October 21, 2015: Excerpted from Artemis Capital Management letter to investors

The arms race of devaluation is not free and has come at the cost of massive global debt expansion. There is no precedent in financial history for a robust economic recovery absent either debt reduction or rampant inflation. We never deleveraged, in fact we just doubled down. According to a recent McKinsey study the world has reached $200 trillion of debt in 2014 (286% of global GDP), which is a staggering 40% increase from 2007 levels (+$57 trillion). In China, debt has grown four times faster than GDP since 2007, and half of that debt is linked to their property market. The world has simply shifted private debt to the public balance sheet.

The private risk transfer to the public balance sheet can also be seen in the evolution of credit default swap pricing since 2007. Notice the sharp divergence between global sovereign CDS (red) and financial corporate CDS (blue) starting in 2013. The next major global crash will likely be driven by unhealthy sovereign credit rather than corporate credit. The next Lehman moment will be the financial collapse of a major developed country instead of a bank.

There are those who point to aggressive central banking of the late-1930s as the model for de-leveraging post-depression but this argument is highly flawed.

We didn’t financially engineer our way out of the Great Depression – we won a World War.

It’s extremely helpful in the de-leveraging process if you are the only capitalist industrial power left in the world untouched by utter and complete destruction. De-leveraging from the Great Depression had as much to do with the blood, sweat, and tears of American soldiers, the development of nuclear weapons, and the fact we were an ocean removed from the battlefield on both sides, as anything related to fiscal and monetary policy from the era.

I don’t think some investors are being radically honest when they omit this brutal truth in their analysis of late-1930s as model to argue for more quantitative easing. More quantitative easing is a great thing if you run a large risk parity fund but it will not help the American middle class.

Artemis Capital Management / Zero Hedge

Zero Hedge/Bawerk

Corporate foie gras

One of the arguments put forth in the bull vs. bear debate is that the solidity of US non-financial corporations have never been stronger. The amount of cash held by non-financial corporations has risen 150 per cent since the depth of the crisis in 2009. With such a massive cushion to stave off whatever the market may throw at them, they will be able to cope, or so it is held.

In addition, we know that financial corporations are flush with cash, or excess reserves held at the Federal Reserve. Throughout the various quantitative easing (QE) programs conducted by the Federal Reserve, commercial banks have been force fed cash as ducks on a foie gras farm. This has swelled their excess reserves to the unprecedented, and what would be thought unimaginable only few years’ back, level of US$2.6 trillion.

With all this cash the system should be, again according to the perma-bulls, more than ready to withstand the shock from the ongoing global deleveraging, a stronger dollar, emerging market blow-ups and the forthcoming US recession.

We beg to differ. When it comes to excess reserves they are most likely already “spoken” as a form of collateral in shadow banking chains. While the initial effect from QE on the shadow banking system was massive deflationary shock as all the high quality securities used in re-hypothecated collateral chains were soaked up by the Federal Reserve, it is a safe bet that excess reserves has to some extent filled that void.

In the non-financial sector on the other hand cash is, well, plain old cash. With more than US$1 trillion of the stuff on their balance sheet complacency is destined to be prevalent. And it is.

Credit market instruments, i.e., debt, have also risen at a tremendous rate. Net debt, that is credit market liabilities less cash, has actually never been higher. As the chart below shows, sitting at more than US$6.6 trillion, non-financial net debt outstrips even the high from 2008.

Now, if we express the gargantuan debt load as share of market value of non-financial equities outstanding things looks not only sustainable, but outright sound. At only 30 per cent the debt to equity ratio is at multiyear lows. We need to go all the way back to the peak of the dot-com folly to find today’s equal.

And it is exactly the folly of the dot-com (and went) that best epitomizes todays manic corporate debt issuance. According to Bloomberg more than US$2.7 trillion in stock buybacks has been effectuated over the last six years. We would be amiss if we didn’t mention that this spending spree, not on capital goods or R&D that will help propel future growth mind you, but on liability massaging, coincided with ZIRP.

Investors desperate for yield have more than happy to lend US Inc. trillions of dollars, even though it is used mainly to buy back own stock. Not surprisingly this also help goose the market value of equites outstanding; also known as the denominator in the ratio presented in our chart.

So more debt begets higher market value of equites which in turn improves the debt/equity ratio which gives the incentive to issue more debt ad infinitum. Or in a slightly simpler version, debt begets more debt.

We have seen the story before. In the shaded grey areas we highlight episodes when the virtuous relationship turns ferociously vicious. Remember, markets take the escalator up, but the elevator down. And the longer the escalator the further down the elevator goes.

Source: Federal Reserve Flow of Funds (Z.1), Bawerk.net

When the US recession hits (see here for more) the massive gap between the green and red line in our chart above will close in short order and the calamity will be even worse than last time, which incidentally was far worse than the time before that.

And this Ladies and Gentlemen is aggregate demand management in practice where, for some unexplained reason, the abundance of savings does not clear the market for investable funds not even at the zero lower bound.

The fact that central bank perverts capital markets and is to a large extent responsible for the very same secular stagnation central bankers believe they must fight, seems lost on today’s intelligentsia.

* * *

Back to ZH here, in addition to Bawerk’s explanation of what may be the biggest “non-financial sector” margin call ever on deck, we just wanted to underscore one of the main points made in the piece above, namely the stability – or rather lack thereof – of US Commercial banks, whose cash assets according to the most recent H.8 statement amounts to $2.8 trillion. The problem is that of this, over $2.5 trillion comes from the Fed’s excess reserves which at some point will be unwound, meaning the true cash level of US banks – when one excludes excess reserves – has not budged at all since the financial crisis, and has in fact declined to a pro forma level of just over $200 billion.

economicnoise.com : August 11, 2015

The US and world economies are frauds that are coming unraveled. The Greek bailout is the most recent example of “kick the can down the road” solutions. The US housing bubble was an attempt to cover up/recover from the dot-com bust. Now the US is in a financial bubble engineered to recover from the housing bubble debacle. Soon this bubble will burst. Only the date is unknown.

Two predictions can be made with reasonable confidence:

• The stock market is likely to be halved and that might be optimistic. Only the date is unknown.
• The economy will eventually resemble the Great Depression. Only the date is unknown.

Nothing is ever certain. An experienced CFO told me at the beginning of my career that “even the impossible has a 20% probability.” In deference to him and years of empirical evidence, I put the the above two events as virtually certain, i.e., an 80% probability.

The Current Problem

Phoenix Capital provided reasons to expect horrible outcomes:

• The REAL problem for the financial system is the bond bubble. In 2008 when the crisis hit it was $80 trillion. It has since grown to over $100 trillion.
• The derivatives market that uses this bond bubble as collateral is over $555 trillion in size.
• Many of the large multinational corporations, sovereign governments, and even municipalities have used derivatives to fake earnings and hide debt. NO ONE knows to what degree this has been the case, but given that 20% of corporate CFOs have admitted to faking earnings in the past, it’s likely a significant amount.
• Corporations today are more leveraged than they were in 2007. As Stanley Druckenmiller noted recently, in 2007 corporate bonds were $3.5 trillion… today they are $7 trillion: an amount equal to nearly 50% of US GDP.
• The Central Banks are now all leveraged at levels greater than or equal to where Lehman Brothers was when it imploded. The Fed is leveraged at 78 to 1. The ECB is leveraged at over 26 to 1. Lehman Brothers was leveraged at 30 to 1.
• The Central Banks have no idea how to exit their strategies. Fed minutes released from 2009 show Janet Yellen was worried about how to exit when the Fed’s balance sheet was $1.3 trillion (back in 2009). Today it’s over $4.5 trillion.

The cumulative effects of decades of interventions to mask economic weakness are harmful to the economy. Statistical manipulation and outright lies in government reporting of economic conditions suggest that times are becoming ever more desperate for the political class. There is not enough bailing wire in the world to hold this train wreck in check. Nor is there any way to solve the massive problems created over decades.

Mac Slavo believes we are already in a world-wide depression stating:

With stock markets in China having self destructed, Greece and Europe in another crisis, and corporate earnings for some of the world’s biggest corporations showing lackluster performance, it should be clear that the situation is rapidly deteriorating.

But for the last several years America has appeared to remain fairly insulated from overt crisis. We were told that a recovery had taken hold, jobs were returning and consumer confidence had reached new highs, propaganda which drove millions of investors back into stock markets and real estate. No one in the mainstream world, it seems, believes there’s anything to be concerned about.

Except there is.

Nassim Taleb described the problem:

Uncertainty should not bother you. We may not be able to forecast when a bridge will break, but we can identify which ones are faulty and poorly built. We can assess vulnerability. And today the financial bridges across the world are very vulnerable. Politicians prescribe ever larger doses of pain killer in the form of financial bailouts, which consists in curing debt with debt, like curing an addiction with an addiction, that is to say it is not a cure. This cycle will end, like it always does, spectacularly.

Each intervention has been bigger than the previous one. And they are needed more frequently. Bad times are here and have been despite what government says. Worse times lie ahead. Only the date is unknown.

(read the full article at economicnoise.com)

Keith Dicker
IceCap : August 2015

Governments all around the world have borrowed too much money and the weight of these debts are choking economic growth.

And to make matters worse – these very same governments and their central banks have implemented various plans that have only made matters worse.

The global debt crisis has escalated to a point where the government bond bubble has inflated itself to become the mother of all bubbles. It’s going to burst, and when it does it wont be pretty.

Further evidence to support our view is as follows:

Canada – the collapse in oil and commodity markets has pushed the country into recession and the Canadian Dollar to decline to levels lower than that reached during the 2008 crisis.

Oil dependent provinces Alberta and Newfoundland remain in deep denial. Since everyone in these provinces have only ever experienced a booming oil market, many naively believe things will bounce back – and quickly.

Meanwhile, both Toronto and Vancouver housing markets also remain in denial as they continue to go gangbusters. Buyers today are likely buying at all-time highs.

And as we predicted last year, the Bank of Canada has cut (not raised) interest rates twice in the last 6 months.

We fully expect the Bank of Canada to eventually cut interest rates to 0% and start a money printing program as well. And for the stunner – NEGATIVE interest rates will not be that far behind.

Australia – Over the last 20 years, China has been viewed as the growth engine of the world, and justifiably so. With annual growth rates between 8% to 15%, China’s economy was literally eating every rock, stalk and barrel of practically every commodity in the world.

And naturally, any country or company that produced these commodities made a tonne of money – including Australia.

Today, China’s growth rate has slowed to about 3% which is a dramatic slow down compared to what it achieved in the past. This slowdown and China’s effort to even maintain these rates, will have significant repercussions around the world.

And the first up to bear the brunt of this slowdown is its closest supplier of raw materials – Australia.

With dark clouds on the economic horizon, the Australian government and central bank is doing everything possible to prevent the unpreventable recession.

Interest rates have been reduced to all-time historical lows, meanwhile the Australian Dollar has plummeted -25% over the last year. Yet – the negative outlook has not improved.

Brazil – Like Australia, Brazil has benefitted immensely from China’s growth. And now, also like Australia, it too is feeling the affects of the dramatic Chinese slowdown.

The economy has now declined for 12 consecutive months making it both the longest and deepest recession in 25 years.

But wait – it gets worse. Despite declining growth, inflation continues to soar higher causing interest rates to rise as well.

And if that wasn’t bad, also know that the Brazilian currency has fell off the cliff at -53%.

Sweden – Unlike Australia and Brazil, Sweden relies very little on China as a buyer of last resort. Yet, the Swedish economy is also not very hot these days.

In fact, instead of spectacular and dramatic declines in anything, it is doing the exact opposite – it just isn’t moving.

While Sweden isn’t in the Eurozone, it is smack dab next to it and that in itself is reason enough for the lack of growth. We’ve written before how the debt crisis in the Eurozone is acting like a giant, slow moving tornado that is sucking the life out of the economy and everything near by. And unfortunately for Sweden, it is very near by.

While economic growth in the Nordic state hasn’t declined, it hasn’t accelerated either – and this is what has many worried.

So worried, that the central bank shocked everyone not once but twice, by first announcing that they would begin to print money, and then when they announced that interest rates would be NEGATIVE.

These actions are so severe, that we need to repeat them:

1) MONEY PRINTING
2) NEGATIVE INTEREST RATES

It is hoped that these actions will cause people and companies to loosen their wallets and start spending again. Yet, what the government and the central bank doesn’t understand is that these actions will actually make the problem worse.

As the global economy continues to move as we expect, there is nothing Sweden can do to change what is coming – a global recession and a significantly weaker Krona.

China, Australia, Brazil, Canada, Sweden – it is beyond us how anyone can declare the crisis isn’t spreading.

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IceCap’s full letter below

Zero Hedge: July 20, 2015

Earlier today, Greece used up virtually its entire €7.1 billion bridge loan from the EU to repay its creditors: between the money due to the ECB, the arrears to the IMF and the cash borrowed from the Greek central bank, Athens had about €300 million left over from the entire inbound wire to use as it sees fit just hours after the money was received, and then promptly sent right back.

Or, as some put it, Greece collected a 4% transaction fee for facilitating a €6.8 billion payment from its creditors to its creditors.

So does this mean things are “fixed” in Greece, if only temporarily? Not exactly, as the following table shows, there is exactly one month until the next €3.2 billion payment is due to the ECB. So unless Europe finalizes the terms of the third €86 billion EFSF bailout in the next 4 weeks, Greece will need another bridge loan just to repay the ECB.

Ok, but if Greece somehow survives until the end of 2015 despite a new government and with blistering VAT hikes, even as bank lines to withdraw money refuse to go away, then will it finally be ok?

Well, no.

As we showed before when we showed the various Greek circle of debt hell, unless Greece finds a way to access the market once again following its “triumphal return” in mid-2014 when it issued bonds that cost investors (with other people’s money) their 2015 bonus, it is only then that the Greek debt repayment hell begins.

(read the full article at zero hedge)

Robert B. Reich
The Nation : July 16, 2015

The investment bank made millions by helping to hide the true extent of the debt, and in the process almost doubled it.

The Greek debt crisis offers another illustration of Wall Street’s powers of persuasion and predation, although the Street is missing from most accounts.

The crisis was exacerbated years ago by a deal with Goldman Sachs, engineered by Goldman’s current CEO, Lloyd Blankfein. Blankfein and his Goldman team helped Greece hide the true extent of its debt, and in the process almost doubled it. And just as with the American subprime crisis, and the current plight of many American cities, Wall Street’s predatory lending played an important although little-recognized role.

In 2001, Greece was looking for ways to disguise its mounting financial troubles. The Maastricht Treaty required all eurozone member states to show improvement in their public finances, but Greece was heading in the wrong direction. Then Goldman Sachs came to the rescue, arranging a secret loan of 2.8 billion euros for Greece, disguised as an off-the-books “cross-currency swap”—a complicated transaction in which Greece’s foreign-currency debt was converted into a domestic-currency obligation using a fictitious market exchange rate.

As a result, about 2 percent of Greece’s debt magically disappeared from its national accounts. Christoforos Sardelis, then head of Greece’s Public Debt Management Agency, later described the deal to Bloomberg Business as “a very sexy story between two sinners.” For its services, Goldman received a whopping 600 million euros ($793 million), according to Spyros Papanicolaou, who took over from Sardelis in 2005. That came to about 12 percent of Goldman’s revenue from its giant trading and principal-investments unit in 2001—which posted record sales that year. The unit was run by Blankfein.

Then the deal turned sour. After the 9/11 attacks, bond yields plunged, resulting in a big loss for Greece because of the formula Goldman had used to compute the country’s debt repayments under the swap. By 2005, Greece owed almost double what it had put into the deal, pushing its off-the-books debt from 2.8 billion euros to 5.1 billion. In 2005, the deal was restructured and that 5.1 billion euros in debt locked in. Perhaps not incidentally, Mario Draghi, now head of the European Central Bank and a major player in the current Greek drama, was then managing director of Goldman’s international division.

Greece wasn’t the only sinner. Until 2008, European Union accounting rules allowed member nations to manage their debt with so-called off-market rates in swaps, pushed by Goldman and other Wall Street banks. In the late 1990s, JPMorgan enabled Italy to hide its debt by swapping currency at a favorable exchange rate, thereby committing Italy to future payments that didn’t appear on its national accounts as future liabilities.

But Greece was in the worst shape, and Goldman was the biggest enabler. Undoubtedly, Greece suffers from years of corruption and tax avoidance by its wealthy. But Goldman wasn’t an innocent bystander: It padded its profits by leveraging Greece to the hilt—along with much of the rest of the global economy. Other Wall Street banks did the same. When the bubble burst, all that leveraging pulled the world economy to its knees.

[…]

Meanwhile, cities and states across America have been forced to cut essential services because they’re trapped in similar deals sold to them by Wall Street banks. Many of these deals have involved swaps analogous to the ones Goldman sold the Greek government. And much like the assurances it made to the Greek government, Goldman and other banks assured the municipalities that the swaps would let them borrow more cheaply than if they relied on traditional fixed-rate bonds—while downplaying the risks they faced. Then, as interest rates plunged and the swaps turned out to cost far more, Goldman and the other banks refused to let the municipalities refinance without paying hefty fees to terminate the deals.

Three years ago, the Detroit Water Department had to pay Goldman and other banks penalties totaling $547 million to terminate costly interest-rate swaps. Forty percent of Detroit’s water bills still go to paying off the penalty. Residents of Detroit whose water has been shut off because they can’t pay have no idea that Goldman and other big banks are responsible. Likewise, the Chicago school system—whose budget is already cut to the bone—must pay over $200 million in termination penalties on a Wall Street deal that had Chicago schools paying $36 million a year in interest-rate swaps.

A deal involving interest-rate swaps that Goldman struck with Oakland, California, more than a decade ago has ended up costing the city about $4 million a year, but Goldman has refused to allow Oakland out of the contract unless it ponies up a $16 million termination fee—prompting the city council to pass a resolution to boycott Goldman. When confronted at a shareholder meeting about it, Blankfein explained that it was against shareholder interests to tear up a valid contract.

Goldman Sachs and the other giant Wall Street banks are masterful at selling complex deals by exaggerating their benefits and minimizing their costs and risks. That’s how they earn giant fees. When a client gets into trouble—whether that client is an American homeowner, a US city, or Greece—Goldman ducks and hides behind legal formalities and shareholder interests.

Borrowers that get into trouble are rarely blameless, of course: They spent too much, and were gullible or stupid enough to buy Goldman’s pitches. Greece brought on its own problems, as did many American homeowners and municipalities.

But in all of these cases, Goldman knew very well what it was doing. It knew more about the real risks and costs of the deals it proposed than those who accepted them. “It is an issue of morality,” said the shareholder at the Goldman meeting where Oakland came up. Exactly.

(Full article at The Nation)