July 2018 - Bubbles and Bottoms for governments -

The central banks of the U.S., EU, Japan and China will be discussed in this next chapter, as these four central banks have increased their balance sheet (read: printed money) with the largest amounts. If you want to find the core reason for the massive bubbles in student loans, housing prices, corporate loans, stock markets, medical care, but also more exotic bubbles in cryptocurrencies, the Kardashian`s net worth (funny but true), concert tickets, football transfer fees and fine art just to name a few, look no further than your country`s central bank. Zero interest rate policies and the downright printing of money has inflated assets all around the world, and will be the core reason for the coming economic decline.

Switzerland deserves a special highlight, as they have joined the “printing game” relatively late but are now going into overdrive. Compared to the “big four” their nominal balance sheet is small, but if you look at these holdings as a percentage of the country`s annual GDP, then it starts to become clear:
FED balance sheet: roughly 23%
ECB balance sheet: roughly 41%
BOJ balance sheet: roughly 96%
SNB balance sheet: roughly 130%!

20% of the swiss central bank`s assets are now invested in U.S. companies like Facebook and Amazon (yes, the members of FAANG). The result? A record profit of USD 55 Billion in 2017 for the Swiss National Bank. Everything is awesome! A picture speaks a thousand words, so just to show you the “idiocracy” that`s taking place, here`s the swiss monetary base:

But don`t worry, they`re not alone. The Bank of Japan has gone off the rails as well, and now owns 46% of all outstanding Japanese government debt. It also owns roughly 80% of the 3 big index ETF`s or Exchange Traded Funds in Japan. Picture a supermarket, with the owner being its biggest customer…

Anyone who has learned economics and finance at school, knows that when you print more money, you will create inflation, right? Just look at Weimar, Zimbabwe and now Venezuela. How come there`s no hyperinflation now that we`ve printed so much money over the past 10 years? It`s a question i`ve been struggling with for years, and I probably still don`t have the full answer to this.
I do have a few theories/scenarios that I would like to share with you.

  1. In Switzerland`s case it`s very easy: 94% of their printed money has immediately been invested overseas, and they`ve thus exported their inflation. An interesting statistic? The Swiss National Bank now owns 0.3% of the entire U.S. stock market!
  2. China has their own tricks up their sleeves. They have been on a lending splurge, mostly to 3rd world countries, under the “belt and road initiative”. Often this lending is partly in USD (they can finally get rid of their USD reserves) and partly in RMB (they can export their inflation). This system is already starting to show cracks, with Sri Lanka not being able to pay back their debt to China, and Kenya`s debt to China growing tenfold in 5 years. Is this China`s grand plan? To create debt slaves and receive cheap commodities or land in return?
  3. The money that has been lent to banks by Central Banks was supposed to get back in “the system” in the form of credit to firms and households. Instead, it has been sitting idle in bank`s reserve accounts. This has not been done completely voluntarily, as the governments around the world have forced banks to increase their financial buffers in order to avoid another crisis. One can also see this as “deleveraging”. Currently, USD 2.2 Trillion in bank deposits are held at the Federal Reserve, almost half of the entire FED balance sheet.
  4. The velocity of money has crashed. “The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time.” This means that all these dollars that have been printed, are not being spent. If the printed dollars are not actively participating in the economy, then obviously they can`t induce hyperinflation (they also can`t boost economic growth). The fact that household net worth is at all-time highs confirms this statement. Below is a chart comparing the money supply to the velocity of money. What happens if the money velocity, that has been crashing since 2008, starts catching up and all that printed money starts seeing the light of day?

The U.S. public debt has now reached 105% of GDP, or USD 21 Trillion! To whom do they owe this debt? 69% of the total outstanding debt is held by U.S. individuals and institutions, while 31% is held by foreign entities. The higher the debt, the more interest has to be paid, and with upcoming rising interest rates, there will be even bigger interest payments ahead. Will the U.S. government be able to ever pay this back? This rhetorical question will be answered on the next page.

During previous recessions, the U.S. could grow its way out, mainly because of its young, growing population. Right now, the opposite is true; the population is aging rapidly, and the population growth hasn`t been above 1% per year since the year 2000. One of the results of this is that Social Security costs are expected to exceed Social Security income this year for the first time since 1982. After this year, the disparity between income and costs will only increase.

What does “growing your way out” look like? For example, you stimulate the economy with a dollar and you get 1.5 dollars in return. This has worked up until the mid-80`s, but then it started becoming more and more difficult for the U.S. economy to grow its way out of debt. Credit to the non-financial sector has grown 47% from 2007 until 2017, gaining USD 15.6 Trillion. In the meantime, the U.S. economy grew by only USD 4.9 Trillion. This means that in order for the U.S. economy to grow by 1 dollar, 3 dollars of debt has to be created.

What does it look like when you combine all the private, corporate and government debt from all over the world? A USD 237 Trillion pile of horse manure. It is of course not fair to look at nominal growth, so knowing that world GDP was almost USD 80 Trillion last year, we can calculate that the world debt is 300% of GDP. The good news? This percentage has been slowly declining over the past 2 years.

Don`t just teach your children to read… teach them to question what they read.
Teach them to question everything.
- George Carlin -

In the meantime, bond yields are doing something that normally precedes a recession. The average short-term bond yields climb above the long-term bond yields, which indicates that the long term economic outlook is bleak, and that the yields offered by long-term fixed income will continue to fall. They call this phenomenon “inverted yield curve” and has taken place 9 out of 9 times upon a recession. The good news? It took an average of 21 months for recession to start, after the inverted yield curve took place, so there`s plenty of time to hide! The first chart shows the U.S. yield curve, which is now almost negative, and the second chart is the global yield curve, which has inverted for the first time since 2007.

I sense that i`ve been showing you more bubbles than bottoms, so I would like to end this newsletter on a positive note and show you an interesting bottom that is taking place in the commodity sector. Below you see the GSCI index (Goldman Sachs Commodity Index) compared to the Dow Jones Industrial Average index. As you can see, GSCI is hitting rock bottom, and is ready to shoot back up (bringing along a nice portion of consumer inflation)

The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.