We have markets that aren’t really ma rkets anymore

Monday, 19 July 2021 — Denver, Colorado

[7 min read]

Dear Reader,

For most investors, the biggest thing that happened in September of 2008 was the collapse of Lehman Brothers on the 15th. It was the ‘Big Bang’ of the Global Financial Crisis. In some ways, we’re still living with the consequences of that day.

Today we have quantitative easing. We have central banks playing a leading role in the support of higher and higher stock prices (and lower and lower bond yields). We have markets that aren’t really markets anymore.

By all objective measures of valuation (Tobin’s Q, Buffett’s market cap-to-GDP, Robert Shiller’s cyclically-adjusted price-to-earnings ratio), stocks are expensive. But it’s as if those measures of value don’t matter anymore. All that matters is liquidity. As long as it’s abundant, it has to go somewhere.

Maybe we’re living in an alternate reality. On 10 September 2008, the Large Hadron Collider went online underneath France and Switzerland. In some of the kookier corners of the internet, there’s a belief that when the world’s largest particle accelerator was switched on, it created a disturbance in the universe.

History forked, and we entered a new timeline in which everything took a new course. Or, if you prefer, a timeline in which everything is getting increasingly crazier. These certainly seem like the crazy years. And not just in financial markets.

Australia, for example, seems to be in the grip of a national psychosis regarding the coronavirus. The media, politicians, and public health officials are running the asylum. The national vocabulary is dominated by terms like ‘exposure site’, ‘contact tracing’, ‘variant of concern’, and other fear-inducing terms. From afar, it’s like watching a dystopian TV drama about how to turn a country into a police state.

When you’re allowed to go outside, you’re told you have to bring an ID and wear a mask. And of course, you mustn’t go more than 10 kilometers from your front door. And if you receive a text from a government authority to self-isolate, you must comply.

What’s the goal here? Eradication of a virus that will be with us forever anyway? Or is it sociopaths in power taking full advantage of the circumstances to make an unprecedented grab for more power and control? Hmm.

The only consoling thought is that history moves in cycles, sort of like financial markets. Take the fact that at the end of March, Americans had a 60% allocation to stocks, according to the Wall Street Journal (WSJ). The last time it was that high was at the peak of the dotcom bubble, where it reached 61.7%.

Just when everyone was convinced stocks had to keep going up, they didn’t.

When expectations for future returns are high, the actual returns (going forward) tend to be low. The opposite is true. When expectations are low (because returns have been low), actual returns are high going forward. From WSJ:

‘When households’ stock allocations have risen to 54.6% or higher—as they did during the dot-com bubble and the years leading up to the 2007-09 recession—the average annualized return for the S&P 500 over the next 10 years has been 4.1%. In contrast, when stock allocations have hovered around 29% or lower, the average annualized return over the next 10 years for the benchmark index has been 16.3%.’

You only get reduced allocations to stocks when something bad happens, like a recession or a crash. That’s the cycle. For something good to happen in the future, something bad has to happen in the present, or at least soon.

That’s probably not the most optimistic thing you’ll read today. But cheer up. For those of us with large allocations to cash, a crash can’t come soon enough. That’s when you can load up on quality businesses at a cheap price, unlike today, where you have poor businesses that are very expensive.

By all means, keep buying if liquidity is the only factor you’re considering. But liquidity moves in cycles too. It’s abundant and sloshes around everywhere, lifting all asset prices during a bull market. But beneath the surface, a torpedo punctures the hull and the boat sinks.

In financial markets, you never know where the torpedo is going to come from. If it’s not war or natural disaster, it’s usually a ‘credit event’ like Lehman Brothers. It can be a big, systemically important firm that finds itself on the losing end of a major bet. All its counterparties are then exposed, and you get the dreaded contagion.

Or it can be some hedge fund that nobody ever heard of (like Long-Term Capital Management in 1998). Using borrowed money, very smart people find themselves suddenly on the wrong end of a trade. The end which results in bankruptcy and the liquidation of the fund, and more chaos in the markets than anyone thought possible.

Maybe those things ARE impossible now that central banks are in charge all the time. Maybe rising stock prices have replaced job and wage growth as the number one priority for central planners to keep the population pacified. If stocks were to crash, imagine how many more people might be out in the street, looking for answers and asking for help.

We may get there yet. The French aristocracy had no idea what was coming in 1787. But when the timeline of history swerves in an unexpected way, watch out. It’s swerving now.

Regards,

Dan Denning,
Editor, The Rum Rebellion

‘Liquidity…liquidity everywhere…and not a drop to drink.’

The Lament of the Ancient Mariner
(adrift on a sea of fake money)

When the Nixon Administration cut the link between the US dollar and gold, it didn’t write a new chapter in monetary history; it simply repeated a sad, old one.

It took the dollar from something natural — a vernacular money, developed over thousands of years of trial and error…to something unnatural, established by decree in 1971.

Many times have nations experimented with this ‘fiat’ currency. Never, as far as we know, did the story end well.

Reshaping the financial system

But from the authorities’ point of view, the advantage of this new wampum was that it would give them more ‘liquidity’. That is, they could print as much of it as they wanted.

Since then, the dollar has lost about 85% of its value — compared to the goods and services it is meant to measure. Against its old companion, gold, it has lost 96% of its value.

Creating new money can be extremely profitable. So it’s not surprising that others are trying to elbow their way into the trade. The Epoch Times reports ‘Concerns Surround IMF Plan to Flood World with Liquidity’:

‘A controversial plan to boost global liquidity means the days of the U.S. dollar being the undisputed king of the international monetary system may be coming to a close, experts told The Epoch Times.

‘The Biden administration-backed International Monetary Fund (IMF) proposal to issue an unprecedented $650 billion U.S. dollars’ worth of new “Special Drawing Rights” (SDRs) this year alone will also help re-shape the international financial system.

‘That is more than twice the total amount of SDRs created by the IMF throughout its entire history.

‘The SDR is a sort of proto-global currency, based on a basket of leading currencies, dubbed an “international reserve asset” by the IMF.’

In other words, the IMF is taking it upon itself to give the world more of what it least needs — money — exactly when it least needs it, just at the beginning of a major, international inflation.

Problem with inflation

But the trouble with trouble is that it starts as fun. And the fun continues…for a while. People are happy to get the new money.

Alas, each new note competes with existing notes for the same goods and services.

That’s the problem with inflation — it increases demand without increasing supply.

Prices rise. The money — old and new — falls.

Those new dollars make the people who get them richer…but leave everybody else worse off than ever. They face rising prices with no extra money to pay them.

Transforming the economy

But the IMF is not the only one getting in on the ‘new money’ scam.

Here’s RTE reporting on Wednesday:

‘The European Central Bank is expected to take the next step towards a “digital euro” today by launching the project’s exploration phase, but questions remain about potential pitfalls and benefits for euro zone citizens.

‘The move comes as the coronavirus pandemic has hastened a shift away from cash, and as central bankers around the world nervously track the rise of private cryptocurrencies like bitcoin.

‘A digital euro would “complement cash, not replace it,” the ECB has stressed.’

‘Complement’ is the key word, as in ‘in addition to’. The ECB has already created almost US$4 trillion in new money since January 2020. And ECB chief Christine Lagarde recently told reporters that she has no intention of unplugging the printing press.

‘As the pandemic passes,’ said Ms Lagarde, ‘we need to shift the focus from preserving the economy to transforming it. This will require us to redirect spending by both public and private sectors towards the green and digital sectors of the future.’

Translation: Forget the coronavirus; we’re not going to stop our money printing…not as long as we have such great new boondoggles to finance!

More liquidity

Yes, central banks no longer think their role is to maintain the security of the money system, or to protect the value of the currencies of which they are the custodians, but to use their printing presses for whatever damned fool thing they want.

Oh, dear, dear reader…we almost swoon, thinking of the glorious future made possible by…more liquidity!

All together, central banks and central governments worldwide have flooded the world with some US$27 trillion in stimulus since March 2020.

And there are still other forms of liquidity coming onstream. Cryptocurrencies, for example. Cryptos claim to be money, too. As they grow in number and value, the flood waters rise.

Who knows where the cryptocurrencies will end up? But right now, they are being used as money. If you bought a few bitcoins 10 years ago, for example, you now have a lot more purchasing power…just as if you had earned more money.

And now, like the Ahr and Nahma rivers in Germany, cryptos overflow their banks. At last count, the total buying power of the cryptoverse was some US$1.3 trillion.

Drowning in liquidity

Stock market gains, too, represent a flood risk.

At the bottom of the 2008–09 financial crisis, US stocks had a total value under US$10 trillion. Now, they’re almost US$50 trillion.

Are companies really five times as profitable? Of course not. Most of that gain comes from ‘money’…‘liquidity’…‘benjamins’…‘dinero’…moolah that pushes up stock prices — by some US$40 trillion.

Now, the world is up to its neck in ‘liquidity’.

Next week, we’ll look at how all this money disappears.

Hint: It will not be orderly.

Stay tuned…

Regards,

Bill Bonner,
For The Rum Rebellion