Thursday, September 23, 2021

Evergrande As Lehman? No, But…

 Is Evergrande China’s Lehman? No, it isn’t. But it may very well be its Countrywide Financial.  

Countrywide rose spectacularly on the back of the US real estate bubble by writing an enormous amount of home mortgages that were packaged by Wall Street into all kinds of MBS (mortgage backed securities). At the top of the bubble, lenders couldn’t care less about the creditworthiness of the borrowers. 

Countrywide’s collapse was one of the first signs that the Credit Bubble had burst. Its stock started plunging in mid 2007 and the company was bought out by Bank of America in January 2008 (BOA has regretted it ever since). 

Lehman, on the other hand, filed for bankruptcy much later, in September 2008.

Evergrande is one of China’s largest real estate developers, concentrating on building and financing huge residential properties. It finances its projects through… did you guess it?… bond-type investment products sold to retail and institutional investors. So, no, Evergrande is not Lehman. But it looks awfully similar to Countrywide.

Wednesday, September 22, 2021

Sudden Debt Limit

 The US debt limit now stands at almost $29 trillion and has already been exceeded by a tad, with the Treasury employing emergency-type funding techniques to keep paying its bills (mostly wages). 

Congress needs to vote an increase on the limit, but Democrats want a moratorium on the limit until the end of 2022 (ie no debt limit until then), while Republicans want no increase whatsoever. In other words, they are polar opposites.

Looking at the chart below I can’t really blame the Republicans…. On the other hand, I see the need for immediate investment in infrastructure, particularly in the sustainable energy sector. 

How about this radical idea: BALANCE THE BUDGET! It’s not rocket science, just make sure taxes are raised back to a sustainable level. Trump pushed corporate and individual tax rates to record lows, so there is plenty of room to raise revenue.

Here’s a compromise: a small debt limit increase to tide things over now combined with an immediate significant tax increase on corporate, individual and capital gains income at the high brackets, plus a modest annual tax on large wealth.

It is high time for the US to understand it can’t print its way out of trouble ad infinitum..  

Tuesday, September 21, 2021

The Demise Of Casino Capitalism

Banking, finance and markets exist to make the economy run smoothly. From money transfers and currency exchange, to raising capital for new or existing companies, their role is supportive and secondary. Finance is like a dog’s tail: basically useless except for maintaining balance. And, like I’ve said many times before, in the US the tail is now wagging the dog.

Finance, insurance and real estate (the FIRE tail) accounts for an enormous 22.3% of America’s total GDP, nearly double professional services, the second largest sector.  If we add Government, another sector that acts as an economic facilitator as opposed to being a primary producer, the total rises to an astonishing 35% of GDP. (Keep this in mind, I’ll revert to it at the end).

By stark contrast, Manufacturing which was once America’s proud creator of the currently evaporating middle class, has shrunk to fourth place at a mere 10.8%..

Looking at financial businesses alone, their share of GDP has quadrupled to nearly 9%.

The “financialization” of the economy may produce enormous and quick rewards for those select few who can take advantage of it, but it does absolutely nothing for all the rest. I mean, hedge fund managers are making $1+ billion per year, but employees at the companies whose stocks he/she is trading often need food stamps to survive (keep this in mind, too).

Like all bubbles, the finance economy has gone to extremes. While you may dismiss some crazy instances like GameStop, DogeCoin and “art” NFTs as one of a kind aberrations, you can’t ignore what is happening to the overall stock market.  Its total capitalization now stands at an all time high 200% of GDP, well above the 140% reached during the dotcom mania (1999-2000) and double the level of 2007, right before the Debt Bubble burst.

Is this casino capitalism economy sustainable? Of course not, the tail can’t keep wagging the US dog, particularly when there are other much less waggy dogs out there nipping at its heels (eg China, as Biden himself put it, “is having our lunch”).
Final thoughts: the US won the Cold War when the USSR collapsed, seemingly within days. At the end, USSR was spending almost 20% of its GDP on defense while its middle class had to scrounge to find even basic necessities. It’s not a perfect parallel to the US today, of course, but it sort of rhymes, just substitute finance for defense.

There is one major difference: unlike the USSR, in the US the average Joe can dream of hitting it big by hard work, guts and brains, even if his/her chances of success are actually minimal. Americans, however, have (finally?) come to realize that the American Dream is now pie-in-the-sky, a situation creating huge dissent and class division. Never before  have mainstream American politics been so decisively shaped by polar opposites like Trump and Sanders. 

Here’s a question: could America’s version of Casino Capitalism collapse almost overnight (in a historical time scale)? 

Monday, September 20, 2021

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part V)

 ….continued from previous posts…

Part V - Thought Is Faster Than Light

On Part II of the series I laid out six concerns that could produce an unprecedented crash. Number two:

Speed: computers have made everything faster. Communications, transactions, manufacturing, transportation, logistics, decision making. Reaction to anything is nearly instantaneous.

I would like to expand on this a bit more, though from a non-technological perspective. 

While algorithmic and high frequency (flash) trading are still very prevalent in today’s markets, I’m not looking at them today. Instead, I want to focus on the one thing that seemingly travels faster than light: thought, including the subcategories of memory and feelings. (Yeah, ok, the brain, too, works via electrical impulses, but you get my point).

In my opinion, most everyone active in markets today, amateur or pro, individual or institution, knows (ie thinks, feels) that the US stock market is currently driven by momentum alone, completely detached from all fundamentals such as price to book, price to earnings, dividend yield, etc. The basic reason everyone mentions when asked “why buy or own stocks right now?” is: “because they are going up.”  

You don’t have to go far for proof, just look at the wildly popular SPACs. People are willing to subject themselves to an immediate loss of their capital (due to SPACs origination fees, commissions and expenses) to invest in nothing  tangible, just a promise that whenever the SPAC merges with whatever, the result will be something that will go certainly up. Speculation on momentum, and nothing else. 

Since everyone knows this, that the market is hanging on momentum alone, how quickly will everyone jump ship once momentum shifts? How quickly will the thought of exuberance transform to panic?  Remember, retail speculators today don’t even have to call a broker to place a sell order (he/she may change a speculator’s mind), it’s all a button on an app on a phone. There are no brakes in the system.

Today, market information is disseminated instantly to all, and the thoughts/feelings it produces, ranging from greed to panic are also transformed into action instantly. The classic KAL cartoon below sadly belongs to another era…there’s too much of a delay.

All right, maybe an old cartoon isn’t exactly convincing to you. How about what happened today to a Chinese property developer’s stock trading in the Hong Kong exchange, down 95% in one day - see chart below. Fast enough transmission of fear for you? (On the heels of Evergrande… sounds like Souza’s USMC march, doesn’t it?)

Saturday, September 18, 2021

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part IV)

….continued from previous posts…

Part IV - It’s Only Money

Some years ago a gentleman I worked with at an investment bank had a saying: “It’s only money”. John K. was at least 20 years my senior, having started his career in the early 1960s. At the time, I thought he was merely being sentimental, as in “money can’t buy you love”.  It took me a while to realize that John was being literal and was referring to markets.

Market prices are marginal, ie they are determined by incremental, instead of total, supply/demand and, since they float on a sea of money they rise and fall along with its ebb and flow. John was right: it’s only money. Emphasis on only.

It’s even more so with stocks, since unlike, say, wheat, they have no tangible underlying physical demand and are therefore priced at multiples of other markers like earnings, sales, assets, etc. You can’t eat stocks or, these days, use them as wallpaper; furthermore, their prices are derived from a consensus view of the future, since just about everyone ignores the past. 

Therefore, tongue in cheek, how are stocks any different from Papal indulgences? After all, you pay a given price for a stock today because you believe it to be a fair representation of the future. We call it a discount mechanism, but it is merely one more article of faith in the Permagrowth religion. The more you believe, the more you pay. 

But, wait a minute… what about “it’s only money”? Show me the money, cries the unbeliever - so voila: the connection between money/more money/much more money and share prices is obvious, as you can see in the charts of M3 and S&P 500.

Lest we forget, I’ll end today’s post with a reminder: money is debt. More money is more debt. Much more money is much more debt. 

Why the reminder? Two reasons:
  1. Some will argue that more money/debt is a natural consequence of higher GDP and therefore there is nothing to worry about. False: Debt/GDP is now the highest in US history. Today it takes four times more debt dollars to produce a dollar of GDP than it did in 1980. Debt to GDP has soared from 30% to 125%.
  2. Bubbles initially thrive on debt (leverage) but are eventually poisoned by an overdose of it.The bigger the leverage, the bigger the crash once the bubble is popped. Unprecedented debt therefore will, by default (pun intended), result in an unprecedented crash.
And there you have it…. I may write one more post in this series to include the other elements mentioned in the second post, not sure yet.


Friday, September 17, 2021

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part III)

 …. continued from previous posts…

Part III - Permagrowth As A Runaway Reaction

Continuing from yesterday’s post, let’s put together all six points and apply them to our dominant Permagrowth socioeconomic model. (If you haven’t read my posts before, Permagrowth is my term for the incessant expansion of everything, from population and consumption to money supply and debt.)

Permagrowth is much more than an economic model. Above all, it is a way of life where “more is better” has become rigid and unquestionable dogma. It comes closer to the unshakeable faith in Heaven and Hell dominant in 16th Century Catholic Europe than, say, the economic theories developed by Adam Smith, Keynes, Friedman, or even Marx. In other words, Permagrowth is now a religion. If you don’t believe me, ask anyone why they buy the latest iPhone.

The Pope sold indulgences so that sinners could get into Heaven by paying a steep price in cash. Likewise, Permagrowth devotees are fundamentally convinced that everyone will be “saved” with more money, higher prices for assets, more wealth on paper. Our sins of raping the environment, depleting precious habitats and unleashing natural disasters (eg COVID) are all washed away by … higher stock or real estate prices.

Then came Martin Luther’s Ninety-Five Theses and within just one day in Wittenberg the world changed.

Only Faith In God Decides Who Is Saved, Not Money 

(Only You Can Change The World, Money Can’t 😜)

Change can occur with lightning speed when conditions are right. But it comes as a shock to those lulled into apathy by what they perceive as “normality” in the period immediately preceding change. It was “normal” for the Catholic Church to sell indulgences since the Pope ex cathedra was infallible and God’s sole representative on Earth. It was “normal” for the USSR to produce thousands of nuclear warheads but not enough toilet paper. Dogma and apathy trump common sense every time - until they don’t.

How “normal” is Permagrowth today? My thesis is that it is utterly untenable, that constant expansion has become a runaway reaction that can no longer be contained in its reactor vessel. Think Union Carbide and Bhopal, India writ on a global scale. Its deleterious products are spilling over: not only climate change and habitat destruction, but socioeconomic and geopolitical dislocations are just as rampant. And it’s happening fast - very, very fast.

I could give dozens of examples, but if you’ve been reading this blog you can easily identify them. The most ardent acolyte of the Permagrowth religion is the stock market, particularly in the anything-goes US. 

I’ll be focusing on that in the next post.

…. to be continued…

Thursday, September 16, 2021

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part II)

 …continued from Part I. 

Hopefully I didn’t bore you with ancient history and you are now reading …

Part II - The Big Six 

The basic idea behind this series of posts is that I have never before experienced such extreme conditions in the economy, geopolitics and markets in 40 years as a finance professional. Same holds going back further in history.

In my opinion, these are the most worrisome underlying fundamentals today:

  1. Scale: everything is larger and bigger. Global population, GDP per person, debt, consumption, pollution.
  2. Speed: computers have made everything faster. Communications, transactions, manufacturing, transportation, logistics, decision making. Reaction to anything is nearly instantaneous.
  3. Climate change and habitat destruction: we are destroying our human habitat at an unprecedented scale and speed.
  4. Risk appetite is at an all time high: Stocks in the US and EU are trading at heroic multiples and interest rates are zero or negative. Even recent bankrupts (eg Greece) and companies with junk ratings are borrowing at near zero interest. Central banks’ gusher of money is completely obscuring the dangers.
  5. Generation gap: young people who grew up with game and chat apps view markets as just another game. Their heavy participation in daily “meme” trading is very apparent and defies all common sense ideas on investing.
  6. End of Empire: the US was the undisputed global Empire for the past 100 years. This is no longer the case, as a resurgent China is now more determined and ready than ever to claim primacy, whilst America is riven with internal political, social and economic divisions. The previous switch of Empires created WWI and WWII - and it didn’t even involve a direct confrontation between the old Empire (British) and the new (USA). It was just Germany and Japan who thought they could squeeze into at least some of the vacuum left by Great Britain. Today, the confrontation is direct: China vs USA.
….. to be continued

Wednesday, September 15, 2021

The Mother Of All Bubbles - Are We In For An Unprecedented Crash? (Part I)

Today’s title may be unashamedly clickbait, but it is truly my gut feeling. Allow me to explain by first going back 40 years. This will be a series of consecutive posts.

Part I - Introduction

In the Fall of 1982 I was working at my first job as a chemical engineer for a very large international  firm that designed and built all manner of facilities, from detergent factories in Iraq (!)  and oil refineries in Delaware, to a huge synthetic fuels plant in Beulah, North Dakota. Sounds exciting, but it was actually pretty boring stuff, since as a junior engineer I was assigned only the most basic scut work. Think glorified plumber with a Masters degree and a calculator.

But, the company had a terrific in-house lunch cafeteria where prices were heavily subsidized.  Smart, since it discouraged employees from going out on long lunches. You could finish lunch in 15 minutes and still have plenty of time to chat with coworkers or read the paper, before going back to work.

One day after lunch, I saw an article in the NY Times about a calculation for the “inflation-adjusted Dow Jones Industrial Average” and how it came out much higher than where it was then trading. My rational, mathematical mind was intrigued and soon hooked. I bought a couple of beginner’s books on stocks and subscribed to the Value Line, at the time a very popular weekly stock-picking and analysis service.  I opened a brokerage account, invested some cash … and 18 months later I had job offers from both Merrill and Dean Witter. I chose the first - and a lot of water has since passed under the bridge, no need to detail it here. 

From Synthetic Fuels To Synthetic Swaps

Suffice to say I lived through the 1980s boom and the 1987 Crash (it’s a forgotten blip now, but people were  literally jumping out of windows), the slow recovery, then the dotcom nonsense and bust, the long recovery, then the Great Debt Bubble and bust with the PIIGS snafu, the incredible (at the time) QE, the loooooooong recovery, including the colorful (so to speak) President Trump. Throw in the likes of Paul Volcker, Alan Greenspan and Ben Bernanke. (I won’t mention the current Chairman, he ain’t worth the pixels.)

So, I’ve been around the block. Several times, and always in the “sharp” edge of financial markets where if you stumble, you bleed. Meaning, I’m not an analyst 😜. Moreover, I’ve read a lot of financial and market history. A lot. I can honestly claim that there aren’t many market bubbles and crises that I’m not familiar with, one way or another..

And now, we have this…  in my considered opinion.. The Mother Of All Bubbles.

That’s the end of the Introduction. Sorry if it seems like I’m patting myself in the back but I first have to establish my creds. 

To be continued… 

Tuesday, September 14, 2021

Taxes, Deficits, Debt And Markets

 Effective corporate tax rates in the US are now at 14%, the lowest level in history. Compare this with a high of 45% during the Reagan presidency. Yes,  the iconic Republican President taxed corporations three times more heavily than Democrat Biden does now.

Conversely, federal debt as a percentage of GDP is at 125%, very near the highest level in history. Compare this with a low of 30-50%, again during Reagan’s presidency. If you were around back then (I was) you remember the huge ado about “soaring Federal debt”. Seems silly now, eh?

Debt is created by persistent budget deficits. In 2020 federal deficit reached 15% of GDP, the highest since WWII. Yes, the pandemic certainly worsened the deficit, but it wasn’t so much better before. The US has been running serious deficits since 1975, except for a few years during Clinton. Notice the impact of the Debt Crisis in 2007-10, when the government spent hundreds of billions to save banks, mortgage lenders and insurance companies.

Every sane American should now be demanding higher taxes. Democrats in Congress are trying to put together a rather insipid increase, but even this may be watered down. All Republicans are against it and probably a couple of Democrats, too. Something will pass for sure, but probably nothing big enough to make a difference. Despite AOC and Bernie Sanders…

AOC At The Met Gala

So far, markets are betting that nothing will change materially. Hmmm… the Devil being in the details, I think what is more interesting to follow are proposals for higher wealth and capital gains taxes. Especially for the top 1-5% of Americans who not only own an astonishing share of national wealth (two, yes just two, Americans own more wealth than the bottom 140 million Americans combined), they are also the biggest tax cheats. Wealth and gains taxes may pass more easily, too, since they play well with voters (“soak the rich”). And - this time - the voters are right, too.

To paraphrase Churchill: Never before have so few benefited so much from the indebtedness and consumption of so many.

Climate Crisis: We Need A Permarecession

The Permagrowth Economy is going to wipe out humanity from Earth.

 More specifically, our insatiable desire for ever more cheap goods, meat and travel for every man woman and child, especially the billions of Asians that until recently lived on “a bowl of rice”, is going to create one more Extinction Event - and this time it’s not going to be a comet falling from the sky.

While it’s easy to blame China for a big part in the jump of GHG emissions, please keep in mind that the West is now importing most of its consumer goods from China, ie it has shifted a large portion of its own emissions to Asia. Add the CO2 produced by shipping and real Western emissions are larger than they seem.

What can we do? Reduce consumption of EVERYTHING, from cheap T-shirts and meat, to airplane travel. There is really no other way, because recycling and renewable energy are mere aspirins - if that. 

The COVID pandemic was (is?) a tremendous opportunity for the world to slow down and step back, to create a different socioeconomic model based on Sustainability. Unfortunately, governments panicked and instead of tapping the brakes they stepped hard on the accelerator by printing trillions in new money.

I’m afraid that the only possible solution now is a hard Crash followed by a Permarecession. Actually, we already have the model: Japan during the last 30+ years.