For more than a year, the “recovery” bounce in the stock market has refused to give up. The indexes have recovered more than 50% of what was lost. Technically, they look pretty good. What’s more, the S&P sells at more than 21 times normalized earnings, according to Robert Shiller’s latest tally. It seems like nothing can stop stocks now.
Then there’s the Treasury market. Overall, yields remain remarkably low. It is almost as if Treasury buyers are unaware that they are being asked to finance the biggest increase in sovereign debt ever. It doesn’t seem to matter either that many of the applicants for money will be incapable of repaying it. Several sovereign debtors, including the US, have already reached the “point of no return,” according to professors Rogoff and Reinhard.
Still, the financial press is optimistic. Economists are irrationally confident. Investors and advisors are overwhelmingly bullish. And the American public seems willing to add a trillion-dollar health-care program to its burdens – a sign of remarkable faith in the nation’s prospects.
So, let’s go back and reexamine our basic position. Is this really the “Great Correction” that we think it is?
If there is one lesson we’ve learned over the years, it is that we need to be patient. Things that have to happen generally do, sooner or later. You just have to wait. And when they happen, they generally happen much faster than you expected. Even when you’ve been expecting something for years, it can come and go before you realize what is going on.
You get used to being wrong…or at least premature. You wait. You watch. You think the time has come…and then: whoops…not yet. Pretty soon, you are overcome by anticipation fatigue. Then when the real thing finally does start to happen you don’t believe it. You wait to be sure…you hesitate…and then it’s over!
Just what am I waiting for? I’m anticipating more evidence of this Great Correction, including another big swing down in the real price of stocks, bonds and commodities…further deterioration in the real estate market…a falloff in consumer spending…and a higher savings rate.
I’m also expecting higher yields from government debt…and a dangerous intensification of financial problems in both the private and public sectors. If I’m right, those things must happen eventually. So far, we’re still waiting.
But this week the long-awaited turnaround in the bond market may have begun. Rates are rising along the entire yield curve, especially at the long end. “The bond market is now very close to saying, ‘We’ve had enough,’” predicts the octogenarian stock market technician, Richard Russell. The 30-year T-bond’s recent decisive move above 4.80% marks the end of a 25-year bull market in bonds, says Russell. Rates will be moving higher from here.
Investors are starting to tune into how sovereign debt works. And they’re starting to realize that even governments can default. In fact, almost all of them do default eventually. Yes, even governments whose debts are denominated in their own currencies default. And even when they have the power to print the currency themselves.
How could that be? Well, it is very simple and worth spending a little time on. I want to make two points:
First, governments will usually choose to default on their debt rather than risk hyperinflation of their currencies. Second, when they reach a “point of no return” they have no choice. They cannot cut back spending. Because even the most drastic cutbacks will not do the job. That would simply result in lower tax receipts and an even bigger deficit. At a certain point, the multiplier effect becomes the divider effect.
I’ve made the point many times that democracy seems hell-bent on self-destruction. America’s founding fathers noticed many years ago that when people realized that they could vote themselves money from the public treasury, democracy would be doomed.
Most people presume that if a politician offers benefits, “someone else” will pay for it somehow, someday. In practice, the money doesn’t come from additional taxes. Taxes are already, at least theoretically, at their optimal level. Higher tax rates produce lower economic activity, which lowers tax receipts. So instead of raising taxes, governments borrow the money. Then sovereign debt loads become larger and larger until, as Greece has recently discovered, they are impossible to carry.
America also has public sector debt problems – of about equal measure to Europe – and she has huge private sector debt problems as well. For the moment, the skies over the American financial markets are clear. But out at sea a hurricane is spinning faster and faster. There is a huge wave of debt defaults/foreclosures in the private sector that will hit the markets soon. This wave, combined with record borrowing from the US government, is bound to push up bond yields…making it harder than ever to get needed funding.
The situation with the US government is more complicated than it is with private borrowers – or even with Greece or California. The federal government can print money. But it, too, is ultimately at the mercy of the bond market. Last year Uncle Sam borrowed $2.1 trillion. This year it will borrow $2.4 trillion. Without this money, US government spending would have to come to a halt. The US counts on lenders. It needs lenders. Without them it would be forced to make cuts equal to about 10% of GDP. Think you’ve got de-leveraging now? Just imagine what that would do.
Typically, of course, government bond buyers don’t cut off a lender altogether. They merely demand a higher rate of interest to offset what they see as an increased level of risk. The higher interest rate adds to the borrower’s cost – increasing his deficit and forcing him to borrow more.
This is where it gets interesting. You might say that a government can “print its way out” – it can just print the money it needs rather than borrowing it. But what would happen if the US chose to print $2 trillion this year? It would risk hyperinflation. Lenders would run for cover. Prices would shoot up. The damage to the economy would be severe…so severe that only governments under extreme pressure – think Weimar Germany or Mugabe’s Zimbabwe – are willing to risk it. Instead, they try to muddle through, as Greece is doing now – promising budget cuts, making special financing deals and pushing up the rate of inflation a bit, but not so high as to cause panic in the bond market.
See, as long as the bond market permits it, debt levels continue to grow. But at some point – the point of no return – a government can no longer save itself from disaster. How does that work? Well, when deficit/debt levels are too high, the cuts necessary to bring the budget back in balance are so great that they squeeze the economy hard, reducing output and decreasing government’s tax revenues.
In this case, the government cannot escape. It has to print money. Or default. Most often, it will choose default, because it is the less painful solution. Either way, the government finds that it will be cut off from the bond market. Hyperinflation is merely an additional and unnecessary aggravation. (That said, I agree with Nassim Taleb, that hyperinflation remains an underestimated black swan risk.)
The underlying story of the economy has not changed. We are in a Great Correction. We don’t know exactly what it is correcting…but it looks as though it will at least reduce some of the leverage that has been added to American and British households over the last 60 years.
So far, the process is tentative…and unsure of itself. From a peak of 96% of household income in 2007 debt has fallen to…94%! The drop is so small that it makes you wonder if it is a trend at all. But if it is, it has a long way to go. Ten years ago – at the peak of the dot-com bubble – household leverage was only 70% of income. At the present rate it will take another 24 years to get back to 1999 levels.
Albert Edwards of Societe General has examined the non-financial leverage in the system. There is excess leverage of about 60% of GDP, he says. He calculates it will take a decade of “Japan-like pain” to eliminate it.
Either way, you’re talking about a long process of getting back to “normal.”
The Great Correction is also what is keeping housing and unemployment down. When the banks aren’t adding to the nation’s credit, you just can’t expect many new jobs or many new house sales.
Nothing has changed in the last week – except we have moved one week closer to whatever crisis lies ahead.
Bill Bonnerfor The Daily Reckoning
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill's daily reckonings from more than a decade: 1999-2010.
I call the past year the “Hope Bubble”. We ran out of tangible things to base bubble behavior on, now it’s just pure fantasy, based only on “hope” the market will continue to rise. I ask everyone that tells me we are in recovery mode to tell me “where are the jobs going to come from?” People left mills and factories, went to work in service and construction. Construction, at least the levels needed to put more than a handful back to work aren’t coming any time soon. So, where will the jobs come from? Green jobs? Yeah, right.
Why does Bonner think commodities will fall when before he was expecting inflation and all the other guys at Agora are pushing commodities? I wish they’d have a meeting and get their ideas straight.
of course there is always some crisis ahead eventually. And each week is one week closer to it.
Mr. Bonner, I’ve been a suffering reader for a long time now. And you use to write about how it was easier to print money then to default. Ever since the crisis of 08′ it seems like you changed your tune on that a bit. This is all probably symantics as a default or printing are both really bad for the dollar. But I thought I’d ask what was it that now makes you think defaulting is easier then printing?
Well, just when it appeared Mr. Bonner had gotten over his blip-in-time Great Correction mantra he’s back at it in spades.
I could almost swallow this if he called it the Great Hyper-Correction; something between Great Depression and Great Mega-Depression. But no. We now have a ‘process’ correction albeit a great one as if this is more informative than the ultimate result which is One Hell of A Greater Depression and a global one at that. Tell us something we don’t know.
The process is indeed adjusting daily, weekly, monthly, quarterly, and so on. And yes we do know that. And we also know when has economics done other than a continuous corrective process? It never has stood still and never will. Snapshots of it and their interpretation by experts such as yourself tell us about the details but what we want to know is what do you really make of this whole cohesive mess?
Anyone can call an ongoing process: certainly a Great Correction in this case is viable and accurate at any given point in time. GDI had this evidenced. And certainly one could call it something else too and be right. Call it whatever you want. But it takes a committment, confidence, perhaps even genius, to call what will be and to stick to one’s convictions.
Now as it stands I just don’t know which way Mr. Bonner thinks, where he truly stands, what do his convictions consist of other than only he’s apparently as uncommitted to them as ever. I say a Great Correction is a great cop out. An easy flip of two coins. One with tails on both sides and the other with heads on both sides. How can you miss?
The coin has already flipped. Call it, Mr. Bonner. Waiting until absolutely without question you can see what it’s going to be (because afterall you have insight tools most of us don’t have) and then calling it just won’t cut it. I need more to be impressed if you will than this semantical game you’re asking me to buy into and to reach into your complex mind to decipher.
I don’t think I have the desire much less the energy.
I think Mr. Bonner is brilliant but he doesn’t have a crystal ball and you can’t criticize him if his opinions or predictions change as things develop. I would rather read an economist who openly changes his mind when he thinks his past position is wrong than one who sticks to his guns just to be consistent.
Rick: Well said. I called BB out on this the first time he changed his tune from the Greater Depression to a Great Correction. Jason also hit it on the head, there’s always going to be crisis somewhere ahead and we are always one day closer to it.
I think BB is upset that he’s been completely 100% wrong in this recovery that’s been happening globally. Many here tell me he had it right in calling for a crisis in 2007. Well, there’s living proof of even a clock is right twice a day.
We’ve seen strong numbers coming in from around the world. The yields are not spiking but taking baby steps. This is unfolding perfectly so far. The economy has moved into an amazing sweet spot and stocks are reflecting that.
I’ve been long since July ’09 and done very, very well. I can’t imagine if I’d have been sitting on my hands taking BB’s advice during that period. Or worse yet, shorting this freight train.
Bottom line, step back and look at the global situation. This is a dynamic time with fantastic opportunities to invest and reap tremendous rewards. That is unless you’re sitting on your hands waiting for a crisis that may be years and years ahead.
What’s going to kill this market and take every perma-bull down with it? One word: “complacency”.
1.a feeling of quiet pleasure or security, often while unaware of some potential danger, defect, or the like; self-satisfaction or smug satisfaction with an existing situation, condition, etc.
Great Depression, Great Correction, it doesn’t matter because the outcome remains the same: The “bond vigilantes” will soon have Uncle Sam up on a horse with a rope around his neck. Justice will not be denied.
Well you know, Bill Bonner always says he has no idea of what is going to happen tomorrow if you read him long enough, where have some of you readers been? Are you asking Mr. Bonner to look into his magic crystal ball and come up with dazzling foresight as to what is going to exactly happen, say two months from now? I do not think Mr. Bonner has ever said anything like that. Bill Bonner however does point out real statistics, how many foreclosures there are, the amount of debt consumers have, businesses that are shutting down or have done so, including some very large American enterprises. Mr. Bonner is also asking where are the jobs going to come from in the service and manufacturing sectors when people have little or no money to spend on new gadgets, expensive vacations or nights out on the town. I say some of you are “shooting the messenger”, do not blame Mr. Bonner for using real statistics. I looked on the web tonight and Googled “Machinery Trader” and found over 8000 skid steer loaders for sale! This is only one site, there are many more equipment sales venues out there. The prices for these machines have been steadily dropping for at least a year and are continuing to do so. Is this a sure sign of a recovery in the construction industry? I do not think so., Regards, CanadaNorth
What happens when a Government defaults on it’s debt? Do all its loans in gilts and bonds become worthless?
His timing may be a bit off but I think Bill has the fundamentals right. This whole “recovery” is a house of cards.
The only things making money now are people with access to cheap govt. money.
The biggest crime committed these last 100 years is the HUGE mark up these frikkin banks make from the cost of the money they get from the Govt. and the sudden MASSIVE increase in the cost of that money for me to borrow.
Gimme 1% interest charge on a million $ loan and I will start a business and employ 100 people tomorrow.
How many jobs per millon dollars received have the bail-out businesses created
What I find strange is that Bill did actually call the recovery in the market – up to 10,300.
Immediately after the crash he had analysis of the the typical bounce from previous crashes and the Great Depression and they came up with a very good figure of 10,300 for the Dow.
They admitted it wouldn’t be exact – how could it be? But Bill made the mistake of not taking credit for this insight.
If he chose to avoid buying into the bounce because he didn’t want to risk the inevitable downside of the inevitable crash – he may well be proved correct!
Is common sense! this is not wright at all! The long term trend doesnt look very promising. Pull out of “wright now” and look some years into the future! Future has been compromised by present consumption, and the day will come when the world will have to pay the bill.
I have a house and a car, and both things represent debt to me, so I am not spending any of my income because I have to meet payments every month. And as Im doing many other people of my generation, 30 – 40 years of age, are doing the same. So where is consumption? We are tied up to our debts! The same to the goverment…
As John says, his timing is off and that is the problem, timing is everything. A lot of money can be made between now and when the doomsday finally arrives.
The last time the crash alert flag was raised the whole finacial crises came to pass, so I tend to respect his flag. The issue is timing: the crash occured when banks reported losses due to mortgage resets. My guess is the next crash will occur when the next wave of mortgage resets occur and are reported by banks, and Obama tries to raise funds to bail them out again, or nationalize them.
Nobody knows what the future will be, however the chances are that the market will take a dip in april,May or June as per most springs. Now is the time to look for somthing to short, to buy gold on dips and to protect everything that isin’t in cash. Keep up to date on news. Its up to the individual themselves to make a decision. BB has always given good advice and you need to balance that with your own point of view.Regards Jack.
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