Royal Bank of Scotland to investors: 'Sell everything'

Right now there is a lot going on in the global macroeconomic sense. Everyone is so optimistic, but the hard economic data still shows the same depression we have been in for a decade. Even with endless credit being thrown into the global economy by central banks, we are getting very poor economic growth. That money is fueling misallocated bubbles. Some of the people on this thread won't understand it until we are dealing with the consequences. But that is the way it always goes. There were people in 2003, 2004, 2005, etc. pointing out the mess Alan Greenspan was creating -- many pointing specifically to the housing distortions. He was able to blow that bubble longer than they would have guessed -- sending housing prices beyond what would have seemed rational, and creating a mountain of mortgage debt (including the subprime debt) in the process.

Rather than allowing the deleveraging to fix the mess they created, they stepped in with even more drastic price administration. The answer to too much debt created because of someone trying to price fix interest rates was NOT even more extreme price administration to create even more debt. But that is where we are. And the debt is way greater now. The Federal Reserve sees the bubbles they created and has been threatening to raise rates the overnight lending rate for their member banks to temper it all -- they have been threatening for more than 3 years, though and have raised a total of 50 basis points. We are still at half a percent on the overnight rate. Artificially low. And markets totally tuned them out now -- they are the boy who cried wolf. They aren't the only game in town, and the ECB and the BOJ replaced them in creating the carry currencies after they backed off when they stopped QE3. Everyone is trying to prop up their own debt messes, which has created a revolving currency war -- different central banks taking turns.

The ECB and BOJ have been buying assets at a furious clip and went to negative interest rates. They hadto, because their debt problems are even worse than ours, and even slightly higher rates means game over for them. The Euro collapses amid sovereign defaults without a central bank monetizing the debt to keep them from drowning in it -- at least for as long as they can hold off the reality.

That allows speculators to front run them. For example, and this is just a small part of their balance sheet now, Mario Draghi now owns 10 percent of the European corporate bond market. It is insane. He creates money out of thin air and lends it to entities. The ECB's balance sheet = 35 percent of Eurozone GDP. Those bonds were bought with money he conjured out of thin air. They announce they are going to buy 80 billion Euro worth of bonds a month. In order to even have that much in debt outstanding, it allows shaky entities to issue more and more debt with a huge buyer creating phony demand. In a market with actual price discovery, risk averse lenders would never touch that. Traders aren't dumb. They hop in and buy that debt, knowing that they will be able to sell it to the ECB for more than they paid. It's free money. That free money gets gambled on in various other risk assets. The Federal Reserve did that with three rounds of asset buying so far -- creating a $4.5 trillion balance sheet. The ECB has done it. And the BOJ has done it to an extreme -- they even skip the debt part now and just hopped right into their equity markets to become a buyer of stocks and are the biggest owner of Japanese equities.

It is pure phoniness. It lifts asset prices (which we have seen), but it creates mountains of debt and it debases the currencies. That has eventual consequences. It is setting up the world for a nasty deleveraging that is going to hurt a lot of people when we have to pay the price.

In the run up in U.S. equities since the election, people tuned out the Fed. That is how bubbles go. It turns into a frenzy. Central banks used to have this aura of being all powerful. But they are like the boy who cried wolf -- they have threatened to normalize for so long, but have done nothing (they can't, because they know what is going to happen when they stop spiking the punch bowl), that markets are just ignoring them -- essentially daring them to do it. But they are privately freaked out by the bubbles they have created (take a look at deep subprime auto loans right now, and the default rates, for example) that they WANT to rein in the mess they created. So they came out with megaphones in the last few weeks saying they are going to raise another 25 basis points on March 15 when they meet. It may or may not be a catalyst that pricks the bubble. They could raise 200 basis points, and it is still artificially cheap to borrow. This could bea bit like the early 1930s when the Federal Reserve raised into weakness. It brought about a nasty recession. We can't handle that recession now, because the trillions of dollars of defaults will be crippling.

What it will likely do is raise the dollar some more (which has been rising), which will likely put stress on the emerging markets -- creating a repeat of the conditions that started this thread -- China's mountain of debt and capital flight (this is a worldwide thing, and China's growth has been predicated on debt more than in the developed world) becoming a problem. Which could be the trigger -- just a year on instead. But 25 basis points, in the grand scheme of things, isn't that much -- when they are suppressing rates by hundreds of basis points. The Fed's balance sheet is the key more than the overnight rate -- they have bought $4.5 trillion of assets. They are technically insolvent, because they could never sell those bonds for anything near what they overpaid for them. The unwinding of that balance sheet -- likely in a forced manner, because they won't do it voluntarily -- will be when it is game over. But the question is whether they will be able to get away with QE4 first -- to step in and prop things up even longer when they start losing control again (like they did in 2007 / 2008). I don't see how it is possible, but I am not surprised by anything anymore. It's not that speculators don't know it is fake and is going to end disastrously at some point -- it is that they will take advantage of anything to try to make some short term money. Which gives the central banks license to be reckless. If they end up launching QE4 or they reverse and we end up with negative overnight rates or the ECB or BOJ expands their asset buying because their debt messes are imploding, making their currencies what gets used for the carry trades, the lunacy can go on even longer. So I wouldn't short equity markets thinking "In a month from now." It's why I have seen this out of hand for at least the last 3 years and even moved my retirement account equity allocation to cash -- but I have never shorted these markets (although you would think I have from some of the responses I get on here). We will probably see buckling along the way if they try to raise the overnight rate, like early last year and last summer. Even small gradual raises of 25 basis points, which should be relatively meaningless given how artificially low they STILL have set the price of money. But they will not stop at this point until they are forced to stop -- and they know the blame they are going to take. So they will likely reverse or pull back on the threats (as they have multiple times over the past 2 years).

What I do know is that it can't go on forever. The end may not be next month. But the longer it goes on, it means they have managed to dig the hole even bigger -- which means the deleveraging will be even nastier. All they are doing is enabling more and more debt -- on entities that are way overindebted already. This is all uncharted territory. But they can blow a bubble a lot longer than I would thing rationally possible. Just because I can't give the day and time when they lose control and it implodes doesn't mean that what I am pointing out isn't reality. I would never short these equity markets, and I haven't. At the same time, I know there is going to be a tremendous buying opportunity -- think 50 percent, 75 percent, 80 percent down, or something of that order. Fundamentally, no matter how you look at it, this is silly. We are beyond valuations that you saw in 1929 and 1987 and 2007 -- not quite to the level of froth that Greenspan was able to create in the dot-com bubble. I'd remind people that when that one burst, it took 15 years for owners of Cisco, Microsoft, etc. to get back to where they had been. And if you had owned Pets.com or any other number of ridiculous entities, they never came back.

 

I used to secretly store myself (not saying where). But then I accumulated enough that there was no way I wanted that kind of value all stored that way. So now I still have some secretly stored myself, but for most of what I own I pay for segregated storage @ two different depositories. One in the U.S., one elsewhere. That only became necessary in my mind when I accumulated enough that it was making me nervous.

I don't use a safe deposit box because although I don't anticipate this happening, the exact conditions that could make me physically want to go collect what I own, are exactly the conditions that could conceivably make the bank close its doors and deny me access to my deposit box.

 

It is an excellent question. It relates to what I keep posting about. Short answer (for me): One of the biggest accumulators of very shaky debt has been U.S. shale oil drillers. Many of them would have gone belly up long ago (or never would have gotten the financing to even get started) without the Federal Reserve creating a debt / leverage bubble. This is what happens. A lot of capital gets misallocated in that environment. They are a huge part of the junk debt market.

Those drillers can't make money without oil being at a certain price -- above where it has been for the last year. They need to make money in order to service their debt -- even with interest rates artificially pinned well below where they should be (given the risk inherent in borrowers like those), they are drowning in their debt.

When oil drops below $50 a barrel (as it did last night for the first time since last year), it creates fears of that being the pin prick that sends everything tumbling. Massive junk bond defaults leading to a cascading sinkhole.

Junk bonds and equities are very close cousins. They are on the riskier end of the investing spectrum. They are both severely mispriced because of central banks. The oil thing you are asking about demonstrates why the Federal Reserve (all of the central banks) backed themselves into a corner. They WANT to normalize rates. They know they have made a mess .But if they do (i.e. -- it becomes more expensive to borrow), the bubble pops -- you have defaults (it isn't just shale drillers). That has left them with their foot on the accelator -- keeping rates artificially low longer. What that does, though, is enable more borrowing -- to shaky entities. It creates a self-fulfilling prophecy. By making it too cheap to borrow, they have created way too many oil drillers who set up shop in a highly leveraged way. They need to drill a ton of oil to keep paying their debt. That creates an oil glut and drives the price down. The lower the price goes, the more shaky those drillers are. OPEC is having trouble colluding to cut back on drilling in the face of that to try to raise the price. They don't control enough of the world's oil to act as a cartel that way. On top of those supply factors, worldwide demand for oil is relatively weak -- we have been in a decade long depression thanks to what those central banks created in the first place.

There are certain points ($50 a barrel oil) when other markets start waking up to reality. It was partially what made things buckle last year, and it is what you are starting to read about again right now with oil weak again. If the price gets too low, it will lead to defaults. Those defaults could derail the economy in a hurry -- same way that housing defaults did it last time around.

 

@I Should Coco

Here is something from 2 days ago talking about what I posted: Trouble Brewing in High-Yield Debt, Commodity Investor Warns

It's Rick Rule of Sprott Investment Management in Toronto. I think he is spot on. He doesn't mention the central banks' roles in this -- at least the article doesn't go into it. But the reason people are reaching for yield the way he pointed out is that they are being robbed of income they could normally get in a much safer manner -- that is what happens when you price fix the cost of borrowing to artificially low levels they way they have to an extreme for the last 9 years. It makes people do riskier and riskier things to make up for the risk-free rate of return they are being robbed of (to reward debt creation). It is what created the housing bubble before this, and it has created asset bubbles in the wake of it --they have doubled down on creating more and more debt and leverage to try to avoid dealing with the consequences.

A lot of people have reached into very risky areas to find the income they are being robbed of. Into junk debt, without realizing the inherent risks -- in this case, artificially low rates distort the lending standards and funnel money to very risky propositions. The market can't impose those lending standards and deny that credit because a price administrator has destroyed price discovery.

He points to mining and energy -- the drillers I was talking about.

There is no way for the Federal Reserve and the other central banks to normalize without triggering defaults -- across dozens of way overleveraged areas of the global economy. They have created a mountain of debt, much of it funneled to places that should have never been able to borrow. All we have been doing is keeping it VERY cheap to borrow without the lending standards a market would impose without the moral hazard they have created. It all works if they can keep up that phoniness forever. If they can't, there is going to be a massive deleveraging (the one we needed in 2008 and didn't get, with more pain on top of it because of all the added debt they created). It's inevitable.

What you are seeing with the price of oil is twofold: when the price drops, it makes people worry that it is going to trigger defaults and make THAT the catalyst. It doesn't need to be that, though. There are at least a dozen other potential catalysts -- from sovereign defaults, to various consumer debt markets that have gotten out of hand. On top of it, cheap oil also signals that despite all of the hope out there, the global economy is still weak -- there isn't enough demand to offset the supply glut the leverage has created.

Look at what I quoted from the article. On this thread, I have been the one pointing out what Rick Rule is saying -- in various ways. Yet, junk energy bonds are up 51 percent over the past year (mirroring the equity markets that this thread was about). Others on this thread either have read my posts or ignored them, and weighed in with, "Ha ha. They have gone way up in value. What does he know?" To which, I keep pointing out that anyone pointing out the distortions (and what was creating them) in the housing market in 2004 or 2005 or 2006 was getting laughed at that way too. You are watching something phony -- whether you understand it or not.