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Commentary on The Capital Markets- Category [Market Musings]

Note that I have seen numbers as high as $3 trillion -- but even the lamestream media claims hundreds of billions, which strongly implies that most if not all of this debt was issued and predicated on $100ish oil.

How much leverage is behind that $3 trillion?

What you're seeing right now is an effective global margin call on all the debt taken on in the last few years.

Next, the global economy is slowing down.  This is reflected in decreased demand forecasts for oil.  

Oil price declines should lead to increased demand, right?  Well?

Now let's put a pin in the balloon that this debt problem is all about oil.  No, it's about everything.  IBM anyone?  The stock is collapsing; taking a huge hit on the last earnings release and then taking another 3+% hit Friday.  How low can it go and how smart does it look to have borrowed and bought back all that stock at prices above where the stock is today?

Finally, let's look at The Fed.  My contention is that QE was ended because of the damage being done to fixed income portfolios, most-particularly large portfolios of "forced holders" that had long-chain ladders of bonds (such as pension funds and insurance companies including, I note, Social Security and Medicare.)

Here's the ugly reality -- ending QE did not result in those yields beginning to recover.  Why not?  The obvious answer is that there was never any real demand behind the faux "prosperity" that QE allegedly brought. That is, this supposed economic "benefit" was all smoke and mirrors!

That in turn means that the "profits" were mostly about financial engineering in the public company space and since that all comes about due to increases in leverage so have been the stock market's gains.  Further, all the oil-related earnings are going to come out of forward market estimates into 2015 as well.

This augurs for an extraordinarily bad outcome if that leverage is forcibly unwound because there will be no recovery in the long bond yields; to the contrary they will be further damaged at exactly the same time that equity and other prices will be smashed.

Now what, Ms. Yellen you jackass?

The only way for The Fed to arrest the process in the high quality credit market and thus stop the impending disaster in those pension funds and insurance firms would be to massively contract credit liquidity; that is, to make credit in the high quality space more-scarce.  But to do so means risking an unwind of all of the equity and other asset price bubble that has been inflated since 2009 as once margin calls start it is very difficult to get that process to stop "when you want it to."

Worse, if The Fed was to do that the federal deficit might well double since interest expense in the Treasury complex would rise materially as well, and that's before the inevitable deep and broad recession (which we're about due for, I might add) trashes tax revenues.

Finally, I want to stick a fork in the claims of the "big oil tax cut" for Americans.  Let's assume you're Mr. Average and drive 15,000 miles a year.  Let's further assume you have a moderately-new car (Cash for Clunkers did that for you, right, even if you have an 8 year loan on that car!) and thus you obtain a moderately-decent 25mpg on average.

You thus burn 600 gallons of gas a year.

While the price of oil has been cut in half (as has /RB, for the most part) the price at the pump is not, because most states tax on the number of gallons sold, not on the price of the sale.  The average of those taxes is about 53 cents/gallon, so the real cost decrease to you is from about $3.25 this time last year to about $2.50, or about a 25% decrease.

Last year that 600 gallons cost you $1,950.  This year it's $1,500, or about a $450 decrease over the year.

That is, it's a "massive" $37.50 a month, which admittedly is a decent amount of money but for most people it simply isn't that material to their family financial situation.

What is already happening, however, is the monkey-hammering of a lot of high-wage jobs in the fracking and shale areas of the country -- jobs that for the last couple of years have been adding material amounts of both consumer spending and, sadly, municipal debt in those parts of the country where the drilling and fracking has been going on.  The economic damage to residents in those areas when those jobs evaporate but the projects funded with debt that will drive their property taxes to the moon must continue because the bonds were already sold is going to be quite a problem for years -- and maybe decades -- to come.

This isn't over folks, and there is very good reason to believe it won't be "contained" either, just as subprime wasn't.

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Maybe.

But that's immaterial.

The whine coming from Cramer and company is amusing as all get-out, given that he (and the rest of the clownshow in the major media) know damn well why the market is headed south.

It's spreads blowing wide -- that is, credit concerns.

And who (or what) has blown out the stock market to completely unreasonable levels (in terms of actual operational health of the firms comprising the index) over the last few years?

Credit -- cheap money that isn't really money, in other words.

Why?

Because the stock market is tiny compared to the credit supply.  And when the credit supply is expanded by Fed and private bank action some part of it goes into speculative horsecrap like buying Amazon at 1000x nearly non-existent earnings.  It goes there not because Amazon is going to make a lot of money in the future but because the stock is going up in price.

In other words, the price is rising because the price is rising.

Yes, Mildred, that's circular logic -- but that doesn't matter to a computer that has been programmed to seek movement, and it also doesn't matter to the people backing that computer with allegedly "real" money when they don't have to put up any actual capital and can run on all this "free" created credit.

This all works great, for a while.

But what everyone seems to forget is that this pattern runs both directions.

That is, since there is no capital behind these bets and price movements but only credit, and the person who created the credit expects to be paid back with real money, not hot air, if there is a reversal of the price momentum the losses are multiplied exactly as fast as were the gains as those people who bid up the stocks and hold them watch those "winnings" they have not reduced to cash go from a nice big black number to a gigantic red one that exceeds their ability to pay.

See, if you have to put up real capital then you can never go into a negative equity situation.  You can lose everything you have but that's all, because you had to post up real capital.  It is when you use leverage that contagion takes hold and the more of it you use the worse the problem because if you are geared 5:1 you lose all of your capital with a mere 20% decline in price.

This is how the "fun" of 2008 and early 2009 happened.  But, and this is what you never hear on CNBC, it is also how the price advances since have happened as leverage overall, ex the big banks that did unwind much of their inter-bank games (by forcing you to make good on the bets through government deficit spending), never contracted.

C&I loans never went down in outstanding size.  Not by one dime.  They in fact continued to rise.

A decent part of it went into "energy", and now that credit is severely imperiled.

There are many who say "but the banks are ok so we're ok on a broad basis."  That's quite possibly true but in terms of equity prices it doesn't matter because those prices are not predicated on operating results but rather on financial engineering made possible by continued exponential expansion of the credit supply.

That expansion has now run into the reality of the consumer purchasing power destruction that expanding credit like this inevitably causes.  This in turn has led to demand destruction on a global basis and it is not just in oil, for in the end consumers cannot continue to borrow more on an infinite forward basis; eventually there is a demand to pay the lender back.

That which can't continue forever will eventually stop.  It is only a question of exactly how long the irrational behavior of actors in the market will go on.  And don't get me wrong -- we could see plenty of further insanity in that regard, because a real contraction in the credit situation hasn't happened.

Yet.

But it will, and when it does the top of the balloon you're riding in at DOW 17,500 will rip open, spilling the hot air inside to the atmosphere.

If you're in the basket you're going to find that it's a hell of a long way down.

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Seriously, they do.

So say certain "mainstream bank" folks with a PhD behind their name, which they (of course) display as a means of bolstering their credibility in their writings.

Let me note that one of the precepts of this gentleman's writing is that annualized earnings (and market price) growth is about 7%.  That doesn't sound so bad, does it?  Except for one problem -- when you look at what 7% growth means from, say, 1945 to today, you get a multiplication of 114x whatever you started with.

That's right -- companies have "grown" earnings by 114 times from 1945 to today.

Now granted, the population has expanded (by a lot) since 1945.  Indeed, if we look at 1945 we find that the world population was somewhere around 2.5 billion people.  Today it is about 7.2 billion, or a multiple of roughly 3.

That, of course, leaves an awful lot of those "times" out, doesn't it?

Here's the problem, in a nutshell: To the extent that improvement in corporate "earnings" are reflected in either (1) a larger customer base or (2) improvements in productivity and thus lowering of cost of production ex real wages they're "real", sustainable and good.

To the extent they're predicated on (1) financial engineering, such as using debt to buy back stock, (2) destruction of real wages paid to working-class people or (3) shifting of cost to others, particularly to the taxpayer they're bad because they are destructive of sustainability and in fact supported by nothing more than hot air.

The ugly fact of the matter is that virtually nobody in the analyst community discusses the fact that there has been a 30 year trend of ever-decreasing interest rates on an average basis, which made possible this sort of horsecrap by economic actors from governments to private citizens:

1. Borrow $1,000 at 10% interest.  This requires $100 of interest payment annually.

2. When it comes due, the rate of interest of is 5%.  Instead of paying off the $1,000 you can instead borrow another thousand and still pay $100 in interest.  You now owe $2,000.

3. When that comes due the rate of interest is 2.5%.  Instead of paying off the $2,000 (which you don't have, by the way, so it doesn't matter whether you want to pay it off or not) you instead borrow another $2,000 and pay the same $100 in interest a year.

4. When that comes due the impossibility of paying $4,000 off (remember, you started with $1,000!) looms large.  Fortunately the rate of interest if you shorten duration enough is now 1%.  Bravo!  You not only can roll over the loan you can borrow another $6,000 and immediately spend it, so guess what you do?

This amplification, by a factor of ten, in the amount of "money" circulating in the economy makes it appear as though much growth has taken place.  Unfortunately it has not; what has happened instead is that gasoline has gone from $0.40/gallon to north of $3.00, beef, milk, cheese and similar have dramatically gone up in price, houses have increased in price by a factor of ten and so have cars and other items.

That was not "growth" it was a lie, and it was empowered all through that period of time by leveraging a secular trend engineered by people who have lots of letters after their names who undertook those policies for the specific purpose of "goosing" the figures presented to you.

Unfortunately trees cannot grow to the moon and neither than these policies persist forever.  Eventually the zero boundary takes hold; below zero, were it be attempted, would actually destroy capital in both real and nominal terms (since a nominal negative rate of interest does exactly that for the owners of same!) and thus won't occur.  As a consequence there are only two outcomes possible -- one is that rates flat-line (as occurred in Japan) and thus the lack of growth becomes apparent as it no longer can be sustained via illusion or rates increase with the result being mass-bankruptcy of everyone who got aboard that train -- which, I note, include most-specifically governments at all levels.

Either way the prognostication of this "trend" on a permanent forward basis is mathematically impossible.

The only question is when you and others in the economy and markets will realize that, just like Wile-E-Coyote, you have run off the edge of the cliff and are madly spinning your legs in the air.

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Want a reason to be fearful?

Leverage amplifies losses in exactly the same way it amplifies gains.

But more importantly than the impact on cash earnings is that leverage removes optionality because it encumbers your assets and, since assets are only worth what a buyer will pay for that asset, the potential for instantaneous bankruptcy with no way out of the box is very real.

That in turn, in a world where there is no One Dollar of Capital standard, means that the institution allegedly "covered" against such defaults really is not because they, and the supposed "insurer" in the derivative markets, do not have any money.

We should have learned this lesson in the 1980s, and then again in 2008.  We did not.  We the people did not demand that our government stop handing out allegedly-free "skittles" and worse we wanted everyone to "get theirs" through higher asset prices -- which in turn meant even more leverage had to be put into the system with its attendant risk.

Even today basically nobody is talking about the fact that these claims of "low risk" were not only false they were intentionally false -- that is, they're frauds.

Here it comes America, right as you demanded and, I might add, pretty-much right on schedule too, being about 7 years on from the last time.

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It's worse.

Yet it is worth recalling that the U.S. economy survived 1998 just fine, with the benefits of low interest rates and inexpensive energy providing a bigger boost than whatever slower global growth and a stronger dollar took away. The real risk, it turned out, had nothing to do with anything lurking overseas. Instead, it was excessive valuations being paid for some stocks and the too-good-to-be-true financial statements that some companies had begun to manufacture that left investors exposed.

You mean like megacap companies like Amazon selling at a thousand times earnings (if it has any at all) and firms such as IBM (and others) manufacturing "earnings" by playing the buyback-stock-with-borrowed money game?

That sort of manufactured financial statement?  Or was it something else.

Oh yeah, it was.  But is there really much difference in kind and character than what we're seeing now?

I think not -- indeed, if anything it's arguably worse now in that it's not just "one sector" (that is, tech) playing these games today -- it's literally everywhere!

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