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… 

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.

Money Destruction

 “Can money be destroyed?” This was the question I was asked many years ago by George P., a brilliant young man who two years later became the youngest ever Managing Director at one of the largest and most prestigious US investment banks. I was taken aback by his question, because although it appeared simple, it was not.

We quickly established that he did not mean “value”, eg the price of a stock or any other asset going down in price, or the self-evident physical destruction of paper currency. He was after something else, something much more fundamental. I was stumped, so he just said “never mind” and we left it at that. I was busy with day to day work, so I didn’t revisit his question until much later.

Segue to yesterday post’s opening statement: “Money is debt and debt is money”, and the answer to George’s question becomes obvious: the ONLY way to destroy money is to destroy debt, ie to fail to repay the principal amount of a loan or bond. In other words, to go bankrupt and/or write off all or some of the debt. Money expansion being the primary raw material of “growth”, its destruction leads to a contraction, anathema in our Permagrowth society.

Which is precisely why the Treasury/Fed stepped in during the Great Debt Crisis of 2007-09 with unprecedented QE to replace the money being destroyed by massive defaults, particularly in the real estate sector. As new money piled in, “growth” naturally resumed.

And segue to today… the pandemic, a very real natural phenomenon (as opposed to, say, artificial debt crises and market bubbles) is being “treated” in great part by printing even more money. More than ever before. But, the global “real” economy cannot possibly utilize all this money as fast as it is created. It cannot mine iron ore, it cannot produce steel, cars, widgets, anywhere near as fast as the expansion of money. So, duh!!, instead of real growth we get price inflation. 

In the 18 months from January 2020 to June 2021 the net change in US GDP is $1.04 trillion, but the increase in M2 is a whopping $5.74 trillion, see below. Money supply rose more than 5 times faster than nominal GDP!

Lots and lots of money combined with a constriction of growth… guess what you get? Stagflation. Add a touch of climate change obstacles (eg soaring pollution permit prices) and stagflation gets more entrenched. Until, that is, money (debt) starts to get destroyed (without replacement) and money supply goes down. IF this is allowed to happen, that is. And, right now, it is certainly not allowed - at least in the US and EU, which continue to print with abandon. 

The GDP Factory And M2 As Raw Material

Money is debt and debt is money. It wasn’t always thus, but it certainly has been since the US went off the gold standard back in FDR’s time (June 5, 1933).   If you have any doubt, just look at the charts tracking debt and M2 money stock as a percentage of GDP.

The recent vertical rise in both is due to the Fed’s incessant printing (aka QE on steroids), but the trouble started earlier, when the Fed first began its QE operations to prevent a total collapse during the Great Debt Crisis of 2007-10.

M2 is now at 90% of US GDP, ie there is almost one dollar floating out there for each dollar of economic activity. That’s up from 50 cents per dollar of GDP in 2008, ie before the Fed started its QE. 

Should we be worried? I’m not sure, but I really don’t like this “monetization” of the US economy. It somehow rings hollow to need all this “cash” sloshing around in order to produce a unit of GDP. It is, in my opinion, a very fundamental measure of structural inflation.  Or, at least, of potential hyperinflation.

Think of the economy as a factory producing GDP dollars, using M2 dollars as an input. Well, today’s factory is using a lot more $M2s to produce $GDPs than in the past. Ditto for debt. 

Can this be good? No, it can’t be. Sooner or later this money will find its way to the “real” economy where producers of goods and services will realize that dollars are worth less than before and thus demand  to receive more for their products. As Milton Friedman said, inflation is always and everywhere a monetary issue.

 You don’t believe it? Even in Rome around 260 AD inflation soared to 1000% since the gold content of the coinage was dropped to 5%.  It had previously dropped from 100% to 90%, then 60%…. 

Shipping Rates Deja Vu

 The cost of shipping a 40-foot container from Shanghai to Los Angeles has risen eightfold since late 2019 to almost $12.000.  Other routes have seen similar increases, see below.

What does this mean to you and me? It depends.

A 40ft, 66 cubic meter container (double the.size of the “standard” 20ft box) can fit some 800-1000 large flat screen TVs. Do the math: container shipping now costs around $12-15 per TV, up from $1.5-1.90. It’s a huge increase, but for such relatively compact and high value items it’s not exactly a disaster. The higher shipping costs may be absorbed with relatively minor price hikes. For even higher value and smaller items (eg iPhones) the impact to the final consumer is near negligible.

However, for an importer of cheap, large plush teddy bears things are dire. Same holds for all imported goods that have the killer combination of large size and low unit price. For example, clothing/shoes, furniture, toys, even coffee and fruit are shipped in containers. There, prices will need to be adjusted very significantly. Big box stores and their customers will definitely be in trouble.

Two days ago, a ship-owning company announced it chartered one of its Panamax containerships for 2-3 months at an all time high of $200.000 per day. That’s $12-18 million in revenue. Less than three years ago such vessels were in such low demand that many ended in the scrapyard, essentially worthless. Kinda like a meme stock with a super duper propeller.

Long time readers of this blog may remember my posts in 2007 about insane dry bulk cargo rates, and one shipping company’s stock trading at nosebleed levels. It was a time when, incredibly, oil tankers were being retrofitted as dry bulk carriers. Anyone with any type of shipping experience realized what a panic-driven move that was, at the time.  Well, shipping rates collapsed soon thereafter and the stock became utterly worthless.

Guess what is happening now? Bulk carriers are being retrofitted as containerships… ayup…it’s deja vu all over again 😜

Things have gotten so bad that the world’s third largest container shipping company just announced that it is freezing spot shipping rates until February 1, 2022 - a dubious move, of course. It’s like OPEC freezing oil prices at $120 per barrel. Still, something to think about in this crazy all-bubble time.

Why are containership rates so high? For one, demand for cheap imports came zooming back after long lockdowns. Secondly, ports had to delay unloadings because of workers getting sick/isolating. Ships that would normally turn around in a day or two are now idling outside ports for more than a week, thus reducing available shipping supply.  It won’t last much longer, but for now it is fueling consumer inflation substantially.

Is America A Third World Country, Or Is It Just A Bubble?

 Here’s an Instagram post by Bernie Sanders. So, being that such wealth and income disparity is a major characteristic of Third World countries, is the US one of them?

Or, is it that a stock market bubble has ballooned the wealth of those two Americans so much (and the 1%’s)? 

Cryptos As A “Gold Standard”

 I don’t like cryptos, at least not as they are used today for rampant speculation, tax evasion and criminal activities.  But, I can think of one out-of-the-box idea: use a crypto, say Bitcoin, as an anchor for fiat currencies, very much like the way gold was used some 100 years ago.

In this scheme, central banks would own Bitcoin as an asset and issue fiat currency (dollars, euros, yen, etc) only up to the limit of a set multiple of their Bitcoin holdings.  Since Bitcoin is now very difficult and expensive to mine, the amount of dollars would only rise very slowly.

It would be like going back to the gold standard, but using a digital-era “precious metal”. In one fell swoop, credit growth and monetary inflation would go down very significantly. 

This would also put an end to the Permagrowth economy, as well as the finance-is-everything notion. But, it would keep the existing banking/markets system functioning more or less as today, albeit shrinking its oversized dominance in the global economy.  The tail would stop wagging the dog, but it would still wag.

Comments?

The Retail Tail: Bull Or Bear?

 Axiom: individual “retail” investors pile heavily into stocks at the tail end of a bull market, signaling it’s time to sell and go fishing.

Here are two charts from the Financial Times showing retail investors buying heavily this summer.  Monthly retail inflows averaged around $5 billion until March 2021, but have since ballooned  to $10-15 billion per month. Annual inflows to August 2021 have already reached all time record levels, even though we still have another 4 months to go until the year is over.

You may expect that accelerating inflows would result in accelerating prices, but they haven’t . The S&P 500 index soared 190% from March 2020 to April 2021, but only 6% since then. Looking at it in monthly terms, that’s an average of only 1.2% per month now, versus 15% per month before - even though retail inflows have expanded greatly. See chart below.

It is obvious that heavy retail demand is being met with significant supply from elsewhere, very likely “smart” institutional money that are reducing positions, “dumping” them onto Johnny-come-lately retail speculators. The pace of IPOs has also accelerated, supplying the market with fresh “merchandise”, often of dubious quality.

So, beware the tail you end up holding because it may very well be the bear’s.

Beware The Retail Tail

The No Signal Economy

 In a free-market economy prices act as signals to efficiently adjust supply and demand for goods and services. Likewise, interest rates are the price of money - if they are allowed to fluctuate freely. But today they are not.

Ever since the Great Recession of 2007-10 Western central banks have engaged in massive QE operations, culminating in the ongoing panicky deluge brought on by the pandemic. Short-term interest rates are at zero, or even negative, meaning that money is literally being given away for free.  Just think of the trillions already sent to Americans as “unemployment” payments. Money for nothing, literally.

If money was a “regular” commodity its low price would raise demand and eventually its price (interest rates) would go up, particularly at the long end of the yield curve. But, the Fed is constantly creating new money via the monthly $120 billion bond purchases, so even long term interest rates are kept artificially low. Therefore, interest rates are now useless as pricing signals for money, arguably the most important “commodity” in a free-market economy. Ergo, the broader economy is also operating without its most important signal. 

We are living in The No Signal Economy. You want proof? How about NFTs of an empty box going for $15.000, or SPACs that do not reveal what they intend to invest in, or meme stocks of near bankrupt companies that trade at astronomical valuations? How about 12 year olds who claim they are the equivalent of Warren Buffett, or even smarter? Or 20 year olds who drop out of college because they “know” they can become millionaires trading cryptos? I can go on and on.

Here’s something to ponder: how is today’s No Signal Economy different from the Soviet Five Year Plan Economy? Where toilet paper was impossible to find, but a committee had decided to produce a million extra tractors to join those already rusting in the nearly abandoned collective farms.

The FOMC Crushes Capitalism 🤣🤣

Today, our No Signal Economy is expending enormous amounts of electrical energy to produce cryptos because a committee (the FOMC, in this case) has decided that they are more “valuable” than, say, building a renewable hydrogen plant. Or more high speed trains. Or a robust electricity grid so that 600.000 people don’t have to go without power for a week after a storm.

Yup, when all is said and done the No Signal US is not so different from the FiveYear Plan USSR. Why? Because when prices are as grossly manipulated as they are today they create a grave mis-allocation of resources/capital, leading to the hollowing out of the economy which will then collapse from the inside.

We urgently need to re-start the money pricing mechanism before it’s too late.