When a Nation Goes Nutty

By Bill Bonner

Week 12 of the Quarantine

Sow the wind and reap the whirlwind.                                                                          – Hosea 8:7

SAN MARTIN, ARGENTINA – One country. Two systems.

One financial. One economic.

One for Wall Street. One for Main Street.

One for the elite. One for everyone else.

One fraudulent. The other just a rip-off.

To make a long story precariously short (and deliberately provocative), the “rich” got some of their wealth honestly.

The rest they got by ripping off the poor and middle classes, using their fake-money system.

In effect, after 2008, they had access to an almost unlimited amount of credit priced at artificially low rates, giving them a greater and greater share of the nation’s real wealth.

And who noticed? They said the Federal Reserve was “stimulating” the economy.

But the two-system system is now wreaking havoc on our economy, our society, and our government… and driving the whole kit and kaboodle to a disaster.

To back up…

Sons and Daughters

The two-system system works for us, the top 10% who benefit from it. Many of us are retired.

What’s it to us if there are no jobs?

We have financial assets (stocks, bonds, real estate, cash, gold). We’re happy to see the Fed pumping them up. 

We don’t even mind (for now) that the economy was shut down by the Trump-Fauci duo. We didn’t have to go to work anyway.

But what about the others? The 90%? Our sons and daughters.

The uneducated… the poor… the ones who have nothing… who earn minimum wages… who need jobs… who start families and careers already burdened with hundreds of thousands of dollars’ worth of student debt, mortgages, car payments, and their share of the national debt, too?

And don’t forget the middle-aged, middle classes… Typically, the ones in the middle suffer most when a nation goes nutty.

They have something to lose… but not enough wealth or financial savvy to protect themselves.

And there’s a good chance they will lose everything in the collapsing economy/money-printing lollapalooza/political upheaval ahead.

Built on a Lie

If such a disaster is so obvious (to us), how come others don’t see it? How come they don’t look into an awful future and change it before it happens?

After all, they created the two-system system. They, and only they, could change it.

Well, how about this for a naked reason…

The deciders, the influencers, the economists, columnists, politicians, academics, captains of business, and sergeants of well-meaning nonprofits – almost none of them understands what is really going on.

Why not? Because it’s amazing what you can’t see when your wealth depends on being blind.
All of them – Democrat, Republican, Trump-lovers, Trump-haters – are part of the upper 10%. They all benefit from the fraudulent, fake-money system… and none wants to think about it too hard.

They’ve built their careers, their reputations, their fortunes on a lie. They’re not about to open their eyes now.

Besides, they – like all of us – are caught up in the whirlwind.

Politics… racism… fascism… Keynesianism… MMTism… global warmingism… COVID-19ism… Just read our mail!

We’ve described it previously as “context collapse.” The rules… the traditions… the ideas we thought we could trust… suddenly give way.

The hot air rushes by us so fast, our feet leave the ground… and we are dizzy… and then nauseous.

Context Collapse

Just think about what’s happened in the past few months.

The economy effectively “turned off”… with a 50% drop in GDP… and 20% unemployment.

…The Fed “printed” three trillion in the last three months.

…Between April ’19 and April ’20, the difference in federal tax collections dropped by nearly a trillion dollars.

…Strange new unidentified “defense forces” – kitted out like robocops from a sci-fi movie – appeared on the streets of Washington.

…A U.S. president so afraid of his own people he needs to hide in a bunker? The Washington Post:

The security perimeter around the White House keeps expanding. Tall black fencing is going up seemingly by the hour. Armed guards and sharpshooters and combat troops are omnipresent.

Three months ago, these things would have been considered impossible.

But now, everything is possible… no matter how bizarre, grotesque, un-American and implausible.

And now, as the center of our “normal” beliefs turns to mush, the edges harden.

The “fascists” on the right… the “anti-fascists” (Antifa) on the left.

The fences go up… but the barriers to civilized conduct go down.

Moonstruck Delusions

Some want to destroy what they think is a “capitalist” system.

Some want to protect what they believe is a “conservative” society.

Both groups are moonstruck… seeing new possibilities… with new hope… and even greater delusions. CNN:

The Boogaloos [apparently anarchists] are an emerging incarnation of extremism that seems to defy easy categorization.

They are yet another confounding factor in the ongoing effort among local, state and federal officials to puzzle out the political sympathies of the agitators showing up to the mostly peaceful George Floyd rallies who have destroyed property, looted businesses, or -- in the case of the Boogaloos who descended on Minneapolis -- walked around the streets with assault rifles.

And here’s MSN:

Sen. Tom Cotton, an Arkansas Republican, on Monday pushed for the use of military force against Black Lives Matter demonstrators…

"…let’s see how these anarchists respond when the 101st Airborne is on the other side of the street," Cotton said on Fox News.

After all, paraphrasing former Secretary of State Madeleine Albright…

What good is an army if you can’t use it to protect yourself from the people you stole from?

Stocks Could Plunge 50% If We Have a Powerful Second Wave of COVID-19

By Andy Krieger, Editor, Money Trends

The stock market continues to amaze.

Despite a 34% sell-off this year, the S&P 500 is now almost back to where it was last fall.

But consider the dramatic differences between the economic conditions last year and today.

Our economy was growing fast last year. And unemployment was at just 3.5% – a 50-year low.

Now our economy is suffering from the worst downturn in almost 90 years.

Unemployment levels are above 20%, with 40 million people out of jobs. This year’s second-quarter GDP will show a collapse of nearly 40%. Interest rates have been lowered effectively to zero.

Meanwhile, the Federal Reserve has ballooned its balance sheet by $2.5 trillion… and the Treasury has increased its debt by $3 trillion!

These are staggering numbers. The fact that the stock market is anywhere within shouting distance of last year’s levels is mind-boggling.

In fact, as I explain below, I believe we’re in for a 30%-50% sell-off.

But first, we must answer the question: If things are so bad, why are people buying stocks with such abandon?

Bizarre Economic Follies

You may say the market’s performance is driven by gains in the FAANG stocks – Facebook, Amazon, Apple, Netflix, and Google’s parent, Alphabet. But that’s too simplistic.

The FAANGs comprise 17.5% of the total index value. So that still doesn’t explain the overall performance of the market, which flies in the face of logic and sound fundamental analysis.

It used to be that price-to-earnings (P/E) ratios – which measure how much investors are paying for each dollar of a company’s earnings – meant something. The P/E ratios today are flat-out whacky.

Will they ever mean something again? Absolutely.

But as I’ve learned through more than three decades of experience, the true beauty of markets is that they are driven by people. And people have the amazing ability to suspend disbelief… and ignore the warning signs.

People have been swept away in bizarre economic follies and manias for hundreds of years. The dot-com bubble in the U.S. that burst in March 2000 is a great example.

I remember trading stocks during that period. I was astonished by how foolish people were for assigning such crazy values to certain stocks… just because they sounded like something technological and showed a vague promise of future revenues.

Forget profits. They were irrelevant. P/E ratios were also deemed no longer relevant… until they were, and the Nasdaq collapsed. Prices fell by over 83%, and the market didn’t make a new high until August of 2016 – almost two decades later!

I figured that one day the market would wake up and come to its senses. So I only played it from the short side once it finally broke.

Warren Buffett, meanwhile, was heavily criticized for missing out on the Nasdaq boom.

Analysts said he was too old to understand tech stocks, that he was out of touch, and that he was not worth paying attention to any longer.

Well, that same “out of touch” investment genius has liquidated stocks during the current folly and gone even more heavily to cash. Yup, he is waiting for stocks to become attractive again at sensible valuations.

Please note he was a heavy buyer of stocks right after the stock market sell-off in 2008 and 2009. He is not afraid to buy when other people are afraid. He just needs to have a good reason to do so.

He doesn’t have that reason today, and he didn’t have that reason two months ago. That should tell you something.

Vicious Sell-Off Ahead

At this point, you may be wondering: Are we staring at another bubble today, just like the dot-com bubble of the 1990s?

Yes. But while the current irrationality is extreme, that doesn’t mean it can’t persist for a while longer.

It does mean, however, that one day the markets will find a more reasonable valuation.

Reaching that level of valuation will almost certainly lead to great pain for many.

There is a limit to the number of times the U.S. Treasury can issue an extra $3 trillion worth of bonds… which our central bank will dutifully purchase, even though the bonds are paying almost no interest.

Once we hit that limit, interest rates will start rising so fast, you will get whiplash as you watch the yield shooting up. That is the ultimate doomsday scenario, and I pray we can avoid it.

But what about an imminent drop in the stock markets? Am I forecasting that? Not necessarily. The reason is that, as I said, this insanity can persist for a while.

If scientists can miraculously produce an effective COVID-19 vaccine in massive quantities that gets distributed quickly to a large chunk of the global population… we might even have a V-shaped recovery.

The world could go on a wild spending and investment binge, hiring tens of millions of workers and setting in motion a breathtaking economic recovery.

In such a scenario, the stock market’s hyper-optimism could prove to be justified. However, I give this outcome about a 0.1% probability.

More likely, it will take 12-18 months to produce and distribute an effective vaccine. In that scenario, the current stock market valuations will prove unsustainable.

And if we get a nasty second wave of COVID-19 – let alone a third wave – stocks would likely be headed for a 30% to 50% drop from current levels.

That stock market sell-off will be fast and furious. But for traders, it could be the opportunity of a lifetime.


Creative destruction in times of covid

Is now the time for entrepreneurial true grit?

A STRUGGLING Airbnb was still called AirBed&Breakfast when its founders decided to bet its future on the Democratic National Committee in Denver in 2008. Their air-bed idea was not popular with the 80,000 people congregated to select a presidential candidate. So they focused on breakfast instead, peddling $40 boxes of cereals called Obama O’s and Cap’n McCain’s (their quip: “Be a cereal entrepreneur”).

The timing was as bad as the pun. The event came just weeks before Lehman Brothers collapsed at the height of the financial crisis of 2007-09. Yet shortly afterwards they obtained their first-ever funding. The angel investor who backed them dubbed them “cockroaches” for their survival skills. That may not be the most tasteful way to describe people in the hospitality trade. The founders, though, considered it the best compliment they had ever received.

Like Airbnb, some of the best-known names in business started during steep slumps, including Uber (2009), Microsoft (1975), Disney (1923), General Motors (1908) and General Electric (1890). Disruptive products and services, too, have emerged in times of crisis, notably Apple’s iPod as the dotcom bubble burst in 2000 and Alibaba’s Taobao, an online-shopping mall, during China’s SARS epidemic of 2003.

Such stories loom large in startup folklore as evidence of entrepreneurial true grit. Yet they are rarities. Our calculations indicate that among almost 500 of today’s biggest listed firms in America, whose origins date as far back as 1857, a much larger number started life in expansionary years than during recessions. Of those founded since 1970, more than four-fifths were born in good times (see chart).

That, of course, overlooks innumerable firms created along the way that have either not made it to the top, or fallen by the roadside. But it suggests that however hard it is for the enterprising to build a lasting business, it is even harder for those who start off with the economic winds blowing in their faces.

Save for a few industries such as health care, it is safe to assume that investment in innovation will plummet during the covid-19 pandemic. It usually does in times of crisis. Venture capital (VC) will also dry up as everyone keeps their heads down and tries to preserve cash. In 2007-09, VC funding in America fell by almost 30%.

Yet this column would not be named after Joseph Schumpeter, the father of creative destruction, if it did not believe that following a slump, a burst of entrepreneurial activity will eventually emerge.

As he wrote in “The Theory of Economic Development”, published in 1911 (itself a recessionary year), “the very logic of the capitalist system [is that] after some time of depression, new entrepreneurs would emerge.

And then there would be a new ‘swarm’ of entrepreneurs. A wave of prosperity would start up and the whole cycle would roll on.” Assuming this remains the case, will the protagonists be tiny startups coming out of nowhere?

Will they be better-funded entrepreneurs who have long prepared for such a moment? Or will they be the titans of tech?

With the world in upheaval, enterprising minds are already whirring. Some of them are altruistic: schoolchildren, for instance, have been 3D-printing plastic visors for front-line workers. Some of them are saucy, such as the Thai bodybuilders, put out of work by lockdown, who last month set up Bsamfruit Durian Delivery, promoting it on Facebook not only with photos of durians and mangoes, but of taut abs and bulging bosoms.

Some of them will simply be hungry for fame and fortune, believing, like Michael Moritz of Sequoia Capital, a VC firm, that social changes accelerated by the crisis, such as food delivery, telemedicine and online education, will eventually generate lucrative business opportunities.

They will also expect the economic slump to wipe out incumbents, muting competition and freeing up space and manpower—provided governments do not interfere with the inevitable by propping up zombie firms.

But even with the best ideas in the world, first-time entrepreneurs will struggle to convince investors to give them capital in the depths of the crisis, not least if they can only pitch to them over Zoom.

Instead, the more likely standard-bearers of creative destruction will be existing firms, albeit small ones, which raised enough money before the crisis to survive it and will maintain their flair for innovation throughout, says Daniele Archibugi of Birkbeck, University of London.

There may be plenty of such firms. According to Crunchbase, a data gatherer, startups raised about $600bn worldwide in 2018 and 2019. That provides a cushion of support.

They will, however, have to be quick at shifting from growth to survival and back again, and at embracing new business plans if their old ones are no longer viable.

Betting on an accumulator

Yet it is not just small, scrappy firms that push innovation forward. Big firms have a critical role to play, too. Alongside creative destruction in times of crisis, Schumpetarian academics point to “creative accumulation” in economic upswings, when incremental innovation is carried out in the research-and-development labs of giant firms.

In Europe during the global financial crisis such corporations increased investment into new products and ideas, as did the most innovative small firms. The cash-rich tech giants, such as Microsoft, Amazon, Apple and Alphabet, have become examples of creative accumulation, helping foster innovation during the good times.

They will probably continue to do so during the crisis. As they expand into health care, fintech and other industries, they could even be part of a new wave of creative destruction.

That is the optimist’s scenario. A more pessimistic one is that big tech will use its moneybags and muscle to stifle competition, by buying or scaring off more enterprising rivals. What is in little doubt, though, is that the covid-19 crisis, which has turned so many people’s lives upside down, will eventually produce a wealth of new business opportunities.

If it attracts swarms of entrepreneurs crawling over cosy oligopolies so much the better. But even if the tech titans prevail for now, they will inevitably find themselves victims of the forces of change.

Schumpeter’s “perennial gale of creative destruction” will one day blow them away, too.

Deflation is the real killer of prosperity

The US is grappling with an economic malady that has gone unnoticed

Stephen Moore

Bicyclists pass the U.S. Treasury building in Washington, D.C., U.S., on Thursday, April 16, 2020. President Donald Trump threatened Wednesday to try to force both houses of Congress to adjourn -- an unprecedented move that would likely raise a constitutional challenge -- so that he can make appointments to government jobs without Senate approval. Photographer: Al Drago/Bloomberg
The US Treasury, which is far from being ‘out of ammunition’ © Bloomberg

The coronavirus lockdown has pummelled the US economy, with some 30m jobs destroyed and trillions of dollars of output and wealth lost.

Compounding the havoc is an economic malady that has gone unnoticed: one of the most severe deflations in modern history. Unlike coronavirus, it shows no signs of abating. Prices are tumbling.

The March personal consumption expenditures gauge fell at a 7.5 per cent annual rate, while the Consumer Price Index in April fell by more than in any month since December 2008. More worrisome is the trend in commodity prices, the best day-to-day indicator of inflation. We are now seeing a downward price spiral.

We know that oil prices have plummeted this year, reflecting a rapid fall in global demand, but the shortage of global dollar liquidity is adding to the industry’s pain. Virtually all commodities are seeing declines.

The leading commodity price index, the CRB, is down early a third since February. Or look at the yields on Treasury bonds and Tips (Treasury Inflation-Protected Securities).

Louis Woodhill, a senior fellow at the Committee to Unleash Prosperity, notes that the US Federal Reserve’s “target PCE inflation rate is 2 per cent, and the market is betting that PCE inflation will average barely over half that rate (1.1 per cent) for the next 30 years!”

Both Mr Woodhill and I have been warning of the damage from falling prices for many months.

Our deflation diagnosis may seem surprising because Congress has added some $3tn to the debt and the Fed has injected at least $2.1tn of dollar liquidity into the economy.

The central bank has also cut interest rates close to zero. These actions are normally associated with rising, not falling prices.

So how are we experiencing the opposite result?

When the world gets hit by a catastrophic event one effect is always a stampede to the US dollar for safety. Americans are hoarding dollars, nervous investors are flooding into cash and foreigners are buying the safest investments they can find: US government bonds, which are repaid in dollars.

Deflation, as we discovered during the Depression of the 1930s, when rapid price declines drove the economy to its knees, is a killer of prosperity. Workers get crushed because real labour costs rise, which shrinks hiring and drives up unemployment.

Yet even with every market signal flashing deflation, academics and the Fed are still more worried about inflation. Former Fed governor Larry Lindsey argues in his latest newsletter that there will be a coming inflation when the economy recovers. The inflation hawks may be right, but when 30-year bonds are trading at 1.35 per cent interest rates, the collective wisdom of the market is making a huge bet in the other direction.

Let us assume that the prediction of future inflation, because of all this government borrowing, is correct. This is still not an argument for tolerating the growth-killer of deflation now. If the Fed were targeting commodity prices, it would inject massive dollar liquidity now. As the economy begins to recover, and if commodity prices start to rise rapidly, then it is time to start draining that liquidity.

When your house is on fire, you turn the hoses on and worry about the water damage later.

Have Fed chairman Jay Powell’s interventions failed?

No. If anything, the Fed has actually been too timid in reacting to the crisis. By refusing to let prices guide monetary policy — much as his predecessor Paul Volcker did while killing the inflation of the 1970s — the Fed is still depriving global markets of the dollar liquidity they are pleading for.

If this isn’t corrected, falling prices will prevent the V-shaped recovery that the US and the world desperately need. The good news is the Fed and the Treasury are far from being “out of ammunition”.

They should take the following steps. First, the interest rate that the Fed pays on bank reserves should be reduced to zero (from 0.1 per cent now). Then payroll taxes should be eliminated for the rest of the year (and all those already paid this year by workers and employers refunded) until the deflation abates.

This is much more efficient than more federal spending.

The Treasury should also be authorised to swap T-bills for the non-marketable Treasury securities in the Social Security Trust Fund, so that its trustees can sell them and buy common stocks. If this had been done during the 2008 crisis, social security would have reaped a gain of trillions of dollars, based on the rise in US share prices over the decade.

Share purchases should be done via an exchange traded fund, so that the government has no corporate voting rights.

If the US economy is to get back to the prosperity of Donald Trump’s first three years in office, it isn’t enough to conquer coronavirus.

The Fed and the Treasury must also boldly slay the other invisible killer of growth — deflation.

The writer is a member of Donald Trump’s economic recovery task force and co-founder of the Committee to Unleash Prosperity

Hedge funds braced for second stock market plunge

Managers say asset prices have become too detached from bleak fundamentals

Laurence Fletcher in London

New York Stock Exchange in Wall Street. There are fears investors may have become too complacent after the recent surge in share prices © AFP via Getty Images

Hedge funds are getting ready for another slump in stock markets after growing uneasy that surging prices do not reflect the economic problems ahead.Some managers fear that equity investors, used to buying the dips during the decade-long bull market that ended in March’s sharp sell-off, have become too complacent about how quickly economies can recover from the coronavirus crisis and how effective stimulus packages from central banks and governments can be.

The S&P 500 index completed its best 50-day run in history on Wednesday, according to LPL Financial, closing within 8 per cent of its record high of mid-February.

“The markets are priced to perfection,” said Danny Yong, founding partner at hedge fund Dymon Asia Capital in Singapore.

“The stability in equity markets does not reflect the job losses and the insolvencies ahead of us globally.”Mr Yong has been buying put options — which protect against market falls by allowing their owner to sell at a pre-determined price — on stock indices and also on currencies sensitive to risk appetite such as the Australian dollar and the Korean won.

“I believe we will see new lows in global equity markets later this year,” he added. “As March . . . has shown us, prices cannot diverge from fundamentals for too long.”Other hedge fund managers have expressed concerns about the sharp rebound in stocks from the March lows.

Line chart of S&P 500 index 12-month forward price/earnings ratio showing US blue-chips reach highest valuation since the early 2000s

Stanley Druckenmiller, a protégé of George Soros who stepped back from managing outside money a decade ago, recently said he expected a wave of bankruptcies and that a V-shaped economic recovery was a “fantasy”.

Paul Singer’s Elliott Management, which has $40bn in assets, wrote in its most recent letter to investors that since the impact of the economic downturn is greater than that of the 2008 financial crisis, “our gut tells us that a 50 per cent or deeper decline from the February top might be the ultimate path of global stock markets”.

The fund made money during the first-quarter crash from hedges in stocks and credit, and said it was trying to find new ways of protecting itself against another market fall after some hedges became more expensive.

Despite a slew of bleak economic data — including more than 40m Americans filing for unemployment benefits and an expected record contraction in the eurozone economy in the second quarter — the S&P 500 has surged almost 40 per cent since its trough in March, leaving it down just 3 per cent for the year.

The index is now trading at more than 22 times expected earnings for the next 12 months, according to FactSet figures, taking the common valuation measure back to levels not seen since the early 2000s.

Standard & Poor’s building in New York’s financial district. The S&P 500 has surged almost 40 per cent since its trough in March © Reuters

Mr Yong believes investors could soon discover that the so-called “Fed put” — the concept that the central bank will step in to support markets — may be reaching its limits.

“Some people believe the Fed’s unconventional measures are limitless but this is not the case,” he said.

“It's now about the “Trump Put” — how much more stimulus can he push through? I think he [US president Donald Trump] will be constrained by Democrats in the House.”

Morgan Stanley said in a recent note that its hedge-fund clients hold a net short position of about $40bn in Euro Stoxx 50 futures. Global macro hedge funds have sharply reduced their exposures to stocks this year, according to JPMorgan Cazenove.

“It is entirely possible that there will be a fourth-quarter reckoning, where a second wave of job losses and a prolonged period of business failures tests equity sentiment,” said Seema Shah, chief strategist at Principal Global Investors.

Francesco Filia, head of London-based hedge fund Fasanara Capital, is holding 70 per cent of his fund in cash and also using put options and other instruments to hedge his portfolio while he waits for a “severe rupture” in markets.

He sees threats in the trend towards “deglobalisation,” which could drive inflation higher, and growing political interference in the technology sector, which could hurt shareholder returns.

He expects a potential “2008-style . . . daily liquidity crisis” as investors try to pull money from exchange traded funds that may not be able to meet those redemptions.

However, many fund managers are reluctant to bet outright against stocks in the face of stimulus efforts from the Federal Reserve and European Central Bank, both of which have argued they have firepower in reserve.

The market hitting new lows “is possible”, said Tom Clarke, who has a low exposure to stocks at a macro fund at William Blair in London. But he added that government and central bank stimulus packages have “taken on almost mythical proportions.

There’s no doubt in which direction policymakers want markets to go.”

Additional reporting by Adam Samson