Productivity | Strategy | Profitability
Productivity | Strategy | Profitability
We have finally arrived…not to a wonderful party or some exotic location, no, we have arrived financially and monetarily to the exact same position to where we were back in 2007-08. Back then, the Federal Reserve embarked on "easing" monetarily for the first time since the Dotcom bubble, today the Fed is easing for the first time since the Great Financial crisis with a caveat.
That caveat being a system with more debt outstanding in both real and nominal terms versus any point in human history! No matter what debt ratio you look at, never has debt been a heavier weight around the global financial system and the real economy’s neck…the whole world with few exceptions is now a Banana Republic!
As a background, we reached what I termed ”debt saturation” levels back in 2006. You could see it throughout the system. There were few left who could financially take on more debt while many who could, decided better not to. When the crisis broke, the only sector with the ability (and stupidity) to take on more debt in size were sovereign treasuries aided by the world’s central banks. Central banks responded by flooding the system with liquidity and by funding sovereign treasuries’ deficit spending efforts to jumpstart the system. And here we are again with the exact same situation and problems…only far greater in magnitude!
Globally, total debt is roughly $250 trillion while debt to GDP levels have surpassed 320% as of 2019. Using the U.S. as the example, it is important to understand the nuts and bolts behind total debt outstanding versus debt service payable. For round numbers, on books federal debt was roughly $10 trillion during the 2008 crisis and debt service hovered under $250 billion annually. Fast forward to 2016, total debt grew close to $20 trillion but debt service required was still in the $250 billion per annum range. In short, federal debt outstanding doubled while interest rates were cut in half.
QE AND NEGATIVE RATES
This is why interest expense had remained largely unchanged for several decades...interest rates have gone from double digits to nearly zero bound. The explosion of debt did not sting because the interest rates payable have collapsed. Now, just a few years later, the story has changed and debt service is about to truly matter for two reasons. First, the amount of debt outstanding has grown in the last 10 years faster than interest rates were cut. Secondly, central bank rates approached the level of ”zero %”. Is zero the hard bottom for rates? In fact, central banks are now talking about official ”negative interest rates”. Negative rates are currently a reality as the world (led by Japan and Europe) has over $13 trillion worth of debt currently trading at negative rates.
This is another topic altogether but suffice it to say, negative interest rates are a financial perversion that cannot exist in a real and stable financial system. It is akin to a snake eating its own tail. For purposes of this article, let’s focus on where it has and will lead to. The GFC occurred primarily because the world had reached debt saturation level. The crisis was treated with…more of what caused it. Central banks flooded the system with liquidity that was used to stabilise the financial system and of course the huge ramp up in further debt. Now, 10 years later, we are back to where we were in 2006, but with a real economy far smaller in relation to the debt.
Now, central banks are firmly backed into a corner. They told us for years they could ”normalise” both interest rates and their balance sheets. 2017-2018 showed us that neither rates nor balance sheet size have any hope of ever normalising. Q4 of 2018 illustrated exactly what will happen on the road to normalisation. Now we face another (mandatory) round of QE. Central banks are being forced to ease by lowering rates and providing more liquidity to placate financial markets from rebelling.
As the late, great Richard Russell used to say, ”it is either inflate or die”. Inflate or implode is exactly where we are today because of the gross levels of debt outstanding. Just as with any Ponzi scheme, either new capital comes in or the scheme is finished. In central bank terms, either a new and continued source of credit comes to the rescue, or past debt outstanding is revealed as impaired.
CROSSING THE DEBT TO GDP LINE
If you understand the above, even only a little, then you must be wondering what it means? Or better yet, what it means to ”you”? It used to be in the old days, any nation that crossed the 100% debt to GDP line was considered as entering ”banana republic land”. This was so because at 100% debt to GDP, unless a nation had extreme outsized economic growth, they would soon find themselves with the difficulty of servicing their debt. The biggest problem with servicing debt came about as countries who borrowed in dollars had no ability to print dollars and devaluing their own currency to help trade would hurt their ability to repay the debt. Now that monetising has (temporarily) become acceptable, the 100% debt to GDP threshold has been thrown out and we find the entire world bloated with 320% debt to GDP.
I mentioned ”the old days”, do you remember them? Back when borrowing money had a real interest rate associated with the note. Maybe six or seven percent? Maybe higher, 8-10%. What I’m getting at here is the crux of the problem and ”why” the problem comes to a head on this go ‘round.
In order to accommodate the absurd levels of global debt at 320% of GDP, the only way to do it was to jam interest rates toward and even below zero. The central banks have termed what they have done, and now what again must be done, as quantitative easing or ”QE”. The reality is this, QE is a fancy and unthreatening name for what central banks have tried and failed for hundreds if not thousands of years ...”monetisation”. You can look the definition up in the dictionary but in essence, ”monetising” is simply creating new money out of thin air and generally used to fund the issuance of treasury debt.
In every single instance throughout history where a nation resorts to monetising debt, both the currency and the debt get watered down and diluted in value. In many cases where the monetisation is done on a large scale and long time, the currency and issued debt become devalued and ultimately worthless. Think the French Revolution, Weimar Germany, Zimbabwe, Soviet Union, Argentina or Venezuela. If one could print money or borrow their way to prosperity, poverty would not exist today and would have been eradicated hundreds of years ago. The fact is, if you have a pie and cut more and more slices, each new slice is smaller and smaller. The same is so for a currency. Each new unit digitally printed dilutes existing currency units.
It should be noted that the early stages of monetisation does ”feel good”. This is because of the effects of the inflation created. Monetising devalues the currency and also past debt taken on. Devaluing makes past debt easier to service and ultimately easier to pay off but there is a flip side of the coin. One man’s debt is another’s asset. A devaluation that makes debt easier to pay, also devalues the ”asset” held. Think banks, brokers, pension funds etc. who hold bonds in their portfolio, any currency devaluation also devalues bond holdings. If you understand nothing else about a currency devaluation, please understand that any and all ”savings” in the devalued currency loses value and thus purchasing power.
THE DANGER OF MONETISATION
To wrap this up, history has shown the best way to protect yourself and family against losing purchasing power of your savings is via ownership of both gold and silver. Gold and silver are real money that are not freely printable and most importantly not a liability of any manmade central bank or treasury. What I mean here is that gold and silver are proof of capital, labor, and equipment used to create the bar or coin. They do not promise anything and need no promise to have value. Currencies (debt) on the other hand are a liability of the issuer. For example, dollars are liabilities of the U.S. Fed, euros are liabilities of the ECB and yen are liabilities of the BOJ.
The danger of course is what we spoke of above, these central banks are monetising (printing) new currency with abandon. Reckless monetary policy is exactly what we have witnessed since 2008 and it looks like global central banks are now on the verge of doubling down on lunacy. Gold has historically been THE best safe haven during times of financial distress and panic. In a grossly overleveraged world where nearly all assets have liability of one sort or another, capital will desperately seek the safe haven status of gold simply because it is no man’s liability! EG