In this week's podcast, Michael Pento, fund manager and author of The Coming Bond Bubble Collapse, explains how the United States is fast approaching the end stage of the biggest asset bubble in history. He describes how the bursting of this bubble will cause a massive interest rate shock that will send the US consumer economy and the US government—pumped up by massive Treasury debt—into bankruptcy, an event that will send shockwaves throughout the global economy:
These are the most dangerous markets I have ever witnessed in my entire life, and I’ve been investing for over 25 years. Let’s go over some numbers to let you know exactly how tenuous this bubble is. Its membrane has been stretched so wide and so tight that it’s about to burst, and any semblance of even maybe a little sharp object, something even a hemophiliac wouldn’t be afraid of, sends the market careening downward.
Global central bank balance sheets are up from $6 trillion in 2007 to $21 trillion today and they are still being expanded at the pace of $200 billion each and every month. What’s happening is that the robotraders, the algorithms, the frontrunners on Wall Street and around the world are just gaming the system, looking for the next increase in central bank credit to take their collateral to the ECB or to the Bank of Japan or to the Fed and buy more stocks and bonds.
That’s the game we’re playing. Even a hint that it might someday end sends the entire investment community scampering for the door; and that door is very, very narrow and can only fit a few people through it. So let’s go through a couple of more data points to emphasize just how big this bond bubble is and why it’s so important.
So the European Central Bank is buying corporate bonds. I hope everybody knows that. So much that there's now 30% of investment-grade debt in Europe trading with a negative yield. This is not sovereign debt (as asinine as it is to ever be able as a sovereign nation to issue debt and get paid to do so). Investment grade bonds in Europe now trade with a negative yield.
The Bank of Japan owns 50% of all Japanese government bonds, JGBs.
About 25 percent (and this number vacillates between days where the German tenure goes north or south of the flat line) of global sovereign debt trades with a negative yield.
So what happened on September 8th? Last Thursday, Mario Draghi came out and gave a press conference after leaving rates unchanged in the European Union. The audience was asking questions like: Did you discuss helicopter money? No, we really didn’t discuss it. Did you discuss extending the QE program beyond March of 2017? No, we didn’t discuss extending the 80 billion purchases of assets beyond March. There was a stirring in the audience, the reporters were beside themselves. They couldn’t believe that Mario Draghi, even though he didn’t even hint about stopping QE, he didn’t extend its duration or its quantity. That sent markets cratering. The Dow fell 400 points. The U.S. 10-year yield jumped from 1.52% to 1.68% in one day.
Now, the market had a bounce back the next day, then was down again more than 200 points on the Dow. So you can tell, anybody with any objective, critical, independent mind can tell this is an unsustainable, very ephemeral rally in stocks that has occurred since 2009. And when the bond market breaks, when that bubble bursts, it will wipe out every asset — everything will collapse together — because everything is geared off of that so-called 'risk free' rate of return.
If your risk free rate of return has been warped down to 0% for 96 months, then everything — and I mean diamonds, sports cars, mutual funds, municipal bonds, fixed income, REITs, collateralized loan obligations, stocks, bonds, everything, even commodities — will collapse in tandem along with the bond bubble burst.
Click the play button below to listen to Chris' interview with Michael Pento (27m:46s).
Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson and it is September 13, 2016. The financial world is literally insane right now, by which I mean the traditional definition of insanity is doing the same thing over and over again, but expecting different results. The central banks poured money into the financial markets, expecting an economic recovery. They didn’t get that, so they poured even more money in, but that didn’t work.
So they poured even more money in, and that didn’t work, over and over again, insanely. But they did get a monster bond bubble for their troubles, as well as equity overvaluations that I think are in bubble territory, and a renewed housing bubble in many key markets globally. This is the most dangerous time to be an investor in all of history. That’s my view.
So, we’re going to dig deeper into that insanity, and with us today is a Wall Street expert, a financial expert, and author of the book The Coming Bond Market Collapse. Mr. Michael Pento serves as the president and founder of Pento Portfolio Strategies; and that strategy, excuse me, PPS is a registered investment advisory that operates like an actively managed fund without all the expenses.
Their model portfolio uses a proprietary macroeconomic model (so you know I like it) to determine when and how to invest across an inflation/deflation spectrum which, which I know, huge area of interest to all my listeners. You’ve probably seen him on all the major financial news networks. Michael, real pleasure to have you with us today.
Michael Pento: I’m real excited to be with you, Chris. What a great introduction.
Chris Martenson: Well thanks, Michael. I said the intro. I think these markets are dangerous, especially for the passive investor, to give you some more context. What’s your view?
Michael Pento: Well, I think, and I agree with you 100 percent, they’re the most dangerous market I have ever witnessed in my entire life, and I’ve been investing for over 25 years. Let’s just go back and go over some numbers to let you know exactly how tenuous this bubble is. The membrane has been stretched so wide and so tight that it’s about to burst, and any semblance of even, maybe a little sharp object, something even a hemophiliac wouldn’t be afraid of, sends the market careening downward.
Global central bank balance sheets are up from $6 trillion in 2007 to $21 trillion today, and they are still being expanded at the pace of $200 billion each and every month. What’s happening is that the robo traders, the algorithms, frontrunners on Wall Street and around the world are just gaming the system, looking for the next increase in central bank credit to take their collateral to the ECB or to the Bank of Japan or to the Fed, and buy more stocks and bonds.
That’s the game we’re playing. Even a hint that that might someday end sends the entire investment community scampering for the door; and that door is very, very narrow and can only fit a few people through it. So, let’s go through a couple of more data points that I want to emphasize to let your audience understand just how big this bond bubble is, and why it’s so important.
So, the ECB is now buying -- the European Central Bank -- is buying corporate bonds. I hope everybody knows that. So much so, that there are now 30 percent of investment grade debt in Europe trading with a negative yield. This is not sovereign debt, as asinine as it is to ever be able as a sovereign nation to issue debt and get paid to do so. Bonds, investment grade bonds in Europe, now trade with a negative yield.
The Bank of Japan owns 50 percent of all Japanese government bonds, JGBs. About 25 percent, and this number vacillates between days where the German ten year goes north or south of the flat line; about 25 percent of global sovereign debt trades with a negative yield. So, what happened on September 8th? September 8th, last Thursday, Mario Draghi came out and gave a press conference after leaving rates unchanged in the European Union.
The audience was asking questions like, such as did, you discuss helicopter money. No, we really didn’t discuss it. Did you discuss extending the QE program beyond March of 2017? No, we didn’t discuss extending the 80 billion purchases of assets beyond March. There was a shuddering in the audience. The reporters were beside themselves. They couldn’t believe that Mario Draghi, even though he didn’t even hint about stopping QE, he didn’t extend its duration or its quantity. That sent markets cratering.
The Dow fell 400 points. The U.S. ten year yield jumped from 1.52 percent to 1.68 percent in one day. Now, the market had a bounce back yesterday. Today it's down more than 200 points on the Dow. So, you can tell, anybody with any objective, critical, independent mind, can tell this is an unsustainable, very ephemeral rally in stocks that has occurred since 2009; and when the bond market breaks, when that bubble bursts, it will wipe out every asset. Everything will collapse together, because as you said in your intro, everything is geared off of that so-called risk free rate of return.
If your risk free rate of return has been warped down to 0 percent for 96 months, then everything, and I mean diamonds, sports cars, mutual funds, municipal bonds, fixed income, REITs, collateralized loan obligations, stocks, bonds, everything, even commodities will collapse in tandem along with the bond bubble burst.
Chris Martenson: Now, I want to get to what that bursting is going to feel like, because people need to know about that. But I do want to get to some of those numbers you just mentioned. I’m a big believer that every bubble is in search of a pin. You talked about that stretched membrane. Who knew that a Draghi comment could be a pin, but that’s how insane these markets are. They’re keying off of every single central bank utterance, because everything depends on these central banks just continuing to do more of what they’ve been doing.
But, let’s put some; yes, I can understand how the ECB steps in, buys corporate bonds and people are front running them and an already issued bond; yes, I could see how they could get below negative yield. I can understand that, but just recently we saw Sanofi, the French drug maker. We also saw the consumer goods company out of Germany, Henkel.
Michael Pento: Had issuance, correct.
Chris Martenson: They issued debt with negative yields. They issued negative. How crazy is that? I don’t know how to make sense of it, so I’m asking.
Michael Pento: It's twilight zone. Obviously, if you buy a bond with a negative yield, you're guaranteed to be a loser if you hold it to duration. You're buying bonds, by the way. You’re not buying bonds of some pristine sovereign nation. You’re buying corporate debt. So when you buy a bond that has a negative yield, basically what you're saying is you're gambling that the bid from central bankers will be not only perpetually there, but maybe even increasing. So, you can dump that bond at a principal appreciation price.
That’s the whole game, and that’s why it’s so dangerous. These bonds are owned on leverage. They’re owned on repo. So, you still have 90 percent of your assets that you loan to the central bank. You're getting 90 percent of those assets to buy more bonds, all on leverage. So, when the door looks like it's closing, people run for the exit en masse; and that’s exactly just a hint of what’s going to happen on September 21st.
On September 21st, we have the Bank of Japan meeting. If Mr. Kuroda in the BOJ doesn’t hint at helicopter money, you're going to see the same thing happen that happened on Thursday, September 8th and what’s happening even today on September 13th when this podcast is being recorded. It’s going to be more of the same.
You also have the Fed meeting on the 21st and God forbid they raise rates. You can talk about a complete wipeout. I want to just say this as succinctly as I possibly can. The wipeout that could occur with bond yields spiking and prices tumbling and wiping out much of the gains that has been achieved since 2009. That’s just a preview of what’s going to happen in the future. There's going to come a time when these megalomaniac central bankers become successful, and they actually create the inflation rate that they’re so desirous of maintaining, which is about 2 percent.
But what’s painfully obvious to me is that no central banker could ever peg an inflation target. They can’t meet 1 percent or 1.5 or 2 and even though they don’t measure it correctly, inflation is not going to go to 2 percent and stop. It’s going to keep going higher. So, these central bankers are going to be in unison, going to have to stop what they’re doing with QE. When that happens, you're going to have inflation, negative yielding debt and central bankers becoming sellers of their massive pile.
I mentioned its $21 trillion balance sheet. When that occurs, that’s the real crisis. So, what we’re seeing, what we saw on the 8th of September and what we could see on September 21st, if Mr. Kuroda and Ms. Yellen doesn’t come through with more dovishness, that’s just a preview of the real crisis.
Chris Martenson: I agree and I can’t wait to discuss your book and what that collapse will feel like or mean to the average person, but I want to set the stage here. Everything really depends on will the Fed raise rates or won't they. You can’t follow their language, of course. It’s just crazy talk. Yes, they will or no. They won’t and they’re so market dependent. If the market wiggles a little, they trot somebody else out, is my impression to…
Michael Pento: Chris, let me ask you a question. Let me turn the tables. Do you think the Fed is data dependent or stock market dependent? Which one do you think it is?
Chris Martenson: Can I pick neither? I’ll tell you my pet theory, Michael. It’s this. I think the Fed follows. I don’t think they lead. So, I really want to get your opinion on this. You’ll know much better than I would what this means. I’ve been a little unnerved watching LIBOR quietly creeping up and up and up. It’s now over 0.85 percent. It’s way different from the stated Fed funds rate, and also the European central bank target rate.
So does the Fed have to follow, here or, not because they want to, but because the market’s already done it, or can LIBOR really get that far away from the underlying target rates?
Michael Pento: LIBOR is creeping up because there are changes in the money market funds. I don’t want to get into the weeds on that on the podcast, but the real issue is what I’m concerned about; the success of central bankers. LIBOR is going to spike, interest rates are going to spike. Markets will force rates to spike once inflation becomes entrenched in the economy. What is inflation? It certainly isn’t people becoming more gainfully employed.
Inflation occurs when the market loses faith in a fiat currency purchasing power. That’s exactly what central bankers across the world have been trying to do in earnest since 2009; actually, since 2008. So, when that success comes, then you're going to see free market rates such as that, the dollar cost of; the cost of a dollar over in Europe, short-term dollar loans and you're going to see the free markets and interest rates much, much higher. That’s the real issue and that’s when the chaos begins.
Chris Martenson: Let’s talk about that chaos, because yields on junk rated euro-denominated debt, record low last week, 3.35 percent, a number I don’t even like on a 10 year U.S. treasury. These losses, there's clearly a lot of losses baked into that. For people listening, we’ll explain it offline, but Michael, so who is going to eat the losses, I think is the operative question. If the central bank, if the European central bank suddenly has to begin unwinding its position or the other central banks unwind, there's massive losses. Who eats them?
Michael Pento: Well, the capital at central banks is even narrower than it was at Lehman Brothers, so they have hardly any capital. So, the question is, if they’re going to be selling assets at this huge loss and go through their capital, does anybody care if a central bank isn’t solvent. The answer is yes, in my opinion. Some people will disagree with me.
I think it’s absolutely critical, because if a central bank runs out of assets to sell, then they have no way of draining the money supply. If you can’t take down the money supply, inflation becomes intractable and there’s nothing the central banks can do about it. That’s the real issue.
If that happens, and inflation starts becoming intractable, and you have that spike in bond yields, what happens to every single asset that is planning on, betting on and hoping for this continuance of ZIRP and NIRP forever? Those assets will implode. And what happens to the economies once that occurs? See, I think 2008 was just a preview of what’s going to happen. If we allowed markets to repair themselves in 2008 -- in other words, if we allowed home prices to fall and stock prices to fall, and interest rates to rise, and debt levels to contract -- then we would have had a depression for a few years, at the most, but then we would be able to come out of that with stable money supplies, stable interest rates, a stable currency, low debt to GDP ratios, high productivity rates, massive capital expenditures and a nice healthy, growing economy.
But none of that has been allowed to occur. What we have now, as I think I might have mentioned, we have $60 trillion in additional debt, 230 trillion around the world. 300 percent world record, never happened before; 300 percent global debt to GDP and the debt that’s increasing really very rapidly and has been so since 2009. This debt is not debt that comes from savings that’s used to be borrowed by the private sector to create capital goods and expand productivity.
This debt is used to buy back shares of stock, or to issue junk bonds. So, we are in a very bad situation and, unfortunately, as I mentioned before, it’s not going to end very well.
Chris Martenson: A lot of this sounds structural, because of course, the rationale for going 60 trillion further into debt and ramming up our debt levels globally to these astronomical numbers you just put in was that hey, we’ll get back to rapid growth. We have a decade or more of experience that says we are now in a structurally low growth environment. That is out of comportment entirely with this idea of rapidly expanding debt loads, because those make sense in a rapidly growing environment.
Do you think there are, that we are in a structural low growth environment, much like what Jeremy…?
Michael Pento: Japan.
Chris Martenson: No, I just blanked on the name -- Jeremy Grantham. So are we in a structurally low growth environment like Jeremy Grantham has posited. That it’s just here to stay. If so, what the central banks are doing is even more insane.
Michael Pento: It's more insane.
Chris Martenson: Because there's no way to service it.
Michael Pento: Well, the only way you can service the debt outstanding is by keeping interest rates near 0 percent. The problem is that once you do that for a protracted period of time, eventually the market is going to take those rates higher. So, you’re going to have no choice but to raise interest rates, and that’s when the real collapse comes.
For instance, if we had to pay a normal interest rate -- you go back to 1969, the average interest rate on the 10 year is about 7 percent. Well, where is it today, 1.7 percent? If we had to pay around 7 percent on our outstanding debt, we would be paying a trillion dollars a year just on interest; on debt outstanding.
So, it’s not possible that we can allow interest rates to normalize. We would have a debt implosion. So, the central bankers are caught. They’re going to lose their credibility on the 21st Chris, because there's about four or five Fed members, voting members on the FOMC, who have been out there telling us -- even Janet Yellen hinted at it in Jackson Hole -- the economy is close to reaching our goals and we will be ready to continue raising interest rates very shortly.
They’re on record saying that. If they don’t do that on the 21st, they’re going to be the FOMC that cried wolf. They’re going to lose all credibility. Yet, if they do not raise interest rates, I’m sorry, if they do raise interest rates, they’re going to lose credibility, because they’ve been telling us all this time that they are data dependent. Well, if they’re data dependent, let’s look at the data.
GDP is up 1.2 percent year over year. That’s half the trend rate of growth that we’ve seen since 2010. S&P 500 earnings are down six quarters in a row. Tax revenue is down year over year. Productivity is down three quarters in a row. Look at the August ISM, manufacturing 49.4. The service sector, 51.4, that crashed from 55.5.
So, what data are they looking at? If they’re truly data dependent, they shouldn’t move at all. If I put myself in the mind of these Keynesian group thinkers, but if they do raise rates, if they don’t raise rates, what are they threatening about? So, I think they lose credibility either way.
Chris Martenson: They lost all credibility with me back with Greenspan, but I’m a real skeptic about all this monetary engineering that a group of people sitting around a mahogany table with a dessert trolley nearby can macro engineer something like the economy. So, I’m more a hands off kind of guy to begin with. Here we are, I think…
Michael Pento: Count me aboard that, too, Chris. The Fed should sell, they should their assets. They should drain their balance sheet, which is about 4.7 trillion. They should drain that balance sheet a trillion dollars a year until they’re back down to where they were pre-crisis and then just go home, close shop. I agree with you.
Chris Martenson: Absolutely, and my model is it would have been painful to fall off the stepladder in 2008, but now we’re 12 rungs higher on an extension ladder. I just think it’s going to be kind of painful, so walk us through that, your book is The Coming Bond Market Collapse. Collapse is a strong word. I’m wondering, did you tweak that a little for effect or is a collapse possible and if so, what does it feel like? What happens?
Michael Pento: Zero hyperbole, now I wrote this book in 2012. That was when the Fed was halfway through their QE program and really didn’t have the BOJ and the ECB even kick in yet. So, I never even imagined or even dreamed in 2012 that you’d have 25 percent of the world sovereign debt trading with a negative yield. I wouldn’t even fathom that thought, or that you would have negative yielding corporate debt.
So, when the bond bubble bursts, and I touched on it earlier in this interview, every asset in the world is pegged off that risk free rate of return. So, when the debt bubble bursts, everything bursts. You mentioned, you said the stock market might be overvalued. The price to sales ratio is at virtually an all-time high. Total market cap to GDP at an all-time high, virtually all time high. Median PE ratios, at an all-time high.
If you look at what’s going on, it’s mostly the PE ratio as high as it is; really should be much higher, because what are corporations doing. They’re borrowing money to buy back their shares, reduces the share count and that lowers the PE ratio; raises the earnings per share. So, I think stock prices collapse. I think global bond markets collapse. I think commodity prices collapse, with the exception of precious metals.
I think every other asset, too; I’m talking about real estate. If you look at cap rates in commercial real estate, they’re at virtually all-time lows. So, this is pervasive and its global. Just to think back in 2008, in 2008, yes, the United States and parts of the world had a real estate bubble. That’s a problem. That turned out to be a huge problem.
But now we have the entire world’s flush of sovereign debt in a bubble; and when that breaks, it’s going to be exponentially worse than the housing bubble, especially because there is nothing left for central bankers to do. Do you remember back in 2008, what occurred? We took interest rates, the Fed, Mr. Bernanke started 5.25 percent all the way down to zero.
What are we going to do now? The Fed fund rate is pretty much at 50 basis points, the effective Fed fund rate. So, there's no room left and we already blew up the Fed’s balance sheet by $3.5 trillion, 3.7 to be exact. So, what else is there for the Federal Reserve or central bankers to do? It’s going to be very devastating.
Chris Martenson: I want to test you on this, because I’ve seen trial balloons. I know you're familiar with them. I’d love to get your views. Helicopter money, obviously a thing they can do, but first you have to get everybody in a ring fence and close the gate. You can’t let people have access to cash. That doesn’t work.
So, the war on cash comes out and you’ve got, of course, Larry Summers and Rogoff and Andrew Haldane out of the Bank of England, et cetera,; this chorus of people saying oh, no cash. It's bad stuff. Criminals use it. But instead, what they really need is, they need me and you trapped in our bank accounts so they can push money out and force us into negative interest rates. I think that’s obviously what they’re thinking about. Do you think they can do it?
Michael Pento: I’ve written about this. It’s impossible to really charge you an interest rate on your deposit unless they outlaw physical currency. You see some talk about this in Europe, about lowering the 500 euro bill. For some reason now $100 bills are the safe haven for drug dealers, so we’re talking about getting rid of those. That’s the first salvo into what I feel yes, eventually we’re going to go completely digital currency.
So, you have no chance. You can either spend your money or leave it in the bank. You have no choice. You cannot take it out of the bank. You can spend it, or you can leave it in the bank. You cannot take it and hoard it. That’s why I think the reliance on precious metals and hoarding of gold is going to be absolutely crucial.
Chris Martenson: So, precious metals, big believer in that; and my listeners, as well. More than an insurance policy. My number is whatever number you would like to never see go to zero.
that’s a good amount to have. Final question, because we’re running out of time here for you, is: Are we going to have the much anticipated second half recovery, or will it be the ever illusive third half recovery? Which one are we going to get?
Michael Pento: I don’t know who has less credibility, the Fed or the Wall Street carnival barkers who come on television regularly and tell you that the second half is going to be better than the first half. No, I see no reason why the second half is going to be different in 2016 than it was in 2010, ’11, ’12, ’13, ’14 and ’15. The only semblance of recovery that we’ve had has come from a lowering constantly, perpetually lowered borrowing costs, so that has run out of room, and perpetually inflating asset bubbles.
That is running out of room. So I certainly don’t think, even though we have those conditions where people could refinance their mortgages at lower and lower interest rates, they’ve been doing that really since 1981, and asset prices that continually rise; rising stocks, bonds and real estate. That’s pretty much ending, and it’s pretty much ending across the globe. Even at that pace, we’ve been running at a 2 percent GDP growth rate since 2010. Now, we’re at 1 percent; and now that those conditions are ending, I really don’t believe we’re going to have a second half recovery. I think we’re going to be in a recession.
Chris Martenson: All right. Well, thank you so much for that. This has been a fantastic interview. I’m sorry we don’t have more time. Tell people how they can follow you more closely.
Michael Pento: So, the website is pentoport.com and my email is [email protected] and the number here at the office is 732-772-9500. I publish a weekly podcast. You should go to the website and get a trial subscription for that. It's $49.99 a year and great insights, great data you’ll find nowhere else. I also manage money. Part of what I do here is I manage money, as you mentioned, the inflation deflation dynamic portfolio.
If you’re going to have central bankers that are going to helicopter money, which is very possible, you're going to have to change your investment spectrum to fit that model. But if central bankers are going to end QE, and if the Fed is going to raise interest rates, you better have a wholly different investment strategy. So, that’s what I do. It's dynamic; it doesn’t stand still; don’t really like principal depreciation here at Pento Port. We’re doing very well this year, and I hope to have some of your listeners reach out to me so I can help them.
Chris Martenson: Well, fantastic. I’m sure some will. Michael, thank you so much for your time today. Let’s do this again.
Michael Pento: Oh, it would be my pleasure Chris.