by Egon von Greyerz

Over the last 150 years, the West has gone from human slavery to debt slavery. Slavery was officially outlawed in most countries between the mid 1800s and early 1900s. In the British Empire, it was abolished in 1834 and in the US in 1865 with the 13th amendment.

But it didn’t take long for a different and much more subtle form of slavery to be introduced. It started officially in 1913 with the creation of the Federal Reserve Bank in New York. More than 100 years before that, the German banker Mayer Amschel Rotschild had stated: “Give me control of a nation’s money and I care not who makes its laws.” The bankers who gathered on Jekyll island in November 1910 were totally aware of the importance of controlling the country’s money and that was the objective of their infamous secret meeting which laid the foundations to the Fed. The Fed is officially the Central Bank of the USA but it is a private bank, owned by private banks and for the benefit of private banks and bankers.

Mortgage = Death pledge

So the Western world was free from human slavery for around half a century but is now subject to a form of slavery which most people are unaware of. It is a slavery which no law, no regulation or edict can abolish. Nor are there any magic financial tricks that can make this form of slavery disappear. I am of course talking about debt slavery which has gradually taken hold of the West in the last hundred years and now is enslaving many emerging market countries too. There is mortgage slavery. The word mortgage comes from Latin and French and means death pledge. And this is exactly what it will be for a lot of people who will neither afford the coming increase in interest rates nor the repayment of capital on their property which will collapse in value. We also have credit card slaves, auto loan slaves and student slaves. Virtually all of these loans will expire worthless as the enslaved borrowers default.

US debt grows at 2x GDP

In 1913 global debt was negligible but grew steadily to 1971 when Nixon abolished the gold backing of the dollar. Since 1971, the debt enslavement has taken off at an exponential rate.

Just looking at US total debt, it was $1.7 trillion in 1971 and is now $67 trillion. At the beginning of this century US debt was “only” $30 trillion so just in the last 16 years it has doubled.

Since 1971, US total debt has grown 39x whilst GDP has grown 16x only. This is more proof that perceived improvement in the standard of living and wealth can only be achieved with printed money and credit expansion. What the world is experincing today is a Fake prosperity based on Fake money and Fake growth. Hardly a recipe for a sustainable US or world economy.

Global debt $ 2 quadrillion

Debt slavery is now a chronic condition which the world finds itself in. The word debt has the same roots as death and clearly has very dark connotations. Slavery means being owned and controlled by someone. What the bankers started on Jekyll Island has now enslaved the world in a debt/death grip from which there is no escape. Global debt of $230 trillion plus unfunded liabilities and derivatives takes us to over $2 quadrillion debt and liabilities is just too big a weight to get rid of.

Krugman – Print more money

So how does the world attempt to solve this debt/death trap. We can of course ask Nobel prize winner Krugman and he will give us the Keynesian solution which the world has applied for ¾ of a century with catastrophic consequences – JUST PRINT MORE MONEY!

Money printing has created a massive debt problem, more printing exacerbated it, and even more merely postponed the inevitable collapse. Any further dose of this poisonous medicine will be like pushing on a string – it will have zero effect as a remedy but a disastrous effect when it comes to the destruction of money. And this is of course what is likely to happen in the next few years. I have for many years been clear that massive money printing is the only tool that central banks have left. This will lead to hyperinflation, the total destruction of paper money and to a deflationary asset and debt collapse. Only after that can the world grow again, but before that there will be a lot of pain in the world.

Sweden – An enslaved cashless society

The powers that be have not been satisfied just to enslave the world with debt. People must also be prevented from spending whatever money they have left. The banning of cash transactions and withdrawals is growing. In many European countries, the cash limit is between Euro 1,000 and 3,000. But that is just the first step. Sweden for example has virtually abolished all cash transactions. Many retailers only take credit cards. New bank notes have also been introduced making the old ones unusable. This is similar to India and a way of punishing the holder of cash and confiscating money. It is no coincidence that personal debt in Sweden is among the highest in Europe. Abolishing cash will stop the Swedes from taking their money out of the bank.

Sweden also have made the few remaining coins look like cheap plastic monopoly money. One Swedish Krona used to contain 80% silver until 1942. Then it was reduced to 40% silver until 1968. From then there was no silver content but only copper and nickel. The latest Krona introduced 2016 is made of steel with a copper plating that quickly wears off. It is also much smaller and half the weight of the previous one. Well, nothing changes in the world. The Romans experienced exactly the same between 180 and 280 AD when the Denarius went from almost 100% silver to 0%. The Krona has like all other currencies lost 99% of its value in the last 100 years. So only 1% to go until it is worthless. This will of course happen to the Krona like all other currencies.

Big Brother is watching

The first reason for abolishing cash is to have total Big Brother (Orwell- 1984) control of the people’s spending and tax compliance. Remember that most countries had no income tax 100 years ago. In the US for example income tax was first introduced in 1913 (same year as Fed was created). The tax rate was 1% for income above $3,000 for individuals and $4,000 for couples.

Above $500,000 income ($11m today) the tax was 7%. The high threshold meant that virtually nobody paid any tax. These tax levels are slightly different to today when the total tax burden in most countries, including all direct and indirect taxes, social security etc amount to over 50%. This is part of the financial slavery and control of the people today. The individual’s incentive to work hard and spend his money on what he chooses is taken away and instead the state takes a major part of the cake and wastes most of it on bureaucracy, health or social security. Income tax should be abolished and replaced by a Value Added Tax or sales tax.

The second reason to abolish cash is to totally control people’s spending. With a banking system that is leveraged up to 50 times, there is no chance that bank depositors will ever get their money back. The government knows this and this is why having only electronic money gives the state total control of people’s assets and cash. The state can now control exactly how much money is withdrawn and stop people from spending their own money. Governments believe that this is an efficient method of controlling the people but instead of achieving control of the money, governments are at some point likely to lose control of the people which will result not just in bank runs but in government runs, civil unrest and anarchy.

EU to ban cash withdrawals

Another very dark new development is that the European Union is considering measures to stop people withdrawing cash to stop bank runs. The plan is currently being discussed and would block pay-outs for 5 to 20 days. Once this law is in place, it is very easy to extend to much longer periods or to become permanent.

The trend is clear. Governments worldwide know that the banking system is totally bankrupt. The problem is that most governments are also bankrupt. The only solution they have is to print money but as I have discussed above, money printing will solve absolutely nothing.

Nobody holding cash or assets in the bank must believe that the government guarantees of $100,000 or €100,000 is worth anything. Firstly, governments haven’t got any money and secondly they will renege on their commitments.

End of a century of illusions

We are now reaching the final stages of the 100 year old plan devised by the bankers and the elite to control the financial system and thus also major parts of the world as Rothschild said. The final collapse is inevitable as von Mises stated:
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
 Autumn 2017 looks precarious

The coming autumn could be decisive. All the bubble markets show no fear. Stocks are at highs and the VIX or volatility index at historical lows. Property markets continue to be strong fuelled by cheap money. And the global Bond market continues to expand exponentially.

Stocks investors’ complacency is dangerous. Dollar holders should start worrying now. The dollar is weakening and is on the verge of a collapse. Short term the dollar is possibly a bit oversold but medium to long term it looks sick. Out of all the weak currencies, the dollar is likely to fall first then followed by most of the others until they reach their intrinsic value of zero.

Gold – New highs in 2017?

Gold and the other precious metals have now finished their correction. Next should be a major breakout which will accelerate in the autumn. The crypto currencies could continue to benefit from the mess in the world and go higher. But remember that cryptos have nothing to do with wealth preservation. It is electronic money with no underlying value. When the mania is over, cryptos are likely to be as valuable as Tulip bulbs when that speculative craze collapsed in the 1630s.

As currencies fall, exchange controls will be introduced in most countries. The US will most certainly be one of the early countries to announce it.

Physical Gold will in the next few years be one of the few ways to preserve wealth as the world experiences a total wealth destruction. There is still time to take money out of the bank and to own gold in a safe jurisdiction like Switzerland and Singapore. But that opportunity will not be open for long. Also, gold is unlikely to be as cheap as today for very much longer. We could see new highs in 2017. However, the price level short term is irrelevant. What is important is that physical gold is superb insurance against a very risky world.

Egon von Greyerz
Founder and Managing Partner
Matterhorn Asset Management AG

Hot Summer Mailbag

Perhaps the best part of being a writer is the chance to interact with readers. I can’t tell you how much I’ve learned from you over the years. Whether it’s through our online comment threads or emails or conversations in the hallway at a conference, nothing pleases me more than to share thoughts with you. The exchanges are always stimulating, even when we disagree. Believe it or not, I make a special point to read those who disagree with me if they come armed with cogent thoughts. And I will admit to changing my mind at times. Or at least softening my position. I know many of you think I have too much going on to take time to read your comments, but I make it a priority.

Today I am at Camp Kotok in a remote area of Maine where connectivity (the electronic kind) is limited. Rather than try to write a regular letter, I decided to hand the keyboard over to you – or at least to a few readers like you. I went through the feedback to my last few letters and picked some comments to share and respond to. These are a small fraction of the feedback we received, so forgive me if I omitted your brilliant submission! And because I want to get to the Camp Kotok opening reception in a bit, this letter will be shorter than usual.

Photo: Kevin Baird via Flickr

But first, a quick request. I had a visit with an ear specialist (ENT) about three years ago, a doctor whose office is near Baylor Hospital. I have lost track of his name, but I really need to see him again. I know he was a long-time reader. If you recognize yourself here, would you please get in touch with me? Thanks. Now to the comments.

First, a follow-up to last week’s note about Google email delivery. Reader Thomas Hurley sent this advice for other Gmail users:

Dealing with Gmail is not extremely hard. First, decide that you are smarter than Google and only have one category: PRIMARY. I never, ever let Google decide where to put my email except for Spam, which I do review because they make mistakes. But if I tell them that something is NOT SPAM, then that mail goes into the Inbox in the future.

Under SETTINGS set INBOX TYPE to DEFAULT. Under CATEGORIES check PRIMARY and uncheck all the rest so that there is only one Inbox except for SPAM. Final optional step is to open a Mauldin Economics email and then click on the Labels icon at the top of the page and create an icon. All future emails will still go into the Inbox but will also show up under that label for quicker identification. Additionally, one might sort for Mauldin Economics, and in that case I can add the Label MAULDIN ECONOMICS to 100 past emails at a time.

I hope that advice helps. Our Mauldin Economics tech team tells me that email delivery is a never-ending battle. Email providers constantly tweak their algorithms to screen out junk, and we occasionally get caught in their dragnets. You can always point your browser to, where you will see links to our last few articles on the home page to see if you are missing the letters we send. If you find that you are, just resubmit your name, and the team will get you back on the list. And check your filters and firewalls – you may be missing a lot of things you would prefer to have.

Now, on with the mail.

Three Black Swans

This comment came in response to my July 22 “Three Black Swans“ letter:

Gas prices – what role has this played in the economy? Seems to me that inflation for the masses is good and bad for the government. Deflation is good for those who save and bad for those who spend. What person wants to pay more for goods? What I see in my household budget is inflation, yet they tell me we have deflation. It’s all so confusing – or is it? – Glenn De Vries

John: Thanks for writing, Glenn. The problem with understanding price inflation is that not every price rises the same amount at the same time. That means your perceived (or, if you could calculate it, even your actual) inflation rate can be quite different from someone else’s, simply because we all spend our money differently. Healthy young people don’t notice that prescription drug prices are rising. Retirees may not be aware that video game prices are dropping.

Benchmarks like the Consumer Price Index try to reflect the experience of an “average” family, but few families are actually average. We all have our own preferences and priorities.

And I want to clear up a common misconception. Deflation is actually good for your household budget in that it means that you have to spend less to get the same goods and services. Inflation, in contrast, means that you have to pay more. Governments like to have inflation because they want to inflate away their large debts.

I find it passing strange that economists think 2% inflation is the right number to target. First, 2% inflation means that in 36 years you will have lost 50% of the buying power of the dollars you save today. It also means you need to earn at least 2% on your savings just to stay even on buying power; and if you want to grow your future buying power, you have to make more than 2% – not easily done when interest rates are 1% – unless you want to take on some extra risk.

I have been in the room with Nobel laureates conversing under the Chatham House Rule (which means that I cannot name names), when they have argued that the Fed should actually,  surreptitiously, target 4% inflation, or let the economy run “hot,” because that is the only way that we can “grow” our way out of the massive debt we have accumulated. There is a certain twisted logic to that. If you could have 4% inflation and 2% actual growth, that combination would increase the nominal size of the economy by 6%. If you were increasing total debt by only 3%, then your debt-to-GDP ratio would decline by 3% a year. No one in the room argued that we should actually balance the budget.

And no one spoke up for the little guys (that would be you and me, Glenn) who at 4% inflation would see a 50% loss of their buying power in 18 years. Inflation is a destroyer of capital and purchasing power.

Prepare for Turbulence

The following two comments were posted in response to “Prepare for Turbulence.”

John wrote: “It doesn’t make sense to cover over a problem for years, let it get bigger and bigger, and postpone acknowledging it until the worst possible time.”

I believe mankind, and especially the Western democracies, are guilty of this for at least 150 years. Think of the financial crises in the late 1800s. Then there are all those in the 1900s. Then 2000 and 2008. The core problem is that we do not learn. Politics blinds us to the correct way forward. Wealth buys Congress and the bureaucrats.

On a larger front, the West dithered until we had WW I. Then it dithered again, and we got WW II. Now we are dithering on three fronts at once – the Middle East, N. Korea, and the South China Sea. The West seems incapable of taking the needed action in a timely manner. If not us, who? If not now, when? We fail to ask those questions. WW II cost tens of millions dead and trillions in wealth destroyed. Watch and learn, folks. Even bigger things are coming that are not financial. There will be no place to hide.Paul Everett

John: This is indeed frustrating, Paul. Societies make the same mistakes over and over – the cycle goes back much further than the 150 years you mention. The limitations of our human nature have been with us from the beginning.

Part of the problem is communication. Societies have evolved with leaders who make decisions for everyone and observers like me who comment from the sidelines. I notice things are happening but have little power to change them. Those who do have that power don’t notice what is actually happening. We don’t have very good feedback loops.

Further, what you and I might believe to be the necessary actions will not be what others think we should do. The lack of consensus – until action is actually required and it’s too late – ultimately means a bigger crisis when things finally come to a head.

Here’s another comment from “Prepare for Turbulence”:

John wrote, “For instance, with a glut of more than 7 million previously leased cars clogging the auto market, new-car production is projected to continue to fall.”

That is only half the auto industry problem. The mix of cars has changed quite dramatically over the last decade. Sedans are out and SUV’s are in. So, if you have a used SUV you’re going to do quite well at trade-in time. However, if you have a sedan to trade in, you are going to be very disappointed. The used car volumes swamp new car sales. There were about 40 million used cars sold last year. A lot of sedan owners are going to be underwater on their car loans because of the low resale value of their car.Michael Yaffe

John: I was aware of the rather large number of cars coming off lease and affecting future sales volume, but you have given me a new fact that I absolutely love. All of the promotions based on low rates and six- and seven-year loans have pulled consumption forward. Although these promotions make this quarter’s and this year’s sales look good, they exert a drag on future sales as people are lured into greater debt.

 This effect is going to be a big problem, and soon. Generous vendor financing by the auto manufacturers has put people in deeper debt than many realize. It will not take much of an economic downturn to throw many of those loans into arrears. And what will the lenders do, repossess vehicles no one wants to buy? I suspect we’ll see a miniature version of the extend-and-pretend game that mortgage lenders played in the last recession. If that is not the case, then those lenders are going to take large losses. In many cases the lenders are the very car companies that will be seeing lower sales.

Trade War Games

Here’s a comment responding to “Trade War Games” and my concerns about rising protectionism.

Much of America’s trade deficit stems from our refusal to adopt a Value Added Tax when virtually all of our trading partners have one. To review, VAT is added to the cost of everything purchased inside a country, including imports, but does not apply to export sales. So, if the total tax burden in two countries is equal and the actual manufacturing cost is equal but one uses VAT and the other does not, you can expect that the total cost to produce, ship, and sell goods in BOTH countries will be lower for the company located in the country with the VAT. Those who wish to challenge this notion are welcome to sit down with paper and work it out.

Companies in the non-VAT country pay both the full tax in their own country plus the VAT when they try to export to the VAT country against competition from the locals who pay only the full tax. Meanwhile, in the non-VAT country, imports enjoy a tax reduction equal to the VAT percentage while local makers pay full tax.

This unfairness has persisted since the 1950s when the VAT was invented. It was, long ago, “justified” in Europe by the need to rebuild their destroyed in World War II economies. I humbly suggest that the need for America to subsidize manufacturing in Europe [and China] via refusing to adopt a VAT is long since past and that using a VAT here, possibly as an exchange for lower or no income taxes, would right our trade situation in multiple industries at once.

And, since most of our trade partners already have a VAT, their “bully pulpit” to complain about the US starting a trade war doesn’t exist ... they started it, as the saying goes, long ago.Rolf Parta

John: Regular readers know I would like to see a VAT system in the US. I think it could eliminate or greatly reduce both income and payroll taxes. For some reason, though, the politicians who could make this happen refuse to consider the idea. They fear – perhaps reasonably – that we would end with both a VAT and existing taxes on top of it. There are ways to prevent that from happening, but it would take more vision and dedication than the current congressional leadership seems to possess.

And let me make a further point. Today’s deficits will grow even larger because of entitlement programs. The only way to get serious money, and by that I mean the trillions it will take to balance the budget or even come close, is a VAT. Let’s face it: We are going to get a VAT sooner or later – probably under a Democratic Congress and administration, but Democrats are not going to look kindly upon lowering income tax rates. A Republican administration, on the other hand, could use a VAT to completely eliminate Social Security taxes and deeply cut corporate and income taxes.

The Republican leaders in Congress currently believe that they’re going to be able to make cuts in programs and reform entitlement spending such that they can handle future deficits. Yet they can’t pass even a simple tax reform package or healthcare reform. This is the Gang That Can’t Shoot Straight.

At the beginning of the year I was really encouraged that Republicans could act and we would get major tax reform and healthcare reform and bureaucratic reform that would push out a potential business-cycle recession or worse at least three or four years. Now, they are likely to pass something they will call tax reform, but it will actually be just tinkering around the edges. Real change requires real change. Real tax reform requires real tax reform. I will openly admit that “my team” talked a good game but just hasn’t been able to move the ball down the field. I’m extremely disappointed.

The Wedge Goes Deeper

This comment is in response to “The Wedge Goes Deeper.” That letter was written by my associate Patrick Watson, who filled in while I was away on honeymoon. He wrote that Amazon’s pending Whole Foods Market takeover, combined with the arrival on the scene of deep-discount grocers like Aldi, would lead to further class separation in the US. Reader Ron Miller responded:

I’ll apologize for what is probably a trivial comment, but the reason for the growing success of the Aldi supermarket chain is not just that it’s “spartan” while prices are low. That growing popularity is mainly attributable to the fact that customers are learning that, very contrary to the Dollar-General experience, they need not sacrifice a whit of quality at these low prices.

The quality is as good or better than the big chains (not including Whole Foods, which sells Mercedes-priced groceries), and the reduced prices seem to be achieved because they sacrifice a very few amenities (bag boys), they prepackage all produce, and they carry only one brand — i.e., there is seldom any choice other than the Aldi brand which must lead to significant savings in shelf stocking, warehousing, and wholesale prices.

Were these Aldi brands not top-notch in quality, the chain would have failed, but the products are just as good or better than the stuff at Kroger for 50% higher prices. I’m not sure what to compare them to – perhaps they are to groceries what Ikea is to furniture… minus all the self-assembly jokes.

John: Ron, the relationship of price and quality is actually a burning debate among economists. Sometimes the price of a good remains the same but its quality increases. That change ought to be deflationary. Each dollar you spend is buying more utility for you. But making this effect show up in CPI and other stats is difficult. Economists make “hedonic adjustments” for that very reason, but the methodology is still imperfect. And, the aggregate impact could be significant when you consider the rapidly increasing capabilities of electronics products, just to name one category.

Only an economist can say that selling one barrel of oil for $100 is equivalent in terms of GDP to buying two barrels for $50 each. GDP, as measured by dollars spent, may not be the best way to actually measure growth of the economy.

My friend Dr. Woody Brock (one of the smartest economists anywhere) argues that the current CPI numbers significantly overstate inflation because of the way they are calculated. My friend John Williams at Shadow Stats argues, conversely, that inflation is massively understated. Your conclusion basically comes down to the assumptions you make.

Your missing his son Trey at Camp Kotok analyst,

John Mauldin

How to Reduce Germany’s Surplus

Hans-Werner Sinn
Germany's surplus

MUNICH – The Economist was right when it recently reported that Germany’s current-account surplus is too high. But why is the German surplus too high? Some say that Germany has a high export volume because it manufactures high-quality products, while others argue that Germany imports too little, because its wages are too low.
Still others point out that, by definition, a country’s current-account surplus is equal to its capital exports. Germany thus has a surplus of savings over investments, and needs to save less and invest more.
Of course, the German current account surplus also reflects deficits in other countries, not least the United States, which accounts for about one third of the value of current-account deficits worldwide. So, one could just as soon call on deficit countries to increase their competitiveness, reduce wages, and save more while investing less.
Consider Southern Europe’s heavily indebted countries. Although they have managed to balance their current accounts, owing to lower interest rates on their foreign debt, they could be running substantial surpluses to pay off their debts.
But ad hoc recommendations won’t take us very far. To decide where adjustments should be made, we first need to understand why excess capital is flowing from Germany to the rest of the world.
In my view, the US federal government’s extreme indebtedness and budgetary profligacy is a major source of the problem. The US Federal Reserve’s loose monetary policy has artificially sustained the US economy, which itself is built on limited-liability consumer and home loans.
The US has been able to live beyond its means by selling dollar-denominated debentures to the world, because the dollar is the world’s main reserve currency. But this approach has produced a retail-based economy and a weak domestic manufacturing sector.
Another problem lies in the eurozone. The introduction of the euro dramatically improved the creditworthiness of southern European countries, as it seemed inconceivable that euro countries could ever go bankrupt. After all, they have the right to print money that other countries accept as legal tender. The result of this artificial sense of security was that abundant private capital flowed into Southern Europe until around 2008, creating inflationary credit bubbles that destroyed those countries’ competitiveness.
When the financial crisis hit, the southern euro countries took advantage of their right to print money, effectively borrowing from the euro system what they could not borrow in the markets.
They used that money to redeem old debt, to continue buying goods, and to purchase real estate and other assets abroad.
Moreover, the ECB promised free protection, through outright monetary transactions, for private investors who dared to continue putting their money in the south. Not surprisingly, all southern European countries saw their debt-to-GDP ratios continue to increase, despite the pledges made in the enhanced fiscal compact of 2012 to reduce the ratios year-on-year, in order to approach gradually the limit of 60% established in the Maastricht Treaty.
The excessive Keynesianism used to legitimize indebted eurozone countries’ lack of budgetary constraints during the crisis also caused capital to be sucked out of Germany, when investors actually tried to retreat from southern Europe. This has stimulated imports, thereby contributing to the increase in the German current-account surplus.
But Germany hardly profits from the situation, as the debentures and promissory notes that it received from deficit countries hardly bear interest anymore, and their repayment is increasingly uncertain. In fact, roughly half of the net foreign assets that Germany has accumulated through its past current-account surpluses now comprise mere Target claims on the Bundesbank’s balance sheet, which currently stand at €861 billion.
The Target claims reflect the financing that, according to the rules of the euro system, the Bundesbank has been forced to extend to the eurozone’s deficit countries, by crediting their payment orders. The Bundesbank will never be able to declare these claims due and payable, and the ECB Governing Council has set the interest due on them at zero.
Against this backdrop, a two-prong approach for reducing the German current-account surplus seems appropriate. First, Germany could introduce depreciation allowances for private investments, as the president of the Ifo Institute has suggested. This would help to redirect some of the capital currently flowing to other countries back toward domestic uses.
Second, southern eurozone countries and the US could finally return to a policy of disciplined debt management. This would reduce their imports from Germany and hence capital outflows from Germany, which is measured by the current-account surplus. In particular, the Fed and the ECB need to end their loose monetary policies – especially the fiscal bailout packages and ECB guarantees that are artificially redirecting capital into Southern Europe.
Logic dictates that Germany cannot simultaneously reduce its current-account surplus and continue to extend cheap public and private loans to other countries. Much would be gained if politicians understood this basic reality.

Sentiment Speaks: The Market Got It Wrong - Again?

by: Avi Gilburt


- Recent price action.

- Anecdotal and other sentiment indications.

- Price pattern sentiment indications and upcoming expectations.
Recent price action
Last week, I noted:
While many will now turn bullish in disbelief of the action in the equity markets, I am now finally turning somewhat cautious, and will likely remain so until the fall. My expectation is for last week’s ascent to slow down in the SPX over the coming weeks, which will likely result in a multi-month top being struck, sending us back down to the 2300 region in the SPX in the coming months.
And, while the market continued its ascent, we have seen more consolidations taking hold, which suggests to me that the ascent is indeed slowing.
Anecdotal and other sentiment indications
As the market continued to rally this past week, more and more investors and analysts have been scratching their heads. Unfortunately, they believe that the market is simply not justified for reaching these heights.
Ahhhh. But, wait a second. In their mind, the market is only as a high as it stands right now because of central banks. Yea. That must be it. At least that is the reason they have all fallen back upon because they cannot fathom any other reason for markets to reach these heights. And, if they cannot see any other reason, then clearly none must exist.
So, they are quite certain that the only reason markets have reached these heights is because of central banks. In fact, they clearly believe that central banks are all powerful, control all markets, and markets cannot come down again because of the central banks.
Now, I truly love Disney World. In fact, I am going with my family in a few weeks. And, like many others, I really appreciate Fantasyland. However, when dealing with the markets, it seems many of those who believe central banks are all powerful are perpetually living in Fantasyland, even though they reside well beyond the boundaries of Disney World.
I have now read a multitude of articles written on Seeking Alpha calling for the end of the bull market over the last several years. And, many note how central banks are the only reason the markets have reached their current heights. One recent article even noted that, despite all its herculean efforts, the BOJ will never be able to hit its inflation target.

Huh? Wait a second. I thought central banks are all powerful? I thought they control the markets? I thought they are the only reason the equity markets have reached these heights? Yet, how can they not hit their inflation targets?
Either they are all powerful and can control the markets, or they can’t? Have you ever heard of anyone being “a little pregnant?”
While you try to figure that one out, let me give you something else to chew on. If central banks are as powerful as these analysts claim, and they have every reason to continue to prop up the financial markets, should that not mean that we will never have a large correction again? And, is that not what Janet Yellen said not too long ago?
Moreover, the analysts that claim that central banks are pushing the markets higher are, oddly enough, the same ones who have been calling for a market crash for years. Does anyone else see any inconsistency or circular “logic” here? You can’t have it both ways boys.
And, if you really think about it, one has to question why those who are so certain regarding the power of central banks have not been suggesting investors place their money alongside those central banks for the last few years rather than cautioning about a crash every week!?
The reason they have not is because not even they truly believe their own rhetoric, and just use it as a convenient excuse as to why the market has acted opposite of their expectations. Yet, they continually lecture the poor fools who made money during the 700-point rally from the February 2016 low.
My friends, we will have a correction again. In fact, we will likely see a 20% correction beginning next year no matter what the central banks do, and likely from much higher levels. And, when we do get that correction, many of these analysts will begin to pound their chests, as their broken clocks strike that particular time of day which makes them see correct.
But, either the central banks are all powerful and have been pushing the market up to new all-time highs week after week or something else has. If the central banks are truly that powerful, then we will never see another 20% or more correction. And, if we do see such a correction, then clearly the central banks are not all powerful, and something else is controlling the market. To be honest, I don’t need to wait for that 20% correction to already know the answer. If one understands that correlation is not akin to causation, then you will know the answer too.

At the end of the day, anyone who believes in the omnipotence of central banks will be setting themselves up for a world of hurt several years down the road, and from a much higher stock market level. And, just as the truth of the matter is that the central banks are not controlling the market on the way up, they will be unable to prevent the market to drop on its way down. To believe otherwise is to believe that central banks can control the markets on the way up, but not on the way down. Again, a little pregnant?
And, for those who have not bothered to learn from history, allow me to remind you of the words of Irving Fisher in 1932, who also originally believed in the omnipotence of the central bank:
“The Federal Reserve System, from February to December 1931, increased the issue of Federal Reserve notes by 80%. These issues were due to bank failures which made necessary a larger use of cash. Yet, after a wave of bank failures . . . both banks and their depositors began raiding each other in a cut-throat competition which more than defeated the new issues of Federal Reserve notes.”
Here is one more quote for you to consider:
"Those who cannot remember the past are condemned to repeat it.”
George Santayana
Price pattern sentiment indications and upcoming expectations
As I have noted over the last two weeks, I am looking for the market to top out in the near term. Our longer-term target for this wave (3) off the February 2016 low begins at 2487SPX, and was as high as 2564SPX. However, based upon the smaller degree set up in place now, as long as we remain over 2450SPX, I think we will likely strike the lower end of that target region between 2487-2500SPX before wave (3) tops out. While there is a smaller probability we can push higher into the upper region of our target, for now, my expectation is that we can top out in the lower end of that target region.
But, as I have noted many times before, it is not likely that this bull market run off the 2009 lows has run its course. Rather, whatever top we create over the coming few weeks will likely send us down to the 2300SPX region, and set up a rally back up towards the 2611SPX region. It will be after the rally off the next pullback that the market will set up for a 15-20% correction, likely starting in 2018.

Money Is Money, Wherever It Comes From

One of the crucial things to understand about today’s world is that money is fungible. Whether it’s created in Japan, Europe, China or the US, once it’s tossed by a central bank into one or another part of the global economy, it eventually finds its way to a common pool of liquidity.

So the modest US tightening of the past year (100 basis point increase in the Fed Funds rate, slight decrease in Fed balance sheet) has to be seen in a global context. And that context is still insanely easy. Here, for instance, is China’s “social financing” – their term for total new debt:

This chart is in Chinese yuan, so it’s not immediately clear just how much borrowing is taking place.

But converting to dollars yields a monthly average of about $250 billion, or $3 trillion per year.

That’s a ton of new debt, much of which generates demand for raw materials from other countries, thus exporting Chinese inflation to the rest of the world.

The European Central Bank is, if anything, even easier. Here’s a brief excerpt from Doug Noland’s latest Credit Bubble Bulletin – which as usual should be read in its entirety by anyone who wants to understand today’s monetary insanity.

ECB chair Mario Draghi: “Inflation is not where we want it to be, and where it should be. We are still confident that it will gradually get there, but it isn’t there yet, and that’s why the Governing Council reiterated that the present very substantial monetary accommodation is still necessary…Now, the last thing that the Governing Council may want is actually an unwanted tightening of the financing conditions that either slows down this process or may even jeopardise it; and that’s why we retain the second bias, or let’s call it, reaction function. ‘If the outlook becomes less favourable or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase our asset purchase programme in terms of size and/or duration.’ And I think the Governing Council has given enough evidence that when flexibility is needed to achieve its objectives, it has been very able to find all that was needed. So that’s why we keep this bias.” 
If central banks have become so keen to protect markets from risk aversion, why shouldn’t the cost of market “insurance” remain extraordinarily low. Why wouldn’t speculators gravitate to products fashioned to profit from providing myriad forms of market risk mitigation (hawking flood insurance during a drought)? And, importantly, as Bubble risks escalate, why would sovereign yields around the globe not discount the high probability that central banks will at some point be called upon to make good on their New Mandate – i.e. respond to faltering Bubbles with aggressive new QE programs with enormous quantities of bonds/securities to purchase?

Meanwhile, in Japan, a couple of central bank governors who are reportedly skeptical of hyper-easy money resigned and were replaced by people who were the opposite of skeptical:

Bank of Japan newcomers back 2% price goal
(Globe and Mail) – The two new members of the Bank of Japan’s policy board said on Tuesday that the central bank should continue efforts to achieve its 2 per cent inflation goal and it was premature to debate an exit from its massive monetary stimulus.
Goushi Kataoka, a 44-year-old former economist at Mitsubishi UFJ Research and Consulting and an advocate of massive money printing, said he wants to see the price goal achieved quickly although he cannot say when that can be.
The other new board member, Hitoshi Suzuki, a 63-year-old former deputy president of Bank of Tokyo-Mitsubishi UFJ, who is well-versed with financial markets, said it was “dangerous” to markets to debate an exit from the stimulus now. 
“There’s a considerable distance from the 2 per cent target. From my own experience of dealing with markets for 20 years, starting a debate on exit now would be dangerous to markets,” Suzuki told a joint news conference. 
He added that the price target was a high goal but he wants to achieve it by any means.
Here’s the recent increase in the BoJ’s balance sheet – which is another way of saying the amount of money the bank has created and released. Note that it has more than doubled in three years:

So what does all this mean? Here’s Noland’s conclusion:
There is no doubt that central bank liquidity backstops have promoted speculation, securities leveraging and derivatives market excess/distortions. I also believe they have been instrumental in bolstering passive/index investing at the expense of active managers. Who needs a manager when being attentive to risk only hurts relative performance? And the greater the risk associated with these Bubbles – in leveraged speculation, derivatives and passive trend-following – the more central bankers are compelled to stick with ultra-loose policies and liquidity backstops.
After all, who will be on the other side of the trade when all this unwinds? Who will buy when The Crowd moves to hedge/short bursting Bubbles? This is a huge problem.  
Central bankers have become trapped in policies that promote risk-taking, leveraging and hedging at this precarious late-stage of an historic Global Bubble. These days, central bankers cannot tolerate a “tightening of financial conditions,” and they will have a difficult time convincing speculative markets otherwise.

Credit default swaps: a $10tn market that leaves few happy
Owners of contracts designed to insure against default frequently find themselves stymied

by: Robert Smith

© Bloomberg

If your house were burgled, you would expect your insurance to pay out for the stolen items in full.

Imagine your dismay if the company providing the cover said you could — in theory — sue the burglar, so it was not sure whether you deserved full compensation.

If you had no intention of launching a lawsuit, the insurer might assess how much your right to take legal action was worth, and deduct this from your payment.

The scenario may seem far fetched, but this is precisely the predicament Banco Popular credit-default swap holders find themselves in.

A committee from the International Swaps and Derivatives Association (Isda) is gathering feedback on whether bondholders’ right to pursue litigation over the Spanish bank’s collapse could be viewed as an asset that would ultimately limit any payout to owners of the CDS.

While use of credit derivatives has declined since the financial crisis, it is still a $10tn market. And the Popular episode highlights that despite recent overhauls, the instrument still has handicaps when it comes to its intended purpose — insuring bonds against default.“

CDS is definitely good for trading strategies and tagging along to the market sentiment around a particular story, but when it comes to insuring against a default it’s never a perfect proxy,” said Gildas Surry, a partner at Axiom Alternative Investment.

The paradox of CDS is that the so-called credit insurance market is not actually insurance at all. This central tenet of the market was enshrined in law 20 years ago, through a legal opinion Robin Potts QC provided to Isda in 1997, which market practitioners said was necessary to ensure CDS remained tradable instruments.

Cynics argue that this has allowed the market to escape more stringent regulation, however.

After all, while you cannot legally buy insurance on someone else’s car, for fear of foul play, investors frequently buy CDS contracts on bonds they do not own.

Concerns around foul play often dog the CDS market, given that the funds that buy and sell CDS can also change the fate of the companies involved by offering or withholding finance.

A group of hedge funds that sold CDS on UK retailer Matalan recently offered to fully support a new bond issue from the company, so long as the company issues the debt out of a new entity.

This process would “orphan” existing CDS contracts written against the old entity, making them essentially worthless as they no longer reference any debt, and hand the funds a profit.

Sources with knowledge of the matter said that Matalan was unlikely to accept the deal, but noted that concerns around orphaning had still contributed to a collapse in value of CDS contracts linked to its debt.

“If you’re shorting through the CDS market you should’ve learnt by now that you can get the credit trajectory correct, but still lose money due to the nature of the instrument,” said a bond portfolio manager.

Some market practitioners fear that these attempts to exploit contractual quirks have undermined liquidity in the so-called single-name CDS market, where investors buy insurance on a single company, rather than a broad basket of companies through an index.

“All the legal complexities of CDS create a nice playground for hedgies, but we need to have more and more investors involved,” said Jochen Felsenheimer, a managing director at XAIA Investment. “Real-money investors are happy using the indices, but as long as they see tricky goings on in single-name CDS, they simply won’t touch it.”

The potential for a messy outcome on Banco Popular has caused particular consternation because the CDS market’s rules were rewritten in 2014 ostensibly to iron out major flaws in the auction process. These auctions see traders bid on defaulted bonds and other assets to determine their value, deciding the level of payout that CDS buyers receive.

“It’s the biggest problem in CDS and it’d be much neater if you always had a payout at 100 [per cent],” said an analyst at a credit hedge fund. “You just don’t know what you’re going to get back in the auction. It’s needlessly complex, but it suits a load of different people, unfortunately.”

Isda has made efforts in recent years to make the determinations committees, which decide on the outcomes and auction processes in the CDS market, more independent and transparent. But many in the market argue that the scope for conflicts of interest is still rife.

Asset manager Pimco sits on the Isda committee deciding whether legal claims should be included in the Banco Popular auction, for example, but is also part of the bondholder group that has hired lawyers to explore litigation options. Pimco declined to comment.

This widespread distrust of the auction process is yet another drag on the market.

“When you have guys trying to find a clause which could be interpreted in a certain way to trigger a fancy outcome in the auction — sure they will make a nice one-time profit, but step by step they will destroy a very useful market that needs to be kept alive,” said Dr Felsenheimer.