One of my favorite lines is “I’m not the kind of guy to say I told you so – but if I was, I’d sure be saying it now.”
As far as saying “I told you so,” back in the summer of 2008, in my “Friday Night Illumination” emails to my banker and trader friends, I screamed, “SELL EVERYTHING!”
People thought I was nuts. Literally, that I’d lost my mind. Sell everything – no one ever says that, ever.
But I said it, over and over. SELL EVERYTHING! It was an insanely bold call. At least that’s what everyone said to me after the fact.
It wasn’t a bold call. It was telegraphed. And I wasn’t the only one who read it right.
Today I’m going to show you how it will not only be different – but also a lot worse…
That’s because the rescuing armies this time – the U.S. Federal Reserve and the globe’s other central banks – are the ones going under. If that happens, we’re going to have a global depression of biblical proportions.
There is time to stop it. However, those central banks are stoking the locomotive’s furnace to the tune of “Old Charlie stole the handle, and the train, it won’t slow down.”
The crash is coming because central banks’ engineered low-to-no interest-rate policies grossly distort free markets. That makes true price discovery impossible, and front-running, financed by flimsy carry trades, has become a perpetual-motion trade.
If you don’t get that, don’t worry – you’re not alone. The central banks don’t get it, but they’re starting to. It’s not complicated at all. It is what it is. It’s about casino capitalism.
Here’s the game that’s being played, plain and simple. And here’s how it’s going to end.
Central banks artificially lowered interest rates, which causes market distortions, which leads banks and households to leverage themselves up, up and away. When the housing market and mortgage securities imploded, the pain spread around the world.
But the pain wasn’t all about mortgages.
It was all about “credit” in the system and how easy credit, courtesy of low interest rates, facilitated cheap financing of real estate and heavily margined and leveraged securities positions. Easy credit also aided and abetted counterparties wagering trillions of dollars on bilateral derivatives contracts that they folded up and tossed about like paper airplanes.
Confidence in the system collapsed when credit evaporated and players crapped out.
The credit crisis was a global phenomenon. That’s because credit stems from banks. Banks everywhere were in trouble. By trouble, I mean insolvent. Central banks had to rescue them.
That’s where “stimulus” came in. Zero interest rates don’t matter if you’re a bank with zero money to lend. So what if you can borrow from the Fed at zero interest? If there’s no one borrowing from you and you can’t make money by lending, you’re toast.
That’s where quantitative easing came in. QE was a desperate measure. Plain and simple, if you’re a central bank and your banks don’t have any money and you work for them, you find a way to give them money so they don’t have to close down for good.
The Fed and other central banks (using different names, though the European Central Bank just went ahead and called its latest $1 trillion giveaway QE) printed money and steered it directly onto banks’ balance sheets so they wouldn’t be insolvent.
Stay with me here, because this is the part that will blow your mind if you don’t know it.
This Year’s Front-Runners
The Fed and the world’s other central policymakers manage this balance-sheet bloating trick by buying bonds from banks. But there’s no difference inside the bank if they have bonds (which are worth something) on their balance sheets that they sell for cash. It’s just a switch. There’s no addition to the balance sheet.
What really happens is that banks (I’m talking about big banks, the too-big-to-fail banks that all failed in the credit crisis) buy government bonds from governments that always have to roll over their debts. Sure, they pay full price for the bonds, but they don’t put up the full amount. They buy them on margin.
It’s done with clicks on electronic ledgers, so don’t sweat the mechanics. Anyway, central banks then buy those bonds from the banks and pay in full (credit them in full on another electronic ledger). And presto!
The Fed stuffed its big banks with more than $4 trillion. That’s enough to make them not only solvent but very profitable again. And the folks in the government? They love it because they don’t have to worry about selling their debt. They’ve got a readymade syndicate to take all they have to offer – at very low rates mind you!
Bank balance-sheet bloating has been going on around the world.
And, as if not a single lesson was learned from the last credit crisis, speculators have leveraged up their “risk-on” positions because they can finance them for next to nothing.
Almost all of the big bets being made, in the tens of trillions of dollars, are front-running bets. Front-running central banks, that is.
Take any example you like, the front-running trade works the same everywhere.
Let’s take Europe, because it’s the latest example of massive front-running.
Hedge funds, institutional traders, mutual funds and banks all bought the sovereign debts of beleaguered European Union member countries back in 2012. They were all paying big interest-rate spreads over better quality bonds, like U.S. Treasuries.
But when ECB President Mario Draghi famously said, “Whatever it takes,” (to support the euro, the EU and its banks), the front-running began.
Buyers paid higher and higher prices for government bonds, driving their yields down. As of this morning, the 10-year yield on German Bunds is 0.34%; 0.57% for French bonds; 1.46% for Spanish ones; and 1.62% in Italy. And the Swiss 10-year yield is negative 0.08%.
Why so low? Because, just like in the United States, bond buyers (speculators) knew the central bank would have to come and buy their inventory from them. The ECB just announced a 1 trillion euro QE program. So, the speculators who drove up bond prices and drove down yields to insanely low levels will make a fortune selling their stockpiled government bonds to the ECB at the bloated prices they drove them up to.
But, Houston, we have a problem.
Ghosts in the System
Somewhere, probably in Europe, maybe in Japan, maybe in Russia, banks are going to fail, probably because they loaned too much money to beleaguered oil and gas companies. Or worse, a European crisis could erupt from a Greek implosion and contagion – and then what?
After everything central banks have done to save the credit system, in the end they leveraged it up even higher with even lower interest rates.
A break anywhere in the credit system could cause contagion. If the central banks have done all they could do and are themselves leveraged well beyond being insolvent (none of them have real capital – they’re all ghost lenders), confidence in the system will evaporate.
That’s when it will be time to sell everything.
It could happen. It’s going to happen.
Only by immediately addressing the structural problems facing indebted countries and still shaky banks can we veer off in another direction. But the likelihood of that happening is precisely between slim and none.
I’m not saying I told you so.