Doug Casey’s Note: David Stockman is a former congressman and director of the Office of Management and Budget under Ronald Reagan.
Now, anyone with connections to the government should elevate your suspicion level. But as you’ll see, David is a genuine opponent of government stupidity. Although his heroic fight against the Deep State during the Reagan Administration was doomed, he remains a strong advocate for free markets and a vastly smaller government.
We get together occasionally in the summer, when we’re both in Aspen. He’s great company and one of the few people in this little People’s Republic that I agree with on just about everything. Absolutely including where the US economy is heading.
I read his letter the Contra Corner every day and suggest you do likewise.
International Man: What do you make of the ballyhooed potential trade deal with China? Peak Trump: The Undrai... Best Price: $12.72 Buy New $43.07 (as of 11:40 EST - Details)
David Stockman: First of all, the deal is all ballyhoo. You know what they say in Texas, “All hat and no cattle.” That’s what we got here.
There’s not going to be a deal, because the problem that Trump is focused on and obsessed with is that we bought $543 billion worth of stuff from China last year, and we sold $120 billion.
It’s not because of bad trade deals The Donald thinks that his predecessor made. Or because the Chinese are the worst kind of trade cheats in world history.
The reason is the economic differential—the economic cost and wage gap between the two countries is so great, that we have this huge imbalance. The Fed is the partial cause of that economic and cost differential.
If you look at manufacturing, our average wage is over $30, which includes the cash wage plus the health benefits, retirement, and Social Security taxes, and all the rest of it.
And in China, it’s about $5. When you have $30 versus $5, it tells you all you need to know.
So, we have this huge gap overall, which is $423 billion, in other words, exports minus imports. But almost 55% of that is accounted for by two trade code categories that really focus on smartphones, laptops, desktops, other computer equipment, electronics, and so forth.
Apple iPhones and the whole rest of it—the supply chain has been entirely transplanted to China. That’s because of a wage arbitrage. Last year, in those categories, we imported $275 billion worth of stuff, including about $90 billion worth of cell phones—and we exported to them only $27 billion worth of stuff.
So, there’s a massive 10-to-1 ratio of imports to exports, and it’s due to wage and cost differences, not because the Chinese cheat. The point is you’re not going to negotiate that away.
Trump has identified the problem of $423 billion merchandise trade deficit of one country. He’s only going to blow up the global trading system and supply chains with these idiotic tariffs. They’re really getting pretty serious.
There’s no doubt that this isn’t going to stop anytime soon.
I think it’s important to recognize that by the end of this year we’ll be looking at $550 billion Chinese imports in the US economy. At all stages of the supply chain—some finished goods, some intermediate goods, some parts—that will be subject to tax of $120 billion by a unilateral action of the president of the United States, who thinks he’s the trade czar of the world.
If we tax one country as opposed to all imports, you cause massive repercussions and ricochet effects in the supply chain.
It’s the greatest foreign aid program the United States ever conceived. We’re driving business, jobs, and work to Vietnam, India, Indonesia, Mexico, and a lot of other places, as we rip up these supply chains in China.
China is a red Ponzi. It’s a house of cards. It’ll collapse of its own weight sooner or later.
But we are going to hasten the collapse of the red Ponzi because they’re selling at prices in order to maintain business and not lose it to Vietnam and others.
That means that the already meager profits of Chinese companies will disappear entirely.
No one’s ever tried to tax the flow of trade with one country at a 21% rate in today’s world, where things can change so rapidly due to technology and the massive infrastructure of global transportation and shipping.
Trump is the biggest, baddest bull in the china shop that has ever entered world commerce. This is a disaster in the making.
International Man: Speaking of the next crisis…
After the 2008 crisis, the Fed kept interest rates artificially low, as a “temporary” measure. All this did was create easy money and pump up the stock market.
The Fed’s attempt to normalize interest rates caused the stock market to tank. They’ve since capitulated and ended the tightening cycle.
What do you think about the Fed’s ability to paper over the next crisis by turning on the money spigots again?
David Stockman: I think it’s very limited. I think they shot their wad, so to speak. They have very little dry powder left.
Remember, before the dot-com crisis, the federal funds rate was over 6%, and so they had 600 basis points to cut. At the time of the housing subprime crisis in 2008, the funds rate was 5.5%. So again, 500 basis points to cut.
Here we are in month 121 of the longest business expansion in history—albeit the weakest one. The unemployment rate is at 3.7%, and they’ve already thrown in the towel and have cut the rates. This morning the federal funds rate is 2.12%.
They’ve got no room left to go. Now, people say they could go negative. They will not go negative in the United States. If they actually tried to drive interest rates in the short end of the market into negative territory—and finally crush whatever life is left in the savers and retirees of America—people would be descending on Washington with pitchforks and torches. So that won’t happen.
You could say they’ll go to quantitative easing (QE). I doubt that. The QE experiment has failed entirely. We’ve had massive increases in the Fed’s balance sheet, which went from about $850 billion on the eve of the subprime crisis to a peak of $4.5 trillion. Ben Bernanke promised at the time and said it over and over: This is an emergency. It’s the 100-year flood. It’s a one-time thing. We will normalize as soon as the economy has stabilized.
Well, 10 years later, I would say it has stabilized. They began to shrink the balance sheet in a very tepid way. They got to $3.8 trillion, which is nothing in terms of rolling back this massive monetization of the public debt that they undertook. And then they threw in the towel because Donald Trump barked at them in a very menacing and snarly voice.
So, they basically have this huge balance sheet in conjunction with the other central banks of the world. Collectively, they have driven bond yields to rock bottom. I would say we’re now in the mother of all bond bubbles in history.
They’ve practically destroyed the bond market in terms of any meaningful price discovery and any meaningful economic content of the yields. You have $16 trillion of investment-grade sovereign debt trading at negative yields. You have even the entire US yield curve as the only bond market left with a positive number in front of the yield, and now we’re under 2%. They’re close to destroying the bond market completely.
So, if they try to go big time with a new round of QE, that will blow up the bond market. There’s no doubt about it.
I think that will be a calamity and will generate an unprecedented collapse of the entire global financial system.
So, they’ve painted themselves into an unbelievably tight corner. Of course, they’re sitting there in the Eccles Building thinking they’re the masters of the universe, and they’re doing a great job—patting themselves on the back. They’re completely delusional.
These are very foolish people who have been wearing their Keynesian beer goggles for so long that they can’t even recognize or anticipate the massive looming crisis right in front of their face.
International Man: It’s not just in the US. The central banks of Europe, Japan, and most other countries around the world are doing the same thing. How do you think this will play out?
David Stockman: I think it’s clear that we’re at a race to the bottom and not just in terms of the traditional notion of exchange rates, beggar thy neighbor and having my rates below yours.
Although Donald Trump seems to think that’s the name of the game and that the Fed ought to do the very stupid things that the ECB and the Bank of Japan are doing. His philosophy, I guess, is if my neighbor burns down his house, I ought to follow his wise example and do the same to mine.
This is really crazy. But in any event, let’s understand what this race to the bottom is. This is a race to the bottom on yields. This is a race to the bottom of the $60- or $90-trillion global bond market, depending whether you’re counting investment grade or everything. If you count everything, it’s something like $90 trillion.
There isn’t much room left to go. The entire German yield is negative. The 10-year German bond is at negative 66 basis points. This is absurd.
The Austrians issued a 100-year bond two years ago, with a coupon of 2%. That bond was recently trading at 210% of par and at a yield that is less than 1 now. The point is, if Austria survives until 2117 when the bond matures, investors are going to be paid back 100 cents on the dollar, not 210 cents. Somebody is buying the damn thing with a guaranteed 55% loss if they hang onto it over time.
So, the point here is that the central banks have stimulated a massive frenzy of speculation in the bond market, where investors—and I would really say “speculators”—are chasing prices up.
Why would anybody buy that Austrian bond at 210% of par? Well, the answer is that a couple months ago, it was at 160, and a few months before that, it was at 130.
So, the idea that stocks are supposed to be where you speculate on price and bonds are supposed to be the safe instrument where you lock in a modest but safe yield has been turned upside down.
The speculators are now moving into the global bond market, chasing price. And of course, as the prices rise, the yields collapse. That’s how we’re getting nominal negative yields. No one has really issued that much debt with a negative coupon. They’ve issued debt with low coupons that then trade up way above par, driving the current yield into negative territory.
This is the biggest disaster to hit the financial system since the 1930s or maybe even before. It’s all the doing of the central banks. And it isn’t too long, in my judgment, before the chickens come home to roost.
International Man: In 2008, the subprime mortgage crisis played a key role. What do you think could the catalysts for the next crisis?
David Stockman: It’s the mother of all bond market bubbles. And it’s not just that speculators have driven the price of almost all sovereign debt way above par. It’s going to come back to par, either when the market corrects or when the bonds are redeemed—and somebody’s got a capital loss of large magnitude sitting right on their balance sheet at the moment.
That’s the crisis because it’s being done on leverage. Of course, there are some cash buyers, but all the smart money and the speculators are buying this low-yielding or negative-yielding debt on repo and collecting the capital gain. Let’s say the price moves 110 to 120 on 95% leverage, and they’re laughing all the way to the bank. This is big-time speculation.
When it reverses, they’re going to unwind these trades and all these elevated, insane prices in the bond market.
That’s what $16 trillion of negative yield means. It equals insanity.
So, the point is it’s going to correct, and when it does, it will correct hard. It will ricochet through the entire financial system.
The main thing keeping up stocks for the last four or five years has been buybacks. Households were net sellers, actually, of US stocks.
Between 2014 and 2018, companies were the only net buyers of stocks: $2.4 trillion or something like that. But they were able to do that only because they can borrow money at practically zero.
They didn’t want to generate cash reserves for the rainy days that always come in business life—because they couldn’t earn a red cent on it. So, they bought back their stock. The Great Deformation:... Best Price: $4.26 Buy New $8.99 (as of 05:50 EST - Details)
When the big bond market bubble collapses, the stock buyback machine is going to grind to a halt, and the big stock bubble is going to disappear.
In other words, the correction is going to cascade and ricochet through the entire global financial system. It consists of $250 trillion of debt—of bonds, bank, junk, commercial real estate securitization, and all the rest of it. And the global stock market is about $80 trillion.
That’s to say nothing of the derivatives, which are orders of magnitude larger than those two markets.
So, we’re talking about a threat to the entire financial superstructure of the world. I don’t think it’s going to be a happy ending.
The 2000 dot-come excess or the 2004 to 2008 subprime housing credit excess is minor league compared to $16 trillion of bonds trading in negative yields.
Editor’s Note: Excessive money printing by central banks and misguided economic ideas have created all kinds of bubbles in the financial system. These established trends in motion are accelerating, and now approaching a breaking point. It could cause the most significant economic disaster since the 1930s.
Reprinted with permission from International Man.