THE CREDIT BUBBLE IS BURSTING / MACLEOD FINANCE

The credit bubble is bursting

The process of a dollar currency and credit collapse, initially evidenced in the stock market, is now underway. As this article will go on to make clear, there is now no escape.

ALASDAIR MACLEOD

 

The chart of the S&P 500 Index below shows how this broad-based index has lost its bullish momentum. 

With the 55-day moving average having turned down, the index below the 200-day MA, and having been turned down failed to rally above it is enough to get technical analysts calling an end to the equity bull market.

More importantly, the first quarter of 2025, a period of time when portfolio managers review their allocation is likely to trigger significant shifts from momentum to value, from high risk to low risk, and from equities to bonds.

The one sector which investors in western financial markets have missed is precious metals, which have outperformed everything as the table below shows: 

Investment management thinking

Now, imagine that you are an investment manager faced with worried clients questioning the exposure you have taken on his behalf: Tesla down 32% since your 31 December report and Nvidia down 19% to mention a few. 

What will be going through your head, considering the outlook for Q2?

Here are a few of the problems you face:

· Equities have lost momentum. Clearly, exposure must be reduced. You will look at what profits can be taken in that context (no one likes realising a loss, especially discretionary clients).

· The economy appears to be on the edge of a recession, which could drive equities lower.

· Due to tariffs, CPI inflation is likely to rise at least for this year, making it difficult for the Fed to cut interest rates in the face of a weakening economy, and bond yields could rise further along the yield curve before the inflation outlook improves.

· You have little or no exposure to gold, which has been a mistake. It looks good on the charts, silver too. 

But having risen so far (gold over 17% in the last quarter, and having risen 90% since November 2022), do you dare to buy gold ETFs and invest in gold mines, and if so which ones and do you know a good mining analyst to advise you?

Don’t feel sorry for portfolio managers, they are paid handsomely to worry about these things. 

But they probably won’t understand the bigger picture because they rarely have to. 

All they are paid to achieve is a decent relative performance to the S&P, irrespective of whether it goes up or down.

But here are some points they probably miss:

· We are in the biggest global credit bubble in history, evidenced by $300 trillion of debt obligations (not including derivatives). 

It includes record amounts of unproductive debt funding consumer spending, malinvestments, and excess government spending. 

Credit bubbles burst and the advance warning is always in stocks or property. 

This is now happening in stocks and already has in commercial real estate.

· US tariff policy combines with excess credit to create the conditions seen in 1929—1932, when the roaring twenties bubble burst, combined with the Smoot Hawley Tariff Act in 1930 which raised US tariffs on all imports by 20%. 

Other nations responded by increasing their tariffs, just as they are in the process of doing today. 

The Dow fell nearly 90% top to bottom, some 9,000 banks failed, and the world was plunged into depression.

· In the US and other advanced economies, government finances are in a far worse condition today than in 1930 due to escalating welfare commitments. 

As the US economy enters a repeat of the 1930s conditions, the combination of collapsing tax revenues and soaring welfare liabilities can only lead to a funding crisis.

· Including the Fed, major central banks are already deeply in negative equity. 

As the Fed and US Treasury are forced to bail out the US economy, their increasing demand for credit will simply become unfundable. 

It will lead to soaring bond yields and falling purchasing powers for the dollar due to massive expansion of base money.

· In 1934, the dollar was devalued by 40% with gold having formally been exchangeable at $20.67 per ounce to it not being exchangeable at $35. 

This time, we are seeing the end of the post-Bretton Woods fait currency regime — and its approach looks like being rapid as foreign central banks increasingly dump dollars and euros for the safety of gold.

Our discretionary portfolio manager will not only fail to identify the facts which are driving his responsibilities to his customers, but he has been badly misled by post-Keynesian macroeconomics. 

Specifically, brokers research will be warning him that the US and perhaps other economies appear to be stalling into a potential recession. 

He and his peers will believe that to derisk portfolios, he should increase exposure to bonds at the expense of equities.

He will expect falling demand to lead to lower consumer prices after the temporary rise in them due to increased tariffs. 

Therefore, the Fed should be able to reduce interest rates eventually and portfolio shifts into bonds will ensure that yields will fall along the yield curve.

However, a portfolio rebalanced by selling equities for bonds will offer scant protection from widespread wealth destruction. 

The signal that this is the case comes from gold, which is real legal money without counterparty risk.

Why is gold rising?

Doubtless, our model fund manager believes that along with copper gold is rising due to the treat of US tariffs, and it has certainly been a catalyst. 

Otherwise, it misrepresents the reality. 

To illustrate why, I shall test my readers’ patience by resorting to bullet points again:

· There has been growing demand for gold from central banks. 

It is of the highest importance to understand why they are selling dollars and other fiat, but predominantly USD. 

They are getting out of western fiat currencies because they see risks which our model portfolio manager does not yet recognise. 

And they understand that the post-Bretton Woods fiat currency system is ending.

· Comex futures expiry is increasingly being used as a means to obtain physical bullion. 

We don’t know who are buying gold in this way, but it must reflect a combination of central banks, sovereign and other wealth funds, insurance companies and pension funds, family offices and high net worth Asians — all of whom are outsiders with a top-down approach to fiat currency risk. 

To these can be added paper short obligations in other financial centres, such as London and Shanghai.

· The gold leasing game is ending. 

In early days, gold leasing was the basis of the carry trade into US T-bills, with up to 16,000 tonnes or up to half global official reserves (Veneroso, 2002). 

They were sold into the market and mostly not returned at lease expiry. 

Since then, leasing has provided liquidity in bullion markets, remaining in official vaults in London, New York, and Paris under double ownership. 

Following recent withdrawals of gold from the Bank of England, central banks are almost certain to kerb their leasing activities, withdrawing supply from bullion markets. 

This is leading into a gold liquidity crisis.

· As well as the withdrawal of future gold leasing, gold derivatives outstanding are likely to contract. 

The suppression of gold since the 1980s has been through the expansion of gold paper substitutes. 

Along with rising gold prices, the lack of central bank leasing as a source of liquidity is bound to discourage participation in these activities. 

The contraction of futures and dealings for forward settlement can only propel gold prices higher still.

Throughout monetary history, the failure of fiat currencies has always been due to a growing lack of trust in them. 

It usually starts with major foreign holders seeking value preservation. 

In the dollar’s case, they hold about $32 trillion of currency and financial exposure in bank deposits, short term debt, long term debt, and equities. 

At over $14 trillion, their US equity exposure is the largest single category. 

And if they judge that the bull market is over, they will certainly liquidate these positions.

Lagging these foreign perceptions, domestic Americans will begin to hedge their currency risk. 

This is just beginning the US as US funds adjust their portfolio exposure towards gold and gold substitutes. 

The next chart from the World Gold Council shows how this is being reflected in ETFs, with figures for March yet to come in:

The dark blue is North America, which in February added 72.2 tonnes equivalent, while Europe (light blue) having added 39 tonnes in January only added 2 tonnes in February. 

Asia also added 24.4 tonnes in February. 

This tells us that it was only in February that investment managers in the US began the process of reweighting their portfolios in favour of gold.

Finally, increasing members of the public will begin to realise that inflation is not due to consumer goods rising in price but the currency losing purchasing power. 

Once this public realisation gets hold there is no escape from a total fiat currency collapse.

The only question is how long the entire process will take, but there is no escape.