jueves, 9 de octubre de 2014

jueves, octubre 09, 2014

Things That Make You Go Hmmm...

The Consequences of the Economic Peace

By Grant Williams

October 6, 2014

“There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
 
­–
 
 
 
 
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
 
“I find economics increasingly satisfactory, and I think I am rather good at it.”
 
 
 
 
This week’s TTMYGH is going to be a little different.
 
After several weeks on the road and staring down a couple more, I am going to make an attempt to turn the presentation I have been delivering into written form, after many requests for a version that people can look at in the comfort of their own homes (and, presumably, without my annoying voice clouding the issue).
 
I’m hoping I can turn a very visual and fluid presentation into a more static one; but I’m sure that if I fail miserably, you’ll let me know.
 
This will make for a chart-heavy and consequently much longer piece than usual (though lighter on additional articles in the interest of saving your time and space this week), but let’s see if we can’t make this work.
 
The presentation, entitled “The Consequences of the Economic Peace,” is a look at the ramifications of several decades of easy credit and an attempt to draw parallels with a time in history when the world looked remarkably similar to how it does now.
 
That last time didn’t end so well, I’m afraid.
 
So... without further ado, here we go.

The Consequences of the Economic Peace

The 19th century was a time of upheaval right across the world.
 
There were no fewer than 321 major conflicts in a century which encompassed, among others, the Napoleonic Wars, the Crimean War, the US Civil War, the Boxer Rebellion, the Opium Wars, and the Boer War.
 
That single century saw no fewer than 52 major conflicts in Europe alone.
 
Britain, as the world’s preeminent superpower, was involved in an astounding 73 conflicts in that single 100-year span. In addition, France fought 50 wars and Spain fought in 44.
 
How crazy was Europe in the 19th century?
 
Well, Britain and France fought on the same side in six major conflicts; the Spanish and the French sided together on nine occasions; and Britain and Spain found themselves in alliance in seven different wars.
 
HOWEVER…
 
Britain and France fought each other in no less than eight separate wars between 1803 and 1900; and in 1815 alone Spain and France fought each other on four occasions, while the British and Spaniards were on opposing sides six times during the century.
 
And people wonder why the EU is such a tricky proposition…
 
The serious point to be made, though, is that once it comes to war, former alliances count for nothing.
 
Anyway, as the 19th century made way for the 20th, Jan Bloch, a Polish banker, wrote a book entitled Is War Now Impossible?, in which he predicted that the lightning wars of the past — where cavalry ranks and infantrymen faced each other in hand-to-hand combat, deciding victory and defeat in short, brutal fashion — were to be replaced by drawn-out, grinding trench warfare.
 
“Everybody will be entrenched in the next war. It will be a great war of entrenchments. The spade will be as indispensable to a soldier as his rifle.”
 
— Jan Bloch, Is War Now Impossible?
 
Cheerful soul, was old Jan.
 
But, despite Bloch’s dire predictions, the first decade of the 20th century was blissfully peaceful, with no conflicts between European powers anywhere on the continent.
 
By the time 1910 rolled around, however, political tensions were rising across Europe.
 
The Franco-Prussian war that had so inspired Bloch had led to the creation of a German Empire and the ascension of Wilhelm II to the German throne in place of arch diplomat Otto von Bismarck. It had also made the country more bellicose.
 
Russia, meanwhile, had lost most of its Baltic and Pacific fleets in the Russo-Japanese War of 1905, and that defeat had led to revolution. Defeat in the Far East forced the country to turn its attentions westward towards the Balkans — a region it eyed lasciviously — as did its old rival Austria-Hungary.
 
Europe%201914.jpg 
 
Meanwhile, in 1907, Britain and France had signed the Entente Cordiale, which finally put to bed a thousand years of almost continual conflict between the two countries (or at the very least reduced the “warfare” between the two to bouts of French impoliteness countered by silent indignance with some heavy tutting on the part of the British).
 
In 1908, Austria-Hungary had annexed Bosnia & Herzegovina; and in 1912 Serbia, Greece, Montenegro, and Bulgaria formed the Balkan League to challenge the Ottoman Empire.
After some classic in-fighting when Bulgaria turned on its allies (only to be defeated inside a month), the Balkan League emerged victorious — a victory that disturbed Austria-Hungary, who feared nothing more than a strong Serbia on her southern border.
 
1914%20State%20of%20Play.psd 
 
So here’s where Europe stood in 1914:
 
Great Britain, her power receding, was struggling to play the role of the world’s policeman; Germany, newly industrialised and ruled by a nationalistic leader, was puffing her chest out to the rest of the continent; and good old France was in steady decline and (no doubt painfully) reliant upon her old foe Britain for support.
 
And yet, despite such geopolitical turmoil everywhere, the man in the street was remarkably sanguine about the state of the world:
 
The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper.
 
— John Maynard Keynes, The Economic Consequences of the Peace
 
Those words were written by none other than everybody’s favourite economist, John Maynard Keynes, in his book The Economic Consequences of the Peace, a publication which made him a household name all around the world.
 
It’s a sad indictment of today’s society that the only way for a modern-day economist to achieve Keynes’ level of fame would be to become a serial killer or marry a Kardashian.
 
But I digress... let’s get back to Europe in 1914. Despite the numerous mounting problems, as Keynes had pointed out, everyday life went on as usual — and the men and women of Europe in general and the UK in particular assumed that nothing untoward would happen.
 
Europe’s leaders would make sure everything got sorted out.
 
Sound familiar?
 
Then, on the 28th of June, 1914, amidst all the known knowns, a young man called Gavrilo Princip stepped up to a passing car in Sarajevo and with a single shot became a Black Swan that changed the course of history when he assassinated Archduke Franz Ferdinand of Austria.
I won’t go into the details of WWI at this stage; but in case you don’t know about it, I’m told there have been several books written on the subject (Barbara Tuchman’s The Guns of August being my own personal favourite). Anyway, after four years of warfare that tore the world apart like never before, a peace was finally reached.
 
But it was a peace which one man in particular vociferously condemned — and that man was John Maynard Keynes.
 
Keynes had left Cambridge University to work at the Treasury in 1915, and he had been hand-picked to attend the Versailles Conference as an advisor to the British Government. He was staunchly against reparations of any kind and advocated the forgiveness of war debts (yeah, I know… go figure); but as it turned out, his advice to focus on economic recovery was disregarded; and Keynes resigned his position, returned to Cambridge, and set about scribbling furiously in his notebooks.
 
In just two months, Keynes wrote the book that would make him a household name around the world — The Economic Consequences of the Peace.
 
In the book, Keynes was highly critical of the deal struck at Versailles, which he felt sure would lead to further conflict in Europe — describing the agreement as a “Carthaginian peace” — and with the passing of a surprisingly short period of time, he would be proven correct.
 
The three major figures on the Allied side of the negotiating table at Versailles were President Woodrow Wilson of the USA, President Georges Clemenceau of France, and British Prime Minister David Lloyd George.
 
Wilson wanted what he called a “fair and lasting peace,” which was based upon his famous “Fourteen Points” plan and which would create a League of Nations (the forerunner to the UN) as well as reduce the armed forces of all countries.
 
The French? Well they were just pissed.
 
Understandably, they wanted Germany to be punished and proposed severe reparations alongside punitive confiscation of land, arms, industry — and even citizens.
 
Britain’s Lloyd George was caught between a rock and a hard place. Privately, he agreed with Wilson on each of his points, but public opinion in Britain dictated that he side with Clemenceau, and so it was the French proposal that won out.
 
On the other side of the table was, of course, Germany; and, in truth, based purely on the numbers, Keynes’ claims about the nature of the peace are hard to dispute.
 
Germany was forced to pay £6.6 billion in reparations.
 
Now, to put that into perspective, that’s about £320 billion in today’s money. Want a little more perspective? Well, the amount of money that Germany was forced to pay back after WWI — an amount so punishing that it led, as we’ll see, directly to WWII — was conjured up out of thin air by the Bank of England — INFLATION-ADJUSTED, I’D LIKE TO STRESS — in just 33 months between January 2007 and September 2009.
 
Reparations.psd 
 
Along with those reparations, Germany lost 13% of its land in total and 15% of its agricultural land, 12% of its population, 48% of its iron ore production, and 10% of its coal (which was given directly to the French). Meanwhile, Germany’s army was cut to 100,000 men, its navy to 36 ships (and no submarines), and the nation was banned from having an air force.
 
Reparations%202.psd 
 
The peace hammered out at Versailles would end up having grave consequences just 20 years later as the economic straitjacket into which Germany was buckled enabled a firebrand former lance corporal in the Bavarian army to seize control of the country and once more plunge the world into the darkness of war.
 
Alongside warfare, there are few things that affect a greater proportion of a nation’s citizens than economics; and as hard as it is to believe, given today’s apathy towards the subject, before the advent of cable TV, the study of economics was the stuff of rock stars.
 
Until Sismondi’s Nouveaux Principes d’Économie Politique was published in 1819, classical economists had either denied the existence of business cycles or blamed them on external factors — chief amongst them, funnily enough, war.
 
In 1860 the French economist Clement Juglar had identified repeating economic cycles lasting 7 to 11 years, and Joseph Schumpeter had expanded upon Juglar’s work by identifying four separate stages within the Juglar Cycle:
 
expansion, crisis, recession, and recovery.
 
These four stages form what we used to lovingly refer to as “the Business Cycle.” (I say “used to” because the downward half of the business cycle has been abolished by the Federal Reserve — for reasons we shall come to shortly.)
 
Kondratieff%20Mugshot.psd
 
 
However, in 1920, a year AFTER the Treaty of Versailles, a Russian economist called Nikolai Kondratieff founded something he named The Institute of Conjuncture (not conjecture, conjuncture), at which he and a team of fellow economists studied, yes, conjuncture — or business cycles, with a particular focus on the long waves they identified within those cycles.
 
Over the years since Kondratieff first laid out his theory on long-wave cycles, a tremendous debate has ensued as to the usefulness of such long-term prognostication; but there is one very good reason why I (and many others) believe there to be a significant advantage gained through the study of long-wave cycles…
 
(Wikipedia): Long-wave theory is not accepted by most academic economists.
Good enough for me.
 
But let’s get back to our Russian friend.
 
Kondratieff, being a Russian, of course took the long view.
 
He took Schumpeter’s four stages and equated them to the four seasons in a year. Once he had identified what he felt to be the length of each “Spring,” “Summer,” “Autumn,” and “Winter,” Kondratieff had his “Wave;” and, as it turned out, that Wave ran for approximately 53 years.
 
In 1925, when he published his book The Major Economic Cycles, using existing data, Kondratieff overlaid his wave on world history and projected it forward — meaning that everything for the 89 years that followed was conjecture on his part (not conjuncture, conjecture).
 
Kondratieff%20Wave.psd 
 
How’d he do? Well, as it turns out, surprisingly well. Kondratieff nailed far too many major turns to have his work simply dismissed, and his most recent turn into Winter occurred in 2000 or, for those of you who measure the passing of time by such things, precisely at the bursting of the tech bubble.
 
 
Kondratieff%20Winter.psd
 
 
The blue shaded area shows how far into the current Kondratieff downwave we are and — far more importantly — how much farther we have to go before things are supposed to turn around.
 
But what do the inner workings of a Kondratieff Winter look like? And are we in the middle of one, as a nearly 90-year-old forecast would have us believe?
 
Like Schumpeter’s cycles, the four seasons in a Kondratieff Wave are broken down and characterised by the phenomena usually seen during each specific phase of the full cycle.
 
I won’t go through all four seasons now, as we don’t have time, but rather we’ll focus on the longest phase — Winter — as it’s the one we find ourselves mired in.
 
In a Kondratieff Winter, the first major phenomenon is a bout of deflation. So how are we doing on that score?
 
In the USA, after a short bout during the depths of 2008–9, the Fed has managed to turn the ship around nicely. The Eurozone? Well, they’re in the middle of a pitched battle against the spectre of deflation; and so far, not to put too fine a point on it, they’re getting their arses kicked. The UK, a country utterly addicted to debt, is in fine health (assuming you measure a country’s health by its strong inflationary forces and its massive debt load — don’t laugh, many people do); and then of course there’s Japan — the country it’s impossible to ignore when having these kinds of discussions.
 
 
Deflation%20Battle.psd 
 
 
Japan suffered from a prolonged period of deflation lasting the best part of 20 years, but Abenomics has seemingly fixed that little problem — for now at least.
 
So I think it’s fair to say that there is no outright deflation, but it’s equally fair to say that this is clearly an ongoing struggle, so let’s hold off on making a definitive judgment on that particular piece of the puzzle.
 
Next up is the premise that equities will be in a bear market during a Kondratieff Winter.
As I’m sure everybody reading this knows, that’s a big fat FAIL, and we need no charts to show equity markets around the world at all-time highs.
 
Which brings us to another key signal of a Kondratieff Winter — the mass repudiation of debt.

During Winter, debt — one of the major causes of the onset of that season — is …, well, repudiated.
 
Nobody wants anything to do with it.
 
As you can see from this chart, as the world went into the Kondratieff Winter in 2000, far from repudiating debt, we’d been embracing it like never before:
 
Debt%20Repudiation.psd 
 
By the end of 2007, before things got nasty, the total global issuance of debt securities (as measured by the BIS) had doubled since 2000 to reach a staggering $69.2 TRILLION.
 
From there?
 
Well, it’s not exactly what you’d call “repudiation.” In fact, another $21.6 trillion has been added to the mountain of debt hanging over the world.
 
Why the massive surge? Well that would largely be down to our old friends at the Fed again, and we’ll come to why shortly. The truth is, we’ve all been beaten over the head with stories of the Credit Crunch and tales of austerity, or tales of how hard it has been to find access to credit since 2008; but, as always, the reality is somewhat different.
 
Since December 2007, total debt in the financial sector has increased a mere 0.5% — OK, again, it’s hardly what you’d call “repudiation.”
 
It’s a start, but the nonfinancial sector has taken the baton up with some relish and run with it, increasing total debt by 67% in just over six years.
 
And then, of course, there’s government — that body of men and women to whom the word repudiate means “spend more” (just like austerity or cutback).
 
They too have layered on another 67% of debt burden while struggling manfully to balance the budget and be responsible in these new, austere times.
 
Repudiation%20Schmudiation.psd 
 
Based on these numbers, if they REALLY decided to impose austerity, the debt burden would skyrocket.
 
So that’s ANOTHER big fat fail. Comrade Kondratieff is starting to look a wee bit unhinged.
 
But now we get to the middle of the order, and here’s where things pick up a bit.
 
Bankruptcies? Well, they spiked in the US in 2005 as people rushed to declare themselves bankrupt before new rules made it harder to do so. Those new rules slashed personal filings by almost 75% in 2006, but guess what? Up they went again — on a far steeper trajectory than prior to the alterations to the rules.
 
Bankruptcies%202.psd 
 
I’ll give Kondratieff that one.
 
Banking crisis? C’mon!! I’ll give him that one too — AND the damn credit crunch while I’m at it.
 
Which brings us nicely to “rising interest rates.”
 
I’m sure there are a few people reading this who are old enough to remember those, but of course rates have been falling and then falling some more for decades now, so the average memory gets a little shaky.
 
Falling%20Rates.psd 
 
Let’s face it, as the major tool available to supposedly help smooth out the business cycle, you’d expect interest rates to at least look SOMEWHAT cyclical in nature, no?
 
Most people assumed that once rates got to zero they couldn’t fall any more.
 
How could those people BE so foolish?
 
Zero is only the lower bound for interest rates in the REAL world, but we live in a central bank-created Fantasyland, so normal rules don’t apply.
 
Either way, we need to stick another one in the Kondratieff fail column.
 
Currency crises? Well there have certainly been plenty of those since the turn of the century, so Kondratieff scored on that one, too … which just leaves a rising gold price.
 
It seems so long ago — for those of us who believe in the yellow metal — that gold rose year after year, but from the beginning of the Kondratieff Winter gold climbed relentlessly, and even the setbacks of the past couple of years haven’t been enough to steal this one from me, so it goes in the Kondratieff win column.
 
So there you have it. It’s close and hardly conclusive, but by a narrow majority it looks as though we ARE in a Kondratieff Winter. However, the fact that the score is so close is actually rather misleading, so let’s take a look at the missing ingredients and see if they have anything in common.
 
The misses — deflation, an equity bear market, debt repudiation, and rising interest rates — are all, of course, inextricably linked. They ALL flow directly from interest-rate policy.
 
Rising interest rates generally dictate that equities enter bear markets, deflation becomes a threat (or at the very least, inflation becomes much less of one), and debt is discharged or defaulted upon.
 
Opposites%20Retract.psd 
 
Of course, the policy of the Fed has been one of lowering rates consistently and at the first sign of any trouble in the economy (trouble that USED to be called a normal part of the business cycle); and those falling rates have had a predictable effect on equities, debt, AND inflation.
 
Falling interest rates. Every central banker’s first (and until recently, last) line of defence against the downward part of the business cycle.
 
By lowering rates to zero and thereby staving off those three important components of the Kondratieff Winter, the Fed (and its cohort around the world) has, optically at least, made it look as though things are not so bad.
 
But even interest rates are beholden to the law of diminishing returns, and as the zero bound is reached and the effect of another marginal cut in rates diminishes to virtually zero, new measures are called for.
 
Those new measures have largely been in the form of QE these past few years, but even magic money conjured out of thin air has its limits in terms of effectiveness — which is why the Europeans are now experimenting with negative interest rates.
 
The longer this goes on, the more desperate their measures become.
 
The question is, WHY?
 
The answer has its roots in another peace treaty of sorts that again involved Keynes — this time the Bretton Woods agreement, which was thrashed out at the Mount Washington Hotel in New Hampshire after WWII.
 
That agreement, which (like those at Versailles in 1919) went against the proposals of Keynes, established the IMF and the World Bank, cemented the dollar’s status as the world’s reserve currency, and ushered in an era of unprecedented economic peace, as a quarter of a century passed between its signing and the oil shocks of the 1970s.
 
That economic peace, however, would have far-reaching consequences.
 
If we take a look at the growth of both credit and GDP in the US after WWII, we see a remarkable story unfold.
 
 
Credit%20Growth.psd 
 
I know, I know... it’s a “busy” chart. It was easier in the live presentation where I could build it sequentially, but bear with me.
 
Clearly, credit growth has accelerated away from real growth, and the reasons for that acceleration are clear. They begin with our old friend, the federal funds rate (blue line).
 
Now, as you can see (in the red-dotted box in the bottom left-hand corner of the chart), for the first 20 years after WWII, credit and GDP grew in lock-step. So what changed?
 
Well, of course, the soundness of money changed.
 
When Nixon closed the gold window on August 15, 1971, to “... protect the dollar from speculators,” he also ensured that credit creation would become as easy as just saying “yes.”
 
Immediately after the dollar was “saved from speculators,” the divergence between growth and credit creation began to increase, even as interest rates soared due to the inflation unleashed by Nixon’s actions.
 
Finally, though, interest rates reached their peak and began the journey lower from a little over 18% to where we find them today, and that meant the gloves were off and credit creation could take off like a rocket, fueled by those rapidly declining rates and a growing sense that the Fed would continue to lower them at the first sign of any trouble.
 
The business cycle was sooooo 1960s.
 
Interestingly enough, if we highlight the period between 1954 and 1969 (dark grey triangle) we see that credit and GDP both grew steadily despite interest rates increasing 11-fold.
 
1954-1969.psd 
 
A close-up look is even more instructive when it comes to the nature of the unchecked business cycle.
 
As I pointed out, between October 1954 and October 1969, rates (blue line) climbed 11-fold; but more tellingly, during that 15-year period they fluctuated along with the business cycle, adjusting up as well as down as conditions warranted.
 
Rates quadrupled, fell by five-sixths, rose nearly seven-fold, fell by three-quarters, quadrupled again, halved, then doubled — all in the space of 15 years.
 
However, if we overlay the business cycle (represented by the PMI Composite Index — red line), we see something that today would be considered extraordinary: a business cycle that ebbs and flows without ever getting out of hand, despite the extreme interest rate moves that occurred.
 
In fact, the PMI was in expansion (above 50) far more often than it was contracting (below 50), DESPITE a rise in interest rates from bottom to top of 8.5%!
 
Anybody care to hazard a guess as to what the US economy would do today if rates were to hit 9%? Never mind that debt-service payments would wipe out every dollar of tax revenue collected by the US government several times over.
 
Sticking with our chart, it’s easy to see the next consequence of this peaceful economic environment and easy credit was an explosion in equity markets, with the S&P 500 following the trajectory of the expansion in credit until the mid-’90s, when it became clear that the Fed’s default response would be to slash rates in the face of any sign of a faltering business cycle... and then the party REALLY got going.
 
S%26P500%20vs%20Credit.psd 
 
A reversion to the credit growth trendline when the tech bubble burst was followed by a return to trend growth along with even sharper credit creation… and then came 2008… and the Fed’s massive blitz of funny money, which was absolutely vital in order to stop everything falling apart and the lines for credit and GDP growth converging again, as they hadn’t since 1971.
 
Fast.
 
But the twin milestones of the closing of the gold window in ’71 and peak rates in ’81 created even more instability elsewhere.
 
Next up? The US budget deficit; and once again you can see the difference made by the abandonment of the gold standard, compounded by the peaking of interest rates.
 
US%20Budget%20Deficit.psd 
Monetary%20Base.psd 
 
The US monetary base has followed a familiar path — at least up until 2008 when, after dropping rates to essentially zero and running headlong into the law of diminishing returns, the Fed was forced to expand the base from $800 billion to its current nearly $4 trillion — or face a shattering of the economic peace.
 
All of which brings us to the Fed’s balance sheet.
 
The cost of maintaining the economic peace is staggering — way beyond anything we thought we understood just a few short years ago.
 
Assets on the Fed’s balance sheet now stand at $4.4 trillion, as opposed to the $925 billion they owned on September 10, 2008.
 
But it’s when we take a look at the Fed’s total assets versus their capital that things get interesting.
 
In order to keep the peace, with interest rates already pegged at 0%, the only option open to the Fed was to massively increase the wrong side of their balance sheet — which of course they did without hesitation.
 
Now, if we take a dozen snapshots each 12 months apart and do a little measuring, we start to get a better sense of the ledge out onto which the Fed has so gleefully sauntered:
 
Fed%20Balance%20Sheet.psd 
 
As you can clearly see, the degree to which the Fed has been forced to lever itself to maintain the economic peace is downright terrifying, and their solvency is (how can I put this delicately?) “questionable.”
 
At least it WOULD be if they couldn’t create money out of thin air.
 
Back in 2007, the issue of leverage in the investment banking community (which hadn’t mattered to anybody for many years) suddenly mattered to everybody and for the usual reason in such cases: people started to worry about losing money.
 
Amazingly, having financial institutions levered 30x became something to fear seemingly overnight; and, of course, whilst things like that can go on for a long time, as soon as the fear takes hold, it’s GAME OVER.
 
Today, in 2014, after the massive expansion of its balance sheet in the name of peacekeeping, the Fed’s leverage far exceeds what was enough to cripple the world financial system back in 2008.
 
2825.png 
 
The price of peace has been heavy indeed; and generally speaking, throughout history, when the price of peace finally becomes too high, the pendulum tends to swing back to the other extreme…
 
Now, you may not have noticed it, but since the turn of the century and the onset of the Kondratieff Winter, the number of wars in which we are all embroiled one way or another has taken a significant turn higher. There are wars going on everywhere, and some of the “enemies” being found to rally people against are a little abstract, to say the least — Fox News’ “War on Christmas” being a prime example of the extremes to which things have traveled.
 
Nevertheless, the drums are beating.
 
HOWEVER, there’s one war that’s far more insidious than any of the overt conflicts you hear about from endless men and women behind microphones and podiums.
 
It’s the one war that isn’t talked about and the one war the public ISN’T kicking up a fuss about… which is a shame, as it’s the one war that affects just about everybody:
 
War%20on%20Savers.psd 
 
The last remaining pool of untapped capital is the world’s savings, and that is firmly in the sights of central banks and governments everywhere.
 
If you think about this war in its basic terms, it’s really quite scary.
 
As we’ve already seen, the expansion of the last 40 years has come down to one long orgy of credit creation, and this orgy has required more and more punch to keep the party going.
 
The increase in real GDP generated by each additional dollar of debt has plummeted from $4.61 in the immediate aftermath of WWII to just $0.08 in 2012:
 
Incremental%20Debt.psd 
 
(At this point, the charts were just getting a bit too depressing, so I thought I’d flower this one up for you a bit.)
 
All the while, every major central bank in the world has been trying its damnedest to create 2% inflation to help lessen the impact of the soaring debt burden — a burden enabled by two things:
 
1.The dollar’s status as the world’s reserve currency

2.The economic peace
 
Paying off your debt in a currency you yourself can debase is a tried and tested strategy of just about every central bank in the world, but never before have so many countries needed to employ that strategy simultaneously. And with currencies essentially being a zero-sum game, it is impossible for them all to be successful.
 
Now, allowing the imbalances created over the last 40-odd years to correct themselves would plunge the world into a depression — thus desperate measures are called for. The Fed (as well as every other major central bank around the world) has been forced into doing absolutely everything necessary to maintain the economic peace and keep the expansion of credit going — including abolishing the downward half of the business cycle to try to ensure that deflation and all the other deadly facets of the Kondratieff Winter are avoided.
 
The situation is akin to that faced by the swordfishmen in Sebastian Junger’s book The Perfect Storm. The men get caught in the biggest storm of the century and face a life-and-death battle for survival at sea. Junger’s book was made into an excellent movie by Wolfgang Peterson.
 
In the climactic scene of the movie, ruggedly handsome skipper George Clooney (who, it has to be said, looks NOTHING like any fisherman I’VE ever seen) and ruggedly handsome fisherman Mark Wahlberg (ditto), having battled against 100-foot waves for hours, finally catch a glimpse of sunlight, and think they’ve made it to the other side of the storm.
 
Immediately though, the sunlight disappears, the skies darken, and they realise they are back in the middle of the maelstrom.
 
Worse still, they find themselves faced with one more giant wave, 150 feet high.
 
Clooney guns the boat’s weary engines, and they try desperately to climb the near-vertical face of the wave; but as they near the top, the forces of nature are simply too much for them, and the boat plunges down the face of the wave, is turned over, and vanishes forever.
 
The Fed, the BoE, the BoJ, and the ECB are on the face of that wave — gunning the engines for all they’re worth and running into diminishing returns everywhere they turn as the suffocating debt load threatens to overwhelm them.
 
Zero interest rates, QE1, QE2, QE3, Operation Twist, ABS purchases, the doubling of the Japanese monetary base, and now negative interest rates. They’ve tried everything, and the wave continues to rise up to meet them.
 
At some point — maybe soon — the forces of nature that drive the business cycle will overwhelm their futile efforts.
 
Meanwhile, in the background, stealth efforts to create inflation with the aim of getting citizens to pay for government profligacy continue apace.
 
There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
 
— John Maynard Keynes
 
Keynes was never more right than when he identified the pernicious effects of inflation, and today’s disengaged society just makes the task of debasing a currency that much easier.
 
Kondratieff’s research into cycles turned up another extraordinary phenomenon that further cemented the link between economics and war.
 
It became apparent that those same 53-year economic cycles could be relied upon to mark major conflicts as well as major economic turning points.
 
53%20Year%20War%20Cycle.psd 

Now, as you can see, the bad news is that these long wave cycles are uncannily accurate at predicting major conflicts, but the good news is that we seem to be in mid-cycle, which would suggest that we are at the furthest point from war that we could be.
 
But of course, just as Kondratieff expanded upon Juglar & Schumpeter’s shorter cycles to find the larger wave, the process goes both ways; and nestled within the 53.5-year war cycle is another cycle of shorter duration — this time 17.7 years.
 
17%20Year%20War%20Cycle.psd 
 
… and the news from THAT cycle isn’t so good, I’m afraid…
 
War and economics have always been inextricably linked, and they will forever remain so. If you’re not used to that idea already, get used to it.
 
Fast.
 
The worse the economic situation gets, the higher the likelihood of conflict. That has been the case since the dawn of money, and it’s just as true today, regardless of the fact that most people firmly believe that a major war is now impossible.
 
1914%20State%20of%20Play.psd 
Remember this slide? It showed the geopolitical state of the world right before the outbreak of WWI.
 
Well, exactly a century on, the echoes from the past are too loud to simply ignore, as the slide below demonstrates only too clearly:
 
2014.psd 
 
Not only is the big picture eerily reminiscent of 1914, but if we dig a little deeper into the detail, we find that though the names have changed, the mechanics of today’s world are a little too close for comfort to those of 1914.
 
Plus%20ca%20Change.jpg 
 
Territorial claims, religious unrest, heavily armed unstable nations, proxy wars, terrorism, and — above all — complacency.
 
But it doesn’t end there, I’m afraid.
 
Plus%20Cest%20La%20Meme%20Chose.jpg 
 
Fear in the West over the growing economic strength of China, China’s own desire for a bigger role on the world stage, globalisation, and increased tourism are all prevalent — as is the general assumption that war is unthinkable (and there’s that word again).
 
 
GBBO.jpg
 
Keynes’ description of life right before the outbreak of WWI could have been written for today, only instead of his “daily newspaper” we’d have to substitute American Idol, Big Brother, or my own favourite — The Great British Bake Off, a top-rated show from the UK about which one of a dozen ordinary people... can bake the best cake.
 
Don’t laugh. An argument on that show between this man and this woman a few weeks ago — over a baked Alaska — knocked both Ukraine and ISIS off the front pages of the broadsheets FOR A WEEK.
 
I despair.
 
The Treaty of Versailles ushered in an era of peace after WWI, but that peace was short-lived because, from an economic standpoint, it heaped enormous pressure on Germany, pressure that was enough to drive them back to war just 20 years after its signing.
 
The Bretton Woods Agreement — a new financial system recognised as being so crucial that it was hammered out while the world was still at war — demonstrated that the lessons of Versailles had been learned to a degree and that the importance of money in relation to warfare was understood.
 
Its signing began an era of economic peace that lasted a quarter of a century, but that too began to fray in the early 1970s as the dollar came under pressure from those “evil speculators” (and by “evil speculators” Nixon essentially meant the De Gaulle administration in France, who continued to run down their dollar reserves by exchanging hundreds of millions of dollars for gold, as they were perfectly at liberty to do thanks to the Bretton Woods agreement).
 
In order to keep that peace, America was forced to renege on the agreement. But by doing so, the money spigot was opened wide, and the US embarked upon an era of credit creation which just got more extreme the longer it continued, seemingly consequence-free.
 
The bursting of the tech bubble was the first real sign that something was wrong, but the response from the Fed was both instant and desperate — and designed solely to prevent the wheels from coming off — a decision that would merely set the world firmly on course for an epic disaster.
 
Many thought that in 2008 we faced our global Day of Reckoning and survived, but the truth is that 2008 was actually just another tremor — albeit a major one — warning of a massive impending quake.
 
The real day of reckoning, when the unconscionable level of debt that has been built up during the fiat money era finally topples over under its own weight like the giant wave in The Perfect Storm, lies ahead of us.
 
Definitions.jpg 
 
Both war and financial collapse occur in cycles and are subject to the overwhelming laws of nature.
 
Those inherent characteristics of the natural order are permanent. They cannot be altered.
 
What the Fed and the rest of the central banks have done in trying to rewrite the natural laws of finance and human behaviour is likely to lead either to war or to a collapse of the financial system — or both. At this point, the exact outcome is undecided, but the options have narrowed considerably.
 
Over the past six years, those at the helm have pulled every lever and pushed every button available to them in a desperate attempt to stave off an inevitable and natural cleansing of the business cycle, because all those years of economic peace have resulted in an unprecedented credit inflation. And, as my friend Dylan Grice recently said,
 
“If you’ve had… an unprecedented credit INflation, you WILL have an unprecedented credit DEflation”
 
All that the central banks of the world have ended up doing as they have desperately tried to maintain the economic peace these past several decades is to make that credit inflation larger and therefore infinitely more dangerous than anything that has gone before it.
 
The consequences WILL be dire.

0 comments:

Publicar un comentario