Crisis are a Given, but Debt isn’t

Famed investor Jim Rogers has come out with some warnings. He told viewers of CNBC who invest in US stocks to ‘be careful… you’re in a fool’s paradise… It is only a matter of time before the US stock market runs into devastating problems due to the Fed QE program.’

Not that QE only damages the US stock market. International Monetary Fund managing director Christine Lagarde pointed out in the Financial Times that the Fed has the entire world hostage:

Because the normalisation of monetary policy affects so many markets and people across the globe, the US has a special responsibility: to implement it in an orderly way, linking it to the pace of recovery and employment; to communicate clearly; and to conduct a dialogue with others.

Good luck trying to convince the Federal Reserve to be considerate. ‘Special responsibility‘ is not exactly in their mandate. And as for ‘dialogue‘, so far the Fed’s attempts at transparency have only made things more confusing.

The US doesn’t have a good history when it comes to this sort of conundrum either. The 1971 Treasury Secretary John Connelly once famously told Europe ‘it’s our currency, but your problem‘. Interestingly, the issue of the day was inflation in America. How times haven’t changed.

Today the inflation shows up in asset markets instead of the Consumer Price Index. It’s important to remember that the Federal Reserve’s solution to the housing bubble crisis is to create a stock market bubble. And the solution to the stock market bubble of 2000 was the housing bubble. Spot the pattern.

It’s the bond and currency markets that provide the final complete collapse in a bubble driven economy like America’s. You see, the Fed and the government can go on bubble blowing until the currency collapses or the bond market refuses to fund the government. That’s when you get a real crisis – one that can’t be fixed with a new bubble somewhere else. It’s the kind of crisis you’ve been reading about in the articles about the US government shutdown. A crisis which is ‘far worse than 2008’, according to all the commentators.

But for now, we’ve got a new stock market bubble to worry about, according to Rogers. That’s why, apart from a speculative tip we just sold out of, stock tips have been few and far between over at our newsletter The Money for Life Letter. There are plenty of other ways of securing a prosperous retirement than the stock market.

Rogers explains that crises happen in all markets, and the economy, on a periodic basis. Historically, there’s a recession every four to six years in the US. Stock market crashes happen and, yes, house prices can fall. Even the wine futures we uncovered in our newsletter can be in a bubble. They’d probably call it a ‘bead’ instead, which is wine speak for bubble. Interestingly, quality wines have smaller bubbles and their prices should be more stable.

Anyway, there’s a more important point at play in all this. Yes, regular crises can be found in all asset markets. But it’s the level of debt in an asset market which makes one of those periodic crises worse. Margin lending in the stock market, subprime loans in the housing market and credit card debt all inflate asset values or consumption to unrealistic levels. And they also raise the stakes when things go bad. People stand to lose disproportionately when debt is involved.

When it comes to investments, you can lose more than your initial investment when you use debt. In an economy, debt has to be paid off, turning a tailwind into a headwind.

So, using that logic, if you follow the levels of debt in a market and take a look at the frequency of periodic crises, you can find some events to make the most of…or avoid.

Today, it’s sovereign debt that comes to mind first and foremost. We’ll get to that in a moment though. First, it’s worth noting that the American stock market is looking dangerous on the measure of periodic crises and levels of debt, as Rogers has no doubt noted in his warnings. This chart shows margin lending in blue and the stock market index in red. The last two times debt soared, the stock market tumbled.


As always, the US market is closely correlated with ours. The Federal Reserve’s QE efforts have propped up foreign asset markets, especially emerging markets, as Christine Lagarde explained in the FT article mentioned above. Emerging market shares, bonds and currencies were the ones to tumble when the Fed’s tapering was digested by investors. And they surged when the tapering was put off.

Australia is a stable kind of emerging market to Americans. To many we’re a proxy for investing in China. So our stock market’s fate is largely tied to events everywhere but Australia these days.

But back to the level of debt governments are dealing with. Remember, it’s a sovereign bond crisis and currency collapse that leads to the final end of a crisis-ridden, bubble-driven economy.

Poor old Barack Obama had two major slips of the tongue recently. He suggested that Social Security cheques would have to be delayed if the budget impasse wasn’t solved. That is odd because the program is supposed to be fully funded, not relying on borrowed money. Did Obama admit that the retirement system of America relies on the country being able to borrow money?

More importantly, he told Wall Street that it should be ‘concerned’ about the government shutdown. We mentioned it yesterday, but dismissed it as a political comment. The thing is, Obama practically predicted the 2009 stock market bottom in the US. He was 3 days early with his recommendation to buy stocks based on earnings multiples.

So now he’s saying Wall Street, and that means the world, should be concerned. Uh oh.

Wall Street’s banks responded quickly. They increased the amount of cash held in ATMs by 20-30% in case of a panic. Also, as part of a regulatory measure born by the financial crisis, the banks had to lay out their ‘living wills’. In other words, they had to present a plan for what would happen if they failed.

It’s truly hilarious to see a bunch of people who can’t predict a crisis ponder on how they will deal with one. For example, Bank of America reckons it will sell its broker dealer business to raise cash to survive a crisis. Nobody knows who will buy it. JP Morgan will sell ‘marketable securities’. The whole point of a crisis is the lack of a healthy market!

Anyway, the point is that the ongoing financial crisis is starting to transition to government financing in the US. Let alone Europe, which you’ve read plenty about. With so much of the economy relying on solvent governments, what would our world look like without them? Maybe a stock market bubble isn’t all you should be worried about after all. Perhaps there is much more at stake.

Don’t get us wrong. This government shutdown circus in the US is just an aside to all this. It’s the perfect example of politicians, faced with a real problem, creating a political problem they can easily solve which resembles the real problem closely enough that the public is fooled, and then solving the political problem so they can claim to have solved the real problem. But the real problem remains – too much government debt.

The International Monetary Fund’s managing director Christine Lagarde has it half right. She reckons the global economy is experiencing ‘transitions on an epic scale‘ and ‘Overall, the global outlook remains subdued.’ We have no clue how you can possibly reconcile the two, but we know which of the two our money is on. ‘Subdued’ is nowhere near ‘epic’ enough for what’s coming.


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From the Archives…

The Fed Does the Reverse Volcker and Targets the US Unemployment Rate
27-09-2013 – Greg Canavan

How Much Juice can Australian Property Have Left?
26-09-2013 – Greg Canavan

Nothing Lasts Forever…Especially Easy Money
25-09-2013 – Chris Mayer

The Unintended Consequences Brewing Thanks to the Federal Reserve
24-09-2013 – Greg Canavan

The Market’s Declining Response To ‘Open Mouth’ Operations
23-09-2013 – Dan Denning

Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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