• Blog

    2017 Year In Review

    Markets fiddle while Rome burns
    by David Collum

    Friday, December 22, 2017, 8:15 PM

Every year, friend-of-the-site David Collum writes a detailed "Year in Review" synopsis full of keen perspective and plenty of wit. This year's is no exception. As with past years, he has graciously selected PeakProsperity.com as the site where it will be published in full. It's quite longer than our usual posts, but worth the time to read in full. A downloadable pdf of the full article is available here, for those who prefer to do their power-reading offline. — cheers, Adam


“He is funnier than you are.”

~David Einhorn, Greenlight Capital, on Dave Barry’s Year in Review

Every December, I write a survey trying to capture the year’s prevailing themes. I appear to have stiff competition—the likes of Dave Barry on one extreme1 and on the other, Pornhub’s marvelous annual climax that probes deeply personal preferences in the world’s favorite pastime.2 (I know when I’m licked.) My efforts began as a few paragraphs discussing the markets on Doug Noland’s bear chat board and monotonically expanded to a tome covering the orb we call Earth. It posts at Peak Prosperity, reposts at ZeroHedge, and then fans out from there. Bearishness and right-leaning libertarianism shine through as I spelunk the Internet for human folly to couch in snarky prose while trying to avoid the “expensive laugh” (too much setup).3 I rely on quotes to let others do the intellectual heavy lifting.

“Consider adding more of your own thinking and judgment to the mix . . . most folks are familiar with general facts but are unable to process them into a coherent and actionable framework.”

~Tony Deden, founder of Edelweiss Holdings, on his second read through my 2016 Year in Review

“Just the facts, ma’am.”

~Joe Friday

By October, I have usually accrued 500 single-spaced pages of notes, quotes, and anecdotes. Fresh ideas occasionally emerge, but most of my distillation is an intellectual recycling program relying heavily on fair use laws.4 I often suffer from pareidolia—random images or sounds perceived as significant. Regarding the extent that self-serving men and women of wealth do sneaky crap, I am an out-of-the-closet conspiracy theorist. If you think conspiracies do not exist, then you are a card-carrying idiot. Currently, locating the increasingly fuzzy fact–fiction interfaces is nearly impossible thanks to the post-election bewitching of 50 percent of the populace.

“The best ideas come as jokes. Make your thinking as funny as possible.”

~David Ogilvy, marketing expert

You might be asking, “What’s with the title, Dave? My 401K is doing great, and I own a few Bitcoin!” Yes, indeed: your 401K fiddled its way to new highs day after day, but this too shall pass—it always does—and not without some turbulence. This year was indeed a tough one to survey. As many peer through beer goggles at intoxicatingly rising markets, I kept seeing dead people (Figure 1).

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping: I admit to not understanding it.”

~Richard Thaler, winner of the 2017 Nobel Prize in Economics

Figure 1. An original by CNBC's Jeff Macke, chartist and artist extraordinaire.

A poem for Dave's Year In Review

The bubble in everything grew

This nut from Cornell

Say's we're heading for hell

As I look at the data…#MeToo

[email protected]

Some will notice that in decidedly political sections, the term “progressives” is used pejoratively. Their behavior has become nearly incomprehensible to me. My almost complete neglect of the right wing loonies may reflect some bias, but politically, they have taken a knee. They have become irrelevant. Free speech is a recurring theme, introducing interesting paradoxes for employee–employer relationships.

Some say I have no filter. They obviously have no clue what I want to say. In case my hints are too subtle, I offer the following:


I sit in front of a computer 16 hours a day, at least three of which are dedicated to non-chemistry pursuits. I’m a huge fan of Adam Taggart and Chris Martenson (Peak Prosperity), Tony Greer (TG Macro), Doug Noland (Credit Bubble Bulletin), Grant Williams (Real Vision and TTMYGH), Raoul Pal (Real Vision), Bill Fleckenstein (Fleckenstein Capital), James Grant (Grant’s Interest Rate Observer), and Campus Reform—but there are so many more. ZeroHedge is by far my preferred consolidator of news. Twitter is a window to the world if managed correctly. Good luck with that. And don’t forget it’s public! Everything needs an open mind, discerning eye, and a coarse-frit filter.

“You are given a ticket to the freak show. When you’re born in America, you are given a front row seat, and some of us get to sit there with notebooks.”

~George Carlin, comedian


Footnotes appear as superscripts with hyperlinks in the “Links” section. The whole beast can be downloaded as a single PDF xxhere or viewed in parts—the sections are reasonably self-contained—via the linked contents as follows:

Part 1

Part 2

My Personal Year in Review

Who cares what an academic organic chemist thinks? I’m still groping for that narrative. In the meantime, let me offer a few personal milestones that serve as a résumé while feeding my inner narcissist. I remain linked into the podcast circuit, having had chats with Max Keiser and Stacy Herbert (Russia Today aka RT),5 Chris Martenson,6 Jim Kunstler (The KunstlerCast),7 Lior Gantz (Wealth Research Group),8 Anthony Crudele (Futures Radio Show),9 Susan Lustick (News-Talk 870 WHCU),10 Jason Burack (Wall St. for Main St.),11 Dale Pinkert (FXStreet),12 Lance Roberts (Lance Roberts Show),13 and Jason Hartman (Hartman Media Company).14 I also spoke at Lance Roberts’s Economic and Investment Summit discussing campus politics15 and the Stansberry Conference (Figure 2) arguing the merits of price gouging.16 I got into a big spat with the American Federation of Teachers and some local social justice warriors that made it to the national press (see “Unions”) and dropped 30 pounds unaided by disease.

“And, before anyone should doubt what a chemistry professor would know about unions and what effect they would have, it should be noted that Collum has amassed a following for his annual 100-page papers on the state of business and politics. Turns out, he knows a thing or two about economics and politics as well.”

~Joe Cunningham, RedState

Figure 2. The lovely Grant Williams, brainy Danielle DiMartino Booth, and one of the Paddock brothers in Las Vegas.

On the professional side, I had a great year: I finished my stint as department chair; started a sabbatical leave; broke my single-year total publication record; and broke my single-year record for papers in the elite Journal of the American Chemical Society. I attempted to extend a contiguous string of 20 federal grants without a rejection by submitting two NIH grants and subsequently got totally blown out of the water. (OK. I’m still walking that one off. I think the panel finally noticed that I am deranged.) I was accepted into an organization called the Heterodoxy Academy, whose membership includes hundreds of tenured professors standing up for free speech on college campuses.17

“My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself.”

~Jason Zweig, Wall Street Journal columnist


“I dig your indefatigable bearishness, my friend.”

~Paul Kedrosky, one of the earliest bloggers

I’m sensing a tinge of Paul's sarcasm. My net worth from January 1, 2000, has compounded at a ballpark annualized rate of 7 percent. That’s not so bad, but the path has been rather screwy. From mid ’99 through early ’03, I carried cash, gold, silver, and a small short position. I kept buying gold through about 2005 (up to $700 an ounce), resumed in 2015, and bought several multiples of my annual salary’s worth in 2016. I’m done now. Gold is up 8 percent, and silver is down –2 percent in 2017 thanks to a minor end-of-year sell off. The spanking from ’11 to ’15 seems to have subsided.

Precious metals, etc.: 29%

Energy: 0%

Cash equivalent (short term): 62%

Standard equities: 9%

“Most people invest and then sit around worrying what the next blowup will be. I do the opposite. I wait for the blowup, then invest.”

~Richard Rainwater

I was totally blindsided by the downturn in gold starting in ’11 and energy in ’13. (Energy peaked in ’08 but was on the mend until ’13.) I bought energy steadily starting in ’01 with broadly based energy funds and a special emphasis on natural gas. The timing of entry was impeccable and all was going swimmingly—I was a genius!—until the Saudi oil minister attempted to talk oil down from $110 to $80 per barrel18 in '13. He thought he could blow the frackers out of the game fast, but it was a hold-my-beer moment for our credit system. The frackers kept fracking, the oil price overshot the Sheik's target by $50 per barrel, and I got whacked for 30–45% losses over four years starting in '14.19

It is impossible to know when you’re being a highly disciplined buy-and-hold investor—a Microsoft and Apple gazillionaire refusing to sell—or just an idiot. I sensed that the rotten debt had been purged and we were through the worst of the energy downturn. I worried that a recession could do a number on me, but it took years to get to my position through incremental buying. I’m holding on, goddammit! We seem to be running out of downside. Unbeknownst to me until October, however, my employer had liquidated my energy funds—every last one of them—and put me in a life-cycle fund in April. Sell ’em after they plummet? Thanks guys. A rational investor, if committed to hold them, would undo the general equity fund restrictions—I did—and buy the energy funds right back—I didn’t. Friends in high places all said to wait. About a week later, the Middle East erupted in what looked like a sand-to-glass phase transition (see “Middle East”), and energy started to move in sympathy. Peachy.

Fidelity actually saved me a little money, but I am still white-knuckling the cash, growing a long wishlist, waiting for a generalized sell-off/recession to offer some serious sub-historical-mean bargains (see “Broken Markets”). The correction in ’09 at the very bottom brought us to the historical mean, but not through it. For this reason, I have largely skipped this equity cycle. The current expansion is long in the tooth and founded on poor fundamentals. I hope that the wait won’t be too long. Until then . . .

“Remember, when Mr. Market shows up at your door, you don’t have to answer.”

~Meb Faber, co-founder and CIO of Cambria Investment Management


“A decade after the biggest crisis since the Depression, a broad synchronized recovery is under way.”

~The Economist, March 2016

Whoa! Fantastic! Goldilocks survived another bear. There is just one hitch: that was a total load of crap in 2016, and it’s a colossal load now. Let’s take a peek at a few gray rhinos—“large and visible problems in the economy that are ignored until they start moving fast.” GDP growth rates from 1930–39 and 2007–16 were as follows:20

GDP growth in the 1930’s

1930: –8.5%     1935: 8.9%
1931: –6.4%     1936: 12.9%
1932: –12.9%   1937: 5.1%
1933: –1.3%     1938: –3.3%
1934: 10.8%     1939: 8.0%

GDP growth in the new millennium

2007: 1.8%       2012: 2.2%
2008: –0.3%     2013: 1.7%
2009: –2.8%     2014: 2.4%
2010: 2.5%       2015: 2.6%
2011: 1.6%       2016: 1.6%

Whether you use the arithmetic or geometric mean, both gave us 1.3 percent annualized growth. Let’s spell this out: during the recent era in which markets soared, the economy tracked the Great Depression. It is instructive to look at the economy with a little more granularity than the writers at The Economist-Lite.

According to John Mauldin, total domestic corporate profits have grown at an annualized rate of just 0.1 percent over the last five years.21,22 Goldman’s Abby Joseph Cohen says R&D spending is down to 2.5 percent of GDP from 4.5 percent and is a drag on the economy.23 Economic bellwether General Electric saw revenue drop 12 percent and earnings fall 50 percent year-over-year,24 and these numbers are aided by the company’s legendary creative accounting schemes.25 Meanwhile, corporate America witnessed a 71 percent rise in business debt since 2008. According to economist Lacy Hunt, “It’s the investment, the real investment, which grows the economy,” prompting the legendary market maven @RudyHavenstein to state dryly, “I like Hunt.” Where are they spending all that borrowed money? Hold that thought. Long-term demographic problems—“quantitative aging” (Figure 3)—exacerbated by dropping sperm counts26 suggests the economy will continue to shoot blanks.

Figure 3. Demographics looking sketchy.

Putative job gains affiliated with this low growth are fragile if not dubious as hell and are being boosted by the “Dusenberry effect”—consumers’ reluctance to stop spending even after their income drops—which will cause the next recession to be a real Dusey. (Sorry.) Eventually, common sense prevails as companies run out of credit and savings-deficient consumers reassume the fetal position. According to extensive work by Ned Davis Research, cash levels among households are near their lowest levels of all time; consumer resiliency is always temporary.

“When it is all said and done, there are approximately 94 million full-time workers in private industry paying taxes to support 102 million non-workers and 21 million government workers. In what world does this represent a strong job market?”

~Jim Quinn, The Burning Platform blog

The Bureau of Labor Statistics has turned to Common Core math. How can we have 100 million working-age adults—40 percent of the working-age population—not working, 4 percent unemployment, and employers claiming the labor market is tight? Are 90 percent of those without jobs professional couch potatoes? Let’s first look at employment in some detail and then address that whole “tight” part. Googles of pixels have been dedicated to the obligatory labor force participation rate (Figure 4), a critical component of any economic debunking. Of those employed, 26 million people are in low-wage, part-time jobs (Figure 5), 8 million hold multiple jobs, and 10 million are “self-employed.”27 Another 21 million work for the government, which means they are a tax on the free market. In 2016, 40 percent of new jobs were fabricated through the specious “birth and death model.”28 2017 will presumably post similar numbers. Occasional reports of large job growth are deceptive. July, for example, witnessed 393,000 benefit-free, part-time, low-skill jobs offset by a drop of 54,000 full-time workers. Payroll numbers keep coming in lower than expected, which economists invariably blame on some big, yet unseen effect they are paid to notice. Nine out of 10 millennials living on their parents’ couches a year ago are still clutching TV remotes.29 There are now 45–50 million Americans on food stamps, up from 14 million in December 2007,30 when the last recession was already underway.

Figure 4. Labor force participation.

I am going to let Jeff Snyder take a crack at explaining the tight labor market:31

“The economy is tight, not favourably tight as in no slack in the labour market, but more so tight in that there is little margin for addition. . . . The reality in the markets is this: executives are reluctant to pay wages at a market-clearing rate.”

~Jeff Snyder, Alhambra Investments

Figure 5. Low-paying service jobs versus manufacturing jobs.

Poor economic numbers are pervasive. Auto sales are canaries in the coal mine and getting crushed despite aggressive incentives.32 Ford is already suffering and predicting a multi-year slowdown.33 A car industry crunch analogous to that in ’09 may appear in ’18 as expiring leases leave consumers underwater owing to dropping used car prices, and decreasing profits in the auto industry may “then turn from secular to structural problems.”34 Morgan Stanley predicts a 50 percent drop in used car prices over the next 4–5 years,35 which will gut the new car business. The auto downturn has already begun. Wells Fargo is reporting large drops in auto loans after a long stretch during which subprime car loans flourished yet again.36 That should put a fork in the new car market.

Yield-starved investors are chasing cash- and income-starved car buyers. Subprime auto-asset-backed securities will take yet another beating. Chrysler is teaming up with Santander Consumer USA to push out “unverified income” subprime auto loans using “automated decision making.” Santander seems to have nine lives, and they’ll need all of them. The hyperdeveloped loan market for used cars, however, is already faltering (Figure 6); delinquency rates are rising. Goldman expects “challenging consumer affordability” and has downgraded General Motors to “sell.”37 Those cars y’all bought on cheap credit yesterday will not be bought tomorrow. Claims that the hurricanes cleared out auto inventory38 are grotesquely underestimating the magnitude of the overhang and will be paid for by reduced consumption in other sectors. Any consumption pulled forward with debt has a deferred cost.

Figure 6. Some key auto industry stats (a) loans and leases, (b) loan delinquencies.

We’ll take a crack at the housing market in its own section and simply note here that the cost of renting or buying normalized to income has never been higher. Approximately half of tenants spend more than 30 percent of their income on rent, doubling from a decade ago.39 A survey of 20 cities showed that housing costs are growing at a 6 percent annualized pace. Our paychecks are not. Housing is a bubblette and likely to offer fire-sale bargains again. What many fail to grasp is that the reduced cost of borrowing owing to low rates is offset by higher prices. When interest rates were 15 percent, houses were cheap.

Austrian business cycle theory says easy money policies generate overdevelopment and other malinvestment. The day of reckoning appears to be here. (I say that every year…channeling Gail Dudek.) Familiar brands like Toys “R” Us (my keyboard has no backwards R), JCPenny, Abercrombie & Fitch, Sears, Bon-Ton, and Nordstrom are gasping their last gasps before drowning in debt with no customers to save them. Total retail revenues and sales (including online) are up only 28 percent from the 2007 high.40 The management of Ascena Retail referred to an “unprecedented secular change.”41 More than 100,000 retail jobs have vaporized since October 2016.42 Credit Suisse estimates that more than 8,000 retail outlets closed this year.43 Consumer goods companies have held up better because consumers generally put off starving or freezing to death until all options are exhausted. Restaurants are extending the longest stretch of year-over-year declines for 16 consecutive months (last I looked).44 Business Insider blames millennials because they are “more attracted than their elders to cooking at home” (particularly when it’s their parents’ home.) Manhattan retail bankruptcies are called “horrifying.”45

Chapter 11s and company reorganizations in foreign courts increased sevenfold.46 Mall owners are using jingle mail—a term from the ’08–’09 crisis referring to leaving keys to creditors. Commercial retail will be coming into its own refinancing wave in 2018. Bears are sniffing around commercial-mortgage-backed securities as malls around the country begin to die.47 The next downturn will finish many of them off. Exchange-traded funds (ETFs) are positioning to short the brick-and-mortar retail. (Quick: somebody grab the ticker symbol “MAUL.”) Some suggest the Rout in Retail is merely a secular shift to online. Sounds logical except online sales represent only 8.5 percent of total retail sales.48 This argument might be masking a huge downturn in retail corresponding to the bursting of yet another Fed-sponsored bubble.

As Amazon encroaches on every nook and cranny of retail sales, what began as a murmur has turned into a chorus: “This isn’t fair; somebody must do something!” Walmart knows this plotline. Market dominance does not connote “monopoly,” but Amazon has an image problem. Amazon gets a $1.46 subsidy (discount) per box from the USPS, well below its cost.49 Seems cheesy. Congress is showing concern out of self-interest. A monopoly is when a company uses its power to blow its competitors out of the water garishly. Who decides what is garish and when enough is enough? A judge under political pressure. A detailed summary of the breadth of Amazon’s market share and its anti-competitive pricing suggests that we are getting close.50 There’s nothing like a protracted anti-trust suit to mute the growth of a large conglomerate. Just ask the Microsoft high command.

If our problems are not Amazon, what are they? Austrian business cycle theory says that our debt-driven, consumer-based economy endorsed by sell-side economists and analysts worldwide is unsustainable. Wealth is made, mined, grown, or coded, only then do you get to consume it. Wealth is extinguished by consumption, depreciation, and destruction. Central bankers seem to believe you can will wealth into existence by generating animal spirits.

The next recession will start unnoticeably. Economists seem to miss every single one, often declaring telltale indicators irrelevant. Then you will hear phrases like “technical recession,” “growth recession,” or “earnings recession,” all eventually giving way to somebody opening the Lost Arc. If the next recession flushes the waste products (malinvestment) left behind by the central-bank-truncated ’08-’09 recession, it will reveal the central bankers to be charlatans. Even a typical recession witnesses near 40 percent losses in equity portfolios, which will leave already immunocompromised consumers vegetative. Banks will constrict lending to preserve capital, further slowing the economy. Weak businesses living off easy credit will become pink mist. An accelerating vicious cycle downward will take with it formerly viable businesses that could have survived a less arrogant monetary policy. This collateral damage was avoidable at least in its magnitude, but it can’t be avoided now. Are we on the cusp of the next recession? Citigroup “clients” say not even close (Figure 7). I think we are staring into the abyss.

Figure 7. June 2017 Citigroup client survey of recession odds.

Will this expansion continue because it has been pathetic or die because it is old? I cast my vote for the latter. The Fed and its central bank brethren, whether to retrieve residual credibility—they have precious little—or out of the deep-seated, albeit misguided belief that they are in charge of the economy, have decided it is time to “normalize rates” and undo quantitative easing. (We are now forced to accept the equally silly term “quantitative tightening.”) You can blame the ensuing problems on the tightening if you wish, but the huge mistakes were made long before this tightening cycle commenced. Every postwar recession until now was been preceded by a tightening cycle (although not all tightening cycles lead to recessions). Why not simply refuse to tighten? It won’t work, but the Fed governors are probably entertaining this possibility.

“The central banks did their job. Unfortunately, almost nobody else has done theirs.”

~Martin Wolf, Financial Times

“As has come to be commonplace, almost everything Mr. Wolf suggests is incorrect.”

~Tim F. Price, Cerberus Capital and author of Investing Through the Looking Glass (see “Books”)

I’ll close this discussion with a brief mention of “creative destruction,” the process by which the new (and improved) ushers out the decrepit and out-of-date. It is a central tenet of capitalism—survival of the fittest—but has a disruptive dark side. McDonald’s (and every other service industry) is turning to kiosks to replace more costly human labor. Driverless cars will be awesome but also force car-based workers—potentially millions of them—to find new work. The financialization of the economy by central bankers has tipped the capital–labor balance profoundly toward capital. We will produce goods better and more efficiently, but the Darwinian adjustments will rock the system. Accelerated product cycles facilitated by excess capital can also be highly inefficient. The Erie Canal was completed in 1825 and faced its own black swan—railroads—that same year. Blockbuster was offed by Netflix as fast as it appeared. Can creative destruction happen too fast? Have product cycles become too short? Bulldoze your house every five years to build a better one and tell me how that works. Loose credit accelerates creative destruction, but not without a price.

“A high initial saving rate has been associated with subsequently stronger economic growth, while a low saving rate produces a lower growth pattern.”

~Lacy Hunt, economist, noting soaring consumer debt

Broken Markets

“I think we have fake markets. . . . Everything is so tight, it is hard to pick a winner from a group that is fake.”

~Bill Gross, Janus

"One word characterizes why the bull market can go on for years…'Goldilocks'"

~Sam Ro, Yahoo Finance

“I’m not worried about the economy so much; what I’m concerned about is valuation.”

~David Swensen, Yale University’s longtime CIO

"I think the bull market could continue forever."

~Jim Paulsen, Wells Fargo

Regression to the mean is a force of nature. It is also a mathematical truism that markets reside below the mean for half of their price-weighted existence. The failure to go through the mean in ’09 is an anomaly caused by global central bankers that remains as an IOU on investors’ balance sheets and foreshadows trouble to come.

Our system is constantly being overtly displaced from equilibrium by central bankers who view displacement as their mandate. Physical scientists know that any system displaced from equilibrium tends to return to equilibrium. The French physicist Carnot, often called the father of modern thermodynamics, showed that the round trip necessarily comes at a cost no matter how efficient the process: it’s a law of physics. Any chemist will tell you that a system massively displaced often returns with a considerable cost: you blow up your laboratory. Geologists? Volcanoes and earthquakes. Ski bums? Avalanches. How far are asset markets from equilibrium? The pros have some opinions:

“Asset valuations historically aren’t way out of line, but elevated I would say, relative to historical averages.”

~Lael Brainard, Federal Reserve governor

“Measured against interest rates, stocks actually are on the cheap side compared to historic valuations.”

~Warren Buffett, Berkshire Hathaway, channeling the Fed model

“Compared to the Dutch Tulip Mania of 1637, stocks still look undervalued.”

~Rudy Havenstein (@RudyHavenstein), Funniest Tweeter of the Millennium

Case closed. Let’s get a six-pack and watch football. The problem is that Brainard is a Fed governor, Havenstein is nuts, and Buffett is known for spewing some serious bullshit. Buffett’s favorite indicator—market cap to GDP—is double the historical mean (vide infra)—what market analyst John Hussman calls “historically offensive valuations.” Buffett also wrote an article in 1999 stating without qualification that returns are not about the economy at all.51 Secular bull markets are powered by falling interest rates and secular bear markets by rising rates. With interest rates at multi-century lows, it seems likely the old codger knows that his implicit reliance on the Fed’s valuation model is lunacy. As an aside, Berkshire has the largest cash hoard in its history—$100 billion—and it’s not being used to buy stocks that are “on the cheap side.”

Others, only partially impeded by cognitive dissonance and the task of selling assets at any cost, seem to have neurons firing spasmotically (sense something):

“We think the market still has the potential to move higher as investors capitulate into equities.”

~Merrill Lynch

“Folks, I have been in this business for over 46 years, and observing markets with my father for 54 years, and I have never experienced anything like what is currently happening. . . . There are years left to run in this one.”

~Jeff Saut, Raymond James

“It seems like uncertainty is the new norm, so you just learn to live with it.”

~Ethan Harris, global economist at Bank of America Merrill Lynch

The fear of missing out (FOMO) is driving the markets way out over their skis. Markets could get much crazier, of course, but as any serious blackjack card counter will tell you, when the deck is stacked against you, size your bets accordingly.

"If you pay well above the historical mean for assets, you will get returns well below the historical mean."

~Paraphrased John Hussman

This Hussman quote is a recycle from last year but well worth repeating to make sure you understand it. He goes on to channel Ben Graham by noting that the devastating losses come from purchasing low-quality securities when times are good. The Hussman quote also pairs well with ideas about valuation I cobbled together from a well-known maxim about savings:

“Overvaluation is appreciation pulled forward.”

“Undervaluation is deferred appreciation.”

~David Collum

This one passed the Google test for originality. I don’t know about you, but I want my appreciation in the future, or as James Grant (channeling Joe Robillard) likes to say, “I want everybody to agree with me . . . only later.” Valuations are meaningless as long as market participants are determined to buy stocks, but that mood will change at some point. Once markets are overvalued, however, you will give back those and any further gains during the next irrepressible regression to the mean, more so as you linger below the mean. I hasten to add that slight overvaluation is not a problem: the regression will be embedded within the noise. If, however, markets are way overvalued, an unknowable but inevitable combination of price drop and time—a retrenchment that could last decades—will usher invested boomers to the Gates of Hell. What do current valuations tell us about future returns assuming the laws of thermodynamics have not been repealed?

Market Valuations

“The median stock in the S&P has never been valued higher than it is today.”

~Jesse Felder, The Felder Report

“There’s just no other way to say it: the market is insanely overvalued right now. It’s the longest recovery in history. It’s also the weakest. But you’d never know it from the stock market.”

~ David Stockman, former Reagan economic advisor and former Blackstone group partner

“We are observing an episode that will make future investors wince. Just like the two closest analogs, the 1929 high and the tech bubble, I expect that future investors will shake their heads in wonder at the stark raving madness of it all, and ask what Wall Street could possibly have been thinking.”

~John Hussman, Hussman Funds

“The gap between the S&P 500 and economic fundamentals can now be measured in light years.”

~Eric Pomboy, president of Meridian Macro Research

"I believe fragilities today are much more systemic on a global basis than back in 2007. Where’s the Bubble? Virtually everywhere… The scope of today’s global Bubble goes so far beyond 2007."

~Doug Noland, McAlvaney Wealth Management

It took a few years to blow up yet another equity bubble—referred to fondly by Jesse Felder and others as the “everything bubble”—but determined central bankers are not in short supply. A host of metrics point to a very mean regression cited below. As I rattle off a few stats, bear in mind the serious yet unknowable losses possible if regression rips through the mean.

“Russell 2000 with a 75 p/e is just astronomical.”

~Jesse Felder

Starting simple: McDonald’s saw zero revenue growth between 2008 and 2016 but had a 154 percent growth in debt. Its share price is up more than 200 percent. This is not an outlier. Additional examples assembled by Mike Lebowitz of 720Global are shown in Figure 8. I know it’s a table, but look at the contrasting revenue growth versus share price gains!

Figure 8. Revenue growth versus price change.

“And please don’t claim corporate profits are soaring, so the valuations are justified. . . . Corporate profits are unchanged since 2014—no growth at all.”

~Charles Hugh Smith, Of Two Minds blog

The S&P 500 resides 70 percent above its ’07 high even though nominal GDP and total sales rose 10 percent during the same period. Price-to-revenue ratios are sharing the nosebleed seats with 1929 and 2000 (Figure 9).52 Buffett’s market cap–to-GDP indicator is no better, prompting Felder to guesstimate prospective 10-year returns—returns going to somebody else, apparently—at -2.6% annualized.53 In case you suck at math, you will be 10 years older, 33 percent poorer, and in need of a 50 percent gain to stumble your way back to even. Ever the optimist, John Hussman and his relatively complex valuation model, which shows high correlations when back-tested, predicts 60–70 percent losses over the next 10 years.54 To help the value-driven bottom-feeders, Hussman broke down the markets by valuation “deciles” and found that even the deep-value guys are looking at a >50 percent haircut—“haircut” sounds better than “castration” or “blood eagle”—at the end of the current market cycle.55

“Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value. . . . What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss? . . . After years of running into the wind, we are left with no sense stronger than, ‘it will turn when it turns.’ . . . Just because AMZN can disrupt somebody else’s profit stream, it doesn’t mean that AMZN earns that profit stream. For the moment, the market doesn’t agree. Perhaps, simply being disruptive is enough.”

~David Einhorn with tongue in cheek

The legendary Howard Marks, using non-GAAP earnings (with a 25 percent fictional fudge factor)56 to calculate trailing P/E ratios, sees a 40 percent regression to the mean. The Case-Shiller weighted P/E ratio—far superior to the non-GAAP alternatives—is in the top 3 percent of historical readings,57 prompting Bob Shiller to dryly note that the markets are “at unusual highs.” (By the way, it was Shiller who slipped Greenspan the phrase “irrational exuberance.”) Dividend yields have flopped around over the centuries. A 56 percent equity decline is required to attain the 150-year historical average of 4.4 percent—assuming reduced cash flows owing to the price collapse don’t lead to dividend cuts.58 Tobin’s Q—essentially price-to-book value ratio and the favorite of Mark Spitznagle—is at all-time highs. The Economist sounds dismissive by suggesting that “a high Tobin’s Q signals that an industry is earning a lot from its assets,"59 which suggests that The Economist is underutilizing its intellectual assets.

Figure 9. Valuation metrics from Grant Williams’s World of Pure Imagination.60

Consistency aside, how can these predictions possibly be correct? The reported P/Es are not that bad. The high-growth QQQ index, for instance, is sporting a P/E of only 22, and the Russell 2000—the small-cap engine of economic growth—is in the same neighborhood. Alas, Steve Bregman of Horizon Kinetics notes that the P/E of the QQQ is calculated by rounding all P/Es above 40 down to 40 and assigning a P/E of 40 to all negative P/Es—companies losing money, aka Money Pits.61 For some of the largest companies in the QQQ—think Amazon—with almost no GAAP earnings, these little fudge factors are not just rounding errors. In the scientific community, we call such adjustments “fraud.” Bregman pools the market caps and earnings to give a more honest analysis, which gently nudges the QQQ P/E to 87. In short, Wall Street is “making shit up.” Mark Hulbert, noting that more than 30 percent of the Russell 2000 companies are losing money, concurs with Bregman and suggests that the rascals at the parent company would get a P/E of 80 if they weren’t fibbing like teenagers.62

Market Sentiment

Which FANG Stock Will Be The First To Break Out?

~Headline, Investor’s Business Daily (September)

I couldn’t care less about market sentiment except to understand how we got to such lofty valuations and how investors have become drooling idiots babbling incoherently about their riches. Nothing scares these markets. Previous bubbles always had a great story, something that investors could legitimately hang their enthusiasm on. The 1929 and 2000 bubbles were floated by dreams of truly fabulous technological revolutions. The current bubble is based on a combination of religious faith in central bankers and, as always, investors’ deluded confidence in their own omnipotence as market timers. Oh gag me with a spoon, really? Unfortunately, some group of prospective toe-tagged investors with silver dollars on their eyes are going to own these investments to the bottom. For now, though, we have nothing to fear but fear itself. Veni vidi vici.

“This is not an earnings-driven market; it is a momentum, liquidity, and multiple-driven market, pure and simple.”

~David “Rosie” Rosenberg, economist at Gluskin Sheff

The FOMO model is not restricted to Joe and Jane Six-pack. Norway’s parliament ordered the $970 billion sovereign wealth fund to crank up its stock holdings from 60 percent to 70 percent.63 Queuing off an analysis I did last year, a collective (market-wide) allocation shift of such magnitude would cause a 55 percent gain in equities.64 The percentage of U.S. household wealth in equities is in its 94th percentile and above the 2007 numbers.65 A survey of wealthy folks shows they expect an annualized 8.5 percent return after inflation.66 Good luck with that if you wish to stay wealthy. At current bond yields, a 60:40 portfolio would need more than 12 percent each year on the equities. Venture capitalists think they can get 20 percent returns (despite data showing this to be nuts.)67 Maybe they can set up an ETF to track the 29-year-old high school dropout and avid video gamer who professed to love volatility and got himself a 295 percent gain in one year trading some crazy asset (probably Tesla or “vol”).68 He actually ordered a Tesla and proclaimed, “I will soon get my license!” Better get that Tesla ordered soon, young Jedi Knight, given the company’s annualized $2+ billion burn rate and stumbling production numbers. Meanwhile, the legendary Paul Tudor Jones' fund saw 50 percent redemptions.69 (Boomers: Insert Tudor Turtle joke here.) Prudence disappoints investors in the final stages of a market cycle.

Unsurprisingly, the complacency index is at an all-time high.70 The oft-cited Fear and Greed Index (explained here71) is pegging the needle on extreme greed (Figure 10). A survey by the National Association of Active Investment Managers found investment managers to be more than 90 percent long the market.72 An American Association of Individual Investors survey showed that retail portfolios were at their lowest cash levels in almost two decades.71 High “delta,” which supposedly reflects investors’ willingness to use levered calls to catch this rally,72 suggests that investors perceive that risk has been eradicated in these central-bank-supervised markets. The few investors retaining a modicum of circumspection are “suffering extreme mental exhaustion” (PTSD) watching the consequences of the “deadweight of [the] US$400 trillion ‘cloud’ of financial instruments . . . supported by ongoing financialization” levitate anything with a price tag on it.73 Booyah Skidaddy. Let’s not forget, however, that traders make tops and investors make bottoms. In the next bloodletting, we may see bonds and stocks compete in synchronized diving. While traders run with the Pamplona bulls, investors sit in the shadows waiting for their day in the sun.

Figure 10. Fear and Greed Index.


Market pundits hurl around several definitions of volatility, and both have gotten huge press this year. A narrow dispersion of prices has arisen from the collusion of sentiment, $3 trillion of quantitative easing this year alone,74 trading algos, and programmed contributions to index investments that have created markets that seem very tame (not volatile). Headlines reported all sorts of records such as days without a 1 percent drop,75 consecutive S&P 500 closes within 0.5 percent of previous closing price,76 longest streak of green closes on the S&P, consecutive months without a loss,77 index advances accompanied by new 52-week lows,78 and days without a 3 percent draw down.79 Often the records were kept intact thanks to late-day panic-buying by the FOMO crowd. For the short sellers, it has been the Bataan Death March, particularly in February, when a leveraged fund was forced to liquidate billions of dollars of short positions.80 Even the treasury market shows an “implied volatility” at its lowest level in more than 30 years,81 which highlights historic investor complacency. Some say it is a new era; others see a calm before the storm.

A second definition of volatility is explained in Investopedia:82

Volatility: A variable in option pricing formulas showing the extent to which the return of the underlying asset will fluctuate between now and the option’s expiration. Volatility, as expressed as a percentage coefficient within option-pricing formulas, arises from daily trading activities. How volatility is measured will affect the value of the coefficient used.

Glad to have cleared that up. It’s no surprise the market players found a way to turn an arcane market indicator into a trading device: you can buy and sell vol through various indices such as the “VIX,” XIV, and “SVXY.” What’s more, the buying and selling of vol influences the markets (10× leveraged according to Peter Tchir). As the vol indices go down, the markets go up, and if I have this right, there is causality in both directions. Vol has been plumbing record lows. Indeed, those shorting vol (driving it down) are making fortunes—a one-decision trade—at least until buying vol becomes the new-and-improved one-decision trade. Billions have flooded into vol short funds each week.83 It is estimated to be a $2 trillion market. Barron’s called shorting the VIX “the nearest thing to free money.”84 References to exceptionally high “risk-adjusted returns” leave me wondering: How do you adjust for risk on the vol trade? Maybe we should consult the logistics manager at a Target store who made a cool $12 million in five years by shorting the VIX.85 He reminds me of those Icelandic fishermen-turned-bankers. They did quite well for a while, but they returned to fishing the hard way.

In an incisive analysis of the risks of the vol trade,86 Eric Peters notes that “to sell implied volatility at current levels, investors must imagine tomorrow will be virtually identical to today.” Seems like a reach given that such an assumption has no precedent in the recorded history of anything. The fact that 97 percent of VIX shares are sold short also seems a wee bit lopsided (Figure 11).87 The VIX even had a flash crash88: how ironic is that? JPM’s Marko Kolanovic—reputed to be one of the best technical traders in the known universe—says that a regression of the VIX to the historical norm could cause “catastrophic losses” because of all the shorts.89 Given that volatility begets volatility, forcing an epic short squeeze on $2 trillion of vol shorts at some point, one wonders what comes after “catastrophic”?

Figure 11. Volatility (VIX) short positions.

Stock Buybacks

“Companies might have to start rotating out of the debt that they incurred to buy back their stock and start issuing stock.”

~Chris Whalen, The Institutional Risk Analyst

In 2016, I referred to Whalen’s vision of stock buybacks as “buying high–selling low.”90 Peter Lynch’s original enthusiasm for buybacks was that clever management sneakily buys back undervalued shares, not overvalued shares. This buyback ploy began to turn into a scam in 1982, when buybacks were excluded from rules prohibiting price manipulation.91 Buybacks are so large now that they correlate with and quite likely cause large market moves (Figure 12). Since 2009, U.S. companies have bought back 18 percent of the market cap, often using debt—lots of debt.92 The 30 Dow companies have 12.7 billion fewer shares today than in ’08: “the biggest debt-funded buyback spree in history.” An estimated 70 percent of the per-share earnings—24 percent versus only a 7 percent earnings gain since 2012—is traced to a share count reduction from buybacks.93 Pumping the share prices at the cost of rotting the balance sheet (which gullible investors ignore) achieves two imperatives: it prolongs executive employment and optimizes executive compensation. Contrast this with paying dividends to enrich shareholders to the detriment of option holders. The rank-and-file employees might be comforted if companies plugged the yawning pension gaps instead (vide infra), but such contributions would have to be expensed, lowering earnings and, stay with me here, reducing executive compensation.

Figure 12. (a) S&P real returns versus margin debt. (b) S&P nominal returns versus share buybacks, and (c) buybacks versus corporate debt.

In one hilarious case, Restoration Hardware, a loser by any standard except maybe Wall Street’s, used all available cash and even accumulated debt to buy back 50 percent of its outstanding shares to trigger a greater than 40 percent squeezing of the short sellers who, mysteriously, think the company is poorly run.94 In the “eating the seed corn” meme, the 18 biggest pharmaceutical companies’ buybacks and dividends exceed their R&D budgets.95

Market narrowing—the scenario in which a decreasing number of stocks are lifting the indices—is acute and ominous to those paying attention.96 The so-called FAANGs + M (Facebook, Apple, Amazon, Netflix, Google, and Microsoft) have witnessed a 50 percent spike in their P/E ratios in less than 3 years.97 The FAANGs compose 42 percent of the Nasdaq and 13 percent of the S&P. An astonishing 0.2 percent of the companies in the Nasdaq have accounted for 45 percent of the gains.98 This is a wilding. The average stock, by contrast, is still more than 20 percent off its all-time high. What is going on?

Indexing and Exchange-Traded Funds

“When a measure becomes an outcome, it ceases to be a good measure.”

~Goodhart’s Law

Charles Goodhart focused on measuring money supply,99 but his law loosely applies to any cute idea that becomes widely adopted (such as share buybacks). This is total blasphemy, but market indexing may be a colossal illustration of Goodhart’s Law. John Bogle was the first to articulate the merits of indexing in his undergraduate thesis at Princeton.100 Columbia University professor Burt Malkiel provided a theoretical framework for the notion that you cannot beat the market, which was translated into the best-selling book A Random Walk Down Wall Street. Even Warren Buffett endorses the merits of indexing, although once again, his words belie his actions. Bogle’s seminal S&P tracking fund now contains 10% of the market cap of the S&P 500 after quadrupling its share since ’08. (Behaviorist Peter Atwater attributes the recent enthusiasm to investors who are PO’d at active managers.)101

“When the world decides that there is no need for fundamental research and investors can just blindly purchase index funds and ETFs without any regard to valuation, we say the time to be fearful is now.”

~FPA Capital

Then there are the massively popular ETFs that allow you to index while picking your favorite basket of stocks (have your cake and eat it too). Is there anybody who disagrees with the merits of indexing? Didn’t think so. Do ya see the problem here? Goodhart might. Maybe I was oblivious, but acute concerns about indexing seem to have emerged only in the last year or so. Let’s ponder some of them, but only after a brief digression.

“There is no such thing as price discovery in index investing.”

~Eric Peters, CIO of One River Asset Management

In his must-read book The Wisdom of Crowds, James Surowiecki posits that a large sample size of non-experts, when asked to wager a guess about something—the number of jelly beans in a jar, for example—will generate a distribution centered on the correct answer. Compared with experts, a crowd of clueless people offers more wisdom. I submit that this collective wisdom extends to democracies and markets alike. A critical requirement, however, is that the voting must be uncorrelated. Each player must vote or guess independently. As correlation appears, the wisdom is lost, and the outcome is ruled by a single-minded mob. Thus, when everybody is buying baskets of stocks using the same, wholly thoughtless protocol (indexing), the correlation is quite high. Investors are no longer even taking their own best guesses. The influence of correlation is amplified by a flow of money (votes) putting natural bids under any stock in an index, even such treasures as Restoration Hardware. What percentage of your life’s savings should you invest without a clue? Cluelessness has been paying handsome rewards.

A big problem is that index funds and ETFs allocate resources weighted according to market cap and are float-adjusted, reflecting the market cap only of available shares not held by insiders. You certainly want more money in Intel and Apple than in Blue Apron, but indexing imposes a non-linearity that drives the most overpriced stocks to become even more overpriced. That is precisely why the lofty valuations on the FAANGs just keep getting loftier. The virtuous cycle is the antithesis of value investing. The float adjustment drives money away from shares with high insider ownership. Curiously, an emerging strategy that is not yet broadly based (recall Goodhart’s Law) is to find investments that are not represented in popular indices or ETFs on the notion that they have not been bid up by indexers.

“With $160-odd trillion global equity market capitalization, we have much more opportunities for ETFs to grow, not just on equities, but in fixed income. And I believe this is just the beginning.”

~Larry Fink, CEO of Blackrock, the largest provider of ETFs

The indexed subset of the investing world could be at the heart of the next liquidity crisis. In managed accounts, redemptions can be met with a stash of cash at least for the first portion of a sell-off. This is why air pockets (big drops) often don’t appear early in the downdraft. By contrast, ETFs trade shares robotically—quite literally by formulas and algos (the robots)—with zero cash buffer. The first hint of trouble causes cash inflows to dry up and buying to stop. Redemptions by nervous investors cause instantaneous selling. Passive buying will give way to active selling. The unwind should also be the mirror image of the ramp: FAANGs will lead the way down owing to their high market caps. Once again, selling begets selling, and the virtuous cycle quickly turns vicious. Investors will get ETF’d right up the…well, you get the idea.

“You’re better off knowing which ETFs hold this stock than what this company even does. . . . That’s scary to me. . . . The market needs to have a major crash.”

~Danny Moses, co-worker of Steve Eisman

“Throw them out the window.”

~Jeff Gundlach, CIO of DoubleLine Capital, on index funds

I would be remiss if I failed to note that there are also some really wretched ETFs. What are the odds, eh? I’m not sure I even believe this, but it has been claimed that a 3×-levered long gold mining ETF lost –86 percent while a 3×-levered short gold mining ETF lost –98 percent, both over the same time frame that the GDX returned zero percent. You wouldn’t want to pair-trade those bad boys. It is also rumored that the SEC has approved 4×-levered equity ETFs. Investors are going to be seeing the inside of a wood chipper at some point. A 3×-levered Brazilian ETF (BRZU) lost 50 percent in a single day. Apparently none of these investors ever saw The Deer Hunter. We might as well set up ETFs in which investors choose the leverage multiple. One quick click, and it's gone.

“ETFs are the new Investment Trusts (similar vehicles in 1920’s) that led to the Great Crash and will lead to the next crash.”

~Mark Yusko, CEO and CIO of Morgan Creek Capital Management

“Passive investing is in danger of devouring capitalism. . . . What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.”

~Paul Singer, founder and president of Elliott Management Corporation

Miscellaneous Market Absurdities

“Last time this mood took over, it ended very badly. Look at your investments with 2009 eyes. Did you tail hedge then? Should you risk up now?”

~Jeff Gundlach

Recent initial public offerings (IPOs) get routinely flogged. SNAP’s 33 percent drop has become onomatopoetic. What would you expect for a company whose customer demographic is 12- to 18-year-olds with no income? GoPro (GPRO) has lost 95 percent in two years. A few more show precipitous drops from post-IPO highs: FIT, TWLO, FUEL, TWTR, ZNGA, and LC. Blue Apron (APRN) dropped 45 percent from its highs in the 36 days after its IPO. The company also cut 1,200 of a total of 5,000 jobs, prompting one veteran to ponder: “Seriously, how is that not illegal?” This is a new era, dude.

The froth creeps into the screwiest places. The hard asset purchase of the year was the da Vinci painting of Salvatore Mundi that sold for $450 million. It was the only known da Vinci in private hands. A Modigliani nude sold for $170 million. A Basquiat painting purchased in 1984 for $19,000 moved across the auction block at a snot-bubble-blowing $111 million (23% compounded annualized return). The fabulously creative modern artwork, The Unmade Bed (Figure 13), sold for a cool $4 million.102 (I have one of those in my bedroom that I got for a lot less.) According to CBS News, a Harambe-shaped Cheeto sold for almost $100K on eBay.103 An obscure Danish penny stock company (Victoria Properties) surged nearly 1,000 percent in a few days, prompting management to remind investors that “there has been no change in Victoria Properties’ economic conditions. . . . The company’s equity is therefore still equal to about zero kroner.”104 Ford is valued at around $7,000 per car produced. Tesla is valued at $800,000 per car produced—they are literally making one model by hand on a Potemkin assembly line.105 A company called Switch has a “chief awesomeness officer.106 Ding! Ding! Ding!

Figure 13. A $4 million masterpiece of modern art.

Long-Term Real Returns and Risk Premia

“Maybe it’s time to quietly exit. Take the cash, hide it in the mattress, and wait for the next/coming storm to pass.”

~Bill Blain, Mint Partners

“People have just gotten so immune to any pain and anguish in any of these markets that when it happens it is going be very psychologically painful.”

~Marilyn Cohen, Envision Capital Management

If the next correction is only 20–30 percent, I was simply wrong. Mete out a 50 percent or larger thwacking, and I am declaring victory (in a twisted sort of way). When the pain finally arrives, the precious few positioned to take advantage of the closeout sales will include idiots sitting in cash through the current equity binge buying (me). In theory, the short sellers would be in great shape too, but they all reside in shallow graves behind the Eccles Building. Some wise folks, like Paul Singer, have had the capacity and foresight to be raising billions of dollars for the day when monkey-chucking darts can find a target.107

"We think that there has never been a larger (and more undeserved) spirit of financial market complacency in our experience.”

~Paul Singer after raising $5 billion to buy distressed assets in the future

There will be few victory laps, however, because boomers will be living on Kibbles ’n Bits. How painful will it be? Figure 14 from James Stack shows the fractions of the last 100 years’ bull markets that were given back.108 On only one occasion were investors lucky enough to hang onto three-fourths of their bull market gains. One-third of the bulls were given back entirely. Two-thirds of the bulls gave half back. The results are oddly quantized. How much will the next bear take back? It depends on how much the reasoning above is out of whack. Do ya feel lucky?

Figure 14. Fraction of the bull taken by the bear.108

“The vanquished cry, but the victor doesn’t laugh.”

~Roman proverb

Ethereal gains bring up an interesting point, more so than I first thought. In a brief exchange with Barry Ritholtz, I asserted that the “risk premia” on equities—the higher returns because of underlying risk—will be arbitraged away in the long run because occasionally risk turns into reality, and you get your ass kicked. I’m not talking inefficient high-frequency noise but rather the long term—call it a century if you will. With his characteristically delicate touch, Barry noted that I was full of hooey. Refusing to take any of his guff, I dug in. Certainly a free market would price equities much the way junk bonds are priced relative to treasuries to account for mishaps. Look back at Figure 14 in case it didn’t sink in. There is also the problem with interpreting index gains owing to survivor bias. Economist David Rosenberg claims that if the eight companies who left the Dow in April 2004 had remained, the Dow would still be below 13,000.109 Of course, presumably investors swapped them out as well if they were indexing (although somebody ate those losses).

“I will get back to you next week with the answer to your singular investment question. Should you have further easy questions such as: is there a God and what gender he/she may be, that will necessarily be part of a separate email chain.”

~Brian Murdoch, former CEO of TD Asset Management on bonds versus stocks

Start with the inflation-adjusted principle gains on the Dow (Figure 15), which returns less than 2 percent annualized. Think that’s too low? Take a look at my all-time favorite chart—the Dow in the first half of the 20th century, when inflation corrections weren’t needed (Figure 16). Now throw in some dividends (4 percent on average) and some wild-ass guesses on fees and taxes (including those on the inflated part of the gains). I get a real return on the Dow in the 20th century—a pretty credible century to boot—of only 4–5 percent annualized. Let’s adjust recent returns using the Big Mac inflation metric.110 Big Macs have appreciated sixfold since 1972 (4–5 percent compounded) with little change in quality. Over the same period, the capital gains on the Dow rose twentyfold. Adjusted for Big Mac–measured inflation, the Dow averaged less than 3 percent compounded (ex-dividends). An eightfold rise in the price of extra-large pizzas since 1970 (cited in my now-extinct blog for Elizabeth Warren) paints an even bleaker picture of inflation-adjusted S&P returns.

Figure 15. Inflation-adjusted DOW.

Figure 16. Non-inflation-adjusted Dow: 1900–1940.

Those 4–5 percent inflation-adjusted equity gains do not account for the fourfold increase in the U.S. population, which should be included because the wealth of the nation was shared by four times as many carbon-based life-forms. The returns are also not in the same zip code as the 7–8 percent assumed by many pensioners.

Back to the debate, the 4–5 percent inflation-adjusted equity gains contrast with 30-year treasuries returning about 4–5 percent nominally. Hmm…Seems like equities still won, and that Ritholtz appears to have been right. I consulted both digital and human sources (Brian Murdoch, Benn Steil, and Mark Gilbert), and everybody agreed: that punk Ritholtz was right. Even more disturbing, is it possible that Jeremy Siegel is not being a total meathead by asserting that you should buy equities at all times (BTFD)?

The explanations for why markets fail to arbitrage the risk premia are said to be rather “mysterious.” According to Brian Murdoch, “academics have been remarkably unsuccessful in modeling it. . . . Despite three decades of attempts, the puzzle remains essentially intact.” Benn Steil concurred. Academic studies (warning!) claim that bonds do not keep up with stocks even over profoundly long periods, and no amount of fudging (fees, taxes, disasters, or survivor bias) accounts for the failure to arbitrage the marginal advantage of stocks to zero. Schlomo Benartzi and Richard Thaler suggest that short-term losses obscuring long-term gains—“myopic loss aversion”—is the culprit.111 (Ironically, I read this paper a week before the Nobel committee told me to read this paper.) Elroy Dimson et al. dismiss all the possible errors that could be root causes and put the sustainable risk premium on stocks at 3–5 percent.112

Let’s flip the argument: Why would you ever own a bond? There are rational answers. To the extent that you do not buy and hold equities for 100 years (unless you are Jack Bogle), you also pay a premium for the liquidity—the ability to liquidate without a huge loss because you were forced to sell into a swoon. You also forfeit the ability to sell into a rally, however, and certainly wouldn't want to sell into a bond bear market either. Of course, the role of financial repression—sovereign states’ ability to force bond yields well below prices set by free markets—could explain it all. Governments like cheap money and have the wherewithal to demand it. Maybe the message is to never lend to governments. I remain in an enlightened state of confusion.


“Gold is no more of an investment than Beanie Babies.”

~Gary Smith, economist

“If you don’t have 5–10% of your assets in gold as a hedge, we’d suggest you relook at this. . . . [I]f you do have an excellent analysis of why you shouldn’t have such an allocation to gold, we’d appreciate you [sic] sharing it with us.

~Ray Dalio, Bridgewater Associates

Ray is rumored to have ramped Bridgewater’s gold position fivefold this fall. He cites geopolitical risk as a reason to own the barbecued relic.

“If we actually see missiles in the air, gold could go higher.”

~CNBC trader on thermonuclear war

Since the early 1970s, gold has had an annual return of 8 percent (nominal). Gold bears are quick to point out it doesn’t pay interest. Nor does my bank, and by the way, what part of 8 percent don’t they understand? By that standard, the 8 percent gain in 2017 was good but not statistically unusual. Coin sales are down,113 which suggests that either retail buyers are not in the game or the bug-out plans of hedge fund managers—I’m told they all have them—are complete. Sprott Asset Management made a hostile move on the Central Fund of Canada, a gold–silver holding company, in a move that might portend promising future returns.114

“Significant increases in inflation will ultimately increase the price of gold. . . . [I]nvestment in gold now is insurance. It’s not for short-term gain, but for long-term protection. . . . We would never have reached this position of extreme indebtedness were we on the gold standard. . . . It wasn’t the gold standard that failed; it was politics. . . . Today, going back on to the gold standard would be perceived as an act of desperation.”

~Alan Greenspan, 2017, still babbling

On the global geopolitical front, Deutsche Bundesbank completed repatriation of 700 tons of gold earlier than originally planned.115 The urgency may be bullish, but a possible source of demand is now gone. Chinese gold companies have been actively searching for domestic deposits and international acquisitions as they push to quadruple their reserves to 14,000 tons by 2020.116 (The U.S. sovereign stash is less than 9,000 tons.) The gold acquisitions of China (Figure 17) show a curious abrupt and sustained increase in activity in 2011. When did gold begin its major correction? Right: 2011. Makes you wonder if geopolitics somehow preempted the supply–demand curve. Because gold can leave Shanghai but not China, it’s a one-way trip. The Shanghai Gold Exchange must get its bullion from other sources. Russia continues to push its reserves up too. Rumors swirl that China and Russia are colluding for something grand, possibly a new global reserve currency based on the petro-yuan and gold. This would change the global landscape way beyond generic goldbuggery.

Figure 17. Abrupt changes in Chinese gold acquisitions through Hong Kong in 2011.

“Bringing back the gold standard would be very hard to do, but boy would it be wonderful. We’d have a standard on which to base our money.”

~Donald Trump, 2016

The gold market continues to be dominated by gold futures rather than physical gold. The bugs think this will end. I can only hope. In this paper market, gaming is the norm. On a seemingly monthly basis, gold takes swan dives as somebody decides to sell several billion-dollar equivalents (20,000–30,000 futures contracts) when the market is least liquid (thinly traded). Stories of fat-fingered trades abound, but I suspect these are just traders molesting the market for fun and profit, unconcerned that a regulator would ever call them on it. The silver market looked even creepier for 17 days in a row (Figure 18). I never trust that kind of linearity.

Figure 18. Silver acting odd over 5 minutes and 17 days.

Price changes often appear proximate to geopolitical events, but everything is proximate to a geopolitical event somewhere. India’s success at destroying its cash economy—the only economy it had—via the fiat removal of high-denomination bills117 was akin to announcing that only electric cars are legal starting next week. Some suggested that the move was also an attempt to flush gold out of households and into the banking system.118

Gold inched toward currency status at a more local level as Idaho, Arizona, and Louisiana voted to remove state capital gains taxes on gold—baby steps toward an emergent gold standard.119 The Brits are going the other way by banning salary payments in gold.120

Finishing with some fun anecdotes, a massive gold coin worth millions was stolen from a German museum.121 Some guy restoring a World War II tank found $2.5 million in gold bullion tucked in a fake fuel tank.122 A piano repairman discovered 13 pounds of gold in an old piano.123 According to British law, the repairman gets half, and the folks who donated the piano get squat. Beyond that, the gold market has been quiet for almost five years (Figure 19). Some wonder whether Bitcoin is sucking oxygen away from gold. Which way is gold gonna break if Bitcoin or the dollar tanks? Inquiring minds want to know.

Figure 19. Five years of gold price discovery.


“Worse than tulip bulbs. It won't end. Someone is going to get killed. . . . [A]ny [JPM] trader trading Bitcoin will be fired for being stupid. . . . [T]he currency isn’t going to work. You can’t have a business where people can invent a currency out of thin air and think the people buying it are really smart. It’s worse than tulip bulbs."

~Jamie Dimon, CEO of JPM

Unbeknownst to Dimon, his daughter was trading Bitcoin: “It went up and she thinks she is a genius.” More to the point, traders at JPM were already firing up crypto exchanges (while Goldman and the CFTC seemed to be positioning to enter the game). Dimon decided it was a prudent time to STFU (shut up) by declaring, “I'm not going to talk about Bitcoin anymore.” The joke was on us, however; nobody seemed to notice that Dimon slipped in an earnings warning the same day his Bitcoin quotes hit the media.124 Well played, Jamie.

“Bitcoin owners should appeal to the IRS for tax-exempt status as a faith-based organization.”

~Andy Kessler, former hedge fund manager

I wish I had a Bitcoin for every time somebody asked me about it. Cryptos and goldbugs share a common interest in escaping the gaze of the authorities. My ignorance of blockchain technology is profound, but I suspect that is true for many who talk the talk. I wonder if somehow blockchain might play a role in bypassing the SWIFT check-clearing system used by Western powers to shake down opposition (Russia).125 I also wonder, however, if the miracles of blockchain should not be confused with those of Bitcoin. Any mention of price or gains below should be followed with an implicit "last time I checked" or even “as of two minutes ago.”

My failure to jump on Bitcoin leaves no remorse: (a) I never take a position that risks a you-knew-better moment, and (b) I would have been flushed out, and then I really would have kicked myself. Recall the legendary founding shares in Apple that were sold for $800 and are now estimated to be worth maybe $100 billion?126 There’s rumor of a guy who lost his Bitcoin “codes” that are now estimated at more than $100 million. That’s real pain.

I offer my current view of cryptos from a position of total technical ignorance guided by an only slightly more refined understanding of history and markets. Please forgive me, crypto friends. I know you are tired of hearing the counter arguments and the cat calling. I am restrained by the words of a famous philosopher:

“Only God is an expert. We’re just guys paid to give our opinion.”

~Charles Barkley, former NBA star

What would have flushed me out of a Bitcoin long position? Let’s take it to the hoop:

  • The price action. Exponential gains, even wildly bent on a semi-log plot, have few analogs in history, all of which led to legendary busts (Figure 20). The South Sea bubble, Tulipmania, Beanie Baby, and Mentos-in-a-Coke analogies are legion. They all had a story that convinced many.

Figure 20. One-year price chart of Bitcoin (as of 2 minutes ago).

  • The participants. I have a friend—a very smart former Wall Street guy—who swears by it and is up 100,000 percent. You do not need to size your position correctly with that kind of gain. But then there is the clutch of camp followers emblematic of all manias. We have grad students speculating in Bitcoin. A 12-year-old bought his first Bitcoin in May 2011 with a gift from his grandmother.126a At more than $17,000 per coin, his stash is more than $5 million. On MarketWatch, he declared he had a price target of $1 million.

“I’m obviously very bullish, but I expect to make a couple million dollars off very little money. This is the opportunity of a lifetime. Finance is getting its Internet.”

~Bitcoin investor

  • Competitors. A Bitcoin competitor issued by Stratis soared to more than 100,000 percent since its initial coin offering (ICO) this past summer. As of December 1, there were 1,326 cryptocurrencies with a total market cap of >$400 billion.127 Paris Hilton has a cryptocurrency.128 The market is saturated more than the dot-com market ever was. It is a certainty that more than 99 percent will die much like most of the 270 auto companies in the ’20s and dot-coms in the ’90s. A site called Deadcoins shows that some already have.129 The debate is whether 100 percent is the final number.

  • Volatility. Massive corrections followed by ferocious rallies akin to a teenager on driving on black ice would have convinced me it was too crazy for my style. Corrections last seconds to hours, with wildly enthusiastic buyers poised to BTFD. Isaac Newton got into the South Sea bubble, was smart enough to get out, and then reentered in time to go bankrupt. I am decidedly dumber than Isaac.

Figure 21. Bitcoin photo bomber (acquiring $15K of Bitcoin via crowdsourcing).

For Bitcoin to become a currency in its current form, out of reach of sovereigns, seems to require a society-upheaving revolution, which is a rare event that usually gives way to new, equally ham-fisted regimes. The chances seem slim to none for several reasons.

“No government will ever support a virtual currency that goes around borders and doesn’t have the same controls. It’s not going to happen.”

~Jamie Dimon (again)

  • The competition. I am doubtless that central banks and sovereign states will never endorse Bitcoin in its current form. They have their own digital currencies and a monopoly on the power to create more, and they commandeer our assets through taxation. Existential risk will bring on the power of the State. When sovereigns decide to do battle, the cryptos will be brought to heel or forced underground.

  • Instabilities. Digital currencies are showing digital instabilities that could just be growing pains or evidence of more systemic problems. How software buffs who know that software is duct tape and bailing wire could think that a software-dependent currency is invincible is beyond me. Ethereum dropped 20 percent in a heartbeat when a hacker theft was reported.130 It dropped 96 percent after the Status ICO clogged the network.131 One user put a stop-loss on Ethereum at $316 on GDAX, which executed at $0.10 during a flash crash.132 So-called “wallets” have been freezing up, although there is some debate as to whether the owners lost the Bitcoins.133 This stuff happens with all risk assets now but not with usable currencies.

  • Volatility. Nobody will use a currency to pay for groceries if prices move 10 percent a day or even 5 percent as you move from the frozen food to the vegetable aisle. This, by the way, is the same explanation for why I don’t consider gold “money” or a “currency.” As long as there exists a Bitcoin–dollar conversion, a sovereign wishing to keep Bitcoin in the realm of a speculative plaything could use its unlimited liquidity to trigger price swings with a little day trading.

  • Legality. If up against the wall, sovereigns will use arguments about fighting crime, stemming ransomware, or controlling monetary policy and declare a War on Cryptos akin to the potential War on Cash. China has already blown shots across the Bitcoin bow by shutting down exchanges as well as ICOs as they struggle with excessive sovereign debt and capital outflows.134 Britain has also done some sabre rattling.135 The IRS has declared gains taxable (akin to gold) and is paying companies to locate digital wallets.136 The fans of BTC declare invincibility—freedom! The average blokes may smoke pot and drive too fast, but they seem less likely to risk a spat with the State on this stuff.

“Right now the trust is good—with Bitcoin people are buying and selling it, they think it’s a reasonable market—but there will come a day when government crackdowns come in and you begin to see the currency come down.”

~Mark Mobius, executive director at Franklin Templeton Investments

Others have unshakeable faith even in the more obscure cryptocurrencies. I’m unsure what I’m hoping for on this bet (Figure 22):

Figure 22. John McAfee, technology pioneer, chief of cybersecurity, visionary of MGT Capital Investments, going all in on cryptocurrencies.

Housing and Real Estate

“We bailed out the financial system so that financiers with access to cheap credit can buy up all of America’s real estate so that they can then rent it back to you later.”

~Mike Krieger, Liberty Blitzkrieg blog

Greenspan claimed those who predicted the housing bubble were “statistical illusions” (as were those who saw Greenspan as a charlatan). There are, once again, housing bubbles littered across the globe at various stages of expansion and contraction owing to central banks providing in excess of $3 trillion dollars of QE this year. Credit is fungible, so the flood of capital can come from anywhere and migrate to anywhere it finds an inflating asset. Hong Kong’s spiking prices are rising by dozens of basis points per day. Attempts by authorities to cool the market only fanned the flames, resulting in “a sea of madness.”137 Australian authorities tried to cap the dreaded interest-only loans at 30% of the total pool, prompting one hedge fund to return money to investors and declare that “Mortgage fraud is endemic; it’s systemic; it’s just terrible what’s going on. When you’ve got 30-year-olds, who have never seen a property downturn before, borrowing up to 80% to buy three and four apartments, it’s a bubble.”138

Prices in London are now collapsing.139 Why would anything collapse with so much global credit? Simple: top-heavy structures tend to collapse from even small shocks. I will focus, however, on only two countries—the U.S. because it is my home turf and Canada because it is the most interesting of the markets.

The U.S. appears to be in a bubblette, an overvalued market that does not approach the insanity of 2007 (detected by statistical illusions as early as 2002).140 Twenty percent down payments have become passé again. A survey of 20 cities reveals 5.9 percent annualized price rises.141 The median sale price of an existing home has set an all-time high and is up 40 percent since the start of 2014141 despite what seems to be muted demand (Figure 23). Thus, home ownership has dropped by 8 percent since ’09 because soaring prices have rendered them unaffordable. More than 40 percent of 25-34 year olds, a group historically en route to home ownership, have nothing set aside for a down payment.141 Those who scream about the need for affordable housing don’t notice that we have plenty of low-quality houses. We lack low-cost houses. And the Fed says inflation is good.

Figure 23. Median new home sales price in the U.S. versus number sold and versus home ownership rate.

In 1960, California had a median home price of $15,000—three times the salary of an elementary school teacher.142 The median home price in San Francisco is now $1.5 million,143 which is unlikely to be three times a teacher’s salary. A couple earning $138,000 will soon qualify for subsidized housing in San Francisco. California housing seems to be interminably overvalued, possibly owing to the draw of droughts, mudslides, crowds, and, fires. Despite modest 6 percent population growth since 2010, housing units have shown an only 2.9 percent increase. There could be a supply–demand problem, especially when the fires subside.

Florida is rumored to have eager post-hurricane sellers—those with something left to sell, that is.144 Condo flippers drove prices skyward in Miami, but they are heading earthward with a glut of units scheduled to come online in 2018. It’s not just the sand states starting to see softness. In New York City, rising rates seem to be nudging commercial and residential real estate down and foreclosures up to levels not seen since the 2009 crisis (79 percent year-over-year in Q3).145 Sam Zell is, once again, a seller and claims "it is getting hard."146 Recall that Zell nailed the real estate top by selling $38 billion in real estate in ’07.147

“The condo market at the high-end [in Manhattan] . . . is a catastrophe and will get worse.”

~Barry Sternlicht, Starwood Property Trust

Those who already own houses can once again “extract equity” from their homes using home equity lines of credit (HELOCs).148 They then wake up with more debt on the same house. Pundits claim consumers’ willingness to mortgage their future is “a healthy confidence in the economy.” Fannie Mae and Freddie Mac have also entered phase II of the catch-and-release program. Their regulators have authorized them to once again engage in unchecked, reckless lending, prompting some to begin estimating the cost of the next bailout.149

What happened to all that inventory from the colossal boom leading to the Great Recession? Some fell into the foundations, but a lot found its way into private equity firms. Mind you, single-family rentals are a low- or no-profit-margin business under normal circumstances. As long as rates stay low—Where have I heard that one before?—inherently thin profits can be amplified to a significant transitory revenue stream through leverage. A proposed merger of Invitation Homes (owned by Blackstone Group) and Starwood Waypoint Homes (owned by Starwood Capital) would spawn the largest owner of single-family homes in the United States with a portfolio worth over $20 billion.150 Of course, rates will rise again, and these sliced-and-diced tranches of mortgage-backed securities must be offloaded to greater fools. Private equity guys are already frantically boxing and shipping.151

To avoid costly and time-consuming appraisals, market players are using “broker price opinions,” which can be had by simply driving by the house and taking a guess (or just taking a guess). In ’09, the legendary “Linda Green” signed off on thousands using dozens of different signatures.152 U.S. securities regulators are investigating whether bonds backed by single-family rental homes and sold by Wall Street’s biggest residential landlords used overvalued property assessments.153 Let me help you guys out: yes.

“The main risk on the domestic side is a sharp correction in the housing market that impairs bank balance sheets, triggers negative feedback loops in the economy, and increases contingent claims on the government.”

~IMF, on the Canadian housing market

Heading north, we find that Canada’s real estate market never collapsed in ’09 (Figure 24), an outcome often ascribed to the virtues of the country’s banking system. An estimated 7 percent of Canadians work in housing construction,154 and Canadians are using HELOCs like crazy.155 After Vancouver tried to burst a huge bubble in 2016 with a 15 percent buyers’ tax,156 Chinese buyers chased Toronto houses instead. Annualized gains of 33 percent with average prices of $1.5 million are pushing even the one-percentile crowd to remote ’burbs.157 Toronto authorities have now imposed the Vancouver-like 15 percent foreign buyers tax,158 causing a single-month 26 percent drop in sales and ultimately chasing the hot money to Montreal,159 Guelph, and even Barrie.160

“Make no mistake, the Toronto real estate market is in a bubble of historic proportions.”

~David Rosenberg


Figure 24. Canadian versus U.S. median home prices and what they buy ($700,000 for that little gem).

The most interesting plotline and a smoking gun in Canada’s bursting bubble was failing subprime lender Home Capital Group (HCG). Marc Cahodes, referred to as a “free-range short seller” and “the scourge of Wall Street,” spotted criminality and shorted HCG for a handsome profit.161 HCG was so bad it was vilified by its auditor, KPMG.162 Imagine that. HCG dropped 60 percent in one day when news hit of an emergency $2 billion credit line at 22.5 percent interest by the Healthcare of Ontario Pension Plan.163 (The CEO of the pension plan sits on Home Capital’s board and is also a shareholder.) Cahodes was printing money and ranting about jail sentences when, without warning, the legendary stockjobber Warren Buffett took a highly visible 20 percent stake in HCG at “mob rates” (38 percent discount).164 The short squeeze was vicious, and Cahodes was PO’d. As Paul Harvey would say, “now for the rest of the story.”

HCG is, by all reckoning, the piece of crap Cahodes claims it is. Buffett couldn’t care less about HCG’s assets—Berkshire can swallow the losses for eternity. Warren may have bought this loser as a legal entry to the Canadian banking system, which is loaded with hundreds of billions of “self-securitized” mortgages. The plot thickened as a story leaked that Buffett met with Justin Trudeau (on a tarmac).165 When the Canadian real estate bust begins in earnest, Buffett will have the machinery of HCG and the political capital to feed on the carcasses of the big-five Canadian banks.


“This massive financial bubble is a ticking time bomb, and when it finally goes off, it is going to wipe out virtually every pension fund in the United States.”

~Michael Snyder, DollarCollapse.com blog

The impending pension crisis is global and monumental with no obvious way out. The World Economic Forum estimates the pension gap—unfunded pension liabilities—at $70 trillion and headed for $250 trillion by 2050.166 Conservative but still conventional assumptions about prospective investment returns and spending patterns in old age suggest that retiring into the American dream in your mid 60s requires you bank 20–25 multiples of your annual salary (or a defined benefit plan that is the functional equivalent) to avoid the risk of running out of money. A friend—a corporate executive no less—retired with 10 multiples; he could be broke within a decade (much sooner if markets regress to historical means). Of course, you can defiantly declare you will work ’till you drop, but then there are those unexpected aneurysms, bypass surgeries, layoffs, and ailing spouses needing care. I’ve seen claims that more than 50 percent of retirees do not fully control their retirement age.

“Companies are doing everything they can to get rid of pension plans, and they will succeed.”

~Ben Stein, political commentator

The problem began as worker compensation became reliant on future promises—IOUs planted in pension plans—often assuming the future was far, far away. However, a small cadre of demographers in the ’70s smelled the risk of the boomer retirements and began swapping defined-benefit plans for defined-contribution plans.167 (A hybrid of the two traces back to 18th century Scottish clergy.168) The process was enabled by the corporate-friendly Tax Reform Act of ’86.169 Employees were unknowingly handed all the risk and became their own human resource specialists.

Retirement risk depends on the source of your retirement funds. Federal employees are backstopped by the printing press, although defaults cannot be ruled out if you read the fine print.170 States and municipalities could get bailed out, but there are no guarantees. Defined-benefit corporate plans can be topped off by digging into cash flows provided that the cash flows and even the corporation exist. The depletion of corporate earnings to top off the deficits, however, will erode equity performance, which will wash back on all pension funds. The multitude of defined-contribution plans such as 401(k)s and IRAs managed by individuals are totally on their own and suffer from a profound lack of savings.

Corporate and municipal defined-benefit plans assumed added risks by falling behind in pension contributions motivated by efforts to balance the books and, in the corporate world, create the illusion of profits. The moment organizations began reducing the requisite payments by applying flawed assumptions about prospective returns, pensions shifted to Ponzi finance. My uncanny ability to oversimplify anything is illustrated by the imitation semi-log plot in Figure 25. The red line reflects the assumed average compounded balance sheet from both contributions and market gains. The blue squiggle reflects the vicissitudes of the market wobbling above and below the projection. If the projections are too optimistic—the commonly reported 7–8 percent market returns certainly are—the slope is too high, and the plan will fall short. If the projected returns are reasonable but management stops contributing during good times—embezzling the returns above the norm to boost profits—the plan will fall below projection again. Of course, once the plan falls behind, nobody wants to dump precious capital into making up the difference when you can simply goose projected returns with new and improved assumptions. In a rational world, pensions would be overfunded during booms and underfunded during busts. Assuming we can agree that we are deep into both equity and bond bull markets and possibly near their ends, pensions should be bloated with excess reserves (near a maximum on the blue curve), and bean counters should keep their dirty little paws off those assets and keep contributing because we won’t stay there.

Figure 25. Childish construct of pension assets.

That’s a good segue to drill down into the contemporaneous details. Public pensions are more than 30 percent underfunded ($2 trillion).171 A buzzkiller at the Hoover Institution says that the government disclosures are wrong and puts the deficit at $3.8 trillion.172 Bloomberg says that “if honest math was being used . . . the real number would actually be closer to 6 trillion dollars.”173 What is honest math? Using prevailing treasury yields for starters. Bill Gross—the former Bond King—says that if we get only 4.0 percent total nominal return rather than the presumed 7.5 percent, pensions are $5 trillion underfunded.174 Assuming 100 million taxpayers, that’s $50,000 we all have to pony up. California’s CalPERS fund dropped its assumption to a 6.2 percent return—still seriously optimistic in my opinion—leaving a $170 billion shortfall.175 The Illinois retirement system is towing a liability of $208 billion with $78 billion in assets ($130 billion unfunded).176 Connecticut is heading for a “Greece-style debt crisis” with $6,500 in debt per capita (every man, woman, and child?).177 The capital, Hartford, is heading for bankruptcy.178 South Carolina’s government pension plan is $24 billion in the hole. Kentucky’s attempt to fill a gigantic hole in its pension fund (31 percent funded) was felled by politics.179 A detailed survey of municipal pension obligations shows funding ranging from 23 percent (Chicago) to 98 percent (Suffolk).180 My eyeball average says about 70 percent overall. Notice that despite being at the peak of an investment cycle, none are overfunded (Figure 26.) Large and quite unpopular 30 percent hikes in employee contributions are suggested. The alternative of taking on more municipal debt to top off pension funds is a common stop-gap measure of little merit long term; somebody still has to pay.

Figure 26. State pension deficits.

The 100 largest U.S. corporate defined-benefit plans have dropped to 85 percent funded from almost 110 percent in 2007. During the recent market cycle that burned bright on just fumes, the companies gained only 6 percent above the 80 percent funding at the end of 2008. Of the top 200 corporate pensions in the S&P, 186 are underfunded to the tune of $382 billion (Figure 27). General Electric, for example, is $31 billion in the hole while using $45 billion for share buybacks.

Figure 27. Underfunding of 20 S&P pension funds.

When are serious problems supposed to start, and what will they look like? Jim Bianco says “slowly and then suddenly.” Some would argue “now.” The Dallas Police and Firemen Pension Fund is experiencing a run on the bank.181 They are suing a real estate fund who slimed them out of more than $300 million182 and are said to be looking at $1 billion in “clawbacks” from those who got out early trying to avoid the pain.183 The Teamsters Central States and the United Mineworkers of America plans are failing.184 The New York Teamsters have spent their last penny of pension reserves.185 The Pension Benefit Guaranty Corporation has paid out nearly $6 billion in benefits to participants of failed pension plans (albeit at less than 50 cents on the dollar), increasing its deficit to $76 billion. CalPERS intends to cut payouts owing to low returns and inadequate contributions (during a boom, I remind you).

“The middle 40% [of 50- to 64-year olds] earn $97,000 and have saved $121,000, while the top 10% make $251,000 and have $450,000 socked away.”

~Wall Street Journal

Looks like those self-directed IRAs aren’t working out so well either. Two-thirds of Americans don’t contribute anything to retirement. Only 4 percent of those earning below $50,000 a year maxes out their 401(k)s at the current limits.186 They are so screwed, but I get it: they are struggling to pay their bills. However, only 32 percent of the $100,000+ crowd maxes out the contribution. When the top 10 percent of the younger boomers have two multiples of their annual salary stashed away, you’ve got a problem.186 If they retired today, how long would their money last? That’s not a trick question: two years according to my math. Half the boomers have no money set aside for retirement. A survey shows that a significant majority of boomers are finding their adult children to be a financial hardship.187 Indeed, the young punks aren’t doing well in all financial categories; retirement planning is no exception. Almost half of Gen Xers agreed with this statement: “I prefer not to think about or concern myself with retirement investing until I get closer to my retirement date.”

Moody’s actuarial math concluded that a modest draw down would cause pension fund liabilities to soar owing to a depletion of reserves.188 There is a bill going through Congress to allow public pensions to borrow from the treasury; they are bracing for something.189 This is a tacit bailout being structured. The Fed cowers at the thought of a recession with good reason: Can the system endure 50% equity and bond corrections—regressions to the historical mean valuation? What happens when monumental claims to wealth—$200 trillion in unfunded liabilities—far exceed our wealth? Laurence Kotlikoff warned us; we are about to find out.190 Beware of any thinly veiled claim that the redivision of an existing pie will create more pie.

My sense is that we are on the cusp of a phase change. Stresses are too large to ignore and are beginning to cause failures and welched promises. Runs on pension funds akin to runs on banks would be deadly: people would quit working to get their pensions. At this late stage in the cycle, you simply cannot make it up with higher returns. Enormous appreciation has been pulled forward; somebody is going to get hosed. It’s only fourth grade math. Bankruptcy laws exist to bring order to the division of limited assets. We got into this mess one flawed assumption at a time.

On a final note, there is a move afoot to massively reduce contributions to sheltered retirement accounts. This seems precisely wrong. (I have routinely sheltered 25–30 percent of my gross income as a point of reference.) Congress is also pondering new contributions be forced into Roth-like accounts rather than regular IRAs. I have put a bat to the Roth IRA both in print191 and in a half-hour talk.192 Here is the bumper sticker version:

  • Roth IRAs pull revenue forward, leaving future generations to fend for themselves;

  • Fourth grade math shows that Roth and regular IRAs, if compounded at the same rate and taxed at the same rate, provide the same cash for retirement.

  • Roth IRAs are taxed at the highest tax bracket—the marginal rate—whereas regular IRAs are taxed integrated over all brackets—the effective tax rate.

If you read a comparison of Roth versus regular IRAs without reference to the “effective” versus “marginal” rate, the author is either ignorant or trying to scam you. Phrases like “it depends on your personal circumstances” are double-talk. This synopsis of a Harvard study has two fundamental errors: Can you find them?

“If a worker saves $5,000 a year in a 401(k) for 40 years and earns 5% return a year, the final balance will be more than $600,000. If the 401(k) is a Roth, the full balance is available for retirement spending. If the 401(k) is a traditional one, taxes are due on the balance. Let’s say the person’s tax rate is 20% in retirement. That makes for a difference of $120,000 in spending power, which a life annuity will translate into about $700 a month in extra spending.”

~John Beshears, lead author of a Harvard study

Inflation versus Deflation

“Deflation does not destroy these resources physically. It merely diminishes their monetary value, which is why their present owners go bankrupt. Thus, deflation by and large boils down to a redistribution of productive assets from old owners to new owners. The net impact on production is likely to be zero.”

~Guido Hülsmann. Mises Institute

“My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target.”

~Lael Brainard

“Inflation is a tax and those least able to afford it generally suffer the most.”

~Esther George, president and CEO of the Federal Reserve Bank of Kansas City

“Barring major swings in value of the dollar, inflation is likely to move up to 2 percent over the next couple of years.”

~Janet Yellen, Federal Open Market Committee chair

Barring major swings in the value of the dollar? What kind of circular reasoning is that? The Fed tells us inflation is too low relative to their arbitrary 2 percent target. I say they are lying—through their teeth—and I have company. John Williams of ShadowStats has been ringing the alarm for decades, currently putting inflation at 6 percent compared with official numbers of less than 2 percent (Figure 28).193 A study by the Devonshire Group concurs with Williams.194 The most notable support for the official consumer price index (CPI) inflation numbers comes from MIT’s Billion Prices Project (BPP). I hammered this in 2014 and repeat it here.195 Rumor is that the BPP is reverse-engineered to match the CPI, presumably to maintain credibility while usurping the CPI market share by claiming a bigger sample size. The BPP is statistically flawed, ironically, because its sample size is too large. There is no way to statistically weight a billion prices. Ask the creator (Roberto Rigobon) how he does it. I did.

Figure 28. CPI-based versus ShadowStats-based inflation.

Many cite fantastic product improvements to justify low inflation numbers. The price of front-edge tech is always dropping. Having a supercomputer in your pocket is cool and getting cheaper on a performance-adjusted basis. Yes: that stuff is deflationary. Nonetheless, every one of those rug rats you sired necessarily owns one along with the bigger laptop version and requisite Internet connection fees. The digital world is not making paychecks go further. More to the point, however, no savings on your tech tools and toys can possibly offset the soaring tuition, food, healthcare, and rent that account for a vast percentage of a lifetime consumption. But, hey, at least you have a cool $1,000 iPhone 8!

“The deflation devil is gone.”

~Jens Kramer, NordLB

The divergences of the CPI from alternative measures began decades ago and have gotten progressively worse. The discrepancies trace to tricks like “hedonic adjustments” and “substitutions” that would in any other setting euphemistically be called “bullshit.”196 Hedonically adjusted car prices are reported to have been flat since the late ’90s; the median price rose 73 percent.197 Nobody seems to correct for the fact that the stuff we buy has the life expectancy of a fruit fly and can’t be repaired. The fraud is motivated by cost-of-living adjustments in government payouts that would soar if tethered by reality. The fudge also causes the reported inflation-corrected GDP to be grossly overestimated (Figure 29), which makes politicians and central bankers look good. (The GDP has its own goofy fudge factors, too, like payments by you to you for mowing your lawn.) There is, of course, the fact that every interest-bearing asset requires the system have more money at the end of the year to pay the interest in lieu of offsetting losses elsewhere. The miracle of compound interest requires a compounding money supply. Read that one again. Take the time to watch physicist Albert Bartlett discuss exponential functions.198

Figure 29. CPI- and ShadowStats-adjusted GDP.

Inflation also creates an insidious taxation that confounds most investors. Consider two hypothetical scenarios in a 10-year investment:

(A) Six percent nominal annualized gain negated by +6 percent annualized inflation;

(B) Six percent nominal annualized loss negated by –6 percent annualized inflation (6 percent deflation).

The inflationary 80 percent nominal gain in Model A feels a lot better than the deflationary –48 percent nominal loss in Model B. But adjusted for the two ’flations, they are necessarily equal—they both sported precisely 0 percent real return. But that is not really true. In the inflationary case, your 80 percent nominal gain gets tagged with a 20 percent capital gains tax, bringing your real return over the decade to –16 percent! The technical term for that is “loss.” If taxes are meted out annually, the loss is closer to –20 percent. By contrast, the dreaded deflationary nominal loss leaves you with the same buying power (zero percent loss), no taxes, and a potential tax write-off against future gains. How odd: a ’flation-adjusted return in a deflationary environment costs you nothing and the State gets nothing. By contrast, the inflationary environment causes you to forfeit 16 percent of your assets to the State. Gains resulting from the inflation component are not just zero, but net losses after taxes. The windfall profit for the State from printing money for free and the taxes on the inflationary gains leaves little wonder that the State likes inflation.

“If one is completely honest, how much do we really know about the inflation process?”

~Claudio Borio, Bank for International Settlements

The Phillips curve—the relationship between low unemployment and high inflation and vice versa (Figure 30)—appears to be flummoxing the Fed governors. Why is inflation low concurrent with low unemployment? This is yet another conundrum resolvable with low-level neural activity. Both inflation and employment stats are unsuitable for wrapping fish. Moreover, claims of a tight labor market are really employers being unable to pay new employees the going wage. Supply–demand curves meet at price, but employers refuse to go there because, quite simply, the economy has a degenerative rot (see “Economy,” above).

Figure 30. Phillips curve created by William Phillips.

A point that I’ve made before but feel compelled to dwell on199 is that the most hidden inflation of them all is accelerated depreciation. If you create wealth at the same rate you consume it, depreciate it, or destroy it, wealth will not compound. Any apparent compounding is in the metric of wealth—inflation. That said, the garbage I buy depreciates very quickly. My house and its contents are depreciating assets on a tear. What used to last 20 years lasts one-tenth of that. Consequently, any adjustment for inflation must include depreciation.

“What fraction of nominal gains at the top of the distribution gets eaten up by disproportionately high-price inflation for status goods? That is, some of this just means higher prices for fine art and Hamptons real estate, not standard of living gains.”

~Josh Barro, Business Insider, explaining how inflation hurts the rich

"What is a dick?"

~Austin Rogers, Jeopardy

The velocity of money is, in simple terms, the sum of financial transactions divided by the money supply. It stands to reason that if you jam money into the system (the denominator) via quantitative easing and other dubious monetary policies, the velocity of money will necessarily drop, particularly if you saturate the financial system, as shown in Figure 31. This figure also shows what the Fed chooses to ignore—asset inflation. We'll see that again in the section on bonds. The Fed and markets seem to interpret low velocity as a low inflation risk. The money velocity in Weimar Germany also plummeted—twice even—but then it took off like a discharging monetary capacitor (or smacking the bottom of a ketchup bottle).200 Once faith in the money erodes, it starts moving in highly inflationary ways. The “Financial Stability Monitor” of the U.S. Department of the Treasury shows that inflation risk and contagion risk are very, very low.201 Even if true—it’s not—it won’t last forever. On a final humorous note, workers at the Bank of England may strike for a pay raise to counter rising prices. These blokes are unable to hedonically adjust their lifestyles.

Figure 31. Velocity of money versus the S&P 500.

Let’s take a protracted walk down memory lane to see what uncontrolled inflation looks like at the street level:

“Along with the paradoxical wealth and poverty, other characteristics were masked by the boom and less easy to see until after it had destroyed itself. One was the difference between mere feverish activity, which did certainly exist, and real prosperity, which appeared, but only appeared, to be the same thing. There was no unemployment, but there was vast spurious employment—activity in unproductive or useless pursuits. The ratio of office and administrative workers to production workers rose out of all control. Paperwork and paperworkers proliferated. Government workers abounded, and heavy restraints against layoffs and discharges kept multitudes of redundant employees ostensibly employed. The incessant labor disputes and collective bargaining consumed great amounts of time and effort. Whole industries of fringe activities, chains of middlemen, and an undergrowth of general economic hangers-on sprang up. Almost any kind of business could make money. Business failures and bankruptcies became few. The boom suspended the normal processes of natural selection by which the nonessential and ineffective otherwise would have been culled out. Practically all of this vanished after the inflation blew itself out.”

~Jens O. Parsson, The Dying of Money, on the great Weimer inflation

“Let us at least hope that the great monetary misadventure has burned itself out. In the wrong circumstances, such a doctrine is a formula for asset bubbles and deranged financial cycles, and that is precisely what events have conspired to produce.”

~Ambrose Evans-Pritchard, editor of the Daily Telegraph


“Observe Mr. Bond, the instruments of Armageddon.”

~Stromberg in The Spy Who Loved Me

It is difficult to cordon off bonds, debt, banks, pensions, etc. This section focuses on some of the zanier aspects of dumb creditors. Bonds are like stocks: low yields reflect appreciation pulled forward, appreciation that you will not get prospectively. As a rule of thumb, the nominal return on bonds is approximated by the interest rates. What are the odds, eh? That estimate is the upper limit, however, because defaults become large as rates rise. The paradox of the new-era bond market is that monetary inflation, rather than scaring the credit markets and driving up yields, has charged into bonds to drive the yields down. Once rates start rising, banks tighten lending, which causes high-risk creditors to roll over their debts at higher cost . . . or default. Delinquencies beget delinquencies, and the edifice begins to crumble. When the 36-year secular bond bull market finally ends, duck, because it's gonna get fugly.

“If 2.60% is broken on the upside—if yields move higher than 2.60%—a secular bear bond market has begun.”

~Bill Gross, the former Bond King

“If we take out 3 percent in 2017, it’s bye-bye bond bull market. Rest in peace.”

~Jeff Gundlach, the new Bond King

The $13 trillion in bonds returning negative nominal yields is exceedingly likely to cause catastrophic damage because it represents colossal losses before inflation adjustments. The idiocy of negative rates was concocted by men and women attempting to be important. As we ponder some bond anecdotes, ask yourself whether bonds have adequate risk premia to protect against their two arch nemeses: inflation and default. Are you counting on selling your bonds to someone who is even more gullible than you, possibly even a sovereign state in a bailout?

“The idea of negative nominal interest rates takes some getting used to, but it should be possible to persuade the public that such flexibility is well worth it to provide better employment security and more secure lifetime savings.”

~Marvin Goodfriend, professor of economics at Carnegie Mellon University

“I find a lot of what is written by representatives of the financial sector—they’re very hostile to negative rates—to be kind of ignorant.”

~Ken Rogoff, professor of public policy and economics at Harvard University

"Mainstream economics had come to rest on a number of gloriously improbable assumptions."

~Edward Chancellor

We begin with the gold standard—the U.S. sovereign debt. Wonky folks often extol the virtues of low rates, noting that the U.S. should borrow as much money as possible because it’s cheap! We as a nation can sell 30-year bonds at less than 3 percent yield. Would you lock in less than 3 percent for 30 years? I wouldn’t buy those with your money, but somebody will own those bonds for the next 30 years. Economists estimate the rate on a 100-year U.S. bond should be around 4 percent.202 That’s a darker kind of stupid. Treasury Inflation-Protected Securities (TIPS) are priced to earn approximately 0.50 percent;203 try to live off $5,000 (before taxes) for every $1 million in savings. The Fed took control of the bond market to force us to look elsewhere for returns. Let’s reach for more yield and see where it takes us.

“More people have died reaching for yield than at the point of a gun.”

Staying in the U.S., you could get Apple 30-year bonds for about 1 percent over the treasuries.204 Will Apple exist in 30 years? Will you? Amazon—that wonderful juggernaut—offers 10-year bonds that pay less than 1 percent over treasuries. Illinois is within a whisker of being the first state to have its bonds rated as “junk,” which has caused yields on their 10-year bonds to “soar” to 4.8 percent.205 I think they will find a legal default mechanism before you get your money back. Hartford municipal bonds are already junk. I can’t imagine buying bonds deemed worse than those in Illinois. Inflation in Germany is heading for 2 percent with 10-year bonds around 30 basis points (0.3 percent), but maybe you can make it up with risk-parity leverage.

“As banks are the transmission mechanism of monetary policy, we all have to wonder why central bankers think that damaging bank profitability is a good strategy.”

~Peter Boockvar, Lindsey Group

There was a fledgling bond rout in Japan, prompting the Bank of Japan to put a bid under its 10-year bonds to keep rates at 0.11 percent.206 Nothing there. The Japanese bond market is so dysfunctional that there are days in which not a single bond trades.207 The nearly $2 trillion Chinese bond market showed an inverted yield curve suggesting that something is seriously wrong.208 Europe is also bad. It’s the home of negative interest rate policy. I’ll pass on losing money like that. Irish 5-year paper paid 17 percent six years ago and now has negative yields.

“When there’s in fact no apparent difference anymore between euro junk bonds and U.S. treasuries, then all kinds of bad economic decisions are going to be made and capital is going to get misallocated.”

~Wolf Richter, Wolf Street blog

The real toxic brew was generated when Mario Draghi’s QE targeted corporate bonds, taking possession of 15 percent of all eligible European corporate bonds and driving yields on high-yield corporate bonds below those of U.S. treasuries (Figure 32). To clarify, they are called “high-yield” bonds because “junk bonds” sounds bad, and “widow-making sacks of shit” suffers serious branding issues. Quality European corporate bonds have, by proxy, become way overpriced too: Nestle now has negative-yielding bonds (and chocolate bars with negative calories).209 You can get positive yields on Austrian 100-year “century bonds.”210 Recall that we were bombing the hell out of them only 70 years ago. Draghi said he would “do whatever it takes,” which translated to the purchase of $2.6 trillion in QE (monetary bestiality). Those who took him at his word in 2012 have made 1,000 percent returns on friggin’ bonds.211 You must also do whatever it takes too—whatever that means now.

Figure 32. European high-yield corporate bond yields relative to treasuries.

Now let’s try groping for yield. According to Stuart Culverhouse, chief economist at Exotix Partners, “there is strong appetite for frontier issues—and markets have taken the Federal Reserve tightening policy in their stride.” The phrase “strong appetite” means that the nutjobs are already in the markets. “Frontier” is where law and order comes from the barrels of AK47s. Culverhouse alerts readers to upcoming issues from Sri Lanka and Papua New Guinea.212 I imagine the bonds are covenant-lite too. A Nigerian 30-year series sold at 7.6 percent.213 Recall that Nigerian princes often solicit your help moving their assets offshore. ZeroHedge rhetorically asked, “When does North Korea come to the market?”

"Junk Bond Fever Hits a New High in Tajikistan"

~Bloomberg headline

We should probably go south of the border, if only for entertainment’s sake. Argentina has issued a MOAB (mother of all bonds)—a 100-year bond that yields 8 percent. For those keeping score, the gauchos have defaulted six friggin’ times in the previous 100 years. There is no chance the buyers of those bonds assumed a free-market-based profit (cough*bailout*cough). Venezuelan 10-year bonds are currently returning 32 percent with inflation at 900 percent.214 They were denominated in dollars, which means the socialists held the duration risk while the bond holders retained the default risk. I’m using past tense because they defaulted.215 For inexplicable reasons, Trump banned the trading of Venezuelan bonds.216 Does anybody really need to be banned from this? In the category of “I’m not making this up,” Goldman got an exemption.

Our last stop is Puerto Rican municipal bonds. Puerto Rico has more debt than any state except California, New York, and Massachusetts. Kyle Bass noted they owe $50,000 per worker when you include off-balance-sheet crap.217 They’re never gonna pay up. Kyle said maybe 10–20 cents on the dollar after a “record-setting bankruptcy.” This analysis was before the hurricanes squeegeed every last tangible asset off the island. According to Cate Long, less than 25% of Puerto Rican debt is held by hedge funds, and the bonds have been in technical default since 2015.218 Bass’s comrade, Seth Klarman of Bauposte, was sitting on over $1 billion of these things that, for reasons beyond me, were held in various well-concealed shell companies.219 Klarman has tricks up his sleeve, but it seems clear that owners of Puerto Rican debt are explicitly betting that insolvency will be precluded by interventions.

When the headlines read that we “forgave” or “wiped out” sovereign debt for some banana republic, we are not doing God’s work. We are sending your dollars directly to the banks that are on the hook. This is cronyism of a higher order, not free-market capitalism. Once the hurricane hit Puerto Rico, The Donald chimed in:

“You know they owe a lot of money to your friends on Wall Street. We’re gonna have to wipe that out. That’s gonna have to be—you know, you can say goodbye to that. I don’t know if it’s Goldman Sachs, but whoever it is, you can wave goodbye to that.”

~Donald Trump

My read says he is telling the banks to swallow it. One could imagine that the Trumpster has few if any warm memories of bankers from his multiple bankruptcies. His utterances caused a rout in Puerto Rican bond prices. A bill in Congress allocated billions of hurricane aid (and bailed out the highly subsidized and fully insolvent National Flood Insurance Program),220 but it does not appear to have explicit debt bailout. Nonetheless, it is suggested that “creditors will be lining up to try to claim portions of the aid intended for Puerto Rico, a complication democrats in Congress are working to sort out.”221 NPR suggests that wiping out the debt “would be a drastic and highly unusual intrusion of the government into the debt markets.” Unusual intrusion into the debt markets? Sure.

“Be careful what you wish for, Ray [Dalio]. You may find that risk you are looking for and then some. Unwinding risk parity funds will add some serious fuel to the inferno. Bridgewater Associates will probably apply for bank status late some Sunday night.”

~David Collum, 2015 Year in Review

“It will be a lively day on Wall Street if, in response to an upside spike in volatility, risk-parity portfolios have to unwind all at once.”

~James Grant, writer and publisher, October 6, 2017

Ray Dalio brought us “risk parity” investing: you lever up your bond portfolio to achieve the equivalent risk and, by implication, returns on bonds relative to equities.222 I’ll take the other side of that bet: real risk parity might be achieved by having fewer dollars committed to bonds than equities. James Grant made some pointed assertions that Ray Dalio is doing some very quirky (and even dubious) things of late,223 which no doubt pissed off Ray. Mark Yusko claims that Ray retained enough marbles to exit his risk parity trade, leaving others to wonder what happened when the bond rout arrives. The possible unwinding of risk parity trades prompted Goldman to suggest that “as an alternative to bonds and given little potential for diversification across assets, we remain overweight cash.” The junk bond market has seen some big outflows and looks ready to topple. Junk bond funds are now buying equities.224 Bad decisions make good stories.

“Liquidity that has been pumping up the markets will be drying up in 2018. . . . We’ve been in an artificially inflated market for stocks and bonds largely around the world.”

~Jeff Gundlach


“We are trying to preserve conglomeration. . . . There will be another financial crisis. And it will pop out. And we’ll all say, ‘How did it happen?’”

~Henry Kaufman, legend of Wall Street

More than scandals in any other industry, banking scandals follow the business cycle, which means they are currently in a period of relative calm. That said, Wells Fargo’s problems continue to mount, as estimates of the bogus accounts first reported in 2016 nearly doubled to 3.5 million.225 Almost a million auto loans were tagged with unnecessary (and difficult to cancel) insurance policies reputed to push a quarter million drivers into delinquency and create a pile of wrongful repossessions.226 Management is gobsmacked at how this occurred right under its nose. Reserves for legal costs are in the many billions.227 Warren Buffett, a big fan of owning well-managed companies and the largest shareholder of Wells Fargo, could not be reached for comment. Meanwhile, Wells Fargo director Elaine Chao joined the Trump administration, but not before collecting a $5 million bonus paid to all banking executives for taking government jobs to continue working for the banking industry.228

Bankers haven’t gone to jail because they haven’t committed crimes

~Wall Street Journal headline

Speaking of non-criminal behavior, the U.S. Supreme Court ruled that a municipality can sue banks under the Fair Housing Act of 1968 for preying on people of color and saddling them with high-risk loans. The investigation of the infamous London Whale who lost billions of dollars for JPM got dropped—vaporized, to use an MF Global term—without explanation. Prosecutors claim that he was hiding offshore and refused to come when summoned.229 It’s unclear which JPM office he works at now. Monte dei Paschi di Siena—Didn’t they die?—has earmarked 1.5 billion euros to compensate retail junior bondholders who were, technically speaking, “reamed out” by deceptive sales tactics.230 Retail senior bond investors will be reimbursed by the Italian government.230 Only Italian debt holders will be paid back, while those outside of Italy will get hosed. The entire Italian banking system is a hot mess. Bailouts are following the usual playbook: the banks get to keep the good stuff, and taxpayers get the bad.231 Heads I win, tails you lose. Nothing changes. On the bright side, Vietnam gave the death penalty to bank frauds. Odd that it gets called “third world.”

I’ve droned on incessantly about depositors in banks getting nothing for their hard-saved capital. Bank of America, for example, paid $200 million in interest on $500 billion of deposits while those same retail depositors paid $4.1 billion in fees, which corresponds to a negative interest rate of 0.64 percent.232 On the bright side, Interactive Brokers established a “Stock Yield Enhancement Program” that enables clients to participate in picking up extra yield by allowing their shares to be lent out for shorting.233 Isn’t that how it used to be done?

Despite favorable borrowing rates and end-of-cycle booms, stresses in the banking system can be detected. Banks are not that profitable owing to central bank policies. Chris Whalen notes that Citigroup has picked up the synthetic collateralized debt obligation (CDO) pipe once again in what is likely an epic reach for yield.234 The word “synthetic” is always a red flag. A CDO is “a product that fraudulently leverages the real world and literally caused the bank to fail a decade ago.” The too-big-to-fail crowd is, once again, using dubious off-balance-sheet derivatives, which illustrates that, and I quote Chris,

“The large banks cannot survive without cheating customers, creditors and shareholders . . . and, eventually, will suffer a catastrophic systemic risk event.”

~Chris Whalen, Risk Analytics

The bank derivative positions (Figure 33) are huge. I am well aware that those are notional values, but the trick of “netting”—cancelling positions like you factor equations in algebra—failed in ’09 and will fail in the next crisis because crises don’t wait for humans to catch up. The only thing worse than “excessive” leverage is excessive off-balance-sheet leverage. Deutsche Bank continues to struggle and seems likely to be at the heart of the next banking crisis. If you would like an incisive description of what the money markets looked like from inside the system during the last crisis, check out this link.235

Figure 33. Top 25 bank assets ($8 trillion) and derivatives ($230 trillion).

Corporate Scandals

“Would you like to pay the $50 upcharge to not be beaten unconscious in an overbooking re-accommodation situation?”

~United Airlines (not)

The shenanigans of corporate America are always a source of considerable entertainment. Some are hunormous, posing existential risk, whereas others simply make you wonder who is driving that cab (like when the CEO of Uber got in a kerfuffle with an Uber driver on camera.)236 The transportation industry was on a roll.

Airlines became frequent flyers in the mile-high club. United booted two women for wearing yoga pants.237 I can only imagine. EasyJet bumped a kid off a flight and abandoned him unsupervised.238 The big story, however, was when United kicked a doctor off a flight, breaking his nose in the process.239 An out-of-court settlement within the week probably made the good doctor some serious money and tainted the “fly the friendly skies” slogan forever. The plot within the plot is that the free market was subverted. If the flight attendants had the authority to up the bid—they did not—or if the airlines sold cheaper tickets to passengers willing to risk getting booted, both parties would have parted ways satisfied.

Once passengers got grumpy, all hell broke loose. American Airlines got sued by a passenger who claims to have been crushed between two obese passengers.240 For a brief moment, laptops were banned from air flights from Europe.241 The reversal of that bit of genius was predictable. A passenger threw such a shit fit over a $12 blanket that Hawaiian Airlines had to divert the flight.242 A man was thrown out of a plane in Mexico—not off the plane, out of the plane.243 He landed on a hospital (no joke) but had lapsed in paying his Obamacare premiums (joke).

“I think all CEOs should keep their mouths shut. You want to be a political pundit? Go on CNN.”

~Caller to talk radio

Politics crept into the boardroom, often with no obvious gain and dubious results. The Camping World CEO told Trump supporters to shop elsewhere, somehow missing the subtlety that the Field & Stream crowd might include more than a few Trump supporters.244 A Pepsi commercial depicted one of the Kardashians breaking the ice with Orwellian police in a scene right out of 1984.245 Target took an overt and very progressive stand supporting the notion that you should use whichever bathroom you identify with, forgetting that their customers are demographically a bunch of parents.246 The Starbucks CEO announced he would hire 10,000 refugees.247 Potential domestic baristas were not happy. Walmart was forced to apologize for a sign marketing a rack of guns as back-to-school supplies.248 A Keurig spokesperson tweeted that the company tried to pull its ads on Sean Hannity’s show because of a controversial guest, forgetting that those who would be offended by his guests don’t watch the show. Youtube filled with scenes of creative destruction (smashing Keurig coffee makers).249 Sean overtly helped Keurig pull their beans from the fire (possibly for additional remuneration).250 A Google employee on her way out the door cancelled the account of Twitter's most famous poster, Donald Trump (Figure 34); Kellyanne thanks you for trying.

Figure 34. Trump supporting Twitter employee cancels Trump’s Twitter account.

Poland Spring got in hot water for selling bottled tap water.251 You gotta love the profit margin on that product. By the way, anybody who is buying bottled water while not fully funding their 401(k) and paying off all debts public and private is more than a few quarts short. Kobe Steel got caught faking quality standards for the last 50 years.252 Its credit default swaps have soared, suggesting that more problems are coming. Amazon got grief for its searches being biased toward placing more expensively priced products as top links. That’s not a scandal—it’s how the world works.

Over at Equifax, 143 million accounts got hacked—a little ironic for a company that monitors credit records and protects against identity theft.253 The fun started when three senior executives were outed for selling shares after the company discovered the security breach but before it was announced.254 Bond rating agencies tagged their “less than creditworthy” bonds with downgrades.255 Customers scampered over to LifeLock, not realizing it purchases data from Equifax. Few may recall that the LifeLock CEO posted his social security number on a truck to demonstrate his conviction in his own product and then got his identity stolen 13 times.256 And when you thought the bottom had been plumbed, Equifax sent out an email asking people to check their accounts—sounds like a phish—by making customers agree not to sue them.257 Soon thereafter, Uncle Sam hired Equifax to safeguard taxpayer data.258

The Fed

“I find myself more and more relying for a solution of our problems on the invisible hand which I tried to eject from economic thinking twenty years ago.”

~John Maynard Keynes

“Fed officials are launching a political campaign to retain their vast discretionary control over the American financial system. The brazenness of the effort shows how far afield central bankers have roamed from their traditional remit of monetary policy. . . . [T]he Fed has succeeded in lifting some asset prices, and no one knows what will happen to those prices once the Fed begins unwinding its portfolio. (Yes we do!) . . . You have to ignore history to believe that regulators are suddenly so wise that they know the current regulatory regime will prevent the next crisis.”

~Wall Street Journal Editorial Board

The Fed governors—including a few ex-Fed governors—seemed particularly rudderless this year. In the spirit of David Letterman, I begin with “Stupid Fed Tricks” interwoven with some of the Fed’s most enthusiastic detractors.

“A return to a reasonable pattern of home equity extraction would be a positive development for retailers and would provide a boost to economic growth. . . . The previous behavior of using housing debt to finance other kinds of consumption seems to have completely disappeared.”

~Bill Dudley, president of the Federal Reserve Bank of New York

“Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road—either too much inflation, financial instability, or both.”

~Janet Yellen, after 8 years of waiting too long

“What Yellen had to say doesn’t even reach the status of babbling; it was flaming incoherence.”

~David A. Stockman (@DA_Stockman)

“The good news is that, while the current expansion is quite old in chronological terms, it is still relatively young in terms of the health of household finances.”

~Bill Dudley

“Are you kidding? Are you kidding? No one knows what you’re doing.”

~ John Taylor, economist, replying to Bill Dudley’s claims of clarity

“There doesn’t seem to be any risk to keeping rates low and lots of benefits to it.”

~Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis

“Each and every subsequent economic and financial hiatus has been a direct result of excessively loose monetary policy to clear up the previous mess. The current perilous state of the global financial system is evident to anyone who scrapes at the cheap veneer of normality. . . . The Yellen Fed is no longer data dependent, but is instead thinking of its legacy.”

~Albert Edwards, Société Générale

“Maybe our rate hikes are actually doing real harm to the economy.”

~Neel Kashkari, president of the Federal Reserve Bank of Minneapolis

“If there’s a future crisis and we really need people to believe in us, we’ve earned and established that credibility.”

~Neel Kashkari

“I don’t think you have to have a PhD in Economics . . . to be Fed chair or governor or president of the Federal Reserve Banks.”

~Bill Dudley, GED

“The Federal Reserve might have PhDs from great Ivy League schools, but they don’t understand markets.”

~Rick Santelli, CNBC

“The Fed has been reluctant to target equity prices.”

~James Bullard, president of the Federal Reserve Bank of St. Louis (tacitly admitting they target equity prices)

“Normalizing monetary policy will require that the Fed disown the idea that the level of wealth (i.e., financial-asset valuations) is an appropriate objective of monetary policy.”

~Peter Fisher, former Fed Governor

“I actually feel bad for Bullard. The cognitive dissonance between what the job requires and what any thinking human being observes must be crippling.”

~Ben Hunt (@EpsilonTheory)

“Are central bankers twisted geniuses manipulating the markets in order to meet their inflation goals? Or are they bumbling ex-academics whose ramblings are over interpreted by investors besotted with their brilliance?”

~James Mackintosh, Wall Street Journal

And just a few more detractors to pile on.

“The Fed remains incoherent on their objectives and the means used to achieve them.”

~Mike Lebowitz, Clarity Financial, LLC

“For non-gamblers at home that means there’s as much of a chance she’s bluffing as she is full of sh*t.”

~Tony Greer (@TGNY2000), TG Macro, on Yellen

“I think we injected cocaine and heroin into the system and now we are maintaining it on Ritalin.”

~Richard Fisher, former president of the Federal Reserve Bank of Dallas

I have all but given up trying to understand the hubris—the Hayekian fatal conceit—the Fed suffers to conclude that it can and should control the economy. The best economic analyses draw strong analogies from Darwinism, wherein repeated trial and error nudges markets in a relentless quest toward equilibrium. The notion of QE is anathema to free market thinkers, but not new. Tiberius called for it in 33 AD to stem a panic, and just as we have witnessed of late, it worked for a while.259 Those who credit the Fed for saving us from disaster in ’08–’09 ignore two teeny details: (1) they were the root cause of the crisis by fueling and cheerleading a systemically dangerous housing bubble; and (2) the subsequent stick save cost a fortune, and the bill has yet to be delivered. We are way more out of whack now than in ’07. It is reminiscent of WWI failing to correct the imbalances—and actually generating new ones—which made the conflagration in WWII inevitable. The next recession should make my point.

The markets are buoyed by unprecedented QE, also known as batshit-crazy money printing. In case you are tempted to say the Fed is on the sidelines (with the cash, apparently), money is fungible: global money printing creates bubbles globally. We are on target for $3 trillion in global QE this year, $1 trillion more than last year.260 The total since ’09 is quoted to range from $20 to $33 trillion.261 In case you’re wondering what a trillion means, I find this useful:

One million seconds = 11 days ago (your bread is now stale)

One billion seconds = 1985 (Madonna was like a virgin)

One trillion seconds = 32,000 BC (central bankers began to roam Europe)

All this money has done a lot of long-lasting damage to the economy. Savers and wage earners were sacrificed to the Gods of Banking (unless they bought Bitcoin or the FAANGs). Claims that the economy is in great shape are unsupported by the numbers (see “The Economy”). Inflation is not tame, which the monkey-spankers at the Fed would know if they realized that everything “is rising faster than inflation” or if they simply went shopping. Wage inflation, by contrast, is stupendously under control. The Fed gave bankers gobs of money to use during the next crisis and then, by paying interest on reserves at the Fed, compensated the banks for not lending it (except to companies for share buybacks).

“Just a word about money-market mutual funds. They should not exist. Unfortunately, they do.”

~Ben Bernanke, Citadel and former chairman of the Federal Reserve, in 2011 Fed meeting minutes

Bernanke may have, by his own assertion, a huge IQ, but he is dead wrong: the most important price in the world—the price of capital—should be determined by price discovery in the money markets rather than under the jurisdiction of a committee of clueless academics. Past Fed heads have been criticized for causing recessions through Fed-induced monetary contraction. This current gaggle of governors is a cowardly one. The Greenspan–Bernanke–Yellen-era Fed developed a neurodegenerative aversion to the natural restorative forces that corrections have on markets and recessions have on economies.

The current Fed governors have been left with a huge debt overhang and $200 trillion in unfunded liabilities ($2 million per taxpayer).262 Their working model seems to be that they can “inflate it away” without riling markets. Mind you, this notion has been around a long time, but it leaves some yawning unresolved issues. First, it presumes that inflation is some kind of smart bomb. It’s more like a biological weapon, heading where it wants, not where central bankers want. Right now, the inflationary tractor beam is financial assets. The Fed must know this. Second, money is created by creating debt:

“Loans create deposits, not the other way around.”

~Bank of England

Inflating away debt is an Escherian paradox unless you do so by loss of confidence in the money itself.

Third, an oft-stated tenet of the inflate-it-away model is that the inflation must be unexpected. Once the markets and society at large subliminally sniff out the inflation, they begin to adjust. It is no longer unexpected, and the pushback becomes an overwhelming force of nature that can run uncontrollably. I’m not sure I even believe what I just said, but it may explain why the Fed claims inflation is low: it is trying to dupe us.

“We’ve never had QE like this before; we’ve never had unwinding like this before. Obviously, that should say something to you about the risk that might mean, because we’ve never lived with it before. . . . The tide is going out.”

~Jamie Dimon

I believe the Fed governors are terrified of recessions because of the awareness—yes, I believe they have some left—that a recession will cause pensions, municipal budgets, and economically sensitive social structures to break. By contrast, they seem unafraid of inflation out of a misplaced 100% confidence they can control it. Nobody else believes this.

“Inflation cannot be allowed to develop because there would be no way of avoiding a dramatic rise in rates.”

~Aleksandar Kocic, Deutsche Bank

“The Federal Reserve . . . has no clue what they are doing. They are going to ruin us all.”

~Jim Rogers

If the Fed has inflation under control, why do they proclaim ignorance?

“We do not, at present, have a theory of inflation dynamics that works sufficiently well to be of use for the business of real-time monetary policymaking.”

~Daniel Tarullo, former Fed governor

“This year the shortfall of inflation from 2%, when none of those factors is operative, is more of a mystery, and I will not say that the committee clearly understands what the causes are of that.”

~Janet Yellen

“Our understanding of the forces driving inflation is imperfect.”

~Janet Yellen

“If inflation remains in a slump, the Fed may require a shallower path of rate rises.”

~Charles Evans, Federal Open Market Committee

The Fed has kept interest rates “too low for too long” yet again. Dubious claims about tame inflation and the strong economy that don’t square with the numbers are a narrative to justify rate hikes. Many share the belief that the Fed was offered opportunities to lift the rates over the last eight years but stood with the bat on its shoulders, frozen in fear of a 1937-like downturn. It is now forced to raise rates into an economy that is weakening.

“I have confidence in one thing: The Fed will blow it.”

~Robert Rodriguez, FPA Capital Fund

The Fed is also wrestling with what to do about its balance sheet in the aftermath of QE. A chat with Jim Kunstler got me thinking too. I must confess that the transmission mechanism through which a bloated Fed balance sheet causes future economic problems is not in my wheelhouse. That aside, the governors have pondered reducing it very slowly by letting the assets expire,263 but how? The balance sheet expanded when the Fed created money “from thin air” with a simple spreadsheet entry and then bought bonds and who knows what else. By statute, all interest payments (minus expenses) are remitted back to the Treasury. In essence, the interest paid by the Treasury to the Fed gets returned to the Treasury: The Fed monetized Treasury debt (free money). When a bond expires, the Treasury pays the principal to the Fed. So here is the big question: does the Fed extinguish it with the stroke of the same accounting pen that created it, in turn negating the original monetization? Alternatively, the Fed could pass the principal back to the Treasury, making it a permanent fixture of the monetary base. I asked some smart people about this: nobody knew, although David Andolfatto, vice president of the Federal Reserve Bank of St. Louis, was confident the money would be extinguished. Given that remittance back to the Treasury would be inflationary, I'll take the other side of David's bet; the Fed will choose the inflationary path.

“The unpopularity of inflation may be due to reasons that economists find unpersuasive.”

~Ben Bernanke

Unpersuasive? No offense, but you are clueless. Try this one: us plebes are getting donkey-punched by your financially repressive policies. Unfazed by my opinion, Bernanke chimed in with a paradigm-shifting new theory on inflation targeting.264 Instead of trying to stick inflation at 2 percent like a Mary Lou Retton vault, the Fed should pursue “price-level targeting,” which sounds like inflation targeting to me. The distinction is that price-level targeting can, in his words, “‘look through’ a temporary change in the inflation rate so long as inflation returns to target after a time.” He’s had years to ponder this problem, and his grand epiphany is to target an average inflation rate of 2 percent? The cleverness of that solution is impossible to underestimate.

The Fed took money from the savers and gave it to the debtors, who then took out more debt. The patients have now all been bled. Both groups are broke and wages are stagnant. Is it any wonder the economy is stuck? Neel Kashkari wrote an essay explaining why the Fed protects financial institutions during a crisis, but he fails to detect the circular reasoning: the Fed defines a crisis as any time the financial institutions need protection.265 The Fed lacks the DNA to let a credit purge play out. I leave you with a few more words from some veterans:

“While conventional monetary policy boosts economic activity in the pre-crisis period, bond purchases are found to have no statistically significant real effects post-crisis.”

~Bank of International Settlements

“With all the thought and work and good intentions, which we provided, we achieved absolutely nothing. . . . [N]othing that I did, and very little that old Ben [Strong of the Federal Reserve] did, internationally produced any good effect or indeed any effect at all except that we collected money from a lot of poor devils and gave it over to the four winds.”

~Montagu Norman, governor of the Bank of England (1920–1944)

“I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit . . . by the opinion and duress of a small group of dominant men.”

~Woodrow Wilson, after signing the Federal Reserve into existence


“The divide is not between the left and the right anymore but between patriots and globalists!”

~Marine Le Pen, French politician

“Many people are saying that the world and Europe are going a bit off the rails.”

~Angela Merkel, chancellor of Germany

“Let’s hope that nothing is declared tomorrow because perhaps the person who makes the declaration will end up like the person who made the declaration 83 years ago."

~Spanish spokesperson, delivering a death threat to the president of Catalonia

Given that a bad year for Europe is when the entire continent is a raging inferno, life was good. Many geopolitical events—movements of chess pieces—make sense in the context of post-WWII attempts to prevent WWIII.

Europe continues to try to “unlock value” by spinning off components. I’m still trying to figure out whether Brexit is going to happen or if the gaffers and nobs will tell the sods to wank themselves. Secession movements moved from Britain to Spain. Catalonians began seceding from Spain, whose measured response included beating voters senseless and hurling death threats at the Catalonian leader. Catalonians voted 90 percent in favor of secession.266 The Spanish high command said “screw that” and ousted the Catalonian government, which is still stuck in Belgium avoiding extradition. Catalonia will be governed from Madrid by a party that got 8.5 percent of the vote.267 Meanwhile, Spanish bond yields plumbed unbelievable lows. Spain sure looked like a failed state to me, with an insolvent banking system, precisely zero euros in its pension fund, and heading into anarchy and chaos. I stand corrected. At least Madrid solved the “manspreading” problem—the crime against humanity of sitting on a subway or train with your legs apart for thermal regulation—by simply banning it.268

“Europe will be devastated by African refugees if they don’t make it more difficult for Africans to reach the continent.”

~Bill Gates, co-founder of the Gates Foundation

“Immigrants who don’t like The Netherlands’ freedoms should ‘f*** off’ and leave."

~Ahmed Aboutaleb, Muslim mayor of Rotterdam (2015)

Millions of teddy-bear-clutching immigrants from North Africa and the Middle East face challenges settling into their new digs in Europe. There are sovereign battles over how many refugees each country should take. Seems that only Poland has a target number of zero.269 (It has credits accrued for taking in Jews during the early 16th century.270) Rioting in Paris continues in areas that the police refuse to enter.271 France set up a decidedly Orwellian site for Muslims who wish to voluntarily “deradicalize.” There have been no takers.272 Shockingly, lucrative contracts are to be had in the “deradicalization industry." The French are finally getting ahead of the problem: they've banned burkinis (swimwear).273 In Rotherham, UK, cops have been overwhelmed by pressure to create a Sharia-based no-go zone. A Huffington Post article by René Zografos stated, “It’s well known for Scandinavians and other Europeans that liberal immigration comes with drugs, rapes, gang wars, robbery and violence…we see the respective nations’ cultures fading away, for good and for bad.”274 The article was deleted by sundown.

The situation in countries like Sweden and the Netherlands appears dire, with cultural clashes commonplace. Sweden is a superpower of humanitarianism: it culturally seems to take whatever guff comes its way. Those who speak out are called racists or Islamophobes.275 I’m not sure whether the criteria of phobia—irrational fear—is warranted in some cases (vide supra). In one Swedish city, 268 apartments were commandeered by local officials for immigrants while existing residents have been placed on a three-year waiting list.276 Those working at the police station in Rinkeby, Sweden require police escorts to go to work. Sweden has 55 no-go zones at last count.277 At some point, that number will begin to drop as they merge. In high-density neighborhoods, modest garb is being demanded of non-Muslim residents. Given that dogs are “impure”—my three Labs certainly are—dog owners are being told to keep the dogs indoors. Could get a little rank in there. The Swedes response is a little odd: they are proposing an hour-long paid break each week for sex.278

Hamburg authorities took possession of six residential units and are now renovating the properties for immigrants.279 A district spokeswoman noted that “all renovation costs will be billed to the owner.” Ouch. The chairman of the Association of German Administrative Law Judges, says that “courts are now completely stretched to our limits. . . . At some point, everything will collapse.” They are imitating the Swedes (sort of) by setting up bestiality brothels as part of a push for “lifestyle choice.”280 A year after accepting billions of euros to retain millions of refugees, President Erdogan (pronounced er-do-wan or air-jor-dan) threatened to open Turkey’s borders to Europe.281 Of course, Switzerland is way too busy printing money and buying hard assets (like FAANG stocks)282 to worry about immigrants.


“Would the Left’s greatest minds still proclaim the Gospel of Socialism after Venezuela’s collapse? Unlikely.”

~Steve Hanke, professor of economics, Johns Hopkins University

The big story south of the border is Venezuela. The lethal combination of dictatorial rule, socialism, the “curse of resources,” and consequent hyperinflation has created a “failed state.” While getting some help from Russia and China,281 U.S. sanctions and who knows what else nudged the country off the cliff. Nonetheless, the wounds are largely self-inflicted. (As an aside, Overthrow is a much better look at the U.S.’s role in toppling governments than Confessions of an Economic Hit Man.)

Hyperinflation reached more than 4,000 percent by November while the bolivar headed to zero (Figure 35). You lose half your spending power in a week at that rate. They tried the standard “out with the old, in with the new” currency swap ploy, which never solves the problem without structural reform. It didn’t this time either; they are flirting with establishing their own oil-backed cryptocurrency even though they seem incapable of producing oil now.282 Although Venezuela has the largest reserves of crude oil in the world—296 billion barrels—its production collapsed because, well, that’s what happens in failed states. The country degraded into anarchy and defaulted on its sovereign debt. In the unlikely event the U.S. does a humanitarian debt forgiveness, it will merely be to give money to influential banks who bet that we would bail them out.


Figure 35. Venezuelan hyperinflation and the value of the bolivar.

Venezuela is a case study in life during the zombie apocalypse. Angry mobs— quite literally millions of people—rioted in the streets.283 Gangs of marauding bikers using Molotov cocktails robbed tractor trailers—full Mad Max.284 Venezuelans are starving, losing an average of 19 pounds in 2016.285 I suspect that they lost more in 2017. Although citizens in the U.S. are getting rather numb to scandals, in Venezuela, footage of a portly dictator eating an empanada raised eyebrows.286

North Korea

“Little Rocket Man . . . We’re going to do it because we really have no choice.”

~Donald Trump

Things are heating up in North Korea—or at least that’s what we’re told. I sensed this in 2016 when the rhetoric demonizing Kim Jun Un (K’Jun or L’il Kim) ramped up. Of course, he is a bad dude—demonizing him is trivial—but the volume and frequency was the tell. K’Jun played into our hands by sending American tourist Otto Warmbier home in a basket after the putative hijinx of stealing a banner.287 Whether he did it or not, Warmbier should get a Darwin Award for merely traveling to North Korea. China was rumored to be preparing to whack K’Jun and install his brother, Kim Jong Nam, until somebody—K’Jun maybe—whacked Mr. Nam. Two apparently white women swiped Nam with nerve-gas-impregnated ointment and then claimed they thought it was a spoof. The message was similar to the message sent when a Roosky got offed using plutonium. In any event, it would be logical that it was K’Jun's doings. . . or somebody making it look like K’Jun assassinated him . . . or somebody else making it look like the first somebody assassinated him. Whatever.

We’re told that K’Jun launched rockets that could destroy Earth with footage serving as trailers for WWIII. Seems a little unnerving. The baffling part is that propaganda footage coming from the north invariably shows K’Jun with his 65-pound big-hatted generals (Figure 36) displaying military weaponry that he got because he didn’t sell enough flower seeds to get the coveted Daisy BB gun. Alternatively, his armaments were grabbed from the “free” table after a circa 1950 global military–industrial arms show. These rather elaborate shows are where the U.S. sells weapons to its enemies . . . such as the North Koreans.288

Figure 36. Kim Jun Un and the North Korean Navy.

One theory is that we have wars to teach ourselves geography. Maxine Waters confused Crimea with North Korea. I would expect nothing less. An online survey showed that few could identify North Korea on a map (Figure 37). No problem, because for a while at least, it looked like North Korea soon wouldn’t be on any maps.

Figure 37. Survey showing putative locations of North Korea.

"[Trump] has dispatched Maxine Waters to NOKO to talk to Lil Kim. After 1/2 hour with her he will drink whatever he gave to his 1/2 brother."

~Mike Huckabee


“If command and control economies worked, we’d all be speaking Russian.”

~Kyle Bass, Hayman Capital

China is approaching superpower status if it is not already there. Like everybody else, I don’t really have a clue what’s happening, but China is key. Trump played a game of chicken with China over North Korean strategy. (I hope it’s a strategy.) The world was too busy criticizing The Donald to notice that China blinked: they banned steel and coal imports from North Korea and forbid business owners from transactions with North Korea to satisfy UN mandates.289 North Korea is very much China’s problem, and they will probably deal with K’Jun at some point.

I suspect several big issues are in China’s interest: (a) establishing a petro-yuan—a market for oil denominated in yuan to unseat the dollar as the reserve currency, (b) creating (in conjunction with Russia) an alternative to the euro-dominated banking system (specifically the SWIFT check-clearing system290) because of our tendency to use it as a blackmail device, and (c) surviving the next recession without losing control of its banking industry or the masses.

The dollar has been the global reserve currency since the fateful Bretton Woods Conference in 1944.291 It is a mixed blessing in that we get to print dollars recklessly, and the world absorbs them. The problem, however, was described by Robert Triffen and is called Triffen’s dilemma or paradox.292 The requisite trade imbalance eventually destroys your currency (Day of the Triffens). Reserve currency status is a suicide mission in which you get the 72 virgins up front. China seems positioned to take on the burden, as evidenced by aggressive gold purchases (see Figure 17) and increasing numbers of bilateral trade agreements and exchanges. It buys oil from the Saudis, oil and other resources from the Russians (maybe uranium with help from the Clintons?), and gold from a number of countries using newly formed gold exchanges.

“China is the largest global imbalance that I’ve ever seen in my life.”

~Kyle Bass, on China’s $40 trillion in debt

A few obstacles stand between China and global domination. It has expanded credit at an annualized rate of 25 percent for years, causing huge distortions in its banking system.293 It also has a two-tiered economy: a vibrant private sector and stagnant state-sponsored economy. Luke Gromen says that if US dollar printing goes supernova to cover $200 trillion in unfunded liabilities—$1–2 million per taxpayer—it will also break China if the petro-yuan is not firmly established.294 China’s stock market is now state sponsored (supported by central planners). It has the same kind of record-breaking streaks as US markets without corrections. Admittedly, all equity and bond markets are state sponsored, but misery will not love company; it never really does. China’s yield curve just inverted:295 short-term interest rates rose above long-term rates. Pundits will claim it doesn’t matter this time, which will coincide with China entering recession. Then we begin to probe the durability of its banking and social structures under stress.

“Considering the pace of the slump, which is very fast, it’s fair to say we are likely in a bond disaster.”

~Qin Han, Guotai Junan Securities, on the yield curve inversion

How dangerous is China’s next recession? It has a truly gargantuan 300 percent debt-to-GDP ratio.296 Its banks have “ghost capital,” rehypothecated (repeatedly) to support this mountain of debt and rendering debts essentially uncollateralized.297 Pundits around the globe raved about China’s Forex reserves to protect them.298 The U.S. had them in the 1920s, and Japan had them in the 1980s. How’d they work out? China’s reserves have already dropped 25 percent since 2014.299 A thorough report by Myrmikan Capital describes in lurid detail the near tripling of China’s bank assets since 2008 to stimulate the smokestack industries.300 It concluded that “the insanity is unwinding.”

“China is done.”

~Myrmikan Capital

If you think big change will occur seamlessly, you might be optimistic. I was amazed that beginning in the early ’80s, China sent its best students to the U.S., many never to return. In retrospect, it seems like a diplomatically strategic move. And then there’s the Chinese pilot who pulled a Top Gun–quality stunt by flying upside down above a U.S. spy plane.301 China has no intention of forging a future without carrying a big stick.

“If the U.S. and South Korea carry out strikes and try to overthrow the North Korean regime and change the political pattern of the Korean Peninsula, China will prevent them from doing so.”

~Global Times, China’s state-run newspaper

Middle East

“This is not a war. It is cruel murder.”

~Ron Paul, former politician, on our support of the Saudis in Yemen

What an odd mix of cultures. Portions of the Middle East are 21st century on steroids, whereas other parts remain unchanged since the Crusades. We should just stay the hell out, but somehow our oil ended up under their sand. U.S. Middle East policy has been abysmal for decades, acutely so since 9/11/01. Millions have died, and much of the death and dismemberment traces to U.S. Middle East policies that look like war crimes in a war with the criminal price tag of $4–6 trillion.302 If I were king, I would put the sheiks on notice:

“Guys. We want to buy your oil at market price. We’re going home now. If you should decide not sell us the oil, we’ll be back, and there will be hell to pay. Have a nice day.”

Dave Collum, as King

Weird things are happening in the Middle East even by Middle East standards. Saudi power shifts were supposedly evident in 2014, but chess pieces started moving around the board quickly this year. Soon after Trump got the red-carpet treatment in Saudi Arabia,303 King Salman arrested 11 Saudi princes, including some famous ones (Prince of Persia).304 That same day, another eight big wigs (tall turbans?) died in a helicopter crash (or at least feigned doing so). The princes were shaken down for an estimated $800 billion in assets, although that might have been an afterthought.305 Missiles started sailing over the kingdom and were soon being blamed on Iran306 (a theory supported by U.S. neocons). The prime minister of Lebanon wussed out—resigned out of fear of assassination.307 Qatar was hit by an embargo cutting off an estimated 40% of its food supply while the country was already embroiled in a serious cash crunch.308 It looked like game day, but then all seemed to go quiet again.

I'm not sure where this fits in, but we dropped the MOAB (mother of all bombs) with a kill radius of a mile to remove 36 terrorists in what seemed like overkill in the most literal sense.309 It was likely a message to somebody—maybe everybody—that we could nuke them without leaving a radiation afterglow.

“It doesn’t make sense that Assad would do it. Let’s not leave our brains outside the door when we examine evidence. It would be totally self-defeating as shown by the results. . . . Assad is not mad.”

~Peter Ford, former UK ambassador to Syria

Of course, the war in Syria is a bloodbath that has left an estimated 500,000 dead310 and millions displaced into Turkey and Europe. The demonization of Assad continued to focus on gas attacks that nobody seems to believe happened. None of this makes sense to me. None.

Given its length, we've had to break this report in half so as not to crash your browser. Click here to read Part 2 of David Collum's 2017 Year in Review, available free to all readers.

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