Submitted by Gordon Gekko of Equity And Exuberance
“Let Them Eat Credit”(reference)
The financial world is riddled with analysis that is either extremely bullish, moderately bullish, or extremely bearish. I am not the mainstream media, and I am not ZeroHedge. I will simply attempt to present the world as it is. Warning: The world as it is includes profanity.
Over the last thirty some odd years, the world has seen an unprecedented level of economic growth and prosperity. That much is certain. However, things are not as they appear when the bullish rose-tinted glasses that most view the world through are removed.
And the issue is debt.
Rajan was right. It isn’t just the U.S. housing market. It’s the world. China’s people are currently being sated by an endless funnel of credit and liquidity. Well, not endless. As a bubble gets larger and larger, the amount of debt eventually becomes too much to bear. China is no exception, as is the world.
Why did the world grow at such a frenetic pace over this period of time? Was it innovation or the piles and piles of sovereign debt that built up in the world financial system? That is what I will attempt to flesh out.
Shout out to John Meynard Keynes. Anyone who knows anything about economics knows that Keynesian economics, or at least the modern understanding of it, is mostly thin air. Keynes never said governments could run deficits in good economic times. The man would be rolling over in his grave right now if he knew what he had done by setting the precedent that gave governments such incredible power through the $.
Innovation seems like a rather convenient explanation. Leverage makes a lot more sense. If you lever a return, it multiplies. If you lever the world’s growth, it multiplies as well.
This also somewhat explains why corporations are not investing and are choosing to hoard cash instead. What happens to all that debt if the economy stays in bad shape? The world economic outlook is bleak, and it’s even bleaker if you are in the crowd that understands that China isn’t growing at 7% or anywhere close to that. China is like a giant MLP that piles on increasing amounts of debt to keep up dividend levels. It’s just growth levels instead. Enough about China… to the topic of QE!
Right now, for some unbelievably stupid fucking reason, everyone thinks its okay that practically every developed country in the world is purchasing its own debt. QE in the simplest terms is government-sponsored financial leverage. I am astounded that, at the very least, nobody realizes what a terrible precedent this sets. If ya can’t pay the debt, why not buy it and inflate the financial system/rich people! Sovereign debt repos by sovereigns to infinity! Great idea!
Whoever invented QE and somehow made it sound like it would ‘create jobs’ deserves a serious pat on the back from the leaders of every developed country. Easy money makes the rich richer, as can be seen by the performance of the S&P 500 post-QE/common sense. Jobs have not been the result. You’re either not smart or naive if you think QE and ZIRP “creates jobs” to quote our almighty leader (wait, is it Obama or Bernanke?).
And the rich getting richer is exacerbated even more since the average American got so burned on a NINJA loan that they took out in mid-2007 that they won’t even use the spigot of easy credit when it’s flowing. I’ll take a 7% ARM loaded with hidden fees, but a 3% fixed rate post-‘every bank getting sued for fraud so they can’t de-fraud customers as much’ on a somewhat stabilized home market, oh no I don’t know that sounds like too much of a risk to me. Don’t get me started on reverse mortgages.
Side-note in all seriousness now that I’m on the topic of banks, if you’ve ever worked at a bank, you know why financial crises and bubbles happen. Banks A-Y won’t quote at a rate, but Bank Z will. Bank Z gets market share. Investors in Banks A-Y want to know why profits are lower in this business line. Banks A-Y capitulate and start quoting lower. The cycle repeats itself again and again and again and the bubble occurs. Just check out Fannie/Freddie’s behavior after losing market share to private label MBS.
Not to mention holding long-term liabilities on short-term credit is an inherent moral hazard. When the music stops, there will always be a Drexel/Bear/Lehman that gets caught with their pants and down holding the newest financially engineered risky asset that liquidity suddenly evaporates in. Banks do this/hold each other’s CDS/send their big guys to the Fed and Treasury all for control. If there is no political will to rid the system of moral hazard, then large banks will keep doing it.
Thanks Chuck for explaining this issue so succinctly:
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
C stockholders really loved that one. Although, yes, the politics of a bulge bracket choosing not to dance left his hands pretty much tied.
Back to the world. The world’s debt load is mind-bogglingly large. To put it in perspective, the media views the United States as more fiscally and economically sound than the rest because…
1. Sovereign debt is essentially equal to the value of all the goods and services produced in the country annually
2. The rate at which that pile of sovereign debt is growing is slowing
3. U.S. equities are outperforming the world right now and confirmation bias tends to get involved with the mainstream media
4. Sure as hell beats a quadrillion yen
I believed like everyone else in the financial world that the next thirty some odd years would be a deleveraging cycle with slower growth, but our quality of life left fairly intact. My views changed with the advent of Abenomics.
Japan set off a debt bomb that will so greatly roil the financial system that another Great Depression is all but a certainty; it is simply a matter of when.
Let’s say a Japanese default occurs. The implications of a G7 default are absolutely mind blowing. World financial stability would crumble beneath us. Liquidity in the sovereign debt market would be severely impacted.
World governments would attempt to provide liquidity because their incumbent status in the world financial system is much, much to important to risk, but hell if the EU can’t even do Euro Bonds, then how in god’s name could they pull off World Bonds?
Yeah, World Bonds… let that sink in for a bit. Or rather, EU-China-Japan-U.S.-Russia…etc. Bonds?
Who gets included in these bonds and who doesn’t? If you aren’t included, say hello to my friend over here civil war because sovereign debt is less liquid so you can’t pay off your debts. The sheer scale and political will it would require to somehow save the world financial system after a Japanese default is truly awe-inspiring. And a Japanese default isn’t a crazy scenario at all.
But alas, world powers know how important their control of the currency system is. Central banks truly hate gold. Conspiracy theories aside, why else would they hold so much of it if not for attempting to control it? They hate BitCoin too, or really the precedent that a virtual currency sets.
I’m losing my train of thought. Japan. What’s so shitty about it?
1. A quadrillion yen
2. That’s about triple the value of goods and services produced annually in the country. The term GDP is overused; I feel like people forget what it really means.
3. Ginormous deficit, and it isn’t going away thanks to their awful demographics.
Bravo guy who wrote the ‘let’s censor just the P in V’ law. You unwittingly made the country with the weirdest sexuality even weirder, and therefore you made the demographics even shittier, and therefore Japan’s chance of default even higher.
We’re fucked. We really are fucked. We went too far down the rabbit hole of leverage.
Thanks baby boomers! You left us a nice steaming pile of debt horseshit to deal with while you slowly die off on pensions and social security.
Strap in, Millennial Generation. It’s gonna be a bumpy ride.