Jim Rickards – Dennis Tubbergen

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 Bloomberg, the 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.

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Precious Metals Outlook and Inevitable Changes

As I suggested last week, metals markets continued to consolidate after a big run-up. Further consolidation or pullbacks are likely but long term, I expect precious metals to remain in a bull market.

In the September issue of my client newsletter, the “You May Not Know Report”, I illustrate the volatility that has often existed historically in metals markets. The chart on this page, published by past RLA Radio guest, Jay Taylor, illustrates the price volatility of gold priced in German Marks during the Weimar Republic hyperinflation.

While gold priced in German Marks increased by a rather remarkable factor of 100 trillion, it was far from a smooth ride as one can see from the chart reproduced here.

The red line on the chart shows the monthly price change in gold priced in German Marks while the solid line on the chart shows the overall price direction.

Also, in the September issue of the “You May Not Know Report”, I discuss three areas of dramatic change that is occurring due to Federal Reserve and political policy. The piece was written from more of an opinion perspective but is based on facts and current trends.

In this week’s post, I’ll offer you a condensed version of these emerging trends and discuss how they may affect you. As is often the case, these emerging trends are due, at least in part, to unintended consequences of Fed and political policies.

To get to the point, where we live, how many of our children are educated and how we receive healthcare are all changing quickly for many Americans.

Let’s begin with where we live. As past RLA Radio guest Jim Rickards recently noted there is a lot of hard evidence to support the fact that those who have the ability are leaving big cities in droves.

He notes that the cost to rent a U-Haul trailer to move from Los Angeles to Sedona, Arizona is four times the cost to rent the same trailer to move from Sedona to LA. The same is true when renting the same U-Haul to move from New York City to the Catskill Mountains.

Rickards states that there are three reasons for this migration and compares it to the Dust Bowl migration of the 1930’s when desperate people moved west to seek jobs in the California agricultural industry. Now, ironically, the move is in the opposite direction.

The first reason is that millennials are getting older. In just a couple of years, the oldest of the millennial generation will turn 40. While city life is appealing to many, if not most twenty-somethings, it’s not as appealing to many who are approaching 40.

The second reason is the current pandemic. It’s no secret that rural areas have not been hit as hard as densely populated areas like New York City.

The third and primary reason is the riots. Many city dwellers who fear for their safety and the protection of their property are simply leaving.

Rickards points out that those who are leaving the city are the people you don’t want to leave – those with assets, talent, and energy are those who have the option to exit. Rickards notes that this will have a devastating economic impact.

Something similar is happening in education.

While many of those who have the financial ability to leave the cities are leaving, many parents who have the ability to pay to educate their children are also doing so, bypassing the traditional education system.

With many states mandating that classes be held remotely this fall; many parents are stepping up and taking responsibility for the education of their children. Learning pods are gaining in popularity. A learning pod has a few families who combine resources to hire a private teacher to educate their children.

I am aware of families with school-age children who are electing to establish learning pods. One such family of which I am aware has teamed up with three other families and hired a full-time teacher to educate six children. Each family pays a share of the teacher’s salary.

This is a good option for affluent single-parent families or two-parent families where both spouses work. But it is only an option for those who can afford it.

Healthcare is also changing since many “non-essential” medical services were suspended as part of the lockdown response to COVID-19.

There is a growing movement of physicians who don’t take health insurance and charge patients a monthly fee for access to health care. These doctors are unaffiliated with a hospital or healthcare group and work independently. These practices are known as direct primary care practices and they’re growing in popularity.

Yahoo News reports that monthly membership fees to join a direct primary care practice range from $50 to $150. That fee covers office visits and the member patient typically gets drugs from the physician at much lower prices.

A direct primary care membership makes a lot of sense for many people but once again, it is only available to those with discretionary income.

Here’s the probable reality of these trends.

Once an affluent person leaves a city, they’re likely not returning. Many families who decide to take control of the education of their children will find that they prefer the individualized instruction their children receive, and they won’t return to the traditional education system. And, those who become members of a direct primary care practice may find it difficult to return to waiting a month or more for an appointment when choosing to get their medical care more traditionally.

The unintended consequence of these government policies is citizens taking action to avoid the regulations that negatively affect them. Arguably, it has been these policies and the Fed enabling these policies via money creation that has been the primary cause of the wealth gap and social unrest.

And, this is not new. Nearly 10 years ago in the book “Economic Consequences”, I explored the idea of unintended consequences in detail. Here is an excerpt of just one example of unintended consequences from that book:

The City of Detroit is a perfect example of failed regulation, failed bureaucracy and unintended consequences. The Model City program, initiated by President Lyndon Johnson in 1966 as part of his Great Society programs poured a total, of about $1 billion into the City of Detroit to attempt to revitalize the inner-city slums.

The result?

By the mid 1990’s, the Model City area lost 63% of its population and 45% of its housing units. In 2009, an auction was held to sell over 9,000 seized homes and lots many located in the Model City area. Only 20% of the properties sold despite the fact that bidding began at just $500 on many properties.

If you’re not familiar with the Model City program, here is some background as it relates to the City of Detroit. In Detroit, the Model City program attempted to turn a nine square mile area into the government’s idea of a model city. Government bureaucrats were telling people where to live, what to build and which businesses should be opened and closed. In return, people received cash, training, education and healthcare.

Immediately after the Model City program was initiated, 22,000 middle- and upper-class citizens moved out of the city. These folks simply didn’t like paying higher taxes and being told what to do. In July of 1967, police attempted to break up a party in the middle of the new Model City; their efforts resulted in a race riot that was one of the worst of the 1960’s. The Mayor of Detroit feared that additional police presence might only make matters worse, so he did nothing to stop the riots. Five days later, President Lyndon Johnson sent in 2 divisions of paratroopers in order to settle things down. Over the next 18 months, another 140,000 people exited the city, almost all of them middle and upper class.

Instead of coming to the realization that this type of central planning didn’t work, in 1974 the program was expanded under the Community Development Block Grant Program. Under this program politicians and bureaucrats would decide which groups and individuals would receive funds for various renewal programs and efforts. Despite these efforts, the exodus from the city continued.

Today, with the population of Detroit down to just over 700,000 from about 2 million in the 1950’s, the unintended effects of the Model City program are clear.

If we update those population numbers for 2020, the population of the City of Detroit now stands at about 667,000. That’s about 1/3^rd of the city’s population in 1950.

Pretty much the only folks left in Detroit are the ones who don’t have an option to leave.

Today’s policies are likely to have an even more devastating impact on the less affluent. Not only will many big American cities meet the same fate as Detroit, education, and healthcare will also be negatively affected.

Bailout or Not: Many States and Cities Are In Trouble

As I suggested might happen on my “Portfolio Watch” live webinar last week, both gold and silver pulled back after big, parabolic moves up. It would not be unusual to see the pullback continue for a bit or to see these markets consolidate. From a fundamental perspective, I remain bullish on precious metals.

By my technical measures, stocks are now once again in an uptrend. I remain very skeptical of stocks given that stock valuations using the market capitalization to gross domestic product ratio is at all-time highs.

This week, I’ll examine the financial state of many states and cities around the country. In a word, many states and cities have finances that are abysmal.

John Rubino of dollarcollapse.com and past RLA radio guest had this to say on the topic last week (emphasis added):

Lacking monetary printing presses, US cities and states tend to behave more like normal economic entities than do most nations. That is, they’re always balanced on the knife-edge of insolvency as taxes fail to cover the promises, legitimate and otherwise, that mayors and governors have made to voters.

Toss in the covid-19 lockdowns and – in a few especially badly-run places, continuing riots – and many if not most American cities and states are looking at functional bankruptcy, featuring mass layoffs of teachers, cops, librarians and pretty much every other kind of employee. Trash won’t be collected, libraries won’t open, 911 calls won’t be taken.

To repeat the guiding prediction of this series, American towns will look more like Caracas than Zurich.

The one hope mayors and governors have been nursing is a massive federal bailout that papers over unfunded pensions and ongoing operating deficits alike with trillions of newly created dollars.

This prospect seemed imminent just a couple of weeks ago. After all, in an election year how can Washington allow the above carnage? But now imminent seems to be off the table and even “inevitable” is in question. Republicans (who don’t much care about big cities run by the opposition) and Democrats (who desperately want a bailout, but maybe not as much as they want to crush Trump in November) can’t agree on a new plan and have, for now at least, given up trying.

Mr. Rubino references an Associated Press article in his piece (emphasis added):

Stay-at-home orders in the spring, business shutdowns and tight restrictions on businesses that have reopened are slamming state and local government revenue. In a June report, Moody’s Analytics found that states would need an additional $312 billion to balance their budgets over the next two years while local governments would need close to $200 billion.

Many states already are staring at ledgers of red ink. Texas is projecting a $4.6 billion deficit. In Pennsylvania, it’s $6 billion. In Washington state, the deficit is expected to be nearly $9 billion through 2023. California’s budget includes more than $11 billion in cuts to colleges and universities, the court system, housing programs and state worker salaries.

Will the Washington politicians bail out state and local governments?

This being an election year, there will probably be some additional form of stimulus package and it’s important to remember that regardless as to the extent that state and city governments are included in the package, there is no money to pay for such a package without once again resorting to the printing press and simply creating the money that is needed to fund any additional spending.

That’s the problem. Nothing is free. There is ALWAYS a tax to pay, either an actual tax where the government has you parting with some of your hard-earned dollars or an inflation tax where the value of the currency is diminished.

An inflation tax punishes savers and investors.

On this week’s RLA Radio program, guest expert, Peter Schiff, commented that presently 60 cents out of every dollar that the United States spends is created by the Federal Reserve.

As next weeks’ RLA Radio guest, Jeff Deist, president of the Mises Institute and former advisor and chief of staff to congressman Ron Paul noted, when the year 2020 began a $1 trillion operating deficit at the federal level was anticipated.

Now, however, the reality of the situation is that the United States could finish the year with an operating deficit that exceeds total tax receipts. That is simply remarkable when you think about it. And, it’s completely unsustainable.

While it remains to be seen if the Washington politicians decide to bail out states and cities and to what extent, it’s likely that many states and cities will require more than one bailout even if they get their first one.

I reach this conclusion for a couple of reasons.

First, state and city tax revenues will continue to decline as lockdowns in response to COVID continue to force more businesses to permanently close. As I have reported here, many businesses that closed temporarily to comply with lockdown restrictions are now closed permanently. Businesses that are permanently closed no longer pay taxes.

Second, there is literally an exodus taking place from many states and municipalities as people are seeking out peaceful country living. This will further diminish tax revenues in these areas. Past RLA Radio program guest, Jim Rickards had this to say on the topic (emphasis added):
I want to discuss some of the permanent changes that the national economy is going through. It has to do with what you might call the Great American Exodus. There’s a massive migration out of the big cities. Millions of Americans are fleeing the cities for the suburbs or the country from coast to coast.

There’s hard data to support that claim.

For example, let’s say you want to rent a U-Haul trailer from New York City to the Catskill Mountains, which are not that far away. Or you want to rent a U-Haul trailer from Los Angeles to, maybe Sedona, Arizona.

It’ll cost you much, much more than if you were going the other way. If you went from Sedona to LA, or the Catskills to New York, the price is only about one quarter as much. In other words, you have to pay a 400% premium to get the trailer going out of town, but U-Haul will practically pay you to bring it back in.

And there are shortages. If you’re moving out of your apartment to a house or another apartment outside of the city, try getting movers. I’ve done this recently myself, and know others who have. It was very hard to book moving companies or something as simple as a U-Haul trailer.

So the mass exodus out of cities is a real phenomenon, backed by solid evidence.

This is a shift we probably haven’t seen since the 1930s, when people left the Dust Bowl and moved out to California, looking for jobs in the agricultural industry. That was a mass migration. We’re seeing another one now, except this one’s going in the opposite direction.

And that’s a big problem for the economy because cities are centers of economic activity that contribute a lot to GDP.

Rickards cites three reasons for this mass migration.

One, millennials are getting older. The first of the millennial generation will turn 40 in a couple years. It’s normal for people who enjoyed living in the city in their 20’s and 30’s to want to move to the country as they get older.

Two, the pandemic. Highly populated areas are inherently more dangerous when it comes to virus transmission. Many people are looking to minimize that risk by moving to less populated areas.

Three, the riots. Peaceful protests are protected by the constitution. Peaceful protests against injustices should be supported. But, no one has a right to loot stores and burn buildings; that shouldn’t even be a debate.

Rickards adds that calls to defund the police are making many city dwellers see the writing on the wall and they’re opting to move while they can. Rickards notes that crime rates in New York are already rising and since the riots, retirement applications among police officers have increased by 400%.

No matter the amenities offered by city life; if citizens perceive it to not be safe, many will understandably opt to move. And they are.

Rickards concludes by saying (emphasis added):

Now, you cannot underestimate the economic impact of this. The cities are where most 80% or more of the population, economic output, job creation, and R&D are centered. And who’s leaving the cities?

It’s the people who can have the option to leave. It’s the talent. It’s the money. It’s the energy. It’s the people that you most want in your cities who have the ability to leave.

And of course, now we have this whole work from home model. So a lot of corporations are saying, we don’t need 10 floors on 53rd and Park Avenue. We can do two floors of shared conference facilities, with a shared receptionist. So the commercial real estate market faces some strong headwinds.

The bottom line is, we’re looking at a substantial drag on economic recovery based on this migration out of the cities. It’s a big story that’s not getting nearly enough coverage.

As economic recovery lags, so do tax revenues. As people leave cities, taxes these people would have paid leave with them.

The facts are pretty clear. One bailout of states and cities will lead to another. And if you’re a saver or investor, you’ll be paying for the bailout via the inflation tax.

There is still time to protect yourself. If you’ve not already done so, consider using the two-bucket approach to manage your assets.

You might also be wise to see if it makes sense for you to eliminate the tax liability on your IRA or 401(k) while tax rates are lower. My office can help. If you’d like an analysis done on your ultimate income tax liability on your retirement account(s), give the office a call at 1-866-921-3613.