Steen Jakobsen: The Four Horsemen Portend A Painful Reckoning

Even the US is now 'swimming naked'
Tuesday, November 13, 2018, 10:02 PM

Steen Jacobsen, Chief Economist and Chief Investment Officer of Saxo Bank sees economic slowdown ahead.

Specifically, his "Four Horseman" indicators: the drivers of economic growth, are all flashing red. 

Jacobsen believes that the central banks will continue their liquidity tightening efforts for as long as they can get away with (i.e., until the financial markets start toppling over). In his opinion, they eased way too much for way too long; and the malinvestment and zombification that resulted needs to clear the system -- and it will likely do so more violently and painful than the central banks will like:

I like to make things simple. Right now we have the Four Horsemen: the four drivers of the global economy. They are the quantity of money, which is falling; the price of money, which is rising; the price of energy,which is a tax on consumers and is rising; and globalization/productivity, which is falling.

So, if you look at the economy as a black box, I really don’t know what happens inside of it. But I can observe what goes into the black box: it's these four things.

Globalization / productivity, we know that's all about Trump, trade war and the likes. It's not exactly improving; it's actually worsening.

As for the quantity of money, a lot of people argue with me that the Central Banks are still expanding their balance sheets, but the fact of the matter is that the QT in terms of the U.S has been reducing the Federal Reserve balance sheet. And we have a stealth reduction of the balance sheet in terms of the Bank of Japan. The EBC would love to cut and is publicly committed to doing so. The Bank of England is doing its first hike. So the quantity of money is falling.

As for the price of money, I think Powell is really in the mold of Volcker. He's a practical guy, and what he's decided to do is pretty much just to hike interest rates until the market collapses. That would indicate that pausing from this tightness is probably 5-10% below the recent low that we saw in the stock markets. If we don’t get to that level again, he's going to continue the hiking.

So you almost have a self-feeding process by which, ultimately, the stock market will have to collapse because behind the scene, the pragmatic way that Powell does his policy really means the interest rate is going up and, hence, you haven't seen your move to safety yet in terms of Treasurys.

And then, the final one, which is often ignored, the price of energy. Before the dramatic drop over the past few weeks, the price of energy was up at 15 to 20 percent this year in terms of the oil price input. But, if you add to the fallout from the emerging market selloff and the currency-negative impacts, you will have prices on petrol in energy-intensive countries like India, Indonesia, China where the prices are up somewhere between 50 and 100 percent. Imagine how much of the purse that expensive energy takes away from these developing economies in terms of the purchasing power.

So I think the full force of these Four Horsement that drive the world economy is now going to slow economic growth dramatically after this recent boost from the twin tailwinds of the tax cut and repatriation of capital. So even the U.S. now seems to be swimming naked.

Click the play button below to listen to Chris' interview with Steen Jakobsen (48m:35s).


Chris Martenson: Welcome, everyone, to this Peak Prosperity podcast. I am your host, Chris Martenson, and it is November 5, 2018 Guy Fawkes Day. Hey, today, we're going to be discussing these volatile financial markets and what we might make of them. Will the volatility continue? Will it increase? Will it decrease? Do we have enough information to say that the Central Banks removal of fresh new liquidity from the global punchbowl means that the parties' over?

Returning with us today to discuss the economy and markets is one of my favorite guests, Steen Jakobsen, the Chief Investment Officer and Chief Economist of Saxo Bank. He has many years of experience within the fields of priority trading and alternative investment. He travels widely, reads and writes constantly and thinks very broadly and creatively about the world and where it's headed. Steen, it is a real pleasure to have to back with us today.

Steen Jakobsen: Thank you for having me, Chris, as always.

Chris Martenson: Well, Steen, equity markets. Once again, I'm going to call them interesting and displaying volatility that some young traders might not even recognize. What do you make of this recent volatility? Is it just normal hiccups or the start of something more?

Steen Jakobsen: I think it's more the end of something. I think what we, and I certainly being one of them, mistakenly refer – when we looked into 2018, we ignored this great wall of repatriation out of the European deposit from the U.S. corporation into the U.S. And, of course, the runner rate we have right now in terms of bad banks in the U.S. – we will exceed one trillion dollars of reduction of flow in the U.S. stock market itself which, of course, has carried this normally all the way through even each of the narrative of commentators on the markets that the stock market has only been going down for three weeks.

Chris, you are someone who travels the rest of the world. The world has been going down all of this year. So I think what's really happening is that we have a recoupling of the U.S. stock market to the rest of the world. And blended into that, of course, a huge disappointment of some of the marquee names like Apple, Facebook and the likes that has been early leaders.

But, certainly, to me, this is almost entirely about the fact that the U.S. stock market was kept artificially alive and in the process probably also made Fed do a policy mistake in terms of keeping the August protectory in place too long.

Chris Martenson: Steen, I'm seeing a really confusing set of indicators here. Some are solidly risk off, some still seem to be risk on. For instance, I don’t see treasuries really moving in the way I would expect in terms of them really gaining in price, dropping in yield as this volatility in equities increases. So that's just one of many confusing indicators I see. As you look across the landscape, what are you looking at and do you see similarly confusing indicators at this point?

Steen Jakobsen: I guess I'm a little bit more primitive than you, Chris. I operate in a world of primitivity, and I like to make things simple. So we have, right now, a macro theme called the Four Horsemen, and this is not like the Bible thing. It's just there are four drivers of the global economy. And if you allow me, I'll go through those four. And they will be the quantity of money, which if falling; the price of money, which is rising, which is part of what you just said; the price of energy, which is rising, which is a tax on consumers; and then, you add the more sort of soft value of globalization / productivity which is also falling.

So, if you look at that sort of way of up close in the economy – and this is back to what I told your listener about last year – I really don’t know what happens in the black box. But I can observe what goes into the black box, and these are the four things that goes into the black box: globalization, quantity of money, price of money, price of energy. And let me take you individually through all of them.

Globalization / productivity, we know that's all about Trump, trade war and the likes. It's not exactly improving; it's actually worsening. The quantity of money – a lot of people argue with me that, well, the Central Banks are still expanding the balance sheet, but the fact of the matter is the QT in terms of the U.S, of course, has been reducing the stock in the Federal Reserve balance sheet. And we have stealth reduction of our standard balance sheet in terms of the Bank of Japan. EBC would love to cut it. Bank of England already indicating and doing the first hike. So the quantity of money falling, the credit impulse, which we have talked about at length, turned around over the course of the last three to four months, entirely based on China, again, expanding monetary fiscal and monetary policy.

The price of money, pricing, the Fed protectory, I think the mistake, again, I made – and I make a lot of mistakes – was that I think Powell is really in the mold of Volcker. He's a practical guy, and what he's decided to do is pretty much just to hike interest rates until the market collapses. So, in other words, that would indicate, Chris, that the market, the stock market impact or the Fed pulsing from this tightness is probably five to ten percent below the recent low that we saw in the stock market. If we don’t get to that level again, he's going to continue the hiking.

So you almost have a self-feeding process by which, ultimately, the stock market will have to collapse because behind the scene, pragmatic way that Powell does his policy really means the interest rate going up and, hence, you haven't seen your move to safety in terms of treasury.

And then, the final one, which is probably ignored, the price of energy. One thing is that the price of energy is up at 15 to 20 percent in terms of the oil price input. But, if you add to the fallout from the emerging market selloff and the currency negative impact, you will have prices on petrol in energy intensive countries like India, Indonesia, China where the prices are up somewhere between 50 and 100 percent. Imagine how much of the purse that actually energy takes away from these developing economies in terms of the purchasing power.

So I think what we're sitting in the middle of, Chris, is finally sort of all of these four engines, or the lack of the four engines, supporting the world economy, is now coming into the real economy after we have had the tailwind of the tax cut and repatriation of capital. So even U.S. now seems to be swimming naked.

Chris Martenson: I really like this view, and it just kicked off about 600 questions in my mind. So many things you touched on. Steen, first, you mentioned a stealth balance sheet reduction by the Bank of Japan. Explain that. What did you mean by that?

Steen Jakobsen: Yeah, so we know there's a fixed number of yen that the Bank of Japan hold and have suggested they will intervene. And they have done significantly less than that, mostly two thirds of that. And now, they're even allowing the YCC, the yield curve control. So in Japan, unlike in the U.S, they are really trying only to steer money to policy through the ten years interest rate being fixed. And the fix should be between zero and ten basis point. As we talk, it's trading 11, 13, 14.

So, actually, the Bank of Japan has allowed the rates to go beyond the boarder, or the rules, in this case. In fact, they have indicated – and they have done that through less intervention then they announced. And part of that is actually the inflation pickup has been significantly higher, and we've seen the corporate structure in Japan also delivering better earnings results.

So basically they're a function of policy but also a stealth action because they're actually done less than you would had put into your budget if you were looking for the amount of yen that would have been printed in the year 2018 from Bank of Japan.

Chris Martenson: So the overall theme, which I've been trumpeting as being really important, is this quantity of money. If I told people, listen, there's just one chart you need to look at, it's just take the collective actions of the major Central Banks in terms of their additions or reductions in their balances sheets which is the quantity of money out there. And we are, as yet, on track, I guess, for 2018, maybe early 2019, for that to actually dip below zero. Is that what you're seeing, and do you think we'll get there, and will that continue?

Steen Jakobsen: I'm actually at negative already. So we have a model which is – we can collect some charts here for your listeners – we can provide you. We have a liquidity by major Central Bank. It's negative one percent on GDP right now. And what's interesting, Chris, is that this is below what we saw in 10’ 11’. It's certainly below what we saw in '08 and '09 and is even below the recent low we saw with the fallout in China in '15. So, of course, the major stimulus, plus / minus, in this remains China. But China contracted. I think I made it a big focal point of our last conversation a year ago about China slowing down. And now it's happening.

And so the global monetary, if you look at M 2 – and let me just briefly explain why this is important to your point. The way that we have created growth in the world since the great financial crisis has been the following. You have a fraction. On the top of the fraction you have the credit creation that has generally been in the neighborhood of six to ten percent. Below it you have the world growth which is five to six. So from 2010, 2008 onwards, we've had a positive fraction, bigger than one, one and a half, two even. Right now, what we see is a global growth after the confusion is plus two against a six percent growth. And we have one third of it.

But a global contraction in terms of the flow of that flow is now minus one percent of GDP. In other words, the very method by which we expanded the growth factor in the world, the creation mode that has now gone into a negative and, hence, we see both fixed income and equity markets are starting to sell off. And, certainly, you see the countries with higher fiscal and current account deficit having to pay the price because the marginal credit cake, the size of the credit cake, is smaller. And not only is the cake smaller, you pay more for a piece of cake than you did before in terms of the price of money.

Chris Martenson: Now, Steen, I hope you can explain something for me, and I hope some of my listeners find this useful. But I've never understood how it's equivalent looking at what the ECB balance sheet's doing versus what China's up to, mostly because I understand how the ECB money flows into the capital markets. China doesn’t feel quite as open on a capital market basis. Are they equivalent? Is China's easing the same as the ECBs easing? How would I begin to make sense of that?

Steen Jakobsen: First of all, from a statistical point of view, it's very difficult to monitor these credit flows. So creating the credit cake that I just eluded to, in China's case, you need six to eight different indicators to create that number. Wherein, the case of the U.S. it's three, and in the case of Europe it's actually two. So it's far more complicated because you need to include the shadow economy, the banking sector, the credit facilitation announced by the PBOC.

But, relatively speaking, you can do that , and it does work in the same way but in a much different way at the same time in a sense. The policy by the PPOC, the China Central Bank right now, is to take a huge chunk of the shadow economy, the one which is not done directly through state owned enterprise banks and liquid banks, but through peer to peer and other lending and put it onto the balance sheet of the SOE owned banks. The way they do that is by reduction of the RRR, the reserve requirement ratio.

The reserve requirement ratio is generally – if you did it in a U.S. bank you would see this as an increase in the multiplier, but in the case of China, it is really a story of moving as much capital lending from the shadow economy onto it, so by giving them more and bigger balance sheets. So the difference is you have a far more managed process where a traditional reserve requirement decrease, in the case of the U.S., would mean more there. It doesn't necessarily mean that in China.

And I think that is often the difficulties I have with reading English, U.S. based research on China. Everyone assumes they are like for like. But, in the case of China, you have a system with far more action players for every level of policy that you're trying to enforce.

Chris Martenson: Thank you for going through that because that's been my confusion. They didn't seem apples to apples. So I was never quite clear on how to put them all into one chart, but that really helps a lot as we look through that.

So we've been through the first horse on quantity of money that's falling right now, minus one percent of GDP. That seems like a big deal to me. How long has it been since we've seen that? I think it was, as you mentioned, we have to go back to one part of 2015.

Steen Jakobsen: '15 when we had the scare of the variation in China and then in '11 during the European banking crisis and then '08 and '09. But the significance is it is lower than at those times. But what I also want to bring in is that we really in Europe talk a lot about the Brexit and the lack of consequence in the economy. Do you know which credit cake is shrinking the most in the world right now? The UK one.

So as interesting as the – the solution in terms of Brexit remains elusive. The actual underlying economy is now having to pay the full price of the inaction and lack of transparency, lack of credit creation. So that is the custom theme I'm trying to get to here. I have no idea about the future, Chris, but I can name what goes into the economy. And in the case of the UK economy and the world economy there is less credit, the very credit that has been that 80 percent of the juice for all of the action we've seen since 2009 and the low in the stock market.

Chris Martenson: Yeah, that 80 percent of the juiced – so this is one of my main critiques when I'm really wagging my finger at the Central Banks. I start with the Federal Reserve. I start with Alan Greenspan and his, I think, super ill-advised attempt to replace the business cycle with the credit cycle. So we're now on our third major attempt to if you can steer macro policy with credit cycles. I just see them as boom-bust opportunities with each one being apparently larger than the prior. So that's kind of how I'm seeing it. Can you talk to us about that dynamic of using credit cycles and whether they are, indeed, in your estimation, steerable by Central Bank policy in the ways they want?

Steen Jakobsen: They're clearly not. And the way – the crowding out that happens from what you very eloquently described is productivity. So if you look at the productivity for all of the major nations in the world – if you look at the 1980s and 1990s and early 00s, you had nice steady productivity growth of three to five to six percent a year. It seems to be an inaction of the suspension of the business cycle and replacement by credit cycle you had zero growth. And why is that? That's pretty simple.

Because when you move from a game of being a productive company, a productive person, to one which I call a person of rentier, a person who is just increasing capital values instead of creating fundamental values in society, you crowd out the ability. And when you then take interest rates to zero, you take away all of the disciplinaries involved in being a business person. In other words, the down side becomes nonexistent to some extent because there will always be support. And so you create both the incentive structure.

But mostly importantly, our society, both the U.S, but also the rest of the world, have become a massive, nonproductive society which is really about buyback programs for companies, lack of investment and research and development. And the problem with that is as we stand in 2018, on the brink to 2019, with everything being equal, some normal – call it normal - trade war which is going to decrease the amount in volumes. You have America first versus 2025 China, both of them plans which is really about self-sufficiency inside your own country, looking not out of the window but looking into the bathroom pretty much instead.

And all of this means that at a time when we most need productivity to work for the system, we have no investment in it. And what we also know is that in productivity comes from one thing only really. It comes from education, education and education. And what is the one thing in America where people don’t have equal access to? It is education, right? We are underfunding the public service system in terms of schools, in terms of basic research. We all wanted to be in the private sphere because it's not on behalf of the taxpayer.

But, hang on a minute. Look at the history of innovation. Look at the history of productivity. All of the great leaps that we've done in that respect has been done as a public experiment. Take the internet that was born out of this learning in school which is a public thing. The genome mapping, probably the second one that comes to mind in terms of the global reach in terms of productivity. So, Chris, the ultimate price for this expansion of the credit cycle is where we are today where we are nonproductive people, and we are just interested in improving our world by a one percent a year marginal change relative to a world where we want to be better, we want to be more productive, we want to be more educated. We want to be better citizens of the world and the like. So we have to factor the others in the that. That's the price because the business cycle is what cleans the system. If you don’t have a business side to clean out the weak players, you're going to have only weak players ultimately.

Chris Martenson: This is a fantastic topic to discuss because this is going right to the heart of what I've been thinking for a long time here. You just reminded me that – I hope I have the numbers right, but I read a report recently that the DIS [PH] noted that in 2016 – I think the data comes from that – that 12 percent of all countries in the OECD countries, if I have my numbers right – were zombies. Meaning their operating earnings were insufficient to cover debt services payments. This is the Japanification, right. We've all turned Japanese, I guess, by spreading of these zombie companies.

To me, that feels tied right into this whole idea that the essence of a zombie company, it's fundamentally a nonproductive company, and they're kept alive because the credit cycle is still in expansion mode. But when, not if, but when the credit cycle comes to an end, and they always do, the tears are going to be pretty powerful in this case. Because I would assume at least 12 percent of company are now exposed to – and I assume the number is even higher now than 2016 – that means that they are all exposed to just being wiped out.

Steen Jakobsen: Chris, every 25 basis points there's going to be an additional 10, 20 percent added to your tally. I mean, think about the world and that's also the problem with the credit cycle. It's okay to go from a global interest rate on average of six percent to zero, but what are you going to do at zero? Are you going to go to negative three? Of course, it's theoretically possible, but at even minus three a lot of things happen, among those, of course, being that cash doesn’t work.

So the fact of the matter here is that we are in a corner. And from that corner, I think there is a positive solution which is to refocus our research and development, basic research in education, I think that's the positive measure. Or there's some negative measures that if we continue to pretend that this is going to be okay and this is the IMF, the World Bank, the ECB, Federal Reserve all declare that we are past any crisis. We haven't even started on the crises yet because, as you said, we pretty much pretended and extended by actuating a credit cycle instead of a productivity cycle.

And I think if I was to forecast the next two to three years, I think two or three significant things is changing. One is whoever is productive as a country, as a company, as a person, will survive, and they will be the only survivors. Number two, there will be a talk of close down in all this testosterone driven politics in the world, the Donald Trumps, the Aragon's or whatever. I think the world is fed up. I think there's going to be a huge political swing towards women and non-testosterone driven decision making. And I think number three, environment is going to a massive issue.

Next year, we're seeing the introduction of the maritime sector having this sulfur content reduced to 25 percent instead of much higher and burning bunker oil. Everywhere in the world, except the one in leadership and the ones that sits on the social media, they want the world to change, Chris. I think that's the positive news here because you can not get out of this crisis by consuming as if.

So enough people are going tell the dollar is going to be 25 percent stronger. I go fine, but how does the world look with a 25 percent stronger dollar? That's a world with a total recession and is going under.

Chris Martenson: Well, especially with roughly four trillion dollars of emerging market debt denominated in dollars. I think you have a multitrillion dollar wipe out if that happens.

Steen Jakobsen: Exactly. So what's going to stop this strong dollar needs the strong dollar, and that's always been the case. We fail to remember the story. And the thing – I stole that sort of rhythm of words from oil. In oil they always said what's going to stop the oil is going to oil because ultimately the oil gets too expensive to go on. And the same that you say we're so dependent on dollar funding in the emergent market.

But, also, don’t forget U.S corporations are more leveraged today than they were before the crisis because they're using all these financial shenanigans of buying back their own stock, and very often in the process, despite buying back, they're eluding the investors.

Chris Martenson: Well, this is why I really fault the Central Banks because they are supposed to be the adults in the room. There supposed to take the punchbowl away. They're supposed to understand these things. I can't fault the CFO who says listen, if I can borrow at one percent and retire a stock that's got a dividend yield of three percent, I mean, do that. But, across the universe if they're all doing that then we get into the issue of…

Steen Jakobsen: I think you can, Chris. You have to blame the CEOs.

Chris Martenson: Okay.

Steen Jakobsen: I mean, monopolies of the 20s and 30s was big oil and then the Morgan's and the Rockefellers. But they were part of the fabric of society. They built endowments to business school and schools and they built housing for the employees. There is zero, I mean literally zero filtering of the profit from the corportate sector into the employees and custody of the disposal income. Someone in the world needs to protect the disposal income of the employees. It certainly hasn't been the corporation. I think that could fail on them because, ultimately, in a game of less and less people who are at the high end of salary and the way the labor market and the sophistication of the world. What you need today is invest in your employees and in people and in education of the employees and to support whoever works for you.

So I think from that perspective I think we slowly lost the moral compass that was initiated, and the calous of the Central Banks, I whole heartedly agree with you. But I think the corporate business getting away with it because it's legal. I mean, Chris, because it's a guy who's done nothing as a CEO, and he has a contract that gets him paid $160 million, it doesn't mean it's fair, it doesn’t mean it's moral. It means it's legally obtainable and it's what it is. But it doesn't make it right, Chris. And I think the accountability of what we do and how we do it, that is also lost in this process. That has also been crowed out. And when that's covered the world, that is the biggest problem. Dominance. I mean, dominance has disappeared.

Chris Martenson: I totally agree, and I love this idea that you think that we hit a nadir, a low point of this abrogation of the social contract, that we're done with the testosterone driven politics. I hope we are because if we continue that path I see war at the end of that, and that could be extraordinarily unpleasant. But I'm thinking now, and you remind me of that famous saying by Charlie Munger who said, "You show me the incentive, I'll show you the outcome."

The Central Banks have incentivized this particular behavior set that we're seeing. I'm not saying they're 100 percent responsible. I agree CEOS have their own moral compasses that should have been guiding them that seem to have gone adrift. But, the Central Banks really, with their credit cycles, they did a lot of things that weren't just about monetary policy. They were engineering with social policy and political policy because of the incentive structures they created. They should have known better. That's my main critique for them.

Steen Jakobsen: And they made the whole world unaccountable by making interest rates go to zero. I think the worst thing they done is taking the rates very close to zero because in the world of zero interest rates nothing works, and certainly not discipline, not accountability.

Chris Martenson: Absolutely. So let's talk about number two of your horsemen, the price of money. I guess we have to start at the headwaters of the Nile. Where do you see U.S. treasury rates going from here?

Steen Jakobsen: As I eluded to before, I think Powell is actually a very good Central Banker because he's not an economist, which always a good start, and I think he's very pragmatic. I think he's going to hike on until the market stops. And as I said before, that is in my terms, in market terms, five to ten percent below the present low which means we are one, two, interest rate hikes away from Fed going on course. So I think in treasury terms, I think treasury is coming into buying out opportunity and they will be devalued, if, as I expect, they go ahead in December simply because interest rates cannot go higher, Chris.

I mean, the whole thing and it the whole conversation we had today is about the fact if you have a smaller credit cake and the cake of the pieces in the credit cake getting more expensive, something needs to give, and that is, of course, the projection of the price of the cake that needs to get cheaper. If you get less cake, you've got to pay a less price. So I think we are one, it's not two hikes away from Federal Reserve stopping because then the consequence on the market will be felt.

What's interesting about Friday's close was that we made new lows in ten years and thirty years. So, if you look at the interest rate, they just continue to go high in the market of right now flat, sidelined activity. But the effect on the cost of capital continues to be impacted by the four horsemen.

Chris Martenson: Well, now, let's turn to a piece that just catches my eye on a daily basis – LIBOR. It's making new, fresh cycle highs right here as we're talking. More than double of where it was last year at this time. It seems important, especially given the zombie companies I talked about. How important is LIBOR, or is that an irrelevant benchmark these days?

Steen Jakobsen: It is in the U.S. because financing is either equity or bond markets. So two-year rates and LIBOR is following each other. But, I agree with you, Chris. I mean, you should look at the steepness of the rising in two and five years and LIBOR this year. It's amazing. It continues – it's about 80 basis points. Even in the strongest economic momentums, the magnitude of the move in basis points, this is up there with some of the biggest. This is one of the harshest, most steep rises we've seen in the cost of capital.

But it's just a function of that the U.S. has been delayed for all this action from the Trump cabinet in terms of tax cuts and other things. That's sort of hidden inside the inevitable which was that, again, the four horsemen role, negative gravity on all of this interest, a higher price on energy and less offered to play with for the world. So I think it's a natural consequence. I'm not entirely surprised, but, to be honest, I'm surprised that Federal Reserve is totally ignoring the impact of repatriation of capital.

And, Chris, we talk about our more than four trillion that's taken from the Europe banking accounts into the onshore U.S. banking system. Again, that should be something good, but, in reality, means that the U.S. credit system is overflowing with domestic credit that no one can use which means that no one's going to make demands on lending which means the last of your money is going down which means that economic activity, again, continues to just be pretty much based on buybacks and manipulation of balance sheets.

Chris Martenson: And those buybacks, by the way, will, I think, go down in history as one of the dumbest corporate moves again. But corporate buybacks tends to…

Steen Jakobsen: It's when you leverage them – do some of the math. And you're borrowing money to do it at the bottom of the interest rate cycle that just makes no sense.

Chris Martenson: Oh, I know. It just going to be, again, the dumbest of the dumb moves out there. When we should have been investing in the productivity, number four, but looking at this price of money still, you know, one of the things that confusing me here is I'm watching junk bond indexes. I like to watch from the outside in. I watch the weaker elements first to see if it's going to progress towards the core. You just mentioned emerging markets have been falling for a long time. The rest of the world is weak. It's finally made it's way, seemingly, to the core, the United States equity markets. But, I'm confused here, Steen, looking at JNK, HYG, other junk bond indexes. They seem complacent here. I don’t get it.

Steen Jakobsen: They're not complacent, but they're a function of what I just told you. If you take four trillion dollars in Europe deposit dollars and move it into the U.S. onshore banking system, what's going to happen? Everyone's going to look for the excess return, so what is happening is all the junk bonds, all the credit spreads, are sufficiently fueled by this new money that came into the U.S. onshore banking system during the 2018. One trillion went into buybacks of stocks but another two to three trillion is sitting in slush funds in bank accounts and some people want to invest in junk bonds and other.

So I think it's counterintuitive, actually. I think these sort of JNK and the others will be slower moving than everything else because I see companies paying an earlier price than the cash deposit and the free cashflow that's been available to the onshore banking system. And look at JP Morgan and look at all the major banks. They're not lending out any money. There's no one that wants to lend money. There's plenty of money in the system and that, of course, is keeping the credit down.

And you will see that, Chris. And you see the slowdown in U.S. growth. And I think come year one, year two, you will see significantly the slower growth and then, all the sudden, you will have an explosion where you see the spread go up by not one factor but probably two to three factors. Because then you're recoupling back to the economic gravity of the four horsemen. But this inflow of capital has totally distorted everything you and I grew up watching and using early alert systems.

So I think any factor, and no disrespect meant, but I don’t think any historic use of credit spreads or whatever can be used in the U.S. as long as this slush money is still filtering through the banking system in the U.S. I think the stock market as an indication is starting to unwind, and I think as we come into the end of the year and into early next year it's totally disappear. And then you see the natural move where all the sudden you get two standard or three standard deviations to move to the outside. I'm like you, Chris, I'm waiting to see when something breaks, and then I'm going to go on those trades and be short credit vis a vis the U.S. government.

Chris Martenson: Well, if my trusty triple C credit spreads are no longer a reliable indicator that makes my stomach clench a little because I love having early indicators. What is a useful indicator here or do we just watch and wait?

Steen Jakobsen: You watch the entire global over global growth, the one I tried to explain earlier. That is your new credit spread indicator because gives you whether the world is in an expanding credit mode or it's contracting. Of course, the issue you have right now is that China is actually spending again. China is so much in a hole that it has to fill this hole up. And to go to a positive drift, they need to do a lot of stuff.

So I would expect, and one of the calls we make right now, and made over the last six months, is to sell U.S. equity exposure at three deviation expenses for all the reasons we discussed and buy something like emerging market, particularly emerging market in China which is two to three standardization cheap. In the process, as a portfolio construction, you are playing in the version, which is noncorrelated to momentum trading a war which most of the strategies are built on, and then you increase your potential upside and you use the volatility that you build the portfolio.

So I think it's a very, very easy game to do. I'm not saying sell all of your U.S exposure but sell all of the froth that you were given in '18 and '17, so go back to where you were in 2016. So I think it offers us a lot of opportunity to play the game, but what would be incoming is more credit expansion, bigger credit cake from China. It will take longer than the market wants which is going to create a slow down and a nervousness all the way through the end of the year into early next year. In particular, of course, if the midterm means we're going to have a split Congress – sorry, if the House and Senate is going to be split, then I think Trump will be on his reelection campaign. I think there's only one thing that really works fine and that's being anti-China [PH].

Chris Martenson: So, Steen, how would I track this M 2 growth over GDP? Where would I find that data?

Steen Jakobsen: Go to the net. There's huge amount of M2 numbers. I'm very willing to – people can follow from my column at Saxo Research. We can put a link into this podcast and that's something we do extensively. But there is a huge number – I'd be more than willing and get – people can get Christoph’s email to follow both the credit cake, which is the change of change and the actual change as you eluded to for your listeners here.

Chris Martenson: That would be great. I personally would love to have that. And even if I got that I might be able to share it with a few of the people one my end who care. That would be just fantastic. Let's talk about China for a bit. So a lot depends on this. Last time we talked China's credit impulse was negative, but now you're saying it's turned around. First question, is it too little too late or are they doing enough here?

Steen Jakobsen: It's never too little in the case of China because that's the way – you led with the question before. But the thing is that China is in a deeper hole than they are actually admitting. So, in other words, growth in China right now is significantly lower than what is reported. So the problem is that when they start to engineer an easing of monetary policy, which has been very aggressive in terms of cutting rates and cutting the RRR, as we talked about. But now, they're also doing opening up of the markets and other things.

But I remain very, very focused on China ramping up. So they are _____ in terms of the U.S. And funny enough, every time they are _____ [00:35:55] in terms of boosting, it also means the peak in the dollar is very close in sight which is an interesting leading indicator as well.

But in terms of China, they will be there, but it will take longer this time than it did in '07 and '08. Don’t forget, the stock market in the U.S. bottomed in March 2009, but all the way through 2008, China did the biggest fiscal expanding by any nation every in the history of monetary history. So China has always, for some reason, been _____ [00:36:32] the residual of when the rest of the world's been doing. When the rest of the world has been peaking, China has been in a hole. And that's what we see similar here. And China needs this. They cannot afford for things to fail now. So they're going to go full in. I can guaranty you that.

Chris Martenson: I agree that they want to do that. I'm wondering if they can because '08, '09 they had a lot of headroom. I'm looking at a chart here that shows that China's current account deficit is now, for the first time, on this chart at least, it's in deficit. So it seems like – China, obviously, a very positive export balance country, but still they have a negative current account deficit. Does that factor in here?

Steen Jakobsen: Absolutely. And that makes it slower. So, in other words, in 2008, 2009, one credit CNY would create one credit growth, one CNY growth. Now, you need two and a half CNY input to get one growth. So it's simply one to three slow in terms of what happens. So, absolutely. And as you rightly say, they had a current account in Q1 for the first time in decades. And the overall position is weak.

But, at the same time, they have more people in the middle class. They have a stronger pull from technology. They have a higher propensity to use productivity and the like. So the American version of China is always one where China is a backward country that just produce cheap stuff. But they have the world's two strongest super computers, by the way, run on chips made in China. First quantum telecom communication was there. They have the greatest amount of users on the internet, blah, blah, blah. I'm not the ambassador for China here, but the simplistic message of China not being able to ram up stuff.

And then, in the process, also don’t forget, in 2008, 2009 China was still mainly an export economy. Now, they take more from domestic consumer service spent than they do from exports. So the whole setup is constantly changing. I think, to some extent, as much as you and I love the charts, what it does not explain when we look at a chart is what is the different premises and what is the different execution of strategy that happens in the different time loops? I think you should be very careful ignoring those.

Chris Martenson: I always have a huge grain a salt whenever I'm trying to understand or explain China because it operates very differently in ways that I don’t fully understand. So it seems that they have more command and control and more ability to pull levers. And, as well, I was talking with somebody last year who was fairly high up in the Chinese leadership, and his understanding of resources, energy, economics, science, it was just astonishing. And really, one of the things that he noted to me privately was that in China they don’t have a lot of lawyers trying to run the ship, as it were. Meaning that the United States is really heavily stocked with very non-technically oriented political leadership. And China's got a lot of technical capabilities and they get things.

So on your last horseman here, to get to it, energy. This is something, obviously, that I spend a lot of time looking at. China is now the largest oil importer in the world, and that's going to grow. They are past peak oil by their own admission out of the Beijing Petroleum Institute. So they're going to be importing more and more. Looking at that energy seems to be, to me, to be one of the key things that really going to be driving the next, say, five years of this discussion. I don’t see a lot of focus on that. In the United States we're still waving our little foam finger around saying we're number one, we've got a lot of shale oil.

I think this is a bigger deal than most people are understanding. How is it that you came to put energy in your four horsemen model? And do you have any supply concerns as part of that?

Steen Jakobsen: The reason it's in there is that everything you've done today, Chris, has electricity in it which means that you are, whether you want it or not, you are a victim of the drop of energy prices. And the flux in energy price over the course of last year is meant that you're paying 25 percent more as an end user which is a direct tax on your consumption. That's the number one reason. The second reason that in terms of inflation – there really is only one driver of inflation in the world, at least topline inflation, and that is the real change in energy.

So by using as an input the price of energy to estimate or guestimate, in my case, the consumption tax, I also get an early sign of what happened to the inflation rate. And then if you look at a chart of year over year change to the oil price and the CPI in the U.S., it's correlated 98 percent. So people can talk about wage growth, they can talk about all signs of change and they make perfect sense because, again, everything you do, Chris, today will have electricity consumption in it. And through that, of course, oil consumption, core consumption, whatever.

The other think I want to mention on the supply side – I think two things are happening in the world. I think peak demand, to me, you're much better at this than I am, Chris, but I'm really more concerned about peak demand of oil. And I think what's going to drive peak demand of oil is that, in China, for instance, the party secretary of the local city, the local government, they all have two goals now to fulfill. One is the GDP growth, the second one is reduction of pollution. If you look at the maritime world, they're introducing a sulfur tax now where all the ships in the world have to have either what is called a scrubber or the have to burn more clean fuel.

Everywhere I go in the world – I was in South Africa last week – a businessman came up to me – he was the biggest producer of diesel generators in Africa. Of course, a vast business, a big business in Africa because the electricity grid is not entirely built out. He was asking the same question – do I need to be the best of the worse in a sense, of course, these being very polluted?

So I think we're going to have in the world, probably even a global transport tax. Why is it that to make two cents you send things to Viet Nam and China and ship it back on very polluted ships and the likes back into the U.S. when it can be done locally or through 3 Ds and all this? We know why, you and I, Chris, because we haven't build any R&D and we're not investing in manufacturing because we like cheap labor.

But to operate in the world and to go to higher productivity, I think a big chunk of that, Chris, is going to be on supply. Suddenly energy is going to less relevant than the demand. I think every single process there is, any business that survives in the next ten years, will have to deem themselves to be best in class, even the best afterwards in terms of their energy consumption. So I find that interesting.

And, also, the week before I was in the middle East. It's a big theme in the middle East now. They do realize that it's probably more likely, because we have discovered some oil fields – there was just one outside Bahrain which is deemed to be almost the biggest than Saudi. So I don’t think it's going to be peak supply, I think it's going to be peak demand that is first up. But, Chris, I have to say you are the expert here, not me.

Chris Martenson: Well, I keep hearing about the peak demand, but I just follow the charts, and we're up over 100 million barrels a day of liquid fuel consumption. That's a first. That just happened a quarter ago. And, of course, we're still seeing 85 to 90 million new internal combustion engine net vehicles added to the landscape. And yes, electric vehicles are coming along, but on a percentage basis, they're swamped by the fact that the rest of the world is still growing and the emerging markets – people want transportation and cars and scooters and things like that often make up that mix.

So just following where it is right now. I'm a little concerned on the supply side for me because we have four missing years of upstream oil and gas investment, about a trillion and a half dollars didn't happen. And that, of course, it's like farming, but with a five-year lag instead of a one-year lag. That creates a supply hole somewhere out there in the '20, '21, '22 zone. Just looking at that, the demand side is, yes, it's shifting, but this is a supertanker, to put that metaphor. Take

Steen Jakobsen: I agree. And in terms of energy, we are under five percent global now. So I'm not objecting to we could see $100, $120 oil. What I'm really saying, at the margin, the winning businesses of the world need to be compliant with being reductive. And as marginal changes, I think everything in the world is based on marginal changes. So I think the – I agree with the next year, even two, but I think this marginal change will be a massive momentum. Chris, I go to thirty countries. Everywhere they want to talk about environmental. Now, I'm not exactly an environmental expert, as you very well know. So this is part of the political fabric now, but it's very much, and more importantly, it is really what the consumers demand.

So I think let's agree that momentum is on your side in the short terms, but I firmly believe the next trend in the world is going to be consumers demanding to be part of a better world in terms of the pollution.

Chris Martenson: I absolutely agree, and this comes full circle, and where we align perfectly is a statement you said earlier is that the productive are going to survive. The rest are going to have difficulty. So productivity, one big portion of that, is energy efficient. And so a big critique I have in my country, we still build houses that are fundamentally not energy efficient, like poor insulation, all that stuff, in buildings, commercial buildings in particular.

As you go into a more energy expansive world, all the sudden, I think that's the bit shift. People are going to say, wait a minute, I can rent a building that has half the energy input cost of another. I want that one, not this one. That's going to be true across the entire transportation landscape. So companies that are fundamentally inefficient that have 60-thousand-mile-wide supply chains because they haven't thought it through and suddenly their transportation costs go up because of these factors, they're going to have a tough time relative to the others that have seen this coming.

Steen Jakobsen: Exactly. Absolutely, Chris. And I can tell you in my world I'm being forced by local borrower to go into having all kinds of alternative energy. I'm not allowed to do fossil burning anymore by regulation.

Chris Martenson: Big trends coming forward. And not a minute too soon either, by the way. I think we're a little late to this game. But it'll happen and I'm looking at that. Over the near term I still have concerns about supply going forward. We'll see because that Bahrain discovery you talked about is actually going to require horizontal drilling. It's unclear if they have the technology and the expertise and the infrastructure there to do that. It could be a big thing, but we'll have to see after they get a few actual wells drilled. So I'm looking at that one, but I got one eye half open.

With that, Steen, we're out of time for today. We could talk to you forever. Thank you so much for your time today. Tell people how they can follow you and your excellent work more closely please.

Steen Jakobsen: I represent Saco Bank as an Economist and Chief Investment Officer. So feel free to go to saxobank.com and find the research. There's plenty of research. And I think, as a courtesy, because we talked a lot about credit cakes and monetary aggregates, I will shoot you a link directly to these research so your listener can follow it, Chris.

Chris Martenson: Thank you so much. Steen, thank you so much, and I can't wait for our next conversation.

Steen Jakobsen: Thank you very much, Chris.

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Energy cliff

seems to me that energy affordability is key to energy consumption...globally, energy is becoming increasingly unaffordable even at currently relatively low prices.  at a certain price demand for oil (energy) plummets.  low oil prices bankrupt producers...higher oil prices lead to recession.  my posiiotn is we are in for a massive decline in oil prices due to lack of global demand caused primarily due to affordability and OVER supply in the short term.  longer term (2-3 years out) the spike will follow as supply dries up due lack of new discoveries and investment.

cmartenson's picture
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asgordon123 wrote:

seems to me that energy affordability is key to energy consumption...globally, energy is becoming increasingly unaffordable even at currently relatively low prices.  at a certain price demand for oil (energy) plummets.  low oil prices bankrupt producers...higher oil prices lead to recession.  my posiiotn is we are in for a massive decline in oil prices due to lack of global demand caused primarily due to affordability and OVER supply in the short term.  longer term (2-3 years out) the spike will follow as supply dries up due lack of new discoveries and investment.

The whipsaw effect is one that we've been talking about here for a while.  On our recent Peak Prosperity Summit tours I've been showing that the return on capital of the oil majors has plummeted from 20% - 30% all the way down to single digits and even into negative territory over the past 5 years.

So there's a price of oil below which they are not viable concerns.  

On the demand side there's a price of oil above which the economy cannot survive.  

Mathematical game over is when those two prices cross.  How close are we?  Much closer than we were ten years ago when global debt was some $100 trillion lower.

The relative collapse in the price of oil over the past few weeks is very much a source of concern for those following the oil industry.  There's going to be some major trouble if oil stays down here in the mid $50's for very long.  There's no money to be made at these prices for any of the shale producers I study.  

There's also much less incentive to explore for new finds offshore, or in other capital intensive, long lead time palces either.  

Later, that lack of investment leads to lack of supply and then prices shoot up (I think in ~2020, the IEA is recently saying they think 2020).  Either way, practically tomorrow.

blackeagle's picture
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Joined: May 16 2013
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2020 horizon...

This horizon, could mean a coup in Venezuela to install a friendly government which will make oil flowing again relatively quickly to help dampen the shortage shock.

As long as the current government mismanages the country and drowns in its problems, this oil stays aside for later use.

I am sure many (all?) oil companies are honing their teeth for the day this country becomes more friendly.

sebastian's picture
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Ka Boom

It sure does feel like it’s the start of the Ka Boom...

I have a hard time sharing the PP message with my neighbours and friends.

Not because I don’t want to or think they wouldn’t benefit from it but because most folks are so entrenched in the status quo that I feel I would ostracize myself. 

Its sad but is my belief that most people are happy with taking the blue pill and will fight change til way  past overshoot....

Get out of the city if you can. 


Uncletommy's picture
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Short term gain means long term pain - shale producers!

We musn't forget that shale oil has a lighter profile and is great for making gasoline and other low density products. The current glut of crude is, basically, coming from the huge activity in fracking those tight/light formations. Couple this with lower consumption of gasoline powered vehicles due to reduced use, purchases of electric or hybrids vehicles, denser housing, on-line shopping, etc, and you have a formula for lower gas prices. Also, the fact that many new vehicles are financed over 8 years, who would want to own a gas guzzler, especially considering that they are about 14% less fuel efficient than compression/ignition diesel. "Where's my Ford 150?"

And, if you happen to be in the fracking business, borrowing money to drill wells that produce a product below the price of production, you might just want to consider supplying the cheaper, heavier stuff to sell to refiners. Diesel prices appear to remain higher, currently. Price has a wonderful effect on supply. The Canadian supplier, Cenovus, has even suggested that some of Canada's production should be shut in to bring up the price. The current price differential between WTI at $56.46 to WCS at $24.64 has got to make you wonder! Add to this capacity restraints on delivery and huge stock piles and how we got here. Why are many of the BRIC countries still buying gold? Look no father than the counrties buying gold and consuming the most energy. I don't know what Mr. Trump is going to do when all those US dollars come flooding back home. Maybe he can build another wall! 

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