Approaching a Tipping Point

Taking the path of least resistance doesn’t always lead to places worth going.  In fact, it often leads to places that are better to avoid.  Repeatedly skipping work to sleep in and living off credit cards will eventually lead to the poorhouse.

 

Sometimes the path of least resistance turns out to be problematic

 

The same holds true for monetary policy.  In particular, cheap credit policies that favor short-term expediency have the effect of layering society up with an abundance of long-term mistakes.  Artificially suppressed interest rates via central bank asset purchase schemes are not without consequences.

What’s more, once set in motion these consequences don’t stop until they’ve fully run their course.  The booms of plentiful credit must always be followed by the busts of unserviceable debt.  As more and more debt drifts into arrears the debt structure breaks down.  Yet when the actual tipping point is crossed is often unclear until after the fact.

Quantitative easing “officially” ended over two years ago.  The interim period has been relatively sanguine; asset prices have continued to inflate.  But lurking around the corner is the inevitable downside of quantitative easing.

As we’ve seen, the downside’s onset has taken years to manifest.  Nonetheless, credit markets are now signaling a breakdown. Moreover, we expect these signals to grow ever louder as the year progresses.

 

The Insanity of the Echo Bubble

In a recent article titled LIBOR Pains, Pater Tenebrarum succinctly describes the nature of the problem:

 

“There are several points worth noting in this context:

  1. corporate debt relative to assets is back at a record high (last seen at the peak of the late 1990s mania);
  2. US corporations are spending far more than they are taking in, i.e., the sum of capex, investment, dividends and stock buybacks vastly exceeds their gross cash flows – the gap is in fact at a record high, above the previous record set in 2007.
  3. the return on equity of US corporations is at a record low (yes, you read that right!).”

 

A chart we didn’t show in the above mentioned article: the debt-to-asset ratio of non-financial corporations. It is now finally back at the level that prevailed at a point in history which in hindsight is widely recognized as a time of almost unparalleled collective insanity. It is less obvious today in some ways, mainly because it has migrated from retail traders to institutions. Institutional insanity is less conspicuous, but it may be even more dangerous for that – click to enlarge.

 

Obviously, the palette of high debt, low profitability, and low return on equity paints a grim picture of things to come.  So how did corporate officers manage to paint themselves into such a tight corner?

In short, false signals from the Fed’s cheap credit compelled them to make decisions that otherwise wouldn’t have made good business sense.  An abundance of debt was taken on to make business investments that have not panned out.  Financial engineering has also exacerbated the mistakes.

The big banks packaged their corporate loans into collateralized loan obligations and passed them off to hedge funds.  This served to further the debt gorge.  Again, Pater explains:

 

“The opportunity to make a paltry 8 percent per year on an investment that is leveraged 10:1 was apparently considered such a great deal that it was expected to trigger sufficient demand for these securities to drive up their prices – in spite of the fact that banks no doubt were and are producing them by the wagon-load.  That is certainly testament to the insanity of the echo bubble.”

 

Unfortunately, this insanity has real consequences.  Financial markets, and the Fed’s cheap credit, may be where these debt bubbles start.  But it is not where they stop.  They extend out into the real economy, where they disfigure the landscape in absurd ways.

 

Credit Contraction Episodes

Numerous capital resource misallocations have developed over the last eight years.  In some areas, the resulting market distortions have reached a perilous state.  For these markets, new credit is no longer expanding; rather, it’s contracting.

For example, too many people have borrowed too much money to buy too many cars.  Many even used the Fed’s cheap credit to buy cars they couldn’t afford with money they could never pay back.  Auto loan delinquencies, now at $23.27 billion, haven’t been this high since late-2008.

 

Delinquencies of consumer and corporate loans in USD million (car loans are a separate category). The sum of the two is now more than $62 billion, which was last seen in Q3 of 2008 – at the time a record high. As a percentage of outstanding loans of these two types, the 5.52% in Q3 2008 were of course much higher than the 3.85% the figure represents today, as credit has expanded at a torrent pace since 2008. What is noteworthy is the trend – we only ever see such a clear uptrend in delinquencies ahead of recessions. This trend also belies the “everything is awesome” rhetoric of the Fed. If it were, delinquencies would trend in the opposite direction – click to enlarge.

 

Like corporate debt, the flow of consumer credit was further liquefied by the bundling of sub-prime car loans into asset backed securities.  This, in turn, provided false signals to the automotive industry.  Business leaders made capital investments to increase automotive production capacity that was never needed in the first place.

Not only were too many cars bought with cheap credit.  The same cheap credit that financed the extraneous car purchases was used to finance the production of extraneous cars.  In other words, a great big mistake has been made.

 

Vehicle loans owned & securitized vs. total vehicle sales. Evidently it takes far more credit than previously to actually sell fewer cars. As a general rule of thumb, when a credit expansion becomes uncommonly large, a sizable (and growing) percentage of borrowers is not really creditworthy. It cannot be otherwise – at some point the pool of creditworthy borrowers will be fully loaned up; thereafter, credit can only be expanded further by lending to future bankruptcy candidates. It seems to us that this is going to hurt quite a bit when the party ends – which appears to be happening – click to enlarge.

 

Now the automotive industry has a great big problem on its hands.  The Detroit News lays out the particulars:

 

“New- and used-car sales have increased seven years in a row as the economy has improved, a streak not seen since the 1920s, but industry analysts worry that the used-car market may not be able to easily digest a record number of vehicles with expired leases being listed for sale.

“Most leases are for 36 months, so three years after they leave dealerships they come back as used cars, and in 2017 the auto industry is bracing for a record 3.6 million off-lease vehicles.”

 

There are simply too many cars to go around.  Hence, auto sales are no longer going up.  They’re going down.  Specifically, U.S. auto sales declined in March for the third month in a row.  Naturally, these are the sorts of unwelcome credit contraction episodes that happen just before the debt structure breaks down in earnest.

 

Charts by SG Cross Asset Research, St. Louis Federal Reserve Research

 

Chart and image captions by PT

 

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • Gold – An Overview of Macroeconomic Price Drivers
      Fundamental Analysis of Gold As we often point out in these pages, even though gold is currently not the generally used medium of exchange, its monetary characteristics continue to be the main basis for its valuation. Thus, analysis of the gold market requires a different approach from that employed in the analysis of industrial commodities (or more generally, goods that are primarily bought and sold for their use value). Gold's extremely high stock-to-flow ratio and the main source of...
  • India – Is Kashmir Gone?
      Everything Gets Worse  (Part XII) -  Pakistan vs. India After 70 years of so-called independence, one has to be a professional victim not to look within oneself for the reasons for starvation, unnatural deaths, utter backwardness, drudgery, disease, and misery in India. Intellectual capital accumulated in the West over the last 2,500 years — available for free in real-time via the internet — can be downloaded by a passionate learner. In the age of modern technology, another mostly...
  • Cracks in Ponzi-Finance Land
      Retail Debt Debacles The retail sector has replaced the oil sector in a sense, and not in a good way. It is the sector that is most likely to see a large surge in bankruptcies this year. Junk bonds issued by retailers are performing dismally, and within the group the bonds of companies that were subject to leveraged buyouts by private equity firms seem to be doing the worst (a function of their outsized debt loads). Here is a chart showing the y-t-d performance of a number of these...
  • Pulling Levers to Steer the Machine
      Ticks on a Dog A brief comment on Fed chief Janet Yellen’s revealing speech at the University of Michigan. Bloomberg:   “Before, we had to press down on the gas pedal trying to give the economy all of the oomph that we possibly could,” Yellen said Monday in Ann Arbor, Michigan. The Fed is now trying to “give it some gas, but not so much that we’re pushing down hard on the accelerator.” […] “The appropriate stance of policy now is closer to, let me call it...
  • French Election – Bad Dream Intrusion
      The “Nightmare Option” The French presidential election was temporarily relegated to the back-pages following the US strike on Syria, but a few days ago, the Economist Magazine returned to the topic, noting that a potential “nightmare option” has suddenly come into view. In recent months certainty had increased that once the election moved into its second round, it would be plain sailing for whichever establishment candidate Ms. Le Pen was going to face. That certainty has been...
  • The Cost of a Trump Presidency
      Opportunity Cost Rears its Head Last Thursday’s wanton attack on a Syrian air field by the US and its bellicose actions toward North Korea have brought the real cost of candidate Trump’s landslide victory last November to the forefront.   It didn't take long for Donald Trump to drop his non-interventionist mask. The decision was likely driven by Machiavellian considerations with respect to domestic conditions, but that doesn't make it any better.   Unlike...
  • Central Banks Have a $13 Trillion Problem
      Paycheck to Paycheck GUALFIN, ARGENTINA – The Dow was down 118 points on Wednesday. It should have been down a lot more. Of course, markets know more than we do. And maybe this market knows something that makes sense of these high prices. What we see are reasons to sell, not reasons to buy.   DJIA daily (incl. Thursday)... it was just taking a rest - click to enlarge.   Nearly half of all American families live “paycheck to paycheck,” say researchers. Without...
  • Heavily Armed Swamp Critters
      Worst Mistake GUALFIN, ARGENTINA – By our calculation, it took just 76 days for President Trump to get on board with the Clinton-Bush-Obama agenda. Now there can be no doubt where he’s headed. He’s gone Full Empire. Not that it was unexpected. But the speed with which the president abandoned his supporters and went over to the Deep State is breathtaking.     Once there was only a Trump fragrance called Empire... now he has gone full empire himself   Among the noise...
  • Hell To Pay
      Behind the Curve Economic nonsense comes a dime a dozen.  For example, Federal Reserve Chair Janet Yellen “think(s) we have a healthy economy now.”  She even told the University of Michigan’s Ford School of Public Policy so earlier this week.  Does she know what she’s talking about?   Somehow, this cartoon never gets old...   If you go by a partial subset of the ‘official’ government statistics, perhaps, it appears she does.  The unemployment...
  • French Selection Ritual, Round Two
      Slightly Premature Victory Laps The nightmare of nightmares of the globalist elites and France's political establishment has been avoided: as the polls had indicated, Emmanuel Macron and Marine Le Pen are moving on to the run-off election; Jean-Luc Mélenchon's late surge in popularity did not suffice to make him a contender – it did however push the established Socialist Party deeper into the dustbin of history. That was very Trotskyist of him (we can already picture a future Weekly...
  • Trump Is An Insider Now
      Conspiracy of the Few GUALFIN, ARGENTINA – “U.S. stocks fall on Trump talk…” began a headline at Bloomberg. Or it may be Trump action. We had already counted six major campaign promises – including no O’care repeal and no “America First” foreign policy – already buried (some for the better).   A bunch of campaign promises get the MOAB treatment...  A great many  theories have been proposed to explain Trump's recent series of u-turns: 1. he is in thrall to...
  • Simple Math of Bank Horse-Puckey
      The Raw Deal We stepped out on our front stoop Wednesday morning and paused to take it all in.  The sky was at its darkest hour just before dawn.  The air was crisp.  There was a soft coastal fog.  The faint light of several stars that likely burned out millennia ago danced just above the glow of the street lights.   And this is what they saw watching the sky from Mt. Wilson that night...   After a brief moment, we locked the door behind us and got into our...

Support Acting Man

Austrian Theory and Investment

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com