David Stockman: Debt is Third Ben Franklin ‘Certainty’

Andy’s Notes: Agree with Stockman 110%. We might ask Jamie Dimon if he’s ever heard of Ben Franklin. People might ask why we are harping on consumer debt lately, especially when the bulk of the work over the last decade and change has been dedicated to consumers and their plight. Certainly the consumer debt situation is much closer to the tipping point than it was a decade ago. We would argue the tipping point has already been passed and that is why we are now hearing so much about consumers and their debt problems – even in the mainstream press. After all, it is the typical M.O of the press not to acknowledge a crisis exists until it is totally out of control. For those who have forgotten, we refer you back to 2006 and the non-existent housing bubble..

Benjamin Franklin supposedly said, “In this world nothing can be said to be certain, except death and taxes.”

If old Ben were still around he would surely add “debt” to his famous saying. Indeed, a recent Experian study of its 220 million consumer files actually proves the case.

It turns out that 73% of consumers who died last year had debts which averaged nearly $62,000. In addition to the kind of debt that apparently always stays with you — credit cards and car loans — it also happened that 37% of the newly deceased had unpaid mortgages and 6% still had student loans with an average unpaid balance of $25,391!

Something strange is going on in the financial system. And according to The Wall Street Journal, it’s causing some investors to move massive amounts of money out of the banking system.

Once upon a time people used to have mortgage burning ceremonies when later in their working years the balance on the one-time loan they took out in their 30s to buy their castle was finally reduced to zero.

And there was no such thing as student loans, and not only because students are inherently not credit worthy. College was paid for with family savings, summer jobs, work study and an austere life of four to a dorm room.

No more. The essence of debt in the present era is that it is perpetually increased and rolled-over. It’s never reduced and paid-off.

To be sure, much of mainstream opinion considers that reality unremarkable — even evidence of economic progress and enlightenment. Keynesians, Washington politicians and Wall Street gamblers would have it no other way because their entire modus operandi is based not just on ever more debt, but more importantly, on ever higher leverage.

The chart below not only proves the latter point, but documents that over the last four decades rising leverage has been insinuated into every nook and cranny of the U.S. economy.

Nominal GDP (dark blue) grew by 6X from $3 trillion to $18 trillion, whereas total credit outstanding (light blue) soared by 13X from $5 trillion to $64 trillion.

Consequently, the national leverage ratio rose from 1.5X in 1980 to 3.5X today.

My point today is not to moralize, but to discuss the practical implications of the nation’s debt-topia for Ben Franklin’s other two certainties — death and (especially) taxes.

There’s no doubt that the modus operandi of the American economy has been transformed by the trends displayed in the below chart.

It so happened that the 1.5X ratio of total debt-to-income (GDP) at the beginning of the chart was not an aberration. It had actually been a constant for 100 years — except for a couple of unusual years during the Great Depression.

It was also linked with the greatest period of capitalist prosperity, economic growth and rising living standards in recorded history.

By contrast, today’s 3.5X debt-to-income ratio has two clear implications.

  • First, the nation effectively performed a leveraged buyout (LBO) on itself during the last forty years. And that did temporarily add to the appearance of prosperity.
  • But it also means that the U.S. economy is now lugging two turns of extra debt compared to the historic norm. Mainstream opinion, of course, says “so what?”

The U.S. economy is lugging $35 trillion of extra debt, that’s what.

That’s right. In the absence of the 40-year leverage aberration since the late 1970s, the chart below would show about $29 trillion of credit market debt (public and private) outstanding, not $64 trillion.

Make no mistake, $35 trillion of extra debt make a very practical and very large difference.

The soaring leverage ratio of recent years came at a heavy price — and one which Keynesians and their camp followers simply refuse to acknowledge:

America’s 40-year LBO didn’t create permanent incremental growth. It just stole it from the future.

Today’s added leverage and the incremental spending it currently finances eventually become tomorrow’s higher debt service cost and reduced spending. In fact, the latter is already occurring. And that’s the reason I call the chart below “The Great Inverse.”


The trend level of real GDP growth captured by the gray bars has been heading south since the early 1970s. And during the last 10 years it’s averaged only 1.2% annually, or just one-third of the 3.8% average recorded during the American heyday (1953-1971).

This stunning deterioration occurred precisely as the national LBO hit full stride (red line), rising from the historic 1.5X to the current 3.5X.

Ultimately, all this debt and financial suppression is the enemy of investment and productivity.

It encourages massive financial engineering in the form of stock buybacks and merger and acquisition (M&A) deals. This diverts economic resources from productive investment on main street to leveraged speculation in existing financial assets on Wall Street.

The retail sector, for example, was the site of massive borrowings to fund share buybacks and LBOs — until Amazon knocked over the house of cards, causing what I call Retail Armageddon. The retail sector will see upwards of 30,000 store closures over 2016-2018 alone.

We’ve also seen massive debt envelop the auto sector, which is nearly $3 trillion. This is a sector that bears very close watching, as I believe it’s ready to implode any day now.

In short, the sum of business sector debt stood at $8.7 trillion on the eve of the great financial crisis. It now stands at $13.2 trillion. And that $4.5 trillion gain was not pumped into productive investments on main street.

The Fed’s reckless money printing is grinding down the U.S. economy’s growth with rising debt and higher leverage ratios — exactly the kind of causation that lies behind the Great Inverse chart.

And that gets us to death and taxes…

A surprisingly high share of today’s soaring medical costs are designed to ward off the former. But the overwhelming share of households have no savings or remaining debt capacity.

So they demand government help with their medical bills and sooner or latter we end up with Medicare, Medicaid,  tax subsidized employer plans ($200 billion per year) and Obamacare.

During the next decade, for example, upwards of $25 trillion or nearly 63% of personal health care costs will be financed by the programs listed above (including the state share of Medicaid).

Needless to say, that’s why government funded health care has become the true third rail of American politics.

The entire population has been driven into government financed or subsidized health insurance. And as these policies became increasingly socialist (i.e. based on community ratings and homogenized rather than risk-differentiated premiums), the whole system becomes more inefficient and costly.

But capitalism doesn’t work if you have no economic prices and no real consumers. What you get instead is price-insensitive patients and organized provider cartels, which attempt to maximize their incomes by lobbying public and private insurance payors.

The solution of government insurance then becomes the driving force of endlessly escalating government budgets.

There is not a snowballs chance in the hot place the system will be reformed any time soon because the baby boom gave itself an LBO. That is, 73% of the population going into its “final expenses” with $62,000 of debt.

In short, the national LBO of 1980-2017 has saddled the nation with a giant Welfare State (health care and retirement pensions) because the bottom 90% of the population has no material savings.

And financing that mushrooming Welfare State will mean, in turn, higher taxes and more public debt as far as the eye can see.

When you look at the Great Inverse chart above it becomes fairly obvious that even more debt and taxes will result in even lower economic growth. That will only necessitate even higher taxes and debt to pay for the Welfare State.

Benjamin Franklin also famously said at the end of the Constitutional Convention, “gentleman you have a Republic, if you can keep it.”

If he had known about today’s trifecta of death, taxes and debt, he might not have pronounced so boldly.

UK Banks Ordered to Hold More Reserves as Consumer Debt Surges

Andy’s Notes: We’ve been saying for over a decade now how the US isn’t the only country in the world with consumer debt problems. One of our closest allies is right there with us. Part of this is due to inflation that has resulted from the shelling of the Pound after BREXIT last year (The UK is a net importer as well), but a look at longer trends shows BREXIT isn’t the only contributor.

The Bank of England is to force banks to hold more capital in the face of rapid growth in lending on credit cards, car finance and personal loans.

The intervention by Threadneedle Street, which could amount to banks needing £11.4bn of extra capital in the next 18 months, is one of a number of measures intended to protect the financial system from the fast pace of growth in consumer finance.

In addition to increasing the capital requirements, the Bank said it was bringing forward the part of the annual stress tests on banks which scrutinises their exposure to consumer credit. This will now take place three months earlier, in September.

The Bank of England’s Prudential Regulation Authority and the City regulator, the Financial Conduct Authority, will also publish next month how they expect lenders to treat borrowers in the rapidly growing market.

The measures were announced in the Bank’s half-yearly assessment of risk to financial markets which also set out measures to rein in mortgage lending and highlighted the risks associated with the UK’s exit from the European Union.

While the Bank found risks to financial stability were neither “particularly elevated nor subdued” it warned that there “pockets of risk that warrant vigilance”.

“Consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier. Lenders may be placing undue weight on the recent performance of loans in benign conditions,” the Bank said in the financial stability report.

All components of consumer credit have been growing faster than the rate of growth of the economy, at more than 10%. Within that car finance has been rising 15%, credit cards 9% and personal lending 7%.

In March, the Bank highlighted consumer credit as a greater risk than buy-to-let mortgages. At the time, it said that last year banks had £19bn of impairments on credit cards, compared with £12bn on mortgage loans. It said it was launching a review into the credit quality of new lending – underwriting standards and the risk models used by banks – and said it would scrutinise these findings over the coming months.

The City regulator, the Financial Conduct Authority, has announced a raft of measures to help people in credit card debt, including waiving or cancelling interest and charges if customers cannot afford to curb their liabilities through a repayment plan.

Goldman Sachs ‘Discovers’ that the ‘not-so-USFed’ has Caused Most Recessions

Andy’s Notes: Unreal. Other than the fact that the author clearly doesn’t understand that the action of the ‘Fed’ shrinking its balance sheet is deflationary in nature, this is unbelievable. To sum it all up – The not-so-USFed is owned by private banks and is one itself. Goldman Sachs is a major shareholder in the ‘Fed’. So Goldman is ‘investigating’ it’s own subsidiary basically, then pointing out something that anyone with two brain cells to rub together has known for a long time. This belongs in The Onion as well. 32 quarters of ‘growth’. But the recession never ended by many metrics. What you’ve got here is an expansion put on the VISA card of the G20. It’s been borrowed. Best case scenario, the United States has borrowed $4 for every $1 of growth. When you figure in generational accounting and unfunded liabilities, then we are borrowing around $17 for $1 of growth. No wonder most rational analysts have had migraines for the last decade.

One week ago, Deutsche Bank issued a loud warning that as a result of the aging of the current economic expansion, now the third longest in history at 32 quarters, if with the lowest average growth rate of just 2%…

…. coupled with the collapse in the yield curve…

… and the risk that the Fed could fall behind the inflationary curve as a result of near record low unemployment (assuming the Phillips urve still works which it doesn’t)…

… the risk is growing that the Fed could hike rates right into a recession that it itself causes:

… which makes sense: recall BofA’s chart from earlier this year which showed that every tightening episode usually ends with a financial “event.”

Overnight, it was Goldman’ turn to scare its clients with an extended analysis of when and under what conditions the next recession could strike, and as Hatzius and co write in “s economic team write in The Next Recession: Lessons from History, “with the current expansion already the third longest in US history, investors have begun to look ahead to the next recession. We ask how likely the next recession is to come soon and where it is likely to come from….

While some frequent contributors to postwar recessions such as oil shocks look less threatening today, others such as declines in financial asset prices, sentiment-driven investment swings, and too-rapid tightening of monetary policy retain their relevance as recession risks. Combining lessons from this historical investigation, our cross-country recession model, and both our own research and academic research on US-specific leading indicators, we then develop a recession risk dashboard. The dashboard reinforces our view that recession risk remains only moderate.

While the answer to the first part remains elusive, and to Goldman it is still relatively low, the answer for the second part is clear: in the post WW2, virtually every recession (and depression) was caused by the Fed.

Goldman starts with a historical overview of the causes of recessions. Looking at 33 US recessions since the 1850s, it finds that while many pre-WW2 recessions originated in the financial sector, most post-WW2 recessions were caused by monetary policy tightening and oil shocks and, and sentiment-driven swings in borrowing and investment led to recessions in both eras. A similar IMF study of the key contributors to 122 advanced economy recessions shows that even before 2008, financial crises were a fairly common source of modern recessions too.

Here is what Goldman found:

A Historical Look at the Causes of Recessions

A starting point in understanding past recessions is to simply look at the contributions of the various components of GDP during prior downturns. Exhibit 1 shows the cumulative growth contributions over all quarters included in the NBER-defined recessions since the introduction of the national accounts. The main lesson is a familiar one: while consumption has declined more often than not in recessions, investment spending—including inventories, business fixed investment, and housing—has accounted for the largest contributions to declines in output. This same stylized fact holds for a broad international sample of advanced economy recession.

Exhibit 1: Investment Usually Dominates Output Declines During Recessions

We turn next to classifying the most important causes of prior downturns to create a taxonomy of recessions. To expand our sample, we study all prior US recessions as defined by an NBER database that includes 33 business cycles back to 1854, shown in Exhibit 2. Of the 33, 21 occurred before World War 2, when the US economy was much more frequently in recession, and 12 have occurred since.

Exhibit 2: The US Economy Has Spent Much Less Time in Recession Since WW2

Relying on several historical sources, we identify the key contributors to each recession. Exhibit 3 summarizes our findings. We draw four lessons.

  1. First, the most frequent contributors to modern recessions have been monetary policy tightening and oil price shocks, with the former in response to inflation that often gained momentum from the latter.
  2. Second, sentiment-driven swings between over-borrowing and heavy investment followed by deleveraging and investment cutbacks contributed to the two most recent recessions and also played a role in early recessions, especially during boom-and-bust cycles of railroad investment.
  3. Third, while the financial sector has not been the origin of as many modern US recessions, it was a very frequent source of early US recessions.
  4. Fourth, fiscal policy shocks have sparked US recessions, but only in the context of demobilizations from major wars.

Exhibit 3: Major Contributors to Early and Modern US Recessions

With all that in mind, what does Goldman’s model say about probability of recession today? According to the bank’s preferred tool for answering this question, its cross-country recession model shown in Exhibit 7, while recession risk has risen, primarily due to the decline in spare capacity in the US economy. recession risk remains only moderate at about 13% on a 1-year horizon (compared to an unconditional probability of 23% since 1980) and 24% on a 2-year horizon (compared to an unconditional probability of 34%). 

Exhibit 7: US Recession Risk Has Risen, but Remains Only Moderate

Of course, if Goldman is right, the current expansion, already the third longest, will surpass the 1961-1969 expansion as the second longest in history, and take aim at the 1991-2001, the last real economic cycle the US had before the Fed started inflating bubbles to “deal” with the consequences of previous burst bubbles.

Goldman’s conclusion:

Both our cross-country recession model and our US recession risk dashboard suggest that near-term recession risk remains only moderate. But when the next recession does come, where will it come from? Our historical analysis offers three main lessons.  

  • First, the dominant cause of postwar US recessions—monetary policy tightening in response to high inflation often boosted by oil shocks—looks much less threatening in a world with well-anchored inflation expectations and shale-imposed limits on oil prices.
  • Second, this does not mean that over-tightening is not a risk; tightening cycles in the late 1950s were quite tame, but nonetheless ended in recession.
  • Third, the more timeless drivers of the business cycle—the sentiment-driven swings in both financial asset prices and borrowing and investment that are often attributed to “animal spirits”—retain their relevance as recession risks.

So while the Fed clearly has been the driver behind most modern recessions, the irony will be if the US economy is already contracting – as commercial loan data suggest – just as the Fed not only tightens but begins to shrink its balance sheet, a combination that would resut in such a massive expansion in the Fed’s reserves (as QE4, 5 and so on are unleashed) some time in 2018, it will make everyone’s head spin.

Andy Weighs in on Liberty Talk Radio

Andy’s Notes: I had a chance to sneak on for most of the show and talk about the latest nonsense in the world of economic insanity. Being on LTR is always a good time and this was no different. I appreciate Joe’s willingness to continue having me on as I’m able. As you can see from the title below, we talked about bubbles, consumers, what a healthy consumer looks like, and all sorts of topics in between.

Americans Dying an Average of $61,500 in Debt

Andy’s Notes: Look for changes in estate law in the coming years to ensure that these debts aren’t washed away by death, but are passed along to the survivors.

According to a recent study, the average total household debt in America is just over $132,500, broken down as per the chart below…

… and thanks to the Fed’s recent and ongoing rate increases, the repayment of said debt will become increasingly more difficult. So difficult, in fact, that most Americans will be saddled with a sizable chunk of it at the time of their death.

Actually, most already are.

According to December 2016 data from credit bureau Experian provided to credit.com, 73% of American consumers had outstanding debt when they were reported as dead. Those consumers carried an average total balance of $61,554, including mortgage debt. Without home loans, the average balance was $12,875.

As credit.com reports, the data is based on Experian’s FileOne database, which includes 220 million consumers. (There are about 242 million adults in the U.S., according to 2015 estimates from the Census Bureau.) To determine the average debt people have when they die, Experian looked at consumers who, as of October 2016, were not deceased, but then showed as deceased as of December 2016.

Among the 73% of consumers who had debt when they died, about 68% had credit card balances. The next most common kind of debt was mortgage debt (37%), followed by auto loans (25%), personal loans (12%) and student loans (6%).

The breakdown of unpaid balances was as follows: credit cards, $4,531; auto loans, $17,111; personal loans, $14,793; and student loans, $25,391. And, as a reminder, debt doesn’t just disappear when someone dies.

What happens to that debt when you die, aside from it continuing to accrue interest until someone remembers to inform the creditors?

“Debt belongs to the deceased person or that person’s estate,” said Darra L. Rayndon, an estate planning attorney with Clark Hill in Scottsdale, Arizona. If someone has enough assets to cover their debts, the creditors get paid, and beneficiaries receive whatever remains. But if there aren’t enough assets to satisfy debts, creditors lose out (they may get some, but not all, of what they’re owed). Family members do not then become responsible for the debt, as some people worry they might.

That’s the general idea, but things are not always that straightforward. The type of debt you have, where you live and the value of your estate significantly affects the complexity of the situation. For example, federal student loan debt is eligible for cancellation upon a borrower’s death, but private student loan companies tend not to offer the same benefit. They can go after the borrower’s estate for payment.

To be sure, things can get messy. If your only asset is a home other people live in, that asset must be used to satisfy debts, whether it’s the mortgage on that home or a lot of credit card debt, meaning the people who live there may have to take over the mortgage, or your family may need to sell the home in order to pay creditors. Accounts with co-signers or co-applicants can also result in the debt falling on someone else’s shoulders. Community property states, where spouses share ownership of property, also handle debts acquired during a marriage a little differently.

“It’s one thing if the beneficiaries are relatives that don’t need your money, but if your beneficiaries are a surviving spouse, minor children — people like that who depend on you for their welfare, then life insurance is a great way to provide additional money in the estate to pay debts,” Rayndon said.

The best option, of course, is just to pay it all off while one is alive, however in a nation with over $15 trillion in household debt, that is increasingly unlikely. And, if the Fed normalizes rates as it promises, which for some odd reason means interest on savings accounts doesn’t budge even as the interest due on debt ticks up with ever move of the Fed Funds rate, it means that the only possible debt discharge for tens of millions of Americans, will increasingly be the most terminal one too.

It remains unclear if debt incurred in this life carries over into the next one.

Forget the Stock Market, Pay Attention to This

Graham’s Musings: This is one of those tidbits that occasionally makes the paper/news/etc. It’s the true state of affairs.. Read it and weep o’ misled kings of Keynesianism.

You can take this to the bank: Americans are messed up about money.

A slew of new surveys and data have come out revealing that we don’t save enough, we spend money we don’t have, we have our financial priorities backwards — and more. Here are five new stats that prove Americans are backwards about money.

  1. About 1 in 4 literally have no emergency savings. A survey released Tuesday by Bankrate.com found that 24% don’t have even a single dollar saved for an emergency. And that’s just one of many surveys showing how little we have saved: A survey released in January by Bankrate found that nearly 60% of Americans wouldn’t have enough savings to pay for a $500 expense if it came up unexpectedly. What’s more, more than one in five say they’d slap down their credit card to pay that expense and more than one in would mooch off family to get the cash. Experts recommend that Americans have a least three to six months of income in the bank to pay for unexpected emergencies.
  2. We are more worried about paying for our next vacation than about saving enough for retirement. That’s the finding of a study released this week by COUNTRY Financial, in which Americans report being more concerned about affording that vaca vacations (36%) than having adequate retirement savings (32%). That may explain, in part, why more than half of Americans will be broke when we retire, according to a survey from GoBankingRates.com.
  3. Millions of us hide money from our spouses and partners. An estimated 12 million Americans confess they have kept a source of money secret from their romantic partners, according to CreditCards.com. That’s typically not smart, experts say: “Any time you get into these kinds of things where you are operating behind the scenes, it usually comes out at some point,” Corey Allan, a marriage and family therapist told Credit Cards.com. “We can’t keep things hidden, especially in today’s technological world. Any spouse who has any kind of suspicion can become a detective and find it.”
  4. We prioritize paying the wrong bills first. When we can’t pay all our bills, we make bad choices about which to pay. “Consumers in financial distress tend to prioritize unsecured personal loans ahead of other credit products such as auto loans, mortgages and credit cards,” according to a study of roughly two million consumers who had all four types of debt out this week from credit monitoring service TransUnion. But experts say that’s a backwards way to handle these bills.
  5. We’ve racked up $1 trillion in credit card debt — and that’s just a fraction of what we owe. That’s according to data released this year from the Federal Reserve, which found that U.S. consumers owe $1.0004 trillion on their cards, up 6.2% from a year ago; this is the highest amount owed since January 2009. What’s more, this isn’t the only consumer debt to top $1 trillion. We now also owe more than $1 trillion for our cars, and for our student loans, the data showed.This story was originally published in May and has been updated.

Censorship or Glitches?

Andy’s Notes: Posted with a half grimace as we’ve had numerous attacks on this site over the past 6 months as many of you know. The cynical side says censorship. Glitches would be a coincidence and I don’t believe in coincidences.

In the past few days several readers have told me via emails that they experienced some censorship in relation to my website. With regard to the guest contributions of May 12, several readers in Europe said they were not allowed to tweet the article on the digital revolution and Engdahl’s article on controlling the food supply.

Another reader sent me this report of his attempt to access my website via Firefox:

I got a warning message, with the following text: “Your connection is not secure The owner of www.paulcraigroberts.org has configured their website improperly. To protect your information from being stolen, Firefox has not connected to this website. Learn more… Report errors like this to help Mozilla identify and block malicious sites.”

I just now used Firefox to access my website, and experienced no problem.

The digital world is full of glitches, which is why I doubt driverless cars will be successful. These reports might all be the result of glitches.

However, please do inform me if you experience difficulties accessing the website or using social media to spread the word.

As the world is presently goverened, controlling the explanations is of the utmost importance to the ruling elites.

It will be interesting to see if the ruling elites require Twitter to block President Trump.

The Most Disturbing Thing Central Banks Are Doing Right Now

Andy’s Notes: The ‘Fed’ has no right to even exist let alone buy, sell, or conduct any other activity for that matter. It might be good for writers to consider that reality before going off on what this or that illegal strategy might do to your personal finances… Just saying…

At the end of August, the Federal Reserve met in Jackson Hole, Wyoming for its annual confab and investors hung on every word uttered by the former tenured economics professors comprising the committee to destroy the global economy.  There were strong hints from Fed Chair Janet Yellen and Vice Chair Stanley Fischer that they want to raise rates in the near future, but they have broken such promises before. (This “will-she-won’t-she” romantic comedy is really getting old.)

The worst thing the Fed could do is keep interest rates low; instead, it should announce that it will start raising rates by 25 basis points each quarter until the Fed Funds rate reaches 2% and then urge Congress to act on meaningful tax reform and fiscal stimulus that are the only policies that will help minorities and all Americans.  And then this nation should embark on meaningful civic and economic education for all of its children (and even the adults) to insure that they understand how economies work – which is not by increasing entitlements and reducing the cost of money to the point where it has no value.

When you look deep into Fed policy, all that stares back is a black hole. And the hole keeps getting deeper and deeper. While it went largely unnoticed at this meeting, the Fed also made some very disturbing noises about its plans to deal with the next recession.

These plans are unconstitutional and dangerous.

And they’re the next step in a quiet revolution that’s already being waged by central banks worldwide.

Here’s the most disturbing thing central banks are doing right now (and how it can hurt you)…

The Fed May Be Going Shopping – for Something It Has No Right to Buy

Acknowledging that it will not be in a position to lower interest rates by 300-500 basis points as in past recessions, the Fed is paving the way for the next generation of quantitative easing.  Some believe the Fed is hinting that it may add corporate bonds to its shopping list the next time it has to bail out the economy and markets.  While that would likely violate the Constitution, which vests Congress with the right “To borrow Money on the credit of the United States” (Article I, Sec. 8), the Federal Reserve has shown little regard for any limitations on its powers and Congress is asleep at the wheel.

Buying corporate bonds would be just one more in a series of policy blunders that destroyed global bond markets.  Fed purchases of corporate bonds would further reduce market liquidity and distort free market pricing mechanisms (if the latter can even be said to exist anymore).  While I have no doubt that we could see the Fed further expand its balance sheet, I am equally confident that further balance sheet expansion will do little to promote economic growth.

On a larger scale, central banks have already been on an illegal shopping spree for quite some time.

And it’s creating a radical change in the investment landscape.

Right now, central banks, sovereign wealth funds, and certain regulated institutions are buying assets without regard to whether they are fairly priced or generate reasonable returns.  I would also include corporations buying back record levels of stock in this category since they are driven by different motivations than investors seeking returns.  The fact that some central banks are large owners of stocks (Swiss National Bank) and ETFs (The Bank of Japan) tells you that something is seriously awry.  Rather than acting as lenders of last resort, these central banks are meddling in stock markets and inflating the value of companies to dangerous levels.  While these buyers can hold these stocks indefinitely, they are driven by different motivations than traditional investors seeking an attractive risk-adjusted return on their capital.

This is a profound change in the investment landscape that requires new thinking from investors.

Stock purchases by central banks in particular deserve more attention than they receive in the media.  They are nothing short of lunacy. There is no good reason why a central bank should own stocks.  That is not what central banks were created to do.  Central banks are supposed to act as lenders of last resort, not prop up stock prices.  It’s troubling enough that they are monetizing massive amounts of government and now corporate debt in a global Ponzi scheme that is destroying the world’s fixed income markets. Buying stocks is beyond the pale.

This May Mean The End of Post-World-War-II Capitalism

With central banks owning $25 trillion of financial assets and sovereign wealth funds owning countless trillions more, it is time to ask whether post-World War II capitalism is morphing into a new phase.  These non-economic actors have different motivations than traditional investors who buy assets in order to earn a profit over a reasonable period of time.  Central banks are buying stocks and bonds in order to monetize government debt and keep afloat the immoral Ponzi schemes required to finance massive entitlement promises to their constituents.  Sovereign wealth funds are looking for places to park their cash for extremely long periods of time and often focus on assets with trophy or strategic value. But the most important thing these two types of buyers have in common is that they don’t have to sell, which means that their ownership can inflate asset values for prolonged periods of time.  This destroys the price discovery mechanism that markets are supposed to provide.  And without price discovery, markets cease to allocate capital efficiently.

This remains one of the most baffling investment climates that my generation has experienced.  Central bank policies are distorting markets to the point where they no longer function as reliable indicia of the economy or the value of individual securities.  The more than $13 trillion of global bonds (today I read that the number is $16 trillion – who can keep track?) yielding below zero signal systemic distress, yet most investors and mainstream commentators and the financial media continue to shrug it off.  I beseech the readers of this publication not to shrug it off.  Negative interest rates and their causes are symptoms of serious problems at the heart of the global financial system.  Negative interest rates effectively allow governments to confiscate capital; they steal from the future to pay for promises that never should have been made and can never be kept.  They are another form of default.  As my friend David Rosenberg writes:  “So we know full well that the central banks want inflation – it is the easiest way to default on the global debt-to-GDP ratio without having to write anything down and generate real losses.”  Markets may appear to be sound, but that is an illusion; they are broken.  A combination of regulatory and monetary policy errors are draining liquidity, distorting pricing, and impairing the ability of the system to react to stress.  Markets are more fragile today than they were on the cusp of the 2008 financial crisis; governments and companies are more leveraged; and the geopolitical landscape is dangerously unstable.  Investors are ignoring these warning signs at their peril.

 Figure 1 Lulled to Sleep

Figure 1
Lulled to Sleep

What is an investor to do in such an environment?  The first mission should be to defend against losses.  Cash may yield nothing but it is still an important tool for managing risk and positioning to take advantage of future market dislocations.  I believe in the adage that many investors make 80% of their money in 20% of the time.  That is certainly the history of the credit markets, where most of the money is made after the market crashes; the rest of the time, the risk-adjusted returns are extremely unattractive (like today).  The human compulsion to act is the enemy of good investing; that is particularly true when markets are overvalued like they are today.  Rather than feeling they are missing out on the current rally, which has no relation to fundamentals, investors should not be reluctant to hold cash, avoid losses, and wait for better opportunities to buy assets at reasonable values. You can read about my cash recommendations here.

One of the symptoms of severe market distortions resulting from ceaseless central bank interventions is artificially low market volatility.  On August 23, The Wall Street Journal reported that stock market volatility over the last 30 days was the lowest in 20 years.  See Figure 1 above.  Factors contributing to this phenomenon include massive stock purchases by some central banks and the sharp reduction of market exposure in Europe after the Brexit vote.  Markets are complex systems.  Much like earthquake zones, they need to release pressure in order to prevent pressures from building up and unleashing larger fractures.  Markets have been unusually quiet since the financial crisis.  While human beings tend to assume that present conditions will persist indefinitely, there is abundant evidence that current conditions are unsustainable.  I believe volatility is significantly undervalued just as bonds and stocks are grossly overvalued. Future adjustments are unlikely to be gentle.

Illinois Sends ‘Dear Contractor’ Letters

Andy’s Notes: The most corrupt state in the history of states might be at the tip of the spear of municipal bankruptcy, but rest assured they aren’t alone. Call your legislators and ask them how much YOUR state has been borrowing from the federal government to keep this sham going. Then look at the federal debt numbers and ask yourself – is this sustainable????

The state of Illinois has not passed a budget for close to three years.

Arguably it’s just as well because Illinois budgets for decades have been nothing but a moth-eaten collection of lies, one time deficits repeated endlessly, and financial wizardry statements designed to disguise Illinois’ real problems: failure to rein in spending coupled with a very business unfriendly environment.

As Illinois’ bond rating careens towards junk, Illinois Unpaid Bills Jumped to $14.3 Billion. Today, the state told contractors to halt roadwork other than that required for safety.

Dear Contractor

I do not have a link, but here is the letter in image form.

This does not raise much alarm in Illinois has these kinds of letters went out last year as well. It’s simply business as usual in Illinois.

My IDOT contact, who wishes to be left unnamed, reports …

Last year when they did this the extra work bill to the state cost millions of taxpayer dollars. At the last minute, the shutdown was averted but not until the shutdown measures were employed and thus extra cost was due to contractors and consultants.

Look out for the Road Builders Association to come out with an estimate of what it will cost this time around after the letter today.

Last year, the supplier for paper and toilet paper had not been paid and thus various offices were reportedly cut off of supply. IDOT employees were going to have to work from home due to the potential unsanitary conditions.

Five Illinois Universities Rated Junk

Yesterday, the Illinois Policy Institute reported MOODY’S DOWNGRADES 7 ILLINOIS UNIVERSITIES, 5 ARE JUNK.

Everybody wants to blame the downgrades on the state’s current budget impasse. The stalemate of nearly two years has led to cuts in state appropriations to Illinois universities. But the universities’ financial difficulties started before the state’s budget gridlock and are largely of their own making. Illinois colleges and universities have long overspent on bloated bureaucracies and expensive compensation and benefits, prioritizing administrators over students.

For years, university and college officials across the state have hiked tuition to pay for administrative hiring sprees, generous executive compensation and out-of-control pensions. Their spending priorities distorted university finances long before the budget impasse began.

The number of administrators in Illinois’ universities grew by nearly a third (31.1 percent) between 2004 and 2010. At the same time, faculty only increased 1.8 percent, and the number of students only grew 2.3 percent.

Illinois Tuition Fees

Retirement Costs Soars

Blame Who?

It is easy to blame Governor Rauner, but he is last on my list. Illinois has been in trouble for decades. The state’s only solution has been to tax, and tax, and tax.

That is precisely the same position as Chicago Mayor Rahn Emanuel.

The result is easy to predict.

Illinois’ Economic Growth is Worse than During the Great Depression

Illinois’ total state economic activity has increased by only 4 percent since 2007, which is lower than the U.S.’ 10 percent GDP growth during the worst decade of the Great Depression according to the Illinois Policy Institute.

Illinois Employment

Feed Me

Illinois Debt Backlog

It took $31.6 billion of new tax revenue to reduce the backlog of bills by $1.3 billion. But the complete picture is much worse as Illinois’ pension debt rose more than $25B from 2010 through 2015.

Failed State

  1. On June 4, 2017, Politico reported How Illinois became America’s failed state.
  2. The Heratige Foundation beat Politico to the idea by a mile with its September 28, 2015 analysis Illinois: The Anatomy of a Failed Liberal State.
  3. The Chicago Tribune is behind the times with its January 3, 2017 analysis, Illinois in danger of becoming a failed state.

Illinois is not in danger of becoming a failed state, it is a failed state. I have been talking about this for years.

Five Desperately Needed Reforms

  1. Municipal bankruptcy legislation
  2. Pension reform
  3. Right-to-Work legislation
  4. End of prevailing wage laws
  5. Workers’ compensation reform

Number one on my list of Illinois reforms is bankruptcy legislation. It is the only hope for numerous Illinois cities whose hands are also tied by union-sponsored prevailing wage laws.

Despite massive gains in the stock market since 2009, Illinois pension plans have gotten deeper and deeper into the hole.

Even a modest pullback in the stock market will sink numerous Illinois pension plans. I expect much worse than a modest pullback.

Tax hikes are not the answer. Reform is the answer, and bankruptcy reform is at the top of the list.

Required Pension Contributions to Double or Triple

Inquiring minds will also wish to consider Required Pension Contributions of California Cities Will Double in Five Years says Policy Institute: Quadruple is More Likely.

The same fate or worse faces Illinois.

Madigan Sponsored Problem 

The problem is on Speaker Madigan’s side. He insists on tax hikes first and reforms second.

Governor Rauner has held out and I support that policy. Once the governor agrees to tax hikes, no reforms will ever take place.

Illinois is Bankrupt

Illinois is essentially bankrupt. Unfortunately, there is no provision for states to declare bankruptcy.

States can default, however, and default is an easy prediction for Illinois’ public union pensions.

ANOTHER Greek Bailout?!?!?!

Andy’s Notes: If people still haven’t gotten the concept that this is never-ending, then we’ll just tell you – this will go on until the system resets; most likely under a new currency of some type.

As expected by most (if not all, judging by the 8 year lows in Greek bond yields), European finance ministers have reportedly reached an agreement to bail out Greece once again (provide them with yet another EUR8.5 billion loan), and agreed to discuss the possibility of debt extensions.

Blomberg reports that Euro area finance ministers reached an agreement paving the way for the disbursement of the next tranche of emergency loans, setting out terms of potential debt relief measures, two people familiar with the matter say.

Euro-area finance ministers approved a payout of 8.5 billion euros for Greece, according Luxembourg Finance Minister Pierre Gramegna.

Euro-area finance ministers are mulling a possible extension of the maturities on some Greek loans by 0 to 15 years, according to a draft statement seen by Bloomberg, even though it was not immediately clear what a 0 year maturity extension represents. The preliminary draft includes a proposal to defer the interest and amortization on Greece’s EFSF loans by the same duration

And yes, holdout IMF which threatened for two years it would not participate in a Greek deal absent a debt reduction is now in: as Christine Lagarde said: “I’d like to announce my intention to propose to the IMF’s Board the approval in principle of a new IMF Stand-By Arrangement for Greece.”

The only potential risk factor: Greece commits to keeping a primary surplus of 3.5% until 2022 and that Greek Gross financing needs should be below 15% of GDP in the medium term, and below 20% afterwards to ensure debt stays on a downward path.





In other words, if Greece does not reneg for the next 18 months, it may get another debt maturity extension, resetting the clock all over again.

Priced In?  Was the deal ever in doubt.

This deal puts an end any uncertainty about the possibility of Greece defaulting on over EUR7 billion in debt repayments due next month.

So the question is – who exactly are the EU finmins bailing out?

And another question: will Greek debt finally be eligible for ECB QE? With Mario Draghi running out of German debt to buy, this could provide with the central banks with a loophole to extend QE by at least a few months.