The top is in (save 4 QE4)

Life comes with an expiration date, only we don’t know it. Everything in life expires as well. In the world economy the time has come, for the end to a means (maximizing growth with easy money and easy credit). A means of achieving a laudable end (super-welfare states, unlimited credit, and two cars and houses  per middle income family). A great end. Yeah! I know the reader loves that “end”. We now think happiness depends on the make of your car. We can’t do without our BMW, or can we?

camper_van_1_1112565i

Will this do for a Hummer?

Don’t be upset. The end to a means doesn’t mean it is the end of “the end” (perpetual prosperity) itself. There are other means we can use to achieve it (depending on how lavishly you define prosperity). wallpapers-hummer-h2And that must be what super Mario had in mind when he stated he would do “anything it takes” to save … the euro, his job, and prosperity (at least for himself and his family).

Three disagreements. First, the end doesn’t justify the means, no matter how laudable it might turn out to be. Second, he got the option spectrum wrong. More of the same will not do. I said that five years ago, and I was 90% confident. Now, I’m 100% confident my call is correct. Third, the euro will not survive in its actual form, regardless of the means used by the ECB. It’s just a matter of time. It is unfortunate that I share Varoufakis’ point of view, but that’s the way it is. I can’t help it.

From now on, it will take something else, something different. More credit growth and easy money (in any of the garden varieties available) will not hold this farce together much longer. Unless it is a load of brand new USD notes. So he, Dragui, and them at the politburos of our beloved Central Banks, will have to come up with an entirely new hat trick. Smart people, and cheaters, always have one last ace up their sleeve. Let’s pray they do. Do you think Mario is smart? A liar he certainly is. But he gets paid to do that -or that’s exactly what his friend Junckers told him he had to do when things got difficult enough. He should have been rewarded with a super bonus for the best lie since Puzo’s “The Godfather”.

Because if they don’t … Well, Houston, we’ve got a problem here. The top is in for risky assets, and debt write downs will begin in earnest.

We’ve been here before. Why won’t easy money suffice any longer? Because they have already fooled themselves and the population for too long. The common knowledge game is losing players by the hour. When you play liars poker, you just have to be patient and wait long enough -liars always set their own traps. They (our central bankers and politicians) have as well. Think global. They are cornered now. It has taken humanity a full seven years to realize that more credit and heli-money was a bluff. It will only take a couple more months (more than two in fedspeak) to put the last nail in the coffin for that paradigm. The medicine is not working any more. With every new round of credit and currency debasement people are becoming more and more skeptical. For a reason (see chart)3-debtdebt-and-GDP-1024x485

Only an outright engagement in QE 4ever, by the FED, can change the course. If that is the case, I am now sure that money will not mainly move into HY bonds and bank reserves -with just a small portion destined to equity. New money did not flow into consumption or hard goods in the previous QE’s, because people were aware of the precarious situation of the world economy. They saved for retirement, and waited. Their money bubbled financial prices up, but did not touch the real economy. Inflation was nowhere to be seen. And Heli-Ben got his Wealth Effect (backed and helped by some animal spirits and some spectacular widening of the income disparities).

So far so well (or not so well, if you take a close look at financial valuations). But there is a limit to everything in human conduct. In behavioural economics, altering the same variables in the same DSGE model generates different results depending on the mood of economic agents. That’s why those models the fed dwells on, for hours, are plain useless. New serious printing by the Fed, and we will soon begin a long journey into hyperinflation (BOJ and ECB still have some leeway, and nobody trusts/cares about the PBOC anyway). The FED is key.

I never thought inflation would be an issue up to know. My previous posts speak for that. I never stood for gold, or thought the USD would lose its reserve status during the last QE’s. In fact I was long the USD vs the euro for years (and still am, though moderately). I always thought deflation was the name of the game, and even sustained that deflation was not the ogre they tried to sell at the politburos. So much for the previous QE’s.

imgres-41-e1349787038365Next time, if it comes, printing will generate different effects. They can print some more -but extending and pretending is “kaputt”. Everybody will realize in a short time, that CB’s are joining Nic Cage in his last trip to Las Vegas.

And it (QE4) may well come, after they try to reign in the monetary monster they have created. The Fed might not raise rates, but they should at least signal that the party is over. That they are finished with easy credit and easy money, and will implement a new policy asap. Paraphrasing Churchill, you can always count on the Americans to do the right thing, after they have exhausted all other alternative options. Let’s hope he was right. They have to end the party now. And the smart minds in the US know it.

I think they will give it a try (thank you Stanley, you are a brave man). So deflation and recession will probably take a hold worldwide (more or less). Admittedly, the hawkish message from the Fed may bring the calendar forward a few months, but it won’t change the outcome. Only QE4ever can. When the recession begins, in their shoes, I would monitor markets closely, try to deflate the asset price bubble in an orderly way, and begin to monitor some write-downs, even while making sure the banking system remains resilient enough. I would use fiscal policy (more debt) only when necessary to keep the banking system afloat. An incredible feat if they can handle it. 1508-HPF_Web_World Exports by Volume and Price_web_W495

They might as well begin now, just in time, because the next global recession is nearly with us. China will get worse before improving, and so will the BRICS and Europe. US decoupling is a Chimera. There is a future beyond for most of us, right after the debt reset and the new model is set up and running. We have to get there first, and it won’t be nice. The sooner the better, we are wasting time, and time is the only truly irreplaceable asset. At least on an individual basis.

But wait, even if we get rid of the debt overhang, and easy money, we have still the “long live the welfare state” assumption in full force. Mild recessions, or lackluster growth, will not be enough to balance budgets with the entitlement load they have embedded into them. And the population thinks they have a right to entitlements. They do not understand, nor do they want to understand, that entitlements are always relative to the health and size of the underlying economic system that finances them.5522465794_eb89a5aea0

A serious additional problem generated by politicians and media that have kept on promising everything, and the impossible. It will take at least another seven years for the population to realize that the actual entitlement level is inviable in most of the western countries.

We don’t have them, ’cause we’ve run out of time messing around since 2008.  So it is going to be a rude awakening for our increasingly brainless population (we really have to fix education). No easy money will mean no growth, not even the paltry growth of late. And with no growth, tax revenues will not be enough to pay for entitlements. Japan, France, Italy and Spain will be the poster child for events coming up because of our insatiable population. They want first class free health care, and decades-long high pension benefits, regardless of the output of the economy. We have to take them back all the way from paradise to earth, and it’s a long trip.entitlement-spending-double-600_entitlements_chart_2

I think there will be some lags. Lags are essential to economics (and constantly abused to solve non linearities in DSGE models). I think there will be a time lag between the end of easy money, some sane Central Bankers are urgently desiring, and assuming later, that they can’t do it without busting sovereigns in the process. The banking system can make it if sovereigns hold. That’s a  big “if”. It was a one way road, ever since you hit the QE2 button folks!

It is because of time lags, and the desire of some central bankers to preserve their jobs and reputation, that I think the end of easy money comes first (inducing deflation, debt write-downs, and a possible depression), and, just as soon as they find out that we need to restart the entitlements to avoid full scale war, the nuclear option will eventually come to play -QE 4ever. Whenever (and if) that turns real, you’ve just to load up on real assets (no paper or digital assets) asap. Or maybe they will stand up to the ensuing depression. You never know. And you never know what’s worse. In a depression we might all be running for our lives, whilst in a hyperinflationary scenario we would only be running to preserve some of our money’s value.

Anecdotal evidence also suggests no more printing for now. No other than Bill Dudley just said that the bar for QE 4 is high. Even a Goldmanite and central banker understands now that a touch more of extra easy money and soft speak by central bankers would just be counterproductive. Their credibility is very low -nonexistent if you ask me. The big news is that even the dumbest market players are beginning to get it by now. Give them a couple more months. It isn’t easy to let go of your childhood fantasies. You want to hold on.

American_union_bankOf course governments can try the “spend more” keynesian variety. Summers and Krugman will be, as was to be expected, the cheerleaders for that. I can’t wait to find out what precisely Krugman will have to say about all this. A smart mind ( a nobel prize wow!) in a tough spot. Should we print a couple more trillion to get the motorway system rebuilt like Summers suggests? I wouldn’t want to go anywhere near Princeton for the next couple of months. Some awkward questions are going to be asked there.

But most of the post-keynesians are still alive and well. It will take further evidence to get rid of the “last of the keynesians”. It was amazing to recently read no less than Paul McCulley requesting an apology from all the non-believers in QE. After all, Heli-Ben has been able to print and spend without abolishing the USD or generating substantial inflation. Isn’t that awesome! In a short time, we shall all end up like the Chinese journalist that was jailed -because he failed to see the advantages of being long in the Shanghai Stock Exchange.

We all know nearly never made it. We did come close to escape velocity but … Headwinds were just too strong. We never stood a chance. Debt was huge, entitlements absurd, jobs are being destroyed by robots daily, education has been deteriorating globally for some time, productivity is going nowhere and is even negative lately, population growth is not the way forward above the seven trillion mark, inequality is extravagant, global tensions grow by the hour etc.

Life is like rafting in wild waters. There is no way back. We can grieve our lost chances, but we have to keep moving faster than the current or we will not survive the next rock. Listen to this masterpiece by Maria Callas and relax -if you have two minutes………….. Finished? Time to assume it’s going to be deflation, depression and a house of cards galactic debt write down, or… the nuclear “all in” Zimbabwe, Argentina, Weimar republic option. Big scale. Even the economically sound countries will have to debase their currencies, or be left out of the global market. The SNB can lecture us all on that. I hear Jordan is still on board, who said miracles don’t exist?

Well, let’s get serious now. I realize not few are getting burnt in global stock markets and are not in the mood for sarcastic blabbering.

  • If we have no QE 4, the top in equities is in. I have been talking about “timing the top”, “a mulligan for Lewis’ big short”, and other similar expressions to suggest outrageous valuations, but no certainty of a top. They never ring bells at tops. But I am pretty confident now. If you spend your time reading this, you want an honest, well informed opinion, even if it makes me look like a fool by Christmas. Furthermore, the top is global, unless some CB’s resort to outsized money printing again, and with the inevitable caveat of QE4ever. Not even more “nirping” or currency debasement would get the bull back -if the FED doesn’t print.  I hold a big short right now, with some stops well above current market levels. I’m serious about this short. I love to be on the other side of Heli-Ben’s trend (the guys at Alhambra Investment also have fun reading him).ABOOK-Sept-2015-Bernankes-Trend-Dollar-Trend
  • The swissie (CHF) is approaching interesting levels again. Above 1.12 to the euro I would begin to buy back a small portion of my January position. An average price above that level would be just fine for a small position. I would add more on weakness but slowly and carefully, I am not be expecting a huge blow off like the last time (thank you again, Jordan-Danthine, for the new sails in my boat), but I see some value above those levels.
  • My main call in the currency arena continues to be SEK. I’m long SEK against both CHF and EUR -and have been since January. I have added to my SEK longs step by step because feel confident there is no relevant money to be lost. I continue to think a 9.00 target for the EURSEK is at hand. Against the swissie I am already deep in the money (short from the 9.40 level) but still think 8.20 is a reasonable target.

No more relevant activity in financial markets. I will monitor CB’s balance sheets, and wait for a recession no later than Q1 2016, but remain alert for any departures to Las Vegas. I hope this reading will help you navigate these troubled waters. Or better still, bridge them if possible. There is a beautiful lake at the end of the river, but not before some grade VI rapids.


“Bridge Over Troubled Water”

When you’re weary, feeling small,
When tears are in your eyes, I will dry them all;
I’m on your side. When times get rough
And friends just can’t be found,
Like a bridge over troubled water
I will lay me down.
Like a bridge over troubled water
I will lay me down.

When you’re down and out,
When you’re on the street,
When evening falls so hard
I will comfort you.
I’ll take your part.
When darkness comes
And pain is all around,
Like a bridge over troubled water
I will lay me down.
Like a bridge over troubled water
I will lay me down.