IN-DEPTH: TRANSCRIPTION - LONGWave - 05-08-24 - MAY - The Credit Crisis v A Debt Crisis
SLIDE DECK
TRANSCRIPTION
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Thank you for joining me. I'm Gord Long.
A REMINDER BEFORE WE BEGIN: DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are COMMENTARY for educational and discussions purposes ONLY.
Always consult a professional financial advisor before making any investment decisions.
SLIDE 3 - COVER
Credit and Debt are the two sides of the same coin!
Credit worthiness is required to secure debt. Therefore Debt can’t grow unless the Creditworthiness’ growth rate is matching it or has preceded it. This is why I always say in my newsletters that Credit Leads – Markets Follow.
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We are going to explore both sides of this coin in this session with a keen eye on the signals coming out of US Fiscal and Monetary Policy that affect both Credit and the assumption of the important elements of Debt.
As such I will cover the subjects outlined here.
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We will begin with the big disruptor to Credit and Debt – Inflation and the destabilizing shock it can have on a complex, risk adverse and highly sensitive global financial system.
The bigger Inflation is - the higher prices rise – the bigger credit and debt levels required
The Bigger the Debt in our financial system – the bigger the GDP
Interestingly, everyone loves a bigger GDP but only a select few love Inflation!!
That is important to understand and which camp players are in! You may not be in the same camp as your own government!
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- The US public has experienced goods and service increase by an official rate of 5% from 2021 to 2016.
- From 2016 to 2020, things became 8% more expensive.
- From 2020 to today, things have become 21% more expensive.
What this has meant is a 34% increase in prices.
To them everything is 1/3 more expensive to even exist than a decade ago!!
Many pensioners living on CPI based COLA adjustments would likely (angrily) suggest the official numbers are bogus!
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US workers see that their real disposable income simply hasn’t kept up and feel they are falling behind.
US Real Disposable Income fell over $1 Trillion in 2022, the second largest percentage drop in real disposable income ever – behind only 1932, the worst year of the great Depression.
Inflation has only gotten worse in 2023 and 2024, with the rich being owners of assets becoming richer while the poor being owners of debt and requiring credit to survive have become decidedly poorer.
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When we look at global government debt we are all well aware it continues to dramatically accelerate higher.
This initially began when the US came of the gold standard and global fiscal imbalances were then settled through credit versus gold in 1980 through the Bank of International Settlements.
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We had ~$62T in government debt, on a global economy as measured by GDP in 2020, of ~$84.96Tdebt
It will be $82T in 2022 with an expected GDP of $104T.
This is ~$20T of new Debt to grow the Global economy by the same ~$20T!
ARE WE GROWING DEBT OR GDP?? It makes you wonder whether we are growing the economy or just debt??
Well the answer is they are BOTH now inextricably, economically connected!
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The question is whether this relationship is sustainable and what will change?
We currently have the expectations that we can continue to create Credit and Debt at a sufficient rate to make it sustainable. Are these false expectations? Bad things happen in financial markets when false expectations are proven to be false!
Here are just 10 areas where credit and debt needs are clearly ballooning:
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- The interest on the US debt is quickly approaching $2T/year and is now more than the tax revenues taken in.
- Unfunded US Entitlement Liabilities are now more than $80T with the contributions held in US Treasury Bonds increasingly being redeemed for payouts. The US Treasury will be forced to issue more debt to pay the principle owed when these Treasuries mature.
- The Green economy is costing Trillions and growing with over $9 Trillion urgently needed according to a recent study by the Financial Times.
- Climate Change is costing Trillions and the COP conferences say much more is needed,
- Global Conflict is forcing the Remilitarization of the world.
- The Restructuring of global trade (De-Risking / On-shoring / Friendly shoring)
- The Houthis' sustained disruption of the Asia-Europe shipping route is repricing global shipping, insurance and other costs.
- Rare earth metals and global commodity costs are continuing to re-price.
- Between now and 2030, demand for power from global data centers will easily more than double ... within that comes $50bn of capital investment in US power generation alone.
- FX De-Dollarization
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…. all must be financed and are INFLATIONARY!
Is our financial system ready for this?
The Financial System is already experiencing serious secular and unprecedented issues...
- Fed has taken Rates from Zero to 5% (after claiming inflation was transitory??)
- Mis-matched goals as Government spends a $6.2T in Fiscal Deficit while the Fed executes Quantitative Tightening and fights inflation no seen since the 1970’s,
- Withdrawals surge from captive "nothing" to 5% Money Market Funds – Liquidity drain
- Fed forced to implement BTFP for 1 year.
- Banks face regulatory solvency problems.
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BANKS:
The FDIC’s published reports show more than $500 billion in unrealized losses in the US banking sector.
There was $620b in unrealized Treasury losses last year with Silicon Valley Bank, Signature, First Republic, and now Republic First.
CENTRAL BANK:
The Federal Reserve, which in theory would bail out the banking sector, is itself insolvent by $900 billion.
Total Federal Reserve capital is just $51 billion… versus $948 billion in losses. This means the Fed is insolvent 19 times over.
GOVERNMENT:
The US government, which would bail out the Fed, is insolvent by more than $50 trillion.
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Daily we see signs of Economic slowdowns and stagnation.
With rising Inflation and slowing growth, Stagflation which we warned about in our 2023 Thesis paper is near.
If something dramatic doesn’t change we are on a path towards a Debt Crisis by the end of what is likely to soon be labeled the Beta Drought Decade.
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The question is: Are there spending limits controlled by Credit and Debt growth that will restrict government, corporate and consumer spending?
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The short answer is YES!
The global pie of growth in credit and debt must be shared.
The unwritten rule and reality is that Money, credit and debt always go where it is treated best.
The US is an “abuser” since it has long consumed more than it produces and finances the difference from that global pool.
As this chart illustrates:
- The Rest of the world (in red) is no longer as ready to finance the US as previously,
- Credit Creation is not matching debt needs and
- The Fed has been forced to grow its balance sheet to make up the shortfall
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The Billionaire Bond King and former PIMCO founder of the largest Bond fund in the world, recently spelled it out - and I quote:
- The US fiscal deficit, largely driven by a massive rollout of Treasury bonds, is now deemed a "necessity" to propel the economy forward, which is fueling upward pressure on bond yields.
- The outstanding balance of Treasuries has surged at over a 10% annual rate for the past 18 months, thanks to post-COVID deficits of $2 trillion-$3 trillion dollars.
- By the end of 2023, the Federal government had racked up nearly $30 trillion in debt.
- "The US economy requires fiscal deficits and net increases in Treasury debt of 1-2 trillion or more annually in order for the economy to grow
- "That's a lot of bonds,"
- While Treasury debt has been growing at a rapid rate, other types of debt, including business and household debt, have been growing more slowly.
- As a result, in order to make up for this difference, the government must ramp up Treasury debt BY OVER 10% to uphold 5.5% nominal GDP growth,.
- "Look for 5% plus 10-year yields over the next 12 months — not 4.0%.
- Those that argue for lower rates have to counter the inexorable upward climb in Treasury supply and the likely Sisyphean decline in bond prices."
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This closely aligns with the views held by MATASII.
We believe the US is in the midst of the third Great Bond Bear market shown here on the right in red.
We suspect we are near a Bear Market counter rally that will be driven by an already well telegraphed election year rate pivot by the Fed.
A rising unemployment rate of 4% as reported by the monthly Labor Report is the likely trigger point the Fed is currently watching.
It will bring with it:
- A new Interest Cost Control (ICC) methodology in concert with the US Treasury regarding Treasury Debt costs
- A re-launch of Quantitative Easing (QE) and a US version of
- Yield Curve Control (YCC)
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The mechanics to watch this unfold is through the lens of how Credit will lead and where it will be created.
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Although US economic growth has remained strong so far, the Fed must be concerned that if interest rates remain high, Credit Growth will slow further and tip the US into Recession.
This concern may force the Fed to begin cutting the Federal Funds Rate soon even if Inflation remains above the Fed’s 2% target.
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We show here the annual increase in Total US Debt each year going back to 1952.
After a record-breaking $8 trillion surge in Total Debt in 2020, the annual increase slowed to:
- $6.3 trillion in 2021,
- $5.1 trillion in 2022 and
- $4.1 trillion in 2023.
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Government Debt has increased by $23 trillion since 2007 (nearly 400%). That prevented two Great Depressions in 16 years.
Since 2007, Total Debt in the United States has increased by $46 trillion or by 87%.
The increase in Government Debt has accounted for 51% of the increase in Total Debt.
Without that increase in Government Debt, it’s likely that the US economy would have spiraled into a Depression and that the size of the economy would be at least 10% to 20% smaller than it is today.
Household Debt jumped by a record-breaking $1.6 trillion in 2021. It slowed to a still large $1.1 trillion increase in 2022. But in 2023, it fell back to just $525 billion
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- Household Debt increased by an average of 8.0% a year between 1952 and 2023. During 2023, it increased by only 2.7%. That was the weakest since 2015.
- The two largest components of Household Debt are Mortgage Debt and Consumer Credit.
- In both of these categories, Credit Growth was exceptionally weak last year.
- Mortgage Debt increased by an average of 8.1% a year between 1952 and 2023. But in 2023, it grew by only 2.8%.
- The increase in Consumer Credit was also very weak during 2023, just $126 billion, down from around $350 billion a year during the two prior years.
- Consumer Credit increase by 7.7% a year on average between 1952 and 2023. Last year, it increased by only 2.6%.
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The $200 billion increase in Corporate Debt last year was the weakest since the aftermath of the Crisis of 2008, down from an increase of $1 trillion in 2020, $730 billion in 2021, and $800 billion in 2022.
- It grew by only 1.5%. The average annual growth rate since 1952 has been 7.5%.
- It was a similar story for the GSEs. Their debt increased by just $280 billion last year, down from… The average annual growth rate for GSE debt between 1952 and 2023 was 13.3%. Last year it was only 2.4%. That was the weakest since 2014.
- The increase in Non-Corporate Business Debt was also weak, just $167 billion.
- That amounted to a 2.3% increase last year. The average since 1952 has been 8.4% a year.
- The same weak trend held for the Financial Sector excluding the GSEs. Debt there rose by only $120 billion last year.
- In percentage terms, the debt of this sector grew by only 1.3% last year. The average annual increase since 1952 has been 9.0%.
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- The increase in Government Debt jumped from $1.5 trillion in 2022 to $2.6 trillion in 2023. That was the second largest increase ever. The largest was $4.6 trillion in 2020.
- In percentage terms, however, the increase in Government Debt last year appears less shocking. The 9.8% increase in 2023 had been surpassed many times before. The average increase since 1952 has been 7.2% a year.
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Government Debt accounted for 64% of the increase in Total Debt
That large increase in Government Debt was one of the main reasons the US didn’t fall into a Recession in 2023.
If the Government had borrowed and spent less, it’s likely that the other sectors would have borrowed even less than they did.
Total Credit growth would have been much weaker and that, most probably, would have thrown the economy into a Recession.
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Between 1952 and 2009, Total Credit Adjusted for Inflation grew by less than 2% only nine times. Every time that happened the US went into Recession.
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Even though Total Debt grew at a slower pace in 2023, Total Debt adjusted for Inflation increased by 0.2% last year, whereas it had contracted by 2.3% in 2022.
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Despite this improvement, Total Debt adj. for Inflation was still below the 2% Recession Threshold in both 2022 and 2023.
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The reasons the US economy has continued to grow despite weak Credit Growth is due to the extraordinary surge in Wealth since the end of 2019.
Wealth has boosted Consumption and helped keep the economy growing.
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What happens if Wealth creation slows?
What happen if it shrinks significantly?
What we learned in previous major market crashes was that Wealth and leverage collapsed when underlying Collateral values shrank. In the last crisis of 2008 it was the value of residential real estate assets falling in price and taking the whole mortgage finance market with it.
Could that happen again?
The answer is effectively YES! Maybe even more so.
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My experience has been during every major market crisis I have lived through we suddenly, as the crisis unfolds, learn about new terminology and financial methods we had never heard of before or were even remotely aware of.
During the Dotcom Bubble burst of 2000 we learned about …. then in 2008 ….
2000 2008
ABS (Asset Backed Security) CDS (Credit Default Swaps)
IPO (Initial Public Offering) CDO (Collateralized Debt Obligation)
SPE (Special Purpose Entity) MBS (Mortgage Backed Security)
Derivatives (Energy) REHYPOTHECATION / NOVATION
Currency & Interest Swaps Leveraged Loans
Today few are aware of:
INFLATION SWAPS
CLO (Collateralized Loan Obligations) [versus CDO]
LDI (Liquidity Driven Investment) [recent UK Gilt Crisis]
COLLATERAL TRANSFORMATION
COLLATERL SWAPS
… and list goes on ….
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The result has been the explosion in the use of Derivatives which has a similar profile to the growth in Global Debt.
The 2000 Crisis is marketed here by the first vertical red arrow. The 2008 Crisis is marked by the second vertical red arrow.
We have traveled a long way since the last financial market crisis and the overall growth in global government debt.
It makes no sense that a global economy of ~100T would support Currency and Interest Swaps alone of ~700T in a quadrillion derivatives market.
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A derivative complex that is primarily OTC, unregulated and with little visibility.
This is a massive complex which controls almost every facet of the visible and regulated financial exchanges.
The next crisis will stem from something breaking in this untested and evolving goliath as it pushes the continuously stretched Credit creation bounds.
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So what can we conclude?
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There is no economic growth without debt growth.
There is no debt growth without credit growth.
The Crisis Will Occur When Debt Growth No Longer Produces Growth
- Globally as we saw earlier this has already eroded to taking $1 Debt for a $1 of Growth
- In the US It now takes as much as $2.50 of New Debt to produce the $1 of Growth
- In the US it Takes as much as $1.50 of Deficit Growth to produce the $1 of Growth
- The Velocity of Money must be sustainably larger than Money Supply or GDP shrinks.
The Crisis Will Be the Implosion of the Derivative Security Complex
- An Unprecedented “Super Cycle” degree Collapse
- Collateral Underpins All Derivatives
- Collateral Will Be Swept Up On A Vast Scale.
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All of this couldn’t have been any clearer than during Fed Chairman Powell stressed emphatically that he did not see rates going higher. He convinced the markets that movements on rates were to the downside.
Additionally, he announced the tapering of Quantitative Tightening.
There was no reason for him to take this position with:
- Core Inflation still very much an issue, especially in Services (remembering we are a services economy).
- The money supply (M2) has bounced to March 2023 levels and has been rising almost every month since October last year.
- US government deficit spending has more than offset the decline in the Federal Reserve balance sheet.
- The Fed’s balance sheet has shrunk by $1.5 trillion from its peak while] the US government deficit remains above $1.5 trillion per year.
The Fed is not as concerned about a market correction as it is about maintaining some calm in the bond market amidst an unsustainable increase in government deficit and public debt.
The Fed is choosing to keep the sovereign debt bubble alive as a priority over reducing inflation.
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It is impossible to reduce inflation to the 2% target when the government deficit, which is printing new currency, remains out of control. It is even more difficult when the Federal Reserve delays normalization of the balance sheet, bringing the monthly redemptions to less than half the previous figure.
The Federal Reserve is reluctant to admit two things:
- The Treasury’s debt supply is significantly higher than private sector demand, and
- The Fed is more concerned about a bond market meltdown than elevated inflation.
The Fed’s decision could be seen as a dangerous way to keep the government’s misguided fiscal policy alive at the expense of making families and small businesses poorer with elevated inflation and higher-for-longer-rates.
Powell tries to be prudent and rigorous about inflation when the government fuels the fire. Powell is like a fireman trying to stop a fire with a bucket of water, while the owner of the building, the government, throws gallons of gasoline over the ceiling.
… OR SHOULD I SAY THE MASSIVE GLOBAL DERIVATIVE STRUCTURE?SLIDE 45
As I always remind you in these videos, remember politicians and Central Banks will print the money to solve any and all problems, until such time as no one will take the money or it is of no value.
That day is still in the future so take advantage of the opportunities as they currently exist.
Investing is always easier when you know with relative certainty how the powers to be will react. Your chances of success go up dramatically.
The powers to be are now effectively trapped by policies of fiat currencies, unsound money, political polarization and global policy paralysis.
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I would like take a moment as a reminder
DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are for educational and discussions purposes ONLY.
As negative as these comments often are, there has seldom been a better time for investing. However, it requires careful analysis and not following what have traditionally been the true and tried approaches.
Do your reading and make sure you have a knowledgeable and well informed financial advisor.
So until we talk again, may 2024 turn out to be an outstanding investment year for you and your family?
I sincerely thank you for listening!
