We're In Uncharted Territory

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Investigative journalist Bethany McLean is an expert on crisis.

She has written New York Times best-selling books on the collapse of Enron (The Smartest Guys In The Room) as well as the mortgage industry and Wall Street abuses that led to the 2008 Great Financial Crisis (All The Devils Are Here and Shaky Ground).

So when she says she’s deeply worried about today’s macro environment, we’d better take notice.

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Looking at the accelerating expansion of debt issuance, the red-hot run-up in the financial markets, and the economic uncertainty caused by the ongoing pandemic -- Bethany concludes we're at a precarious never-been-here-before moment in history, aka "uncharted territory". And she sees good probability another major crisis may be around the corner.

She also sees a familiar dangerous lack of imagination in those both running and cheerleading the current system. Similar to the ‘rock stars’ at Enron, no one seems able to entertain the idea that things could get out of hand much faster than folks are prepared for.

Once glance at the current level of investor euphoria confirms this:

<img class=“aligncenter” src=“https://peakprosperity.com/wp-content/uploads/2021/09/Citi-euphoria-feb-15-2-teaser.jpg” alt="“Panic/Euphoria Model” width=“500” height=“292” />

We’re farther from the historical average than we have ever been on this measure – as well as on so many other metrics we don’t have room to list them all here. We are truly in uncharted territory.

Which is why Bethany agrees that now, more than ever, is the time to partner with a financial advisor who understands the nature of the market risks in play as well as the opportunities, can craft an appropriate portfolio strategy for you given your needs, and apply sound risk management protection where appropriate:

Anyone interested in scheduling a free consultation and portfolio review with Mike Preston and John Llodra and their team at New Harbor Financial can do so by clicking here.

And if you’re one of the many readers brand new to Peak Prosperity over the past few months, we strongly urge you get your financial situation in order in parallel with your ongoing physical resilience preparations.

We recommend you do so in partnership with a professional financial advisor who understands the macro risks to the market that we discuss on this website. If you’ve already got one, great.

But if not, consider talking to the team at New Harbor. We’ve set up this ‘free consultation’ relationship with them to help folks exactly like you.

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This is a companion discussion topic for the original entry at https://peakprosperity.com/were-in-uncharted-territory/

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My husband heard from them and they were thrilled that he was mostly in cash. We’ll probably go with New Harbor - they GET it.

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All this low interest debt and the prospect for inflation means only fools hold cash…or worse: long duration bonds.

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I completely disagree. In times of unprecedented risk, when markets have all peaked, cash is exactly where you want to be [ at least partially ]. Inflation is a red herring. The cure for inflation is inflation.

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When times don’t make any sense, I check out what smart and experienced money individuals are doing. Grantham is a guy managing real money, lived through many market cycles, and has a decent track record. (he’s always early but eventually right) He’s in the bubble camp and would probably tell us small guys to go to cash. Ray Dalio is a hedge fund manager running lots of money, has a good track record, and a real keen sense of history. I appreciate that. He tells us cash is trash. He actually sounds a lot like Armstrong - Asia is rising and we (US) are on the decline. Move money east.
So - is money getting shredded and is this the start of a hyperinflation? Or is this a classic bubble and cash will win in the end? Don’t know.
We are all small fish. We won’t know the outcome until it is too late. Rather than betting the farm on one outcome, a better path forward is to create several buckets that will excel in different environments, knowing full well some will get hammered and others will thrive. Buckets for me include ag land, PM’s, equities (low PE dividend stocks), and cash. %'s? Trust yourself.
 

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That’s because they will tell your husband what to do with that cash, and charge him for it.

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What is the definition of “Composite” on the left-side Y-axis in the euphoria-panic chart?

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In one of Charles Hugh Smith recent musings (#21 2021), he presented one of the more convincing arguments for deflation.

The general answer takes one of two paths: inflation leading to hyper-inflation or a deflationary collapse of defaults and popping asset bubbles. [...] Consider two variables that are rarely visible in pundits' arguments: 1) What will benefit the banks? 2) What will benefit the nation's place in the geopolitical order / global economy? [...] Hyper-inflation will destroy not just the currency but the entire banking sector,which is politically powerful. Will the banks just sit by passively watching their wealth and income being destroyed by accelerating inflation? I think not. [...] The politically powerful elites have their ace in the hole in a deflationary collapse:they can demand politicians (who need their contributions to fund their re-election campaigns) bail out the banks, transferring the losses from defaults from private banks to the public sector, exactly what happened in 2008-09.
I thought it very interesting to think about it from a “who benefits” perspective. The assumption that hyperinflation is beneficial to governments is naive.  
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I speak with Charles often and he has been driving this point home frequently in our recent conversations.
Those running/funding America will not stand idly by to watch the dollar lose its reserve currency status or become valueless confetti.
Wolf Richter made a similar point in my interview with him last week. He sees the Fed being forced to tighten once the CPI hits 4% (which he predicts will happen within the coming year)

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Charles thesis certainly does change one’s relationship to cash.

Inflation is a glacier, deflation a tsunami.
The elite do not carry personal debt. They are hurt by deflation when asset prices drop, but not completely ruined. I read a history of the ascent of Bank of America to a major financial power. It was due to repossessing farmland from distressed farmers who could not make their mortgage payments in California during the great depression. Some banks do fantastically during a deflationary collapse. A deflationary collapse can lead to a sell-everything dynamic. Even assets chosen as safe haven's can drop in price proving not much of a safe haven in the end. Gold is an example. Another of Charles' big points is that trends will drift out of control and move in unforeseen ways. We do our best to find certainty, but, the forces and trends are many and certainty is just not possible.
Everyone has a plan until they get punched in the face.
And, it is good to think through our responses in advance to a range of possible events.
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https://www.jsmineset.com/2010/07/19/explained-time-and-time-again-currency-induced-cost-push-hyperinflation/

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I read Charles Hugh Smith regularly and value his insights. But I am not so sure about this prediction. While higher interest rates would defend the dollar’s role as the reserve currency, they would also make financing the Federal government and all of its fixed obligations really difficult (translation: politically near impossible).
So those people who prize the dollar’s role as a reserve currency and the bankers will be up against other very powerful interests. Which will prevail?
We have a supposed national debt around $30 trillion and it is growing rapidly. Even a 5% interest rate would make the annual Federal payment about $1.5 trillion. That’s more than twice current expenditures for defense and more than either Social Security or Medicare in 2020. It is about equal to all tax revenues from individuals including FICA.
Are we really going to double tax rates? I don’t think so. So where is that “new” money going to come from if interest rates rise significantly?
I don’t think the new money can be found…particularly not with the MMT delusion and other delusions gaining more and more traction. We are already badly fractured as a nation…the current trajectory toward deflation or inflation is not going to make a reasonable political solution (if there is one) any easier to find.
If someone can tell me how we can pull off higher interest rates with a Federal government and a whole society up to its eyeballs in debt, I really want to know. I just don’t see it as a politically-realistic option.
 

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Part of the financial scams which the US gov runs, involves the marketing of those scams.
As labels for parts of Scams go, I think “Modern Monetary Theory” is pretty good.
They are simultaneously diluting the money supply and re-distributing wealth, e.g. as $$ flows to the stock market and Bitcoin.
Stanford comes in real handy in situations like this. Just as Scott Atlas from the Hoover institution helped legitimize the Trump Pandemic-ism Du Jour, Stanford has also provided economist Michael Boskin to add cachet and flair to i.e. think Reagan’s economic machinations.
Fancy labelling and pedigree endorsements.
Used to sell some less nice stuff.

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First there WON’T be any HYPER-inflation, just inflation. Hyperinflation did not occur in the Weimar Republic until France re-occupied Germany in order to try to collect on war reparations. This occupation destroyed the Weimar Republic’s means of production. Venezuela has hyperinflation because they have destroyed their means of production of oil. Argentina has high inflation, about 4% per month but somehow the eke by, banks still function and rich people still own assets like farmland where they can export soybeans and obtain foreign currencies.
 
Having a reserve currency is a double edged sword for the United States. It allows our country to consume more than it produces for an extended period. The benefit is low inflation since we get the lowest prices for any good or service in the entire world but the cost is having good (or at least better) jobs for the average wage earner.
 
I think that the best course of action is to hedge your bets instead of trying to pick a single winner. I would have my 25-35% of liquid assets in equities that will do well during inflation trying to pick those with the least amount of leverage. There are REITs with only 20% leverage and commodity producers (miners) that pay high dividends. Both of these should do well with inflation and will survive deflation. I wouldn’t own bonds because they will do poorly if interest rates rise and there isn’t much room for interest rates to drop. Cash will do better than bonds (or at least not more than 2% worse). I would have NO debt to prepare for deflation and substantial cash, 65 - 75%. Once you see which way the winds have shifted you can deploy your cash. My hard assets I would invest in housing or farmland. If people spend 30% of their income on housing then the debt free house will provide that income whether there is inflation or deflation. Relatively it is the same, it is just the value in dollars that have changed due to inflation or deflation.
I will be happy if I come out even, I don’t need to predict the exact path, just prepare for both.
 

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We have a nation mired in debt. Its not just the national debt thats out of control, its corporate and personal debt too. At this point, QE and interest rate manipulation amounts to monetizing the debt. In order to pay the debt, they have to issue more debt. The more they borrow and print, the higher inflation gets. The higher inflation gets the higher interest rates become. The higher interest rates become the more difficult it is to pay the debts.
The whole global debt structure is dependent on low, no, or below interest rates, I dont think the economy can withstand a 2.5% 10 year rate. They already tried it [ remember the fed was going to “unwind” its balance sheet? ] and they had to reverse course when the 10 year got around 2.5%. The debts have gotten higher since then and they are dependent on even lower interest.
The problem is now the debts are much bigger and they have to borrow and print even more to make the payments…but the interest rates are rising as bond holders are demanding more in anticipation of inflation. The bigger the debt the more they need to borrow, and the more they borrow the higher the cost. Its coming to a head. They’ve painted themselves into a corner.
The idea that they can “inflate the debt away” was always wrong. Higher inflation causes higher interest rates and higher rates pop the bubble and cause deflation. They were always just kicking the can down the road and we’re about out of road.

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When the elite lose by both rising interest rates and low-to-negative interest rates, that creates a setting where a radical re-writing of the rules offers advantage. A great reset.
Maybe a pandemic, a world war. Some emergency where all the rules can be rewritten or suspended.
Just talking off the top of my head.
 

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The World Economic Forum runs its Cyber Polygon simulation of a cyberpandemic on July 9, 2021. So maybe we’ll conveniently have a real cyberpandemic shortly after that (~August - October). Since no crisis goes to waste, I expect they’ll have a ready-made “solution” that gets them out of the jams they’re in now, and installs a new monetary system in which they’re on top again. Heads they win, tails we lose.

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that interest rates “should” go up to fight inflation. However, I just don’t see how higher interest rates can be tolerated as drbrucedale points out.
Enter “Yield Curve Control”.
https://www.brookings.edu/blog/up-front/2020/06/05/what-is-yield-curve-control/
 
That will work right up until is doesn’t. Then, chaos ensues.

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You’re right Mark, if they can, somehow, hold back the tide through YCC or other methods then I guess we’ll have inflation. Its hard to imagine…can the fed buy ALL the bonds and unilaterally fund the entire government?
Nobody will buy bonds that pay 0% when inflation is sky rocketing, its a guaranteed loss. The fed owns a small percentage of the debt, theres an ocean of bonds out there owned by private investors, banks, pension funds, other countries etc…

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Lacy Hunt and Mish provide 6 reasons to expect disinflation:

  1. Inflation is a lagging indicator, as classified by the National Bureau of Economic Research. The low in inflation occurred after all of the past four recessions, with an average lag of almost fifteen quarters from the end of the recessions. (Table 1 Inflation Troughs Below)
  2. Productivity rebounds in recoveries and vigorously so in the aftermath of deep recessions. This pattern in productivity is quite apparent after the deep recessions ending in 1949, 1958 and 1982 (Table 2 Below). Productivity rebounded by an average of 4.8% in the year immediately after the end of these three recessions and unit labor costs were unchanged. The rise in productivity held down unit labor costs.
  3. Restoration of supply chains will be disinflationary. Supply chains were badly disrupted by the pandemic. Low-cost producers in Asia and elsewhere were unable to deliver as much product into the United States and other relatively higher cost countries. This allowed U.S. producers to gain market share. As immunizations increase, supply chains will be gradually restored. Thus, the pandemic cost the low-cost producers market share which was shifted to domestic producers. The pandemic did far more for domestic firm’s
  4. Accelerated technological advancement will lower costs. Another restraint on inflation is that the pandemic greatly accelerated the implementation of inventions that were in the pipeline. Necessity is the mother of invention, as has been demonstrated in earlier crisis situations like wars. Thus, the technology du jour is not the same as the technology of a year ago. This will also serve to act as a restraint on inflation. Much of the technology substitutes machines for people, communication without travel, and work without offices.
  5. Eye popping economic growth numbers, based on GDP in present circumstances, greatly overstate the presumed significance of their result. This is where the fallacy of the broken glass comes into play. Many businesses failed in the recession of 2020, much more so than normal. As survivors and new firms take over their markets, this will be reflected in GDP, but the costs of the failures will not be deducted.
  6. The two main structural impediments to traditional U.S. and global economic growth are massive debt overhang and deteriorating demographics both having worsened as a consequence of 2020.
https://www.thestreet.com/mishtalk/economics/expect-inflation-to-accelerate-heres-8-reasons-to-expect-decelerating-inflation