Comstock Partners, Inc.November 05, 2015
The Global Debt Controls the Global Economy
The main reason the US economy is struggling to recover from the “Great Recession” of 2007 and 2008 is because the debt load is so very difficult to overcome. The global debt has increased by about $60 trillion since 2007 and there is no way to have a smooth and quick recovery after the debt has grown so much so quickly (see first attachment). Keep in mind that the reason for the “great recession” was due to the overwhelming debt incurred by almost every country (this includes the developed nations as well as the emerging markets). The main reason for the increased debt burden started with the Federal Reserve reducing the Fed Funds Rate to 1% in June of 2003 and keeping it there for a year. They thought that they were giving relief to the U.S. due to the bursting of the dot.com bubble. They were not aware of the possibility of being the main cause of the “housing bubble” (which they were). In fact the Fed had no idea they were the cause of the dot.com bubble after Fed Chairman Greenspan warned global investors about the possibility of “irrational exuberance” in 1998. After the market dipped it came roaring back enough for Greenspan to reverse his warnings to state, “everything is OK now”. Our Federal Reserve also tried to alleviate U.S. investor’s concerns by stating that there was “no housing bubble in 2005, 2006, and 2007.” When the housing bubble turned out to be worse than the dot.com bubble they invented Quantitative Easing (QE), which essentially meant that the Fed bought a tremendous amount of U.S. Treasury securities. The theory, at least, was that by lowering interest rates and buying Treasury securities that bank reserves would be increased and that would find its way into the real economy as loans to businesses and individuals. This turned into QE 1, followed by QE 2, then QE 3 (interspersed with “Operation Twist”--- purchases of longer term Treasuries while selling shorter term Treasuries). This caused the Fed’s balance sheet to grow from $800 billion in 2007 to $4.5 trillion now. The most amazing part of this was that the rest of the worlds’ central banks decided to copy the Fed and start their own QE, which drove up all of the central banks’ balance sheets to outrageous levels.
There have been many very sophisticated investors and money managers that have warned about the U.S. debt explosion over the past 35 years (and especially the last 15 years) when the dot.com bubble burst (see second attachment). Just this week Stanley Druckenmiller warned about the devastation of the U.S. economy due to the promise of entitlements. He stated that if the entitlements (mostly Social Security and Medicare) in the U.S. were paid to everyone that expected to receive them, and the revenues that would be coming in as expected over the next 20 years the National Debt would no longer be the $18-$19 trillion that all of the Presidential Candidates talk about as an impossible burden. In fact, if you take the present value of the entitlements promised to the expected recipients, the National Debt would no longer be $18 -$19 tn. but would be closer to $205 trillion. If that number doesn’t scare you nothing will. David Stockman also has gone through his present value of entitlements that comes in around $80 trillion. Either one shows just how outrageous entitlement promises have become and that they must be corrected. Stockman has also shown the growth in global GDP and global debt from 1994 to present. He shows that global GDP grew from $28 tn in 1994 to $78tn presently (CAGR-Compound Annual Growth Rate—5.3%) and the global debt grew from $40 tn in 1994 to 225 tn presently (CAGR-9%). This kind of growth relative to GDP is unprecedented and this is why the growth in global GDP is being smothered by global debt. The only thing close to this is the growth in debt relative to GDP in the U.S. presently and Japan back in 1989.
We presently have the problem of tightening while the rest of the world is now following our footsteps in printing money and essentially having a “currency war” (3rd attachment) with us. About half the Federal Reserve Governors are “hawks” and espouse raising rates. The other half are “doves” and espouse keeping rates around zero. It is our opinion that the Fed will not raise rates. We believe the economic data will not support a rise in rates now and, in fact, we may not support a rate rise in all of 2016. This is because of the debt load we discussed in the second paragraph has made the recovery weaker than any recovery since World War II. And once the entitlement debt problem becomes more well- known the recovery will slow down even more next year. We have been predicting for some time that not only will we not raise rates, but we will resort to using every tool we have in order to compete with Europe, China, Japan, and all other central banks that are using the “Quantitative Easing” (QE) we have been using for the past seven years. In fact, we believe that we will probably use QE-4 after the three other QEs we used in the past. That sure didn’t work very well for us the first 3 times, but it is our last resort except to drive rates down to negative rates. We don’t believe that negative rates will work because if banks have to pay money to the Fed on their excess reserves they will not hold excess reserves. The American public won’t accept having to pay money to hold their money in banks.
All in all, it looks to us like the global debt has run out of steam and we believe the global debt will start shrinking as commodities continue declining (copper is a good example of this making a low not seen since 2009). This should continue the deflationary aspects of the worldwide stock markets and end the rally over the past month. The stock market range in the U.S. expressed by the S&P 500 has been from 2040 to 2135 until just recently when it broke down through the 2040 support. After the recent rally the S&P got back to about 2100, but we still don’t believe it will rise above the range high of 2135 and instead decline below the support again, but this time it should continue down just like Japan did in the early 1990s.