Tuesday, April 11, 2023

Brave New Overleveraged World

 A loyal reader asked a pointed question: is this the worst market mispricing ever? (Thanks AKOC).

Perhaps it is. Why? 

Because the entire global economy is grossly overleveraged on a fundamental basis.  

When we think of markets and leverage we think of margin debt, derivatives, corporate debt, etc.  This was certainly the case in 2007-10 during the Great Debt Crisis, which was "resolved" when the US and EU central banks and governments stepped in and assumed the debt. Private sector debt became government debt, with lots of it sitting in central bank balance sheets. The problem was - literally - papered over.

Then came deflation (thank you China and you cheap manufacturing juggernaut), interest rates went to zero or lower, and for almost a decade everyone forgot that debt carries a servicing cost (interest). Even the worst serial bankrupt in Europe came back and tapped markets for fresh debt (Greece).  It had to mortgage its silverware for 99 years, but.. it did.

COVID changed everything: American, European and Japanese governments panicked and printed money like never before.  They made 2008-10 QE look like a statistical aberration by comparison (see charts below).

United States Federal Reserve  Balance Sheet Assets

European Central Bank Balance Sheet Assets

 
Bank of Japan Balance Sheet Assets

Looking at the charts we can draw only one conclusion: the West is fundamentally extremely overleveraged.  Central banks are financing the economy - take that out and what remains? Let's remember that central banks are regulators and lenders of last resort, not day to day financiers.  By trying to stay in the economic race the West is shooting itself in the foot.

Who is doing things differently?  The second largest economy in the world - China.  Its economy is growing rapidly - yes, it created a real estate lending bubble of its very own in the process - but, in general, it has kept its central bank's nose clean (see chart below).  

Back in 2006-07 I started this blog by posting just a few charts of debt going through the roof. They seemed self evident to me, but it took a couple of years until the doodoo hit the fan.  Today, the first three charts seem just as self evident, so I'll leave it at that.


27 comments:

  1. china wise... I strongly suspect they make up all the numbers... =)

    more seriously though,... we sound like some kind of end-of-the-world fanatics... I wonder though.... time will tell...

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  2. I hate to think of myself as a Cassandra, but then I remember that Cassandra was right!

    All kidding aside, the world certainly won't end if stocks, bonds or derivatives go down significantly. I am really puzzled with how an "always up" market has come to be absolutely expected 100% of the time and any correction is seen as a disaster. In itself, this is a major bubble indicator...

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    1. Just for the record... I agree assets prices are going down significantly in real terms..., I am not sure that they will go down nominally... =)

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  3. Hello Hellasious You maybe remember me, a French reader who lost his German grandfather more or less were the second, or even first world war is fought again this time only slightly more west of the Don river than 80 years ago. I went away from your blog in about 2016/17 when you drastically decreased your number of publshed of articles here AND you wrote that the American banks were in far better shape the European banks, which I never could 100% believe. A few days ago I found the bookmark for your blog at the end of the list. So you begun to write again. Thank you !

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    1. Hello Arnould, welcome back - glad to see you again!

      After the near cataclysm of 2007-10 things got somewhat boring, so to speak, and I eventually stopped writing. Some personal stuff also got me busy.

      I see things getting pretty nasty again, this time on a broader scale involving whole nations because they have printed so much money/debt. So, I'm back...

      Stick around, I think we're in for a long ride this time :)

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    2. After negative interest rates which back in 2010 I never thought would be possible, "they" may invent something to kick the can, as you say... I wonder what this shall be ?

      For the info of your readers here : my grandfather was not a nazi, on the contrary, we think that he was sent to the russian front because he said to someone (his best friend...) that he did not think that Germany would win. He had 3 very young children and my not yet born mother when he totally disapeared on Feb. 13. 1942. He was a peasant, in the army his job was to look for the horses which he loved to do. War is ugly.

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  4. Might be an amateur and broad question: could this lead to the implosion of the dollar?

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    1. By H. Not at all amateur :). Yes, it could. The fear of such a result is even driving cryptos up once again.

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  5. There's also the possibility that the West, and the US, just chugs along. What are the alternatives? A dystopian dictatorship (China), or a genocidal fascist dictatorship (Russia)?

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    1. By H. I think the West will “chug” along, indeed. But “chugging” is not “leading”.. and under our current socio-economic model (Permagrowth) chugging is just not good enough.

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    2. Gerald O'Hara : [the men are discussing the prospect of going to war with the North] And what does the captain of our troops say?

      Ashley : Well, gentlemen, if Georgia fights, I go with her. But like my father I hope that the Yankees let us leave the Union in peace.

      Man : But Ashley, Ashley, they've insulted us!

      Charles Hamilton : You can't mean you don't want war!

      Ashley : Most of the miseries of the world were caused by wars. And when the wars were over, no one ever knew what they were about.

      Gerald O'Hara : [the other men protest] Now gentlemen, Mr. Butler has been up North I hear. Don't you agree with us, Mr. Butler?

      Rhett Butler : I think it's hard winning a war with words, gentlemen.

      Charles Hamilton : What do you mean, sir?

      Rhett Butler : I mean, Mr. Hamilton, there's not a cannon factory in the whole South.

      Man : What difference does that make, sir, to a gentleman?

      Rhett Butler : I'm afraid it's going to make a great deal of difference to a great many gentlemen, sir.

      Charles Hamilton : Are you hinting, Mr. Butler, that the Yankees can lick us?

      Rhett Butler : No, I'm not hinting. I'm saying very plainly that the Yankees are better equipped than we. They've got factories, shipyards, coalmines... and a fleet to bottle up our harbors and starve us to death. All we've got is cotton, and slaves and... arrogance.

      Man : That's treacherous!

      Charles Hamilton : I refuse to listen to any renegade talk!

      Rhett Butler : Well, I'm sorry if the truth offends you.

      Charles Hamilton : Apologies aren't enough sir. I hear you were turned out of West Point, Mr. Rhett Butler. And that you aren't received in a decent family in Charleston. Not even your own.

      Rhett Butler : I apologize again for all my shortcomings. Mr. Wilkes, Perhaps you won't mind if I walk about and look over your place. I seem to be spoiling everybody's brandy and cigars and... dreams of victory.
      chicken

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  6. btw Hell, or anyone here... do you have an explanation for why credit suisse failed? ... I can't seem to find a reason.... there is some talk about this scandal and that.. losses here and there... but do these things really add up to a major bank failure.... ?... leaves a lot of question marks...

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    1. It wasn't just one thing... CS had suffered several setbacks in recent years from Archegos and Greenhill to management upheavals. At one point depositors removed over $120 billion necessitating the bank to seek a cash lifeline, which its major shareholder (Saudi National Bank) refused to provide. At that point it was game over.

      I doubt it will be the last bank to fail, particularly if inflation stays stubbornly high or even goes up again (oil prices are ramping up again..).

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    2. but that feels like a statement that CS was fundamentally unprofitable... which I would also infer from its share-price.... which leads me to feel strange.... a bank can fundamentally unprofitable?..... I don't think I have ever heard of such a case... cash strapped yes... heavy mis-investment yes... but fundamentally unprofitable?...

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    3. FY2022 accounts of Bank of America show 113.5 billions USD of Unrealized Losses on a portfolio of Securities (Treasuries, MBS) of 867 billions USD (Note 4 - Securities). If people massively withdraw deposits from BoA it will go bust like SVB, unless the Fed steps in again.
      Like Senator Sinema said to Michael Barr (Fed Vice Chairman) during the Senate Banking Committee Hearing on March 28th : "When people on Reddit and Twitter can spot bank mismanagement before the regulators something is terribly wrong" !
      Investment banking and retail banking should never be allowed to be in the same entity because the "betting part" of the bank puts people deposits at risk.

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    4. ok, I think I understand... it is SVM on a large scale..

      basically the rise in interest rates means the banks have lost a lot of money on so called safe assets like U.S. treasuries. If we mark to market, the banks may be bankrupt. However, because they can hold the treasuries to maturity and thus recover the original value, the banks are also not bankrupt.

      The upshot is that many banks are now extremely vulnerable to bank-runs... and everyone is busy feeling their way forward... more to the point... the Fed probably cannot raise interest rates anymore... if inflation does not disappear now, the magic trick is up... everyone will know the Fed cannot control inflation....

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    5. "if inflation does not disappear now, the magic trick is up... everyone will know the Fed cannot control inflation...." BINGO! Very well said.. and the reason why I continuously harp so much on getting rid of the excess liquidity (QT) as the ONLY way to seriously kill inflation.

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    6. BTW, Apple's 4.15% savings rate is going to force banks to finally raise their deposit rates from 0% to 4%. Or they will suffer bank run which leads to an inevitable collapse. OTOH, their meager profit margin will be squeezed or go negative if deposit rates go to 4% when nearly all their outstanding loans are collecting sub 5% interest rates. The upcoming banking collapse is going to be spectacular.

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    7. Hi anon: really interesting point... would love to hear Hell's take on it...

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  7. Brave new world indeed with the VIX at 16 and change... what gives?

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    1. hey camabron... yeah,... reading through what I wrote, I dun thing it is that clear...

      I think the direct danger is not bank runs... but rather the measures the Fed has to take to prevent bank runs. It repo facilities it is using to provide liquidity are essentially QE... if this accelerates, we are in danger of a never ending (or even ever accelerating) QE...

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  8. In re Apple savings rate... I'm not sure it will make much of a difference to the banking world. The median balance of savings accounts in the US is a mere $5.300, so it's not exactly what banks rely on to fund themselves, ie that's not where the money is.

    Instead, the financial world relies heavily on institutions and UHNW individuals, many of them with money located abroad in tax havens. As I have said frequently, the wealth pyramid is very, very narrow at the top - very few people/institutions control a huge percentage of the wealth. They don't care what Apple pays, of course...

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    1. I don't think smaller (regional/community) banks' deposits come from UHNW individuals.

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    2. Not directly, but they certainly get liquidity through the interbank market.

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    3. "Not directly..."

      Liquidity does not help if the banks are forced to realize losses due to loss of deposits (to Apple.)

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