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Broken lines, broken strings,
Broken threads, broken springs,
Broken idols, broken heads,
People sleeping in broken beds

—Bob Dylan, “Everything is Broken” from the album Oh Mercy, 1989

I was on a client call earlier this week with Steve Blumenthal. The gentleman is at that stage in life where he needs cash income and not risk. Steve commented, “The bond market is broken.”

And indeed, the traditional fixed income bond market is broken, thanks to the Fed. We were able to suggest some alternatives (they are out there) that could help solve his problem.

But it got me to thinking… What else is broken? And the more I thought, the more I realized that the data that we use every day, the very systems that we are forced to work with, are indeed in various stages of being broken.

There is a great scene in the fabulous movie The Princess Bride where the criminal “mastermind” Vizzini keeps uttering the word “inconceivable.” After the nth time, Inigo Montoya turns to him and says, “You keep using that word. I don’t think it means what you think it means.”

Today we are going to look at data from the standpoint of Inigo Montoya. I don’t think that data means what you think it means. Indeed, much of the data in the way we use it is simply broken.

(In a few weeks, I will do a letter on things that aren’t broken, which are in fact incredible. I am an optimist, but I’m also realistic. I am “long” on the human experiment. Government? Not so much…)

Our economic and financial systems are badly broken in multiple ways. Some of the cracks are enormous, maybe beyond anyone’s ability to repair. Step one is admitting they are broken.

…click on the above link to read the rest of the article…

Survival of the Biggest

December 17, 2020

Survival of the Biggest

Small Business Slaughter
Triumph of Bigness
Zombie Companies
Small Business Startups Are Increasing
Final Thoughts and Valuations

The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process… At the heart of capitalism is creative destruction.

…Situations emerge in the process of creative destruction in which many firms may have to perish that nevertheless would be able to live on vigorously and usefully if they could weather a particular storm.

—Joseph A. Schumpeter

The most important feature of an information economy, in which information is defined as surprise, is the overthrow, not the attainment, of equilibrium. The science that we have come to know as information theory establishes the supremacy of the entrepreneur because it appreciates the powerful connection between destruction and what Schumpeter described as “creative destruction,” between chaos and creativity.

—George Gilder

In its purest form, capitalism is an evolutionary process. Businesses that best adapt to changing conditions survive and grow. Typically, that means offering a product or service superior to current ones, or giving consumers more choices. Weaker or poorly managed businesses that don’t adapt to the new situation wither and eventually die. That’s not always pleasant but it’s how nature works. Joseph Schumpeter coined the term “creative destruction” to describe the process. It is not pleasant when you are on the destruction end, but the creative side can bring innumerable joys and sometimes even wealth.

The difference, however, is we don’t have capitalism in its purest form, or anywhere close. It has been tweaked, modified, corrupted and/or regulated into something else, the particulars of which vary. The common thread is that survival depends not only on impersonal nature, but on other non-random forces that can be manipulated. Governments can and often do create barriers to entry, protecting favored constituencies and groups from competition.

…click on the above link to read the rest of the article…

This Was All Predicted 10 Years Ago

December 3, 2020

This Was All Predicted 10 Years Ago

In 2010, the scientific journal Nature published a collection of opinions looking ahead 10 years, i.e., where we are right now.

Nature then published a short response from zoologist Peter Turchin in its February 2010 issue.

Quantitative historical analysis reveals that complex human societies are affected by recurrent — and predictable — waves of political instability (P. Turchin and S. A. Nefedov Secular Cycles Princeton Univ. Press; 2009). In the United States, we have stagnating or declining real wages, a growing gap between rich and poor, overproduction of young graduates with advanced degrees, and exploding public debt. These seemingly disparate social indicators are actually related to each other dynamically. They all experienced turning points during the 1970s. Historically, such developments have served as leading indicators of looming political instability.

Very long “secular cycles” interact with shorter-term processes. In the United States, 50-year instability spikes occurred around 1870, 1920 and 1970, so another could be due around 2020.

We are also entering a dip in the so-called Kondratiev wave, which traces 40- to 60-year economic-growth cycles. This could mean that future recessions will be severe.

In addition, the next decade will see a rapid growth in the number of people in their 20s, like the youth bulge that accompanied the turbulence of the 1960s and 1970s.

All these cycles look set to peak in the years around 2020.

Again, that was from 2010. Right on schedule, we are experiencing the “instability spike” Turchin says tends to come along every 50 years.

Why 50 years? It relates to the human lifespan.

Consider who was “in charge” during the period around 1970. Baby Boomers were all 25 or younger at the time. Managing the chaos fell on older generations, who remembered it well and spent the rest of their lives trying to prevent more of it.

But after 50 years or so, they are mostly gone. We who remain must learn the lesson again.

…click on the above link to read the rest of the article…

Prelude to Crisis

January 2, 2020

Prelude to Crisis

Simple Conceit
Radical Actions
Ballooning Balance Sheet
Merry Christmas and the Happiest New Year

Ignoring problems rarely solves them. You need to deal with them—not just the effects, but the underlying causes, or else they usually get worse. The older you get, the more you know that is true in almost every area of life.

In the developed world and especially the US, and even in China, our economic challenges are rapidly approaching that point. Things that would have been easily fixed a decade ago, or even five years ago, will soon be unsolvable by conventional means.

There is almost no willingness to face our top problems, specifically our rising debt. The economic challenges we face can’t continue, which is why I expect the Great Reset, a kind of worldwide do-over. It’s not the best choice but we are slowly ruling out all others.

Last week I talked about the political side of this. Our embrace of either crony capitalism or welfare statism is going to end very badly. Ideological positions have hardened to the point that compromise seems impossible.

Central bankers are politicians, in a sense, and in some ways far more powerful and dangerous than the elected ones. Some recent events provide a glimpse of where they’re taking us.

Hint: It’s nowhere good. And when you combine it with the fiscal shenanigans, it’s far worse.

Simple Conceit

Central banks weren’t always as responsibly irresponsible, as my friend Paul McCulley would say, as they are today. Walter Bagehot, one of the early editors of The Economist, wrote what came to be called Bagehot’s Dictum for central banks: As the lender of last resort, during a financial or liquidity crisis, the central bank should lend freely, at a high interest rate, on good securities.

…click on the above link to read the rest of the article…

Corporate Debt Is At Risk Of A Flash Crash

August 24, 2019

Corporate Debt Is At Risk Of A Flash Crash

The world is awash in debt.

While some countries are more indebted than others, very few are in good shape.

The entire world is roughly 225% leveraged to its economic output. Emerging markets are a bit less and advanced economies a little more.

But regardless, everyone’s “real” debt is likely much bigger, since the official totals miss a lot of unfunded liabilities and other obligations.

Debt is an asset owned by the lender. It has a price, which—like anything else—can go up or down. The main variable is the lender’s confidence in repayment, which is always uncertain.

But there are degrees of uncertainty. That’s why (perceived) riskier debt has higher interest rates than (perceived) safer debt. The way to win is to have better insight into the borrower’s ability to repay those loans.

If a lender owns debt in which his confidence is low, but you believe has value, you can probably buy it cheaply. If you’re right, you’ll make a profit—possibly a big one.

That is exactly what happens in a recession.

Investment-Grade Zombies

While it’s easy to point fingers at profligate consumers, households largely spent the last decade reducing their debt.

The bigger expansion has been in government and business. Let’s zoom in on corporate debt.

The US investment-grade bond universe is considerably more leveraged than it was ahead of the last recession:

Compared to earnings, US bond issuers are about 50% more leveraged now than in 2007. In other words, they’ve grown debt faster than profits.

Many borrowed cash not to grow the business, but to buy back shares. It’s been, as my friend David Rosenberg calls it, a giant debt-for-equity swap.

…click on the above link to read the rest of the article…

The Problem With Keynesian Economics

July 19, 2019

The Problem With Keynesian Economics

In The General Theory of Employment, Interest and Money, John Maynard Keynes wrote:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

I think Lord Keynes himself would appreciate the irony that he has become the defunct economist under whose influence the academic and bureaucratic classes now toil, slaves to what has become as much a religious belief system as an economic theory.

Men and women who display appropriate skepticism on other topics indiscriminately funnel facts and data through a Keynesian filter without ever questioning the basic assumptions. Some go on to prescribe government policies that have profound effects upon the citizens of their nations.

And when those policies create the conditions that engender the income inequality they so righteously oppose, they often prescribe more of the same bad medicine. Like 18^th-century physicians applying leeches to their patients, they take comfort that all right-minded people will concur with their recommended treatments.

This is an ongoing series of a discussion between Ray Dalio and myself (read Part 1, Part 2, Part 3, and Part 4) . Today’s article addresses the philosophical problem he is trying to address: income and wealth inequality.

Last week I dealt with the equally significant problem of growing debt in the United States and the rest of the world. The Keynesian tools much of the economic establishment wants to use are exacerbating the problems. Ray would like to solve it with a blend of monetary and fiscal policy, what he calls Monetary Policy 3.

The Problem with Keynesianism

…click on the above link to read the rest of the article…

Japanified World Ahead

April 17, 2019

Japanified World Ahead

Losing Decades
Too Much, Too Fast
A $10 Trillion Federal Reserve Balance Sheet
Mastering Private Markets
Living on Puerto Rico Time

Regular readers may have noticed me slowly losing confidence in the economy. Your impression is correct and there’s a good reason for it, as I will explain today. The facts have changed so my conclusions are changing, too.

I still think the economy is okay for now. I still see recession odds rising considerably in 2020. Maybe it will get pushed back another year or two, but at some point this growth phase will end, either in recession or an extended flat period (even flatter than the last decade, which says a lot). And I still think we are headed toward a global credit crisis I’ve dubbed The Great Reset.

What’s evolved is my judgment on the coming slowdown’s severity and duration. I think the rest of the world will enter a period something like Japan endured following 1990, and is still grappling with today. It won’t be the end of the world; Japan is still there, but the little growth it’s had was due mainly to exports. That won’t work when every major economy is in the same position.

Describing this decline as “Japanification” may be unfair to Japan but it’s the best paradigm we have. The good news is it will spread slowly. The bad news is it will end slowly, too.

I believe we will avoid literal blood in the streets but it will be a challenging time. We’ll be discussing how to get through it more specifically at the Strategic Investment Conference next month. It is now sold out but you can still buy a Virtual Pass that includes audio and video of almost the whole event. Click here for information.

Losing Decades

…click on the above link to read the rest of the article…

Brexit, EU, Germany, China and Yellow Vests In 2019 – Something Wicked This Way Comes

January 21, 2019

Brexit, EU, Germany, China and Yellow Vests In 2019 – Something Wicked This Way Comes

– “Something wicked this way comes” warns John Mauldin
– Shaky China: Chinese landing could be harder than expected
– Brexit and EU Breakage: “I have long thought the EU will eventually fall apart”
– Helpless Europe: If Germany sneezes, their banks & the rest of continent catches cold
– We may see “yellow vests” spread globally: Economics is about to get interesting …

Source: TradingEconomics.com

For a couple of years now, the economic narrative has shown a comparatively strong US against weakness in Europe and some of Asia (NOT China). The US, we are told, will stay on top. I agree with that, as far as it goes… but I’m not convinced the “top” will be so great.

Americans like to think we are insulated from the world. We have big oceans on either side of us. Geopolitically, they serve as buffers. But economically they connect us to other important markets that are critical to many US businesses. Problems in those markets are ultimately problems for the US, too.

Last week I gave you my Year of Living Dangerously 2019 US forecast, but I didn’t discuss important events overseas. Summarizing last week quickly, I think the base case is that the United States economy slows down but avoids recession in 2019. That said, there are significant risks to that forecast, mostly to the downside.

Today we’ll make another literary metaphor to frame our discussion. “Something Wicked This Way Comes” is a 1962 Ray Bradbury novel about two boys and their horrifying encounter with a travelling circus. Later it was a movie.

In our case, something wicked most certainly is coming this way. Several somethings, in fact, approaching from all directions. The real question is how much damage this circus will do before it leaves town.

Shaky China

…click on the above link to read the rest of the article…

Bear Markets, Fed Mistakes, and Quick Shots from John

January 4, 2019

Bear Markets, Fed Mistakes, and Quick Shots from John

Powell Was Right but the Fed Is Wrong
Time for an Emergency Fed Meeting
Living on Island Time
Quick Shots from the Frontline

A winters day,
In a deep and dark December…

“Wait, it doesn’t feel like winter. It’s not deep and dark, and it’s actually warm, and the sun is shining. ~~Toto~~Shane, I don’t think we’re in ~~Kansas~~ Texas anymore.”

Yes, we have actually moved from Texas to a new location. I’ll explain why and where below. But first, we really do have to follow up last week’s letter. Today, we’ll address several things, so think of this as my year-end “Quick Shots from the Frontline.” It will be more like a personal, from the heart, fireside chat. (Trigger warning: I will be taking off my politically correct gloves. Naming names and pointing fingers. Just Uncle John telling it like it is.)

This letter may run a little longer, but next week I promise to get back to the typical 3,000 or so words. Today is just you and I having a conversation. Pick up your favorite beverage (for me, it’s a glass of coffee or tea now), sit back, and let’s chew on the world.

Powell Was Right but the Fed Is Wrong

Last week. I argued Jerome Powell did the right thing by raising rates a mere 25 basis points. He forcefully declared the Fed’s independence from the market and politicians for the first time since Volcker. Greenspan, Bernanke, and, in particular, Yellen all gave the markets a “put” option—basically a third unofficial mandate to make sure that asset prices keep rising. Now, of course, that’s not the way they would express it, but that is, in fact, what they did.

…click on the above link to read the rest of the article…

A Worldwide Debt Default Is A Real Possibility

November 14, 2018

A Worldwide Debt Default Is A Real Possibility

Getty

Is debt good or bad? The answer is “Yes.”

Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash yet.

Whether it’s wise or not depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.

The problem is that many people, businesses, and governments borrow because they can. It’s been possible in the last decade only because central banks made it so cheap.

It was rational in that respect. But it is growing less so as the central banks start to tighten.

Earlier this year, I wrote a series of articles (synopsis and links here) predicting a debt “train wreck” and eventual liquidation. I dubbed it “The Great Reset.” I estimated we have another year or two before the crisis becomes evident.

Now I’m having second thoughts. Recent events tell me the reckoning could be closer than I thought just a few months ago.

Debt Doesn’t Fuel Growth Anymore

Central banks enable debt because they think it will generate economic growth. Sometimes it does. The problem is they create debt with little regard for how it will be used.

That’s how we get artificial booms and subsequent busts. We are told not to worry about absolute debt levels so long as the economy is growing in line with them.

That makes sense. A country with a larger GDP can carry more debt. But that is increasingly not what is happening.

Let me give you two data points.

…click on the above link to read the rest of the article…

Debt Alarm Ringing

October 31, 2018

Debt Alarm Ringing

Addicted to Debt
Lost Exorbitant Privilege
Trigger Points
Frankfurt, Cleveland, Golf, and Here and There

Is debt good or bad? The answer is “Yes.”

Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash available yet. Whether it’s wise or not depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.

Unfortunately, many people, businesses, and governments borrow because they can, which for many is possible only because central banks made it so cheap in the last decade. It was rational in that respect but is growing less so as the central banks tighten their policies.

Earlier this year, I wrote a series of articles (synopsis and links here) predicting a debt “train wreck” and eventual liquidation—an event I dubbed The Great Reset. I estimated we have another year or two before the crisis becomes evident.

That’s still my expectation… but I’m beginning to wonder again. Several recent events tell me the reckoning could be closer than I thought just a few months ago. Today, we’ll review those and end with a few suggestions on how to prepare.

Addicted to Debt

As noted, debt can be appropriate—even government debt, in some (rare) circumstances. I am glad FDR issued war bonds to help defeat the Nazis, for instance. Now, however, governments go into debt not because they face existential threats, but simply to keep their citizens and benefactors comfortable.

Similarly, central banks enable debt because they think it will generate economic growth. Sometimes it does, too. The problem is they create debt with little regard for how it will be used. That’s how we get artificial booms and subsequent busts.

…click on the above link to read the rest of the article…

China for the Trade Win?

October 3, 2018

China for the Trade Win?

Empire of Debt
Debt in Pictures
Wargaming the Trade War
Some Thoughts on Getting Through the Great Debt Reset
San Francisco, Frankfurt, and Puerto Rico?

With all the trade war talk, we all ask the obvious question: Who will win? President Trump says the US will win. Chinese business leaders say no, we will win. Free-traders on both sides say no one will win. Few stop to ask, “What does a ‘win’ look like?”

This makes discussion difficult. People are chasing after a condition they can’t even define. Victory will remain elusive until they know what they want. Regardless, you can score me on the “no one wins” side. I believe, and I think a lot of evidence proves, that free trade between nations is the best way to maximize long-run prosperity for everyone.

However…

As Keynes famously said, we’re all dead in the long run. Trade war may end with no winners, but the parties will be better and worse off at various times as it progresses. So we have to distinguish between “winning” and “holding a temporary lead.”

On that basis, I think the US will have the upper hand initially, and could hold it for a year or two. This is because, for now, our economy is relatively strong and we can better withstand any Chinese retaliation. Beyond that point I think our current policies will begin to backfire, maybe spectacularly.

Remember, too, China has growing trade surpluses with much of the world. One Chinese insider told me that within four years China can replace lost US exports via increased trading with the rest of the world. I can’t verify that but looking at general statistics it certainly seems plausible. That doesn’t mean lost US trade won’t be felt, but China is not entirely helpless.

…click on the above link to read the rest of the article…

These Four Predicted The Global Financial Crisis; Here’s What They Think Causes The Next One

September 16, 2018

These Four Predicted The Global Financial Crisis; Here’s What They Think Causes The Next One

A different kind of hurricane slammed into the American East coast, the nation and ultimately the world ten years ago today.

Amidst the multiple introspective columns and soul searching that naturally occurred this week, which looked back on the missed warning signs behind the 2008 financial collapse exactly a decade ago this weekend, there is a small group of people whose opinions are actually worth paying attention to.

Though arguably no single individual accurately called all aspects of the crisis in its entirety, precipitated by the implosion of Lehman Brothers, some did very publicly predict key facets with prophetic clarity. As Market Watch’s Howard Gold explains in his profile of four analysts the world should have been listening to: “People warned about subprime mortgage loans, derivatives, and too much leverage, but nobody, to my knowledge, said a bursting housing bubble would cause a global crisis that would lead to the demise of venerable financial firms, require trillion-dollar taxpayer bailouts, and cause a recession that rivaled only the Great Depression in its magnitude.”

Trouble is like many religious prophets of ancient history, they were rejected at the time, cast as dour harbingers of gloom and doom.

*Clockwise from upper left: Gary Shilling, Jim Stack, Raghuram Rajan and John Mauldin. Via MarketWatch*

Here are four names and their very public warnings that attempted to jolt the financial and banking sectors out of their sleepy stroll toward the abyss before 2008, as well as their predictions for the next big one, and what to look out for.

Howard Gold interviewed each, and laid out the key quotes summarizing then and now…

…click on the above link to read the rest of the article…

“This Will Be The Mother Of All Minsky Moments”

September 12, 2018

“This Will Be The Mother Of All Minsky Moments”

We have all had the fun as kids of going to the beach and playing in the sand. Remember taking your plastic bucket and making sandpiles? Slowly pouring the sand into ever bigger piles, until one side of the pile starts to collapse?

In his very important book Ubiquity, Why Catastrophes Happen, Mark Buchamane wrote about an experiment with sand that three physicists named Per Bak, Chao Tang, and Kurt Wiesenfeld conducted in 1987.

In their lab at Brookhaven National Laboratory in New York, they started building sandpiles, piling up one grain of sand at a time. It’s a slow process, so they wrote a computer program to do it. Not as much fun but a whole lot faster.

During this experiment, they learned some interesting things that can help us understand how all sorts of calamities, including market crashes, unfold.

Critical State

What is the typical size of an avalanche? After a huge number of tests with millions of grains of sand, they found out there is no typical number:

Some involved a single grain; others, ten, a hundred, or a thousand. Still others were pile-wide cataclysms involving millions that brought nearly the whole mountain down. At any time, literally anything, it seemed, might be just about to occur.

The pile was completely chaotic in its unpredictability.

Now, let’s read this next paragraph. It is important, as it creates a mental image that helps us understand the organization of the financial markets and the world economy. (emphasis mine)

To find out why [such unpredictability] should show up in their sandpile game, Bak and colleagues next played a trick with their computer. Imagine peering down on the pile from above and coloring it in according to its steepness.

…click on the above link to read the rest of the article…

The Debt Train Will Crash

July 16, 2018

The Debt Train Will Crash

Off the Tracks
Woes to Come
Growing Leverage
Pension Problems

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.

Before we go on, let me give a quick plug for Over My Shoulder. We rejuvenated this service a few months ago and it’s working even better than expected. Having Patrick Watson co-edit with me has been a big help. We’ve worked together, on and off, for 30 years now so he knows how I think. Between us, we have sent subscribers tons of fascinating economic analysis from my best sources—most of which you would never see otherwise. You get both the original item and our quick-read summary.

At just $9.95/month, Over My Shoulder may be the best financial research bargain out there, if I do say so myself. Click here to learn how you can join us.

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.

…click on the above link to read the rest of the article…

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