Eye of a Hurricane

Here’s a graph from Zerohedge.com. Take a look at it. I’m using it to make three points:


1.) Many people have forgotten how close the world came in 2008 to a total financial system collapse. This graph shows how the cataclysm was postponed. Not avoided, postponed. If the collapse had been “avoided,” central bank assets would have levelled off and fallen, while the interest rates would have returned to levels of 4-5%. What has actually happened is that the central banks have continued to swell their balance sheets with bonds (government debt and mortgage bonds), driving interest rates lower in hopes of reviving a moribund global economy.

2.) We don’t know how this is going to end, except that it will end badly. The global economy is at the end of a long credit-debt cycle, and desperately needs to blow off all the bad debts so it can restart the cycle. But the governments of the world are stopping that from happening, for the simple reason that they don’t think the social and political status quo will survive. It didn’t survive the Great Depression intact (see World War II), and the blow-off this time would be far worse. So the Central Banks continue buying up private market debt (mostly mortgage bonds) and public debt (government bonds). They blindly hope that at some point the global economy will begin growing on its own again without monetary intervention. That is kind of like hoping that a man drowning in debt will find such a well-paying job that he can pay off his debts and start consuming normally again. So far, there is no evidence of it happening.

3.) This monetary policy cannot continue. It only works as a short-term fix. What it does is pull forward future demand (via debt) to stimulate consumption. The idea is that by driving down interest rates, businesses will borrow money to expand, new industries will spring up, and the consumer will play his part by spending more, through credit cards and mortgages. But it’s a dangerous game. The low interest rates on bonds are destroying pension funds and insurance companies and retired people trying to live on their investments. And when interest rates are allowed to rise, the governments themselves will be bankrupted because they will have to pay out far more interest on their bonds. So the Central Banks are caught in a quandary. They are afraid to stop swelling their balance sheets, because interest rates will rise and cause defaults by their governments. But if they keep rates near zero, they will cause widespread collapses of pension and investment funds. So they keep on doing what isn’t working, hoping for a miracle.

Considering all this, the best advice is to stay nimble. We are in the eye of a hurricane.

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