Debt Consequences

          Worldwide debt is at record levels.  When the currency creation stops or slows, I expect to see an ugly deflationary environment emerge as the debt is purged from the system.

          It doesn’t take an economist to realize that when there is too much debt to be paid, some of it won’t be paid.  That means the lenders lose money as it disappears from the financial system.

          Reuters reported that global debt levels are now approaching a record $300 trillion.  (Source:  https://www.msn.com/en-us/money/markets/global-debt-is-fast-approaching-record-24300-trillion-iif/ar-AAOqYWx).  It’s perfectly reasonable to assume that much of that debt will never be paid, meaning financial losses for those who hold the debt.

          I fully expect to see defaults on debt all around the world in the relatively near future.  It may be these debt defaults that further spook equity markets.  One big Chinese default may already be spooking stocks as equities had another tough week last week.

          Evergrande is a Chinese company that has huge amounts of debt.  If you’re not familiar with Evergrande or haven’t heard this story out of China yet, here’s a little background about the company courtesy of Yahoo News (Source:  https://news.yahoo.com/evergrande-chinas-fragile-housing-giant-053203700.html):

With a presence in more than 280 cities, Evergrande is one of the largest private companies in China and one of its leading real estate developers.

The firm made its wealth over decades of rapid property development and wealth accumulation as China’s reforms opened up the economy.

Its president, Xu Jiayin — also known as Hui Ka Yan in Cantonese — was at one point China’s richest man but has seen his wealth slashed from $43 billion in 2017 to less than $9 billion now.

What does it do?

While predominantly a real estate firm, in recent years the group has embarked on an all-out diversification.

Outside of property development, it is now best known in China for its football club Guangzhou FC, formerly Guangzhou Evergrande.

The group is also present in the flourishing mineral water and food market, with its Evergrande Spring brand. It has also built children’s amusement parks, which it boasted were “bigger” than rival Disney’s.

Evergrande has also invested in tourism, digital operations, insurance, and health.

            This past week, the big news out of China was that Evergrande had more debt than the company could pay.  The company owes more than $300 billion to creditors.  This from “Credit Bubble Bulletin” (emphasis added): (Source:  https://creditbubblebulletin.blogspot.com/2021/09/weekly-commentary-evergrande-moment.html)

Evergrande owes over $300 billion – to banks and non-bank financial institutions, domestic and international bondholders, suppliers, and apartment buyers. It has bank borrowings of $90 billion, including from the Agricultural Bank of China, China Minsheng Banking Corp, and China CITIC Bank Corp (reports have 128 banks with exposure). Thousands of suppliers are on the hook for $100 billion.
It appears an Evergrande debt restructuring is inevitable. From a few decades of close observation, these types of situations generally prove worse than even the more bearish analysts fear. Assume ugly and messy. The presumption all along – by bankers, investors,
and apartment purchasers – was that Beijing would never allow the collapse of such a huge player. This fundamental market perception is in serious jeopardy.
Evergrande is the most indebted of a highly levered Chinese developer sector (top three in revenues). It “owns more than 1,300 projects in more than 280 cities.” Evergrande employs 200,000 – and “indirectly helps sustain more than 3.8 million jobs each year.”
Evergrande epitomizes China’s historic Credit Bubble. It has borrowed and spent lavishly, in what history will surely view as a company that operated at the epicenter of an extraordinary Bubble of asset inflation, speculation, and reckless debt-financed malinvestment. Estimates have Evergrande bondholders receiving 25 cents on the dollar in a restructuring. It borrowed $20 billion in the booming off-shore dollar bond marketplace. As a focal point of the global Bubble in leveraged speculation, China’s offshore debt market has ballooned during this protracted cycle. From the FT (Hudson Lockett and Thomas Hale): “Chinese issuers face their largest-ever wave of dollar bond maturities this year at $118bn, according to Refinitiv. But even that is dwarfed by the Rmb7.8tn ($1.2tn) of onshore debt maturing in 2021. The latter figure could have big repercussions for offshore bondholders, especially if the restructuring of onshore debt is prioritized.”

            The restructuring referenced in the article is now happening and investors are not happy.  This from “Zero Hedge” (Source:  https://www.zerohedge.com/markets/enraged-evergrande-investors-go-full-pitchfork-hold-management-hostage-company-offices)

As the collapse of Evergrande reverberates throughout the Chinese economy, pissed-off retail investors have gone from storming the company’s headquarters to taking management hostage, according to The Straits Times, citing posts ‘making the rounds’ on social media.

What we know so far: over 70,000 retail investors forked over vast sums of money, in some cases their entire life savings, after the country’s second-largest, ‘too big to fail’ property developer wooed them with promises of 10%+ annual returns. And while the company most likely is TBTF (as you can read in gory detail here, although Beijing has yet to make an official proclamation), these anxious retail investors may be in more of an “Alive” situation than a Sully Sullenberger landing when it comes to resolving this mess.

After accumulating some 1.97 trillion yuan (US$410 billion) in liabilities, the company – which became the country’s largest high-yield dollar bond issuer (16% of all outstanding notes) – sparked protests across the country earlier this week after announcing they were forced to delay payments on up to 40 billion yuan in wealth management products.

As we noted earlier Thursday, in an effort to appease its angry (and very soon, poor) stakeholders, Evergrande plans to let consumers and staff bid on discounted apartments this month as compensation for billions in overdue investment products as the embattled developer seeks to preserve cash, according to people familiar with the matter.

According to Bloombergthe company will organize an online property event by Sept. 30 for investors who opt for real estate in lieu of cash. The world’s most indebted property developer is pushing the discounted real estate as the preferred of three options for angry investors seeking repayments.

The plan, it would appear, did not go off quite as planned: in response, nearly 100 investors stormed Evergrande’s headquarters to demand their money back.

          It remains to be seen exactly how this will play out or if the Chinese Government might step in, but this story makes my point; an economy that expands via debt accumulation and currency creation is not a healthy economy.  Eventually, excessive debt levels need to be dealt with.

          The concern is that this may be a “Lehman Moment” for China.  A $300 billion default by Evergrande could affect the banking sector as well as the financial markets.

          When economies and the financial system are as fragile as they are presently, a collapse can begin with just one event.  I believe we may be at that point presently.

          While it is too early to tell how the Evergrande situation will play out, there will be other Evergrande’s given current worldwide debt levels and one of these events will be the straw that breaks the proverbial camels’ back.  It will be that event that is the catalyst for the inevitable reversal.

          As I’ve discussed here, in my opinion, there are many other reasons that a reversal will have to occur.  On top of unmanageable debt levels, there is unsustainable currency creation that has fueled speculation in financial markets and created inflation in the economy.  The policy of disincentivizing work has led to supply shortages that will further harm the economy.

          Jim Rickards, a past guest on my radio program, wrote a piece this past week titled “No Recovery Until 2045?”  (Source:  https://dailyreckoning.com/no-recovery-until-2045/)

          In the excellent article, Mr. Rickards offers an interesting perspective.  He notes that when debt levels get high enough, stimulus efforts fail.  He notes that when sovereign debt exceeds 90% of the country’s economic output, the stimulus achieved is less than the new debt added to fund the stimulus.  In other words, the greater the debt of a country, the more the return on stimulus investment diminishes.

         At the present time, US national debt to GDP exceeds 130%.  We are well past the critical 90% mark.  The more debt-funded stimulus packages are attempted from this point on, the less effective they will be. 

         The current economic numbers bear this out; we have inflation and a contracting economy with both inflation and economic contraction likely to increase in the near term.

         If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

What Will the Next Recession Look Like?

          I have frequently commented on my belief that the economy and financial markets are extremely artificial, with asset prices rising largely due to massive levels of currency created by the Federal Reserve.

          Artificial economies and artificial markets always, eventually reverse following the basic rules of finance and economics.

          I have often quoted the late economist Hebert Stein when it comes to currency creation.  Mr. Stein stated that “if something cannot go on forever, it will stop”.  That statement is as profound as it is simplistic.

          As I’ve discussed in “Portfolio Watch” many times, currency creation will eventually cease.  It will end proactively or reactively – but it will end.

          The question is that when currency creation does stop what will the economy and financial markets look like?  How will you be affected?

          It is the answer to this question that matters.

          In this issue of “Portfolio Watch”, we will consider the answer to this question.

          John Wolfenbarger recently published a piece on this topic at Mises.org.  (Source:  https://mises.org/wire/four-reasons-next-recession-will-be-worse-last-one).  It is a well-done article.

          In his article, Wolfenbarger notes, as I did in last week’s “Portfolio Watch” that stocks are extremely overvalued.

          In last week’s issue, I noted that the increase in stock prices is very closely correlated to the Federal Reserve’s level of currency creation. 

          Wolfenbarger utilizes the most often cited market valuation metric, the “Buffet Indicator”, to make his case.

          The chart above illustrates the Buffet Indicator, a.k.a. Stock Market Capitalization to Gross Domestic Product.  Note from the comments on the chart that stocks are now 30% higher than at the tech stock bubble peak in calendar year 2000 and pushing twice as high as at the time of the financial crises.

          Wolfenbarger also rightly observes that real estate prices are also at levels that one might consider to be nosebleed levels.  Using the most commonly referenced real estate valuation indicator, one discovers that real estate values are now 27% higher than at the peak of the housing bubble in 2006.

          The point is that when the next recession hits, asset prices are more inflated than in the past significantly increasing the likelihood of a catastrophic decline in asset values.

          Couple these abnormally high asset valuation levels with the fact that the US economy has weakened over the past two decades and we have the makings of a perfect storm when the next recession hits.

          A weaker economy should not mean higher stock prices.  I’m certain that without the extreme easy money policies that the Fed has pursued over that time frame, asset prices today would be far lower than they are presently.

          Here is an excerpt from Wolfenbarger’s article:

The US economy is not as strong as it used to be. That is certainly true in the wake of the covid pandemic, but it has also been true for the past two decades. All of the taxes, regulations, and other government interventions in the economy in recent decades have created a weaker and more fragile economy that will make the next recession even worse.

The chart below of industrial production shows it is only 8 percent higher than at the 2000 peak and 1 percent lower than at the 2007 peak. It has nearly flatlined over the past two decades. That is much weaker than the 3.9 percent annual growth in industrial production from 1920 to 2000.

          Consider that for a moment.  Asset prices are at all-time highs and industrial production has declined since the financial crises.

          That’s economic math that doesn’t add up and it goes a long way to proving my point that the current environment is artificial.

          Wolfenbarger makes another excellent point in his piece.  Debt levels are also near historical highs.  Often I have discussed the relationship between asset price bubbles and easy credit.  Briefly, asset bubbles cannot exist without easy credit.  Easy credit is “bubble fuel”.

          Wolfenbarger puts it this way:

Excessive debt has been the problem with every financial crisis in history due to prior money creation out of thin air, so the next one promises to be one for the history books, given these unprecedented high debt levels. Debt liquidation and defaults will lead to deflation, as we saw in the Great Recession and even more so in the Great Depression.

          I have frequently quoted Thomas Jefferson who noted that if the American people ever allow private banks to control the issue of their currency, first by inflation then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the very continent their fathers conquered.

          We are seeing inflation presently; extreme deflation will have to follow at some future point to purge the excess debt from the system.

          Finally, Wolfenbarger makes the point that the Fed is out of policy options.

But money created out of thin air does not create new goods and services that improve living standards. If it did, a place like Zimbabwe would be the wealthiest country in the world. However, newly created money can flow into financial assets, which helps explain why their valuation levels are so high.

The graph below shows “Austrian” money supply (AMS), the best measure of money supply that is consistent with this Austrian school of economics definition (although it no longer includes traveler’s checks, which have been discontinued in the Fed’s database due to limited use these days). AMS is up 40 percent since February 2020 and is up an astounding 225 percent since the Great Recession ended in June 2009!

This is well above the money supply growth that drove the Roaring Twenties and ultimately led to the Great Depression of the 1930s, as detailed in economist Murray N. Rothbard’s definitive history of that period, “America’s Great Depression.”          The “Revenue Sourcing” planning process hedges for inflation and deflation.  I believe it is the only way to survive the coming recession.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Stocks and the Fed

As I was doing the research this week that I do every week, it struck me as to how tightly correlated the performance of stocks is to the balance sheet of the Federal Reserve.

          The chart on this page is a chart of an exchange-traded fund that tracks the performance of the Russell 3000, a very broad stock market index.

          The most recent low on the chart is the market bottom of March of 2009.  Since that time, as you can see from the chart, stocks have moved up significantly; the chart pattern is nearly vertical.

          Each bar on the chart represents one month of price action.  The green bars on the chart are the months during which the Russell 3000 moved higher and the red bars on the chart represent the months during which stocks moved lower.

          Since March of 2020, stocks have moved lower only 4 months with the balance of the months seeing stocks move higher; significantly higher in many months.  Since the market low of March of 2009, stocks have moved higher by 213%.

          The second chart is a chart from the Federal Reserve representing total Federal Reserve bank assets.

          Notice the correlation between currency creation by the Federal Reserve and the parabolic rise in the price of stocks.

          On my radio program, I’ve gone on record stating that it is my belief that the Fed’s taper talk is just talk.

          In the September issue of the “You May Not Know Report”, I reference an article published by Ryan McMaken about the political realities of the current fiscal situation.  I’d encourage you to check out the piece in the “You May Not Know Report”.

          In short, McMaken points out that the Fed’s “dual mandate” of keeping prices stable and maintaining full employment is really not the point any longer.

          Here is a bit from his piece (Source: https://mises.org/wire/how-fed-enabling-congresss-trillion-dollar-deficits) (emphasis added):

If all this spending were just a matter of redistributing funds collected through taxation, that would be one thing. But the reality is more complicated than that. In 2020, the federal government spent $3.3 trillion more than it collected in taxes. That’s nearly double the $1.7 trillion deficit incurred at the height of the Great Recession bailouts. In 2020, the deficit is expected to top $3 trillion again.

In other words, the federal government needs to borrow a whole lot of money at unprecedented levels to fill that gap between tax revenue and what the Treasury actually spends.

Sure, Congress could just raise taxes and avoid deficits, but politicians don’t like to do that. Raising taxes is sure to meet political opposition, and when government spending is closely tied to taxation, the taxpayers can more clearly see the true cost of government spending programs.

Deficit spending, on the other hand, is often more politically feasible for policymakers, because the true costs are moved into the future, or they are—as we will see below—hidden behind a veil of inflation.

That’s where the Federal Reserve comes in. Washington politicians need the Fed’s help to facilitate ever-greater amounts of deficit spending through the Fed’s purchases of government debt.

When Congress wants to engage in $3 trillion dollars of deficit spending, it must first issue $3 trillion dollars of government bonds.

That sounds easy enough, especially when interest rates are very low. After all, interest rates on government bonds are presently at incredibly low levels. Through most of 2020, for instancethe interest rate for the ten-year bond was under 1 percent, and the ten-year rate has been under 3 percent nearly all the time for the past decade.

But here’s the rub: larger and larger amounts put upward pressure on the interest rate—all else being equal. This is because if the US Treasury needs more and more people to buy up more and more debt, it’s going to have to raise the amount of money it pays out to investors.

Think of it this way: there are lots of places investors can put their money, but they’ll be willing to buy more government debt the more it pays out in yield (i.e., the interest rate). For example, if government debt were paying 10 percent interest, that would be a very good deal and people would flock to buy these bonds. The federal government would have no problem at all finding people to buy up US debt at such rates.

But politicians absolutely do not want to pay high interest rates on government debt, because that would require devoting an ever-larger share of federal revenues just to paying interest on the debt.

For example, even at the rock-bottom interest rates during the last year, the Treasury was still having to pay out $345 billion dollars in net interest. That’s more than the combined budgets of the Department of Transportation, the Department of the Interior and the Department of Veterans Affairs combined. It’s a big chunk of the full federal budget.

Now, imagine if the interest rate doubled from today’s rates to around 2.5 percent—still a historically low rate. That would mean the federal government would have to pay out a lot more in interest. It might mean that instead of paying $345 billion per year, it would have to pay around $700 billion or maybe $800 billion. That would be equal to the entire defense budget or a very large portion of the Social Security budget.

            McMaken makes a great point.  Politically speaking, it would be a major problem for the Fed to taper and/or raise interest rates.

            So, the Fed will likely continue on their current unsustainable course until things blow up.

            Going back to the ‘dual mandate’ of stable prices and maximum employment, it’s now obvious that the first objective of stable prices is out the window.  The inflation genie is now fully out of the bottle.

            Prices are rising across the board in nearly every category of spending.  Looking past the heavily manipulated inflation reporting metric most often used to report the headline inflation rate – the Consumer Price Index – one finds the actual, real-world inflation rate is 12% or 13% per annum.

            With the Fed staying the course as far as easy money is concerned, look for the real inflation rate to continue to accelerate and look for the Fed to continue to say that inflation is transitory or come up with some other narrative to explain away the rising inflation rate as attributable to something other than reckless Fed policy.

            The Fed may have gotten some cover this past week for staying the course.  The jobs report was a huge disappointment to the downside.  This from “Zero Hedge” (Source:  https://www.zerohedge.com/markets/goodbye-taper-huge-jobs-miss-us-adds-just-243k-jobs-august):

Moments ago the BLS reported that in August just a paltry 235K jobs were added, far below the 725K expected below even the most pessimistic forecast; the number was not only a huge drop to last month’s upward revised 1.053MM but was the weakest print since January.

While we expect that the pundits will quickly blame the resurgence of covid in August, manifesting itself in zero jobs added in leisure and hospitality, with Bloomberg already busy spinning by saying that “the deceleration in hiring likely reflects both growing fears about the rapidly spreading delta variant of Covid-19 and difficulties filling vacant positions” the reality is that the US economy is rapidly slowing even as inflation continues to soar, positioning the US squarely for a stagflationary crash and putting the Fed’s tapering plans squarely in doubt.      

          The economy is slowing. 

            Even mainstream forecasters are revising economic growth estimates downward.  In the “Zero Hedge” article referenced above, it was noted that Morgan Stanley cut its 3rd quarter GDP growth estimate to 2%.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

The Political Realities of the Taper

This past week, after the Federal Reserve’s Jackson Hole, Wyoming symposium, Fed Chair, Jerome Powell commented on Fed policy.  It was widely anticipated that the Fed Chair would discuss the ‘taper’, or the Fed’s plan to slow the rate at which currency is being created.

          The Fed Chair, in many respects, disappointed.  This is from “Zero Hedge” (Source:https://www.zerohedge.com/markets/dovish-powell-sparks-most-painful-meltup-52nd-record-high-2021):

All that angst and jitters heading into today’s Jerome Powell speech, with so many fearing that the Fed Chair would finally make good on urgent warnings from a growing number of Fed speakers that the Fed’s easing is causing bubbles across all asset classes – including housing and certainly stocks – and warns traders that the big, bad taper is coming, and… nothing.

Instead, Powell was far more dovish than almost anyone had expected, barely mentioning the upcoming taper (and only in the context of what the Fed said in the recent Minutes), while reserving the bulk of his speech to discuss why inflation is transitory. 

Predictably, Powell’s dovishness sparked a waterfall in the dollar and yields, with the 10Y and the Bloomberg Dollar index both sliding.

          I have long been of the strong opinion that it will be difficult for the Fed to ‘taper’.  Not because of economic reasons, but because of political reasons.  Ryan McMaken, of the Mises Institute, wrote an excellent piece on this topic that explains:

Much of the discussion over the Fed’s policies on interest rates tends to focus on how interest rate policy fits within the Fed’s so-called dual mandate. That is, it is assumed that the Fed’s policy on interest rates is guided by concerns over either “stable prices” or “maximizing sustainable employment.”

This naïve view of Fed policy tends to ignore the political realities of interest rates as a key factor in the federal government’s rapidly growing deficit spending.

While it is no doubt very neat and tidy to think the Fed makes its policies based primarily on economic science, it’s more likely that what actually concerns the Fed in 2021 is facilitating deficit spending for Congress and the White House.

The politics of the situation—not to be confused with the economics of the situation—dictate that interest rates be kept low, and this suggests that the Fed will work to keep interest rates low even as price inflation rises and even if it looks like the economy is “overheating.” If we seek to understand the Fed’s interest rate policy, it thus may be most fruitful to look at spending policy on Capitol Hill rather than the arcane theories of Fed economists.

Why Politicians Need the Fed to Keep Deficit Spending Going—at Low Rates

Federal spending has reached multigenerational highs in the United States, both in raw numbers and proportional to GDP.

If all this spending were just a matter of redistributing funds collected through taxation, that would be one thing. But the reality is more complicated than that. In 2020, the federal government spent $3.3 trillion more than it collected in taxes. That’s nearly double the $1.7 trillion deficit incurred at the height of the Great Recession bailouts. In 2021, the deficit is expected to top $3 trillion again.

In other words, the federal government needs to borrow a whole lot of money at unprecedented levels to fill that gap between tax revenue and what the Treasury actually spends.

Sure, Congress could just raise taxes and avoid deficits, but politicians don’t like to do that. Raising taxes is sure to meet political opposition, and when government spending is closely tied to taxation, the taxpayers can more clearly see the true cost of government spending programs.

Deficit spending, on the other hand, is often more politically feasible for policymakers, because the true costs are moved into the future, or they are—as we will see below—hidden behind a veil of inflation.

That’s where the Federal Reserve comes in. Washington politicians need the Fed’s help to facilitate ever-greater amounts of deficit spending through the Fed’s purchases of government debt.

Without the Fed, More Debt Pushes up Interest Rates 

When Congress wants to engage in $3 trillion dollars of deficit spending, it must first issue $3 trillion dollars of government bonds.

That sounds easy enough, especially when interest rates are very low. After all, interest rates on government bonds are presently at incredibly low levels. Through most of 2020, for instance, the interest rate for the ten-year bond was under 1 percent, and the ten-year rate has been under 3 percent nearly all the time for the past decade.

But here’s the rub: larger and larger amounts put upward pressure on the interest rate—all else being equal. This is because if the US Treasury needs more and more people to buy up more and more debt, it’s going to have to raise the amount of money it pays out to investors.

Think of it this way: there are lots of places investors can put their money, but they’ll be willing to buy more government debt the more it pays out in yield (i.e., the interest rate). For example, if government debt were paying 10 percent interest, that would be a very good deal and people would flock to buy these bonds. The federal government would have no problem at all finding people to buy up US debt at such rates.

Politicians Must Choose between Interest Payments and Government Spending on “Free” Stuff

But politicians absolutely do not want to pay high-interest rates on government debt, because that would require devoting an ever-larger share of federal revenues just to paying interest on the debt.

For example, even at the rock-bottom interest rates during the last year, the Treasury was still having to pay out $345 billion dollars in net interest. That’s more than the combined budgets of the Department of Transportation, the Department of the Interior and the Department of Veterans Affairs combined. It’s a big chunk of the full federal budget.

Now, imagine if the interest rate doubled from today’s rates to around 2.5 percent—still a historically low rate. That would mean the federal government would have to pay out a lot more in interest. It might mean that instead of paying $345 billion per year, it would have to pay around $700 billion or maybe $800 billion. That would be equal to the entire defense budget or a very large portion of the Social Security budget.

So, if interest rates are rising, a growing chunk of the total federal budget must be shifted out of politically popular spending programs like defense, Social Security, Medicaid, education, and highways. That’s a big problem for elected officials because that money instead must be poured into debt payments, which doesn’t sound nearly as wonderful on the campaign trail when one is a candidate who wants to talk about all the great things he or she is spending federal money on. Spending on old-age pensions and education right now is good for getting votes. Paying interest on loans Congress took out years ago to fund some failed boondoggle like the Afghanistan war? That’s not very politically rewarding.

So, policymakers tend to be very interested in keeping interest rates low. It means they can buy more votes. So, when it comes time for lots of deficit spending, what elected officials really want is to be able to issue lots of new debt but not have to pay higher interest rates. And this is why politicians need the Fed.

The Fed Is Converting Debt into Dollars

Here’s how the mechanism works.

Upward pressure on rates can be reduced if the central bank steps in to mop up the excess and ensure there are enough willing buyers for government debt at very low-interest rates. Effectively, when the central bank is buying up trillions in government debt, the amount of debt out in the larger marketplace is reduced. This means interest rates don’t have to rise to attract enough buyers. The politicians remain happy. 

And what happens to this debt as the Fed buys it up? It ends up in the Fed’s portfolio, and the Fed mostly pays for it by using newly created dollars. Along with mortgage securities, government debt makes up most of the Fed’s assets, and since 2008, the central bank has increased its total assets from under $1 trillion dollars to over $8 trillion. That’s trillions of new dollars flooding either into the banking system or the larger economy.

For years, of course, the Fed has pretended that it will reverse the trend and begin selling off its assets—and in the process remove these dollars from the economy. But clearly, the Fed has been too afraid of what this would do to asset prices and interest rates. 

Rather, it is increasingly clear that the Fed’s purchases of these assets are really a monetization of debt. Through this process, the Fed is turning this government debt into dollars, and the result is monetary inflation. That means asset price inflation—which we’ve clearly already seen in real estate and stock prices—and it often means consumer price inflation, which we’re now beginning to see in food prices, gas prices, and elsewhere.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Is a Stock Crash Imminent?

          For more than a couple of years, I have been of the opinion that stocks have been overvalued.  Over that time frame, except for early 2020, stocks have continued to rise.

          For the record, I don’t believe that this continued rise in stock prices invalidates my initial opinion about stock valuations; instead, it demonstrates how closely linked stock performance is with the easy money policies that have been pursued by the central bank of the United States, the Federal Reserve.

          As overvalued as stocks were a few years ago, they are even more overvalued today; more so than at any time in history by many different measures.

          A couple of months ago, I reported that our longer-term trend-following indicators seemed to have stock prices beginning to break down from a technical perspective.  Now, there are other indicators that may be confirming that this is the case.

          This past week, while doing the research that I do nearly every day, I read an article that succinctly and concisely described some of these indicators.

          The Hindenburg Omen, an indicator that has appeared before nearly every historical stock market correction flashed a warning sign last week.  (For clarity, a Hindenburg Omen appears before market corrections, but a market correction does not occur every time a Hindenburg Omen appears.)

          For readers that are unfamiliar with the Hindenburg Omen, it is the name given to market conditions when a large number of stocks on the New York Stock Exchange are making new lows while a large number of stocks are making new highs. 

          The chart reproduced below here shows the Federal Reserve’s balance sheet as well as Hindenburg Omens that have occurred historically.  Notice that the last Hindenburg Omen emerged just prior to the stock market correction of early 2020.

                   If you look at the chart carefully, you’ll see a very strong correlation between the Fed’s balance sheet and the price movement of the S&P 500.

                   Notice also from the chart that multiple Hindenburg Omens appeared prior to the stock market correction of 2007 through early 2009.

          The recent emergence of another Hindenburg Omen doesn’t mean that a stock market correction is imminent, but it does increase the probability of a correction.

          The Shiller CAPE ratio is also sounding an alarm presently.  If you are unfamiliar with this indicator, it is also known as the Cyclically Adjusted Price-Earnings ratio.  It is defined as the S&P 500’s current price divided by the 10-year moving average of inflation-adjusted earnings. It is used as a valuation metric to forecast future returns, where a higher CAPE ratio could reflect lower returns over the next couple of decades, whereas a lower CAPE ratio could reflect higher returns over the next couple of decades, as the ratio reverts to the mean.

          The chart republished above here shows the Shiller CAPE ratio with the Federal Reserve’s balance sheet.

          The current level of the Shiller CAPE ratio is approaching 37, an all-time high.  For comparison’s sake, the Shiller CAPE ratio stood at about 27 prior to the stock market decline beginning in 2007.  Today’s Shiller CAPE ratio is nearly 40% higher than in 2007.

          Again, an all-time high Shiller CAPE combined with a Hindenburg Omen is no assurance that a crash is coming, but again, the likelihood is higher.

          As I have discussed in these pages frequently, Warren Buffet’s favorite stock market valuation measure is the market capitalization to gross domestic product ratio.

          It is calculated by taking the total value of the stock market and dividing by the total economic output of the United States.

          It was this indicator that Mr. Buffet referenced in a 1999 speech during which he forecast that stock prices were likely to fall.

          Mr. Buffet was 100% correct.

          At the present time, the Buffet indicator has stocks more overvalued than at any time in history.

          As you can see from the chart of the Buffet Indicator reproduced below, the ratio is now more than twice the indicator’s level prior to the market decline of 2007 and has far exceeded the levels it reached in 1999 when Mr. Buffet used it to forecast a decline in stocks.

Three indicators, all seemingly confirming that the probability of a stock market correction is high.

          Interestingly, on all three of these charts, the common denominator is the currency created by the Federal Reserve.

          It is this currency creation that has, in my view, propelled this bull market in stocks to levels that would never have been attained without the currency creation.

          This currency creation has created stock market conditions that are unsustainable.

          Again, this doesn’t mean that a stock crash is imminent, but a crash is, in my opinion, inevitable once the currency creation slows.

          There is one other chart that makes this point nicely.       

          The chart above illustrates the Buffet Indicator with the white line and corporate profits as a percentage of Gross Domestic Product with the blue line.

          It’s instructive to note that there has been only one other time in the last 30+ years that stocks have been so overvalued relative to earnings; it was at the time the tech stock bubble began to unwind as stock prices crashed. 

          One look at the chart has one concluding that stock prices are FAR more overvalued today than at the time of the tech stock wreck.

          As inflation rises with geo-political tensions, fasten your seatbelts; it’s likely going to get very interesting from this point on.

          My new book “Retirement Roadmap” was released ten days ago and achieved #1 best-seller status on Amazon in eleven categories.  Thank you for your support!

          If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

The Fed to Raise Interest Rates? I Wouldn’t Hold Your Breath

          Many of the world’s central banks are beginning to raise interest rates in response to higher levels of inflation.  The chart, from “Bloomberg”, shows which countries’ central banks have increased interest rates, cut interest rates, or left interest rates unchanged.

          The blue-shaded countries on the chart have not changed interest rate policy, the red-shaded countries on the chart have reduced interest rates, and the yellow-shaded countries on the chart have increased interest rates.

          The Central Bank of Mexico recently increased interest rates for the second consecutive month.  This from “The Wall Street Journal” (Source:  https://www.wsj.com/articles/bank-of-mexico-raises-interest-rates-again-in-split-decision-11628795651):

The Bank of Mexico raised interest rates for a second consecutive meeting Thursday, citing persistent price pressures and supply shocks that it expects will keep inflation above its 3% target into early 2023.

The board of governors voted 3-2 to increase the overnight interest-rate target by a quarter of a percentage point to 4.5%, in line with market expectations. Deputy governors Galia Borja and Gerardo Esquivel voted to leave the rate at 4.25%.

          The Mexican Central Bank’s actions mirror that of many other countries including Uruguay with a base interest rate of 5% and Russia.  This is from “Market Watch” on July 23, 2021. (Source:  https://www.marketwatch.com/story/russian-central-bank-raises-key-interest-rate-again-as-inflation-surges-271627036812)

Russia’s central bank on Friday raised its key interest rate in response to a stronger-than-expected pickup in inflation as the economy recovers from the effects of the Covid-19 pandemic and demand for energy rises.

In a statement, the Bank of Russia said it had lifted its key rate to 6.5% from 5.5%, having begun to tighten its policy in March, when its key rate stood at 4.25%. It said more rate rises are likely over the coming months.

          There is talk of the US Central Bank, the Federal Reserve beginning to tighten as well for the same reasons.  I believe that this talk is just that – talk, unlikely to be followed by action any time soon.

          I come to this conclusion for one main reason – current debt levels cannot be financed at higher interest rates.  In the recent past, I have presented the argument that current levels of inflation rival levels seen in the late 1970’s into the early 1980’s.

          It was at that time that the Federal Reserve, responding to high levels of inflation raised interest rates.  Going into 1981, the Fed Funds rate was effectively 20%.  The 30-Year US Treasury Bond followed suit, increasing to about 15% as noted from the chart.

          Going into 1981, the US had about $900 billion in debt.  If the entire debt had to be financed at 15%, that would have amounted to interest payments on the debt of $135 billion. 

          In the fiscal year 1981, US tax revenues totaled about $600 billion.  The national debt was about 150% of total tax revenues and interest payments on the debt would have consumed about 23% of tax revenues.

          Given that the official calculation methodology has changed significantly since 1980 to make the reported inflation rate look more favorable, as I have often discussed here and on the radio show and podcast, the officially reported inflation rate today is far lower than the officially reported inflation rate in 1980.

          The real inflation rate, using similar methods to those used in 1980 to calculate the inflation rate, is on par with 1980.

          Should the Fed follow the lead of many other world central banks and hike rates to contain inflation, the Fed creates another problem – financing debt.

          To subdue inflation the way the Fed did in 1980, interest rates might have to be raised to nearly 20% again.  Should that happen and should the 30-Year US Treasury yield rise to 15%, the situation today would look far different than more than 40 years ago.

          Presently, the official national debt is pushing $29 trillion.  Total federal tax revenues for the fiscal year 2021 are projected to be $3.86 trillion.  (Source:  https://www.thebalance.com/current-u-s-federal-government-tax-revenue-3305762)  Using the same assumption as above, should today’s Federal debt levels need to be financed at 15%, interest on the debt would amount to about $4.35 trillion, more than total tax revenues.

          In 1981, the federal debt was about 150% of tax revenues, today the national debt is approximately 750% of tax revenues or about 5 times higher using the same comparison.  In 1981, interest on the debt would have consumed 23% of total tax revenues using the assumptions outlined above, today interest payments would consume 113% of all federal tax revenues using those same assumptions.  That’s also about 5 times higher than in 1981.

          It’s for that reason that I conclude that the Fed may engage in ‘taper talk’, but it will be, only talk.  There may be a symbolic increase in interest rates, but in my view, nothing meaningful enough to get inflation under control.

          Options traders evidently agree with me.  This from “Yahoo Finance” (Source:  https://ca.finance.yahoo.com/news/traders-pile-tail-risk-bets-064012129.html) (emphasis added)

Treasury yields are rising amid optimism over the global recovery but there has been a run on Eurodollar options betting the Federal Reserve will opt not to raise interest rates at all.

Traders this week have been busy snapping up Eurodollar call options on underlying March 2025 futures that target three-month Libor to fix below 0.5%. These pay off if markets price the Fed keeping its benchmark at its lower bound until then. Futures markets are currently anticipating Libor will rise to about 1.47% by the first quarter of 2025.

This tail-risk hedge, a position aimed at protecting against extreme outcomes, has been bought repeatedly over the past week. Thursday’s session saw purchases of more than 110,000 of the options, according to traders in London and Chicago familiar with the transactions. The preliminary release of open interest data, which measures outstanding positions, has ballooned to more than 153,000 from about 22,000 a week ago.

A scenario where the Fed ends up holding rates near record lows through to 2025 would probably mean that the global economy fails to recover from the pandemic, resulting in central banks maintaining their ultra-easy policy.

Traders have already ponied up around $6.5 million on the Eurodollar hedge. While the underlying contract targets rates in March 2025, the option has a seven-month expiry, rolling off in March 2022, or what’s commonly known as a mid-curve option.

          Given this likely outcome, you may want to consider using the recent dip in gold and silver prices to add to your precious metals holdings.

          My new book “Retirement Roadmap” was released last week and achieved #1 best-seller status on Amazon as well as a ‘hottest new release’ ranking.  Thank you for your support!

          It is very much appreciated.

          The book, as well as the Kindle version of the book, are both available from Amazon.

          If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Fifty Years of Fiat

          An important anniversary is approaching this week.  Although it won’t be widely observed or likely even mentioned, it’s the anniversary of the event that led to current economic and investing conditions.      

          This coming Sunday, August 15 will mark 50 years since the US Dollar became a fiat currency.  On August 15, 1971, President Richard Nixon gave a televised speech during which he announced he would be instructing Treasury Secretary Connolly to temporarily suspend the redemptions of US Dollars for gold to protect the US Dollar from speculators.

          Nixon, during his speech, also stated that he wanted to address a ‘bugaboo’, namely that there were many who were concerned that the move would negatively impact the purchasing power of the US Dollar.  Nixon stated that you might spend more if you wanted to buy a foreign car or take an overseas trip, but if you were among the overwhelming majority of Americans who didn’t make those purchases, your dollar would buy just as much in the future as it did presently.

          50 years later, we know that the redemptions have been permanent, and the US Dollar has lost more than 95% of its purchasing power.

          As I have often discussed, it was at that point in time that the US Dollar began to be loaned into existence.  At that point in time, money became debt, and the money supply was expanded by expanding credit.

          More debt meant more money.

          The Austrian economist, Ludwig von Mises, perfectly articulated the outcome of this money transformation in my view.

          He said, “There is no means of avoiding the final collapse of a boom brought on by credit expansion.  The alternative is only whether the crisis should come sooner because of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

          In other words, the currency creation ceases, and the crash happens, or the currency is destroyed, and the crash occurs.  Neither outcome is desirable and both eventualities are painful to endure.  Survival requires an understanding of this principle and preparation in your personal finances.

          Egon von Greyerz, who often offers perspectives on this topic wrote another piece last week as the US Dollar’s fiat currency birthday approaches.  (Source: https://kingworldnews.com/greyerz-warning-we-are-now-headed-for-a-catastrophic-global-crack-up-boom/)

The beginning of the end of the current monetary system started exactly 50 years ago. In the next few years, the world will experience the end of another failed experiment of unlimited debt creation and fake fiat money.

Economic history tells us that we need to focus on two areas to understand where the economy is going – INFLATION AND THE CURRENCY. These two areas are now indicating that the world is in for a major shock. Very few investors expect inflation to become a real problem but instead believe interest rates will be subdued. And no one expects the dollar or any major currency to collapse.

But in the last two years, money supply growth has been exponential with for example M1 in the US growing at an annual rate of 126%!

Von Mises defined inflation as an increase in the money supply. The world has seen explosive growth in credit and money supply since 1971 and now we are seeing hyperinflationary increases.

Hyperinflation is a currency event. Just since 2000 most currencies have lost 80-85% of their value. And since 1971 they have all lost 96-99%. The race to the bottom and to hyperinflation is now on.

          Mr. von Greyerz published this chart that illustrates the price of gold per ounce in various currencies.  Using this metric, from 1971 to the present, the US, the UK, Europe, and Canada have seen their respective currencies decline by 96% to 99%.

          To say that we are on a slippery slope would not be accurate, we have already made the slide down the proverbial slippery slope, we are now just awaiting the outcome that von Mises forecast.

          As many past guests on RLA Radio have stated, hyperinflationary events tend to escalate rapidly and climax relatively quickly as well.

          Von Greyerz offers some terrific perspectives on this principle too.  This is from his piece:

Since the Great Financial Crisis in 2006-9, there has been an exponential growth in US Money Supply.

Looking at US M1 money supply, the graph below shows how it grew from $220 billion in August 1971 to $19.3 trillion today.

From 1971 to 2011 the growth seems modest at a compound annual growth (CAGR) of 6%. If the dollar purchasing power declined by the same rate, it would lead to prices doubling every 12 years. Or put in other terms, the value of the currency on average would drop by 50% every 12 years.

Then from 2011 when the Money supply started growing in earnest, M1 has grown by 24% annually.  This means that prices in theory should double every 3 years.

Finally, from August 2019 to August 2021 M1 has gone up by 126% a year. If that was translated to the purchasing power of the dollar it would lead to prices doubling every 7 months.

          Von Greyerz goes on to explain that von Mises defined inflation as an expansion of the money supply rather than an increase in prices.  To this point, there has not been a lot of price inflation experienced by consumers but there has been inflation in asset prices as I have discussed in previous issues of “Portfolio Watch”.

          Von Mises and von Greyerz are discussing the same phenomenon that Thomas Jefferson described when he warned of inflation followed by deflation if the American people ever allow private bankers to control the issue of their currency.

          Historically speaking, this cycle has repeated itself with amazing frequency.  Fiat currencies have a 100% failure record.

          I remain solidly in this camp even though there are many respected, highly educated analysts who have different opinions.  Those who believe the US Dollar will be a safe haven moving ahead are coming to that conclusion assuming confidence in the US Dollar continues.

          While confidence may continue for a period, over the longer term, confidence will have to disappear unless as von Mises said, there is a voluntary abandonment of credit creation.  While that would be the preferred outcome of the two von Mises describes, it does not seem that the current crop of politicians and policymakers will pursue this ugly, yet more desirable outcome.  Instead, they appear to be opting to kick the can down the road as long as possible, postponing the crash for as long as possible even though the crash will be worse as a result.

          My new book “Retirement Roadmap” an updated version of last year’s “Revenue Sourcing” book will be released within the next 10 days.  It offers strategies for you to consider in your own, personal financial situation to help protect you from this eventuality.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Artificial Economy and the Ultimate Outcome

          For many years now, I have been commenting on how artificial the financial markets have become.  Conditions that would have never existed a few, short years ago now exist and are explained away by many pundits as the “new normal” as if the basic laws of economics and finance have somehow recently changed.

          The basic laws of economics and finance have not changed.  At some future point, this will become evident with economic conditions emerging that are unpleasant at best.  We are already beginning to see evidence of changing economic conditions.

          The most obvious evidence of changing economic conditions presently is inflation.  While there are respected analysts who agree with the Fed’s often stated narrative that inflation will not be a long-term problem, there are at least as many who think that inflation will continue to be a problem as long as easy money policies are pursued.

          This chart illustrates the core inflation rate which has increased quarter-over-quarter by 6.1%, the most in about 40 years!

          Note that since the currency creation began in earnest in 2020, inflation has been building.  I expect that this will continue as long as currency creation continues.  I guess that puts me in the category of those who believe that inflation will be a long-term problem unless policies change.

          As I noted on last week’s “Headline Roundup” webinar, Albert Einstein once said that the ‘definition of insanity is doing the same thing over and over while expecting to get a different result’.

          To continue currency creation expecting to get a different outcome than has been the outcome to date is the very definition of insanity in my view.

          Bolstering my case is the recent behavior of many of the world’s central banks.  Many world central banks are creating currency and using that newly created currency to buy precious metals, gold in particular.

          This chart shows that the central banks of Thailand, Hungary, Brazil, India, Uzbekistan, Turkey, Cambodia, Poland, and Mongolia are among the central banks investing in significant quantities of gold.

          I have my doubts that these central bankers would be making these moves unless they were concerned about the prospects of continued, persistent inflation.

          It is this currency creation that is largely responsible for the artificial state of the financial markets and the world economy.

          Currency creation has been the policy of last resort for central bankers who used to be able to control the money supply by raising or lowering interest rates.

          Since, in our fractionalized banking system, currency is loaned into existence, central bankers could create more currency by simply reducing interest rates and could get inflation under control by raising interest rates.

          It’s important to note that raising interest rates as a policy response has not been used in earnest since the early 1980’s.

          It’s an equally important point to make that reducing interest rates to near zero over the past dozen years or so has not resulted in more money creation as it once would have.  That’s because consumers and businesses are not borrowing in sufficient quantity to create more currency.  This chart showing the velocity of money confirms this.

          Notice that the velocity of money has continued to decline.

          When money is not moving, the only way the Fed can expand the money supply is via currency creation a.k.a. ‘quantitative easing’.

          This currency creation and resultant inflation have led to real interest rates being negative.  In other words, an investor buying a low-yield bond actually loses purchasing power as the inflation rate exceeds the yield on the bond.

        The chart republished on this page illustrates the German Bond market.  Notice from the chart that real interest rates are now negative and have been for 63 straight months.

          This is now the case nearly everywhere in the world.  Presently, the 30-Year US Government Bond yield is under 2%.  As we’ve already noted the inflation rate is significantly more than that resulting in negative yields.

          Despite emerging inflation and asset prices that are at historic highs, the monetary policy is not changing.

          What will be the result?

          My forecast has long been that we will travel the economic road forecast by Thomas Jefferson who warned that we should not allow private banks to control the issue of our currency.  If we did allow private banks to control the issue of our currency, first through inflation, then via deflation the banks and corporations would essentially destroy the country.

          This past week, I read an article in “The Epoch Times” in which economist, Steven Moore was quoted.  Here is a bit from the article (Source:  https://www.theepochtimes.com/economist-stephen-moore-predicts-financial-crisis-within-next-18-months_3924539.html?utm_source=partner&utm_campaign=ZeroHedge):

 Excessive government spending and mounting national debt will likely trigger a financial crisis in the next 18 months, economist Stephen Moore warned on July 28.

“It’s a very precarious time economically for the country,” Moore told The Epoch Times during the annual meeting of the American Legislative Exchange Council (ALEC) in Salt Lake City.

“There is a debt hangover coming. And if we stay on this path that the Biden administration wants us on, I believe there will be another financial crisis.”

His comments came after a group of bipartisan senators and the White House announced a deal on an infrastructure package with $550 billion in new federal spending. Soon after the announcement, the Senate voted 67–32 to begin debate on the measure, with 17 Republicans joining Democrats.

Many conservatives including Moore believe that vote for the bipartisan infrastructure bill is a de facto vote for President Joe Biden’s larger $3.5 trillion social package that calls for tax increases and higher spending on education, child care, climate change, and Medicare expansion.

“I think sometime in the next 18 months, there will be a big correction,” Moore said.

          While I am not forecasting a ‘when’ for the big correction that Mr. Moore describes, I believe that the correction is going to be impossible to avoid.   

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Bubbles Everywhere

          On the RLA Radio program this week, I interviewed the Head of Global Research for Elliott Wave International, Mr. Murray Gunn.  I’d encourage you to listen to the entire interview on the RLA App or at www.RetirementLifestyleAdvocates.com.

          The topics that Murray and I discussed were wide-ranging but there was one underlying common denominator to our conversation – debt.

          Globally, both in the public sector and the private sector debt levels are literally at nosebleed levels.

          Long-term readers of “Portfolio Watch” know that since currency is debt rather than an asset (which has been the case since 1971) when debt levels are so high that they cannot be paid, currency disappears from the financial system.

          That’s known as deflation which results in assets like stocks and real estate being reset.

          There is no shortage of debt.  In this issue of “Portfolio Watch”, we’ll examine several areas in which debt has become totally unsustainable.

          The first area that we’ll examine is margin debt.  Margin debt is debt that is taken on by a borrower using a securities portfolio (usually a stock portfolio) as collateral.  The loan proceeds are then used to buy more securities (usually stock).  Margin loan requirements mandate that a borrower using margin debt to buy securities maintain 50% equity in his or her brokerage account.

          Lance Roberts of “Real Investment Advice” wrote a piece last week that commented on margin debt levels.  (Source:  https://realinvestmentadvice.com/bulls-buy-the-dip-but-is-the-risk-really-over-07-23-21/):

Economist Hyman Minsky argued that during long periods of bullish speculation, the excesses generated by reckless, speculative activity eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

Minsky argued there is an inherent instability in financial markets. He postulated that abnormally long bullish cycles would spur an asymmetric rise in market speculation. That speculation would eventually result in market instability and collapse. Thus, a “Minsky Moment” crisis follows a prolonged period of bullish speculation, which is also associated with high amounts of debt taken on by both retail and institutional investors.

One way to view “leverage” is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to take on excess leverage (borrow money) to invest, which leaves them with “negative” cash balances.

While “margin debt” provides the fuel to support the bullish speculation, it is also the accelerant for the reversal when it occurs. Periods of low volatility, and steadily rising prices, lead to market complacency. As noted, the last period where we saw similar levels of low volatility was 2017.

Of course, that low-volatility period in 2017 didn’t last long. The “Minsky Moment” arrived in 2018 and lasted through 2020 as price swings punctuated the markets. While this current low-volatility regime can certainly last a while longer, it is likely naive to believe the next “Minsky Moment” will be any less punishing than the last.

          Debt-fueled price bubbles are never sustainable.  This price bubble in stocks (in my opinion) has been fueled by record levels of margin debt.  Notice that margin debt levels presently are about triple what they were prior to the dot.com bubble imploding.

          Mortgage debt is up significantly as well.  Over the past five years, according to Statista (Source:  https://www.statista.com/statistics/274636/combined-sum-of-all-holders-of-mortgage-debt-outstanding-in-the-us/), mortgage debt has increased by $3 trillion dwarfing the level of margin debt tied to stocks.

          Not surprisingly, mortgage debt has increased due to artificially low-interest rates.  This massive increase in the level of mortgage debt has fueled sky-rocketing home prices. 

          Notice that the Case-Shiller Housing Index, the most commonly used measure of home prices now stands about 30% higher than prior to the real estate market collapse at the time of the financial crisis.

          This is another example of a debt-fueled bubble in my view.

          It’s common knowledge that the Fed has been using newly-created currency to purchase mortgage-backed securities.  That’s been a primary driving force behind the rapid rise in real estate prices in my opinion.

          But, the Fed has also been buying US Treasuries from member banks using newly created currency to do so.  Notice from this chart of an Exchange Traded Fund that has the investment objective of tracking the US Treasury long bond that bond prices have been steadily rising overall since the time of the financial crisis.

Another example of a debt-fueled bubble is the cost of attendance at a college or university.  Notice that as student loan debt has climbed to more than $1.7 trillion the cost of attending a college or university has also risen almost lockstep with total student loan debt.

          These are just a few examples of debt-fueled bubbles that exist, there are more.

          My point is this.  The currency creation that is presently taking place is only postponing the reset.

          Currency creation doesn’t make the debt go away, it actually allows for more debt to be added to the system, making the ultimate bust worse than it otherwise would be.  When inflation stops, deflation will be there to take its place.

          Are you ready?

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

Inflation Update

         Fed leadership and some politicians have insisted that inflation is transitory or temporary and that once the economy fully reopens, things will return to a more ‘normal’ state as far as inflation is concerned.

          They may now be changing their tune a little or at least hedging their bets.  Treasury Secretary, Janet Yellen said last week that Americans can expect more inflation than was indicated initially.  (Source:  https://www.cnbc.com/2021/07/15/yellen-sees-several-more-months-of-rapid-inflation-worries-about-impact-on-home-buyers.html0) (emphasis added):

Treasury Secretary Janet Yellen cautioned Thursday that prices could continue to rise for several more months, though she expects the recent startling inflation run to ease over time.

In a CNBC interview, the Cabinet official added that she worries about the problems inflation could pose for lower-income families looking to buy homes at a time when real estate values are surging.

“We will have several more months of rapid inflation,” Yellen told Sara Eisen during a “Closing Bell” interview. “So I’m not saying that this is a one-month phenomenon. But I think over the medium term, we’ll see inflation decline back toward normal levels. But, of course, we have to keep a careful eye on it.”

The consumer price index, which measures costs for a wide range of items, increased 5.4% in June, the fastest pace in nearly 13 years. Excluding food and energy, the gauge rose 4.5%, the fastest acceleration in nearly 30 years. Prices that goods and services producers receive for their products jumped 7.3%, a record for data going back to 2010.

Also, housing prices in the nation’s largest cities climbed nearly 15% in the most recent measurements from S&P CoreLogic Case-Shiller.

All of that has added up to concern that inflationary pressures could stall the aggressive U.S. economic recovery, with the housing escalation raising fears of a bubble.

“So I don’t think we’re seeing the same kinds of danger in this that we saw in the runup to the financial crisis in 2008,” Yellen said. “It’s a very different phenomenon. But I do worry about affordability and the pressures that higher housing prices will create for families that are first-time homebuyers or have less income.”

          I’d like to make a prediction – the inflation narrative will continue to change as inflation becomes increasingly, painfully obvious.  The narrative has already changed from transitory to some persistent inflation.  When the narrative changes again, there will be something or someone to blame other than the Fed policy.

          The narrative will HAVE to change; the officially reported inflation numbers are attention-getting and the officially reported numbers are a far cry from reality.  This from Birch Group (Source:  https://www.birchgold.com/news/thirty-year-inflation/?msid=94970&utm_source=market_update&utm_campaign=newsletter_071721&utm_medium=email):

Consumer prices increased 5.4% in June from a year earlier, the biggest monthly gain since August 2008.

That’s what Jamie Cox of Harris Financial Group meant when he told CNBC, “The headline CPI numbers have shock value, for sure.”

Yes indeed. This is the largest one-month jump since 2008. If you take the “lowest of the lowball” Core CPI measure, which ignores food and energy prices (because nobody really needs to eat, right?) the June annual inflation rate is only 4.5%, the biggest jump in 30 years.

The article called this rise “higher than expected.” That’s one way of putting it. Like saying a wreck that totals your car is “inconvenient.”

We shouldn’t worry, though! This is just transitory, just a blip of supply chains and post-pandemic pressures relaxing. Remember?

Well, not everybody’s buying that anymore.

Sarah House, the senior economist for Wells Fargo, said:

‘What this really shows is inflation pressures remain more acute than appreciated and are going to be with us for a longer period. We are seeing areas where there’s going to be ongoing inflation pressure even after we get past some of those acute price hikes in a handful of sectors.’

“More acute than expected” means, higher than the Fed said.

“For a longer period” means, longer than the Fed said.

“A handful of sectors,” hmm. Let’s take a closer look at that.

Here’s a CNN snapshot of the current inflation situation. It’s incomplete but more realistic than the vague numbers we discussed previously.

Ms. House’s “handful of sectors” turned into these thirteen specific price categories, according to CNN.

Admittedly, there is a bit of cherry-picking going on. Overall, food prices have increased 2.4% year over year, so if you don’t eat bacon or fruit or fresh fish or drink milk, your grocery bill hasn’t gone up quite as much.

Although this number didn’t make it onto CNN’s graphic, a New York Fed survey anticipates:

  • +9.4% healthcare prices
  • +6.2% housing prices
  • +9.7% rent payments

It’s really difficult to look at these numbers and understand how they all add up to an overall inflation rate of 5.4%… Still, personal inflation rates are idiosyncratic. If you eat bacon and fruit every day, you’re going to pay more for groceries than people who only eat canned beans and ramen. If you work in transportation, the huge increase in gas prices are probably your major concern.

Your individual situation dictates just how much you’re hurting from inflation. Generally speaking, though, these price rises affect the entire nation.

          Inflation affects everyone.

          Inflation is just another tax.

          The current crop of policymakers are following the actions of many policymakers at various times historically.  When debt levels get high enough and can no longer be addressed via tax increases, only two options remain – cut spending or print currency. 

          When currency is created and inflation results, goods, and services cost more for everyone.  This additional cost for goods and services is a tax that disproportionately affects the poor; those that currency creation was ostensibly going to help.

          The numbers bear that out.

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