InnOvation Capital & Management, LLC
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
JULY 19, 2016
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
WARNING: the following discussion is neither pleasant nor uplifting.
As we wrote last week, debt is the biggest economic problem in the world, and has been for more than ten years; the global economy is drowning in debt. Corporate debt in emerging markets has jumped five-fold over the past decade, and companies in the U.S., Europe, and Japan have been taking advantage of ultra-low interest rates to amass TRILLIONS of dollars of new debt. U.S. corporations are carrying twice as much debt on their books as they did six years ago.
Somebody owns that debt … you and I, and everyone that we know. That debt shows up, primarily in the form of bonds, in our own investment portfolios, as well as investments by our banks and pension plans and insurers. Corporations, non-profit foundations, governments all invest or park their cash in money market and investment funds loaded with bonds and other debt instruments. That debt permeates all of our lives.
The Federal Reserve and other major central banks … in the U.K., European Union, Japan, and China … have encouraged the amassing of debt. The global economy is being propped up by the easy-money policies of central banks, whose leaders believe that they can simply paper over any fiscal or monetary problem by printing more currency. Because they believe that they can “print growth,” every major central bank in the world has gone overboard with easy money.
Do you know how this will play out? Neither do we, and neither do the central bankers. Economic growth and prosperity does not come from creating currency out of thin air, and the world has never seen so much bad debt. But, central bankers are intent on printing money and cutting interest rates, which only makes the problems worse.
How will currencies be valued when they offer no yield? What prosperity will come from highly leveraged companies? How much upside remains in equities which have been artificially inflated?
Since the 2008 financial crisis, central banks around the world have cut interest rates hundreds of times, cumulatively, and created $12 trillion of new currency, this according to MarketWatch. We believe that this course will, eventually, destroy the paper currencies which the central bankers are supposed to be defending.
(Later in the Summer, the Federal Reserve will be the primary topic of one or two issues of IntelDigest. For purposes of this discussion, The Fed is just one of the several major central banks from around the world which have piloted their economies into dire straits.)
The Bank for International Settlements is, essentially, the central bankers’ bank. Based in Basel, Switzerland, the BIS is the oldest international financial organization in the world; over 60 central banks are its members, and its mission is to serve the central banks in “their pursuit of monetary and financial stability.”
A recent BIS report warned of the “risk trinity” of conditions looming over the global economy. These include (1) productivity growth which is unusually low, (2) global debt levels which are historically high, and (3) central banks with fewer options and little room to maneuver in addressing these problems.
Financial markets are fragile, and interest rates have gone negative around the world. Are you annoyed that your bank deposits pay interest of less than one percent? In many countries, citizens now have to pay the bank for the pleasure of depositing money into their accounts.
Central banks and their governments have painted themselves into a corner, and they are unlikely to find the way out because they are stuck in their fundamental presuppositions about monetary policy, which many say are fundamentally wrong. They have manipulated the system, and created a world where savers are penalized and companies are paid to buy their competition rather than compete. They intended to create inflation and growth by continually cutting interest rates, but only select financial assets have appreciated while economies have stagnated.
It is likely that the world economy will be stuck in neutral for the next two years.
As a result, the “smart money” has been betting on gold. Next week, IntelDigest will present a more-detailed examination of Gold as an investment for the next few years. In the meantime, we’ll just point out that many highly-regarded stock investors and hedge fund managers .. Stanley Druckenmiller, David Einhorn of Greenlight Capital, George Soros, as examples … have increased their investments in gold significantly in the last year, and are holding historically high proportions of their respective assets in gold ETFs and gold mining companies. More on this topic next week.
In the very short term, there is still money to be made in U.S. markets. As we wrote last week, U.S. equities, fixed investments, and real estate are continuing to benefit from low interest rates and the influx of capital from around the world … from investors whose home economies are in worse shape than the American economy.
This dynamic may continue through the end of the year, as the long bull market in equities sputters to its end.
However, the fundamental problem of debt is expected to drag down markets in the coming years. Our national debt is now at $20 trillion. Those are current government liabilities. Unfunded future liabilities are much greater. There will come a day when this debt will become impossible to finance, with a resulting devaluation of the U.S. Dollar.
The amassing of debt continues unabated. Government spending in the U.S. (Federal, state, and local) is now $7 trillion per year, making up 38% of the total economy. Add in medical spending, which is directly or indirectly financed by government, and the total government spending as a percentage of the American economy is over 50%.
(At the same time, the private debt of Americans …. mortgages, credit cards, student loans, etc. … now totals $17.5 trillion.)
Nothing is limiting the growth of government spending. When legislators face a fiscal crisis, their options are to raise taxes, cut the cost of government, or inflate the currency. The U.S. Congress of the last two decades has been unwilling to either raise taxes or reduce government spending, so no progress can be expected there.
Therefore, it is left to the Federal Reserve to create inflation; the Fed has a target of 2% inflation per year. But, even if it is successful in breaking the economy out of the current deflationary environment, there is the danger that the Fed will overshoot its target. Massive money printing is most likely to lead to runaway inflation.
Runaway inflation is a form of “stealth taxation” in that it devalues the dollars in our pockets. Devaluing the currency favors debtors, such as the federal government, which is the biggest debtor in the land.
So, here in the U.S., we can look forward to “progressing” from our current low-interest-rate environment, possibly into a negative-interest-rate environment, and onward to a highly inflationary economy.
Whichever way it goes, it’s not good for savers.
Well, that’s enough for this depressing column. However, you will be better prepared to face and plan for the future if you know what’s really happening in the economy. In the next several issues, we will discuss positive strategies which you can use in managing your assets in the coming years.