Bill Bonner

Darkness without a dawn…

The Dow down 167 yesterday. Gold down $48. Nothing to get excited about.

The excitement is still ahead. When the Dow cuts through the 10,000 mark and heads to 6,000. Stay tuned…

In the meantime, yesterday’s Financial Times told us that the industrialized nations will borrow $10 trillion this year. Next year, the figure should be higher.

Where does all that money come from? It’s more than the world’s total savings. Not that we know exactly, but total world GDP is about $50 to $60 trillion. Savings should be about 10% of that — or only about $5 to $6 trillion.

So how are the developed nations able to borrow so much?

With so much debt turning over, it makes the world financial system extremely vulnerable to inflation…or just a change of sentiment in the bond market. Which makes us wonder. What would happen if the lenders balk?

We are, as all Dear Readers know, in a Great Correction. And in a great correction asset prices fall…along with a general fall-off in employment, consumer spending, investment, GDP growth and all the other things that make a robust economy. Demand drops…which typically causes prices to fall (or at least not to rise as quickly as before). There is less demand for credit as for everything else. So, the pool of available bonds falls…forcing up bond prices and forcing down bond yields.

Got that?

Well, don’t worry if you don’t. Because there’s at least a 50/50 chance it won’t happen that way.

So far, the Great Correction has followed the usual script. Bond yields have fallen. Price inflation has generally come down. But demand for credit — as evidenced by the aforementioned $10 trillion government financing costs — is running hot. ‘Typically’ may not matter. Because this is no typical downturn. And it wouldn’t be too surprising if all this demand for credit pushed up bond yields.

Wouldn’t that be a drag?

And here we find ourselves with a grim, but philosophically amusing, insight. Typically, every cloud has a silver lining. Every glass that is half empty is also half full. And dawn follows even the darkest night. That’s just the way the world works. But what if the cloud has no lining, neither of silver nor of anything else that reflects light? And what if the glass is completely empty?

In the normal economic world, low interest rates are the half-full part of the correction glass. A correction comes. Asset prices go down…along with all the other things mentioned above. But interest rates go down too…which make it easier for new projects to clear the “hurdle rate.” At 6% interest, for example, a new project has to return at least 6% to breakeven. Any new investment that won’t produce more than a 6% minimum gain is quickly abandoned. But as the correction drives down yields, to say 3%, all of a sudden a lot more investments begin to make sense. Dawn comes.

Lower inflation rates…and lower asset prices…help too. As prices fall, shrewd investor and careful businessmen can put their money to work again. Employees are re-hired. Household earnings recover. Soon, the downturn is over.

Both booms and busts are, normally, self-correcting.

But leave it to the feds to stop the sunrise. This huge demand for credit from the industrialized governments could drive up interest rates. Imagine what that will do. Already in a slump, households, businesses and investors could find their borrowing costs going up, not down. They could find prices rising, too, especially the prices of energy and food. What a world…a major slump, but with rising prices and rising interest rates!

And then, consider what happens next. The feds will err again. They will feel obliged to finance government borrowing themselves. Here’s the Bank of International Settlements, giving us the heads up:

The Bank for International Settlements Sunday issued an oblique endorsement of coordinated action by the world’s largest central banks to ease funding conditions for banks. “A freezing of interbank markets in major funding currencies, as during the recent crisis, may require the ability to supply official liquidity in major currencies in an elastic manner,” the BIS wrote in its regular quarterly report.” — MarketWatch

It was only a week ago that 6 major central banks announced a coordinated rate cut — expected to juice up the markets. And now all major central banks seem ready and willing to sacrifice the integrity of their currencies in order to protect their bond speculators.

This is what we expected all along. But we didn’t expect it so soon. It causes us to revisit our “long, dark road to Tokyo” forecast. You remember our prediction: the US has already followed Japan through one “lost decade.” We figured it would lose another one as the Great Correction drags on.

But things could happen faster…and worser. Japan financed its own deficits with its own money. Now, everybody is running deficits. And the amounts to be refinanced are staggering. Bond buyers may balk…or simply be unable to swallow so much debt.

Which will cause the central banks to come into the picture — with coordinated money-printing. Instead of going down, bond yields and consumer prices could go up.

Think things are bad now? Wait until the economy has to deal with a Great Correction and inflation.

Bill Bonner
for The Daily Reckoning

Bill Bonner

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 ReckoningDice 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. 

  • http://www.investorsfriend.com The InvestorsFriend

    BILL THE FICTION WRITER?

    Bill did not know how much savings there are in the world. So he simply made up a fictional number:

    …total world GDP is about $50 to $60 trillion. Savings should be about 10% of that — or only about $5 to $6 trillion

    Oops Bill forgot that savings accumulate over more than one year. Some of what is borrowed this year is what was saved in past years. Especially true as debt is rolled over (paid off and re-issued).

    How DO we explain record low interest rates? The world must be awash in savings, no? No one is FORCED to accept 2% on a 10-year government bond, so why DO they?

  • Dave

    I believe people who buy a ten year bond at a 2% yield do so because they believe nothing else will safely give them more than a 2% return.

    If such is the case, and I believe that can be the only explanation, it doesn’t say much for the future does it.

  • Bill B. Bonner

    Shawn, tirent la fourchette hors de votre oreille. Svp.

  • David Bushnell

    “Lagest central banks ease funding conditions for banks” so that they in turn can ease funding conditions for governments by buying their debt. The interest rate is as close to zero as possible, at which point debt is simply magic new money.

  • phelps

    English Bill, english since we want to see if that was an insult, or what.

  • http://www.investorsfriend.com The InvestorsFriend

    Dave you are exactly right, people can’t find a safe return offering more than 2%. That’s presumably because supply of money (savings) exceeds demand (for borrowing). Ergo the world is awash in savings?, no?

  • Angelique Wow

    Shawn, tirent la fourchette hors de votre oreille. Svp.

    Shawn, take the fork out of your ear. Please.

  • phelps

    Thanks Angelique. My French is limited to a line from the movie Southern Comfort.

  • http://www.investorsfriend.com The InvestorsFriend

    What the fork!

  • kamran

    INVESTORFRIEND, why is the world full of savings at 2% after four years of QE’s? Shouldn’t it have already been at work toward higher returns thus growth?

    AAA analysis from Bill with basic economic that the FEDs cannot seem to figure since you need to be a PHD to have that job. I suppose.

  • RandomAtomicChaos

    Economics is not a pure science.
    One factor is not cyclical: as a species we are breeding ourselves into extinction. Increasing economic instability, internecine warfare, and the degeneration of our environment are among the effects of worldwide overpopulation. Malthus was spot on. Nature will provide our “Great Correction”.

    The End is Near.
    The Beginning is Far.

    Have a Nice Day…

Recent Articles

Laissez Faire
The Only Solution for the Obamacare Problem

Loren Heal

Politicians talk about the uninsured. Special interests argue on behalf of those with pre-existing conditions. But why is no one wondering how doctors are affected by Obamacare? They're the ones on the front lines dealing directly with new patients, as well as the red tape that makes bureaucracies go round. Loren Heal explores further...


Huge Gains From Smart Money With No Sex Appeal

Greg Guenthner

Since the beginning of March, hedge funds have been steadily moving out of growth stocks. So it's not coincidence this sector has fallen in tandem. But the question is, where is the "smart money" headed now? Greg Guenthner examines the current, decidedly "unsexy" trend in the market. Read on...


Extra!
High Frequency Trading: An Aid to Economic Collapse

John Rubino

Thanks in part to Michael Lewis's book Flash Boys, High Frequency Trading (HFT) is front and center for this round of the news cycle. Today, John Rubino continues the discussion, explaing why HFT is so dangerous, and how public awareness of it is affecting something called the "trust horizon." Read on...


Maestro
How a Central Bank Really Shapes the Economy

David Stockman

As the saying goes, there are two things you never want to see being made: laws and sausages. But to hear David Stockman tell it, there could be a third thing added to that list: how crony capitalists make money. Today, Mr. Stockman gives a complete rundown of how this corrupt system really functions, and why it makes him ill. Read on...


Video
The Art of Central Banking

Kate Incontrera

If you look at all the measurements, number crunching and financial instruments that are employed at the Federal Reserve, you may come to the conclusion that economics is a science. However, in his speech at the 2013 Agora Financial Investment Symposium, Bill Bonner explains why that couldn't be further from the truth...


5 Min. Forecast
Big Gains from an Earnings Season Surprise

Dave Gonigam

It's earnings season, and that means the "expectations game" is in full swing. Of course, with so much speculation involved, this often ends up being a "contradiction game" between various media outlets. Today, Dave Gonigam explains how to sift through the noise and play a few earnings surprises for big gains. Read on...