Corrupt and Unsustainable

James has been a big help. Trying to get him to sleep at night, we have been telling him fantastic and unbelievable bedtime stories – full of grotesque monsters… evil maniacs… and events that couldn’t possibly be true (catch up here and here).


The CongressHe turned his head until his gaze came to rest on the barred windows of the main building. Finally, he spoke; as far as I was aware these were the first words he had uttered in more than five years. “Grotesque”, he whispered, in a raspy voice. “Grotesque… grotesque…” He turned back to look at me. “Grotesque”, he repeated. It seemed a perfectly reasonable thing to say, all things considered. [from Marb Storek’s famous autobiography, “Euthanasia of the Mind”]


Yes, we have been explaining our modern money system… and coming to understand it better ourselves. The boy, just 14 months old, has probably missed some of the subtle points. But we feel confident that he got the gist of it. He knows the system is corrupt and unsustainable. He probably wonders how it will end; so do we.

Like a child that has climbed a ladder when no one was looking, U.S. stocks are near an all-time high. Soon, its parents will startle awake and try to get it down without injury. For the last five straight quarters, U.S. corporate earnings have fallen, while stocks have gone up. This divergence is not likely to last much longer.

Companies only have value because they earn a profit; take that away, and there is no point in owning them. And price-to-earnings ratios – which measure the multiple that investors are willing to pay for each dollar of earnings – are already far above their long-term averages.

Either companies will find ways to boost profits, or stock prices must fall. Which one will it be? You know what we think. We don’t like to be “negative,” but our guess is that U.S. corporations will not find a major new source of profits anytime soon. What are they going to do?

Cut costs further, after eight years of trimming expenses to protect the bottom line? Refinance loans at lower interest rates, after almost doubling corporate debt over the last eight years? Increase sales? To whom?

The most likely outcome is that stocks will decline. That is how the next chapter will begin.


1-Global-PSNot exactly a cheap market  – S&P 500 with median price/sales ratio. Not that we would want anyone to miss this unique opportunity to get in on the ground floor… – click to enlarge.


No Turning Back

A bear market should be of no particular concern to the authorities. After all, since when was the Fed in charge of making sure that the rich get richer? Ah…  since about 1987!

That’s when Fed chairman Alan Greenspan began the foolish and fatal policy of protecting investors from their own mistakes. When the Dow collapsed by 22% on “Black Monday,” Greenspan reacted by lowering rates and telling the press that he was committed to stabilizing stocks.


2-DJIA, 1987Thinking back to 1987, we recall that many people were spooked by the parallels to 1929. The 1980s boom was in many respects reminiscent of the 1920s: it started after an era of strong price inflation had come to an end, and was replaced by a “disinflation” trend. Other strong similarities were notable productivity gains, very strong credit and money supply growth, a relatively non-interventionist administration and the eerily similar patterns of both the stock market rally and the crash (Paul Tudor-Jones famously made a ton of money when he realized that the market’s price pattern was a near perfect replica of the 1920s market and positioning himself accordingly). Certain market structure and positioning characteristics exacerbated the crash of 1929 (extreme leverage due to low margin requirements, as well as innovations such as investment trusts). The 1987 crash in turn was exacerbated by “portfolio insurance” and “program trading”. With regard to such structural features, today’s situation is best described as 1929 times 1987, cubed – click to enlarge.


Since then, every attempt to correct the stock market or the debt market has been met by the feds like the French Imperial Guard charging the British lines at Waterloo. Hopeless and futile, it nevertheless confused the situation and postponed the inevitable collapse.

And now, almost 30 years later, there is no turning back. No point in reconsidering. It’s too late for further reflection. The Fed must draw up its cannon, unsheathe its sabers, and ride to the sound of the guns. Otherwise, the battle will be lost.

Falling stock prices – when they come – will first be greeted by calm announcements from the Fed.

“We are keeping a close eye on the situation,” it will say. “Our data show nothing to worry about,” and so forth. But investors will worry. They will retreat with more of their money. Prices will fall further… and the Fed will be forced to bring out its heavy artillery.


artilleryFrench line guard artillery in Napoleonic times. At Waterloo it ultimately didn’t help…


“New initiatives,” will be widely discussed. Incredible new weapons will be unveiled. But that is still in the future,  perhaps far in the future. For now, after James leaves tomorrow, we will have to go back to shuffling around the garden and muttering to ourselves.


Charts by: Ned Davis Research, StockCharts


Chart and image captions by PT


The above article originally appeared at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.




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One Response to “The Fed’s “Waterloo” Moment”

  • alexaisback:

    While many want to consider the FED as independent
    Yellen is clearly politicized. Look at all her contact cronies
    and her nomination by Obama.

    Yellen will clearly do what it takes to keep the stock market up
    to protect the Obama ‘ legacy ‘ – the idiot sheep in the US don’t
    realize the damage all the spending Obama has done and the FED has
    done have caused – but only believe the media on the short term hype
    they ‘ saved the country ‘

    In the end The FED will continue to artificially support the market Including but not limited to
    buying stocks just like the BOJ

    Also there is little doubt the FED has been buying the bad debt of many large corporations
    friend to friend Jamie Dimon – no doubt in my mind. And there is no doubt they will
    continue to buy bad debt. Top Secret No Audit Subject to No One helping out a friend.
    . Criminality does not matter.
    . “What difference, at this point, does it make?”

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