Identifying And Understanding Core Economic Problems

Few analysts do a better job than Graham Summers of Phoenix Capital Research in surveying the global economy and presenting its core problems in concise, easy to understand English.I appreciate the way he shears away the fluff and gets right down to the mutton.

Market insiders and sophisticated traders will probably find my post too rudimentary, but I aim my post toward Moms and Pops...and market watchers, like me, who often feel that the "talking heads" are talking too fast, and who seem to be talking over my head. I've come to realize that if a market expert leaves mystified, he/she has left me uninformed in an area that is critical to my welfare and wellbeing.

Summer's article, "Another Triple Digit '2008 Trade' Setup Has Just Hit," appears in the June 15, 2016 issue of Gains Pains and Capital. In it there are three terms that are tossed off the tongues of many a talking head, but which might be clarified and explained for non-professional readers: "bubble," "leverage," and "derivative." 

Here's the thought process I go though when I come across these terms:

1. A BUBBLE is an ephemeral, short-lived thing. Its surface appearance is beguilingly appealing and attractive, but it is a fragile, empty shell. And, so it is with economic bubbles such as the dot.com bubble of 2000, and the real estate/mortgage bubble seven years later. Investors pour excessive amounts of money into such bubbles, based on the unrealistic hope that those bubbles will always continue to generate enormous profits.When economic bubbles, supported by the economic policies of Central Banks (such as the Federal Reserve) pop, all the dollars invested in them also pop into thin air--along with the hopes of investors who "lose their shirts."

2. LEVERAGE, in market lingo, simply means "borrowed." Leveraging means to buy with borrowed money. "Leveraged" describes how much money has been borrowed.When we buy a house or automobile, we do it with borrowed money, so, we could say that our purchase/ownership is leveraged, or financed with borrowed funds."Over-leveraged" means that someone or some entity has borrowed more than income and collateral would normally allow. Below, where you see that institutions are leveraged, say, 30:1 or 78:1, it means that the institution has borrowed 30 dollars or 78 dollars for every dollar of assets in its possession. If you and I had total assets of $1,000,000.00 and were leveraged 30:1, it would mean we'd borrowed much more than we should have--thirty times more than we could pay back from our assets. So, it's easy to see which firms are in trouble because of the amount of borrowed funds they're obligated to pay back from cash flow and other assets.

3. DERIVATIVE(S). A derivative is nothing more than a side bet, or a hedge that is designed to offset a potential loss. A derivative, then, is a form of insurance that provides compensation in the event of loss.

A derivative might simply be an insurance policy (though these things...and their triggers...can be awfully complex) that kicks in if there is a proven loss. For instance, those who are into big-time farming may buy crop insurance as a hedge against crop losses from such things as bad weather, blight, locusts, harvesting/storage/shipping problems, or falling commodity prices. 

In a grossly over-leveraged economy there could be such sudden, devastating losses, that, though insured, the damage could far out-strip the insurer's capacity to provide compensation. That is the BIG fear in the multi-trillion dollar derivatives market. If one little thing...one bank or business failure...could trigger such a deluge of claims that few, if any, claims would/could be paid.So, the derivatives market may have created its own "bubble" in which losses would bankrupt both the insured and the insurers.

Now, here's part of Graham Summer's article summarizing the core of global economic problems:

1) The REAL problem for the financial system is the bond bubble. In 2008 when the crisis hit it was $80 trillion. It has since grown to over $100 trillion.

2) The derivatives market that uses this bond bubble as collateral is over $555 trillion in size.

3) Many of the large multinational corporations, sovereign governments, and even municipalities have used derivatives to fake earnings and hide debt. NO ONE knows to what degree this has been the case, but given that 20% of corporate CFOs have admitted to faking earnings in the past, it’s likely a significant amount.

4) Corporations today are more leveraged than they were in 2007. As Stanley Druckenmiller has noted, in 2007 corporate bonds were $3.5 trillion… today they are $7 trillion: an amount equal tot nearly 50% of US GDP.

5) The Central Banks are now all leveraged at levels greater than or equal to Lehman Brothers was when it imploded. The Fed is leveraged at 78 to 1. The ECB is leveraged at over 26 to 1. Lehman Brothers was leveraged at 30 to 1.

6) The Central Banks have no idea how to exit their strategies. Fed minutes released from 2009 show Janet Yellen was worried about how to exit when the Fed’s balance sheet was $1.3 trillion. Today it’s over $4.5 trillion.

Today, Central Bankers are now actively punishing depositors and bond holders with negative interest rates. Globally, over $10 trillion in debt currently have negative yields in nominal terms, meaning the bond literally has a negative yield when it trades. In the simplest of terms this means that investors are PAYING to own these bonds.

Bonds are not unique in this regard. Switzerland, Denmark and other countries are now charging deposits at their banks. In France and Italy, you are not allowed to make cash transactions above €1,000. So if get fed up with the banks and want to pull your money out, you cannot.

We are heading for a crisis that will be exponentially worse than 2008. The global Central Banks have literally bet the financial system that their theories will work.

They haven’t. All they’ve done is set the stage for an even worse crisis in which entire countries will go bankrupt.