Be Ready» U.S. Economy Collapse is Imminent» US Deficit Soars To $343B In Two Months 2020

Michael Pento: Farewell Paul Volcker Hello Monetary Madness

God bless Paul Volcker. He was truly a one of a kind central banker, and we probably won’t see another one like him ever again. It took his extreme bravery to crush the inflation caused by the monetary recklessness of Arthur Burns and the fiscal profligacy of Presidents Johnson & Nixon. Raising interest rates to 20% by March 1980 was wildly unpopular at the time. But in the end, it was what the nation needed and paved the way for a long period of economic stability and prosperity.

Back in 1971, the world fully had developed a new monetary “technology.” Governments learned that money need no longer be representative of prior efforts, or energy expended, or previous production, or have any real value whatsoever. It can be just created by a monetary magic wand; and done so without any baneful economic consequences.

This phony fiat money can, in the short-term, cause asset values to increase far above the relationship to underlying economic activity. And now, having fully shed the fettering constraints of paper dollars that are backed by gold, central banks have printed $22 trillion worth of confetti since the Great Recession to keep global asset bubbles in a perpetual bull market. Now, anyone whose brain has evolved beyond that of a Lemur understands that this can only be a temporary phenomenon–one where the ultimate consequences of delaying reality will be all the more devastating once they arrive.

This magic monetary wand is also being used to push borrowing costs down to record low levels—so much so, that some governments and corporations are now getting paid when they borrow. Therefore, it’s no wonder to those of us who live in reality that both the public and private sectors tend to pile on much more debt when both real and nominal interest rates are negative. Indeed, debt has been piling up at a record pace. Amazingly, central bankers find themselves in complete denial when it comes to this reality.

To this point, The U.S. budget deficit for the month of November was $209 billion and is running a deficit of $343 billion for just the first two months of fiscal 2020. And, we have the following three data points from my friend John Rubino .

• Total US credit (financial and non-financial) jumped by $1.075 trillion in Q3 2019, the strongest quarterly gain since Q4 2007. The total is now $74.862 trillion, or 348% of GDP.

• U.S. Mortgage Lending increased $185 billion, the strongest quarterly gain since Q4 2007.

• M2 money supply surged by an unprecedented $1.044 trillion over the past year, or by 7.3%.

Not only this, but Morgan Stanley’s research shows that nearly 40% of the Investment Grade corporate bond market should actually be rated in the junk category based upon their debt to EBITA ratios. In fact, the entire corporate bond market has a record net debt to EBITA ratio. And, the total amount of US corporate debt now equals a record high 47% of GDP. In the third quarter of this year, US business debt eclipsed household debt for the first time since 1991. And, according to Blackrock, global BBB debt, which is the lowest form of Investment Grade Debt, now makes up over 50% of the entire investment grade market versus only 17% in 2001.

Here is another fun fact: The IMF calculated that in the next financial crisis– if it is only half as severe as 2008–zombie corporate debt (which consists of companies that don’t have enough profits to cover the interest on existing debt) could increase to $19 trillion, or almost 40% of the total amount of corporate debt that exists in the developed world.

The problem should be clear even to the primates that govern our money supply. Global governments have already proven completely incapable of ever normalizing interest rates, and every moment they continue to force borrowing costs at the zero-bound level compels these corporations to pile on yet more debt. This means the corporate bond market is becoming increasingly more unstable, just as it also raises the level from which bond prices will collapse–when not if, the next recession arrives.

And speaking of recession, during the next economic contraction, the US national deficit should rise towards $3 trillion per year (15% of GDP) and that will add quickly to the National Debt, which is already at $23 trillion (106% of GDP). Meanwhile, while US Treasury issuance will be exploding in size, the $10 trillion worth of US corporate debt will also begin to implode. This means the Fed should be forced to purchase trillions of dollars in Treasury debt at the same time it has to print trillions more to support collapsing corporate bond prices.

That amount of phony fiat money creation would eclipse QEs 1,2,3, & the Fed’s currently denied QE 4 all put together. I wonder what name Jerome Powell will put on his non-QE 5 when the time arrives? If investors are unprepared to navigate the dynamics of depression and unprecedented stagflation, it could mean the end of their ability to sustain their standard of living. A totally different kind of investment strategy is needed during an explicit debt restructuring as opposed to one where the government pursues an inflationary default on its obligations. I believe governments will pursue both methods of default at different times. Determining when and how the government reneges on its obligations is crucial. That is what the Inflation/Deflation and Economic Cycle Model SM was built to do. Get prepared while you still have time.

4 Stages of Monetary Madness

There are four stages of fiat money printing that have been used by central banks throughout their horrific history of usurping the market-based value of money and borrowing costs. It is a destructive path that began with going off the gold standard and historically ends in hyperinflation and economic chaos.

Stage one is the most benign of the four, but it sets the stage for the baneful effects of the remaining three. The first level of monetary credit creation uses the central banks’ artificial savings to set short-term interest rates through the buying and selling of short-duration government debt. This stage appears innocuous to most at first but is insidiously destructive because it prevents the market from determining the cost of money. This is crucially important because all assets are priced off of the so called “risk-free” rate of return. A gold standard keeps the monetary base from rising more than a few percentage points per annum and thus restrains bank lending. However, having a fiat currency also means a nation has a fiat monetary base. This leads to unfettered bank lending and the creation of asset bubbles.

The second stage of monetary madness has been around for decades but is now commonly known as Quantitative Easing (QE). After several cycles of lower and lower short-term interest rates that are intended to bring the economy out of successive recessions, the central bank (CB) ends up pegging rates at zero percent or below. Once CBs run out of room on the downside of short-term rates they go out along the yield curve and begin to artificially push down borrowing costs for long-term debt. It is important to note that at this stage CBs only purchase assets on private banks’ balance sheets and at least pretend they will someday liquidate these holdings.

The third level of monetary madness is now being threatened to be imposed upon the population by central banks across the globe. This stage is called “Helicopter Money” and is the brainchild of noted economist Milton Friedman. But in reality, versions of it have been used many times prior to Mr. Friedman’s appellation of central bank money drops. Friedman argued the use of Helicopter Money to combat deflation, but it has been traditionally used to help an insolvent government service its debt.

At its core, Helicopter Money is defined to be the issuance of non-maturing government debt or the direct issuance of credit to the public that is financed by the central bank. Both forms of money drops operate most efficiently by circumventing the private banking system. This is because CBs and governments don’t have to worry about private banks deciding to forgo buying more government debt if favor of holding the fiat credit as excess reserves. Helicopter Money allows citizens the direct access to new credit without the threat of having it unwound from the CB. The main difference between non-maturing debt issuance and direct public credit is the former allows the government to direct who gets the new money, and the latter gives the CB that discretion. But in either case, Helicopter Money amounts to a direct increase in the broad money supply and inflation.

As I mentioned in last week’s commentary, The Bank of Japan and perhaps even The European Central Bank are seriously contemplating saying “get to the chopper” very soon. Alas, once you get to level 3 there will be an inexorable march towards the next level. This is because there is no calling in the helicopters without causing a devastating plunge in asset prices and a bond market collapse, which results in massive economic chaos.

This brings us to the final stage of central bank intervention, which is the interminable and direct purchase of sovereign debt by a central bank for the sole purpose of keeping interest rates from spiraling out of control. Hence, the 4th stage of Monetary Madness occurs once inflation becomes fully entrenched in the economy.

It would be pure folly to assume that central banks can achieve their 2% inflation targets with impeccable precision. Years’ worth of deficit spending, surging debt to GDP ratios and a gargantuan increase in central banks’ balance sheets will eventually lead to a significant erosion in the confidence of central bankers to maintain the purchasing power of fiat money. Therefore, inflation won’t just magically stop at 2%; it will eclipse that level and continue to rise.

But that’s only half of the issue. Sovereign bond yields have been slammed so far down by CBs that nearly 30% of the entire supply of government-issued debt now trades below zero percent. The return of inflation must surely cause a mass exodus of longs from the bond market, just as short sellers begin to pile on top. The bond market will also respond in violent fashion—taking yields up 100’s of basis points rather quickly—due to the anticipation of waning bond bids from central bankers.

Of course, surging debt service payments will render debt-saturated governments completely insolvent, which forces central banks into stage 4. Sadly, this is the conclusion that lies ahead for the developed world. Investors should not become complacent with the current innocuous state of global bond yields. In reality, they have become incendiary bombs that will inevitably explode with baneful implications for those that are not fully prepared.