IceCap: "Which Bubble Is Created Next?"

From the latest monthly letter by IceCap Asset Management

Selected excerpts from: Connecting the Dots

Rock star status is achieved by the very few. To be eligible, one must simply be held in a very high regard. It’s difficult to achieve, but once you’ve earned this distinguished level of recognition, in the eyes of many you can never do wrong. Until of course you do.

In universities, students no longer aspire to become hedge fund managers, or investment bankers – that is so 2000s. Today, the really sharp knives all want to become a central banker. Posters of Warren Buffett and Ray Dalio have been replaced with the Mona Lisa-like grins of Mark Carney, Ben Bernanke and Janet Yellen.

It is true that these masters’ of the universe control the levers that affect our global economy, but is the praise, the respect, and the power justified? Sadly, no.

Reading down IceCap’s memory lane, you’ll recall our November 2012 “Salma Hayek” publication which described how world leaders had two choices in the way to manage the global economy.

The first option was based upon economic theory by Friedrich Hayek who claimed that the economy couldn’t be and shouldn’t be managed on an acute basis. Mr. Hayek believed that governments should simply ensure there was enough money available. That was about it.

If only our leaders had listened.

Instead, the financial world we enjoy today chose the second option which was built entirely on the mislead belief of John Maynard Keynes, that man could in fact control or better still eliminate the business cycle by changing interest rates, changing tax rates, and spending more money than you own.

In theory, this approach works beautifully. Then it meets reality. From our perspective, reality arrives when there are no more interest rates to cut, no more taxes to cut, and no more money to spend.

Chart 1 shows the success enjoyed by the US central bank’s interest rate policy over the years. In 1997, the Asian crisis followed by the Russian crisis followed by the collapse of a gigantic hedge fund, allowed the American central bank to plant the seeds for the next crisis which turned out to be the tech bubble.

At the time, both financial pundits and the big banks with their balanced funds proclaimed that the world had indeed entered a different financial and economic era – yes, this time it was different.

Of course 4,000 Dow Jones Industrial and NASDAQ points later, the sheep started to lazily admit that perhaps this new post-Y2K economy wasn’t all that it was cracked up to be.

Not to worry, once again the American central bank mounted their ponies and rode the global economy straight into several years of ultra-low interest rates. The hope (there’s that word again) was that really cheap money would encourage people, companies and governments to borrow and spend again.

And borrow and spend they did – right smack into the biggest housing bubble in economic history. Day traders became passé, and the newest game in town was flippin’ houses. Rich people flipped mansions, plumbers and teachers flipped suburban homes and even Vegas strippers got in on the act and flipped condos among other things. By the time it was over, the entire world was flipped upside down – courtesy of the US Federal Reserve and their interest rate machine.

And this brings us to the next global crisis, which we assure you is on its way. After all, Chart 1 proves it is crystal clear that every time the US Federal Reserve acts to “save us” from one crisis, it directly sows the seeds for an even bigger crisis in the future.

The thing to understand about the US Federal Reserve is that although it makes decisions to acutely affect the American economy, it also directly affects the economies of other countries around the world. First of all, many countries do not have their own currency and instead rely upon the US Dollar. Others have their own currency, yet have it directly tied to the US Dollar and therefore the interest rate policies that come with it.

Since 2009, the 0% short-term interest rate policy, money printing, bailouts, implicit and explicit guarantees effectively been exported to the entire US Dollar world.

To put it another way, we estimate that only about 40% of America’s economic stimulus has actually stayed in America – the remainder has flowed elsewhere. But what has made this policy especially ineffective, is that the stimulus has been indirectly thrown at the economy in the form of lower interest rates and higher stock markets. In other words – these extraordinary stimulus plans are not March 2014 Connecting the Dot reaching the real economy and the average person on the street.

Now the curious thing about our world’s financial leaders is that they all read from the exact same playbook. It may come in different names, shapes and sizes but at the end of the day the Bank of England, the European Central Bank and the Bank of Japan all hum and whistle to the same tune as the US Federal Reserve.

This means all of the world’s biggest economies and biggest borrowers have 0% interest rates, money printing and explicit and implicit guarantees for various countries and companies who need to borrow money.

This point is important to understand and this is how you connect the dots to the next crisis on the horizon.

These extreme interest rates, money printing and debt guarantees have created the illusion that everything looks marvelous. On the surface, stock markets are rising, and bankrupt countries look beautiful when borrowing in the bond market.

Yet, when you strip away the wonderful headline news, you can see that no country is decreasing the money they owe. Worse still, new jobs and wages are not increasing enough to maintain an accelerating economy. This is an economic death sentence – debt totals continue to rise, not decline.

What this means is that the weakest of the weak countries are gradually reaching the point where either they won’t be able to borrow additional money, or implicit guarantees from a larger country will no longer be available.

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Full letter below (pdf)


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