'In terms of the business cycle this confirms that the liquidation phase is indeed beginning..'

Posted by archive 
'..out-of-control borrowing was the original problem..'

<blockquote>'<blockquote>“When it becomes serious, you have to lie.”

“I'm ready to be insulted as being insufficiently democratic, but I want to be serious... I am for secret, dark debates.”

“Of course there will be transfers of sovereignty. But would I be intelligent to draw the attention of public opinion to this fact?”

“If it's a Yes, we will say ‘on we go,’ and if it’s a No we will say ‘we continue.’”

“We all know what to do, we just don't know how to get re-elected after we’ve done it.”

– All quotes from Jean-Claude Juncker, prime minister of Luxembourg and president of the European Commission</blockquote>


We often refer to the herd mentality when we talk about investors. Economic academicians and central bankers are equally prone to bovine behavior. Theirs is a slow-moving herd, to be sure, but it raises much dust as it lumbers.

One of the biggest “aha” moments of my life came as I listened to David Blanchflower, former Bank of England governor (during last decade’s financial crisis), in a debate a few summers ago at Camp Kotok, the Maine fishing retreat I attend every August. The debate centered around whether the Fed and the Bank of England should have engaged in quantitative easing.

Blanchflower shared a rather chilling description of what was going on at the time and made the point that, as bad off as the banks were in the US, they might have been worse off in England. They were literally days from a total collapse. Liquidity had to be provided – and that is the one true and worthwhile purpose of central banks (but then they double down). Blanchflower’s argument was that you could not sit in the BOE’s meetings, see how impossible the situation was, and do nothing. You had to act.


You have to understand that in the world of truly elite economists, everyone knows everyone. Many of them went to the same schools, and they regularly talk at conferences, in private meetings, and by phone and email. I can guarantee you that they are talking about if and when it might be necessary for the US to go down the path of negative interest rates. The policy makers are not committed to following that path, but they are certainly talking about it. When they tell us it’s an option, we need to take them seriously.

I have been in the room (under Chatham House rules, so I cannot reveal when or where or who) with some of the world’s most elite economists (Nobel laureates, etc.), who were privately advocating that the US should pursue not just 2% but 4% inflation. This is not the language I hear when they are interviewed in public. They very well get the seriousness of our current economic predicament, but their academic theory tells them that the way to resolve that predicament is with more quantitative easing and even lower rates.

You need to understand that economists have faith in their theories in the same way that many people have faith in their religion.


..we are not really going to get that discussion, except in the context of Keynesian policy. Which is at the very heart of the problem. There would have to be an admission of failure by the economic establishment in order for there to be a serious discussion. It would be like asking the Pope and all his priests to convert to another theological viewpoint. Here and there it could happen, but a mass shift?

In the world of the leading economists and central bankers, “everyone” believes what “everyone” knows to be true. All their research agrees with them, and any that doesn’t is labeled as flawed. Any empirical evidence that shows quantitative easing hasn’t been working is ignored or explained away, even when it is presented by outstanding academic economists. No, quantitative easing didn’t work because we didn’t do enough of it. Negative interest rates aren’t working because we haven’t gone low enough.

Clearly, QE has not worked. We have not had one year of 3%+ growth since the Great Recession and are barely averaging 2%. Yes, if your measure is the stock market and other financial assets that have inflated, then QE has worked quite well. But the boost QE was supposed to deliver just hasn’t reached Main Street. One of the basic tenets of QE and other related policies is that if you want to increase consumption, you lower the cost of borrowing. But if out-of-control borrowing was the original problem, then QE as a solution is kind of like drinking more whiskey in order to sober up. And if you reduce the earnings of those who are savers so that they are no longer able to spend, the whole purpose of the original project – to foster economic growth – is defeated. But we can’t acknowledge that, because if we did, we’d have to admit that our theories don’t work. And we all know, because God knows, that our theories are correct.

- John Mauldin, Tokyo Doubles Down, February 01, 2016</blockquote>

<blockquote>'Call it the law of unintended consequences. When I was working at PSP back in 2005, I sent a Fortune article to the president and senior management which discussed why Tom Barrack, the king of real estate was cashing out. I specifically highlighted this quote, which remains my favorite investment quote of all-time: "There's too much money chasing too few good deals, with too much debt and too few brains." '

- Canadian Pensions Cooling on Infrastructure? February 5, 2016</blockquote>

<blockquote>'Schulte says there is still too much leverage at Deutsche and it is in the centre of a sclerotic system of Euro-paralysis, which prevents any dramatic sort of "TARP" program.

'Over-stretched, badly run'

"This has been brewing under everyone's nose, because while people thought that the problem was periphery banks in Ireland or Spain, the actual problem is that Deutsche Bank, and the French banks with lots of toxic debt in commodities, are over-stretched, badly run, have no sense of risk management and are organs of state capitalism," Schulte says.'

- Are Banks The Next Big Short? February 4, 2016</blockquote>

<blockquote>'Before Keynes became a Keynesian, he wrote this….

“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.

“Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

“Lenin was certainly right. 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.” '

- Something’s Gone Horribly Awry, January 31, 2016</blockquote>

<blockquote>'As we often stress, economics is a social science and therefore simply does not work like physics or other natural sciences. Only economic theory can explain economic laws – while economic history can only be properly interpreted with the aid of sound theory.


The point we are trying to make here is the following: it probably no longer matters what the Fed says or does. The situation is already out of control and has developed its own momentum. The mistakes made during Bernanke’s echo boom cannot be “unmade” retrospectively. Capital that has been malinvested due to ZIRP and QE and the unsound debt associated with it will have to be liquidated – and the markets are telling us that this process has begun.


In terms of the business cycle this confirms that the liquidation phase is indeed beginning. The price distortions of the boom period have begun to reverse. As an aside, this should be very bearish for the stock market, which has been at the forefront of said price distortions.

Given the lag with which money supply growth and gross market interest rates affect bubble activities in the real economy, there is nothing that the central bank can possibly do to stop this process from unfolding in the near to medium term.


The Fed’s “forward looking” monetary policy is in reality backward-looking. Not that it really matters: central planning and price fixing cannot possibly work anyway. Neither the intentions and/or the intelligence of the planners, nor the quality of the data policy decisions are based on matter in this context..'

- Acting Man, The FOMC Decision: The Boxed in Fed, January 29, 2016</blockquote>

Context (Big One: 2015 - 2017) - 'The Fall of a High-Yield Fund Echoes 2007 Crunch'

<blockquote>Bank of Japan, negative interest rates and the risks of monetary alchemy, February 2, 2016

The Era of Bubble Finance, February 5, 2016

Gundlach Says 'Frightening' Seeing Financial Stocks Below Crisis, February 5, 2016

Hedge funds post worst start to year since 2008 -HFR, February 6, 2016

'..the economic analysis of the necessary consequences of intervention in the free market by bank credit expansion.'

Quarterly Review and Outlook, Fourth Quarter 2015

('The Age of Deleveraging (2012 - 2025)) - '..Few readers believe chronic deflation is in the wings..'</blockquote>