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Credit deflation and the reflation cycle to come (part 2)


spunko

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2 minutes ago, Loki said:

I have no faith voting will solve anything, but still agree with your point of view

Best not to. It only encourages them. :)

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UnconventionalWisdom
5 hours ago, Harley said:

 

I've attended a few presentations from the various economic institutes who have mentioned this "puzzle".  There is no puzzle, just an unwillingness to join up the dots which to me shows where they are coming from

Frustrates me immensely. Pay increases less than inflation and their living standards go down. Work hard for a few years and realise you haven't actually improved your living standards. Couple this with people under 35 working hard to pay for a landlord's "investment" or live with 3 strangers and boom you have a population who cant be bothered to put in the extra effort. 

Makes my blood boil.

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6 minutes ago, UnconventionalWisdom said:

Frustrates me immensely. Pay increases less than inflation and their living standards go down. Work hard for a few years and realise you haven't actually improved your living standards. Couple this with people under 35 working hard to pay for a landlord's "investment" or live with 3 strangers and boom you have a population who cant be bothered to put in the extra effort. 

Makes my blood boil.

When i started work the yearly pay increase was always how much over RPI.bad years 0.5% good years 1.5% ABOVE RPI.Now its how much below RPI.The first day i started work in a local factory a single mother with 1 child in rented got 52% of what i got for working.That same factory now?,she would get 102%.The best thing to do at 16 isnt go to college,its get pregnant,crazy.Governments have printed to pay more and more welfare while doing everything to keep a dis-inflation cycle going that eats its own tail.

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Talking Monkey
1 minute ago, DurhamBorn said:

When i started work the yearly pay increase was always how much over RPI.bad years 0.5% good years 1.5% ABOVE RPI.Now its how much below RPI.The first day i started work in a local factory a single mother with 1 child in rented got 52% of what i got for working.That same factory now?,she would get 102%.The best thing to do at 16 isnt go to college,its get pregnant,crazy.Governments have printed to pay more and more welfare while doing everything to keep a dis-inflation cycle going that eats its own tail.

From where we are at now DB even without Corbyn getting in doubt we'll fix much of this mess by say the end of the next cycle in just less then a decade's time, it is just too short a timeframe, more I think it will come to an abrupt halt with a lot of very nasty dislocation

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StrugglingMillennial
1 hour ago, UnconventionalWisdom said:

Frustrates me immensely. Pay increases less than inflation and their living standards go down. Work hard for a few years and realise you haven't actually improved your living standards. Couple this with people under 35 working hard to pay for a landlord's "investment" or live with 3 strangers and boom you have a population who cant be bothered to put in the extra effort. 

Makes my blood boil.

Yep im one of thos, 37 yro but i have plenty of younger friends who have given up trying aswell.

Im not busting my nuts just to line some buy to leech home owners pocket. I owned my own house up until 6 years ago and i would buy again but i wont bother unless the prices crash.

 

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Agent ZigZag
1 hour ago, Talking Monkey said:

From where we are at now DB even without Corbyn getting in doubt we'll fix much of this mess by say the end of the next cycle in just less then a decade's time, it is just too short a timeframe, more I think it will come to an abrupt halt with a lot of very nasty dislocation

I have spent a whole cycle ahead of the curve regarding inflationary investments as to were we are going to. In other words I started acquiring more inflationary assets in 2007, believing we were entering an inflationary cycle. I was wrong but through luck made out very well in a lot of property investments. Maybe now I will have my day in the sun on those investments. To keep the system going of course they are going to print to keep the plates spinning. My concern now is many a folk are giving up already and that really worries me. 

This is from Billfunk from the Brexit debate that is an excellent post and to me suggests real change is required in the UK. If not then fiscal spending in the UK in order to create inflation is doomed.

 

Here it is

 

Get Trump over here fast. Announce 0% corporation tax and 0% tariffs (excluding retaliatory tariffs). Repeat with the Japanese and Chinese (excluding security sensitive industries for the Chinese).

East Atlantic Singapore-esque free trade Capitalist city state is the way to go for GB now. Running a low productivity, quasi-socialist, client state isn't going to cut it going forward. The beauty of Brexit is that Johnson will have a ton of political capital to get this done. He will have to make radical changes to ensure GB comes out of this with its head above water. If he just continues the status quo, the Common Purpose and Open Society apparatchiks currently infesting our public services will make sure of collapse. Undermining their power base - the client state - is not only beneficial to the UK, but absolutely necessary to remain in power.

If Johnson doesn't pivot as I suggest here we will very quickly reach a tipping where the layabouts have the whip hand in elections. A generation or two of this and first world Britain will be a thing of the past. Many of us can already see the slide into degeneracy. Think London only without the accrued wealth of two millennia. For me, ultimately this was what Brexit was about - smashing up the ancient regime and bringing back state capitalism where the workers have a good chance of a decent independent life rather than being farmed as they are currently.

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A classic example of the "political economy" which has been a growing feature in the UK over the decades and why my formal economic training is now largely a waste. 

This is not a political rant but a proffered example of the breadth of the subject one now needs to comprehend when undertaking this investment malarkey.  A question of dispassionately understanding how things work to better play the game.  Or choose a purely political lens and miss, or deliberately obscure, the point.

Alleged low UK productivity compared to France and others may be due in part to worker's attitudes but the impact of that falls into insignificance compared to business investment. 

The UK has a policy of a low wage economy, something pushed by business, and implemented through lax immigration, zero hours contracts, taxpayer subsidisation via benefits, citizen subsidisation via strained social infrastructure, and so on. 

If a company wants more output it just hires more people and sacks them when not needed. No need to increase costs, inflexibility, and risk by investing in plant, machinery, software, training, etc.  Sure, there is a de minimis amount of such investment but the realised potential to substitute that for people is significant. The car wash effect - "employ" cheap (in this case immigrant) labour to wash cars than invest in car wash machines given the marginal cost of labour.

Low productivity is not a "puzzle" but a consequence of policy and beating up workers for it is, to put it politely, disingenuous.  And the unions, with their support for open borders, are part of the stitch up, along with said government and business. 

An expanding rentier system increasingly on steroids.  The people are, as in so many other areas, being mugged by quite a cabal of self and short sighted servers who, faced with the challenge, and for right or wrong, chose the unimaginative lowest possible denominator. 

There is a social and individual psychological impact of such a choice given the human ability (need?) for knowledge, stimulation and challenge.  Remove that and there are consequences.  Maybe a better avenue of study than traditional, now very naive, economic theories.

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Some professional economists seem like the Inca priests of old, recommending another sacrifice to keep things going for as long as possible when they really know better.  The system trumps science.

A case in point, some rather interesting thoughts on negative interest rates in the context of Black Scholes, etc.....

https://youtu.be/F6aengR6fWk

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4 hours ago, Harley said:

A classic example of the "political economy" which has been a growing feature in the UK over the decades and why my formal economic training is now largely a waste. 

This is not a political rant but a proffered example of the breadth of the subject one now needs to comprehend when undertaking this investment malarkey.  A question of dispassionately understanding how things work to better play the game.  Or choose a purely political lens and miss, or deliberately obscure, the point.

Alleged low UK productivity compared to France and others may be due in part to worker's attitudes but the impact of that falls into insignificance compared to business investment. 

The UK has a policy of a low wage economy, something pushed by business, and implemented through lax immigration, zero hours contracts, taxpayer subsidisation via benefits, citizen subsidisation via strained social infrastructure, and so on. 

If a company wants more output it just hires more people and sacks them when not needed. No need to increase costs, inflexibility, and risk by investing in plant, machinery, software, training, etc.  Sure, there is a de minimis amount of such investment but the realised potential to substitute that for people is significant. The car wash effect - "employ" cheap (in this case immigrant) labour to wash cars than invest in car wash machines given the marginal cost of labour.

Low productivity is not a "puzzle" but a consequence of policy and beating up workers for it is, to put it politely, disingenuous.  And the unions, with their support for open borders, are part of the stitch up, along with said government and business. 

An expanding rentier system increasingly on steroids.  The people are, as in so many other areas, being mugged by quite a cabal of self and short sighted servers who, faced with the challenge, and for right or wrong, chose the unimaginative lowest possible denominator. 

There is a social and individual psychological impact of such a choice given the human ability (need?) for knowledge, stimulation and challenge.  Remove that and there are consequences.  Maybe a better avenue of study than traditional, now very naive, economic theories.

And hence why UK industry is so anti-Brexit/immigration tightening, it would stifle cheap labour, push up costs, and reduce profits.

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sleepwello'nights
10 hours ago, DurhamBorn said:

The best thing to do at 16 isnt go to college,its get pregnant,crazy.Governments have printed to pay more and more welfare while doing everything to keep a dis-inflation cycle going that eats its own tail.

And to add to the effect of the disincentive to work there isn't an increase in population. Those with the intelligence and conscience choose to work. Thus the couple who would have the woman stay at home and bring up children cant afford to, so they both work and have fewer children than they otherwise would. 

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I still don't understand why these car washes are tolerated. I saw their latrine the other day, when stuck in traffic I noticed every so often they'd go into the corner behind a banner and have a piss. Any self respecting country would be raiding them and rendering them illegal. 

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sancho panza
On 06/10/2019 at 01:34, DurhamBorn said:

They manufacture 18% market share for heavy vehicle powertrains.Orders for those tend to be leading indicators.Per capita they export double the UK and treble the US.Almost half of value added in manufacture is from automotive.The sectors that turn down first are the largest in Sweden and so are picked up first.These are supply chains into Europe,Germany mainly.2 to 3 month lag roughly,so expect Europe PMI to flag badly November/December.

The main reason i see inflation next cycle is the scale of printing,and the fact it will be everyone like you say.Lots of geo-political risk out there,and governments will be in a green rush against each other.All Fiat will be going down against assets/commods.

Thanks for the explanation DB,I see your point clearly now.

On 06/10/2019 at 01:37, DurhamBorn said:

Cross market work on this flagged the transports as being winners for the cycle ahead.

https://www.telegraph.co.uk/business/2019/10/05/end-road-cheap-car-loans-crisis-looms/

Arriving like clockwork now it seems.

It's frightening how many jobs have been created by car leasing/PCP/cheap car finance.Not sure the money men have been fooled.

Worth noting that the UK car dealers (and UK financials) dropped well ahead of the rest in April 2007........................................history,repaet,rhyme etc

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On 06/10/2019 at 02:35, Harley said:

Multi-currency is very useful, although less do with this KID thing, but not many offer it.  I'm only aware of II, IB, and some foreign ones like Internaxx and Swissquote.  I've been close to trying IB many times.

II offer options or is that IB?  European I assume, not US terms.

IB do options.My UK phone broker has ceased trading them,so we'll be setting up IB today or tmrw and I'll explore some options trades.Will psot them on here if we do any.See what you rteckon.

On 06/10/2019 at 10:14, stokiescum said:

This ones been reduced and I'm watching to see what it goes for it's a nice house (no laughing at the back ) High Lane, Tunstall, Stoke-on-Trent, ST6
https://www.rightmove.co.uk/property-for-sale/property-83548910.html

That looks like it's had £100,000 spent on it tbh.Immaculate.And to be fair,they've spent the moeny well.

 

 

On 07/10/2019 at 15:34, Agent ZigZag said:

 

On another matter been quietly adding to my miners after their consolidation a few weeks back. Anybody else adding for a final flurry in this sector

YEah,we're still adding into oversold conditions.Will do for a while yet.Recently averaged up into Anglogold Ashanti,Gold Fields,Harmony,Alamos,Kinross.I take the view that if they fall back to my average price from here,we'd look to add more.This is a bull market to me.We could get a huge pullback on dollar strentehning ahed of a broader market crash-which we might try and trade-but feels like a long term bull for dip buyers.Obviously DYOR>

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sancho panza
On 07/10/2019 at 19:28, DurhamBorn said:

Once margins fall and profits cant cover the interest bill.Debt deflation.The question is do the companies survive or not,the debt holders are stuffed.

https://www.bbc.co.uk/news/business-49957551

"its operating profits were more than offset by high interest payments on its £1.1bn debt pile."

Interesting to see who the PE firm offloaded to sucker wise.I wonder how much debt it had when Cinven took it over?

 

''Founded in 1965, Pizza Express employs 14,000 people and is now owned by Chinese private investment firm Hony.

The Chinese company bought it from UK private equity firm Cinven in 2014.''

 

Too funny.....................

 

'Most off-putting of all, of course, is the enormous debt number. The interest on that £1.1bn is costing the company £93m a year, which wiped out all its operating profit last year - and then some.

In fact, the debt payments have pushed Pizza Express into the red for the last two years with a loss of £55m last year alone.

The frustrating thing for the business is that it is making a reasonable amount of cash. It's for that reason, its auditors were happy to conclude the chain is a viable going concern when it signed off its accounts in April this year despite the company's debts being worth more than its assets.'

 
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sancho panza
4 hours ago, MrXxxx said:

And hence why UK industry is so anti-Brexit/immigration tightening, it would stifle cheap labour, push up costs, and reduce profits.

....................and reduce rents.Heaven forbid.So working age working couples could afford to have kids.

3 hours ago, spunko said:

I still don't understand why these car washes are tolerated. I saw their latrine the other day, when stuck in traffic I noticed every so often they'd go into the corner behind a banner and have a piss. Any self respecting country would be raiding them and rendering them illegal. 

It's worse than that.Some of these people are loaned sums of money to come to the UK and then spend years working for gang masters to reduce the burden of the debt load that grows with usurious rates of interest.Funnily enough,we hear little from the Unions about these flagrant abuses of working people.

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Another one to report its Q3 production was Endeavour Silver this morning, and it makes for a rather disappointing read. They are in a transition period at the moment, having indentified multiple operation issues in late 2018 and having been implementing measures to fix it since early 2019, so YoY production decrease was to be expected. However, QoQ production drop is very worrying as we should expect them to be firmly on an incline at this point. 

The news release highlights difficulties in implementing operational changes, exactly the type of issues I'd rather not see during this bull run (or, in fact, ever).

Don't know what the markets will make of this but I'm quite disappointed.

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On 07/10/2019 at 20:44, JMD said:

thanks DB, I was looking at Hartlepool also because of its coastal holiday market potential, but it looks like it is 45 mins to Newcastle.

Dont buy a house in Hartlepool for any reason.

Id stay well clear of holiday lets. 

Even with current low mortgage rates and zilch tax, most FHL fail to make any money.

Theres a HMRC review on FHL taxation. This will result in a a tax somewhere between 2x council tax (~2500) or full rates ~6k.

There will be a huge rush to exit on this. And the only FHL mortgage provided (Leeds BS) will find out why its the only FHL mortgage provider.

 

 

On 07/10/2019 at 15:23, DurhamBorn said:

That site is 100% accurate to my area,my house went up 130% from 96 to 2004 and is the same price now as 2004 (down slightly),just as the graph shows for semis in my area.Over 25 years gone up 101%.I havent the inflation figures to hand,but that must be close to simply inflation.

Its both accurate (for current prices) and inaccurate for future prices.

What he number of sales charts tell me is that there is a lot property that ought to have but, for various reasons, has not.

A change in IR or just people dying will see a flood of property hit the market.

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On 07/10/2019 at 14:34, Agent ZigZag said:

There really is a North/South divide. The North never really recovered from de-industrialisation with bugger all sustainable job/industry creation since. Successive governments have papered over the cracks regarding the North. In fact they have left it to rot. 

Since the 1980s job creation has been southern dominated, that would partly explain house price growth.

 

On another matter been quietly adding to my miners after their consolidation a few weeks back. Anybody else adding for a final flurry in this sector

The South is where the North as ~1985ish.

The gutting of finsec employment is hittign the South harder than de-indus hit the North.

Job creation from 1984ish (a few year pre Big Bang) -> 2008ish in the South was pure FinSec.

 

 

 

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21 hours ago, JMD said:

Barnsey, thanks i'll take a look, do you know if it has good demand for potential holiday letting? 

Holiday lets are an idiots market.

 

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sancho panza

Great article here on the coming weak dollar phase and also a good explanantion-as I've seen-of teh repo rate cirsis of late and what it indicates

 

Well wroth a full read and reread imho.

 

hattip kaplan

 

https://seekingalpha.com/article/4294621-crowded-trade

The Most Crowded Trade


 Includes: EEM, GLD, SBRCY, SP500, TLT, UUP, VOO, VWO
Lyn Alden Schwartzer
Contrarian, portfolio strategy, gold & precious metals, dividend investing
(9,150 followers)
Summary

Being long the dollar and dollar-related assets (especially Treasuries at the moment) has been the most popular trade this year and for most of the past decade.

We may be reaching a tipping point for the dollar, where a multi-year bullish trend reaches its apex and sets up for a reversal.

Look for a weaker dollar in 2020. Nothing is for certain, but that's how the math seems to converge.

According to Bank of America Merrill Lynch, being long U.S. treasuries (TLT) has been the most crowded trade over the past four months into September.

This is a good cyclical play. When growth is slowing, back-tests show that going into the dollar and treasuries makes sense as a safe-haven trade.

However, that cyclical play is starting to run into a structural trend, where rising U.S. deficits are starting to matter. This is likely going to require a weaker dollar to fix, and the market is inherently self-correcting. It's largely a question of timing at this point.

I find very few investors that are bearish on the strength of the dollar (UUP) or bullish on anti-dollar bets like emerging markets (EEM). Being long the dollar and viewing dollar-denominated assets as a safe haven is today's most-crowded trade.

Deficit-Driven Liquidity Shortage

A significant chunk of U.S. economic outperformance over the past five years has been about fiscal stimulus.

In my opinion, this next chart is one of the most important visuals to be aware of over the next few years and I've included it in a few recent articles, because this isn't going away. The blue line is the U.S. federal budget deficit as a percentage of GDP. The red line is the unemployment rate. For the first time in modern history, the U.S. deficit is widening to a large deficit during a non-wartime non-recessionary period:

U.S. Deficits and Unemployment

 

Chart Source: Goldman Sachs, Retrieved from CNBC

Meanwhile, the Euro Area has focused on austerity. As a group, they have consistently reduced their budget deficits each year so that now, at under 1%, their debts are growing more slowly than nominal GDP.

Euro Area Government DeficitChart Source: Trading Economics

For example, the United States (black dotted line, right axis below) grew its debt as a percentage of GDP from 62% to 106% over the past decade while Germany (blue line, left axis) decreased its debt as a percentage of GDP from 73% to 61%:

US vs German Government Debt to GDPChart Source: Trading Economics

So, not only does the U.S. have massive unprecedented fiscal stimulus equal to about 5% of GDP during non-recession peacetime, but we're doing so from the highest base of debt-to-GDP that the U.S. has had since World War II.

On the other hand, U.S. monetary policy has been the reverse of its fiscal policy. The Bank of Japan and European Central Bank have locked rates at zero and performed quantitative easing at a far larger scale relative to GDP than the U.S. Federal Reserve. The Federal Reserve stopped quantitative easing in 2014, performed quantitative tightening for a brief time, and raised rates about 2.5% higher than its peers. On that front, the U.S. has been by far the most hawkish one. However, the big fiscal stimulus is what gave the Fed ability to be hawkish.

The result of looser fiscal policy and tighter monetary policy than its peers over the past five years has been stronger U.S. economic growth than the rest of the developed world while simultaneously having a strong dollar, but such a situation is temporary and likely getting close to its apex.

 

The United States has the largest twin deficit (government deficit/surplus + current account deficit/surplus) out of its developed peers, and higher than many of the BRIC nations:

Twin DeficitsData Source: Trading Economics

This twin deficit doesn't matter in the short-term, but it matters significantly in the long-term.

As I'll describe below, the United States appears to be reaching a point where its debts and deficits are starting to matter, causing its monetary policy to reverse, and there are some specific catalysts to look for as it relates to timing.

The Market is Usually Self-Correcting

In late 2014, the Federal Reserve finished its third and final round of quantitative easing (QE), meaning they stopped "printing money" to buy U.S. government debt from institutions. This removed a significant source of liquidity and left the U.S. economy to stand on its own two feet.

Dollar liquidity is a tricky thing, because as the world reserve currency, it's the primary currency for lending to emerging markets, buying commodities, and has all sorts of offshore uses.

The dollar quickly rose higher relative to many other currencies as that round of quantitative easing ended. The blue line in the chart below is the Fed's balance sheet (when it's going higher, that's quantitative easing), and the red line is the trade-weighted dollar index. Once QE ended, the dollar shot up. It was then choppy for a while, but the beginning of QT gave it another kick back up:

Dollar vs QE and QTChart Source: St. Louis Fed

 

A country can't have growing deficits and growing debt vs GDP forever without QE, but they can do it for quite a while until a catalyst brings them to a halt.

Ironically for the United States, a strong dollar tends to be that catalyst.

The following chart shows the percentage of U.S. privately-owned debt that is held by foreigners (blue line) compared to the trade-weighted dollar index (red line), with a few inflection points marked:

Dollar Strength vs Foreign DebtChart Source: St. Louis Fed

As the chart shows, there's a historical inverse correlation between dollar strength and the percentage of U.S. debt that foreign sources hold. Whenever the dollar grows stronger, the U.S. private sector ends up having to fund more of its own government's deficits. Foreigners stop buying, and may even begin selling to stabilize their own currencies.

The major exception on the chart where the inverse correlation broke down was in the 1990's. There was a three-decade trend from the mid-1980's to 2014 where foreigners were funding an increasing portion of U.S. deficits. They went from holding about 15% of privately-held U.S. debt to 60% of it. This was during a rise of globalization, and particularly the rise of China. That foreign buying reversed course in late 2014, and they are now down to about 45% ownership of privately-held U.S. debt.

Starting in 2015, right after QE ended in the U.S. and the dollar became strong, foreigners stopped buying U.S. treasuries. Almost all new U.S. debt issued in the past five years (about $3 trillion worth) has been bought by domestic sources (blue line below). Foreigners (green line) and the Fed (red) have not been buying at significant scale:

Federal Debt HoldersChart Source: St. Louis Fed

 

This is quite a lot of debt for domestic balance sheets to hold. The next chart shows the amount of U.S. government debt held domestically compared to U.S. GDP, indexed to 100 five years ago:

Domestic Debt to GDPChart Source: St. Louis Fed

Basically, various institutions have increased their U.S. treasury holdings by 12.3% per year over the past five years compared to 4.1% annual nominal GDP growth over that time period.

Additionally, U.S. corporate profits peaked in 2014 right when the dollar index shot up at the end of QE. Pre-tax profits are down since then, and after-tax profits have gone sideways thanks to tax cuts.

Corporate ProfitsChart Source: St. Louis Fed

This shouldn't be a big surprise, considering that the S&P 500 is a large component of this and as an index they get over 40% of their revenue from foreign sources. All of those foreign income sources translate into fewer dollars when the dollar is strong.

This dollar strength has put a lot of pressure on the global economy. Many emerging markets have high dollar-denominated debts, so a stronger dollar effectively raises their debts and puts financial pressure on them, which has caused some of the weaker ones (i.e. Argentina and Turkey this time around) to fall into a currency crisis, and to slow the growth of others.

In addition, dollar strength puts a lot of pressure on the United States. Total corporate profits are down, so a combination of tax cuts, share buybacks, and valuation improvements have contributed to continued equity growth. And as previously mentioned, the U.S. has been forced to fund its own deficits.

 

In other words, the combination of loose U.S. fiscal policy and tight U.S. monetary policy is starting to strain the global system. Argentina and Turkey popped first, everyone has been strained, and now some leaks are starting to show up in the United States.

Repo Issues

Most investors are aware that the overnight repo market has required Federal Reserve intervention every night for the past two weeks. Starting in mid-September, repo rates spiked, implying that banks don't have cash to lend to each other, and it required ongoing liquidity injections from the Fed to push back down:

Repo RateChart Source: Trading Economics

Some commentators in financial media were freaking out because the last time the repo market was this bad was in September 2008 when U.S. banks were afraid to lend to each other overnight due to the risk that one of them would announce bankruptcy the next morning. That was an acute liquidity crisis due to an insolvent banking system.

Other commentators were saying the repo spike was nothing, just temporary timing issues. Quarterly corporate taxes were due mid-month. The U.S. Treasury is sucking up a couple hundred billion dollars in extra debt issuance to refill its cash reserves following this summer's debt ceiling issue that forced the Treasury to draw down its cash levels.

Evidence shows pretty clearly that the issue is somewhere in the middle. It was not and is not an imminent bank collapse liquidity crisis, nor was it purely a one-time thing. Instead, five years of domestic institutions fully-funding U.S. deficits basically saturated the banks with treasuries and they have trouble holding more. Their cash reserves have run low.

In particular, large U.S. banks that serve as primary dealers have been filling up with treasuries and drawing down their cash levels ever since QE ended. This chart shows the percentage of assets at large U.S. banks that consist of treasuries (blue line) vs the percentage of assets that consist of cash (red line):

 

Bank Liquidity BedrockChart Source: St. Louis Fed

Primary dealers are the market makers for treasuries. They don't really have a choice but to buy the supply as it comes, and supply is starting to turn into a fire hose and foreigners aren't buying much of it.

The percentage of total assets held as treasuries at large U.S. banks is now over 20%, which is the highest on record.

Cash as a percentage of assets at those institutions is now down to 8%, which is right at post-Dodd Frank post-Basel 3 lows. They're pretty much at the bedrock; they can no longer continue drawing down cash and using it to buy treasuries. Cash levels can't (and shouldn't) go lower like they did in the 2000's because that's the type of leverage that led to the financial crisis back then and current regulations require banks to have more cash.

A lot of people are confused at how there can be too much supply of treasuries, because there is clearly investor demand for treasuries, especially long-duration treasuries that have performed very well this year.

However, most U.S. debt is short-term, and that sheer quantity of short-term debt has been pressuring the banks all year. Over the past few years, bid-to-cover ratios have been declining leading to some messy treasury auctions this year, and starting this spring, the federal funds rate has gone over the interest rate on excess reserves:

IOER-FFRChart Source: St. Louis Fed

Clearly, this issue has been building for years and has accelerated throughout 2019, and September just happened to be when a couple extra pressures finally caused the system to reach its limit. It doesn't take a repo expert to see that it's not a repo-specific problem. It's a sovereign debt problem.

 

The Dollar's Apex is in Sight

As this liquidity squeeze plays out and global economic growth continues to slow, the dollar is still in an upward trend, but these trends historically can reverse very quickly:

 

ChartData by YCharts

 

Unless the dollar weakens, foreigners are unlikely to resume buying U.S. treasuries at scale. Even though U.S. treasuries pay higher rates than European or Japanese sovereign bonds, currency hedging eliminates that difference, so only investors daring enough to hold un-hedged U.S. treasuries can take advantage of that rate differential. This means that domestic institutions likely have to keep funding most the deficits of over $1 trillion per year, and primary dealers already clearly have a liquidity problem and are already holding a record amount of treasuries as a percentage of assets.

There are a few ways this can play out. The most likely outcome is that the Federal Reserve will begin expanding its balance sheet again by 2020 (or perhaps in this fourth quarter 2019) to relieve pressure from domestic balance sheets, which means that the Fed would essentially be monetizing U.S. government deficits. This would inject liquidity into the system, take some of the burden off of domestic institutions for absorbing all of those treasuries, and is likely to weaken the dollar which could allow foreign investors to step in and buy some more treasuries as well.

However, timing and details will be interesting.

Scenario 1) No U.S. Recession

If the Federal Reserve shifts from temporary open market operations "TOMO" to permanent open market operations "POMO" to permanent organic balance sheet expansion (QE by another name), it could address the issue for now.

Many investors assume that we would need a crisis scenario for the Fed to re-start QE, but as I showed with bank liquidity hitting bedrock and no end to U.S. debt issuance in sight, the Fed is likely to expand its balance sheet gradually simply due to liquidity pressures. They used to expand their balance sheet gradually prior to the global financial crisis anyway, so this would be a resumption of that but from a much higher starting point.

 

In a mild scenario, we could see the dollar leveling off and then weakening due to Fed easing, which could help some emerging markets show signs of life. It would give U.S. corporations some currency tailwinds for once rather than headwinds like they've had. In this case, I'd want to be positioned in emerging markets.

Vanguard has a good valuation/growth breakdown of the S&P 500 (VOO) and emerging markets (VWO) via their ETFs:

VOO vs VWOTable Source: Vanguard

Emerging markets have higher 5-year growth rates and much lower valuations. They would be my top choice in a weakening dollar environment.

As a recent data point, when the DXY dollar index dropped from about 100 to 90 in 2017, the MSCI emerging markets index soared over 37% in dollar terms. Lower debt burdens gave them a burst of earnings growth and then strengthening currencies added onto it for dollar-based investors.

However, I don't particularly like just owning an emerging market index due to how heavily weighted they are in China. I prefer analyzing individual markets based on growth, valuations, sector composition, stability, currency fundamentals, and debt levels. I'm optimistic about forward equity returns for Chile, Russia, India, South Korea, Taiwan, and a few others, especially if we get further sell-offs this quarter. I don't have a strong conviction either way on China at this time.

One of my favorite emerging market stocks at the moment is Sberbank (OTCPK:SBRCY) as a small position as part of a diversified portfolio. Many investors underestimate how resilient the company is, it has a single-digit P/E ratio, and it offers a very high dividend yield with a modest payout ratio.

I would have a moderate outlook on gold (GLD) in dollar terms in this scenario. It would benefit from a weaker dollar and lower U.S. interest rates, but without a recession it wouldn't get a fear trade. I'd be a buyer at current levels.

 

Scenario 2) U.S. Recession

In a more severe scenario, Fed dovishness and liquidity injections aren't enough to keep things going and the U.S. begins encountering recessionary conditions in 2020. We could have some rough earnings numbers for these last two quarters of 2019 (the one that just ended, and the next one), leading into ongoing weakness in 2020.

Recessions significantly reduce U.S. tax revenue:

Government Tax ReceiptsChart Source: St. Louis Fed

If we have a recession in the coming year, it'll be the first one where the government is already running an annual deficit at 5% of GDP before the recession even begins, which could make for some very interesting situations. We could easily blow a $500 billion hole in the budget as a low-end estimate, and depending on any stimulus measures the government takes, the range of numbers goes up from there. Annual deficits could balloon from over $1 trillion to over $1.5 trillion or upwards of $2 trillion.

The amount of QE by the Fed to monetize U.S. deficits would likely be larger than many investors realize, just looking at it mathematically. I'd expect at least 20% dollar devaluation in the coming years, if not more.

In this scenario, I consider it highly probable that gold would do especially well. I also think emerging markets, while they would likely be in for a volatile time, would do better than most investors assume at these valuation levels and with a weaker dollar, and would come out strong on the other side of any sell-offs. The night is darkest just before the dawn, in other words.

Most investors have it in their minds that emerging markets necessarily do bad when the U.S. has a recession. The sample size for this, however, is just three. There have been only three U.S. recessions since the MSCI emerging markets index was created in the late 1980's. During the "big one" in 2007-2009, emerging markets were a bloodbath but for context, they went into that global crisis with record high valuations and high expectations, not low valuations and low expectations like we have now.

 

Look how emerging markets held up during the two quarters surrounding the flash crash of 4Q2018 compared to the S&P 500, even without a weaker dollar:

 

ChartData by YCharts

 

At these valuations, although I'd expect to see an emerging market draw down in a U.S. recession scenario, I'm optimistic about emerging markets coming out strong on the other side and would be a buyer of corrections, and particularly of select countries. Especially because, this time around, a weaker dollar is on the table and that would relieve some of their debt pressures like they enjoyed in 2017.

Final Thoughts

Summing this all together, there are multiple ways this can play out, but mathematically they all seem to require a lower dollar, one way or another.

It has been a longstanding belief that U.S. government debt and deficits are a far-off problem and don't really matter, but we are starting to run into tangible effects from treasury bill oversupply and in the coming years this will be a factor to work around. I classify U.S. debt/deficits as one of my four economic bubbles to be aware of.

The dollar has positive momentum at the moment, so it could trend higher in the short-term, but the higher it goes, the more it dooms itself by increasing the likelihood and timeline of a large U.S. recession and the associated debt monetization. Diversification is the safest way to play it. Traders may want to watch it for now, and be prepared to take advantage when/if the dollar strength turns over.

As far as I can tell, most of the dollar bulls who expect a much higher breakout in the dollar underestimate the damage that a strong dollar self-inflicts on the United States economy, which would then likely self-correct via a recession and major deficit monetization. The strong dollar reduces foreign corporate income and forces U.S. institutions to fund the U.S. government deficit, and after five years of doing this they are nearly tapped out and with flat dollar-denominated profits. Any major dollar breakout would likely be brief, self-correcting, and unpleasant.

 

I am including gold and emerging markets (with an emphasis on certain countries) in my portfolio, and which asset class will do better between the two will depend on how events unfold. I also have dry powder in the form of cash-equivalents and short-term bonds to add to my foreign or domestic equity allocation should we get a big equity sell-off later this year or in 2020.

Disclosure: I am/we are long SBRCY, VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long a variety of global equities, domestic stocks, precious metals, and short-term bonds, and cash-equivalents.

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So whilst the credit contraction isn't as severe as 2008, it has now exceeded it in length, with no sign of turning upwards until we're on the other side of the recession. We're entering an environment of significant credit contraction (personal loans credit impulse growth for example now below 2011 level and contracting vs GDP), oversupply of new build housing, and unsustainable wage increases putting huge strain on employers now having to pass on costs, cut overtime, and ultimately start laying people off. All of these things act with an almighty lag of course so as of yet still hiding under the surface. The credit impulse typically leads GDP by about 1 year however stockpiling has muddied the waters somewhat recently and portrayed things to be much better than they really are, in addition to that HUGE credit impulse burst before the referendum.

It's staring us right in the face now folks, don't turn a blind eye to what's becoming blindingly obvious.

https://www.cityam.com/investment-firm-responsible-for-1bn-assets-goes-into-special-administration

Quote

Reyker Securities, an investment management firm responsible for £1bn of assets, has entered special administration amid “financial difficulties” following a failed attempt to sell the firm.

The company, which has around 15,000 clients, had been pursuing an accelerated sales process, but the Financial Conduct Authority (FCA) confirmed this fell through.

“Due to the firm’s financial difficulties the Directors resolved that it was cash flow insolvent, and in discussion with us, took steps to place the firm into special administration,” the FCA said.

 

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15 hours ago, DurhamBorn said:

Well mostly that welfare spending is wrecking the country.So at the moment id be voting right of centre.Corbyn would be a disaster for the UK,one that would take 50 years to put right,if ever.Brown got us where we are now,Corbyn would finish the job.Its ironic,but tax credits caused Brexit,yet the left cant see it.

Well, lets be more exact - Brown caused Brexit, just like hes caused future extreme poverty and the destruction of the UK pensions and financial setcor.

Gdiot was way too slow to undind the one eyed cunts fuck ups.

Dec 2015 - 4 years ago:

https://www.housepricecrash.co.uk/forum/index.php?/topic/210123-the-official-brexit-remain-thread-all-new-threads-will-be-merged-into-this-one/page/160/

Again, along with the near miss (or hit, depending on your stance), another one of Gordie's genius ideas is blowing up the UK again.

Paying out tax credits to EU nationals has drawn in 10% of East Europe workforce, paying them a huge salary to hand wash cars, etc etc. Forcing up costs for the low paid natives, putting them out of jobs etc etc.

All down to that cretin Brown. Seriously, he's been out of power ~6 years and his 'great idea's' are still flying back to coup and dumping on the UK.

There's a BBC article on Camerons attempt to winkle out of the benefit payments:

http://www.bbc.co.uk/news/uk-politics-eu-referendum-35118036

Its always interesting to read the highest rated comments on HYS articles -they tend to be a good indication of what the nation is thinking.

A few years ago, 'UK out of EU' was a fringe opinion held by Colonels from Tunbridge Wells.

Now it appears to be the UK mainstream opinion, both left + right.

My opinion is they should scrap TCs ASAP. Introduce a contribution based welfare system like the rest of the EU.

When I posted this, Id only seen Brexit used on a few bond BBs, used as an example of an extreme, unexpected outcome.

I predicted the outcome and gave the *exact* reason why brexit happened.

I dont think Id heard it in he MSM.

And the MSM is still not acknowledging or considering the cause.

Everyone 'important' were not even considering Brexit as a even an unlikely possibility.

 

 

 

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Linking in with the article you posted @sancho panza

FASTER than QE1, 2 or 3! FASTER than the reaction to the despair of the GFC :ph34r:

But don't worry, we're smarter now, oh wait...

https://realinvestmentadvice.com/the-voice-of-the-market-the-millennial-perspective/

Quote

Millennial Financial Markets

As stated earlier, the dot com bust, steep equity market decline, and the ensuing recession of 2001 occurred when the millennial generation was very young.

The financial crisis of 2008-2009 occurred when millennials were between the ages of 12 and 27. More than half of them were teenagers with little to no investing experience during the crisis. Some older Millennials may have been trading and investing, but at the time they were not very experienced, and the large majority had little money to lose. 

What is likely more memorable for the vast majority of the generation is the sharp rebound in markets following the crisis and the ease in executing a passive buy and hold strategy that has worked ever since.  

Millennial investors are not unlike bond traders under the age of 60 – they only know one direction, and that is up. They have been rewarded for following the herd, ignoring the warnings raised by excessive valuations, and dismissing the concerns of those that have experienced recessions and lasting market downturns.

Are they ready for 2001?

The next recession and market decline are more likely to be traditional in character, i.e. based on economic factors and not a crisis in the financial sector. Current equity valuations argue that a recession could result in a 50% or greater decline, similar to what occurred in  2008 and 2001. The difference, however, may be that the amount of time required to recover losses will be vastly different from 2008-2009. The two most comparable instances were 1929 and 2001 when valuations were as stretched as they are today. It took the S&P 500 over 20 years to recover from 1929. Likewise, the tech-laden NASDAQ needed 15 years to set new record highs after the early 2000’s dot com bust.

Those that were prepared, and had experienced numerous recessions were able to protect their wealth during the last two downturns. Some investors even prospered. Those that believed the popular narrative that prices would move onward and upward forever paid dearly.

Today, the narrative is increasingly driven by those that have never really experienced a recession or sharp market decline. Is this the perspective you should follow?

EGbv5RhXkAEOkuV.png.354bb98661fc191af3d8dd8176622386.png

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21 hours ago, JMD said:

Sugarlips, interesting table, but what conclusions do you draw?  i.e. i'm not sure how to read it as wind/solar is heavily subsidised.

I’m going to let the experts answer this, long but very informative, coal is going to be finished sooner than anyone realises:

https://www.macrobusiness.com.au/2019/10/coal-finished-as-renewable-costs-crash/

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Transistor Man
18 minutes ago, Sugarlips said:

I’m going to let the experts answer this, long but very informative, coal is going to be finished sooner than anyone realises:

https://www.macrobusiness.com.au/2019/10/coal-finished-as-renewable-costs-crash/

Coal is already finished in the UK. Now only a few percent of the electricity generation mix -- down from 40% 10 years ago.  

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