Bear Markets Do Happen

Today… the second of the speech about the end of the world we recently gave at Doug Casey’s La Estancia de Cafayate. (You can catch up on the first part here.) As Yogi Berra would say, America is going to come to a fork in the road… and it’s going to take it.

Right now, the Fed isn’t as aggressive as the European Central Bank (which is set to pump €1.2 trillion into the financial markets by way of its QE program) or as innovative as the Bank of Japan (which is buying stock market funds as well as bonds by way of its QE).

 

LENINE2

Vladimir Ilyich Ulyanov, a.k.a. Lenin, addresses a crowd in St. Petersburg in April 1917

Photo via Wikimedia Commons

 

Valuations are at extreme highs on Wall Street. Take Warren Buffett’s favorite measure – market cap to GDP. With an eight-month exception at the height of the dot-com boom (and you know what happened next), the value of all outstanding S&P 500 shares is the highest it has been relative to US GDP in the last 100 years.

Meanwhile, Deutsche Bank is warning that S&P 500 earnings per share will be flat this year when compared with 2014. Retail sales are down about 9% on an annual basis over the past three months. And the US GDP has slowed to an annual rate of just over 1%… with the possibility of a surprise recession on the horizon. Besides, crashes and bear markets happen. This seems as good a time as any.

 

Buffett-IndicatorMarket cap to GDP a.k.a. the “Buffett Indicator”, via Doug Short/Advisor Perspectives. Yes, the market does appear to be slightly overvalued … click to enlarge.

 

Deeper into the Heart of Darkness

When the next crisis comes, the fork in the road will be a choice. The Fed can either admit its policies have not worked… chuck them out… let interest rates settle where the market wants them to settle and let the free market do its work.

Or it can follow the Europeans and Japanese toward more aggressive intervention – including massive QE and direct stock buying. I don’t think there’s any doubt about what it will do: It will go deeper into that heart of darkness.

In fact, I believe central banks and central governments now have revealed the full madness of their intentions. Well, maybe not the full madness. They haven’t thrown money from helicopters yet … but that will come.

Here’s what’s in the cards for central banks:

 

  • They will set interest rates at preposterously low levels for years and years
  • They will finance 100% of government deficits – forever, if it comes to that – with printing-press money.
  • They will also pump up the stock market with this same money-from-nowhere by directly buying equities ETFs (as the Bank of Japan is already doing).

 

You’d have to be brain-dead (or a modern economist) not to be staggered by the audacity… the ballsy mendacity … and the incredibly big lie that undergirds the entire charade: that you can create money out of nothing and use it to pay for wars, schools, highways, and salaries for bureaucrats … and also to acquire real businesses.

 

brando facepalm

Upon journeying deeply enough into the heart of darkness, you will be greeted by a Brando facepalm. It means you have failed in a singularly depressing fashion. He may mumble something like “… are my methods unsound?” to confuse you.

Photo credit: Vittorio Storaro

 

We’re with Lenin …

I recall Lenin’s quote: “The capitalists will sell us the rope with which we will hang them.”

Today, of course, the capitalists don’t even sell the rope; they give it away, for nothing. But what’s not to like? Stock investors are getting rich. Bondholders are making money. The government can spend as much as it likes. And the voters are bamboozled by it; they think it helps make the economy work better.

This is going to be a hard habit to break. So, here’s the gist of my conclusion: Governments won’t break the habit of getting something for nothing. It will break them. But how?

It looks as though they’ve got the perfect hustle going. They create money to buy their own debt. But this doesn’t cause consumer prices to rise (at least how they’re officially measured). Everybody’s happy.

Obviously, that won’t work forever. I don’t care how many knobs you turn or how many levers you pull. It doesn’t work that way. Ultimately, you’re putting rusty nails on the ground… and you’re going to step on them How? When?

Nobody knows. But I’m going to take a guess …

 

got ropeRope comes for free these days … or at least the money to pay for it does.

Photo via twitter.com, source unknown

 

The Weakest Link

And here I’m no longer using my powers of observation to tell you what is going on. I’m using my intuition and guessing. The weakest link in the central bank chain, I believe, is credit. So let’s look at how this link might break.

In our modern economy, when we talk about “money” what we are really talking about is credit. Banks create this credit ex nihilo (out of nothing) when they make a loan. It exists, for the most part, as a digital record on a computer network somewhere…

And unlike even traditional paper money, this credit can vanish as quickly and easily as it got here in the first place.

Because it is purely digital in nature, you can’t hoard credit. You can’t put it in your safe. You can’t take a wheelbarrow full of it to the grocery store for a loaf of bread. Credit depends on trust. (The word “credit” comes from the Latin “credere” – to believe or trust.)

So, when our financial system implodes – which is what always happens when there is too much debt – the machinery of borrowing and lending will seize up. No one will trust that he will get paid. Credit will simply disappear – trillions of dollars of it – overnight.

This is, of course, not the end of the world. Nor even the beginning of the end. But it will be the end of the beginning of the paper money world President Nixon unwittingly created in 1971. Then the end can begin…

 

G-10-debtDebt components to GDP, G-10 – click to enlarge.

 

Image captions by PT, charts by: Doug Short / Advisorperspectives, Haver Analytics / Morgan Stanley Research

 

This article is part 2 of a speech Bill Bonner delivered at Doug Casey’s La Estancia de Cafayate and appeared originally as “Lenin Was Right …” at Bonner & Partners. The first Part was “I Hope I’m Wrong About This …”.

 

 

 

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