Q1 2019 Z.1 "Flow of Funds"

 Doug Nolan


Total Non-Financial Debt (NFD) expanded (nominal) $721 billion (strongest growth since Q2 ’18) during the quarter to a record $52.579 TN. NFD expanded $2.504 TN, or 5.0%, year-on-year. For perspective, annual NFD growth averaged $1.602 TN over the decade 2008-2017.

NFD expanded $2.432 TN in 2006 and $2.478 TN in 2007. NFD has now expanded $17.514 TN, or 50%, since the end of 2008.

Financial sector debt expanded $127 billion during the quarter ($368bn y-o-y) to $16.444 TN, and Foreign U.S. borrowings increased $130 billion ($88bn y-o-y) to $4.051 TN. Total (NFD, Financial and Foreign) System debt expanded $978 billion during the quarter to a record $73.073 TN. Going all the way back to Q4 2017, Q1’s system-wide Credit expansion was second only to Q1 ‘18’s $1.002 TN.

Total Credit grew at a 5.6% rate during the quarter, up from Q4’s 2.72% to the strongest pace since Q1 2018’s 6.51%. Federal government borrowings jumped to an 8.57% rate, up from Q4’s 2.50% to the strongest pace since Q1 ‘18’s 13.38%. Total Corporate borrowings accelerated to a 6.62% pace, up from Q4’s 3.88% to the strongest rate since Q2 2017. Non-financial Corporate borrowings jumped to a 7.58% pace (from Q4’s 3.35%), the briskest rate since Q1 2016. Total Household Borrowings slowed to a 2.33% pace (from Q4’s 2.82%), with Household Mortgages and Consumer Credit expanding 2.43% and 4.34%. The Domestic Financial Sector increased borrowings at a 3.28% pace, up from Q4’s 2.71%.

In seasonally-adjusted and annualized rates (SAAR), total system Credit expanded $2.884 TN during Q1, double Q1 to the strongest pace since Q1 2018’s SAAR $3.207 TN. Federal borrowings surged SAAR $1.531 TN (up from Q4’s SAAR $444bn). Total Corporate borrowings expanded SAAR $1.014 TN, the strongest since Q1 2016’s SAAR $1.150 TN.

Household borrowings grew SAAR $363 billion (mortgage SAAR $252bn, Consumer Credit SAAR $174bn), the weakest pace since Q1 2016’s SAAR $334 billion. Financial Sector debt expanded SAAR $535 billion, the strongest rate since Q3 2016’s SAAR $557 billion.

Q1 Federal Expenditures were up 5.9% y-o-y to SAAR $4.659 TN, while Federal Receipts increased 3.9% y-o-y to $3.564 TN. State & Local Expenditures were up 2.4% y-o-y to SAAR $2.862 TN, with Receipts up 3.0% to $2.641 TN.

Bank (“Private Depository Institutions”) Assets rose nominal $103 billion during the quarter to a record $19.296 TN. For Q1, Loans were little changed at $11.270 TN, while Debt Securities jumped $83.3 billion to a record $4.384 TN. Over four quarters, Loans expanded $535 billion, or 5.0%, while Debt Securities expanded $167 billion, or 4.0%.

Broker/Dealer Assets slipped $5.6 billion during the quarter to $3.353 TN. Over four quarters, Broker/Dealer Assets gained $262 billion, or 8.5%. It appears growth was isolated in off-balances sheet vehicles (also helping to explain Q1’s tepid bank Loan growth). Wall Street “Funding Corps” jumped $88 billion during Q1 (SAAR $255bn!) to $1.518 TN. Fed Funds & Repo surged $136 billion to $4.032 TN, the high since Q4 2012. Fed Funds & Repo jumped $538 billion, or 15.4% over the past year.

Money Market Fund Assets gained $41 billion during Q1 to $3.079 TN (high since Q4 ’09), with a four-quarter gain of $286 billion, or 10.2%.

Retail sales have bounced back over recent months, recovering from a weak start to 2019 and poor end to 2018. It’s not surprising that household spending tracks the fortunes of the bloated Household Balance Sheet. Household (& Non-Profits) Assets surged $4.697 TN during Q1 to a record $124.694 TN. And with Liabilities expanding just $5.9 billion, Household Net Worth surged $4.691 TN – the strongest ever quarterly increase in Net Worth (2nd place Q4 ‘99’s $3.114 TN). Household Net Worth jumped to 516% of GDP, just below the record 522% from Q3 2018. This compares to peak ratios of 484% in Q1 2007 and 444% during Q1 2000.

On the back of the strong recovery in stock prices, Household Financial Asset holdings surged $4.238 TN to a record $88.895 TN, or 422% of GDP. This ratio compares to peaks 379% during Q3 2017 and 359% during Q1 2000. Financial Assets were up $3.218 TN over the past four quarters. House price inflation continues to boost household perceived wealth. Household Real Estate holdings rose $387 billion during the quarter to a record $29.551 TN, with a four-quarter gain of $1.263 TN.

Rest of World (ROW) also benefitted from the big Q1 equities recovery. ROW holdings of U.S. assets jumped $1.372 TN during the quarter – the largest ever quarterly gain - to a record $28.570 TN. ROW holdings have almost doubled since the cycle peak $14.705 TN back in Q1 2008. Over this period, ROW holdings jumped from 100% to 136% of GDP. ROW Equities (Equities and Mutual Funds) rose $838 billion during the quarter to a record $8.187 TN. Debt Securities rose $381 billion (strongest gain since Q3 2010) to a record $11.548 TN, led by a $208 billion increase in Treasuries holdings (to $6.474 TN).

The market now prices in a 21% probability of a rate cut at next week’s FOMC meeting, with an 86% probability for a cut by the July 31st meeting. I have previously addressed the unprecedented nature of commencing a Fed easing cycle with the unemployment rate at 3.6%, financial conditions loose and stocks near all-time highs. Add to this list system Credit expansion near the strongest in a decade. It’s incredible that the Fed would reduce rates in the current backdrop, but markets are sure trying to force the Fed’s hands. That highly speculative markets have come to have such sway over the Fed (and global central bankers) is indicative of the precarious nature of late-cycle market and policy dynamics.

The predicament is illuminated rather poignantly in Z.1 data. When “risk off” took hold during Q4, Non-Financial Debt growth dropped to SAAR $1.404 TN from Q3’s SAAR $2.300 TN. In short, that’s insufficient new Credit to sustain financial and economic Bubbles. Net Issuance of Debt Securities sank from Q3’s SAAR $1.808 TN to Q4’s SAAR $412 billion – with Corporate & Foreign Bonds sinking from SAAR $411 billion to SAAR negative $125 billion.

But the Fed’s January 4th dovish U-turn opened the “risk on” floodgates. Debt Securities expanded SAAR $1.783 TN in Q1, with Corporate & Foreign Bonds expanding SAAR $588 billion. Loose financial conditions powered equities higher, ensuring rapidly inflating Household Net Worth. After suffering a record $3.960 TN quarterly drop during Q4, Household Net Worth jumped a quarterly record $4.691 TN during Q1.

Systems have become acutely unstable. Market-based Credit so dominates system Credit that “risk on”/“risk off” speculative dynamics now exert an acutely destabilizing impact on financial conditions, Credit expansion, securities prices, Household Net Worth and economic performance. In this highly speculative market environment, “risk on” ensures loose financial conditions, Credit and speculative excess and vigorous market inflation, while exacerbating economic maladjustment.

When “risk on” invariably succumbs to “risk off,” financial conditions abruptly tighten, debt issuance tanks, system Credit growth drops sharply, markets turn illiquid, Bubbles falter, equities prices sink, Household Net Worth deflates, and the Bubble Economy commences a downward spiral. Worse yet, these dynamics are a global phenomenon.

Is the Fed really about to further feed “risk on”, stoking Bubble excess in the process? I’ll assume the Powell Fed would rather sit this one out. They are, of course, ready to respond in the event of “risk off.” But at this speculative blow-off Bubble phase, things tend to unwind really quickly. Global bonds appreciate the acute fragility and are priced for rate cuts and aggressive QE deployment.

The global yield collapse is not so much in response to economic weakness and trade war risks.

The global financial system is an accident in the making. China is an accident in the making.

Markets are demanding: “Give us rate cuts and prepare for aggressive QE - or we’ll give you central bankers the type of vicious market accident you are not prepared to contend with!” The Fed is faced with the Hobson Choice of either stoking the Bubble or waiting for incipient “risk off” - and hoping it possesses the firepower to hold things together. Markets bet confidently the Fed lacks the fortitude to wait.

How the long debt cycle might end

Some fear the fire of inflation; others the ice of deflation

Martin Wolf




Some say the world will end in fire, Some say in ice.” These brilliant lines by the poet Robert Frost capture the world’s possible economic prospects.

Some warn that the world of high debt and low interest rates will end in the fire of inflation. Others prophesy that it will end in the ice of deflation. Others, such as Ray Dalio of Bridgewater, are more optimistic: the economy will be neither burnt nor frozen. Instead, it will be neither too hot nor too cold, like the baby bear’s porridge, at least in countries that have had the fortune and wit to borrow in currencies they create freely.

William White, former chief economist of the Bank for International Settlements, presciently warned of financial risks before the 2007-09 financial crisis. Last year, he warned of another crisis, pointing to the continuing rise in non-financial sector debt, especially of governments in high-income countries and corporations in high-income and emerging economies. Those in emerging countries are particularly vulnerable, because much of their borrowing is in foreign currencies. This causes currency mismatches in their balance sheets. Meanwhile, monetary policy fosters risk-taking, while regulation discourages it — a recipe for instability.



Start then with inflationary fire. Much of what is going on right now recalls the early 1970s: an amoral US president (then Richard Nixon) determined to achieve re-election, pressured the Federal Reserve chairman (then Arthur Burns) to deliver an economic boom. He also launched a trade war, via devaluation and protection. A decade of global disorder ensued. This sounds rather familiar, does it not?

In the late 1960s, few expected the inflation of the 1970s. Similarly, a long period of stable and low inflation has calmed fears of an upsurge, even though unemployment has fallen to low levels. (In the US, it is at its lowest level since 1969.) Some suggest that the Phillips curve — the short-term relationship between unemployment and inflation — is dead, because low unemployment has not raised inflation. More likely, it is sleeping. Inflation expectations may now be anchored. But a strong surge of demand might still sweep them away.



In some ways, a rise in inflation would be helpful. A sudden jump in inflation would reduce debt overhangs, notably of public debt, just as the inflation of the 1970s did. Moreover, central banks know what to do in response to a surge in inflation. Yet higher inflation would also lead to a rise in long-term nominal interest rates, which tend to front-load the real burden of debt service. Short-term rates would also jump as they did in the early 1980s. Risk premia would rise. High-flying stock markets might collapse. Labour relations would become more strife-prone, as would politics. This disarray would hit unevenly, causing currency disorder. The loss of confidence in public institutions, notably central banks, would be severe. In the end, the likely stagflation would end in severe recession, as in the 1980s.

Now turn to deflationary ice. This might begin with a sharp negative economic shock: a worsening trade war, a war in the Middle East or a crisis in private or public finance, possibly in the eurozone, where the central bank is relatively constrained. The result could be a deep recession, even a lurch into deflation, so worsening the debt overhang.




The big difficulty would be knowing how to respond given that interest rates are already so low. Conventional policy (lower short-term rates) and conventional unconventional policy (asset purchases) might be insufficient.

A range of other possibilities exist: negative rates from the central bank; lending to banks at lower rates than the central bank pays on their deposits; purchase of a much wider range of assets, including foreign currencies; monetisation of fiscal deficits; and “helicopter drops” of money. Much of this would be technically or politically problematic, and would require close co-operation with the government. Meanwhile, if governments acted too slowly (or not at all) a depression might ensue, as in the 1930s, via mass bankruptcy and debt deflation. Many fools recommended that in 2008.



Yet none of these disasters is at all inevitable. They would be chosen catastrophes. As Mr Dalio argues, a golden mean is possible. Fiscal and monetary policy would then co-operate to generate non-inflationary growth. Changes in fiscal incentives would discourage debt and encourage equity. Government policy would shift income towards spenders, reducing our current reliance on debt-fuelled asset bubbles for sustaining demand. Still more debt would be moved out of the balance sheets of financial intermediaries directly on to the balance sheets of households.

Even if real interest rates rose, perhaps because productivity growth strengthened durably, the impact of robust non-inflationary growth on the debt burden would almost certainly outweigh a move to somewhat higher interest rates. We would, above all, be moving out of “secular stagnation” into something less bad. That shift might be tricky. But it would be to a better world.





It is not necessary to repeat the mistakes of either the 1930s or the 1970s. But we have made enough mistakes already and are, collectively, making enough more right now to risk either outcome, possibly both.

A breakdown of the global economic and political order seems conceivable. The impact on our debt-encumbered world economy and increasingly fraught global politics is impossible to calculate. But it could be horrendous. Above all, nationalistic strongmen would be unable to co-operate if things went seriously wrong, as they might, perhaps even soon.

That is the most worrying feature of our world.

The Growing Risk of a 2020 Recession and Crisis

Across the advanced economies, monetary and fiscal policymakers lack the tools needed to respond to another major downturn and financial crisis. Worse, while the world no longer needs to worry about a hawkish US Federal Reserve strangling growth, it now has an even bigger problem on its hands.

Nouriel Roubini

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NEW YORK – Last summer, my colleague Brunello Rosa and I identified ten potential downside risks that could trigger a US and global recession in 2020. Nine of them are still in play today.

Across the advanced economies, monetary and fiscal policymakers lack the tools needed to respond to another major downturn and financial crisis. Worse, while the world no longer needs to worry about a hawkish US Federal Reserve strangling growth, it now has an even bigger problem on its hands.

Many involve the United States. Trade wars with China and other countries, along with restrictions on migration, foreign direct investment, and technology transfers, could have profound implications for global supply chains, raising the threat of stagflation (slowing growth alongside rising inflation). And the risk of a US growth slowdown has become more acute now that the stimulus from the 2017 tax legislation has run its course.

Meanwhile, US equity markets have remained frothy since our initial commentary. And there are added risks associated with the rise of newer forms of debt, including in many emerging markets, where much borrowing is denominated in foreign currencies. With central banks’ ability to serve as lenders of last resort increasingly constrained, illiquid financial markets are vulnerable to “flash crashes” and other disruptions. One such disruption could come from US President Donald Trump, who may be tempted to create a foreign-policy crisis (“wag the dog”) with a country like Iran. That might bolster his domestic poll numbers, but it could also trigger an oil shock.

Beyond the US, the fragility of growth in debt-ridden China and some other emerging markets remains a concern, as do economic, policy, financial, and political risks in Europe. Worse, across the advanced economies, the policy toolbox for responding to a crisis remains limited.

The monetary and fiscal interventions and private-sector backstops used after the 2008 financial crisis simply cannot be deployed to the same effect today.

The tenth factor that we considered was the US Federal Reserve’s interest-rate policy. After hiking rates in response to the Trump administration’s pro-cyclical fiscal stimulus, the Fed reversed course in January. Looking ahead, the Fed and other major central banks are more likely to cut rates to manage various shocks to the global economy.

While trade wars and potential oil spikes constitute a supply-side risk, they also threaten aggregate demand and thus consumption growth, because tariffs and higher fuel prices reduce disposable income. With so much uncertainty, companies will likely opt to reduce capital spending and investment.

Under these conditions, a severe enough shock could usher in a global recession, even if central banks respond rapidly. After all, in 2007-2009, the Fed and other central banks reacted aggressively to the shocks that triggered the global financial crisis, but they did not avert the “Great Recession.” Today, the Fed is starting with a benchmark policy rate of 2.25-2.5%, compared to 5.25% in September 2007. In Europe and Japan, central banks are already in negative-rate territory, and will face limits on how much further below the zero bound they can go. And with bloated balance sheets from successive rounds of quantitative easing (QE), central banks would face similar constraints if they were to return to large-scale asset purchases.

On the fiscal side, most advanced economies have even higher deficits and more public debt today than before the global financial crisis, leaving little room for stimulus spending. And, as Rosa and I argued last year, “financial-sector bailouts will be intolerable in countries with resurgent populist movements and near-insolvent governments.”

Among the risks that could trigger a recession in 2020, the Sino-American trade and technology war deserves special attention. The conflict could escalate further in several ways. The Trump administration could decide to extend tariffs to the $300 billion worth of Chinese exports not yet affected. Or prohibiting Huawei and other Chinese firms from using US components could trigger a full-scale process of de-globalization, as companies scramble to secure their supply chains. Were that to happen, China would have several options for retaliating against the US, such as by closing its market to US multinationals like Apple.

Under such a scenario, the shock to markets around the world would be sufficient to bring on a global crisis, regardless of what the major central banks do. With the current tensions already denting business, consumer, and investor confidence and slowing global growth, further escalation would tip the world into a recession. And, given the scale of private and public debt, another financial crisis would likely follow from that.

Both Trump and Chinese President Xi Jinping know that it is in their countries’ interest to avoid a global crisis, so they have an incentive to find a compromise in the next few months. Yet both sides are still ratcheting up nationalist rhetoric and pursuing tit-for-tat measures. Trump and Xi each seem to think that his country’s long-term economic and national security may depend on his not blinking in the face of a new cold war. And if they each genuinely believe the other will blink first, the risk of a ruinous clash is high indeed.

It is possible that Trump and Xi will meet for talks during the G20 summit on June 28-29 in Osaka. But even if they do agree to restart negotiations, a comprehensive deal to settle their many points of contention would be a long way off. As the two sides drift further apart, the space for compromise is shrinking, and the risk of a global recession and crisis in an already fragile global economy is rising.


Nouriel Roubini, a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

People v power

The rule of law in Hong Kong

Huge demonstrations have rattled the territory’s government—and the leadership in Beijing























THREE THINGS stand out about the protesters who rocked Hong Kong this week. There were a great many of them. Hundreds of thousands took to the streets in what may have been the biggest demonstration since Hong Kong was handed back to China in 1997. Most of them were young—too young to be nostalgic about British rule. Their unhappiness at Beijing’s heavy hand was entirely their own. And they showed remarkable courage. Since the “Umbrella Movement” of 2014, the Communist Party has been making clear that it will tolerate no more insubordination—and yet three days later demonstrators braved rubber bullets, tear gas and legal retribution to make their point. All these things are evidence that, as many Hong Kongers see it, nothing less than the future of their city is at stake.

On the face of it, the protests were about something narrow and technical. Under the law, a Hong Kong resident who allegedly murdered his girlfriend in Taiwan last year cannot be sent back there for trial. Hong Kong’s government has therefore proposed to allow the extradition of suspects to Taiwan—and to any country with which there is no extradition agreement, including the Chinese mainland.

However, the implications could not be more profound. The colonial-era drafters of Hong Kong’s current law excluded the mainland from extradition because its courts could not be trusted to deliver impartial justice. With the threat of extradition, anyone in Hong Kong becomes subject to the vagaries of the Chinese legal system, in which the rule of law ranks below the rule of the party. Dissidents taking on Beijing may be sent to face harsh treatment in the Chinese courts. Businesspeople risk a well-connected Chinese competitor finding a way to drag them into an easily manipulated jurisdiction.

That could be disastrous for Hong Kong, a fragile bridge between a one-party state and the freedoms of global commerce. Many firms choose Hong Kong because it is well-connected with China’s huge market, but also upholds the same transparent rules that govern economies in the West. Thanks to mainland China, Hong Kong is the world’s eighth-largest exporter of goods and home to the world’s fourth-largest stockmarket. Yet its huge banking system is seamlessly connected to the West and its currency is pegged to the dollar. For many global firms, Hong Kong is both a gateway to the Chinese market and central to the Asian continent—more than 1,300 of them have their regional headquarters there. If Hong Kong came to be seen as just another Chinese city, Hong Kongers would not be the only ones to suffer.

The threat is real. Since he took over as China’s leader in 2012, Xi Jinping has been making it clearer than ever that the legal system should be under the party’s thumb. China must “absolutely not follow the Western road of ‘judicial independence’,” he said in a speech published in February. In 2015 Mr Xi launched a campaign to silence independent lawyers and civil-rights activists. Hundreds of them have been harassed or detained by the police. The authorities on the mainland have even sent thugs to other jurisdictions to abduct people, including a publisher of gossipy books about the party, snatched from a car park in Hong Kong and a tycoon taken from the Four Seasons hotel in 2017. The message is plain. Mr Xi not only cares little for the rule of law on the Chinese mainland. He scorns it elsewhere, too.

The Hong Kong government says the new law has safeguards. But the protesters are right to dismiss them. In theory extradition should not apply in political cases, and cover only crimes that would incur heavy sentences. But the party has a long record of punishing its critics by charging them with offences that do not appear political. Hong Kong’s government says it has reduced the number of white-collar offences that will be covered. But blackmail and fraud still count. It has said that only extradition requests made by China’s highest judicial officials will be considered. But the decision will fall to Hong Kong’s chief executive. That person, currently Carrie Lam, is chosen by party loyalists in Hong Kong and answers to the party in Beijing. Local courts will have little room to object. The bill could throttle Hong Kong’s freedoms by raising the possibility that the party’s critics could be bundled over the border.

It is a perilous moment. The protests have turned violent—possibly more violent than any since the anti-colonial demonstrations in 1967. Officials in Beijing have condemned them as a foreign plot. Ms Lam has been digging in her heels. But it is not too late for her to think again.

In its narrowest sense, the new law will not accomplish what she wants. Taiwan has said that it will not accept the suspect’s extradition under the new law. Less explosive solutions have been suggested, including letting Hong Kong’s courts try cases involving murder committed elsewhere. Anti-subversion legislation was left to languish after protests in 2003. There is talk that the government may see this as the moment to push through that long-shelved law. Instead Ms Lam should take it as a precedent for her extradition reform.

The rest of the world can encourage her. Britain, which signed a treaty guaranteeing that Hong Kong’s way of life will remain unchanged until at least 2047, has a particular duty. Its government has expressed concern about the “potential effects” of the new law, but it should say loud and clear that it is wrong. With America, caught up in a trade war with China, there is a risk that Hong Kong becomes the focus of a great-power clash. Some American politicians have warned that the law could jeopardise the special status the United States affords the territory. They should be prudent. Cutting off Hong Kong would not only harm American interests in the territory but also wreck the prospects of Hong Kongers—an odd way to reward its would-be democrats. Better to press the central government, or threaten case-by-case scrutiny of American extraditions to Hong Kong.

But would this have any effect? That is a hard question, because it depends on Mr Xi. China has paid dearly for its attempts to squeeze Hong Kong. Each time the world sees how its intransigence and thuggishness is at odds with the image of harmony it wants to project. When Hong Kong passed into Chinese rule 22 years ago, the idea was that the two systems would grow together. As the protesters have made clear, that is not going to plan.

Risky Borrowing Is Making a Comeback, but Banks Are on the Sideline

New and untested players, some backed by Wall Street, have helped borrowers pile up billions in loans. What could go wrong?

By Matt Phillips


A decade after reckless home lending nearly destroyed the financial system, the business of making risky loans is back.

This time the money is bypassing the traditional, and heavily regulated, banking system and flowing through a growing network of businesses that stepped in to provide loans to parts of the economy that banks abandoned after 2008.

It’s called shadow banking, and it is a key source of the credit that drives the American economy. With almost $15 trillion in assets, the shadow-banking sector in the United States is roughly the same size as the entire banking system of Britain, the world’s fifth-largest economy.

In certain areas — including mortgages, auto lending and some business loans — shadow banks have eclipsed traditional banks, which have spent much of the last decade pulling back on lending in the face of stricter regulatory standards aimed at keeping them out of trouble.  
But new problems arise when the industry depends on lenders that compete aggressively, operate with less of a cushion against losses and have fewer regulations to keep them from taking on too much risk. Recently, a chorus of industry officials and policymakers — including the Federal Reserve chair, Jerome H. Powell, last month — have started to signal that they’re watching the growth of riskier lending by these non-banks.
“We decided to regulate the banks, hoping for a more stable financial system, which doesn’t take as many risks,” said Amit Seru, a professor of finance at the Stanford Graduate School of Business. “Where the banks retreated, shadow banks stepped in.”

Safe as houses

With roughly 50 million residential properties, and $10 trillion in amassed debt, the American mortgage market is the largest source of consumer lending on earth.

Lately, that lending is coming from companies like Quicken Loans, loanDepot and Caliber Home Loans. Between 2009 and 2018, the share of mortgage loans made by these businesses and others like them soared from 9 percent to more than 52 percent, according to Inside Mortgage Finance, a trade publication.



Is this a good thing? If you’re trying to buy a home, probably. These lenders are competitive and willing to lend to borrowers with slightly lower credit scores or higher levels of debt compared to their income.

They also have invested in some sophisticated technology. Just ask Andrew Downey, a 24-year-old marketing manager in New Jersey who is buying a two-bedroom condo. To finance the purchase, he plugged his information into LendingTree.com, and Quicken Loans, the largest non-bank mortgage lender by loans originated, called him almost immediately.
“I’m not even exaggerating,” he said. “I think they called me like 10 or 15 seconds after my information was in there.”

Quicken eventually offered him a rate of 3.875 percent with 15 percent down on a conventional 30-year fixed-rate mortgage of roughly $185,000. Eventually he found an even better offer, 3.625 percent, from the California-based lender PennyMac, also not a bank.

“I really didn’t reach out to any banks,” said Mr. Downey, who expects to close on his condo in Union, N.J., this month.

The downside of all this? Because these entities aren’t regulated like banks, it’s unclear how much capital — the cushion of non-borrowed money the companies operate with — they have.

If they don’t have enough, it makes them less able to survive a significant slide in the economy and the housing market.

While they don’t have a nationwide regulator that ensures safety and soundness like banks do, the non-banks say that they are monitored by a range of government entities, from the Consumer Financial Protection Bureau to state regulators.

They also follow guidelines from the government-sponsored entities that are intended to support homeownership, like Fannie Mae and Freddie Mac, which buy their loans.

“Our mission, I think, is to lend to people properly and responsibly, following the guidelines established by the particular agency that we’re selling mortgages to,” said Jay Farner, chief executive of Quicken Loans.

Risky business loans

It’s not just mortgages. Wall Street has revived and revamped the pre-crisis financial assembly line that packaged together risky loans and turned those bundles into seemingly safe investments.

This time, the assembly line is pumping out something called collateralized loan obligations, or C.L.O.s. These are essentially a kind of bond cobbled together from packages of loans — known as leveraged loans — made to companies that are already pretty heavily in debt. These jumbles of loans are then chopped up and structured, so that investors can choose the risks they’re willing to take and the returns they’re aiming for.

If that sounds somewhat familiar, it might be because a similar system of securitization of subprime mortgages went haywire during the housing bust, saddling some investors with heavy losses from instruments they didn’t understand.

If investors have any concerns about a replay in the C.L.O. market, they’re hiding it fairly well.

Money has poured in over the last few years as the Federal Reserve lifted interest rates. (C.L.O.s buy mostly loans with floating interest rates, which fare better than most fixed-rate bonds when interest rates rise.)
























Still, there are plenty of people who think that C.L.O.s and the leveraged loans that they buy are a potential trouble spot that bears watching.

For one thing, those loans are increasingly made without the kinds of protections that restrict activities like paying out dividends to owners, or taking out additional borrowing, without a lender’s approval.

Roughly 80 percent of the leveraged loan market lacks such protections, up from less than 10 percent more than a decade ago. That means lenders will be less protected if defaults pick up steam.

For now, such defaults remain quite low. But there are early indications that when the economy eventually does slow, and defaults increase, investors who expect to be protected by the collateral on their loan could be in for a nasty surprise.

In recent weeks, warnings about the market for C.L.O.s and leveraged loans have been multiplying. Last month, Mr. Powell said the Fed was closely monitoring the buildup of risky business debt, and the ratings agency Moody’s noted this month that a record number of companies borrowing in the loan markets had received highly speculative ratings that reflected “fragile business models and a high degree of financial risk.”

Small, subjective loans

Leveraged loans are risky, but some companies are seen as even too rickety, or too small, to borrow in that market.  

Not to worry. There’s a place for them to turn as well, and they’re called Business Development Companies, or B.D.C.s.
They’ve been around since the 1980s, after Congress changed the laws to encourage lending to small and midsize companies that couldn’t get funding from banks.

But B.D.C.s aren’t charities. They’re essentially a kind of investment fund.

And they appeal to investors because of the high interest rates they charge.

Their borrowers are companies like Pelican Products, a maker of cellphone and protective cases in California, which paid an interest rate of 10.23 percent to its B.D.C. lender, a rate that reflects its high risk and low credit ratings.

For investors, an added appeal is that the B.D.C.s don’t have to pay corporate taxes as long as they pay 90 percent of their income to shareholders. Shareholders eventually pay tax on that income, but in a tax-deferred retirement account like an individual retirement account, the structure can amplify gains over time.

So, naturally, B.D.C. assets have grown fast, jumping from roughly $10 billion in 2005 to more than $100 billion last year, according to data from Wells Fargo Securities and Refinitiv, a financial data provider.



Some analysts argue that risks embedded in B.D.C.s also can be hard to understand. Because B.D.C.s own loans in small companies that aren’t always widely held or traded, there are often no public market prices available to use to benchmark the fund’s investments.

B.D.C.s have also been increasing leverage to bolster returns. It means they’re using more borrowed money, to make these loans to high-risk borrowers. That strategy can supercharge returns during good times, but it can also make losses that much deeper when things take a turn for the worse.

8 Reasons a Huge Gold Mania Is About to Begin

by Nick Giambruno




An epic gold bull market is on the menu for 2019.

I'm not talking about a garden-variety cyclical gold bull market, but rather one of the biggest gold manias in history.

This gold mania will be riding the wave of an incredibly powerful trend... the re-monetization of gold.

The last time the international monetary system experienced a paradigm shift of this magnitude was in 1971.

Then, the dollar price of gold skyrocketed over 2,300%.

It shot from $35 per ounce to a high of $850 in 1980. Gold mining stocks did even better.

Today, gold is still bouncing around its lows. Gold mining stocks are still very cheap. I expect returns to be at least as great as they were during the last paradigm shift.

So let's get right into it, starting with the first four catalysts that will send gold prices higher…

No. 1: Basel III Moves Gold Closer to Officially Being Money Again

The Bank for International Settlements (BIS) is located in Basel, Switzerland. It's often referred to as "the bank of central banks." Its members consist of 60 central banks from the world's largest economies.

It facilitates transactions – notably gold transactions – between central banks, the biggest players in the gold market.

The BIS also issues Basel Accords, or a set of recommendations for regulations that set the standards for the global banking industry.

On April 1, 2019, Basel III went into effect around the world.

Buried among what was mostly confusing jargon was something of huge significance for gold:

A 0% risk weight will apply to (i) cash owned and held at the bank or in transit; and (ii) gold bullion held at the bank or held in another bank on an allocated basis, to the extent the gold bullion assets are backed by gold bullion liabilities.

What this means in plain English is that gold's official role in the international monetary system has been upgraded for the first time in decades.

Banks can now consider physical gold they hold, in certain circumstances, as a 0% risk asset. Previously, gold was considered riskier and most of the time could not be classified in this way. Basel III rules are making gold more attractive.

Central bankers and mainstream economists have ridiculed gold for going on 50 years now.

They've tried to downplay its role in favor of fiat currencies like the U.S. dollar. They've tried to trick people into believing it isn't important.

The fact is gold is real money... a form of money that is far superior to rapidly depreciating paper currencies. This is why central bankers don't want to acknowledge how important it is.

And this is precisely why Basel III is important. It signifies the start of a reversal in attitude and policy.

Basel III is giving gold more official recognition in the international financial system. It represents a step towards the re-monetization of gold... and the recognition of this powerful trend in motion.

No. 2: Central Banks Are Buying Record Amounts of Gold

Countries are treating gold as money for the first time in generations...

In 2010, something remarkable happened. Central banks changed from being net sellers of gold to net buyers of gold. Remember, central banks are by far the biggest actors in the global gold market.

This trend has only accelerated since...

The World Gold Council reports that in 2018, central banks bought a record 651 tonnes of gold. This is the highest level of net purchases since 1971 when Nixon closed the gold window.

And it's a 75% increase from 2017.




Russia Was the Biggest Buyer


Russia's gold reserves have quadrupled in the last decade, making it the fifth-largest holder of gold in the world.

Last year, Russia notably dumped nearly $100 billion worth of U.S. Treasuries, and, according to the World Gold Council, replaced much of it with gold.

If this trend continues, and I expect that it will, Russia will soon become the third-largest gold holder in the world.




A major reason for Russia's gold purchases is to reduce its reliance on the U.S. dollar and exposure to U.S. financial sanctions.

It is providing a template for others to do the same, using gold as money.

For example, in 2016, news broke that Turkey and Iran were engaged in a "gas for gold" plan.

Iran is under U.S. sanctions. Through the plan, Turkey can pay for gas imported from Iran with gold.

Russia, Iran, Venezuela, and others are proving they don't need the U.S. dollar. They are conducting business and settling trade with gold shipments, which aren't under the control of the U.S. government.

This is how gold will benefit from the U.S. government using the dollar as a financial weapon.

No. 3: Oil for Gold- China's Golden Alternative

In 2017, when tensions with North Korea were rising, Trump's Treasury secretary threatened to kick China out of the U.S. dollar system if it didn't crack down on North Korea.

If the threat had been carried out, it would have been the financial equivalent of dropping a nuclear bomb on Beijing.

Without access to dollars, China would struggle to import oil and engage in international trade.

Its economy would come to a grinding halt.

China would rather not depend on an adversary like this. This is one of the main reasons it created what I call the "Golden Alternative."

Last year, the Shanghai International Energy Exchange launched a crude oil futures contract denominated in Chinese yuan. For the first time in the post-World War II era, it will allow for large oil transactions outside of the U.S. dollar.

Of course, most oil producers don't want a large reserve of yuan.

That's why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold – without touching the Chinese government's official reserves – through gold exchanges in Shanghai and Hong Kong. (Shanghai is already the world's largest physical gold market.)

Bottom line, China's Golden Alternative will allow oil producers to sell oil for gold and completely bypass any restrictions, regulations, or sanctions of the U.S. financial system.

With China's Golden Alternative, a lot of oil money is going to flow into yuan and gold instead of dollars and Treasuries.

CNBC estimates that the amount of redirected oil money will eventually hit $600-$800 billion. Much of this will flow into the gold market, which itself is only $170 billion.




Consider this...

China is the world's largest importer of oil.

So far this year, China has imported an average of around 9.8 million barrels of oil per day.

This number is expected to grow at least 10% per year.

Right now, oil is hovering around $60 per barrel. That means China is spending around $588 million per day to import oil.

Gold is currently priced around $1,330 an ounce.

That means every day, China is importing oil worth over 442,105 ounces of gold.

If we're conservative and assume that just half of Chinese imports will be purchased in gold soon, it translates into increased demand of more than 80 million ounces per year – or more than 70% of gold's annual production.

This shift hasn't been priced into the gold price. When it happens, the increased demand for gold from China's Golden Alternative is going to shock the gold market.

The bottom line is, China's Golden Alternative is a big step towards gold's re-monetization.

No. 4: The Fed's Dramatic Capitulation

In the wake of the 2008 crash, the Federal Reserve instituted several emergency measures. The chairman at the time, Bernanke, promised Congress they would be temporary.

This included money-printing programs euphemistically called "quantitative easing" (QE).

Through QE, the Fed created $3.7 trillion out of thin air.

That newly created money was used to buy mainly government bonds, which sat on the Fed's bloated balance sheet.

The Fed also brought interest rates to the lowest levels in U.S. history. The Fed artificially brought rates down to 0% and kept them there for over six years.

Capitalism's Most Important Price

Remember, interest rates are simply the price of borrowing money (debt). They have an enormous impact on banks, the real estate market, and the auto industry, among others.

In 2016, the Fed began its attempt to "normalize" its monetary policy by raising interest rates and reducing the size of its balance sheet to more historically normal levels. By doing so, the Fed was reversing the emergency measures put in place after the 2008 crisis.

Interest rates have risen from 0% to around 2.5%, and the Fed has drained over $500 billion from its balance sheet, or about 11% from its peak.

But then, the stock market tanked...

The S&P 500 peaked at 2,930 in late September 2018. By late December, it had crashed over 19% and appeared to be headed sharply lower.

It was the worst December in stock market history, except for December 1931, which was during the Great Depression.

That spooked the Fed into its most abrupt change in monetary policy in recent history.

Instead of normalizing monetary policy and removing the so-called "temporary" and "emergency" measures in place since 2008 – as it had long planned to do – the Fed capitulated.

Earlier this year, the Fed announced it would not raise interest rates in 2019.

The Fed also announced it would phase out its balance sheet reduction program in the fall.

Previously, the Fed was slowly winding down its balance sheet by about $30 billion a month. At such a snail's pace, it would have taken the Fed over 10 years to drain its balance sheet back to its pre-crisis normal level.

Hooked on Easy Money

This whole charade is indicative of how utterly dependent the U.S. economy has become on artificially low interest rates and easy money.

If the Fed couldn't normalize interest rates when the debt was $22 trillion, how is it ever going to raise rates when the debt is $30 trillion or higher?

The Fed couldn't shrink a $4.5 trillion balance sheet. How is it going to shrink, say, a $10 trillion balance sheet or higher?

The answer is it can't and won't. It's impossible for the U.S. government to normalize interest rates with an abnormal amount of debt. The Fed is trapped.

After nearly six years of 0% interest rates, the U.S. economy is hooked on the heroin of easy money. It can't even tolerate a modest reduction in the Fed's balance sheet and 2.5% interest rates, still far below historical averages.

In other words, this monetary tightening cycle is over. The next move is a return to QE and 0%, and perhaps negative, interest rates. These moves would, of course, weaken the dollar and be good for gold.

By flipping from tightening to signaling future easing, the Fed has turned a major headwind for the gold market into a tailwind.

(Stay tuned for part 2.)

China’s Property Developers Have a 1.25 Billion-Square-Meter Problem

Real-estate giants have become overly reliant on funding from sales of houses they haven’t built

By Mike Bird





China’s real-estate developers are selling more unbuilt properties than they’re finishing—a lot more. When starts and completions move back toward one another, as they must eventually, the sector will feel the squeeze.

Property starts in China always outnumber completions, but in the past 12 months it has been by a factor of nearly 2.5—wider than at any time but 2010-11, following the stimulus spree China launched against the global financial crisis. The gap comes to 1.25 billion square meters.

In the 12 months through March, over 85% of residential-property sales were for future delivery, a record high. Presales are a key source of funds for highly leveraged developers, which get direct access to the cash—unlike in other countries, where much of it would be held in escrow until completion. This funding, essentially a form of debt, will dry up if the gap between starts and completions narrows.

There is no sign of immediate weakness in sales and starts. Indeed, if Beijing attempts to lift the economy with a credit boost it would likely feed into the property market—offering more time to developers, though also increasing their obligations.

Developers’ reliance on presales was demonstrated last September, when a Bloomberg report that a single province was merely considering a ban sparked a fall of more than 5% for Country Garden Holdings Co., a major developer.


Before you build it, they will buy. Photo: china stringer network/Reuters


Developers’ growth has been relentless. China Evergrande Groupreported sales of 561.9 billion Hong Kong dollars (US$72 billion) in 2018, more than triple its 2015 sales. But the sectors’ shares have performed erratically, leaving the CSI 300 Real Estate Index basically where it was at the end of 2015.

When the gap between completions and starts has narrowed in the past, as from late 2014 to early 2016, some developers have come under acute pressure. Kaisa Group Holdingsbecame the first property company to default on offshore dollar debt.

A less frothy presales market isn’t the only threat to developers. High levels of short-term dollar debt mean the companies are exposed both to any tightening in U.S. financial conditions and any further decline in the yuan.

A wobble in the financial health of Chinese developers would in turn hit the Asian junk-bond market. Almost half the region’s dollar high-yield bonds were issued by Chinese property companies, up from roughly a 10th a decade ago.

It may be some time off, but at some point the Chinese real-estate industry will hit a rough patch as funding becomes scarcer. A narrowing in the near-record gap between starts and completions could be one trigger. Investors would be wise to keep an eye on it.


The Mixed Blessing Of Falling Birth Rates

by John Rubino


 
The developed world is doing something unprecedented: It’s no longer reproducing. That’s great for the environment and very good for the work and housing prospects of the relative handful of kids that are being born (since fewer workers mean rising pay and fewer households mean cheaper real estate). But it’s bad for retirees who will have their benefits slashed when there are too few workers to support them.

Let’s begin with some charts from today’s Wall Street Journal. The first shows women waiting longer to have kids, with the average age for first birth rising from 21 in 1968 to 26 today:

birth rates by child


The second shows the result, which is plunging birth rates among younger age groups:


birth rates by age



This is due to a few (admittedly somewhat contradictory) things. First, college-educated women tend to make more money, which raises the opportunity cost of starting a family. Second, soaring student debt for those same college graduates makes work more necessary and the added expense of kids more terrifying. Third, the rise of the gig economy makes Millennial finances more precarious than for any other post-Depression generation, leading many to feel too overwhelmed to even consider starting a family. Fourth, kids are obnoxious (sorry, that’s just me venting about some hopefully very temporary family stuff).

Add it all up, and Americans (along with Japanese, Germans, and Italians) are having too few kids to replace their existing populations.

Immigration will no doubt take up some of the resulting slack, but not all of it because new arrivals soon adopt their host country’s breeding attitude. In the US, for instance, Hispanic birth rates are falling faster than for non-Hispanics.

Hispanic birth rates


Falling birth rates seem to be the new normal, with shrinking populations not far behind. In a wildly overcrowded world (watch the following video if you doubt the truth of this) …





… fewer humans solve a lot of problems. But why write about this trend in a gloom-and-doom finance blog? Because of the impact of falling working-age populations on the global financial system. The only way for Millennials to pay for Boomers’ Social Security and Medicare would be for the latter to confiscate 90% of the former’s paychecks. That won’t happen, so something else has to, most likely massive benefit cuts via hidden inflation.

In other words, we aggressively depreciate the dollar (and euro and yen) while raising retirement benefits by some fraction of that rate, thus stiffing retirees in a way that many won’t notice, at least for a while.

The side effect of this purposeful inflation will be a massive shift of capital out of financial assets like government bonds that depend for their value on the stability of the underlying currency, and into real assets like oil wells, farmland and precious metals which governments can’t create with a mouse click. So buy gold, sit back and enjoy the show.

Canada pension plan chief warns over illiquid private assets   
It is hard to sell the private stuff in a downturn, says Mark Machin of CPPIB

 Jennifer Thompson in London

    
Mark Machin: private assets were among the top performers for CPPIB (Lucy Nicholson/Reuters)
 

The head of one of the world’s biggest retirement funds has warned that investors are becoming too exposed to private assets whose liquidity could prove a problem in the event of a downturn.

Institutional investors such as pension funds have increased exposure to assets such as infrastructure, real estate and private equity in the quest for better returns at a time of record-low interest rates.

“I don’t think there’s anything wrong with private assets or private equity [but] it's very hard to sell the private stuff in a downturn,” said Mark Machin, chief executive of the Canada Pension Plan Investment Board which oversees C$392bn ($291bn) in assets. “My warning is you have to be really careful on how much you load up.”

About half of the Toronto group’s assets are invested privately, a heavy weighting with which Mr Machin is comfortable.

Private assets were among the top performers for CPPIB as it reported annual results for the year ending in March. Private equity in companies based in developed markets outside Canada was the best-performing asset class, with a gross return of 18 per cent compared with 16 per cent the previous year. Infrastructure returned 14 per cent compared with 15.2 per cent the previous year.

In common with other Canadian pension funds, CPPIB is known for being a proponent of “direct investment”, where it bypasses intermediaries to make deals or buyouts. Recent investments include about $750m in Aqua America, a US water company.

CPPIB is also part of a consortium led by private equity firms Apax and Warburg Pincus that plans to return Inmarsat, Britain’s largest satellite company, to private ownership in a deal that values the group at about $6bn including debt.

Overall, CPPIB reported a dip in annual returns after a rocky period for global markets towards the end of 2018. It posted a net return of 8.95 per cent for 2018-19, down from 11.6 per cent the previous year.

Mr Machin had previously warned of lower returns, saying the prospect of double-digit returns year on year was “too optimistic”. He said it was a good result but added that renewed trade tension between Washington and Beijing was causing uncertainty.

“You’ve got rising geopolitical tensions that are very difficult to price,” he said. “The tension between the number one and number two economies doesn’t help anybody.

“We’re probably going to see rising volatility and less robust returns from here.”

Mr Machin's total pay for the year rose 10 per cent to C$5.76m, including deferred awards.

Assets at CPPIB rose C$35.9bn. Much of this was derived from profits generated by the fund’s investment activities, with C$3.9bn coming from contributions made by pension savers. The group’s overall assets rose 10 per cent year on year. Fees paid to external investment managers fell C$152m to C$1.59bn because of lower performance fees.

CPPIB was formed 20 years ago to build a reserve fund to support the Canada Pension Plan, the country’s largest retirement fund with 20m contributors and beneficiaries.

The Ego/Self-System Part II: A Neuroscience Perspective

Article by Robert F. Steele, MA





Introduction

In the first part of this series on self and ego, we presented the traditional attitude toward ego, namely that it is essential for mental health, as humans basically need a distorted sense of reality to continue efficient functioning. This was contrasted with heretical positions from Ernest Becker and J. Krishnamurti, who contended that the ego is dangerous and responsible for much global strife and suffering. It was Krishnamurti, though, who presented the epitome of heresy concerning self and ego. In this part, we will examine Krishnamurti’s positions in relationship to recent discoveries in the field of neuroscience. I find this comparison especially interesting, as Krishnamurti’s positions were first made public in the late 1920s long before there was any technology to scientifically investigate the operations and functions of the brain. This also reminds me of the positions of Copernicus and Galileo, concerning their inflammatory heresy that the Earth is not the center of the universe.

Much of the material presented is the province of experts, and since I am not a neuroscientist, I will rely heavily on extensive quotes to secure positions taken. My role will be to assemble a montage of various views that, when presented, will hopefully illuminate self and ego from a scientific point of view in comparison to Krishnamurti’s positions. I will follow comments to the articles and will respond to questions or comments concerning this and the previous installment.



Is the Self/Ego a Real Thing?

Krishnamurti stated that we are nothing, that the self is not real, in the sense of it not being a thing. What does brain science have to say about this very radical position? Antonio Damasio, an eminent neuroscientist, says in his book, Self Comes to Mind: Constructing the Conscious Brain: “The answers are unequivocal. There is indeed a self, but it is a process, not a thing, and the process is present at all times when we are presumed to be conscious. We can consider the self process from two vantage points. One is the vantage point of an observer appreciating a dynamic object … The other vantage point is that of the self as knower” (Damasio, 2010, Amazon loc. 205).

If there is no physical structure central to self, a self-structure that runs the brain, a me that is in control, what creates this uncanny sense of self as the operator of the system? An answer may lie in looking at how the brain produces consciousness, since this sense of self as operator and knower resides in consciousness.

Consciousness is an emergent property. From moment to moment, different modules or systems compete for attention and the winner emerges as the neural system underlying that moment’s conscious experience. Our conscious experience is assembled on the fly, as our brains respond to constantly changing inputs, calculate potential courses of action … The psychological unity we experience emerges out of the specialized system called “the interpreter” that generates explanations about our perceptions, memories and actions and the relationship among them (Gazzaniga, 2011, p. 102).


Meditation really is a complete emptying of the mind. Then there is only the functioning of the body; there is only the activity of the organism and nothing else; then thought functions without identification as the me and the not-me. Thought is mechanical, as is the organism. What creates conflict is thought identifying itself with one of its parts which becomes the me, the self and the various divisions in that self. There is no need for the self at any time. There is nothing but the body and freedom of the mind can happen only when thought is not breeding the me. There is no self to understand but only the thought that creates the self.

– Krishnamurti



The Invisible Brain

It appears then that there is a close agreement between Krishnamurti and brain science that self is not a physical structure or some immutable, and perhaps sacred or eternal, element. It is a function that emerges from brain activity, as does all that constitutes consciousness, but it is also invisible to itself as far as its internal operations go. It took technology for researchers to be able to peer inside the brain to understand the functions of the brain.

The faculty with which we ponder the world has no ability to peer inside itself or our other faculties to see what makes them tick. That makes us the victims of an illusion: that our own psychology comes from some divine force or mysterious essence or almighty principle (Pinker, 1997, p. 4).

Since the brain’s functions are not part of consciousness, this could explain, at least in part, why the sense of self seems so real; there is nothing in consciousness to compete with or to contradict the self-image, as it is the sole inhabitant of consciousness. Krishnamurti appears to agree with this in his comments about consciousness being its own content. He presents it as a unit, making no separation for the part self occupies in consciousness, along with the other elements that at any given time may be part of consciousness.


Consciousness is its content. The content is consciousness. The two are not separate. That is, the thoughts, the anxieties, the identifications, the conflicts, the anxiety, the attachments, detachments, the fears, the pleasures, the agony, the suffering, the beliefs, the neurotic actions, all that is my consciousness.

– Krishnamurti


Additionally, if we look again at the Damasio quote above, he proposes consciousness is composed of objects and a knower of those objects. It certainly feels that way, but a more removed view might see these elements are really one flow of consciousness. Is this what Krishnamurti is talking about when he talks about the thinker and the thought being one?


The root of contradiction is this division between the thinker and the thought. And the two cannot be integrated. But if one observes the structure of the thinker, you will see the thinker is not, when thought is not. It is the thought that breeds the thinker, the experiencer, the entity that creates time, and the entity who is the source of fear.

– Krishnamurti


Behind the screen of consciousness is the functioning brain, and what is going on within the brain’s silent functions is amazing. Billions of nerve cells called neurons are being created at early stages of the brain’s development, and throughout our life, root-like connections called axons are constantly adding to the trillions of connections between neurons via locations called synapses. “Moreover, when enough new synapses form in a neuron, the length and number of branches in its dendritic “tree” often expand as well, increasing the strength and number of the neurons that can talk to it” (Sapolsky, 2017, Amazon loc. 2283). These connections are learning. Once these networks are in place, matrix-like assemblies interconnect via electrical and chemical reactions to form representations of elements in the outer world. Basically, these representations are assemblies of simultaneously reacting neurons that, when stimulated, cause what we call memories. They can be assembled and downloaded to become a flow of consciousness that also contains a sense of self claiming to be responsible for the flow, and brain science says a sense of self as a center is necessary for there to be consciousness.

The mere presence of organized images flowing in a mental stream produces a mind, but unless some supplementary process is added on, the mind remains unconscious. What is missing from that unconscious mind is a self. What the brain needs in order to become conscious is to acquire a new property – subjectivity – and a defining trait of subjectivity is the feeling that pervades the images we experience subjectively (Damisio, 2010, Amazon loc. 248).

It does not necessarily follow that in needing a sense of center, a knower, there must also be an attached causative agent to the center, the self as a doer, an ego. This brings up the issue of free will.




Is There Such a Thing as Free Will?

In neuroscience, the issue of free will is a hot and undecided topic that, for now, centers around a study first conducted in the 1980s. The physiologist Benjamin Libet famously used EEG to show that activity in the brain’s motor cortex can be detected some 300 milliseconds before a person feels that he has decided to move at the moment they decided to press one button or the other … One fact now seems indisputable: some moments before you are aware of what you will do next – a time in which you subjectively appear to have complete freedom to behave however you please – your brain has already determined what you will do. You then become conscious of this “decision” and believe that you are in the process of making it. (Harris, 2012, p. 8).

Libet (1985) and Libet et al. (1967) conducted experiments showing that brain activity preceded seemingly conscious decisions of subject instructed, for example, to raise their finger at will. Since then, it has become very clear that unconscious processes are involved even when we feel we make deliberate choices (Ginot & Schore, 2015, Amazon loc. 756).

This can be strange and shocking information that challenges the sense of who or what is actually determining our thoughts and behaviors. Another source puts it this way:
Our subjective awareness arises out of our dominant left hemisphere’s unrelenting quest to explain these bits and pieces that have popped into consciousness. Notice that popped is in the past tense. This is a post hoc rationalization process. The interpreter that weaves our story only weaves what makes it into consciousness. Because consciousness is a slow process, whatever has made it to consciousness has already happened. It is fait accompli (Gazzaniga, 2011, p. 104).

Concerning superstition, Bruce M. Hood in his book SuperSense: How the Developing Brain Creates Supernatural Beliefs points out that “In other words, there is no free will in making the decision to believe or not” (Hood, 2009, p. 67). The same could be said of consciousness. One likes music, but was that decided upon or found by discovery? Where do talents or abilities come from? According to science, anything we decide to “do” is not only dependent on brain processes that happen prior to the formation of something in consciousness, but our actions also depend on neurological functions to carry out the decision. Beethoven could no longer conduct because he became deaf, and Ravel could no longer read music after a stroke in his 60s. Yes, we make choices, but in no way are they free. They are forever dependent upon underlying, silently functioning brain systems. What may be important here is that, regardless of what we may or may not be able to choose, the fact that stands out in brain science is that behind everything we do is not a self but a brain. This may be particularly important concerning how the issue of free will may or may not intersect with the teachings of Krishnamurti.


Choiceless awareness implies to be aware both objectively, outside, and inwardly, without any choice. Just to be aware of the colours, of the tent, of the trees, the mountains, nature – just to be aware. Not choose, say, ‘I like this’, ‘I don’t like that’ or ‘I want this’, ‘I don’t want that’. To observe without the observer. The observer is the past, which is conditioned, therefore he is always looking from that conditioned point of view, therefore there is like and dislike, my race, your race, my god, your god, all the rest of it. We are saying to be aware implies to observe the whole environment around you, the mountains, the trees, the ugly walls, the towns, aware, look at it. And in that observation there is no decision, no will, no choice.

– Krishnamurti




Nobody Home

If, as neuroscience indicates, the brain has created the self/ego system, and if its functions are silently behind all behavior, this may turn our idea of who we are and what life is in a very different direction, and the conclusion may be that we are not running things as we thought, perhaps not running them at all. Furthermore, statements from Krishnamurti may support this. First, let us look at what he says about effort:


Effort implies control, effort implies conflict, inwardly, psychologically and outwardly. To this state of things we have become accustomed. Religious people, business people of every kind must make effort. And in that effort there is involved a great deal of energy, in conflict and so on.

– Krishnamurti


He also comments on how the self is trying to reach an ideal position by creating a desired view of the self in the future:


Why does each one of us want to be something? If I am ugly, I want to be beautiful; if I am stupid, I want to be clever; if I am envious, I want to be free from envy. So there is a constant battle between what I am and what I think I should be. The ‘should be’ is the aim of every person who wants to become, and in this process there is infinite struggle, pain, fear, frustration. And seeing this process, being aware that my mind is caught in the web of sorrow, how am I to be free from sorrow?

– Krishnamurti


Krishnamurti seems to be challenging the very role of consciousness in human life. Self/ego, as research presents it, is a projection from the brain that gives a sense of control, and effort and direction in the future. But what is it that is “sensed” as effort? If it is in consciousness, as it obviously is, the sensation must also be a projected image from prior brain activity. Science says the brain’s real efforts have no sensation to them at all. Now, of course, we need some of these sensations to protect the body from damage and danger etc., but those challenges are in the present. I think that if we are honest, we can see self/ego has a preoccupation with a future projection of its fears and desires and, as such, much, or maybe most, of consciousness is filled with these images:


Can the eyes observe without the past? Let me put it differently: I have an image of myself, created and imposed upon me by the culture in which I have lived. I also have my own particular image of myself, what I should be and what I am not. In fact, we have a great many images; I have an image about you, about my wife, my children, my political leader, my priest, and so on; so I have dozens of images. Don’t you have them? Now, how can you look without an image, because if you look with an image, it is obviously a distortion.

– Krishnamurti


An honest appraisal may indicate that we are seldom in the present. There was a passage in one of Krishnamurti’s books where he is speaking to a group of Buddhist monks in which one of the monks, after an extensive discussion, says to Krishnamurti something to the effect that Krishnamurti had led a life of observation, and Krishnamurti replied, “Quite right, sir.” This statement could be taken as a casual reply, but what if the monk had an insight and Krishnamurti’s reply was very literal? Would this mean that Krishnamurti’s utilization of consciousness was predominantly a place of intense observational awareness largely free of future concerns and the sensations of effort associated with the sense of self/ego? Seen from another perspective, Krishnamurti’s position seems to be a complete negation of free will because the behavioral motivators of free will can only exist as a sensation of desire and conflict within the self/ego system as it struggles with the various rules and regulations of life. Would it be logical to say that, without the self/ego system, the future of the self as a projection in “the act of becoming” cannot happen, nor can all the necessary defenses the self employs to guard itself. But also lost are all the attractions and addictive sensations associated with self/ego as desires. Krishnamurti once asked of a questioner: “Do you really want it? Right? What price are you willing to pay for it … ?” Clearly, if one is in conflict about this price, the effort to understand Krishnamurti may be nothing more than just another “act of becoming.”

Since neuroscience is quite clear that the self is an image and therefore imaginary, so the clear indication is that the brain is the source of all that is going on with us rather than the construct we call self. The brain desires and feels it needs the fantasy of self as a controller. In Part I of this series, the motivation for this was explored and proposed to issue from fear. Not fear in the present, but remembered fear projected into the future that has long since been buried deep in the subconscious, and, though buried, still is the source of a preoccupation with the future. Dreaming of a nice future to fill consciousness displaces darker concerns. Does this mean then that consciousness is clogged with obsessive images from memory that creates more obsessive images as future projections? If so, does that mean we are blocking observation of and participation in the present? If we are neglecting the present, how does that influence the actions we take to manage our lives?


When one looks at all this, one asks, if you are serious: what is right action? What is the right thing to do in life? Not in one particular department of life, but the whole, total process of living, what is the right thing to do? Right being the word ‘accurate’ – accurate, precise, without any distortion – what is the accurate thing to do, the right thing to do in life? Do you ask that question? So we are going to investigate into this question because unless we find out, every action that we do leads to further confusion, further misery and man becomes utterly a mechanical entity – which we are gradually becoming. So it’s very important for a serious person, and I hope you are serious, to find out what is the right thing to do.

– Krishnamurti


Other questions are also raised from these concerns. Our brain/body system is a product of the universe. Its elements have been brought to existence over about 3.75 billion years of evolution as a part of the evolving continuity of life on Earth. We are here, just as every aspect of life is, as a development and creation within the same universe. But only the human species seems to not trust the equipment we were given to handle life. Of course, in all fairness, other creatures and lifeforms apparently do not understand the ultimate predicament life puts us in, namely of not having absolute security. Knowing that leaves us either simply accepting things the way they are or creating different diversions and fantasies to push that awareness aside. However, we may pay a high price for psychological escape, and it may cause disintegration with the life systems that we are enmeshed with at the physical level. What we seem to not trust is that, if we take care of the present by being fully aware, the best security will come about without effort simply because that is what the basic design of the brain is intended to do. Not perfect, but the best. In creating the self/ego, has the brain attempted to weasel out from the reality of life as a system of incessant change? Is it possible that, in so doing, misery and uncertainty has been introduced on an unimaginable scale that issues from the connivance of the brain’s own monster creation, the ego?


We begin to discover that when there is the destruction of all the authority which man has created for himself in his desire to be secure inwardly, then there is creation. Destruction is creation. Then, if you have abandoned ideas, and are not adjusting yourself to your own pattern of existence or a new pattern which you think the speaker is creating – if you have gone that far – you will find that the brain can and must function only with regard to outward things, respond only to outward demands; therefore the brain becomes completely quiet. This means that the authority of its experiences has come to an end, and therefore it is incapable of creating illusion.

– Krishnamurti


Can it be that the life Krishnamurti lived was one of accepting the unfolding of events in the universe both inwardly and outwardly? If so, it may indicate that the “now” moment of ongoing creation for the movement of Krishnamurti’s mind and everything happening outwardly were essentially the same; everything going on internally for him, his brain’s functions, issued from the same source as everything else. The irony is that what seems to block the brain from understanding this is the imagination of self which, if this is right, is the memory of fear motivating the creation of a self-system, which necessitates the need for an imaginary future. Krishnamurti replied to a question concerning what his secret is by saying: “I’ll tell you what my secret is. I don’t mind what happens.” From the comments assembled here concerning brain science and Krishnamurti’s own quotes, it seems to be a comment about time. Is Krishnamurti implying that he fully accepted the unfolding of what may happen both within himself and outside of himself, not as a choice or something to practice but as an inescapable fact concerning himself as a creation of the universe interacting with the rest of creation? Would this not mean that the unfolding of creation is a fact beyond control, uninfluenced by the human desire for the basic dilemma, the impermanence of everything, to be different?

In summary, it seems amazing that the statements of this man, Krishnamurti, are so closely aligned with the latest scientific discoveries about the brain. But, in addition, he speaks of insight as a function of the brain too, and this has not, and perhaps cannot, be investigated by the tools of science. Krishnamurti seems to indicate that insight is a special operation and special alignment between the brain and the outer elements of creation that results in perception not limited by the inherent bias in the storehouse of memory. One can only wonder if insight is the result of a truthful relationship between the brain and creation, which brings to consciousness an inescapable sense of reality that transcends opinion and interpretation. If so, it would truly represent a radically different dimension in the ability of the brain to perceive reality.


To perceive this whole movement of the individual and its activities and its organisations, is to have an insight into the whole movement of it. And that very insight is out of time. I don’t know if we have understood that. Insight is not a remembrance, is not a calculated, investigated, investigative result, it is not a process of recording and acting from that, and it’s no longer the activity of thought, which is time. Therefore insight is the action of a mind that is not caught in time.

– Krishnamurti


Robert is a retired mental health counselor and lifetime student of Krishnamurti.