Gold And The Debt Crack-Up Boom

The stock market has entered the “melt-up” phase that characterizes the final stage of a rampant stock bubble – or any bubble for that matter. The stock market is more overvalued than at any point in history using just about any traditional valuation metric. At this point, the stock market has become a function of money managers chasing price momentum. They are doing nothing more than gambling with other people’s money in the hopes that they’ll be able to unload their stock purchases at an even higher level on other gamblers.

Pulling back the cloud of propaganda that surrounds economic news reported by official sources (Government, Fed, industry associations and the financial media) reveals an economy that has been heading into recession and a stunning deterioration in the financial condition of the average household.

A study of U.S. households released by Deutsche Bank showed that the median household net worth is lower than it was in 1989. Despite the rise in home values and stocks, over 30% of all households have a negative net worth. A greater share of Americans have more debt than money in the bank than at any point since 1962. Add on to this the fact that overall systemic debt – a record level of auto, student loan, mortgage, corporate and Treasury debt – has reached a record level outright and as a percentage of the GDP.

Silver Doctor’s Elijah Johnson invited me on to his podcast to discuss why the U.S. economic system is headed for a trainwreck and why gold will surprise to the upside in 2018:

The latest stock featured in the Mining Stock Journal has doubled in six weeks. It has potential to be a 10-bagger from here.  Click on these links if want to learn more about the MINING STOCK JOURNAL or the SHORT SELLER’S JOURNAL

Investment Research Dynamics




World Debt Is Rising Nearly Three Times As Fast

Some nasty dark clouds are forming on the financial horizon as total world debt is increasing nearly three times as fast as total global wealth. But, that’s okay because no one cares about the debt, only the assets matter nowadays. You see, as long as debts are someone else’s problem, we can add as much debt as we like… or so the market believes.

Now, you don’t have to take my word for it that the market only focuses on the assets, this comes straight from the top echelons of the financial world. According to Credit Suisse Global Wealth Report 2017, total global wealth increased to a new record of $ 280 trillion in 2017. Here is Credit Suisse’s summary of the Global Wealth 2017: The Year In Review:

According to the eighth edition of the Global Wealth Report, in the year to mid-2017, total global wealth rose at a rate of 6.4%, the fastest pace since 2012 and reached USD 280 trillion, a gain of USD 16.7 trillion. This reflected widespread gains in equity markets matched by similar rises in non-financial assets, which moved above the pre-crisis year 2007’s level for the first time this year. Wealth growth also outpaced population growth, so that global mean wealth per adult grew by 4.9% and reached a new record high of USD 56,540 per adult.

Total Global Wealth 2000-2017, Current Exchange Rates (Chart 1) | Total Global Wealth 2000-2017, Constant Exchange Rates (Chart 2)

This year’s report focuses in on Millennials and their wealth accumulation prospects. Overall the data point to a “Millennial disadvantage”, comprising among others tighter mortgage rules, growing house prices, increased income inequality and lower income mobility, which holds back wealth accumulation by young workers and savers in many countries. However, bright spots remain, with a recent upsurge in the number of Forbes billionaires below the age of 30 and a more positive picture in China and other emerging markets.

There are a few items in the Credit Suisse’s summary above that I would like to discuss. First, how did the world increase its global wealth at a rate of 6.4% in 2017 when world oil demand only increased 1.6%??

Global Oil Demand (2016-2018)

As we can see from the IEA – International Energy Agency’s Global Oil Demand table above, total world oil demand only increased 1.6% over last year. Thus, the rate of increase of global wealth of 6.4% in 2017 was four times higher than the 1.6% increase in world oil demand. I would imagine some readers would stand on their soapbox and emphatically claim that energy has nothing to do with wealth creation. Unfortunately, these individuals somehow lost the ability to reason along the way. And we really can’t blame them for making such an absurd remark because they probably believe their food magically appears on the Supermarket shelves.

Second, the financial wizards at Credit Suisse reported that global wealth also outpaced the population growth. What they are suggesting here is that the “Millenials” who (many) are becoming wealthier by sitting in front of a screen and clicking on a mouse than their grandparents (the poor slobs) who were mainly working in the manufacturing industry by producing real things.

Third, while the Credit Suisse analysts stated that the Millenials were facing some disadvantages, there was a bright spot with a recent surge in the number of Forbes billionaires below the age of 30. Well, ain’t that a lovely statistic. What once took an individual at the ripe old age of 55-70 years to achieve a billionaire status, now can be done right out of college. It’s probably not a good sign for the economy going forward that we are seeing more billionaires below the age of 30.

Global Debt Is Destroying Real Wealth

Okay, now that we know the global wealth reached a new record high in 2017, what about the other side of the story? You know… the debt. As I mentioned in my previous article, ECONOMICS 101 states:

NET WEALTH = ASSETS – DEBTS

Now, that equation above is a simple one… kind of like 2 + 2 = 4. However, the financial industry likes to focus on the assets and not the debts. But, according to a recent article on Zerohedge, Global Debt Hits Record $ 233 Trillion, Up $ 16Tn In 9 Months, the world added more debt in 2017 than total U.S. GDP:

Total Global Debt - All Sectors (2007-2017)

As we can see, total global debt increased from $ 217 trillion at the beginning of 2017 to $ 233 trillion in the third quarter of 2017. That is a $ 16 trillion increase in global debt in just nine months. While U.S. GDP hit $ 19 trillion in Q3 2017, if we add another quarter for the increase in global debt, it could surpass $ 20 trillion for the entire year.

So, even if global wealth surged in 2017, so did world debt. According to the data, global wealth increased by $ 16.7 trillion in 2017 while global debt expanded $ 16 trillion… nearly one to one. However, this is only part of the story.

If we look at the increase in total world debt and total global wealth over the past 20 years, we can see a troubling sign, indeed:

Total World Debt vs. Total Global Wealth

Since 1997, total global debt increased from $ 50 trillion to $ 233 trillion compared to the rise in global wealth from $ 120 trillion to $ 280 trillion. There are two disturbing trends shown in the chart above:

  1. Global Debt has increased 366% vs. 133% for Global Wealth since 1997
  2. Net Wealth was $ 70 trillion in 1997 versus $ 47 trillion in 2017

If we compared the percentage increase in global debt versus global wealth, global debt is rising at nearly three times the rate of global wealth. Furthermore, doing simple arithmetic by substracting DEBTS from ASSETS, global net worth fell from $ 70 trillion in 1997 to $ 47 trillion in 2017.

By putting the numbers together, right in front of our eyes, we can clearly see that the world is going broke by adding debt. Basically, we erased $ 23 trillion in Global Net Wealth in the past 20 years. However, I believe the situation is much worse than the figures shown above. For example, I came across an article several months ago on Zerohedge that also reported the increase in global debt, stated it did not include FX Swaps, etc. According to their data, Foreign Exchange Swaps likely exceeded $ 13 trillion. FX Swaps are more short-term debt instruments, but they are still debt instruments.

Moreover, we have no idea what other nasty debts or obligations are hidden out of sight of the public. Regardless, if we were just to include the FX swaps worth $ 13 trillion, the estimated net worth of Global Wealth would only be $ 34 trillion ($ 280 – [$ 233 +$ 13] = $ 34).

The Percentage Of World Gold Investment To Global World Assets Is Much Higher Than We Realize

Now, here’s how the financial situation gets really interesting. If we go by NET WEALTH, then the value of global gold investment as a percentage of world assets, IS MUCH HIGHER. According to the typical financial asset allocations, precious metals comprise approximately 1% of total global assets. The following chart shows that total global gold investment is valued at $ 3 trillion and silver at $ 51 billion (based on $ 20 silver, last year):

Total Value Global Gold & Silver Investment

Thus, $ 3 trillion in the value of world gold and silver investment equals a little bit more than 1% of the $ 280 trillion in global wealth. However, if we are clever and remove the debts, the real NET WEALTH is closer to $ 34 trillion. Thus, total world gold and silver investment comprises nearly 10% of GLOBAL NET WEALTH, or ten times higher than it is currently valued.

Furthermore, we must remember, physical gold and silver, purchased and held in one’s hand has no debt attached to it. Of course, this assumes that an individual didn’t take a loan out against their precious metals holdings. Thus, the precious metals have always been the highest quality stores of wealth for 2,000+ years… even though the Millenials forgot about them for the promise of millions of Crypto profits.

Unfortunately, the situation is much worse than what the figures in the charts above reveal. Why? Because, the only way that debts can be paid down is if we have another $ 233 trillion worth of profits from economic activity, correct? Now, I am not talking about $ 233 trillion in costs; I am talking about PROFITS. Big difference.

To pay back $ 233 trillion in debts, we have to burn one hell of a lot of energy… don’t we? That’s correct; we have to burn energy to create economic activity. And not just plain ole economic activity, PROFITABLE economic activity. Well, we are in BIG TROUBLE because we have been burning one hell of a lot of oil (95+ million barrels per day), but global debts are increasing faster than global wealth.

So, it’s just a matter of time before GRAND FACADE comes crashing down.

Precious Metals News & Analysis – Gold News, Silver News




The Household Debt Ticking Time Bomb

I fully expect the Government’s Census Bureau to post a mind-blowing headline retail sales number for December.  Hyperbolic headline economic statistics derived from mysterious “seasonal adjustments” based on questionable sampling methodology is part of the official propaganda policy mandated by the Executive Branch of Government.

But I also believe that retail sales were likely more robust than saner minds were expecting because it appears that households have become accustomed to the easy credit provided by the banking system to make ends meet. Borrow money to “spend and pretend.”  The Fed reported that consumer credit hit an all-time record in November.  The primary driver was credit card debt, which hit a new all-time high (previous record was in 2008).  Credit debt also increased a record monthly amount in November.

“Speaking of signposts, households have grown increasingly comfortable with leverage to maintain their living standards, which of course economists cheer. That’s worked for 24 straight months as credit card spending growth has outrun that of income growth” – Danielle DiMartino Booth, who was an advisor for nine years to former Dallas Fed President, Richard Fisher.

The graph above shows the year over year monthly percentage change in revolving credit – which is primarily credit card debt – and real disposable personal income. Real disposable personal income is after-tax income adjusted for CPI inflation. As you can see, the growth in the use of credit card debt has indeed outstripped the growth in after-tax household income. The credit metric above would not include home equity lines of credit.  At some point, assuming the relationship between the two variables above continues along the same trend, and we have no reason to believe that it won’t, credit card debt will collide with reality and there will be a horrifying number of credit card defaults. Worse than 2008-2010.

This chart shows household debt service payments as a percent of after-tax income:

“Debt service” is interest + principal payments.  With auto loan and credit card debt, most of the debt service payment is interest.  This metric climbed to a 5-year high during a period of time when interest rates hit all-time record lows.  Currently the average household is unable to make more than the minimum principle payment per the information conveyed by the first graphic.  What happens to the debt service:income ratio metric as households continue to pile on debt to make ends meet while interest rates rise?

Household debt service includes mortgage debt service payments.  Household mortgage debt outstanding is not quite at the all-time high recorded in Q2 2008.   The current number from the Fed is through Q3 2017. At the current quarterly rate of increase, an new all-time high in mortgage debt outstanding should occur during Q2 2018.  However, it should be noted that the number of homes sold per quarter during this current housing bubble is below the number of units sold per quarter at the peak of the previous housing bubble.  This means that the average size of mortgage per home sold is higher now than during the earlier housing bubble.  This is a fact that overlooked by every housing and credit market analyst, either intentionally or from ignorance (I’ll let you decide).

The graph to the right shows that access to credit is about as easy as it gets right now. A financial conditions index (Goldman’s is not the only version), measures financial variables that influence economic behavior. This includes the supply and cost of credit.

A declining index value reflects easier financial conditions. The current index is equal to the low-point of this metric going back to 1992. Unless history does not repeat, this index is set to head higher again. We are already seeing signs of this with higher interest rates, rising CPI/PPI-measured price inflation and accelerating consumer credit default rates.

It has been my argument that, on average and in general, the average U.S. household has reached, or will soon reach, the limit in its ability to support an increasing amount of debt. The use of debt has prevented consumer spending from falling off a cliff. Using debt to consume does not accomplish economic growth. It simply shifts consumption from the future to the present. Unless by some miracle the average household experiences an unforeseen jump in income – enough to enable it pay down debt and continue consuming at the present level, consumer spending will hit a wall.

I have no idea what kind of rigged, statistically manipulated vomit the Government is going to report for December and Q4 2017 retail sales but auto sales are already reflecting a serial decline in sales. Unless the banks open up the credit spigots even more – with reckless disregard to rising delinquency and default rates – consumer spending in general, and retail and auto sales in particular, is going to decline precipitously during 2018.  This will wreak havoc on the economy.  The bigger problem is going to be the rising delinquency and default rates. I suspect that this will begin to accelerate over the next 12 months regardless of Fed monetary policy. Speaking of which, I expect the Fed to begin dragging its feet on hiking rates as we move further in the new year.

A portion of the commentary above is an excerpt from the latest Short Seller’s Journal.  This weekly subscription newsletter provides insight to the economic and financial data not reported by the financial media and Wall Street.  In addition to economic analysis, I present ideas for shorting individual stocks.  Currently the path of least resistance to make money shorting is with retail and retail-related stocks.  I also provide ideas for using options. You can learn more about this unique service here:  Short Seller’s Journal information.

Dave, each week I am reminded of the degree to which you do highly disciplined, fact based, and insightful work. Thank you – subscriber, “Rod”

Investment Research Dynamics




Study Finds That 22 Percent Of Bitcoin Investors Are Using Debt To Fund Their Investments

Investing in cryptocurrencies such as Bitcoin, Ripple, Ethereum and Litecoin is extremely risky, and experts all over the country are warning that people should only invest what they are willing to lose.  Unfortunately, many are getting swept up in the current euphoria surrounding cryptocurrencies and are not listening to that very sound advice.  A disturbing new survey that was just released found that 22 percent of all Bitcoin investors are either directly or indirectly investing in Bitcoin with borrowed money…

According to LendEDU, a personal loan research firm, more than 18 percent of Bitcoin investors have used borrowed money to trade the cryptocurrency. In a global survey of 672 active Bitcoin investors, researchers asked traders the method they used to fund their cryptocurrency trading accounts. The majority of investors used banking systems such as credit cards and ACH transfers to fund their accounts.

But 22 percent of traders revealed that they have not paid off their credit and debit cards after purchasing Bitcoin, effectively investing in the cryptocurrency with borrowed money.

Credit card debt is one of the most toxic forms of debt that you could ever carry, and investing in anything when you still have credit card balances is extremely unwise.

Yes, cryptocurrencies went on an epic run in 2017, but there is absolutely no guarantee that they will continue to rise in 2018.

In fact, there is a very real possibility that we could see a cryptocurrency crash, and there are many investors that are actually eagerly anticipating one

Well, as many traders expected, it appears that institutions are using the futures product to slowly but surely build a short position in bitcoin. According to the CFTC Commitment of Traders report (available CBOE futures), non-commercial traders held a net short position of around $ 30mn as of Tuesday Dec 26, or around half of the total open interest.

Separately, the Traders in Financial Futures breakdown provided by the CFTC show that the leveraged funds category that consists largely of hedge funds and various money managers had a short of around $ 14mn, or around a quarter of the total open interest.

In other words, spec investors have used the futures contracts to establish Bitcoin shorts.

On the other hand, there is also the possibility that cryptocurrencies such as Bitcoin could continue to defy gravity and soar even higher over the next 12 months.

In fact, a rumor that Amazon.com will soon start accepting Bitcoin has lots of people buzzing

As a backdrop to all of this, there is a strong rumor that Amazon is about to accept Bitcoin as a method of payment. Patrick Byrne, the CEO of Overstock, has stated that Amazon will soon have no choice but to start accepting it. He is quoted as saying, “… they have to follow suit. I’ll be stunned if they don’t because they can’t just cede that part of the market to us if we are the only main large retail site taking Bitcoin.” Scott Mullins, an Amazon executive has confirmed that Amazon is, “working with financial institutions and crypto-experts to spur innovation, and facilitate frictionless experimentation.”

If the Amazon rumor turns out to be true – Bitcoin will probably go into orbit! Be prepared…

If someone knew exactly what would happen throughout 2018, that individual could make an absolutely obscene amount of money.

Unfortunately I don’t know where cryptocurrencies are heading, but it does appear that things are about to get a whole lot more interesting.  According to Reuters, it looks like you will soon be able to invest in Bitcoin using leveraged ETFs…

The new idea is to build “leveraged” and “inverse” funds that would rise – or fall – twice as fast as the price of bitcoin on a given day.

Direxion Asset Management LLC plans to list such products on Intercontinental Exchange Inc’s NYSE Arca exchange if U.S. securities regulators give the nod, according to a filing by the exchange this week.

In the filing, the exchange said the listing “will enhance competition among market participants, to the benefit of investors and the marketplace.”

So if Bitcoin rises or falls a thousand dollars in a single day, those financial instruments will be designed to move by about twice as much.

That should be fun.

Meanwhile, some are asking what will happen to cryptocurrencies such as Bitcoin, Ripple, Ethereum and Litecoin if the long-awaited collapse of global financial markets finally happens this year.

Well, some believe that it would be doom for cryptocurrencies, but others believe that cryptocurrencies would be like gold and would actually do extremely well during the next great financial crisis…

The question is what will happen to Bitcoin and Cryptocurrencies once the financial collapse takes place. The signs are that when economic circumstances start to deteriorate the price of Bitcoin rises. A prime example of this is during the Cyprus and Greece bailout which saw the price of BTC rise considerably during this period. With banks stopping access to cash in ATM machines, Bitcoin was the perfect solution to be able to store it safely out of the banks and Governments’ hands.

What also happens during a depression is interest rates skyrocket and start to see hyperinflation. This will mean it is extremely hard to get finance from banks and the cost can make it unsustainable. The ICO market is a perfect solution to this problem and as the banking sector suffers, ICOs will boom. More companies will look to these as a cheap way to raise money and will create their own cryptocurrency.

It will be fascinating to see how all of this plays out.

There are some financial experts that believe that Bitcoin is going to zero, and there are others that are absolutely convinced that it is going to a million dollars.

As with so many things in life, timing is everything.  If you are investing in Bitcoin, let us just hope that you got in at the right time and that you will also get out at the right time.

Michael Snyder is a pro-Trump candidate for Congress in Idaho’s First Congressional District, and you can learn how you can get involved in the campaign on his official website. His new book entitled “Living A Life That Really Matters” is available in paperback and for the Kindle on Amazon.com.

The Economic Collapse




An “Unprestigious” Preview of Debt Deflation

An “Unprestigious” Preview of Debt Deflation

By Elliott Wave International


Evidence: Your Bond Fund Is Riskier Than You Think

Debt deflation has taken down a huge multinational builder. Pitfalls in the bond market are growing too risky for bond investors to ignore. Learn what you need to know in a free, new report from EWI’s Murray Gunn — “Your Bond Fund: It’s Riskier Than You Think.”

Learn more and register for free!

This article was syndicated by Elliott Wave International and was originally published under the headline An “Unprestigious” Preview of Debt Deflation. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.




Global Debt Exceeds $200 Trillion and is Rising Rapidly

What storm? The Dow Jones Industrial Average (DOW) reached another all-time high. Interest rates in the U.S. are yielding multi-decade lows, some say multi-century lows. Trillions of dollars in global sovereign debt have negative yield and European junk bonds yield less than 10 year U.S. treasuries. “Official” unemployment is low. Borrowing is inexpensive. Things are good, so they say!

I Doubt It!

Do you believe the above is a fair and accurate representation of our economic world? If so, how do you explain the following?

  • Global debt exceeds $ 200 trillion and is rising rapidly. This massive debt will NOT be paid back in currencies with 2017 purchasing power. Debt MUST be rolled over in continually DEVALUING dollars, euros, yen and pounds.
  • The financial system rolls over maturing debt, adds more, and pretends repayment will not be problematic. Those who hope this will remain true ignore the lessons of history, including sky-high interest rates in the late 1970s, the Asian and Long Term Capital crises in the late 1990s, many defaults and hyperinflations in the last century and the credit-crunch-recession-market-crash of 2008.
  • Official inflation statistics show that consumer price inflation is low – supposedly in the two percent range. However, if you pay for health care, hospital bills, prescription drugs, Obamacare, beer, cigarettes, college tuition, fresh vegetables, processed food, auto insurance, and many other necessities, you know better. The Chapwood Index agrees with your experience. Their statistics show consumer price inflation is much higher than official numbers.
  • National debt – the official debt of the U.S. government exceeds $ 20.5 trillion – more than the U.S. Gross Domestic Product. The debt has increased exponentially (straight line on a log scale chart) for the past century.

  • Interest paid on the official national debt is approximately $ 500 billion per year and climbing. Congress is influenced by the financial elite and will not operate within a balanced budget. Therefore the U.S. will pay more interest each year.

  • U.S. government expenditures increase every year. Since annual revenues are less than expenses by a trillion or so, the shortfall is borrowed. Hence national debt rises every year and interest must be paid on ever-increasing debt.

  • Debt, out-of-control expenses, and economic craziness are universal in our current system. Race, gender, and political party make no material difference. Why should they? Corporations, politicians, lobbyists, military contractors, Big Pharma and individuals want more dollars to spend every year and the government satisfies everyone by adding to the debt load.
  • Debt and currency in circulation rise far more rapidly than growth of the economy which must support the debt. HENCE PRICES RISE.
  • Rising consumer prices are essential to a financialized economy. Do you remember prices in 1970? If you don’t, examine the following overview.

What Could Improce Our Finance World?

  • Balanced budgets and honest accounting at all levels of government. Not likely.
  • Honest currency units, currency units created from productive effort, not units conjured out of “thin air” by central banking and commercial
  • Global peace. Military and defense expenses could be reduced to a fraction of current levels. Redirect those resources toward more productive purposes. All but impossible!
  • Political honesty, absence of corruption and effective, non-intrusive government. Hmmmmm. Maybe we should write to our congressmen.

What Could Make Our Economic World Worse, but we Hope Does Not Occur?

  • Wars with North Korea, Iran, Russia, China, and others.
  • Hyperinflation in western countries, because central banks will be forced to “print” an almost unlimited number of currency units to address their self-created financial problems.
  • Derivatives implosion (remember 2008), nuclear war, electromagnetic pulse weapons, and global plague.

Prognosis:

The world will muddle through its problems in spite of wars, pestilence, corruption, central bankers, and self-serving politicians. Based on centuries of economic history, we should expect increasing financial trauma, periodic market crashes, devalued currencies, debt defaults, and … that someone else will be blamed.

What Can We Do for Self Protection?

  • Realize that markets rise and fall. The stock markets have enjoyed a long bull market while many commodities are relatively inexpensive. Expect a reversal, perhaps soon.
  • Buy silver and gold. Why buy metals? They have been real money and a store of value for centuries. They are currently undervalued compared to total debt and the stock market. See below.

Graph silver prices divided by the official U.S. national debt. Silver prices have increased less rapidly than exponentially increasing national debt for 25 years, and are currently selling for multi-decade lows compared to national debt. National debt will increase 8 – 10% per year and silver prices will rise more rapidly in coming years.

Graph silver prices divided by the S&P 500 Index. Silver prices are currently near a two-decade low when compared to the S&P 500 Index. Silver prices will rise and the S&P will correct, possibly soon.

Based on decades of history, silver prices are inexpensive compared to exponentially increasing national debt and stock market prices. Silver prices will rise compared to both, perhaps soon.

Conclusions:

  • Debt and government expenses are excessive and too large for the economy to support. However, they exponentially increase.
  • Positive change is possible but given the massive economic resistance from debt, central banker intrusion into markets, and over-valued stock markets, significant improvement in revenues, debt loads and balance sheets seems unlikely.
  • Expect a reversal in stock market prices. Expect gold and silver prices will rebound much higher in 2018. Guaranteed – no! Likely – yes!
  • Silver and gold will protect your savings, retirement assets and purchasing power from continual currency devaluations, central bank policy errors, and excessive government debt.

Precious Metals News & Analysis – Gold News, Silver News




The Debt Bubble Is Beginning To Leak Air

“The current state of credit card delinquency flows can be an early indicator of future
trends and we will closely monitor the degree to which this uptick is predictive of
further consumer distress.” – New York Fed official in reference to rising delinquency rate of credit cards.

The recent sell-off in junk bonds likely reflects a growing uneasiness in the market with credit risk, where “credit risk” is defined as the probability that a borrower will be able to make debt payments. This past week SocGen’s macro strategist, Albert Edwards, issued a warning that the falling prices of junk bonds might be “the key area of vulnerability that could bring down the inflated pyramid scheme that the Central Banks have created.”

The New York Fed released its quarterly report on household debt and credit for Q3 last week. The report showed a troubling rise in the delinquency rates for auto debt and mortgages. The graph to the right shows 90-day auto loan delinquencies by credit score. As you can see, the rate of delinquency for subprime borrowers (620 and below) is just under 10%. This rate is nearly as high the peak delinquency rate for subprime auto debt at the peak of the great financial crisis. In fact, you can see in the chart that the rate of delinquency is rising for every credit profile. I find this fact quite troubling considering that we’re being told by the Fed and the White House that economic conditions continue to improve.

While the Fed reports that 20% of the $ 1.2 trillion in auto loans outstanding has been issued to subprime borrowers, there tends to be a significant time-lag between when an individual’s credit condition deteriorates and when the FICO score reflects that deteriorated financial condition. I would argue that the true percentage of subprime auto debt outstanding is likely over 30%.  Bloomberg reported last week that “delinquent subprime loans are nearing crisis levels at auto finance companies.”Before the 2008 crisis, the outstanding level of auto loans peaked in late 2005 at $ 825 billion. The current level based on the most recent data is over $ 1.2 trillion, or nearly 50% higher than the previous peak. More troubling, the average loan balance, at close to $ 30,000, is substantially higher now.

Revolving credit is now over $ 1 trillion. At $ 1.005 trillion, it’s slightly below the previous peak of $ 1.020 trillion in April 2008. Most of the revolving debt category as tracked by the Fed is credit card debt. The Fed reports that 4.6% of credit card debt is 90-days delinquent, up from 4.2% in Q3. I would note that the Fed relies on reporting from banks and consumer finance for the delinquency data. Accounting regulations give banks a fairly wide window of discretion before a loan is officially declared to be delinquent. Banks and consumer finance companies tend to drag their feet before declaring a loan to be delinquent because it directly affects quarterly earnings. I would bet money that the true delinquency rate is higher than is being reported.

Mortgage delinquencies are now following the trend higher in auto, student and revolving loans:

The data in the graph above is sourced from the Mortgage Bankers Association (MBA).  MBA data is lagged. again because of reporting methodology and because banks under-report delinquencies.  As such, the true current rate of delinquency is likely higher. I drew the red line to illustrate that, outside of the period from 2009 to 2014, the current rate of delinquency is at the high end of the historical range going back to 1979.

Let’s drill down a little deeper. The delinquency rate for FHA mortgages soared to 9.4% in Q3 2017 from 7.94% in Q2. That jump in the rate of delinquency is the highest quarterly increase in the history of the MBA’s survey. Recall that the FHA began offering 3.5% down-payment mortgages in 2008. Because of the minimal down payment requirement, the FHA’s share of single-family  home purchase mortgage underwriting went from 3.9%  2007 to it current 17%  share.  In effect, FHA replaced the underwriting void left by the bankrupt private-issuer subprime lenders like Countrywide and Wash Mutual.  It’s no surprise that FHA paper is starting to collapse.  Fannie and Freddie started issuing 3% down-payment mortgages in early 2015.  All three agencies (FHA, FNM, FRE) reduced the amount of mortgage insurance required for low down payment loans. Just in time for the FHA complex to start cratering.

The reduction in mortgage qualification standards was implemented by the Government in order to keep the homes sales activity artificially stimulated. Do not overlook the fact that the National Association of Realtors drops more magic money dust on Congress than the Too Big To Fail Wall Street banks combined.

The rising trend in consumer and mortgage debt delinquencies will, for a time, be dismissed as temporary or related to the hurricanes. The MBA applied a thick layer of “hurricane mascara” on the mortgage delinquency numbers. But the massive debt bubble inflated by the Fed and the Government is springing leaks. And the debt delinquency trend is seeded in economic fundamentals. The BLS released its real earnings report this past Wednesday, which showed that real average hourly earnings declined for the third month in a row. It’s no coincidence that debt payment delinquencies are rising given that after-tax income for the average household is getting squeezed. This will get worse when soaring health insurance premiums hit starting in January.

St Louis Fed President, James Bullard, asserted last Wednesday that there’s no need to raise interest rates with inflation low. I have to believe that these folks at the Fed are intelligent enough to understand that the “official” inflation numbers are phony. Given that assumption on my part, the reluctance of the Fed to raise rates – note: I do not consider the 1% hike in Fed funds over the last two years to be material – is from the fear of crashing the system.

Many of you have seen the recent reports of the “flattening” Treasury yield curve. This occurs when short term Treasury rates rise and longer term rates fall.  A flattening yield curve is the market’s signal that the economy is in trouble.  Currently, the yield spread between 2-yr and 10-yr Treasuries is 59 basis points.  The last time the Treasury curve was this “flat”  was  November 2007.

The front-end of the curve is rising for two reasons. First, the Fed let $ 10 billion in short term T-bills expire without replacing them, which took away the Fed’s bid for short term Treasuries. Second, when short rates rise relative long rates, it’s the market’s way of discounting an uptick in the potential for financial distress.

If the Fed were in a position of “normalized” monetary policy, it would likely be lowering rates in response to the obvious signs of rising financial distress.  But the Fed is backed into a corner.  Rates have been zero to near-zero for so long that the credit market is largely “immune” to taking rates back down to zero from the current 1% – 1.25% “target.”

The Fed inched its way into reducing its balance sheet by letting  SOMA assets fall $ 10 billion in value since early October.  At that rate it would take 35 years to “normalize” its balance sheet. Yet, the Treasury curve is telling us that the Fed should be easing monetary policy, not tightening.  The Fed has an 80-year track record of removing liquidity from the system at the wrong time.

The commentary above is an excerpt from the latest Short Seller’s Journal.  Two short ideas were presented in connection with the analysis presented.  To learn more about this newsletter, click here:   Short Seller’s Journal info.

Investment Research Dynamics




Goodbye American Dream: The Average U.S. Household Is $137,063 In Debt, And 38.4% Of Millennials Live With Their Parents

Once upon a time the United States had the largest and most vibrant middle class in the history of the world, but now the middle class is steadily being eroded.  The middle class became a minority of the population for the first time ever in 2015, and just recently I wrote about a new survey that showed that 78 percent of all full-time workers in the United States live paycheck to paycheck at least part of the time.  But most people still want to live the American Dream, and so they are going into tremendous amounts of debt in a desperate attempt to live that kind of a lifestyle.

According to the Federal Reserve, the average U.S. household is now $ 137,063 in debt, and that figure is more than double the median household income…

The average American household carries $ 137,063 in debt, according to the Federal Reserve’s latest numbers.

Yet the U.S. Census Bureau reports that the median household income was just $ 59,039 last year, suggesting that many Americans are living beyond their means.

As a nation, we are completely and utterly drowning in debt.  U.S. consumers are now nearly 13 trillion dollars in debt overall, and many will literally spend the rest of their lives making debt payments.

Over the past couple of decades, the cost of living has grown much faster than paychecks have, and this has put a tremendous amount of financial stress on hard working families.  We are told that we are in a “low inflation environment”, but that is simply not true at all

Medical expenses have grown 57% since 2003, while food and housing costs climbed 36% and 32%, respectively. Those surging basic expenses could widen the inequality gap in America, as a quarter of Americans make less than $ 10 per hour.

Getting our healthcare costs under control is one of the biggest things that we need to do.  As I talked about the other day, some families have seen their health insurance premiums more than triple since Obamacare became law.

As the cost of living continues to rise, an increasing number of young people are discovering that the only way that they can make ends meet is to live with their parents.  As a result, the percentage of adults age 26 to age 34 that live at home continued to rise even after the last recession ended…

The share of older Millennials living with relatives is still rising, underscoring the lingering obstacles faced by Americans who entered the workforce during and after the Great Recession.

About 20% of adults age 26 to 34 are living with parents or other family members, a figure that has climbed steadily the past decade and is up from 17% in 2012, according to an analysis of Census Bureau data by Trulia, a real estate research firm.

A staggering 59.8 percent of younger Millennials (18 to 25) are now living with relatives, and overall an all-time record 38.4 percent of all Millennials are currently living with family.

If so many of our young people are unable to live the American Dream, what is the future of this nation going to look like?

Consumers are not the only ones that have been struggling to make ends meet.  Corporate debt has doubled since the last financial crisis, and it now stands at a record high of 8.7 trillion dollars

Fueled by low interest rates and strong investor appetite, debt of nonfinancial companies has increased at a rapid clip, to $ 8.7 trillion, and is equal to more than 45 percent of GDP, according to David Ader, chief macro strategist at Informa Financial Intelligence.

According to the Federal Reserve, nonfinancial corporate debt outstanding has grown by $ 1 trillion in two years.

“Everything is fine until it isn’t,” Ader said. “We don’t need to worry about that until we’re in a slowdown and profit declines.”

And let us not forget government debt.  State and local governments all over the nation have piled up record amounts of debt, and the debt of the federal government has approximately doubled over the past decade.

But the fact that we are now 20 trillion dollars in debt as a nation does not tell the full story.  According to Boston University professor Larry Kotlikoff, the federal government is facing a fiscal gap of 210 trillion dollars over the next 75 years…

We have all these unofficial debts that are massive compared to the official debt. We’re focused just on the official debt, so we’re trying to balance the wrong books…

If you add up all the promises that have been made for spending obligations, including defense expenditures, and you subtract all the taxes that we expect to collect, the difference is $ 210 trillion. That’s the fiscal gap. That’s our true indebtedness.

We were the wealthiest and most prosperous nation in the history of the planet, but that was never good for us.

We always had to have more, and so we have been on the greatest debt binge in human history.

Now a day of reckoning is fast approaching, and those that believe that we can escape the consequences of our actions are being extremely delusional.

Michael Snyder is a Republican candidate for Congress in Idaho’s First Congressional District, and you can learn how you can get involved in the campaign on his official website. His new book entitled “Living A Life That Really Matters” is available in paperback and for the Kindle on Amazon.com.

The Economic Collapse




Venezuela Defaults On A Debt Payment – Is This The First Domino To Fall?

Did you know that Venezuela just went into default?  This should be an absolutely enormous story, but the mainstream media is being very quiet about it.  Wall Street and other major financial centers around the globe could potentially be facing hundreds of millions of dollars in losses, and the ripple effects could be felt for years to come.  Sovereign nations are not supposed to ever default on debt payments, and so this is a very rare occurrence indeed.  I have been writing about Venezuela for years, and now the crisis that has been raging in that nation threatens to escalate to an entirely new level.

Things are already so bad in Venezuela that people have been eating dogs, cats and zoo animals, but now that Venezuela has officially defaulted, there will be no more loans from the rest of the world and the desperation will grow even deeper…

Venezuela, a nation spiraling into a humanitarian crisis, has missed a debt payment. It could soon face grim consequences.

The South American country defaulted on its debt, according to a statement issued Monday night by S&P Global Ratings. The agency said the 30-day grace period had expired for a payment that was due in October.

A debt default risks setting off a dangerous series of events that could exacerbate Venezuela’s food and medical shortages.

So what might that “dangerous series of events” look like?

Well, Venezuela already has another 420 million dollars of debt payments that are overdue.  Investors around the world are facing absolutely catastrophic losses, and the legal wrangling over this crisis could take many years to resolve.  The following comes from Forbes

S&P says that it expects Venezuela to default on other bond payments. This comes as absolutely no surprise. A further $ 420m of bond payments are already overdue: unless Venezuela finds some dollars in a hurry, these will also go into default very soon.

S&P also warns that Venezuela could embark on a coercive debt restructuring that would in effect be default. Indeed, it has already announced its intention to do so, though as yet it has produced no plan. But we can imagine what such a debt restructuring might look like: in 2012, Greece imposed a coercive debt restructuring on private sector investors, and Argentina has restructured its dollar-denominated debt twice this century, the second time to sort out the dog’s breakfast Argentina made of the first restructuring. Investors could take substantial losses, and there would no doubt be lawsuits lasting for years. The biggest winners from distressed debt restructurings are always lawyers.

When you add this to all of the other bad news that has been coming out lately, it is easy to understand why things are starting to shift in the financial markets.

In fact, CNBC says that there is “a different tone to the markets in the last week or so”…

Another day, another down open. There’s a different tone to the markets in the last week or so.

It started last Tuesday, when an initial rally faded into a hard sell-off mid-morning. The next five trading sessions generally opened down.

Peter Tchir of Academy Securities, checked off a short list of concerns. There is progress on tax reform “but the reality is it’s not going to be as great as everyone hoped,” he said. There are questions about what the flatter yield curve means. And the recent arrests of high-ranking Saudis in an anti-corruption initiative created uncertainty in the last week and a half.

I keep writing about all of the experts that are warning of an imminent market crash, and yet most investors do not appear to be listening.

In fact, one survey found that the number of fund managers that “are taking higher-than-normal risk” is at an all-time high

According to Bank of America Merrill Lynch’s latest monthly fund-manager survey, which includes 206 panelists who manage $ 610 billion, investors are opting for the latter.

The firm finds that a record number of survey responders are taking higher-than-normal risk. That comes at a time when US stock market valuations are sitting close to their highest in history, creating a precarious situation in which investors are feeling emboldened at a time when they should be exhibiting caution.

This reminds me so much of what we have witnessed just prior to other market crashes.

During the euphoria of the original dotcom bubble, we were being told that Internet stocks would never go down because this was the beginning of an entirely new revolution.

And then investors lost trillions upon trillions of dollars when the market finally crashed.

Just prior to the financial crisis of 2008, we were being assured that there was nothing unusual going on with housing prices.

And then the market crashed and we were suddenly facing the worst financial crisis since the Great Depression.

Every bubble eventually bursts, and this one will burst too.  Those that do not learn from history are doomed to repeat it, and it is likely that more money will be lost during this coming crisis than during any other crisis in our entire history.

Michael Snyder is a Republican candidate for Congress in Idaho’s First Congressional District, and you can learn how you can get involved in the campaign on his official website. His new book entitled “Living A Life That Really Matters” is available in paperback and for the Kindle on Amazon.com.

The Economic Collapse




Will China Bring an Energy-Debt Crisis?

It is easy for those of us in the West to overlook how important China has become to the world economy, and also the limits it is reaching. The two big areas in which China seems to be reaching limits are energy production and debt. Reaching either of these limits could eventually cause a collapse.

China is reaching energy production limits in a way few would have imagined. As long as coal and oil prices were rising, it made sense to keep drilling. Once fuel prices started dropping in 2014, it made sense to close unprofitable coal mines and oil wells. The thing that is striking is that the drop in prices corresponds to a slowdown in the wage growth of Chinese urban workers. Perhaps rapidly rising Chinese wages have been playing a significant role in maintaining high world “demand” (and thus prices) for energy products. Low Chinese wage growth thus seems to depress energy prices.

(Shown as Figure 5, below). China’s percentage growth in average urban wages. Values for 1999 based on China Statistical Yearbook data regarding the number of urban workers and their total wages. The percentage increase for 2016 was based on a Bloomberg Survey.

The debt situation has arisen because feedback loops in China are quite different from in the US. The economic system is set up in a way that tends to push the economy toward ever more growth in apartment buildings, energy installations, and factories. Feedbacks do indeed come from the centrally planned government, but they are not as immediate as feedbacks in the Western economic system. Thus, there is a tendency for a bubble of over-investment to grow. This bubble could collapse if interest rates rise, or if China reins in growing debt.

China’s Oversized Influence in the World

China plays an oversized role in the world’s economy. It is the world’s largest energy consumer, and the world’s largest energy producer. Recently, it has become the world’s largest importer of both oil and of coal.

In some sense, China is the world’s largest economy. Usually we see China referred to as the world’s second largest economy, based on GDP converted to US dollars. Economists use an approach called GDP (PPP) (where PPP is Purchasing Power Parity) when computing world GDP growth. When this approach is used, China is the world’s largest economy. The United States is second largest, and India is third.

Figure 1. World’s largest economies, based on energy consumption and GDP based on Purchasing Power Parity. Energy Consumption is from BP Statistical Review of World Energy, 2017; GDP on PPP Basis is from the World Bank.

Besides being (in some sense) the world’s largest economy, China is also a country with a very significant amount of debt. The government of China has traditionally somewhat guaranteed the debt of Chinese debtors. There is even a practice of businesses guaranteeing each other’s debt. Thus, it is hard to compare China’s debt to the debt level elsewhere. Some analyses suggest that its debt level is extraordinarily high.

How China’s Growth Spurt Started

Figure 2. China’s energy consumption, based on data from BP Statistical Review of World Energy, 2017.

From Figure 2, it is clear that something very dramatic happened to China’s coal consumption about 2002. China joined the World Trade Organization in December 2001, and immediately afterward, its coal consumption soared.

Countries in the OECD, whether they had signed the 1997 Kyoto Protocol or not, suddenly became interested in reducing their own greenhouse gas emissions. If they could outsource manufacturing to China, they would be able to reduce their reported CO2 emissions.

Besides reducing reported CO2 emissions, outsourcing manufacturing to China had two other benefits:

  • The goods being manufactured in China would be cheaper, allowing Americans, Europeans, and Japanese to buy more goods. If more “stuff” makes people happy, citizens should be happier.
  • Businesses would suddenly have a new market in China. Perhaps the people of China would start buying goods made elsewhere.

Of course, a major downside of moving jobs to China and other Asian nations was the likelihood of fewer jobs elsewhere.

Figure 3. US Labor Force Participation Rate, as prepared by Federal Reserve Bank of St. Louis.

In the early 2000s, when China started competing actively for jobs, the share of people in the US workforce started shrinking. The drop-off in labor force participation did not level out until mid-2014. This is about when world oil prices began to fall, and, as we will see in the next section, when China’s growth in average wages began to fall.

Another downside to moving jobs to China was more CO2 emissions on a worldwide basis, even if emissions remained somewhat lower locally. CO2 emissions on imported goods were not “counted against” a country in its CO2 calculations.

Figure 4. World carbon dioxide emissions, split between China and Rest of the World, based on BP Statistical Review of World Energy, 2017.

At some point, we should not be surprised if countries elsewhere start pushing back against the globalization that allowed China’s rapid growth. In some sense, China has lived in an artificial growth bubble for many years. When this artificial growth bubble ends, it will be much harder for China’s debtors to repay debt with interest.

China’s Rapid Wage Growth Stopped in 2014

Rising wages are important for making China’s growth possible. With rising wages, workers can increasingly afford the apartments that are being built for them. They can also increasingly afford consumer goods of many kinds, and they can easily repay debts taken out earlier. The catch, however, is that wage growth cannot get ahead of productivity growth, or the price of goods will become too expensive on the world market. If this happens, China will have difficulty selling its goods to others.

China’s wage growth seems to have slowed remarkably, starting in 2014.

Figure 5. China’s percent growth in average urban wages. Values for 1999 based on China Statistical Yearbook data regarding the number of urban workers and their total wages. The percentage increase for 2016 was estimated based on a Bloomberg Survey.

This is when China discovered that its high wage increases were making it uncompetitive with the outside world. Wage growth needed to be reined in. Its growth in productivity was no longer sufficient to support such large wage increases.

China’s Growth in Energy Consumption Also Slowed About 2014 

If we look at the annual growth in total energy consumption and electricity consumption, we see that by 2014 to 2016, their growth had slowed remarkably (Figure 6). Their growth pattern was starting to resemble the slow growth pattern of much of the rest of the world. Energy growth allows an economy to increasingly leverage the labor of its workforce with more energy-powered “tools.” With low energy growth, it should not be surprising if productivity growth lags. With low productivity growth, we can expect low wage growth.

Figure 6. China’s growth in consumption of total energy and of electricity based on data from BP Statistical Review of World Energy, 2017.

It is possible that the increased rate of electricity consumption in 2016 is related to China’s program of housing migrant workers in unsalable apartments that took place at that time. The fact that these apartments were otherwise unsalable was no doubt influenced by the slowing growth in wages.

This decrease in energy consumption most likely occurred because the price of China’s energy mix was becoming increasingly expensive. For one thing, the mix included a growing share of oil, and oil was expensive. The proportion of coal in the mix was falling, and the replacements were more expensive than coal. There was also the issue of the general increase in fossil fuel prices.

Lower Wage Growth in China Likely Affected Fossil Fuel Prices

Affordability is the big issue with respect to how high fossil fuel prices can rise. The issue is not just buying the oil or coal or natural gas itself; it is also being able to afford the goods made with these fuels, such as food, clothing, appliances, and apartments. If wages were depressed in the developed countries because of moving production to China, then rising wages in China (and other similar countries, such as India and the Philippines) must somehow offset this problem, if fossil fuel prices are to remain high enough for extraction to continue.

Figures 7 and 8 (below) show that oil, natural gas, and coal prices all started to slide, right about the time China’s urban wages growth began shrinking (shown in Figure 5).

Figure 7. Oil and natural gas prices, based on BP Statistical Review of World Energy data.

Figure 8. Coal prices between 2000 and 2016 from BP Statistical Review of World Energy. Chinese coal is China Qinhuangdao spot price and Japanese coal is Japan Steam import cif price, both per ton.

The lower recent increases made China’s urban wage growth look more like that of the US and Europe. Thus, in 2014 and later, Chinese urban wages present much less of a “push” on the growth of the world economy than they had previously. Without this push of rising wages, it becomes much harder for the world economy to grow very rapidly, and for it to have a very high inflation rate. There is simply not enough buying power to push prices very high.

It might be noted that the average Chinese urban wage increases shown previously in Figure 5 are not inflation adjusted. Thus, in some sense, they include whatever margin is available for inflation in prices as well as the margin that is available for a greater quantity of purchased goods. Because of this, these low wage increases may help explain the recent lack of inflation in much of the world.

Quite likely, there are other issues besides China’s urban wage growth affecting world (and local) energy prices, but this factor is probably more important than most people would expect.

Can low prices bring about “Peak Coal” and “Peak Oil”?

What does a producer do in response to suddenly lower market prices–prices that are too low to encourage more production?

This seems to vary, depending on the situation. In the case of coal production in China, a decision was made to close many of the coal plants that had suddenly become unprofitable, thanks to lower coal prices. No doubt pollution being caused by these plants entered into this decision, as well. So did the availability of other coal elsewhere (but probably at higher prices), if it is ever needed. The result of this voluntary closure of coal plants in response to low prices caused the drop in coal production shown in Figure 8, below.

Figure 8. China’s energy production, based on data from BP Statistical Review of World Energy, 2017.

It is my belief that this is precisely the way we should expect peak coal (or peak oil or peak natural gas) to take place. The issue is not that we “run out” of any of these fuels. It is that the coal mines and oil and gas wells become unprofitable because wages do not rise sufficiently to cover the fossil fuels’ higher cost of extraction.

We should note that China has also cut back on its oil production, in response to low prices. EIA data shows that China’s 2016 oil production dropped about 6.9% compared to 2015. The first seven months of 2017 seems to have dropped by another 4.2%. So China’s oil is also showing what we would consider to be a “peak oil” response. The price is too low to make production profitable, so it has decided that it is more cost-effective to import oil from elsewhere.

In the real world, this is the way energy limits are reached, as far as we can see. Economists have not figured out how the system works. They somehow believe that energy prices can rise ever higher, even if wages do not. The mismatch between prices and wages can be covered for a while by more government spending and by more debt, but eventually, energy prices must fall below the cost of production, at least for some producers. These producers voluntarily give up production; this is what causes “Peak Oil” or “Peak Coal” or “Peak Natural Gas.”

Why China’s Debt System Reaches Limits Differently Than Those in the West

Let me give you my understanding regarding how the Chinese system works. Basically, the system is gradually moving from (1) a system in which the government owns all land and most businesses to (2) a system with considerable individual ownership.

Back in the days when the government owned most businesses and all land, farmers farmed the land to which they were assigned. Businesses often provided housing as part of an individual’s “pay package.” These homes typically had a shared outhouse for a bathroom facility. They may or may not have had electricity. There was relatively little debt to the system, because there was little individual ownership.

In recent years, especially after joining the World Trade Organization in 2001, there has been a shift to more businesses of the types operated in the West, and to more individual home ownership, with mortgages.

The economy acts rather differently than in the West. While the economy is centrally planned in Beijing, quite a bit of the details are left to individual local governments. Local heads of state make decisions that seem to be best based on the issues they are facing. These may or may not match up with what Beijing central planning intended.

Historically, Five-Year Plans have provided GDP growth targets to the various lower-level heads of state. The pay and promotions of these local leaders have depended on their ability to meet (or exceed) their GDP goals. These goals did not have any debt limits attached, so local leaders could choose to use as much debt as they wanted.

A major consideration of these local leaders was that they also had responsibility for jobs for people in their area. This responsibility further pushed them to aim high in the amount of development they sought.

Another related issue is that sales of formerly agricultural land for apartments and other development are a major source of revenue for local governments. Local leaders did not generally have enough tax revenue for programs, without supplementing their tax revenue with funds obtained from selling land for development. This further pushed local leaders to add development, whether it was really needed or not.

The very great power of local heads of state and their administrators made these leaders tempting targets for bribery. Entrepreneur had a chance of getting projects approved for development, with a bribe to the right person. There has been a recent drive to eliminate this practice.

We have often heard the comment, “A rising tide raises all boats.” When the West decided to discourage local industrialization because of CO2 concerns, it gave a huge push to China’s economy. Almost any project could be successful. In such an environment, local rating agencies could be very generous in their ratings of proposed new bond offerings, because practically any project would be likely to succeed.

Furthermore, without many private businesses, there was little history of past defaults. What little experience was available suggested the possibility of few future defaults. Wages had been rising very rapidly, making individual loans easy to repay. What could go wrong?

With the central government perceived to be in control, it seemed to make sense for one governmental organization to guarantee the loans of other governmental organizations. Businesses often guaranteed the loans of other businesses as well.

Why the Chinese System Errs in the Direction of Overdevelopment

In the model of development we are used to in the West, there are feedback loops if too much of anything is built–apartment buildings (sold as condominiums), coal mines, electricity generating capacity, solar panels, steel mills, or whatever else.

In China, these feedback loops don’t work nearly as well. Instead of the financial system automatically “damping out” the overcapacity, the state (or perhaps a corrupt public official) figures out some way around what seems to be a temporary problem. To understand how the situation is different, let’s look at three examples:

Apartments. China has had a well-publicized problem of  building way too many apartments. In about 2016, this problem seems to have been mostly fixed by local governments providing subsidies to migrant workers so that they can afford to buy homes. Of course, where the local governments get this money, and for how long they can afford to pay these stipends, are open questions. It is also not clear that this arrangement is leading to a much-reduced supply of new homes, because cities need both the revenue from land sales and the jobs resulting from building more units.

Figure 9 shows one view of the annual increase in Chinese house prices, despite the oversupply problem. If this graph is correct, prices have increased remarkably in 2017, suggesting some type of stimulus has been involved this year to keep the property bubble growing. The size of an apartment a typical worker can now afford is very small, so this endless price run-up must end somewhere.

Figure 9. Chinese house price graph from GlobalPropertyGuide.com.

Coal-Fired Power Plants. With all of the problems that China has with pollution, a person might expect that China would stop building coal-fired power plants. Instead, the solution of local governments has been to build additional power plants that are more efficient and less polluting. The result is significant overcapacity, in total.

May 2017 article says that because of this overcapacity problem, Beijing is forcing every coal-fired power plant to run at the same utilization rate, which is approximately 47.7 % of total capacity. A Bloomberg New Energy Finance article estimates that at year-end 2016, the “national power oversupply” was 35%, considering all types of generation together. (This is likely an overestimate; the authors did not consider the flexibility of generation.)

Beijing is aware of the overcapacity problem, and is cancelling or delaying a considerable share of coal-fired capacity that is in the pipeline. The plan is to limit total coal-fired capacity to 1,100 gigawatts in 2020. China’s current coal-fired generating capacity seems to be 943 gigawatts, suggesting that as much as a 16% increase could still be added by 2020, even with planned cutbacks.

It is not clear what happens to the loans associated with all of the capacity that has been cancelled or delayed. Do these loans default? If “normal” feedbacks of lower prices had been allowed to play out, it is doubtful that such a large amount of overcapacity would have been added.

If China’s overall growth rate slows to a level more similar to that of other economies, it will have a huge amount of generation that it doesn’t need. This adds a very large debt risk, it would seem.

Wind and Solar. If we believe Darien Ma, author of “The Answer, Comrade, Is Not Blowing in the Wind,” there is less to Beijing’s seeming enthusiasm for renewables than meets the eye.

According to Ma, China’s solar industry was built with the idea of having a product that could be exported. It was only in 2013 when Western countries launched trade suits and levied tariffs that China decided to use a substantial number of these devices itself, saving the country from the embarrassment of having many of these producers go bankrupt. How this came about is not entirely certain, but the administrator in charge of wind and solar additions was later fired for accepting bribes, and responsibility for such decisions moved higher up the chain of authority.

Figure 10. China current view of solar investment risk in China. Chart by Bloomberg New Energy Finance.

Ma also reports, “Officials say that they want ‘healthy, orderly development,’ which is basically code for reining in the excesses in a renewable sector that has become yet another emblem of irrational exuberance.”

According to Ma, the Chinese National Energy Administration has figured out that wind and solar are still about 1.5 and 2.5 times more expensive, respectively, than coal-fired power. This fact dampens their enthusiasm for the use of these types of generation. China plans to phase out subsidies for them by 2020, in light of this issue. Ma expects that there will still be some wind and solar in China’s energy mix, but that natural gas will be the real winner in the search for cleaner electricity production.

Viewed one way, we are looking at yet another way Chinese officials have avoided closing Chinese businesses because the marketplace did not seek their products. Thus, the usual cycle of bankruptcies, with loan defaults, has not taken place. This issue makes China’s total electricity generating capacity even more excessive, and reduces the profitability of the overall system.

Conclusion

We have shown how low wages and low energy prices seem to be connected. When prices are too low, some producers, including China, make a rational decision to cut back on production. This seems to be the true nature of the “Peak Coal” and “Peak Oil” problem. Because China is reacting in a rational way to lower prices, its production is falling. China is already the largest importer of oil and coal. If there is a shortfall elsewhere, China will be affected.

We have also given several examples of how the current system has been able to avoid defaults on loans. The issue is that these problems don’t really go away; the get hidden, and get bigger and bigger. At some point, all of the manipulations by government officials cannot hide the problem of way too many apartments, or of way too much electricity generating capacity, or of way too many factories of all kinds. The postponed debt collapse is likely to be much bigger than if market forces had been allowed to bring about earlier bankruptcies and facility closures.

Chinese officials are now talking about reining in the growth of debt. There is also discussion by heads of Central Banks about raising interest rates and selling QE securities (something which would also tend to raise interest rates). China will be very vulnerable to rising interest rates, because stresses that have been allowed to build up in the system. For example, many mortgage holders will not be able to afford the new higher monthly payments if rates rise. If interest rates rise, factories will find it even harder to be profitable. Some may reduce staff levels, to try to reach profitability. If this is done, it will tend to push the system toward recession.

We likely now are in the lull before the storm. There are many things that could push China toward an energy or debt crisis. China is so big that the rest of the world is likely to also be affected.

 

 

Republished with permission from Our Finite World