Slowing but Not Stopping (Yet)

By John Mauldin

If you are a computer (other than the newest experimental quantum ones), your world is entirely binary. Everything is some combination of zeroes and ones. The machines can do marvelous things with those two digits but they have limits.

We humans don’t have to think in either/or terms, yet we often do. I see it in the economic outlooks that cross my screen. Some forecast imminent doom, others endless boom. But in reality, there is lots of room between the extremes.

I’m known as the “Muddle Through” guy, which is another way of saying I think “both/and” instead of “either/or.” We can have both a successful outcome and difficulty getting there. And that’s been my economic outlook for a long time. We are entering a rough period and eventually recession will come, but it will be survivable.

The real damage will come in the “echo” recession that I think will follow. Policy changes, mostly of the political backlash type, will ensure the mid-2020s won’t be fun. Ray Dalio just wrote another piece that I will excerpt and link to below, but I was struck by how similar our worries and concerns are. We are approaching a crisis unlike anything we have ever seen, what I term The Great Reset, without any kind of realistic plan.

But that is more than a few years down the road. Today I want to focus on that “entering a rough period” part that comes first. The signs are growing clearer and the bumps bigger.

Technical Recession

For now, the global slowdown is less visible in the United States. That doesn’t mean it will never reach us. It just means others are further down the road we are all traveling.

Germany, for instance, may already be in recession. GDP there dropped 0.1% in this year’s second quarter, with little reason to expect better from Q3 which we will learn next week. (Two consecutive quarters of negative GDP growth constitutes recession, by some definitions.)

Whatever you call it, Germany is certainly not in a good spot. It is highly dependent on exports which, for various reasons, are weakening, particularly in their auto industry. The entire euro currency project, while well-intentioned, ended up being essentially vendor financing for the rest of the continent to buy German/northern European goods. It went too far, as we saw with Greece, and now Germany’s best customers are in debt up to their eyeballs and in no position to keep buying. Meanwhile, Brexit (depending on how it ends) could greatly reduce UK purchases of German goods.

On top of that, uncertainties induced by President Trump’s trade war are deterring businesses in Europe (as well as here) from investing in future growth projects. And overarching all of it is the technology-driven decline in globalized manufacturing. Production is moving closer to consumers, which will have many advantages, but also create problems for export-intensive economies, especially the emerging-market economies that supply inexpensive labor. Such work is increasingly being automated and moved closer to the actual customer. Which, as we will see below, is visible in the data.

If Germany’s “technical recession” morphs into a real recession, the rest of Europe will certainly follow. And recession in Europe—and the measures its central banks will take to fight it—won’t leave the US economy unscathed.

Not coincidentally, commodity-producing emerging markets are also experiencing difficulty. Ditto for some more advanced commodity exporters like Australia and Canada. Their problem springs from lower commodity prices, but more specifically from China. Sam Rines explored this in a recent note.

Much of the commodity price pressure can be blamed on slowing Chinese growth, but that is not the entire story. China is roughly 20% of global GDP on a PPP basis, and constitutes much of the incremental growth in the global economy. When China's growth slows, the ripples are felt in many places.

Commodity prices and China's growth rate are understandably intertwined, and that may be a difficult correlation to break down. Why? It is difficult to pinpoint the next major tailwind. And—even when speculating on the next tailwind—timing is a further difficult hurdle to overcome.

But why not try. Of the three major headwinds to commodity pricing in the post-dual stimuli world (end of China's building spree, US dollar following QE, and slower overall global growth), the US dollar is the most likely to abate as a headwind in the near-term. Global growth is dependent largely on US and China trade policy, but there could be a marginal shift higher in growth (the worst might be over). Replacing the rapid growth of China is not easy to see. India is gaining share of global GDP. But it is not easy to see the path to a full replacement of the China commodity cycle.

We may soon see the other side of China’s growth story. Just as it had an outsized effect on global GDP on the way up, it will likely be a major drag on the way down.

Note, when my young friend Sam says “the worst may be over,” he is talking in particular about the downturn from slower Chinese growth. If you read his daily missives, as I do, he is far from predicting a US recession.

Slower growth? Yes. It sounds like he thinks we are in a slower muddle-through world for the next few quarters at least. And maybe through the next elections…

Freight Volumes Plummet

While more goods are delivered electronically and supply chains are shrinking, the movement of physical goods is still the economy’s circulatory system. Just as low blood pressure is a problem, so is lower freight volume. And unfortunately, that is what’s happening. Remember that I said we can see less export-driven manufacturing in the data? I think it is here, though hidden within the actual global recession, and we will look back and realize it was localized manufacturing having a visible effect.

The Cass Freight Index is the most comprehensive, high-frequency indicator of this. It tends to lead the economy by a few quarters but has signaled almost every economic turning point. So the fact its year-over-year change has been negative every single month since December 2018 is more than a little concerning. As you can see from the data, there have been periods of negative growth without a recession, but the latest drop’s sheer magnitude and rapidity is eye-opening.

Sidebar: Recessions often happen after businesses become too optimistic, with what Keynes called “animal spirits” soaring. They expand and then find out they have to pull back. And just as they might’ve been a tad too exuberant on the way up, they become too pessimistic on the way down, cutting production and capacity. This same zeitgeist, multiplied by millions of businesses worldwide, creates recessions.

Recessions are an odd thing. We fear them, and if you are a typical hourly worker, rightly so. But a recession is technically only two quarters of negative growth that may be just a little less than the recent peak. I have managed private businesses or partnerships for 45 years.

By that definition more than a few of my businesses have been in recession far more frequently than the national economy. Today a few of my income streams are in roaring bull markets while others lag or fall way behind.

That’s fine up to a point. If the aggregate starts looking more negative I become more defensive. I look at overhead and expenses a great deal more carefully. I have learned to temper my normal optimism when the numbers are telling me something different.

I think that attitude, coming from experience, is common in businesses all over the world. As the infamous Texas Judge Roy Bean purportedly said, “Nothing focuses the mind like a good hanging.” In today’s world, nothing focuses the mind like a few negative quarters. But back to the main story…

The chart is through September. The next Cass report, covering October, will be out in the next week, but at this point it would take a heroic move to change the pattern. Freight traffic is falling and it looks even worse when Cass digs into the specifics.

From Cass:

  • “Consistent with disappointing housing starts (down -1.8% YTD) and lackluster auto sales (down as much as -4.8% in April and -1.2% YTD), spot pricing in transportation has declined dramatically.”

  • “Airfreight volumes in Europe continue to suggest that the region’s economy continues to cool.”

  • “Asian airfreight volumes were essentially flat from June to October 2018, but have since deteriorated at an accelerating pace.”

  • “Even more alarming, the inbound volumes for Shanghai have plummeted. This concerns us since it is the inbound shipment of high-value/low-density parts and pieces that are assembled into the high-value tech devices that are shipped to the rest of the world. Hence, in markets such as Shanghai, the inbound volumes predict the outbound volumes and the strength of the high-tech manufacturing economy.”

Considering historic correlations, Cass believes its current data signals US Q3 GDP growth will be negative, or close to it. They said that before the Commerce Department estimated Q3 growth was a better-than-expected +1.9%. So maybe Cass was too negative… but there’s still time for the government to revise its number lower, too.

And with all due respect to the Commerce Department, the Atlanta Fed “GDPNow” predictions have simply fallen out of bed, down to less than 1% for the fourth quarter, after an anemic third quarter.

Not to be outdone, the latest New York Fed Staff Nowcast for 2019 Q3 was 1.9% and 0.8% for Q4.

Now, 1% GDP growth is certainly not the stuff dreams are made of, especially if you are a Republican looking at a November election cycle.
This actually makes me somewhat more optimistic that the various trade issues will be resolved sooner rather than later. All sides have plenty of incentive to stop the madness. Will it change the direction of animal spirits?
Fast enough to be reflected in GDP growth by midsummer? That’s anybody’s guess, and I mean just that—a guess. Anybody who thinks they know what some hypothetical trade deal will produce is simply bloviating.

Going deeper, Cass notes that “dry van” truck volume is a fairly reliable predictor or retail sales, and is still relatively healthy. That fits what we see elsewhere about consumer spending sustaining growth. But they also note that seasonally, dry van volume should be even stronger than it is. That suggests caution as the year winds down.

Other transport modes—rail, flatbed trucks, chemical tankers—indicate real problems in the industrial economy. Manufacturers seem to have little faith consumers will keep buying at the rates they are.

And, given how much consumer spending is debt-financed, they’re probably right to be cautious. Strong retail spending is not necessarily positive. Consider this Comscore holiday spending report from November 2007.

“The Friday after Thanksgiving is known for heavy spending in retail stores, but it’s clear that consumers are increasingly turning to the Internet to make their holiday purchases,” said Comscore Chairman Gian Fulgoni. “Online spending on Black Friday has historically represented an early indicator of how the rest of the season will shake out. That the 22-percent growth rate versus last year is outpacing the overall growth rate for the first three weeks of the season should be seen as a sign of positive momentum.”

The Great Recession began one month after this “sign of positive momentum.” A strong holiday shopping season won’t mean we are out of the woods, and could mean we are just entering them.

“An Ugly Battle”

Ray Dalio has a new post titled The World Has Gone Mad and the System Is Broken. If you think that sounds a bit despondent, you’re right. Sadly, I am in 100% agreement with the headline. We might differ on a few of the details, and some of the solutions, but on the general direction? Not far off.

You should read the whole thing but here are some quick excerpts.

  • “Money is free for those who are creditworthy because the investors who are giving it to them are willing to get back less than they give. More specifically investors lending to those who are creditworthy will accept very low or negative interest rates and won’t require having their principal paid back for the foreseeable future. They are doing this because they have an enormous amount of money to invest that has been, and continues to be, pushed on them by central banks that are buying financial assets in their futile attempts to push economic activity and inflation up.”

  • “Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power.”

  • “At the same time, large government deficits exist and will almost certainly increase substantially, which will require huge amounts of more debt to be sold by governments—amounts that cannot naturally be absorbed without driving up interest rates at a time when an interest rate rise would be devastating for markets and economies because the world is so leveraged long.”

  • “Pension and healthcare liability payments will increasingly be coming due while many of those who are obligated to pay them don’t have enough money to meet their obligations.”

  • “Since there isn’t enough money to fund these pension and healthcare obligations, there will likely be an ugly battle to determine how much of the gap will be bridged by 1) cutting benefits, 2) raising taxes, and 3) printing money (which would have to be done at the federal level and passed to those at the state level who need it). This will exacerbate the wealth gap battle. While none of these three paths are good, printing money is the easiest path because it is the most hidden way of creating a wealth transfer and it tends to make asset prices rise.”

  • “At the same time as money is essentially free for those who have money and creditworthiness, it is essentially unavailable to those who don’t have money and creditworthiness, which contributes to the rising wealth, opportunity, and political gaps.”

  • “Because the “trickle-down” process of having money at the top trickle down to workers and others by improving their earnings and creditworthiness is not working, the system of making capitalism work well for most people is broken.”

The process is pretty clear. Recession is eventually coming and even a relatively weak one will set off the dominoes Dalio describes.

We will see highly leveraged, unprofitable companies default on their debts and lay off their workers, sending government debt higher as safety net spending rises and tax revenue falls. To think this happens without a significant bear market in equities is rather implausible.

Then public and private pensions will find it impossible to meet their obligations and also impossible to keep disguising that fact. This will force federal bailouts, further aggravating the debt problem. Dalio thinks they will end up monetizing it in some fashion. I think he is right. What we don’t know is the exact mechanism they will use. But it matters a great deal to our response in our personal portfolios and investing.

Now consider that, if Cass is right, not to mention the Atlanta and New York regional Fed forecasts, this will unfold in a highly contentious election year, and possibly with the US still embroiled in a trade war with China and/or others. We’ve seen how reports that negotiations are going well, or not going well, can move markets. In a few months we will start seeing similar responses to political poll results. Indications that Elizabeth Warren, for example, might get a chance to implement her wealth tax idea could trigger sharp changes in stock valuations.

Bottom line: The economy is slowing and market volatility rising. Looking at the data and seeing further out than nine months is extraordinarily difficult.

Yes, the inverted yield curve says recession is coming, but it’s an imprecise indicator. And I am painfully aware that markets can go up significantly (20% or more!) after an inverted yield curve. That being said, we must have our recession antennae raised.

Navigating through this is going to be hard. But “hard” doesn’t mean “impossible.”

The good news is I will likely be home until the third week of November when I go to Philadelphia. Then I spend the next week in Dallas for Thanksgiving with family and friends. There are more travel opportunities but also the need to read and write. Books just don’t happen…

Speaking of books, writing a book about what the world will look like in 20 years obviously requires a great deal of research and help. And then I have to keep up with what is going on in the real world to write this letter. It is something of a mental whiplash. I totally get that most people focus on the near term (very understandable) but writing about what will happen in the middle to late 2030s puts a slightly different perspective on what the latest Fed move might be.

The future of work? Health technology? Age spans? So many things will be different and better and other things will be far more difficult. I am not sure humanity is ready for this much change to happen so quickly. In fact, I am pretty sure we aren’t. Which is why it is so important that we make sure the changes will be positive for us and those who we hold dear.

But the key to that, gentle reader and friend, is to not only accept the changes but make changes in your own world as well. And that is never easy…

And with that, I will hit the send button and wish you a great week.

Your struggling with his own changes analyst,

John Mauldin
Co-Founder, Mauldin Economics

China, Brexit, and the U.S. Election — What Eurasia Group’s Ian Bremmer Expects

By Leslie P. Norton

                                      Ian Bremmer Photograph by Erik Tanner          

  When something big happens in the world—pretty much a daily event at this point—Ian Bremmer is there to explain it. The political scientist, founder of the Eurasia Group consultancy, and PBS host has lately been telling everybody about what he calls the GZero World, in which post–World War II institutions are rapidly losing influence. We caught up with Bremmer, 49, to talk about the geopolitical unwinding that has massive implications for investors. An edited version of our conversation follows.

Barron’s: You’ve written a lot about the geopolitical recession, which isn’t an economic term.

Bremmer: Geopolitics, like economics, are cyclical. People don’t recognize that because geopolitical cycles are a lot longer. We had a good run of U.S.-led global institutions [like the G-7, the seven largest advance economies], reflecting a new order after World War II. Now they’re unwinding. We’re entering an interregnum where the institutions increasingly don’t work. We need to build new ones.

Why is this happening?

It’s extraordinary when you have Western-led global institutions, but economic, political, and even military power increasingly residing outside the trans-Atlantic. The U.S. can talk about a pivot to Asia, but it’s really hard for the global architecture to do this. It’s hard to get troops out of the Middle East. It’s hard to compromise with the Chinese, who have very different institutions and values and norms.

The U.S. foreign-policy establishment once believed that as China became wealthier, it would align more with the U.S., or fail. That was just wrong. In the past three years, the biggest change was created not by President Donald Trump in the U.S. but by President Xi Jinping in China, with his anticorruption program, consolidation of power, end to term limits, the Belt and Road infrastructure initiative, and the AI 2030 and Made in China 2025 policies. This is world-changing stuff.

Are there other reasons?

A growing inability of Western governments to perform for their populations.

There’s extraordinary division with the rise of populism. Other countries, like Russia, are looking to exploit it and make it worse, and China is trying to move into the space created when the West isn’t doing much.
Finally, technology increasingly doesn’t serve the purposes of liberal democracies. It has moved from undermining authoritarian states to supporting them, as the data revolution [enables] surveillance data and social media. These things make the U.S. weaker and more divided, and make China and other authoritarian states stronger. That’s exactly the opposite from what technological advances achieved 10 years ago.
The United Nations secretary general recently observed that the world is splitting into two camps—the U.S. and China.

It’s more West and China-plus. When you have two groups of investors with such dramatically different views of the world, it creates a lot more volatility and risk. Right after the 2008 crisis, a number of Chinese said, “Maybe [the U.S.] economic model doesn’t really work; maybe we can move away from the dollar.” Very quickly they were disabused. It’s different now: Asians think the U.S. is in very serious, inevitable decline; that Trump is driving America off a cliff; and that the Asians are the ones doing long-term strategy. They’re also much more resistant to the kind of populism seen in so many of the democracies in the West.

Do you agree?

Not completely. I do think that U.S. influence and power is in very serious—and structural—decline. And Trump is not helping, to put it mildly. However, the U.S. is not in decline as a country. Look at the biggest objective transformations of the past 10 or 20 years—the energy revolution, the rise of extraordinary technologically and data-empowered companies that are functional monopolies. These are U.S., not Western trends. Americans aren’t experiencing the geopolitical recession the way our allies do, so we’re not incentivized to do much about it.
What countries are most affected by the geopolitical recession?

Turkey is massively affected, as America and NATO’s consistent, strong global-policeman role [is diminished]. Another group is the countries under the American security umbrella in Asia, which don’t know how to balance China’s economic rise: Japan, Singapore, South Korea, Vietnam. Then you have countries in Africa, which have been accommodated by the Chinese model and Chinese money.

Europeans are much, much more affected than the Americans—they’re a transmission belt for all the instability from Africa and the Middle East. Russia is able to do much more in terms of traditional espionage, political influence, and asymmetrical warfare on the ground in Europe, because its in its backyard.

One more point. The two countries that could best respond to a geopolitical recession are the ones that have benefited most by it: China because it represents an opportunity, and America because we’re insulated. We’re buggered. I’m sorry, you were saying?
How does this lead to a market view?

One, this is still pretty bullish for U.S. markets. Two, companies that don’t understand these changes are going to get hurt. Apple [ticker: AAPL] doesn’t get this. Its model is building the best possible consumer electronics with some privacy and data security. That’s just not going to work in China. [AMZN] has a much smarter model. It wants to work with the U.S. government. Its second headquarters, just outside Washington, D.C., will get a lot of big contracts, and it will be part of the infrastructure of the U.S. based Internet of Things.

Who wins the U.S. presidential election?

I don’t know. The impeachment issue is serious. There’s a low but real possibility that, if you keep having significant Republicans functionally turning state’s evidence against the president, you could start to lose some senators. The timing of the Syria [troop pullback] wasn’t great for Trump. If the Republicans do vote in favor of impeachment in the Senate, they’re basically giving up on the presidency in 2020. The bar is high. I don’t think it’s a 1% chance. I think it’s 10% to 15%.
Who will be the Democratic nominee?

Not Biden. Now that Warren is the front-runner, there’ll be a lot of money against her. I don’t think all of Biden’s support will go to Warren. A lot will be up for grabs, with more centrist candidates. No question in my mind that any of the Democrats will beat Trump by millions of the popular votes. That doesn’t mean they’re going to win the election. You’ve got to win these swing states, and Trump has a lot of money and a policy orientation that, for many of them, is very attractive. He’s also a relentless campaigner, and he likes campaigning. But he’s facing the worst set of objective facts around his administration.

What happens in the Middle East, as the U.S. steps away from Syria and tries to counter Iranian aggression?

This has been overstated by a foreign-policy establishment that hates everything about Trump. The Syrian war was lost under Obama. For legitimate reasons, the U.S. didn’t have a strong interest in Syria. We weren’t willing to fight another war there, and that’s why Assad won. Now, the Kurds have sided with Russia and Assad. It may be easier to move toward a U.N.-brokered peace settlement, in Assad’s favor. The Syrian people are getting screwed in all this, but that’s not new. The real concern is that you’ll see more attacks in the region from the Islamic State, maybe some in Europe, and maybe against U.S. assets in the region.

Regarding Iran, Trump was absolutely unwilling to support the Saudis with strikes, despite the [Iranian] attack that took 50% of their oil off the market. He sent some troops over that the Saudis are paying for, and he started a cyberattack. He doesn’t want a war. What he really wants is direct negotiations with Iran, like with North Korea. He really wants a deal. It doesn’t need to be much more than the one Obama already had with Iran that he pulled out of. [It] will be hard for Trump, because he doesn’t have a team to get the hard diplomacy done that Obama did.

Let’s talk about China and trade.

I don’t think there’s even a limited deal. The Chinese haven’t signed anything yet. They basically offered the same thing they offered when U.S. Trade Representative [Robert] Lighthizer walked away a few months ago. The only thing that has changed is that Trump is a little more concerned about the economy and his election—a little more desperate for a deal. The Chinese don’t trust Trump. Xi feels like he has given up a fair amount of political capital already, and hasn’t got anything done. So they’re willing to wait him out, particularly because they see that Trump’s appetite for further escalation with the softening U.S. economy is low. U.S.-China relations are objectively more confrontational today than they were three, six, 12 months ago. That trend will continue.

Your annual Top 10 Risks list won’t be out for a while. What is the biggest short-term risk for global investors?
The role of the U.S. on the global stage. Historically, when you think about global political risk, you think about rogues, you think about emerging markets, you think about country risk. You don’t think of the U.S. driving global political risk. That’s changing.

Thanks, Ian.


by Egon von Greyerz

Something is rotten in the state of Denmark the world (from Shakespeare’s Hamlet).

In a world that cannot survive without incessant deficit spending, money printing and negative interest rates, there is clearly something very rotten. It is not only rotten but it stinks!

Yes it stinks of lies, deceit and moral decadence.

So why doesn’t anyone stand up to tell the world where we are heading.

Well, for the simple reason that no politician can tell the truth.

Because if they did, they wouldn’t be elected.

The principal purpose of any politician is to buy votes and to get votes you can never speak the truth.

Also, there are so many vested interests with unlimited rewards. The moneymen who control the financial system have all to gain from creating false markets, false money and false interest rates.


The Roman philosopher and statesman Seneca said: “Veritas Nunquam Perit” (The Truth Never Perishes).

That might very well be true but it can be suppressed for a very long time as we are seeing now all around the world.

Let us first consider the biggest lie which is money.

For 5,000 years, the only real money has been gold (and at times silver).

Whenever the financial system has deviated from that simple principle, by creating false money, it has ended in disaster for the world, whether that has been done with silver coins filled with zinc or copper or by just printing paper money.


And that is where we are heading now. A catastrophic course of events was triggered when Nixon closed the gold window on August 15th, 1971.

Since then global debt has exploded and all currencies have imploded.

Debt, derivatives and unfunded liabilities have gone from manageable amounts in 1971 to over $2 quadrillion today.

And every single currency has lost 97-99% in real terms.

As I mentioned last week, the world, the politicians and the UN are all focusing on the wrong problem.

The destruction of the world economy will have consequences of a magnitude that is exponentially greater than climate cycles.

We are now at the point when we will not be able to change the course of either of the two.

Climate is determined by very long cycles that humans have virtually zero influence on.

With regards the financial system, there was a time when it could have been saved.

But that time is long gone.

Now we just have to let it take its course which will be totally catastrophic for the world.

So why is no one seeing what is happening and why is no one standing up to say that the Emperor is totally naked?

The truth is very uncomfortable and painful but it does never perish.

It is an incontrovertible fact that virtually all the fiat money that is created by governments, central banks and commercial banks is totally worthless and therefore false.

If a government prints money out of thin air to cover deficit spending, that money has ZERO value since all the work required to create it was to press a button on a computer.

We also know that the money has zero value because no bank or central bank is prepared to pay interest on deposits.

Instead because money is worthless these bankers want to be paid to hold the money.

It is really quite logical.

Why should you pay interest on money which has zero value.


And when a bank receives a $1,000 deposit and then lends out that same money ten times or more, that money is also worthless since it has cost $0 to issue the loans.

It is the same with a credit card company, or car financing, they all issue fake money created by the touch of a button.

It is this vicious cycle of money printing that has inflated asset bubbles to an extreme today.

We all know what happens when a bubble gets too big. IT POPS!

And when it pops, all the air that was inside the bubble just disappears.

For the ones who don’t understand what this means practically, let me explain. Let us start with the asset bubbles.

When the global stock, property and other bubble asset markets pop, all these assets will lose at least 95% of their value in real terms.

The best way to measure real terms is obviously gold since that is the only money which has survived and maintained its purchasing power for thousands of years.

And if we look at the debt bubble, global debt is at least $270 trillion.

But when the debt bubble pops so will other liabilities like the $1.5 quadrillion of derivatives.

So when the debt bubble pops, virtually all that fiat money becomes totally worthless.

No one can repay it and no one is willing to buy it.

I know that the above two paragraphs are a very simplified explanation of what will happen over coming years. But hopefully it makes it easy to understand.

These events will obviously not happen in one go. It will most probably start with stock markets first crashing which will put pressure on credit markets.

More QE will follow but that will only have a short term effect.

More crashes, more money printing, inflation, hyperinflation, credit defaults and bank defaults.

It will all unravel relatively quickly until their will be a deflationary implosion of most assets.

I outlined it briefly in my article last week called “Global Warning”.

We had the first clear signals from several major central banks that something was rotten in the world financial system already in August when the Fed, ECB and BOJ all declared that they would do what it takes to support the system.

I wrote about this important event in my article from August 29th.


Then in September the Fed started overnight Repos of $75 billion increasing to $100 billion.

They also undertook 14 day Repos of $ 30 billion increasing to $60 billion.

Following on from that the Fed has now announced that they will start QE of $60 billion per month.

But we mustn’t call it QE according to the Fed.

So let us just call it money printing because that is what it is.

The President of the Minneapolis Fed said:

“This is not about changing the stance of monetary policy.

This is about making sure markets are functioning.

This is kind of just a plumbing issue.”

He is of course right, it is a plumbing issue.

But the problem is that the financial system is leaking like a sieve with no chance of plugging all the holes.

Between the end of 2017 and 2019 the Fed reduced its balance sheet by $700 billion from $4.5 trillion to $3.8 trillion.

As always, the Fed hasn’t got a clue.

They didn’t understand that there was no chance to take away the punch bowl from a system that couldn’t survive without a constant feed of more printed money.

The problem is that the system won’t survive with more money printing either.

Because you can never solve a debt problem with more debt.

So either way they are doomed.

So the Fed is now joining the ECB which will now start to print € 20 billion a month indefinitely.

The BOJ has of course never stopped printing.

They own 50% of all Japanese bonds and are supporting the stock market aggressively.

The BOJ balance sheet has gone up 8X since 1999 and is now Yen 560 trillion ($5 trillion).

Yes, the system is rotten and is now starting to smell.

The actions by the Fed in particular in the last few weeks smell of panic.

Is there a problem with JP Morgan, or Bank of America, or maybe the Fed is supporting the bankrupt Deutsche Bank?

We will probably soon find out where the biggest pressures are.

On top of the bank problems, corporate debt is getting riskier by the day. The financing of companies like We Work and Merlin are clear signs of how dangerous this market has become.

The central banks are already fire fighting and so far very few people are aware of the fires.

But it is only a matter of time before these pressures in the financial system will spread like wildfires.


Investment markets will soon reflect the risks in the financial system.

Stock markets are likely to fall heavily this autumn and the precarious month of October isn’t over yet.

But potentially the fall might not happen until early next year.

But the risk is there today.

The dollar is extremely weak.

In spite of paying the highest interest of any major currency, the dollar is now weakening and is probably starting the final leg to ZERO.

Finally, the precious metals have merely just started to reflect the risks in the financial system.

The small correction that we have just seen is finishing.

But no use worrying about these small movements in the metals.

Physical gold and silver will soon start their journey to multiples of today’s prices.

But more importantly, they will be life savers as the financial system crumbles.

The Race Is On for The Future of Bond Trading

Shares of electronic bond-trading platform MarketAxess shares have soared, but many players are seeking a piece of the evolving market

By Telis Demos

Rick McVey, CEO of MarketAxess. The electronic bond-trading company recently reported a 30% jump in revenue. Photo: Amy Lombard for The Wall Street Journal

Wall Street has a new bond king. But as always, there are rivals for the crown.

Last week, MarketAxess MKTX -1.54%▲ reported a 30% jump in revenue and 40% jump in net income, both ahead of expectations. The company is in the business of electronic bond trading, offering venues and tools for banks, investment managers and others to trade corporates, munis and other instruments without picking up the phone.

Though stocks and currencies have long gone the way of trading automatically or by click-in centralized marketplaces, about 70% of investment-grade bonds in the U.S. and more than 80% of high-yield bonds still trade much more manually, through conversations or ad hoc messages between traders and dealers, according to Greenwich Associates.

The near-universal expectation is that this share will drop precipitously over the years to come as electronification of bond trading gains ground. That gives MarketAxess, by far the biggest of a handful of electronic bond platforms, a huge runway.

But owning that opportunity comes at a steep price: About 57 times next-12-month earnings for MarketAxess, on par with ultra-popular consumer-facing technology names like Square or Netflix.

At that nosebleed level, the main question is whether anything could start to impinge on the company’s growth story. After a huge run, the shares have already corrected a bit in September’s rotation out of momentum stocks, coming off a peak valuation of around 70 times.

One risk is that big banks’ desks figure out a way to keep more trade execution share for themselves, in part by setting up direct electronic links to clients. Dealers, for example, have recently embraced a new way to trade bonds called portfolio trading, which encourages clients to trade baskets of bonds rather than individual ones. This could, in theory, shift some trading away from electronic marketplaces. Already, about 2% to 4% of bond volume is now being traded in such portfolios, MarketAxess said Wednesday.

Things move quickly in this world, though. MarketAxess says it too is introducing a product designed to help clients price and execute portfolio trades. Portfolio trading could even spur more electronic trades, Marketaxess noted, as balance-sheet-constrained banks look to unload risk. Nonbank ETF market-makers are emerging as some big electronic customers, and might be drawn in to arbitrage opportunities created by this dynamic.

Perhaps the biggest unknown is the competitive landscape. There are many players in electronic fixed-income trading, from Bloomberg to BlackRock,that stand to have roles as the market matures. The growing electronic pie may enable all to keep growing for a long time.

But some big names will also be competing head-to-head. Recently listed Tradeweb Marketsis already handling some portfolio trading and has nabbed share of corporates trading by linking bonds to its big Treasurys rate trading business. MarketAxess recently acquired a smaller Treasurys platform it hopes to expand.

Stock-and-futures giant Intercontinental Exchange,known as ICE, has bought bond marketplaces, such as BondPoint, and bond data providers, such as IDC, in recent years. It is beginning to unveil its own strategy for how it will unite those assets and tackle the bond market holistically. ICE says its new ETF hub will help it compete directly for institutional bond trade execution.

ICE and Tradeweb are set to report earnings in the coming weeks. Investors in MarketAxess would be wise to pay close attention.

Bond trading is going electronic, but the ultimate spoils from that transition are still up for grabs.

Why Rich Cities Rebel

Having lost touch with public sentiment, officials in Paris, Hong Kong, and Santiago failed to anticipate that a seemingly modest policy action (a fuel-tax increase, an extradition bill, and higher metro prices, respectively) would trigger a massive social explosion.

Jeffrey D. Sachs

sachs315_Pablo Rojas MadariagaNurPhoto via Getty Images_chileprotestmanbulletface

NEW YORK – Three of the world’s more affluent cities have erupted in protests and unrest this year. Paris has faced waves of protests and rioting since November 2018, soon after French President Emmanuel Macron raised fuel taxes. Hong Kong has been in upheaval since March, after Chief Executive Carrie Lam proposed a law to allow extradition to the Chinese mainland.

And Santiago exploded in rioting this month after President Sebastian Piñera ordered an increase in metro prices. Each protest has its distinct local factors, but, taken together, they tell a larger story of what can happen when a sense of unfairness combines with a widespread perception of low social mobility.

By the traditional metric of GDP per capita, the three cities are paragons of economic success. Per capita income is around $40,000 in Hong Kong, more than $60,000 in Paris, and around $18,000 in Santiago, one of the wealthiest cities in Latin America. In the 2019 Global Competitiveness Report issued by the World Economic Forum, Hong Kong ranks third, France 15th, and Chile 33rd (the best in Latin America by a wide margin).

Yet, while these countries are quite rich and competitive by conventional standards, their populations are dissatisfied with key aspects of their lives. According to the 2019 World Happiness Report, the citizens of Hong Kong, France, and Chile feel that their lives are stuck in important ways.

Each year, the Gallup Poll asks people all over the world, “Are you satisfied or dissatisfied with your freedom to choose what you do with your life?” While Hong Kong ranks ninth globally in GDP per capita, it ranks far lower, in 66th place, in terms of the public’s perception of personal freedom to choose a life course. The same discrepancy is apparent in France (25th in GDP per capita but 69th in freedom to choose) and Chile (48th and 98th, respectively).

Ironically, both the Heritage Foundation and Simon Fraser University rank Hong Kong as having the most economic freedom in the entire world, yet Hong Kong residents despair of their freedom to choose what to do with their lives. In all three countries, urban young people not born into wealth despair of their chances of finding affordable housing and a decent job.
In Hong Kong, property prices relative to average salaries are among the highest in the world. Chile has the highest income inequality in the OECD, the club of high-income countries. In France, children of elite families have vast advantages in their life course.

Because of very high housing prices, most people are pushed away from the central business districts and typically depend on personal vehicles or public transport to get to work. Much of the public may thus be especially sensitive to changes in transportation prices, as shown by the explosion of protests in Paris and Santiago.

Hong Kong, France, and Chile are hardly alone in facing a crisis of social mobility and grievances over inequality. The United States is experiencing soaring suicide rates and other signs of social distress, such as mass shootings, at a time of unprecedented inequality and a collapse in public trust in government. The US will certainly see more social explosions ahead if we continue with politics and economics as usual.

If we are to head off that outcome, we must draw some lessons from the three recent cases. All three governments were blindsided by the protests. Having lost touch with public sentiment, they failed to anticipate that a seemingly modest policy action (Hong Kong’s extradition bill, France’s fuel-tax increase, and higher metro prices in Chile) would trigger a massive social explosion.

Perhaps most important, and least surprising, traditional economic measures of wellbeing are wholly insufficient to gauge the public’s real sentiments. GDP per capita measures an economy’s average income, but says nothing about its distribution, people’s perceptions of fairness or injustice, the public’s sense of financial vulnerability, or other conditions (such as trust in the government) that weigh heavily on the overall quality of life.

And rankings like the World Economic Forum’s Global Competitive Index, the Heritage Foundation’s Index of Economic Freedom, and Simon Fraser University’s measure of Economic Freedom of the World also capture far too little about the public’s subjective sense of fairness, freedom to make life choices, the government’s honesty, and the perceived trustworthiness of fellow citizens.

To learn about such sentiments, it is necessary to ask the public directly about their life satisfaction, sense of personal freedom, trust in government and compatriots, and about other dimensions of social life that bear heavily on life quality and therefore on the prospects of social upheaval. That’s the approach taken by Gallup’s annual surveys on wellbeing, which my colleagues and I report on each year in the World Happiness Report.

The idea of sustainable development, reflected in the 17 Sustainable Development Goals (SDGs) adopted by the world’s governments in 2015, is to move beyond traditional indicators such as GDP growth and per capita income, to a much richer set of objectives, including social fairness, trust, and environmental sustainability. The SDGs, for example, draw specific attention not only to income inequality (SDG 10), but also to broader measures of wellbeing (SDG 3).

It behooves every society to take the pulse of its population and heed well the sources of social unhappiness and distrust. Economic growth without fairness and environmental sustainability is a recipe for disorder, not for wellbeing. We will need far greater provision of public services, more redistribution of income from rich to poor, and more public investment to achieve environmental sustainability.

Even apparently sensible policies such as ending fuel subsidies or raising metro prices to cover costs will lead to massive upheavals if carried out under conditions of low social trust, high inequality, and a widely shared sense of unfairness.

Jeffrey D. Sachs, Professor of Sustainable Development andProfessor of Health Policy and Management at Columbia University,is Director of Columbia’s Center for Sustainable Development andof the UN Sustainable Development Solutions Network. His books include The End of Poverty, Common Wealth, The Age of Sustainable Development, Building the New American Economy, and most recently, A New Foreign Policy: Beyond American Exceptionalism.

Fumbling Around In The Dark

by: The Heisenberg

- On Friday, a friend of mine (one of the precious few I've got left) asked how I would teach an entry-level finance course in light of upside down markets.

- I was immediately reminded of an October 17 memo from Howard Marks.

- The fact is, valuing companies is no longer straightforward. Nobody quite knows how to do it anymore.

- One key question that emerges is: Who needs equity anyway?

- And still another: Are liabilities now assets?

Last week, Howard Marks delivered his latest memo. In what he describes as a break with precedent, he chose the topic based not on "a series of events [that] can be interestingly juxtaposed," but on "a request."
According to Marks, a colleague (Ian Schapiro, who leads Oaktree’s Power Opportunities group) suggested Howard write something about negative rates.
Howard's knee-jerk reaction (which he calls "immediate and unequivocal") was that such a request wasn't doable because when it comes to negative rates, "I don’t know anything about them."
After thinking about it, Marks realized that was precisely the point. Nobody knows anything about negative rates - not really, anyway.
And so, Marks essentially set about expounding on a collection of quotables and media clippings he says he's been "saving up." There's nothing particularly profound about Howard's latest (dated October 17), but, again, he makes no claims to profundity.
I wasn't going to cover Marks's negative rates memo, but ultimately, I did in a note published elsewhere last weekend. Since then, I've found myself revisiting Howard's piece on a couple of occasions, most recently on Friday evening, when one of the few remaining friends I have left called to ask me how I would approach teaching an entry-level finance course to undergraduates in light of the post-crisis monetary policy regime.
My initial response was that you really can't. Not unless you want to divide things into two sections – the way things used to be versus the way things are now; pre-crisis versus post-crisis, B.C. and Anno Domini (to quote something I penned earlier this month).

My friend sent me a link to an open-source finance text she intended to use, and I quickly realized that every, single chapter would have to be totally rewritten, or amended with footnotes and caveats at every turn if she hoped to somehow bridge the gap between how things used to work and how things work now, after a decade of QE and the proliferation of negative rates and other adventures in monetary Wonderland.
Ultimately, I recommended teaching the course by the book, and then assigning a series of recent academic journal articles as addenda near the end of the semester. I also suggested Marks's memo might be a good way to help folks transition from the old way of thinking about things to the post-crisis reality which, in many respects, is simply a fun house mirror image - a distorted reflection of the old rules.
One of the starkest examples of a world flipped upside down is the proliferation of negative-yielding corporate bonds. This is something I've discussed in these pages on several occasions, and elsewhere ad nauseam. Marks brings it up in his October 17 memo.
"How will the markets value businesses that hold cash versus those that are deep in debt?" Howard wonders.
Another way to frame the question is: How do things change when negative rates effectively convert liabilities into assets? Or, to quote Marks again: "If having negative-yield debt outstanding becomes a source of income, will levered companies be considered more creditworthy?"
I'm going to quote/paraphrase myself a bit in the next couple of paragraphs, so if some of the language sounds familiar, that's why.
It's important to remember that negative-yielding corporate debt isn’t so "anomalous" anymore – at least not across the pond. In other words, Marks isn't idly speculating about some quaint curiosity. At one point in late August, when yields plunged across the globe, more than €1 trillion of European corporate bonds sported yields less than zero.
That, BofA marveled at the time, was half of the entire € investment grade corporate credit market.
At one point this summer, there were 100 different issuers in the € debt market whose entire curve was negative.

In a sense, those corporates can essentially mint assets. Naturally, that would incentivize issuance.
"The risk is that companies begin to view negative yielding debt more as an ‘asset’ going forward, rather than a ‘liability’ and hence issue more of it," BofA’s Barnaby Martin wrote over the summer.
Marks echoed that last week. "Traditionally, markets have penalized heavily levered companies and rewarded those that are cash-rich."
But what happens when debt is an asset and cash is a liability? After all, if negative rates end up being passed along to corporate cash piles, that cash has a negative carry. Either it "earns" a negative yield on deposit, or you pay to store it somewhere, which is, in effect, the same thing (the cost of storage is essentially a tax).
Obviously, companies with massive cash balances would, in many cases, be healthy businesses and those which are highly-levered, not so much, so it's not as simple as saying "the more debt the better" in a world where the old rules no longer apply. But, this is an important discussion to have, because it raises very real questions about how to value companies which fall somewhere in the middle.

That is, what about a situation where two generally healthy companies are juxtaposed, and one chooses to opportunistically take on debt in a hypothetical environment of deeply negative corporate bond yields, while the other insists on holding a lot of cash on deposit when rates are negative?
The leveraged company isn't taking on the debt because they necessarily need to, but rather because in a world where the rules are upside down, it's the "right" thing to do.
If both businesses are thriving, which of those companies should command a premium? Or, as Marks puts it, "How will the market value businesses that hold a lot of cash and thus have to pay banks to keep it on deposit?"
Now you might be asking yourself: Ok, Heisenberg, but isn't this all just a thought experiment?
No. No, it is not. Because as noted above, this is the reality in Europe, and it's likely to become more "norm" than "exception" in other locales going forward, as central banks restart asset purchases and begin cutting rates anew.

The chart in the left pane below shows that policymakers are now cutting rates at an even faster clip than the trend in realized inflation dictates. The chart on the right shows that "peak" Quantitative Tightening has long since passed.
Take a minute to consider what this means for how corporates finance themselves. As the above-mentioned Barnaby Martin writes in a note dated Friday, "the gap between equity and debt costs in Europe is at a 100-year high."
Clearly, that suggests that the trend of "de-equitization" is likely to continue. That is, the number of publicly-listed companies will almost surely shrink.
Indeed, over the post-crisis period, the number of EU-listed companies has collapsed by 25% from more than 10,000 to roughly 8,000 as EU central bank balance sheets have grown.
If you're wondering whether a similar relationship shows up if you plot the number of EU-listed companies with the average bank lending rate to non-financial corporates and the average effective yield on € IG credit, the answer is "yes."
At the same time, the global store of private capital "dry powder" has exploded to more than $2 trillion amid the hunt for yield. As BofA's Martin goes on to write in the same cited note, "while Private Equity accounted for a shrinking proportion of dry powder between 2006-2013, PE now accounts for almost 60% of available dry powder, the largest proportion observed since 2012." That could potentially accelerate the de-equitization process if management and shareholders decide to go the PE route.

All of this has two obvious consequences.

First, credit markets will continue to expand, and that brings risk. The more forgiving the debt market, the more tempting it will be, and as you might imagine, debut issuers across buckets within IG tend to be more highly-levered than their established counterparts.
Perhaps even more importantly, BofA notes the following about the perils of a less "real-time" (as it were) market:
We think the long-term consequence of de-equitization is that markets will be less able to assess the real-time state of the economy. Fewer listed companies mean fewer disclosures about how earnings are faring, how business segments are performing, how geographical earnings splits are evolving… and ultimately, fewer disclosures about emerging risks. And if there is a less reliable pulse on the economy, then this could impart more volatility to the consensus trades of the future, as markets suddenly realize that the "facts have changed."
When you throw in the cross-asset trend of deteriorating liquidity, you're left to ponder a world where investors are increasingly forced to fumble around in the dark.
And that brings us back full circle to Marks's memo and my friend who is facing the unenviable task of trying to explain some of these upside down dynamics to undergraduates.

We're all fumbling around in the dark.
Or, as Howard puts it, "I’m convinced that no one should be categorical about how to deal with a mystery like this in such unprecedented and confusing circumstances."