David Stockman: The Global Economy Has Entered The Crack-Up Phase
Few people understand the global economy and its (mis)management better than David Stockman -- former director of the OMB under President Reagan, former US Representative, best-selling author of The Great Deformation, and veteran financier.
David is now loudly warning that events have entered the crack-up phase, which he predicts will be defined by the following 4 developments:
- Increasingly desperate moves by the world's central banks
- Increased market volatility and losses
- Deflation in industrial and commodity prices
- Decreasing demand due to Peak Debt
As the crack-up phase gains momentum, he predicts an increasing number of "financial breaks" that will add to the unpredictability and instability of the environment for investors. Even 'dancing close to the door' sounds excessively risky at this point.
We’re in the crack-up phase. I think there are four big characteristics of that which are going to shape the way the economy and the markets unfold as we go forward.
You’re going to see increasing desperation and extreme central bank financial repression because they have gotten themselves painted so deep into the corner that they're lost and desperate. Almost week by week, we have another central bank – this week, it was Sweden – lowering their money market rates into negative territory. The Swiss Bank is already there, the Denmark Bank is there, the ECB is there on the deposit rate, the Bank of Japan’s there. All of the central banks of the world now are desperately driving interest rates into negative territory. I believe that they’re lost; they're in a race to the bottom whether they acknowledge it or not. The central bank of China can’t sit still much longer when the reminbi has appreciated something like 30% against the Japanese yet because of the massive bubble of monetary expansion that’s being created there. So that’s the first thing going on. Central banks out of control in a race to the bottom, sliding by the seat of their pants, making up really incoherent theories as they go.
The second thing is increasing market disorder and volatility. In the last three months, the stock market has behaved like a drunken sailor. But it’s really just a bunch of robots and day traders that have traded chart points until somebody can figure out what is happening directionally in the world. It has nothing to do with information or incoming data about the real world. We have today the 10-year German bond trading at 29.5 basis points. Well, the German economy’s been reasonably strong, fueling the Chinese boom. That export boom is over. The Chinese economy is faltering. Germany is going to have its own problems. But clearly, 29 basis points on a 10-year is irrational, even in the case of Germany, to say nothing of the 160 available today on the 10-year for Spain and Italy. Both of those countries are in deep, deep fiscal decline. There is no obvious way for them to dig out of the debt trap that they’re in. It’s going to get worse over time. There’s huge risk in those bonds, especially because there’s no guarantee that the EU will remain intact or the euro will survive. Why in the world would anybody in their right mind be owning Italian debt at 160 other than the fact that they’re front-running the massive purchases that Draghi has promised and the Germans have acquiesced to over the next year or two. But that only kicks the can down the road. One of these days, the central banks are going to falter and the market is going to reset violently to prices that reflect the true risk on all this sovereign debt and the pretty cloudy outlook that’s ahead for the world market.
We now have something like four trillion worth of sovereign debt spread over Japanese issues, the major European countries that are trading at negative yields. Obviously, that is one, irrational and second, completely unsustainable. And yet, it’s another characteristic of what I call these disorderly markets. Investment is now coming home to roost. It will be driving a huge deflation of commodity and industrial prices worldwide. You can see that in iron ore, now barely holding $60 from a peak of $200. Obviously, it’s seen in the whole oil patch. Look at the Baltic Dry Index. That is a measure, one, of faltering demand for shipments and, two, massive overbuilding of bulk carrier capacity as a result of this central bank driven boom that we’ve had in the last 10 to 20 years. So that is going to be ripping through the financial system, the global economy, in ways that we’ve never before experienced. And so therefore, in ways that are hard to predict what all, you know, the ramifications and cascading effects will be. But clearly, it’s something that we haven’t seen in modern times or ever before – the degree of over investment, excess capacity, and everything from iron ore mines to dry vault carriers, aluminum plants, steel mills, and on down the line.
And then, finally, clearly, demand has run smack up against peak debt -- I think that’s the right word for it. We had a tremendous study come out in the last week or so from McKinsey, who do a pretty good job of trying to calculate, track and total up the amount of credit outstanding, public and private, in the world. We’re now at the $200 Trillion threshold. That’s up from only about $140 Trillion at the time of the crisis. So we’ve had a $60 Trillion expansion worldwide of debt just since 2008. During that same period, though, the GDP of the world saw a little more than $15 trillion from $55 or mid-$50s, roughly, to $70 Trillion. So we’ve generated, because of central bank money printing and all of this unprecedented monetary stimulus, we’ve generated something like $60 Trillion of new debt in the world and have barely gotten $15-17 Trillion of new GDP for all of that effort. And I think that is a measure of why the fundamental era is changing. That the boom is over and the crackup is under way when you see that kind of minimal yield from the vast amount of new debt that has been generated.
Now I’d only wrap this up by calling attention to the fact that within that global total of $200 Trillion, the numbers from China are even more startling. At the time of the crisis, let’s go back to 2000, China had $2 Trillion of credit outstanding. It’s now $28 Trillion. So we’ve had just massive 14X growth in 14 years. There’s nothing like that in recorded history, nor is there any plausible reason to believe that an economy, which is basically under a command-and-control system that is run from the top down to the party cadres, could possibly create $26 Trillion in new debt in that period of time without massive inefficiencies in waste and mistakes everywhere within the systems, especially since they have no markets. They have no feedback mechanisms. It all comes cascading down from the top and everybody lies to the next party above them. And I think the system is irrationally out of control.
In any event, my point was that at the time of the 2008 crisis, China had allegedly – if you believe their numbers, which no one really should – but as reported, they had $5 Trillion worth of GDP. It’s now $10. So they’ve gained $5 Trillion of GDP. Their debt at the time of the crisis was $7 Trillion, now it’s $28. So the debt is up more than $20 Trillion while the GDP is up just $5 Trillion. These are extreme unsustainable deformations, if I can use that word, that just scream out, “Danger ahead. Mayhem has happened.” And the unwinding of this and the resolution of this is not going to be pretty.
Click the play button below to listen to Chris' interview with David Stockman (54m:29s)
Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson. It’s a central banker world and that world is increasingly volatile, deformed, and full of risks. Today, we’re speaking with a guest I am especially keen to interview, Mr. David Stockman, economic policymaker, politician, and financier. Mr. Stockman represented Southern Michigan in the US House of Representatives from 1976 to 1981 and later served as the Director of the Office of Management and Budget in the Reagan administration and was the youngest cabinet member of the twentieth century.
Since then, he has held executive positions in many of the most influential banking, buy-out, and private equity firms including the Blackstone Group and Salomon Brothers. He is author of The Great Deformation: The Corruption of Capitalism in America, which is a blunt and sometimes delightfully and deservedly scathing examination of the various fiscal and policy blunders that have degraded our current and future hopes for prosperity. Be sure to have your blood pressure medication handy as you read it because not only does it detail a litany of regulatory and policy blunders of the recent past, it reads like it was lifted from today’s headlines.
He also runs the popular and excellent website, David Stockman’s Contra Corner, where he both blogs and assembles other excellent economic content for you to read, so be sure to visit it regularly.
Welcome, David. It’s an honor to have you as our guest.
David Stockman: Very happy to be with you again, Chris.
Chris Martenson: So there’s such a target-rich environment to talk about with you. Where do we start? You know what I’d love to start with is I was actually a little bit shocked to see Elizabeth Warren come out and say that she didn’t support auditing the Federal Reserve. And I was a little shocked because she’s been a populist and presented herself that way. I can’t think of anything more populist oriented than to have exquisite transparency into the organization that is entrusted with printing money out of thin air and handing it out.
David Stockman: Well, you know, I think that’s a really good starting point. I actually had – I posted a blog on that two days ago. The title happened to be "Audit the Fed, Shackle the Fed." And that’s the difference between where I would be, for instance, and where Elizabeth Warren came out. The Liberals don’t have any objection at the end of the day to money printing. They are still under the Keynesian delusion that somehow zero interest rates will rejuvenate the economy. That we don’t have enough borrowing in this system and that business and consumers, therefore, need to be encouraged to borrow more. You know, that whole syndrome, that whole framework obviously is wrong. It’s failed dramatically. We can see that almost day-by-day as we enter another calendar year and find that the economy, again, has not taken off at escape velocity as we’ve been promised over and over as a result of all this monetary expansion.
So I think, you know, we’re getting to the Rubicon here in terms of where people stand on this issue. And I do appreciate the fact that she has been pretty tough on Wall Street and the bailouts and that was all to the good. But you have to ask, “Why did all this happen? Why have we created so much leverage and risk taking and kind of unproductive trading and churning in our financial markets?” Does this come out of the inherent nature of capitalism? I don’t think so. Has there been an upgrade in the level of greed on Wall Street? I don’t think so. It’s always been there. The change is at the central bank. The change, the difference, is in monetary policy, which is out of control. We’re now in the 73rd month of zero interest rates. That’s the most important price in all of capitalism. And it’s been pinned at zero for 73 months and they still can’t quite get up the nerve to let it rise even by 25 basis points.
So I think those points begin to frame the issue and it’s pretty clear that the kind of anti-bailout Liberals like Elizabeth Warren don’t have a clue as to what the fundamental problem is. And that is, obviously, an overwhelmingly out-of-control central banks, not just in the Eccles Building here but virtually, every central bank in the world.
Chris Martenson: Excellent points, David. You know, what it comes down to for me is this idea that Elizabeth Warren was against the bailouts. I can’t think of anything that’s a more profound and pronounced and ongoing bailout than to drive interest rates to zero, prevent people who are savers from accumulating any interest returns on that money. And since they’re not getting it, somebody is, and that turns out to be the banks and their balance sheets. So the Fed, all on its own, decided that it was going to, at the expense of one set of participants in the economy, punish them and reward another set, which I don’t believe deserved to be rewarded. I can’t think of anything that’s more bailout-ish than that.
David Stockman: No, that is the continuing fundamental bailout that has been in place continuously since September 2008. I actually addressed that yesterday in a blog when I went after Bank of America for its latest malefaction, shifting insured deposit money from the North American bank to London so it could be spread around among some fast money hedge fund traders to pull off various kinds of tax arbitrages.
Well, the point I was making is that the banking system is not, by any means, fixed. That when you have a rogue operation like Bank of America now facing something like 100 billion dollars’ worth of settlements, fines, penalties, recoveries, etc., that, I think, is a sign that nothing has been fixed and all the dangers are still there. But my underlying point – and taking after Bank of America – was that they have 1.1 trillion worth of deposits on a two trillion balance sheet. My view is that the financial repression of the front end of the yield curve by the Fed is at least worth 300 basis points. I mean, we shouldn’t have zero cost of money. We still do have inflation and taxes. That’s worth about 30 billion, arguably, in 2014 to Bank of America in terms of reduced cost of funding their balance sheet. They had profits 11.5 billion, so make your comparison.
The point I was getting at is that in a free market, they would be paying a lot more than zero for their deposits. Maybe the yield on some assets and loans would be a little higher but I don’t think it’s symmetrical or parallel. Because if we actually allowed the free market to price debt and other financial securities, if we allowed the yield curve to find its own proper shape based on honest price discovery in the market, I think the demand for borrowing would fall and therefore, interest rates would be thereby impacted. Whereas the availability of savings would rise as interest rates normalized to something that was reasonable.
You put the two together and you come to the conclusion, at least in my view, that bank earnings are massively overstated or distorted or malformed, if we can use that word, as a result of this massive financial repression by the Fed. That a bank like Bank of America, which allegedly has rebuilt its balance sheet and regenerated some equity, is basically the recipient of this huge gift from the Fed. And so the banking system hasn’t been fixed. It’s simply the financial system that has been totally distorted and malformed by this destructive monetary policy.
So all of that lies in front of us. And obviously, as we move on here from month to month and quarter to quarter, you know, the coiled spring, which is being created in the financial markets as a result of this enormous intervention of money printing is likely to unravel and break out in ways that are very hard to predict but certainly, will be surprising and disruptive.
Chris Martenson: Now, what you’re referring to here is the idea that I guess we just have all this speculative hot money, it’s out there. When the Fed goes out and buys a trillion dollars of mortgage-backed securities and stuffs that cash back into the system, it has to go somewhere. And some of it leaks back into the so-called excess reserves just kicking around at the Fed. But some of that hot money, it’s out in the wild, it’s got to do something so it chases yield, drives yields down even on junk debt to where it has a 5% handle. And in equities, we see some strange things. You probably caught this on ZeroHedge that there are four cheese trucks running around this country that have a collective equity valuation of 100 million dollars.
David Stockman: A hundred million, yeah.
Chris Martenson: Which is a lot of cheese sandwiches, isn’t it?
David Stockman: Right. Yeah, exactly. You know, and I think that’s the point. The mechanical Keynesians say not to worry, the money is circulating through the primary dealers as the Fed, until recently, you know, quit the QE, but until the end of QE bought 3.5 trillion dollars’ worth of treasuries and GSEs from the point of the crisis in September 2008 to October. But not to worry about that because a lot of it just has come back as excess reserves at the New York Fed.
I think what is totally missing from that analysis is that as that massive liquidity injection circulates through the canyons of Wall Street, it dramatically impacts the pricing of everything in the financial market. That is what causes the money market to stay at zero. That’s what causes the sharp repression of 30-year mortgage yields or 10-year treasury yields or the entire treasury curve along with it.
Now, when you get false pricing, when you get artificially low prices, especially on the front end of the curve in the money markets, that is simply a backdoor way of creating more credit. In other words, the money market or the repo market becomes the funding source for speculators buying up the curve, mismatching their maturities, collecting the spread, and laughing all the way to the bank because the Fed has promised them that it will keep their carry costs at zero until further notice with a lot of prior indications. And that the assets that they’re buying will not be allowed to drop dramatically in price and so therefore, the arbitrage is a no-brainer.
Now, that’s what happens when 3.5 trillion dollars circulate from the printing press, the Send button at the Fed, through Wall Street and the primary dealer system, and some of it comes back into the excess reserve accounts. In the process, all pricing is distorted, all assets – financial assets – get re-hypothecated and carried in the overnight credit markets, the repo markets, the short-term, unsecured debt markets. And that is the mechanism by which this huge financial bubble is continuously inflated, whether it’s on the fixed income side, the equity side, or all the derivatives and trades that could be fashioned in those markets.
Chris Martenson: So let’s look at just one aspect of all that money sloshing around, and it’s one that really has got my attention full on. It’s what’s happened – and is happening – in the shale patch. So you have a bunch of drillers out there and they’re punching holes all over North Dakota, Colorado, Arkansas, you name it. And the way it was working was that they would drill these wells at a pretty horrendous cost – seven to 10 million bucks a pop – and then they would take the revenue streams that would come off of that, collateralize it in some way, and go put that in the market, sell junk debt however they wanted to do that. And then, get more capital and keep going. And David, as I analyzed this, I saw that these companies were not generating any positive free cash flow when oil was at 100 a barrel. What are you seeing in that space? And what do you think happens from here with oil at 50 a barrel?
David Stockman: Well, I think you’ve put your finger right on the issue. We keep talking about the fact that all of this central bank intervention and pegging of market prices in virtually every class of financial assets is generating huge underlying malinvestments in the real economy and there is probably no more dramatic case than the oil patch. It is evident right now that oil is not capable of sustaining at $100 or $110 a barrel as the world economy cools down from this enormous central bank boom that we’ve had for the last almost two decades. And therefore, there isn’t enough demand to support the price at $100-plus a barrel.
On the other hand, the desperate scramble for yield that was generated by financial repression by the Fed and other central banks drove tens of billions, hundreds of billions, worth of capital into very high-risk investments such as junk bond funding of the investments in the shale patch. Now, if you look at it objectively, there is probably no price in the last eight or nine years that’s been more volatile than the oil price. You know, it went from 80 to 150 back to 30 up to 115 and now back to in the 40s. At some point, a relatively short period of time here. In that kind of commodity market, pouring fixed yield debt down the well bore for high-cost shale just was the height of irrationality. And yet, that is what occurred.
And now we’re on the back side of that, and that is that all of the malinvestment is going to come undone and there is going to be – there has already been – a massive adjustment even within a few months after the price adjustment took hold. Oil rates, you know, the number already is down from the peak of 1,600 in October to under 1,200 now and is heading down to 80 or 90 a week. And that ricochets through the whole system in terms of local economic activity and jobs and multiplier effects and so forth.
There was a story two days ago about the building boom in Houston—18% of all the commercial square footage under construction in the United States today is in Houston – 80 different high-rise office buildings. And there is going to be a huge collapse of demand as a result of this dramatic adjustment that’s occurring.
Well, the point is all that adds up to economic waste. You bring people to North Dakota and pretty soon, after a few years of earning $200,000 a year, they’re back in their pickups heading back to where they came from. You create a massive local boom in the Eagleford and then all of a sudden, everything is drying up from restaurants to bars to carwashes and all the rest. You create a massive bubble in Houston as a result of the oil price and the shale boom and all of a sudden, there’s going to be half-completed office buildings everywhere.
The Keynesians don’t even recognize that or accept that because they have no history or balance sheets. That’s all yesterday. Their view is, “What do we do tomorrow?” without recognizing that there has been an enormous dissipation of resources, of misallocation of resources, and very brutal financial losses, particularly in the junk bond market, that resulted from the efforts of central banks to control the modern economy. It’s just plain flat wrong. The policy is destructive, and we somehow need to get back to the point where we let the market price, the financial system, and where we let the economy drive the financial markets in terms of capital that’s needed and profits that are produced and valuations that are honestly discovered in markets that are not manipulated and pegged by the central banks.
Chris Martenson: You brought up so many great points in there. And one thing that stuck out for me was this idea that we’re under a couple of decades of Fed intervention. You know, once upon a time, the Fed was not that interventionist. And under Greenspan, that really started to shift.
So the way I look at this, David, is we had a little corporate bond hiccup in ’94. It led to this really bizarre thing known as the Sweeps Program where banks were allowed to effectively sweep demand moneys out of various accounts simply for the optics of being able to say, “Hey, we don’t have to hold anything in reserve. Now we can really jack the lending up.” That gave us a stock boom, which then you know, crashed and required the Fed to come in and ride interest rates down to 1%, which gave us a housing boon, which was even more destructive than the stock boom before. And in response to that, they’ve taken us to 0%.
And so my perception is that the Fed is compounding little errors and making them larger over time. And I feel like we’re at a place now where they’ve got themselves really boxed in a corner where there’s only two ways out of this. One is glorious growth forever, _____ [00:22:20] on, and nothing goes wrong. And the other’s a pretty bad accident. How do you see it?
David Stockman: Well, I take the second view and I think it’s not only the Fed and the US economy but it’s global. I think the central bank-driven global boom of the last two decades is over. Perhaps it started in 1994 when the Greenspan Fed lost its nerve in the face of that little bond market hiccup and over on the other side of the Pacific, Mr. Deng said, you know, “To be rich is glorious,” and the great China construction and debt boom got underway.
We are now through that, we’re done with that. We’re in the crackup phase. And I think there are four big characteristics of that, which are going to basically shape the way the economy and the markets unfold as we go forward. I think you’re going to see increasing desperation and extreme central bank financial repression because they have gotten themselves painted so deep into the corner that they are lost, they are desperate. And so one, you know, almost week by week, we have another central bank – this week, it was Sweden – lowering their money market rates into negative territory. You know, obviously, the Swiss Bank is already there, Denmark Bank is there, the EC is there on the deposit rate, the Bank of Japan’s there. All of the central banks of the world now are desperately driving interest rates into negative territory. And I believe that they’re lost. They are in a race to the bottom whether they acknowledge it or not. You know, the central bank of China can’t sit still much longer when the RMB has appreciated something like 30% against the Japanese yet because of the massive bubble – or monetary expansion – that’s being created there.
So that’s the first thing going on. Central banks out of control in a race to the bottom, sliding by the seat of their pants, making up really incoherent theories as they go. Everybody’s talking about deflation and 2% inflation targets as being some magic elixir. There isn’t a shred of proof anywhere that economies grow better over time at 2% than .8%. It is just made up. So I think that’s the first thing.
The second thing is increasing market disorder and volatility. In the last three months, the stock market has behaved like a drunken sailor but it’s really just a bunch of robots and day traders that are trading chart points until somebody can figure out what is happening directionally in the world. They just keep trading it back to 290, it bounces off, it takes a dive, they trade it back. It has nothing to do with information or incoming data about the real world. We have today the 10-year German bond trading at 29.5 basis points. Well, the German economy’s been reasonably strong, fueling the Chinese boom. That export boom is over. The Chinese economy is faltering. Germany is going to have its own problems. But clearly, 29 basis points on a 10-year is irrational, even in the case of Germany, to say nothing of the 160 available today on the 10-year for Spain and Italy. Both of those countries are in deep, deep fiscal decline. There is no obvious way for them to dig out of the debt trap that they’re in. It’s going to get worse over time. There’s huge risk in those bonds, especially because there’s no guarantee that the EU will remain intact or the euro will survive. Why in the world would anybody in their right mind be owning Italian debt at 160 other than the fact that they’re front running the massive purchases that Draghi has promised and now the Germans have acquiesced to over the next year or two.
But that only kicks the can down the road. One of these days, the central banks are going to falter and the market is going to reset violently to prices that reflect the true risk on all this sovereign debt and the pretty cloudy outlook that’s ahead for the world market.
We now have something like four trillion worth of sovereign debt spread over Japanese issues, the major European countries that are trading at negative yields. Obviously, that is one, irrational, and second, completely unsustainable. And yet, it’s another characteristic of what I call these disorderly markets.
Mal-investment is now coming home to roost. It will be driving a huge deflation of commodity and industrial prices worldwide. You can see that in iron ore, now barely holding $60 from a peak of $200. Obviously, it’s the whole oil patch that we talked about. Look at the Baltic Dry Index. That is a measure, one, of faltering demand for shipments and two, massive overbuilding of bulk carrier capacity as a result of this central bank driven boom that we’ve had in the last 10 to 20 years.
So that is going to be ripping through the financial system, the global economy, in ways that we’ve never before experienced. And so therefore, in ways that are hard to predict what all the ramifications and cascading effects will be. But clearly, it’s something that we haven’t seen in modern times or ever before—the degree of over investment, excess capacity, and everything from iron ore mines to dry bulk carriers, aluminum plants, steel mills, and on down the line.
And then, finally, clearly, demand has run smack up against peak debt, and I think that’s the right word for it. We had a tremendous study come out in the last week or so from McKinsey, who do a pretty good job of trying to calculate and track and tote up the amount of credit outstanding, public and private, in the world. We’re now at the 200 trillion threshold. That’s up from only about 140 trillion at the time of the crisis. So we’ve had a 60 trillion expansion worldwide of debt just since 2008. During that same period, though, the GDP of the world saw a little more than 15 trillion from 55 or mid-50s, roughly, to 70 trillion.
So we’ve generated, because of central bank money printing and all of this unprecedented monetary stimulus, we’ve generated something like 60 trillion of new debt in the world and have barely gotten 15, 17 billion of new GDP for all of that effort. And I think that is a measure of why the fundamental era is changing. That the boom is over and the crackup is under way when you see that kind of minimal yield from the vast amount of new debt that has been generated.
Now I’d only wrap this up by calling attention to the fact that within that global total of 200 billion, the numbers from China are even more startling. At the time of the crisis, let’s go back to 2000, China had two trillion of credit outstanding. It’s now 28 trillion. So we’ve had just massive 14X growth in 14 years. There’s nothing like that in recorded history nor is there any plausible reason to believe that an economy, which is basically under a command and control system that is run from the top down through the party cadres, could possibly create 26 trillion in new debt in that period of time without massive inefficiencies in waste and mistakes everywhere within the system, especially since they have no markets. They have no feedback mechanisms. It all comes cascading down from the top and everybody lies to the next party above them. And I think the system is irrationally out of control.
In any event, my point was that at the time of the 2008 crisis, China had allegedly – if you believe their numbers, which no one really should – but as reported, they had five trillion worth of GDP, it’s now ten. So they’ve gained five of GDP. Their debt at the time of the crisis was seven trillion, now it’s 28. So the debt is up more than 20 trillion and the GDP is up five. These are extreme, unsustainable deformations, if I can use that word, that just scream out, “Danger ahead. Mayhem has happened.” And the unwinding of this and the resolution of this is not going to be pretty.
Chris Martenson: Now, that’s a fantastic list. You’ve given us a number of characteristics of this crackup phase. We’ve got this increasing desperation by the central bank because obviously, they’ve painted themselves in a pretty big corner. Can’t possibly normalize interest rates now without creating just absolute world class mayhem. Increasing market disorder and volatility because we’ve got all this malinvestment and we’ve got a lot of speculators and hot money and everything’s mispriced so who knows what anything is.
And then, this idea of peak debt – a couple hundred trillion of debt outstanding – those are our hallmarks. When this deformation comes up against reality and goes through its unwinding phase, paint that for me. What does that look like? Do markets just go haywire? Do we have flash crashes?
David Stockman: Yeah. You know, it’s a great question. And first of all, everybody ought to be reasonably humble about their predictions and forecasts because we have never been remotely in a world characterized by the things we’ve discussed so far – 200 trillion worth of debt, nearly a 3X debt to income ratio worldwide. The creation of new debt at a rate four, or even more – four times or even more the amount of new GDP that’s being generated. Central bank financial repression at the zero bound that wasn’t even imaginable. And I just don’t think you can stress that enough. Wind back ten years: Who would’ve predicted that any known events in the world would’ve been sufficient to drive the central banks to peg the money market, the short-term rate, at zero for 73 months running and actually, 80 months once they get to July if they manage to raise it then?
So these fundamental characteristics and distortions are so novel and unique that it’s really difficult for anyone to predict how it will unwind. But I think it’s more like a coiled spring. And when finally the pressure is released, you know, there’s going to be a lot of flying parts and pieces everywhere. And it’ll amount to the great reset in financial markets. Everything is dramatically overvalued – bonds, stocks, until recently, commodities. They’re already going into their reset. And I think it’s just the first of many waves of repricing. And that means that you have multi-trillion bond bubbles in the world, you have multi-trillion stock market bubbles in the world. And they’re going to resolve themselves pretty violently once confidence is lost.
Ultimately, this is a con game going on in the world that the central banks have gotten away with for a long period of time. But it doesn’t mean you can do it permanently. Sooner or later, the weight of disbelief becomes too substantial, too great for even the central banks to manage their way through. And we get a break, as they used to call it in old-fashioned times, a financial break. And once the financial break starts, we’ve seen a living demonstration of it in oil – 110 in June, you know, hitting around mid-40s and maybe another big leg to drop very easily in the months ahead. There wasn’t one, you know, out of 100 so-called oil analysts that saw anything remotely like this coming. And yet, the facts on the ground were all materializing, all emerging, all discoverable in June and yet, no one saw it coming.
So maybe we take kind of the oil model and suggest it’s going to be replicated many times over in other financial markets of the world as the central bank prop in this whole bubble finally loses its traction.
Chris Martenson: David, so many excellent points in there. I really want to focus on this idea of confidence. The central banks have really been given a big vote of confidence, they’ve been given a lot of leeway. They’re acting in cahoots with each other. They’ve been doing a lot. I’m reminded now of a George Orwell quote, which is, “In a time of universal deceit, telling the truth is a revolutionary act.” How revolutionary was the Finance Minister of Greece’s pronunciations to the world? I watched the EU bureaucrats just absolutely go into a panic tizzy over the things he was saying. How revolutionary is that?
David Stockman: Well, you know, I think it was a pretty dramatic inflection point. I think of all the points he’s made – and some of them, obviously, are for home consumption politically. But the fundamental point is that we have – the Greek nation – 350 billion dollars’ worth of debt. We didn’t ask to sustain that. It was forced on us by the EU bureaucracy and mechanism that essentially bailed out the banks of Germany and France and Italy and elsewhere, and converted what was de facto, defaulted debt issued by the Greek governments prior to 2010 into permanent obligations guaranteed by the taxpayers of Europe. And that was a fundamental mistake. It was symptomatic of this whole “kick the can” model that has ruled the world for many years now. And I think what’s happening at the moment, which is getting more tense by the hour, is the Greeks have finally said, “No, we’re not going to run our economy and our policy as based on the mandate that we have gotten from the people in order to shield the taxpayers of Germany and Italy and France from the imprudent obligations that they took on, unbeknownst really, to the public on the street in Europe.” But the obligations they took on because Brussels and Frankfurt were unwilling to allow defaults to occur, losses in the banking system to happen, and the market process in finance to work its will.
And now, we’re at the point where the political contagion is breaking out because if they dare let Greece off the hook, how soon will there be an upheaval in Spain in the new government? How soon will there be an upheaval in Italy in the new government? I think you’re really at the explosive inflection point here. They may come up with some words to tide this over for another few months while they negotiate. But you’re at a point where Greece owes 350 billion, has got a GDP of 280 billion at best. Most of what they owe is to the machinery of the IMF, the EU, the ECB. It’s all been moved into the sphere of politics and I think politics is a much more explosive and unpredictable process than the markets recognize at the moment.
In fact, I think the markets have their head in the sand. They are sheep being led to the slaughter. Of course, the fast money thinks they’ll get the word before anybody else. But the kind of rally that occurred in the last couple days in the euro and the yields on the EU members that are next in line are really supremely irrational. You know, rational investors would be selling their way out of the Italian bond as quick as they could get out, or the French bonds, for that matter. Sixty basis points for the 10-year debt of France, that is a stunningly stupid condition. Yet, I think it’s symptomatic of the way the markets are sleepwalking in the face of what looks to be like the beginning of a total breakdown of politics within the EU.
Chris Martenson: Now, what I loved about what the Greek Finance Minister said, which I thought was a little too truthy for the markets, was he just said flat out, “My country’s broke.” And that’s true. And I think that it’s a short hop, skip, and a jump from there to say, well, if Greece is broke and they’re going to admit it and that’s going to have repercussions, then what do we say about Italy or Spain or Portugal or Ireland or Japan or the United States, if you run the clock out long enough?
What’s interesting to me here is, you know, you talk about Greece and I had always thought of it in my head, it’s an economy, it’s a country, it’s a nation state. But I’m looking at a chart here that shows various things that have larger economies, GDPs, than Greece. And right next on the list with a larger economy than Greece is Boston.
David Stockman: Yeah, right [laughter].
Chris Martenson: So when we say they have 380 billion of debt, imagine Boston trying to figure out how to pay 380 billion of debt. But honestly, Boston has a more vibrant economy than Greece currently.
David Stockman: Yeah. You know, I think that the problem is Greece is the inflection point. It’s not just the 350 billion that they can’t service. The fact is they were bankrupt in 2010, he was right. They should’ve proceeded to write-offs and ejection, if it needed to be, from the euro and the EU at the time. But they haven’t and that policy has become the universal policy of central banks in cahoots with governments all around the world. I mean, look at Japan. Their population is getting older by the day. Their economy, notwithstanding all of this massive stimulus from Abenomics, is not expanding. Their total debt is something like 500% of GDP, public and private. Their public debt is 2.5 times GDP, off the charts. This is an equation that can’t be sustained. It is an explosive equation.
So Greece may be the size of Boston but it symbolizes a planet-wide policy and condition and deception about the true state of economic and financial reality.
Chris Martenson: I thought that the chief lesson coming out of this, and seeing the panic that’s ensued, is that you’re not supposed to say the obvious. And that’s really the biggest deformation is that speaking the truth seems to have really slipped in the past number of years and decades. And we’re at the point now where we do have to deal with some real solid structural issues. If something can’t be paid back, it won’t.
And so right now, I look at what’s happening in the EU vis a vis Greece, but soon to be coming to a theater closer to you, is really, they’re just trying to solve this one question. And the question is: Who is going to eat the losses? There’s just losses to be had. I guess we’re now to the point of arguing over who’s going to take them. The standard IMF position, which they are – poor Ukraine. I mean, they had a great deal with Russia in December of 2013. They reneged on that, 20 billion with no strings attached relative to the IMF, which gave them 17.5, very string-laden attachments, and they’ll never dig out from under them is the lesson from that.
And so as I look at it, it’s really the banker, political class on side saying “We don’t want to eat the losses. We think the people should.” Greece is the first nation state I know of, after Iceland, to stand up and say, “That’s not how this is going to work out.”
David Stockman: Yeah, yeah, it’ll be very interesting to watch over the next couple weeks how this plays out. I still think there is some possibility that they’ll find a way to kick a rusty can down the road for a few months. You know, the Germans are saying they must complete the program. Well, what does “complete” mean and what does “program” mean? The new Greek government says it has a mandate not to extend the program. Well, what does “extend” really mean? And can people find ways to split hairs and twist words so that the differences – the vast black and white difference between the north and south of Europe can be accommodated.
I think maybe words can extend the situation for a few months. But it’s pretty clear now that Europe is running into a very difficult place and that this isn’t going to last much longer. The EU and the German differences over monetary policy, the unrest that’s in the electorates of all the major European countries that are heading for elections. All of this creates pressures and tensions and fractures that I do not think are containable and manageable much longer, even if suddenly next week, you get an announcement that they’re going to get by for another 30 days. I don’t think you can run the world 30 days at a time with this much built up pressure and tension.
And so therefore, you know, at the end of the day, we are more exposed to unexpected dislocations to the so-called black swan events than ever before. And when you have a system that has never been this unstable and fragile, in which the environment is rich with opportunities for surprise and dislocation, I think it is a very dangerous time.
Chris Martenson: I couldn’t agree more. And since we can’t predict what’s going to happen, I’m constantly advising people that they should be prepared for almost anything. So true diversification is really important these days.
As a final comment from you, I am wondering—I am watching this Greece thing as a petri dish to figure out how this all might play out. This leftist party gets put in place and they’ve been given a mandate, they feel, and so they’re going to go forward. The EU’s in a tough position here because I don’t think they can “let” Greece get away with this so they’re going to have to be tough. But if they’re too tough and they kind of crush these guys, you know who’s waiting in the wings is the party Golden Dawn, which is the ultra right wing fascist group that’s in Greece. And there’s a sort of rise of those sentiments I’m detecting all across Europe. And I think that’s just what happens when you – you know, we saw this in World War I and then especially before World War II. That strict austerity and things like the Versailles Treaty and all of that just have a way of creating pressures that create either space for, or new recruitment for, fairly extreme groups to arise. Do you see that as a danger?
David Stockman: Yes, I think that—I agree with that completely and I think it’s really the biggest danger at the end of the day. It’s not exactly about numbers and leverage ratios and bailout programs and whether the GDP or the primary surplus in Greece is 4% or 2%. I think what they’ve set in motion by inappropriately bailing out the banks and creating all of this sovereign obligation is radical political upheaval and discontinuities in Europe. It’s very possible that in France, at the next election, you’re going to get the Nationalist party in power, which is anti-EU. In Spain, the Podemos party came out of nowhere and now is running like 30% in the polls, way ahead of the incumbent government party. None of this was visible back in 2010, ’11, ’12, when they were fashioning all of these mechanisms, or even when Draghi was promising he would do whatever it takes.
So we’re in a new phase of this, and that may be the political blowback of what was an unsustainable and profoundly stupid policy at the beginning. You know, it’s a warning that you have to face down the problem of massive excess debt in the world and allow some liquidation to occur, allow some losses and write downs to happen, clear the decks. Because if you don’t, you’re simply buying a little time and sowing the seeds of much greater and more unpredictable and uncontrollable reactions and blowback down the road.
That’s the real lesson in Greece. I mean, this is a ragtag party of Trotskyites and populists and leftists and hippies, for that matter. And who would’ve predicted that they would come to power in this dramatic way? Well, you wouldn’t have predicted that but it is the consequence of the dictation that came out of Brussels when it should’ve faced the problem from the very beginning in a forthright way.
Chris Martenson: And boy, isn’t that just a metaphor for what’s happening all over the world – Japan, US, you name it. We’ve been talking with David Stockman. His website is DavidStockmansContraCorner.com. It’s an excellent website. I visit it daily. David, you’ve been very generous with your time today. Thank you so much.
David Stockman: Very happy to have the discussion.