, i.e. the cost of debt, thus became critical.

With rates now moving up again, premium asset prices are losing their raison d’etre and will stabilize and eventually fall. Peter Boockvar says this, not the conventional business cycle, is what will set off recession. That’s key. Lower asset prices won’t be the result of the next recession; they will cause that recession.

I showed in that letter how companies will need to refinance about $4T of bonds in the next year, almost all of it at higher rates. This will hit debt-burdened companies that are already struggling and make it almost impossible for some to keep operating. Lenders, i.e. high-yield bond holders, will try to exit their positions all at once only to find a severe shortage of willing buyers.

The following week in Train Crash Preview, I listed the steps in which I think the crisis will unfold. They fall in four stages.

• The Beginning of Woes: Something, possibly high-yield bonds, will set off a liquidity scramble. It will spread through the already-unstable financial system and trigger a broader credit crisis.

• Lending Drought: Rising defaults will force banks to reduce lending, depriving previously stable businesses of working capital. This will reduce earnings and economic growth. The lower growth will turn into negative growth and we will enter recession.

• Political Backlash: Concurrent with the above, employers will be automating jobs as they grow desperate to cut costs. Suffering workers—who are also voters—will force higher “safety net” spending and government debt will skyrocket. A populist backlash could lead to tax increases that prolong the recession.

• The Great Reset: As this recession unfolds, the Fed and other central banks will abandon plans to reverse QE programs. I seriously think the Federal Reserve’s balance sheet assets could approach $20 trillion later in the next decade. But it won’t work because the world simply has too much debt. They will need to find some way to rationalize or “reset” the debt. Exactly how is hard to predict but it probably won’t be good for lenders, or for the holders of government promises like pensions and healthcare.

Next in High Yield Train Wreck, we dove deeper into the dream-driven high-yield bond market exemplified by this year’s nutty $702-million WeWork issue. I quoted Grant Williams, who wrote a masterful takedown of this craziness.

Ten years into the ongoing laboratory experiment being conducted by the world’s central banks, everywhere you look there are multiple examples of the kind of lunacy those policies have fomented by reducing the cost of capital to virtually zero and forcing investors to take risks they would ordinarily avoid in order to find some kind of return.

WeWork is one example of a company for whom, in the face of rapid growth, massive negative cashflows aren’t a problem, but there are plenty of others. Uber, AirBnB, SnapChat and, of course, Tesla have all captured the imagination of investors thanks to lofty dreams, articulated by charismatic CEOs—but the day things turn around and the economy begins to weaken or, God forbid, investors seek a return on their investment as opposed to settling for rolling promises of gigantic, game-changing revenues to come, it is over.

We went on to talk about the insanity of yield-hungry investors practically throwing cash at borrowers while demanding little in return. I also showed how this is not simply a junk-rated company problem, since almost half of investment-grade companies are rated BBB and could easily slip to junk status in a downturn.

Source: On My Radar

Growing Leverage

The week after we turned to Europe in The Italian Trigger. Unfortunately, Italy isn’t Europe’s only problem. The big Kahuna is Germany, which spent years offering generous vendor financing to the rest of the continent to entice the purchase of German goods. The result: a giant trade surplus for Germany and giant, unpayable debts for those who bought German goods.

The Euro currency union is fatally flawed because it leaves each member state to set its own fiscal policy. There are good reasons for that, but it is not sustainable indefinitely. The Eurozone must get either much more centralized or fall apart. All the Rube Goldberg contraptions the ECB and others invent are temporary fixes. They’ve worked so far. They won’t work forever.

I still think the most probable scenario is that Germany and the Netherlands (and the rest of the northern European cabal) reluctantly agree to let the European Central Bank mutualize all the sovereign debt, taking onto their balance sheet and issuing new ECB-backed debt for the entire zone. There would have to be serious constraints on running deficits after that point, but it would prevent a breakup, or at least delay it for another decade or so.

Of course, within a few years those new deficit constraints would be ignored. I said in a previous letter Germany will need to collect almost 80% of GDP in 30 years in order to be able to deliver its promised healthcare and pensions. Their inability to do that will be evident much sooner. Germany will end up becoming one of the biggest problems.

The next installment, Debt Clock Ticking, was a bit philosophical. I talked about debt letting you bring the future into the present, buying things you couldn’t afford if you had to pay for them now. But the entire world went into debt for the equivalent of tropical vacations and, having now enjoyed them, realizes it must pay the bill. The resources to do so do not yet exist. So, in the time-honored tradition of lenders everywhere, we extend and pretend. But with our ability to pretend almost gone, we’re heading to the Great Reset.

Source: Moody’s Investor’s Service

Then I reviewed some of the McKinsey and IIF numbers and described the amount of leverage that’s built up in the system. Just a decade after the Great Recession, the average non-financial business went from 3.4x leverage to 4.1x. They are now roughly 20% more leveraged than they were the last time all hell broke loose. CEOs and boards seem to have learned little from the experience—or maybe learned too much. If you believe the Fed has your back, then leveraging to the moon makes sense.

Pension Problems

The last three letters in the series got personal for many readers as I talked about pension debt. In The Pension Train Has No Seat Belts, we looked at the demographic challenge facing US pension funds, mainly state and local government plans but also some private ones. We are asking a shrinking group of working-age people to support a growing number of retirees and that’s just not going to work.

Source: Peter G. Peterson Foundation

The promises employers made to workers are a kind of debt. They’re the borrowers, workers are the lenders… and unlike in 2008, this time it will be lenders who get hurt the most. A new report by the American Legislative Exchange Council (ALEC) shows the unfunded liabilities of state and local pension plans jumped $433 billion in the last year to more than $6 trillion. That is nearly $50,000 for every household in America.

Nor is this only a US problem, as we saw in Europe Has Train Wrecks, Too. According to the World Economic Forum, the United Kingdom alone has a $4-trillion retirement savings shortfall that will rise to $33 trillion by 2050. This in a country whose entire GDP is only about $2.6 trillion and doesn’t account for the increasingly likely disaster Brexit will be. Switzerland, Spain, and others have similarly dire outlooks, often driven by even worse demographics than we have in the US. Germany, as noted above, is simply off the rails.

Finally, in Unfunded Promises, we reached the ultimate debt problem: US government unfunded liabilities. On paper, Washington’s debt is about $21.2 trillion… but that doesn’t include the $13.2-trillion unfunded, off-the-books Social Security liability, or the $37-trillion Medicare unfunded liability. Those aren’t my numbers, by the way; they come from the Social Security and Medicare trustees and are probably understated. My friend, Boston University professor Larry Kotlikoff, thinks it should be more like $210 trillion. He has a considerable amount of published works and a book he co-authored with fellow Texan Scott Burns.

That’s not all. The federal government also has liabilities for civil service and military pensions, veteran benefits, some defaulted private pensions via PBGC, and open-ended guarantees to entities like FDIC, Fannie Mae, and more.

The budget outlook is horrible even without all that, too. The Congressional Budget Office thinks federal debt will be 200% of GDP by 2048, and that by 2041 it will take all federal tax revenue just to support Social Security, the various health care programs and pay interest. That’s before defense or anything else the government does. And that’s assuming relatively high growth and NO recessions and a rising stock market forever as we ride off into the sunset.

I wrapped up quoting my friend Dr. Woody Brock, who thinks the most likely outcome will be wealth taxes at federal, state, and local levels. I truly hope he’s wrong about that, but I fear he is not. My preferred new tax for the US would be a VAT that eliminates the Social Security tax (thus giving lower-income workers and businesses a raise) but still funds Social Security and healthcare. Other government expenditures would be funded from income taxes which could be reduced significantly, and even eliminated on incomes below $50,000. Now that’s a tax cut that would boost the economy and balance the budget.

There really are only two ways to solve this problem: massive taxes on someone, or a debt liquidation of some kind. And remember, if you are getting a retirement pension fund and/or healthcare, your benefits are part of that “debt liquidation.” Both will be painful. We have pulled forward our spending and must eventually pay for it. The time is coming. Please don’t shoot the messenger.

Let’s summarize. Global debt is over $225 trillion. By the beginning of the next decade it could be over $300 trillion. Global government unfunded liabilities are easily in the $100-trillion range today and could easily double by the end of the next decade. Debt service, pensions, and healthcare will take 20-25% of GDP in many countries (more in some of Europe).

Your mileage may and will vary by country. In some, there will be inflation and in others, deflation. We will be thinking the unthinkable and choosing policies that seem insane to even mention today. But then, think about what Japan is doing. And the ECB. Add in automation and the loss of hundreds of millions of jobs in the OECD countries. Then think about what will happen in the emerging economies.

But at the same time, imagine all the new companies being built and fortunes made. The opportunities. The situation, as Doug Casey once quipped, “Is hopeless, but not serious.” Not yet. Not for you and me.

Authored by John Mauldin via MauldinEconomics.com