Michael Bond: I added the images and charts to Doug’s article. My one input upfront is to understand that the credit bubble Doug has been chronicling spawned the tech bubble, the housing bubble, and now the corporate & sovereign debt bubble. The global credit bubble is the granddaddy of them all, so when its terminal phase ends the global damage will be proportional to the boom. Not good.
Doug Noland: Made the Decision
- Bubbles are sustained only by ever increasing amounts of Credit.
2. The most pernicious Bubbles are those fueled by “money” – perceived safe and liquid Credit instruments.
3. Bubbles are mechanisms of wealth redistribution and destruction.
4. Structural impairment caused by Bubble excess escalates over the life of the boom.
5. The pain and dislocation unleashed during the bust is proportional to the excesses of the preceding boom.
Though we’re in uncharted waters when it comes to global Bubble Dynamics, I’ll suggest that geopolitical risks expand exponentially over time.
My thesis holds that 2022 is a pivotal year for a historic multi-decade Bubble period. On multiple fronts, things have come to a head. Today, more than ever, historical context is invaluable for making sense of current developments, while also recognizing the dynamics behind unfolding instability, turmoil and Crisis Dynamics.
In the nine quarters beginning Q3 2019, outstanding Treasury debt expanded $6.4 TN, or 36%, to a record $24.3 TN. Treasury debt has increased 300% since 2007. Since September 2019, Non-Financial Debt has expanded an unprecedented $10.4 TN, or 20%. Federal Reserve Assets surged $5.14 TN in 127 weeks to $8.911 TN, having now inflated almost 10-fold since 2007.
In China, Aggregate Financing surged $12.4 TN since July 2019, or 33%, to surpass $50 TN. Since 2007, Chinese Bank Assets have expanded from $6.9 TN to $54.3 TN, or 684%. China’s M2 “money” supply inflated $7.54 TN, or 25%, since September 2019 to a record $38.3 TN.
Led by the U.S. and China, the entire world succumbed to reckless “money” and Credit growth without precedent. End-of-cycle “blow-off” excess sustained myriad Bubbles, but at tremendous cost. Securities speculative Bubbles morphed into precarious manias. Mal-investment spun completely out of control. Structural maladjustment ran deep and wide, both within real economies and market structures. Powerful inflationary dynamics escaped asset markets to jolt consumer and producer prices. Moreover, the forces of wealth inequality were dramatically energized, within nations and between them.
Annual U.S. CPI has exceeded 7% for the first time since 1982. Short-term rates remain near zero, and the Fed has yet to conclude this round of QE. China is in the initial phase of a historic real estate (chiefly apartment) bust. Beijing’s most recent effort to slow Credit growth was, once again, scuttled. China has significantly escalated pressure on Taiwan, while moving to shore up its dominance in the South China Sea. Russia has reportedly massed a force of 190,000 around Ukraine, the largest European military mobilization since WWII. China and Russia are moving aggressively to galvanize their anti-U.S. global sphere of influence. Here at home, a deeply divided nation sinks deeper into a muck of anxiety, acrimony, vitriol and hostility. In short, years of mismanagement and resulting Monetary Disorder are coming home to roost – Big Time.
Severe banking system impairment in the early nineties emboldened the Greenspan Fed to accommodate a boom in non-bank Credit and leveraged speculation. With Greenspan rate policies backstopping the markets and GSE balance sheets operating quasi-central bank liquidity operations, Bubble Dynamics gathered powerful momentum.
Following 1999’s manic blow-off excess, I thought the Bubble had burst in 2000. I had to reverse course in 2002, warning that Fed reflationary policies were unleashing a “mortgage finance Bubble”. The “Moneyness of Credit” – the transformation of Trillions of risky loans into perceived safe and liquid AAA securities – was instrumental in, at the time, unparalleled Credit and risk-intermediation excesses.
I thought the bubble had burst in 2008. I reversed course (again) in 2009, warning of an unfolding “global government finance Bubble” – the “Granddaddy of all Bubbles.” The so-called “Great Financial Crisis” (GFC) gave cover to a perilous – and fateful – escalation of government inflationism.
I feared QE – the wholesale inflation of central bank Credit – would prove a slippery slope. In the markets, Bernanke’s coercion of savers into risk assets created a dynamic whereby the markets would become only more integral to system financial conditions, perceived wealth and economic performance. I worried about a “moneyness of risk assets” dynamic that would see the Fed entrapped in market liquidity and price backstopping operations, crystallizing the already dangerous market misperception that securities entail minimal risk. Stock prices always rise over time, with occasional downdrafts sure to induce Federal Reserve reflationary measures.
While memories have faded, mortgage finance Bubble consequences were horrible, levying a steep cost on our social wellbeing. From my analytical perspective, the global government finance Bubble created a whole new level of risk. For one, it unleashed capricious inflationary forces globally. Importantly, the custodian of the world’s reverse currency succumbing to rank inflationism (central bank Credit and government debt) freed nations everywhere to do the same.
Post-GFC reflationary measures opened the monetary floodgates. I don’t see how China’s incredible Bubble is sustained without U.S. QE, massive federal deficits, and ongoing Bubble excess. China’s international reserve holdings inflated from about $200 billion to $1.5 TN during the mortgage finance Bubble period, only to then rise parabolically to a high of $4.0 TN in 2014 (as the Fed ratcheted up QE2). Massive reserves, with enormous and unending trade surpluses with the U.S., empowered China to recklessly inflate Credit without the traditional risk of currency instability. Extraordinary unfettered Credit.
During a Bubble’s upswing, perceptions hold that the pie is getting bigger. The forces of cooperation, coordination and integration hold sway. But eventually, the reality of wealth inequities is unmasked. Stagnation and fear of a shriveling pie foment animosity, disintegration and conflict.
China doesn’t become so powerful – financially, economically, militarily, geopolitically – without the protracted U.S. (and then global) Bubble. For today’s heated global rivals, the days of cooperation are over. The enemy of my enemy is my friend. Hostile to a U.S. global order it views as deeply unjust and contra to its interests, Russia is jubilant over the opportunity to partner closely with a likeminded Beijing. Russia gains the security of a vast market for its energy resources outside of U.S. influence, while a military alliance creates the most powerful opposition to U.S. global dominance in decades. Without his harmonious partnership with Xi, Putin doesn’t take the risk of such a confrontational approach with Ukraine, the U.S. and NATO. Might the U.S. and its allies being bogged down with a war in Europe embolden Beijing’s Taiwan aspirations?
President Biden believes Putin has “Made the Decision” to invade Ukraine. The situation in eastern Ukraine is rapidly deteriorating. A car explosion at a government building. Gas pipelines bombed. Satellite imagery showing aggressive Russian military positioning along the Ukraine border – in Russia, Belarus and Crimea. Russian-supported separatists announcing plans to evacuate women and children to Russia. Aggressive cyberattacks.
While the administration stresses it’s not too late for diplomacy, the situation appears increasingly dire. U.S. intelligence believes Russia is now executing its plan of “false flag” attacks and provocations (i.e. accusations of Ukrainian genocide) that it will use as justification for an invasion. “Nearly half of Russian forces surrounding Ukraine are in attack position.” Defense Secretary Lloyd Austin: “I don’t believe it’s a bluff.”
To this point, it’s been easy to dismiss the risk of a full-scale invasion. Surely, Putin wouldn’t take the enormous risk associated with a full-blown war in Ukraine. “Crossing the Rubicon,” as they say. Ukraine is not a current threat to Russia, and there is little prospect for NATO membership anytime soon. It has been reasonable to assume that Putin was playing hardball to extract concessions from the U.S. and NATO. Yet it’s been confounding. Putin’s proposals have been nonstarters – and he can’t be surprised by the West’s refusal to play ball (be blackmailed).
Putin has been excoriating U.S policy for a number of years now. If Russian forces cross the Pripyat River in a move on Kyiv, I’ll see this aggression as much an attack on the U.S. global order as on Ukraine. According to Putin’s thinking, the U.S. has repeatedly trampled over his red lines. Rants on NATO expansion, U.S.-sponsored “colored revolutions,” meddling in others domestic affairs in pursuit of U.S. global interests, unilateral economic sanctions, U.S. dominance of global finance along with international organizations, and so on.
Putin has surely been conceptualizing his counteroffensive for years. Perhaps he waited for President Trump to leave the White House. Or he needed to ensure his military and technology were up to the challenge. Surely, he wanted to cement his relationship with chairman Xi and China. Is it possible he’s been waiting patiently for years for this moment? To us Western thinkers, only “Vlad the mad” would execute such an irrational invasion. Especially at this critical juncture, his calculation might be that the West has so much more to lose than Russia.
Additional corroboration this week of global Bubbles at the precipice. The Nasdaq100’s 1.7% decline pushed y-t-d losses to 14.2%, supporting the thesis of a deflating U.S. “tech” Bubble. Ten-year Treasury yields traded up to 2.06% Wednesday, with stress continuing to build in U.S. corporate Credit. U.S. bank stocks were hit 3.0% this week, and bank CDS prices continue their upward march. And the Fed has yet to even end QE or move off the “zero bound”. The Bloomberg Commodity Index’s 1.6% advance pushed y-t-d gains to 12.6%. Gold this week traded above $1,900, as Hard Assets outperform financial assets.
Chinese Bubble developments this week were no less ominous. A Friday Bloomberg headline: “Crisis in China’s Property Industry Deepens With No End in Sight.” And Thursday: “China Builders Miss More Deadlines as Yango Fails to Pay Coupons.” “Chinese high-yield dollar bonds fall 1-3 cents on the dollar Thursday…, putting them on track for a fourth day of declines.” One cannot overstate the significance of the ongoing spectacular collapse of China’s massive (and massively levered) developer industry.
From the nineties “tech” Bubble to the grander “mortgage finance” Bubble to the unbelievably colossal and historic “global government finance” Bubble. Bubble inflation not only made it to every nook and cranny across the global landscape. Wild excess went to the very foundation of global finance – central bank Credit and government debt. This is it. Nearing the end of the road. There’s no fledging Bubble waiting to heroically save the day this time around.
Moreover, the amount of monetary inflation necessary to sustain aged financial and economic Bubbles has fueled dangerous inflationary dynamics. The Fed and global central bank community are being forced into action, with the tightening of finance necessary to rein in inflation placing myriad Bubbles in danger. There is today acute fragility throughout global finance. “Money” and Credit have been severely degraded. Financial manias and speculative leverage have destabilized markets and economies virtually across the board. Gross inequities have destabilized societies and international relationships. In sum, the existing global order appears one serious catalyst away from a megaquake.
If Putin is determined to wreak havoc, his timing couldn’t be more perfect. And while Beijing today confronts extreme Bubble risks, perhaps it views its now well-tested “zero tolerance” authoritarian capabilities as ensuring the hardened Chinese will weather the cyclone better than its flabby and fractious American adversary.
Hopefully cooler heads prevail. I will gladly admit to being snared by “false flags” and a false alarm. But I know I’m not alone on this. I’ve been fearing escalating tensions with team Russia and China. And from my analytical perspective, these are not coincidences: Out of control monetary inflation, runaway Bubbles, acute fragility, social disorder, strained international relations, power vacuums, and dangerous geopolitical developments.
In the event of an invasion, the U.S. will lead the global charge for imposing the most onerous sanctions ever. Can the Biden Administration keep the Europeans on board with Putin threatening to tighten shut the gas spigot? How will the U.S. approach relations after China repudiates American efforts to punish Russia? And when U.S. market and economic Bubbles suffer serious blowback, how will a deeply divided and weary nation respond to adversity?
Bubbles inflict tremendous damage upon societies. It has been my greatest fear that the “granddaddy” of all Bubbles would also foment global acrimony, hostility and conflict. I’ve become a broken record on this: I hope things are not as dire as I fear. It’s just that I’ve been closely monitoring these dynamics and pondering the Bubble endgame scenario for some time now.
I’m deeply concerned, and part of my anxiety comes from knowing people haven’t been paying attention. A Russian invasion of Ukraine has potential to be a highly destabilizing catalyst, slamming fragile global markets, exacerbating inflationary pressures, accelerating financial asset Bubble deflation, and pushing forward the transition to what will prove a particularly challenging down cycle.
See TSP Smart: Quicklook 18 February 2022
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Categories: Doug Noland