GVA Newsletter
February 2015
Losing the Thread
“We have had the biggest Monetary Stimulus the world must have ever
seen and we still have not solved the problem of weak demand. The
idea that monetary stimulus after six years is the answer doesn’t seem
right to me.” - Mervyn King former Chair of the Bank of England
speaking at the London School of Economics on 1/19/15
“One of the things I’ve tried to argue is look, if we believe that monetary policy is doing what we say it’s doing and depressing real interest rates and goosing the economy and we’re in some sense distorting
what might be the normal market outcomes at some point, we’re going
to have to stop doing it. At some point the pressure is going to be
too great. The market forces are going to overwhelm us. We’re not going to be able to hold the line anymore. And then you get that rapid
snapback in premiums as the market realizes that central banks can’t
do this forever. And that is going to cause volatility and disruption.”
- Charles Plosser Sitting Philly Fed Chair from the Washington Post –
Source Zero Hedge 1-30-15
The New York Times just published a report produced by McKinsey
Global Institute that showed that global debt has grown by $57 trillion to $199 trillion since 2007. China’s debt has quadrupled rising
from $7 trillion to $28 trillion in that time.
The human mind has a hard time understanding what a trillion is, but
we read a great illustration in Tony Robbins new book “Money – Master The Game”. We’ll shorten it for you: one million seconds ago was
12 days, 1 billion seconds ago was 32 years and 1 trillion seconds
ago was roughly 32,000 years in the past. That may give some perspective. Pause and let the difference between a billion and a trillion
sink in for a bit: 32 years vs 32,000 years.
So when you hear that global debt has gone from $142 trillion in
2007, where it was so unsustainable it caused the biggest financial
meltdown since 1929, to $199 trillion in the last 8 years, how does
it influence how you think about how to invest? You can be forgiven
if your mind just goes numb when you here these statistics. Does it
really matter? We are told every day that it doesn’t and the stock
market keeps going up and we are being told that the economy is
stronger than ever, that we are clearly in a recovery.
This is the question: Are we in a real economic expansion and bull
market or the greatest bear market rally ever, driven by debt?
It has been our contention that no one knows exactly when this
charade will end but the higher probability is that it will end and
end badly. We believe that you cannot solve a problem of too much
debt with more debt. That by goosing debt you are not adding real
value to an economy but merely encouraging speculation and increasing risk while diminishing the prospect for sound investment.
It seems to us that Fed policy is not working and our expectation
was that it never would. Commodities are generally a good sign of
economic strength and they peaked in 2011 and have been declining
since. Recently commodities have been dropping quite steeply with
oil dropping 61% in 5 months. Contrary to mainstream media reports
we can list at least five market analysts who were not surprised by
this move.
Maintaining a bubble requires the maintenance of a collective belief.
When that collective belief breaks down, all that remains are the
fundamentals. The bigger the gap between fundamentals and asset
prices, the greater the downside risk. Central Bankers have been able
to maintain control over the narrative for the past six years. But as
the quotes from Mervyn King and Charles Plosser above indicate,
they are losing the thread of the narrative.
We are not trying to predict the future. Rather we are trying to help
our clients make sound decisions about allocating their capital given
information that exists in the present. Our investment decisions are
based on logic, experience and history. Our current focus is the safety
of our client’s principal and following as best we can the wisdom of
the leading thinkers in investing. To quote Warren Buffet’s mentor:
“An investment operation is one in which, upon thorough analysis,
promises safety of principal and an adequate return. Operations not
meeting these requirements are speculative.” - Benjamin Graham –
Intelligent Investor
Thank you for reading,
Tom and Matt
Losing the Thread
Executive Summary
Baltic Dry Index - This indicator of global commerce is crashing
to its lowest level ever.
Oil & Commodities - Is the energy and commodity complex a
good place to invest? What do lower prices say about the health
of the global economy? Are cheap debt and oil gluts connected?
GVA Newsletter
February 2015
Debt - We keep saying that we have more debt than in 2007. A
picture tells a thousand words.
Greece…Again
Central Banks – Ben Bernanke and John Law – The Economist
shares a parallel between Ben Bernanke and one of the most
discredited bubble creators ever.
http://www.economist.com/node/14215012
Create Your Own Economy Corner – Keep Moving Forward
Losing the Thread
Baltic Dry Index - Supply and Demand
The chart below shows the indicator which Jim Cramer used to say
was one of the best indicators of the health of the global economy.
This is a measurement of the cost of shipping dry goods in dollars. To
put this in simple terms, two things impact this number, the supply
of available shipping vessels and the demand for using those vessels
to ship dry goods around the world. It is interesting to see that the
demand for international commerce based on this indicator is at an
all-time low when stock markets are at all-time highs. This is but one
of many indicators we see that seem at odds with the reports we hear
through mainstream media:
What is remarkable is that in the face of massive infusion of money
and credit into the global economy, the costs of these key commodities are largely declining. Of course if you look at the world from
the perspective that there is too much debt than everything makes
sense. Let’s take a look at debt:
Debt
The graph below shows the growth in debt in the U.S. going back to
1977. Our debt now stands at $62 trillion according to this data. In
2008 debt declined slightly and that sent tremors through the world.
The effort being put forward now is to keep growing this mountain
of debt.
Oil & Commodities:
Another area that seems at odds with reports of a healthy global
economy is in the commodity sector. Commodity prices are falling.
Below are the charts that illustrate this:
GVA Newsletter
February 2015
Debt and Bubbles
Ok, now think back to 2006. With the benefit of hindsight we can
see that the low interest rates in the 2000’s encouraged a bubble in
housing. It felt great at the time but it was not real so it was not
destined to last. By not real we mean that new consumption was not
based on real value being added to the economy. You do not create
real value by issuing debt, which was what was happening. People
were borrowing against the phantom growth in the value of their
homes to make consumer purchases that they could not afford based
on the real value that they were contributing to the economy. At
some point it did not matter how much more debt was created. The
market was saturated and the revenue was not there to service the
debt so the whole thing collapsed.
Oil collapsed in 2008 and then rose on expectations of inflation and
global demand into 2011. The rising price coupled with low interest costs made it more attractive to finance new drilling projects
particularly shale projects in the U.S. which otherwise would not be
financially feasible.
The Fed was successful in stimulating investment in the short-term,
however they did not impact real end-demand. Subsequently we got
a lot more oil and not a lot more people using it. Now that the price
of oil is collapsing again we are seeing the shuttering of many drilling projects and significant layoffs. Some have estimated that as
much as 30% of U.S. GDP since 2009 came from the energy sector.
But this was artificially and temporarily created by unsustainable
factors. As those factors lose their effectiveness all we are left with
is more unserviceable debt. Does this sound familiar?
Oil just dropped 61% in five months. When housing began its decline
in 2006 the tremors began in the financial world. No one can predict
the timing but the conditions are the same. All it takes is a shock
to an unstable system and it could be an obvious one like China or
Greece or oil or housing again.
To us it seems that six years of massive credit creation have
failed to stimulate demand, making the debt bubble that much
bigger without the benefits it was supposed to deliver. Refer
again to the quote from Mervyn King. This is not good!
Greece… again
The European Union has strict guidelines that member countries
must meet before gaining entrance. Those guidelines include ratios
of debt to GDP. Why? Why does it matter?
The European Union’s Maastricht Treaty “convergence criteria,” or
requirements for a member country to use the euro as currency:
• Annual budget deficits must not exceed 3% of gross domestic
product.
• Public debt must be under 60% of gross domestic product.
• The country must have exchange rate stability
• Inflation rates must be within 1.5% of the three EU countries
with the lowest rate.
• Long-term interest rates must be within 2% of the three lowest interest rates in the EU.
“Sustainability of Public Finances” is sighted as the reason for the
restriction on debt according to the EU Commission web site:
http://ec.europa.eu/economy_finance/euro/adoption/who_can_
join/index_en.htm
So we must conclude that the creators of the EU believe that the
relationship between debt and GDP does matter. We covered in 2010
how Greece with the help of Goldman Sachs used creative accounting
to qualify for the EU and Matt Taibi of Rolling Stone has chronicled it
in detail so we’ll leave that alone for now. But the fact remains that
Greece in 2010 could not handle its debt burden and yet the policy
makers refused to see the long-term problem. Here is how David
Stockman recently described their approach:
“Europe in Its infinite wisdom decided to deal with this bankruptcy
by loading the largest loan in human history on the weakest of
shoulders, the Greek taxpayer. What we’ve been having ever since
is a kind of fiscal waterboarding that has turned this nation into a
debt colony.”
In 2010 Greece had roughly $230 billion in debt that it could not
pay. Had it gone through bankruptcy and restructured its debt at
that time it might not be facing the $350 billion of crushing unpayable debt it is today. But the bankers and politicians preferred to
delay the day of reckoning, perhaps even believe that it would not
come, rather than face the painful reality they had created and the
people of Greece have suffered the consequences. Essentially the
game of extend and pretend that Europe has been playing is to give
more loans to Greece to finance their existing debt. This means that
their debt burden grows even if their income does not. How can that
end well?
In comes the new Finance Minister Varoufakis with the audacity to
tell the truth. Greece is bankrupt. If you listen to what he is saying
the scary part is that he is the only one telling it like it is and all of
the global “leaders” can’t deal with it.
GVA Newsletter
February 2015
Now Greece is standing at 140% government Debt to GDP. Germany
stands at 80% government debt to GDP according to the McKinsey
study and has a total debt to GDP ratio of 258% (that’s right Germany). China has a government debt to GDP ratio of 55% and a
total GDP ratio of 282%. However, much of China’s debt that is not
officially government debt is financial debt that is encouraged by the
government though quasi government banks. In other words – China’s banking sector is an arm of their government. The government
debt to GDP numbers would likely be higher if the Chinese system
was more like the U.S. system. The U.S. has an 89% government debt
to GDP ratio and 269% total ratio. Here is one chart from the report:
“IF FIVE hundred millions of paper had been of such advantage, five
hundred millions additional would be of still greater advantage.”
So Charles Mackay, author of “Extraordinary Popular Delusions and
the Madness of Crowds”, described the “quantitative easing” tactics of the French regent and his economic adviser, John Law, at
the time of the Mississippi bubble in the early 18th century. The
Mississippi scheme was a precursor of modern attempts to reflate
the economy with unorthodox monetary policies. It is hard not to
be struck by parallels with recent events.
There is a simple concept that is an important lesson from the Mississippi bubble. Banks and the bond market are supposed to be the
ones that limit the ability of a government to borrow. And this is a
good thing. The markets protect the citizens from irresponsible governments. But when the governments and banks collude together –
the bankers make money, the politicians and powerful stay in power,
the status quo is maintained and the people get screwed. This is
what we have on a global scale.
In the case of the Mississippi land bubble, even though Louis the
14th had absolute power, he could not keep the bubble going forever. And we think that markets will ultimately have the last say in
this case too.
Our conclusion in all of this is simple; history has provided us with
ample lessons of what makes a sound investment a sound investment. There are times when speculation can win. In a time of unprecedented debt and bubbles it seems as if speculation always wins
out. This is reinforced by our short memories which no one can really
explain.
According to the McKinsey study, China has quadrupled their debt
from $7 trillion in 2007 to $28 trillion in 2014. China built massively for the Olympics, much like Greece in 2004, and they have
kept building and building using debt to fund massive real estate
projects. Maybe Greece’s problem is that they have not kept building
more stuff? Maybe they should take on more debt not less? I mean if
debt doesn’t matter why not? And what is another trillion anyway?
Central Banks – Ben Bernanke and John Law
Speculative bubbles like the tech craze of 2000 and the real estate
bubble of 2006 have taken place throughout modern history. One
such bubble was the Mississippi Bubble in the early 18th century
when a brilliant Scottish mathematician named John Law convinced
King Louis XIV of France to use securitization to deal with massive
fiscal deficits created from fighting several wars. Below is an article
from The Economist that describes what happened and drawing interesting parallels to today:
http://www.economist.com/node/14215012
Below is the opening passage from the article:
Well-run companies with responsible debt management are likely
good places to invest your capital if you can find them. Putting your
capital blithely into an index that inexpensively rides the market up
and down at a time of record high prices is not a sound investment
strategy in our minds.
Now is a time to be cautious and discerning. And if, as we believe,
deflation is the greater risk, cash is king. But we want to be careful
not to over simplify. Our answer to the issues before us is to begin
by having a clear plan. Let us help you create that plan and design
solutions grounded in the reality we are living in. Your goals are too
important to not give them this benefit.
GVA Newsletter
February 2015
Create Your Own Economy Corner
Keep Moving Forward
Much of the work we do is with people who have been successful
in their lives and we get to learn from their success. If there is one
characteristic they have in common it is that they never gave up.
Some had fewer setbacks than others but every successful person we
have ever worked with, heard of or met has had set backs.
Popular success literature chronicles the famous people who have
had tremendous failures. Abraham Lincoln is perhaps the most used
example. But few people know that Thomas Jefferson declared bankruptcy several times as well as William Mckinley and Ulysses S Grant.
Please note:
Indices mentioned are unmanaged and cannot be invested in directly. Past
performance is not a guarantee of future results. These are the opinions of
GVA and not necessarily those of Cambridge, are for informational purposes
only and should not be construed or acted upon as individual investment
advice.
The information being provided is strictly as a courtesy. When you access
one of these websites, you assume total responsibility and risk for your use
of the websites you are linking to. We make no representation as to the
completeness or accuracy of information provided at these websites. Nor
is the company liable for any direct or indirect technical or system issues
or any consequences arising out of your access to or your use of third-party
technologies, websites, information and programs made available through
this website.
Henry Ford, Walt Disney, PT Barnum, Donald Trump all experienced
serious set-backs on their way to achieving their dreams. We admire
them not just for their success but for their ability to overcome their
failures.
The difference between those who are successful in life is generally not resources but resourcefulness. It is our passion, our desire
and our willingness to keep moving forward that has us achieve our
personal vision. Only you get to determine if you are a success or
failure. In the face of adversity keep moving forward and reach for
your dreams.
“That which we obtain too easily we esteem to lightly. It is dearness only that gives everything its value. Heaven knows how to put
a proper price on its goods.” Thomas Paine
Thanks for reading,
Matt and Tom
GLOBAL VISION ADVISORS
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