What water is to a fish
Tuesday, 5 November 2019
By Harry Dent
- Coma economies
- There is no soft landing to this extreme bubble scenario!
- The acid test: money velocity
Editor’s note: It’s Melbourne Cup Day today. The race that stops the nation. By the time you receive this the race should be done and dusted. Hopefully you managed to take some time to enjoy the spectacle. Maybe you even placed the right bets and pocketed some cash.
While the race doesn’t really stop the entire nation, it is a state holiday in Victoria. That means Port Phillip Publishing’s Melbourne HQ is shuttered for the day. So I (Bernd) have lined up a special guest essay for you from renowned US futurist, Harry S Dent.
Along with our Aussie based international analyst, Selva Freigedo, Harry writes the weekly Boom & Bust Letter. He’s also the author of the best-selling book Zero Hour. If you haven’t read that yet, you can find out how to get your discounted copy here.
Without further ado, I’ll hand you over to Harry.
‘There are these two fish swimming along, and they happen to meet an older fish swimming the other way, who nods at them and says “Morning, how’s the water?” And the two young fish swim on for a bit, and then eventually one looks over at the other and says, “What the hell is water”?’
(Thanks to the friend who shared with me the Artemis Capital Management report that started with this quote from David Foster Wallace.)
Like fish swimming in water, we land creatures walk around totally dependent on air, but we don’t see or notice it until something goes drastically wrong with it (like the sludge they breathe in Beijing) or it disappears (as mountaineers experience summiting Everest).
Investors suffer the same familiarity blindness. Their new and now unnoticed medium: liquidity.
Unfortunately, like fish, Beijing residents or mountaineers, investors don’t realise the predicament they’re in until something fundamentally changes in their environment and suddenly they’re slowly being boiled or choked to death.
We’ve enjoyed unprecedented liquidity in our markets and economy for nearly a decade. Different from any boom period in history. Way more extreme than during rare emergency periods, like during the worst of the Great Depression or during the Second World War.
It’s been this way for so long that we’re now blind — and dependent — on it.
In a time of unprecedented debt burdens, slowing demographics in the developed world and now China, and new global trade wars that could last for decades (like the last one from 1913 to 1946), liquidity has become to investors what water is to fish.
This liquidity started out as life support in early 2009, when central banks stepped in to prevent the next Great Depression. Back then, I would have supported a one-year emergency injection of liquidity to prevent a 1930–33 style banking-system meltdown.
But to put the economy on such massive QE for going on 10 years? That’s nuts.
And Japan’s been doing it since 1997, and since 2013 it’s been doing it at three times our rate! That’s crazier still.
Long-term policies like this don’t allow the economy to re-balance or shed zombie banks, inefficient businesses, and non-productive debt. Those things, like a good detox for a heroin addict, make it possible for us to return to health and growth again.
The debt binge of the magnitude since the early 1980s is like a drug addiction. The steady drip of leverage and liquidity has done significant harm to the system and all in it.
Australia’s Great Bank Unbundling Has Begun
Well, you can’t say they haven’t had a good run…
For decades, Australia’s banks have hidden behind a combination of government regulation and customer ignorance.
And, boy, did they make a killing!
But, in the exclusive story here, you’ll soon see why those days are now over.
Japan is the poster child of this. It’s been a coma economy for two decades now. It enjoyed slight improvement in recent years thanks to the predictable surge in demographic trends. But this will only last through 2020. After that, demographics will once again plunge the country into crisis.
Japan is dying. Right before our eyes and it has printed almost 100% of its GDP to keep it on a morphine drip to ease the pain.
Just like crack dealers, central banks have hijacked free markets through their injection of massive liquidity and artificially low short- and long-term interest rates (from buying their own bonds) that directly impact the values of all financial assets.
Thanks to their efforts, investors and businesses have lost sight of the natural signals needed to make intelligent investments. Rather than freeing the junkie of addiction, or healing the sick patient, this continuous life support has fostered high degrees of speculation, financial engineering, and complacent, passive investment — nearly all buyers, few sellers.
These ‘side effects’ create a bubble that has no discipline and no accountability. It’s longer, more stretched, and more distorted than any in history. And it has fuelled itself until it becomes its own destroyer.
This is where we are today.
That’s what we face.
A gargantuan beast of a financial and investment bubble that could burst spectacularly…
There is no soft landing to this extreme bubble scenario!
It should have blown up already. But the surprise Trump tax cuts and $2 trillion in repatriated profits reenergised the monster.
This is why the US is the only major economy growing while Europe lags and Asia and emerging markets are tanking…the end is nigh!
Click to enlarge
The NASDAQ has been up a cumulative 556%, including dividends, since the March 2009 bottom. The broader S&P 500 has been up 385%. Those are damn good returns for a recovery that was the weakest in history until the tax cut bonanza.
And real estate has offered up 48% returns as of early 2018 (likely just over 50% by now). If that seems low to you it’s because the property price recovery didn’t start until 2012. That puts these returns at about 8% a year since then.
The thing is, most people own real estate with mortgages and 20% down. That leverages your equity up to five times. So, think of these returns as more like 250% in just over six years!
Real estate benefits most from lower long-term rates that make mortgage payments easier to bear and allows consumers and businesses to buy bigger and/or higher quality real estate for the same payment. That means more money chasing slow-to-build structures, which home builders have been more conservative in doing since they got walloped in the 34% crash and foreclosure crisis of 2006–12.
The problem with real estate when the bubble bursts is obviously that people can lose their house, which is much of their net worth. They get underwater in a blink of an eye and can’t even refinance to take advantage of the lower rates if they can afford to stick it out.
Commodities is about the only sector that hasn’t fared well under QE, returning a negative 9% since March 2009.
There are two reasons for this.
First, they topped on a predictable 30-year cycle in mid-2008 and have been down off-and-on ever since. Second, commodities don’t have interest costs. They’re only helped by the lower cost of speculation, as are all financial assets. But given that commodities have been the one bubble that has burst spectacularly (proving that bubbles only do so), speculation has been beat out of this market.
However, commodities would be even lower if it weren’t for the stronger economy that all the massive QE injections enabled.
In short, all financial assets have enjoyed a free lunch of excess returns for longer than nine years now, not to mention avoiding a Great Depression that would have destroyed returns, businesses, and jobs.
So, the trillion-dollar question is: Can we sustain such a free lunch?
Any half-sane person in a non-high-liquidity environment (‘high’ being the key word here) would say, ‘Of course not!’
But we and the markets are ‘on crack’ and have now been in Lala Land for nearly a decade. People are finally starting to think that maybe this is sustainable. The economy has escaped its 2% growth rut for the first time. Maybe we can keep this going, they think.
I ask you though, if the economy has only grown 2% a year with such massive stimulus, how much would it have declined without it?
Let’s look at the best ‘acid test’ to show you the quality of this ‘recovery’ and bull market.
What the heck’s going on with gold right now?
Gold is back. It’s impossible to ignore.
The price is, in the words of Bloomberg columnist John Authers, going ‘crazy’.
It’s soaring up and hitting records. Edging back a bit. Soaring again…and so on.
What’s going on?
The truth about gold’s return to fame, according to Greg Canavan, is more shocking than you might think…
Harry S Dent’s explosive book
The acid test: money velocity
My favourite classically-trained economist is Dr Lacy Hunt. He’s a real-world bond fund manager with a great track record betting on the inevitable trend towards lower rates and deflation ahead.
He has the best single indicator for the quality of a bull market and economic advance: growing money velocity.
Quite simply, it indicates whether or not we’re making productive investments that sustain growth. Those are the kind that beget more profits and more productive investments and more jobs, and so on. That alone shows sustainability.
After a long-term peak in the US, like 1918 and 1997 (80 years apart on my four-season economic cycle), money velocity falls while the economy continues to boom. That’s a sign that investment is becoming more speculative and not productive.
Bubbles will always follow this trend. Remember 1925–29, 1995–2000, and now 2009–18 (and counting)?
These bubbles burst, which causes velocity to fall to long-term lows. This is what they did in 1933 and 1946 as the economy slowed dramatically and debts deleveraged. We can expect the same this time around.
We’re already approaching past lows and we clearly haven’t deleveraged much yet thanks to massive liquidity and the suspension of ‘mark-to-market’ rules that allow banks to NOT restructure or write down debts. That suggests we’ll see lower velocity readings than ever before.
Lacy’s acid test clearly says deflation is inevitable. That’s how he stays with the falling long-term rate trade that Wall Street thinks is already over.
Using that same indicator, Lacy can compare major countries and tell which have higher quality economic expansions and which don’t. Guess which two countries are the worst due to their more centralised control, debt expansion, and over-investing? Yeah baby: Japan, and the very worst, China!
Just look at this beautiful chart.
Click to enlarge
The US had the highest money velocity in 1997, at a ratio of 2.2. They still hold that honour, even after falling to 1.43 in its speculative binge.
The eurozone peaked earlier, by 1995, at 1.70 and is much lower now at 1.01.
Japan’s last peak was in 2002, at 1.0. Today, it’s at a pathetic 0.55.
But no one beats China’s build-things-for-no-one-at-record-debt-creation. It peaked at least as far back as 1990 at 1.55 and has fallen the most of all, to 0.47.
Why did the dollar outperform all major currencies in the last crash in 2008?
Well, being the reserve currency helped, but it was more simply that we were the ‘best house in a bad neighbourhood’ of something for nothing, unprecedented stimulus and debt creation. The US remains the best house today.
Still, we’re all flunking the acid test. We’re all heading towards deflation. We’re all fighting it every way possible, like an addict finding ways to take more and not detox for now. We will all fail, but the US will come out the best and China likely the worst.
Our Aussie subscribers should be proud of their one counter trend in this chart. Australia is one of the rare developed countries that has had rising money velocity since 1990. But at 1.13 today, it’s still lower than the US as Australia has focused too much on a housing bubble that cannot feed productive investment like new plants, equipment, and R&D can…
That said, Australia is likely to fare the best in the great crash and reset ahead, given its strong demographics from high-quality Asian immigration. It just has to deleverage its housing bubble and the banking bubble around that — and that will be more painful than its economists have warned.
Housing prices are starting to fall more rapidly than Aussies have seen in a long time. They are finally scared…and should be.
Everyone has now been trained to think that we can reverse this unprecedented liquidity and the economy can now sustain itself after healing and getting back in gear…we can live without water. You’re not going to pull that one over Lacy’s eyes.
He and I have shown over the past years that the economy has clearly not healed at all.
Debt is only higher, demographic trends are only weaker for most developed countries. Financial assets are more overvalued than ever with the one exception of early 2000 for US stocks. But when adjusted for much slower growth, such valuations are actually higher than ever today.
You simply can’t compare 1995–99 to 2013–18 in growth, real wages, productivity, or anything — except growth in asset prices, which is now totally artificial and dependent on massive liquidity and artificially low interest rates.