This week Doug Noland joins the podcast to discuss what he refers to as the “granddaddy of all bubbles”.
Noland, a 30-year market analyst and specialist in credit cycles, currently works at McAlvany Wealth Management and is well known for his prior 16-year stint helping manage the Prudent Bear Fund.
He certainly shares our views that prices in nearly every financial asset class have become remarkably distorted due to central bank intervention, first with Greenspan’s actions to backstop the markets in the late-1980’s, and more recently (and more egregiously) with the combined central banking cartel’s massive and sustained liquidity injections in the years following the Great Financial Crisis.
At this year's annual Robin Hood conference, which was held virtually, the founder of the world's largest hedge fund, Ray Dalio, talked about asset bubbles and how investors could detect as well as deal with bubbles in the marketplace. Q1 2021 hedge fund letters, conferences and more Dalio believes that by studying past market cycles Read More
All of which has blown the biggest inter-connected set of asset price bubbles the world has ever seen.
Noland foresees tremendous losses as inevitable, as the central banks lose control of the monstrosity they have created:
This is the granddaddy of all bubbles. We are at the end a long cycle where the bubble has reached the heart of money and credit.
There will be no way out. We’re not going to get enough private credit growth to reflate things when this bubble bursts. It’s going to have to come from central bank credit; it’s going to have to come from sovereign debt.
When this bubble bursts, it will shock people how far the central banks will have to expand their balance sheet just to accommodate the deleveraging in the system. And they won’t really be able to add new liquidity to the market; they’re just going to allow the transfer of leveraged positions from the leveraged players onto the central bank balance sheets.
When you get to that point, when the market sees that transfer occurring, I predict there’s going to be fear of long-term financial instruments. We’ll see rising yields. That’s when things will become problematic.
There will be losses. Of this global bubble, I think European debt is about the most conspicuous. Sure, European junk debt is nuts, too. It currently trades at 2%. Why? Because the ECB is buying large amounts of corporate debt. The ECB has kept rates either at 0% or negative. The perception is that the ECB will keep those markets liquid.
But look at Italy. It’s rapidly approaching 135% in terms of government debt to GDP. That debt will not get paid back. But yet, the market is willing hold that debt at 1.7%. This is debt that has traded at over a 7% yield back in 2012. But here it is today at 1.7%. I mean, Europe is just grossly mispricing its huge debt market. The excesses that have unfolded in European debt across the board are just staggering.
So when we get to that point when the central banks begin aggressively expanding their balance sheets (again) but the bond markets are not happy about it, then the central banks will finally have to decide if they want to continue to inflate or if they’re going to focus on trying to keep market yields down. This will be a very, very difficult situation for central bankers when it unfolds.
Click the play button below to listen to Chris’ interview with Doug Noland (54m:31s).
Chris Martenson: Welcome to this Peak Prosperity podcast everybody. It is December 5, 2017. I am your host Chris Martenson. Today we are going to be talking about the massive financial bubbles that currently envelop the earth.
You have heard me talking about them ever since the crash course was released in 2008, and on podcasts ever since. I have been writing about them since 2007, when I personally began shorting the U.S. housing bubble in earnest.
More recently, I penned pieces titled The Mother Of All Bubbles, and When Bubbles Burst. Truly, there is nowhere to hide anymore after so many years of coordinated global central bank action. Our guest today is someone I have followed for years. Whose writings were instrumental in helping me formulate the economic portion of the crash course.
His name is Doug Noland. I first became acquainted with his writings and ideas when he worked for the Prudent Bear funds where he worked for sixteen years with David Tice. In the ten years prior to that, Doug worked as a short side trader analyst and portfolio manager during the great ’90s bull market. If there is ever a crucible for honing one’s skills ,it’s in locating profitable shorts in a rising market.
Doug now works with David Mcalvany at Mcalvany Wealth Management. I have been on David’s program a few times. He is a class act and someone I very much respect. The summary here is that Doug has 30 plus years of experience, and is a great analyst, and commentator of credit cycles and dynamics, which makes him one of the very best people to talk to here at the heights and possibly ends of one of the greatest credit bubbles in all of human history. Doug, welcome to the program.
Doug Noland: Hi Chris. Thanks for having me on. Those are very kind words. Thank you very much.
Chris Martenson: You’re more than welcome. Seriously, I mean every word of it. I have been following you for years. Your writing is just…. I put it. It’s kind of like you do for credit bubbles. What John Hussman does for equity valuations for me. You put the numbers to it. You put the context.
We have to know where we are historically. Doug in your view, did I overdo it maybe and engage in a little bit of podcast hyperbole when I said, “One of the greatest credit bubbles in all of human history?”
Doug Noland: Chris, I think you referred to it as the mother of all bubbles. I refer to it as the granddaddy of all bubbles.
Chris Martenson: Alright.
Doug Noland: No. I agree completely. Yeah. The bubble has gone to the heart of money and credit. It has gone global. As you mentioned, it’s basically across all asset classes. This is a deeply systemic bubble. I feel when this bubble bursts, that is finally when, yeah, and we kick the can down the road as much as we can. There will be serious problems to deal with.
Chris Martenson: Now, I want to talk about the serious problems. But if just to continue setting the stage for listeners here. If I have interpreted you correctly, and what we’re really facing. It’s not say a bitcoin bubble. People are saying there is a clear exponential or hyperbolic sort of an increase there. Or, maybe a housing bubble as we’re seeing in Melbourne, or Toronto, or London; or, maybe even an equity bubble, but a credit bubble. Help us understand what a credit bubble is? Why these other bubbles are just sort of bubblets or derivatives of the big one?
Doug Noland: Sure. I really dove into bubble analysis back in the early 1990s. I was convinced that finance was fundamentally changing with the advent of asset backed securities and mortgage backed securities. The GSE, and Wall Street finance, and all of the derivatives, we were basically changing the way finance was created.
The old model where you had banks creating credit. Bank credit was limited by reserving capital requirements. That was thrown out the window. We now had unfettered credit growth through the market based credit. I started writing my blog at the end of the 1990s. I was convinced that once the central bank realized that this was this new experiment in finance, they would recognize that it was unstable.
They would move to it to rein things in. The way it ended up is that experiment in finance basically failed. It failed first with the collapse of the technology bubble. Then, with the collapse of the mortgage finance bubble, that model new finance basically failed.
What the Federal Reserve did and then the central banks did. They started an experiment in central banking with the class of interest rates and all of the quantitative easing, and buying all of the debt, and basically creating new money. That experiment with central banking was trying to stabilize the unstable finance.
As we have seen especially over the last eight or nine years, that has ended up with central banks creating what, ten, 12, and 14 trillion dollars worth of new money. Interest rates have stayed low. That is what has really led to this global bubble. It’s just a complete mispricing of finance. Back through the mortgage finance bubble period, I used to talk about the moneyness of credit where basically we were transforming and Wall Street was transforming all of this risky credit into perceived safe money like AAA rated securities. That was through the GSE guarantees and the implied guarantee by the government.
What I have said over the last eight or nine years. We have moved it. Instead of the moneyness in credit, it’s called the moneyness of risk assets where basically central banks are back stopping liquidity and basically the prices of risk assets. They have collapsed interest rates. They have force savers out of savings and into the risk markets.
That is how it becomes deeply systemic. That’s how these pricing distortions, and the really significant market misperceptions are throughout the markets at home and abroad. Basically everyone believes that you can buy higher yield, junk debt, or a structured finance.
The Fed will ensure the markets are liquid. Why not write market insurance? Why not write derivatives and sell derivatives, and take those proceeds like writing flood insurance during a drought? That has been part of this whole short volatility trade.
That has created all of this cheap insurance. If the market insurance is so cheap, why not go out and take a lot of risk, and put on leverage, and run these aggressive strategies? If you know it’s so easy to go out and hedge yourself. Unfortunately again, and the granddaddy of all bubbles, I can’t believe it’s gone on this one long.
In fact, if you recall back Chris, in 2001. The Fed came out with an exit strategy. I know. I titled one of my bulletins at the time “No Exit.” Because I didn’t believe they would actually wind down that balance sheet that they bloated during the crisis.
But, back in 2011 when they were talking exit strategy, I didn’t realize they were going to double their balance sheet again to 4.5 trillion over a few years. Anyway, I think this has just gotten away from them. It has gotten away global central bankers. It has certainly gotten away from the Chinese with their credit bubble.
Basically a bubble, this is a long winded answer to your question. A bubble is a self-reinforced, a self-reinforcing inflation that in the end is unsustainable. That’s the deal with credit bubbles. As long as you continue to create more credit, they look sustainable.
But, at the end of the day, that credit is suspect. Especially late in the cycle, it’s very risky credit. If the market turns on that credit as we saw in 2008, then the bubble is extremely vulnerable.
Chris Martenson: Now, how far back Doug do we have to rewind this to figure out where the mistakes came? Einstein to paraphrase said that compounding is one of the most powerful forces in the universe. Well, in my analysis and I think yours as well. The central banks and it’s beginning under Greenspan in the United States. It started compounding errors.
One of the prime errors that I can detect is when we suddenly convinced ourselves that we could grow our credit markets at twice the rate that our GDP, our gross domestic product was growing; which I’ll use as a proxy for income. Not a good one as we all know because a hurricane like Harvey can come and ruin a city for awhile.
That counts as a positive in that model. GDP. does a very poor job by mistaking income and balance sheet actions. But at any rate and leaving that aside, let’s just say to me that was the ultimate, almost cartoonish error that was made. It was falling into this thought the idea. That we could compound our debts at twice the rate of income.
By my measures and up through 2000 itself; and it has only accelerated since then. We were compounding our debts, our total credit market debt. For people listening, total credit market debt; that is auto loans, and student loans, and all household debt, and corporate debt, the federal, state, and local, all of that. Everything you can call debt and not liabilities.
This isn’t unfunded or underfunded pensions and entitlements. Just debt, those were compounding at almost nine percent, 8.9 percent per year starting in 1970, and then carrying through to 2000. That’s a 40 year run.
Meanwhile, GDP, even nominal GDP was compounding at about six percent. Or, our real GDP was compounding it about four percent during that period or roughly half. Just to me, and I don’t know if it needs to be anymore complex than that? That is just a grade school error. Isn’t it?
Doug Noland: Yeah. This gets back to, I call it. It was called this historically. It’s inflationism. There is this view at the Fed. That as long as you continue to have the two to three percent inflation, then you can always inflate your way out of debt problems.
I think their view – they got very complacent. They weren’t fearful of these periods of compounding debt. Because they thought, “Okay. If there’s stress in the system, then we can just increase the inflation rate, and grow our way out of trouble.” That’s just a deep flaw of the whole notion of inflationism.
Definitely, I mean, we can go all of the way back to the ’70s, and taking the dollar off the gold standard. We can do all of that. But I think the biggest mistake started after the stock market crash in ’87. That is when we started to see the growth in portfolio insurance and junk bonds, and all of these more sophisticated Wall Street instruments, derivative markets, et cetera.
Instead of the Fed moving at that point, and saying, “Okay. This finance was unstable,” after the crash in ’87, Greenspan basically assured the market. They would stay liquid. They would reliquefy the market. That changed market dynamics profoundly.
All of the sudden the market realizes. Okay. The Fed is there to backstop liquidity. Then, you’re off and running. Then after that, we saw the excess in huge credit growth in the late ’80s, and the Milken era, and Boesky, and the M&A. It’s almost hilarious now to think back.
Because the ’80s were referred to at the time as the decade of greed. Little did we know what was going to unfold after that. But that really set in motion that the Fed would accommodate excesses. If there were any problems in the system, then the Fed would come out and bail the system out again.
We saw that in early 1990s after the excesses of the late ’80s. You had the bursting bubble. Then, the Greenspan and Fed at that point manipulated the yield curve, and collapsed short-term rates, and provided this big margin for banks to recapitalize themselves after the coastal real estate collapses. That had just invited hedge funds to come in and leverage, borrow short and leverage long, and longer or dated higher yielding securities. That set off the next bubble, right?
Then, the bond bubble burst in 1994. Then, you have Fannie and Freddie come into the market and act almost like central banks, and aggressively expand their balance sheets, and reliquefy the hedge funds that were in trouble. Then, you have the Mexican bailout. That fed the bubbles in Southeast Asia. Then, they burst.
Then, the Russian bubble collapsed in 1998. Then, there were more bailouts in the committee to save the world. Each time the bubble was bigger. Then, the government involvement in the rescue or the bailouts were even bigger. It has just conditioned the markets.
You can expand credit as much as you want and leverage as much as you want. The Fed is there to make sure the markets are liquid. It’s just a very dangerous dynamic. It’s not the way capitalism is supposed to operate.
That is kind of how we got to where we are today. It started decades ago. That is part of the issue also, Chris. Today everybody thinks this is normal.
Chris Martenson: Yeah.
Doug Noland: They think 2008 was the 100 year flood. We don’t have to worry about that again. If there is an issue that comes up, global central bankers are on the case. That is always I think the kiss of death for a market. That is what ensures the bubble gets out of control.
It’s this view that somebody out there, or the central banks won’t allow a crisis. We heard that. Russia and that the West will never allow a collapse in Russia. Washington will never allow a housing bust, right.
That market misperception always leads to the excesses. It will ensure at the end of the day you have a very dangerous bubble.
Chris Martenson: There are several things you need to have a bubble. That misperception is one. Maybe it’s too early for the postmortem. But, it annoys me that Greenspan is skating off into history as a maestro in some people’s eyes when I viewed him as somebody who completely misinterpreted the role of derivatives.
He somehow thought that they had space launched risk into outer space and never to be seen again. They achieved escape velocity. But instead, it’s sort of like there is a second law of thermodynamics for risk. It’s neither created nor destroyed. You can just transfer it for a little while. But, it still sits there.
Of course, it came roaring back with the housing bubble. But here at this point in time, I think the biggest error has to be that everywhere and always…. Listen, bubbles can form in a variety of things; tulips, railroads, swampland, and houses. People look at those and say, “Those were kind of unique things to those individual things that the bubbles were focused on.”
But in truth, there is no bubble I can find. Maybe you have different data. That it could have happened without credit being freely available. I can’t find a bubble that existed purely just because people were using hard earned savings or actual formed capital. It required credit.
As we look at this large sweep of history, and we say, “Wow, these guys had this idea,” and gals now. That we could just continually increase credit forever into infinity. That is just our model. This is how it’s going to work. This really feels like a really extremely defective idea to me.
The astonishing thing to me was it clearly broke apart in 1998. It broke apart again in 2000. It broke again in 2007. Here we are repeating literally the same mistakes except this time everybody has invested their hope in the idea that the relatively small number of people appointed to sit around the mahogany tables at various central banks. These people are going to get it right this time. Don’t worry, nothing bad can happen anymore.
Doug Noland: Yeah. Bubbles, they’re fascinating dynamics. As you said, there has to be a credit component. Under every bubble, there is some expansion of finance. You’re expansion of credit. That is what creates this new purchasing power.
It goes in. It’s going to buy an asset. That asset price goes up. The higher asset price entices more people to come in and leverage that asset.
It’s self-reinforcing. As I said at the end, it’s unsustainable. This is a bubble in finance, right. We can say a bitcoin. We can say tech stocks. By the way those are almost like a consequence of this bubble overall in finance. That’s global finance.
Greenspan was key to this. I talked about the ’87 stock market crash, and also this promise of liquidity, and this assurance. This guarantee of underlying liquidity. You mentioned derivatives. Derivatives are key to this. Because derivatives, basically that market functions on this assumption of liquid and continuous markets.
Because a lot of the people that write market insurance, it’s not really insurance. They don’t set reserves to the side for when there is a market problem. They can pay like you would a casualty loss on an auto accident. That is an insurable event. Market events are not random. They’re not independent.
They’re really not insurable. Whoever writes this flood insurance, they plan one way or the other to offload this risk to someone else. They plan, if they have to hedge their market risk that they’ have written. They are going to go out and dynamically hedge their risk; which basically means selling into a down market.
Well, that’s fine. It works great as long as everyone assumes the markets will always be liquid. We have this myth that all of this market insurance is really real. I think this market insurance, and this overall market insurance marketplace is key to the whole world wanting to take a lot of risk.
I come back also to this flaw in understanding that Greenspan had. He used to say, “Well, you can’t have a national real estate bubble because real estate markets are local.” You can have local bubbles. But, you’re not going to have a national real estate bubble.
My response back then was I’m sorry. The issue is a national bubble in mortgage finance. That is why I never called it the housing bubble. It was the mortgage finance bubble. That was the mispriced mortgage credit and unlimited mispriced mortgage credit. It’s throughout the whole system.
Okay. That’s why it was a national and in many ways an international bubble. When you have these fundamental mispricings of unlimited finance globally, that is how you get these distortions. I also argue Chris that it’s very interesting dynamic. The more systemic a bubble, the less obvious it is.
The tech bubble in the late ’90s, that was pretty conspicuous, right. But, when the bubble burst, it was not isolated. But, it was relatively contained within the technology sector. It didn’t have devastating impact on the whole economy.
The mortgage finance bubble, which was much more systemic. Most people didn’t see it. In hindsight, they say they saw it. But they didn’t at the time. I can assure you. But, it was much more deeply systemic.
This one is so deeply systemic, people just don’t see it. Because basically we’re inflating and distorting all of the markets. Nothing looks extremely unreasonable to most people. But in the end of the day, the finance is deeply unsound and unsustainable. I would argue.
Chris Martenson: Now, one of my favorite current statistics for that is a junk debt in Europe, which is now according to a Financial Times article from a few days ago reportedly trading at or just below a two percent yield. This is for junk debt. For people who don’t know what that is. This is debt that has been issued by companies whose prospects are particularly poor.
They have got some issues. This would be the equivalent of your totally unreliable drunk Uncle Vinny who has never paid a dime back in his life; and lending him more money. Your chance of getting it back, not good. These are really poor prospect companies trading at two percent with a ten year U.S. Treasury yield at 2.3 percent roughly.
I don’t know exactly where it is at this moment. But you call it 0.3 percent higher. The junk debt in Europe, that now we have an implied default rate of less than zero. That means the market is priced European junk debt.
Your drunk uncle, and I said. He has a less than zero chance of not paying you back. Absolutely astonishing and what are the chances Doug that there are some losses somehow in some malinvestment baked into that statistic?
Doug Noland: There will be losses. Of the global bubble, I think European debt is about the most conspicuous. Yeah. The junk debt, the European junk debt is two percent. Why is it at two percent? Because the ECB is buying large amounts of corporate debt. The ECB has kept rates either at zero or negative. The perception is that the ECB will keep those markets liquid.
With that perception, why not try to get a little higher yield? I would argue though, Italy at 1.7 percent today, a yield, and ten-year Italian bonds. Italy rapidly approaching 135 percent on government debt to GDP. That debt will not get paid back. But yet, the market will hold that debt at 1.7.
I think this is debt that has traded over seven percent yield back in 2011 and 2012. Here it is today at 1.7 I mean, and just a growth mispricing of a huge debt market. Italian debt, there is over a trillion dollars of Italian debt out there. Yeah. It’s staggering, the excesses that have unfolded in European debt across the board. That’s junk and sovereign.
Chris Martenson: Now Doug, I pick up your excellent ratings at creditbubblebulletin.blogspot.com. I am looking here at one of your weekly commentaries from Saturday November 4th.
Opening line, I want you to explain this to people. You say, “… Of the diverse strains of inflation, asset inflation is by far the most dangerous.” Why is that?
Doug Noland: Yeah. I have to credit the great German economist, Dr. Kurt Richebacher for this analysis. I had the good fortune. I started reading the Dr. Richebacher’s monthly newsletter back in 1990. I fell in love with the quality of his analysis. I was fortunate to help him with his newsletter for, I think five years that began back in the ’90s.
Chris Martenson: That’s great.
Doug Noland: Yeah. I mean, he just was just a great, a brilliant guy, and a great thinker of Austrian economics. He talked about this a lot. Okay. You get back to credit. Credit is key. If you can see an expansion of credit, that’s an expansion of purchasing power. Then, it’s a matter of trying to understand where that purchasing power is going? What the impact of it is? What the inevitable consequences are of that credit inflation?
What he argued; I agree completely. Consumer price inflation, that is one of many different types of inflation, right. You can have an inflation in consumer prices. You can have an inflation obviously on asset prices. If you have too much credit and excess purchasing power, you can trade deficits and current account deficits.
You can have an investment boom. You can have many variations of credit inflation. What he said. What he believed was that consumer price inflation was probably the least dangerous of those.
Because it was the most easy to deal with. There is a constituency out there that can recognize consumer price inflation. Say, “Wait, we don’t want to have too much inflation,” so they demand that the central banks tighten.
Let’s say and like we saw with Volcker and the Volcker bet where they put the screws to be economy to get those inflationary biases wrung out of the economy. Well, Dr. Richebacher and I certainly argue today that asset inflation is much more dangerous.
Because there are no constituency. Indeed people love asset inflation. Who is complaining about asset inflation today? There were some complaints after the asset bubbles burst in 2000 and 2009. But after people start to make money in the market, they forget about that, and just bring on more asset inflation.
This type of asset inflation, not only is it self-reinforcing. It leads to significant distortions and investment. If you allow this inflation for too long, you will have deep distortions in the economic structure. Those are very dangerous as we learned and not that many years ago. As we have forgotten, but that is why asset inflation is so dangerous. Because no one will rein it in. The inevitable structural impact can be negative and take years to rectify.
Chris Martenson: We now know that the European Central Bank intervened along with the Bank of Japan in January of 2016, and early February to help prevent a market decline from going any further. We also saw a very odd and for me difficult to reconcile blast higher after the surprise Trump election. It started. The Dow was off 2,000 – I mean, sorry, 1,000 points by I don’t know 2:30 in the morning.
Then, by open, it was almost green again. How likely is it in your mind that there was some help provided to falling markets there in the early Wednesday morning after the Trump surprise? More broadly, do you believe that these central banks are so scared of the Franken markets they’ve created, that they are now intervening covertly as well as overtly?
Doug Noland: It wouldn’t surprise me. My analysis, I kind of ignore for the most part the covert t aspect of this. I focus on what they tell us they’re going to do. But, if they’re going to tell us that they’re going to buy trillions of dollars worth of debt, and create trillions of dollars of money, and create negative interest rates; assure the markets that they’re backstopping them.
I don’t know why they wouldn’t act covertly when they think it’s necessary? I don’t know, if they did after the election. After the election, there was certainly a major short squeeze. A big unwind of derivatives when it became obvious that the markets were not going to tank after the election.
I could see market forces that could also lead to that type of a market dislocation in a melt up. But nothing would surprise me at this point. I assume over the years, they have often intervened to stabilize the markets. Because this is a very unstable financial structure.
It’s interesting these days. The VIX is so low. Those are the volatility indices that are so low. The assumption is the markets are extremely stable. But, I think the markets are so unstable, the central banks have had to come in with extraordinary markets to convince everyone they’re stable; which is part of this misperception that has led to the very dangerous bubble that we see today.
Chris Martenson: You mentioned the things we do know. We do know that the Japanese Central Bank has been buying ETFs of Japanese stock shares and doing it preferentially on days when the markets were declining. That is overt at this point and time. Of course, the Swiss National Bank overtly buying U.S. equities, and particularly the large issues.
That is what we know about. Then, of course, there are things we have to sort of wonder about. Like after Superstorm Sandy as the justification, the New York Fed which has a very large trading desk operation. I would love to see audited just to find out. They said, “Hey, we didn’t like how risky it seemed after Sandy proved that things can happen. So, we have decided to move our trading desk somewhere.”
Coincidentally, it’s in Aurora, Illinois now, which is where for those who know, the Chicago Mercantile Exchange servers are located. Where some of the most highly levered trades exist. That can help do things like drive VIX down or prop, and buy futures in other highly levered products at key moments. If you wanted it to do that. But purely coincidental, we’re being led to believe that the Fed moved its trading operation there.
Chris Martenson: As well, we know that the Chicago Mercantile Exchange has a central bank and its preferred buyer program. Because they’re such heavy customers. They they’ve offered them some of the best volume discounts. But Doug, I haven’t found a single balance sheet of a single central bank anywhere that will admit to having any of these products anywhere in its portfolio. Yet, they are some of the most heavy buyers.
You call that covert. You call it…. I don’t know. It’s half over. I don’t really know. I am squinting at it. I’m just saying, look, I think these central – and it honestly matter to me. Because I think that they fail. It’s just a question of how spectacularly do they fail in these efforts?
What matters to me is that it indicates to me that I think these central banks are actually afraid of the very conditions that they have created for themselves. My overt data for this is by the numbers, and when you look at corporate earnings. When you look at the acceleration in certain things. When you look in certain economic components. When you look at trade.
When you look at growth. Growth isn’t great. It’s not bad. When you look at unemployment. Listen Doug, by the numbers not bad, but when we wander over and look at the amount of central bank stimulus still pouring into these markets.
Well over one hundred billion a month still, that’s an emergency. Which is it? Is everything okay? Or, is it an emergency? I think the central banks are acting like they’re scared.
Doug Noland: Right. I agree completely. To me, it gets back. You mentioned it earlier in the conversation. The problem with discretionary monetary management and with discretionary central banking. One mistake leads to a bigger mistake. This is actually a debate that goes back 150 years and back to Britain.
We have seen that repeatedly where we have market distortions that are induced by the central bankers. That lead to a bubble. Then, you have a collapse, and then, only deeper, government involvement. We’re at the point now where I think they’re very fearful of backing off whatsoever. They talk interest rate normalization. But, we’re not even close to that.
The ECB started with their QE program in 2012. Here we are. There is still going to be injecting more liquidity into the markets in 2018, extremely hesitant to back away at all from QE. If everything was stable, I think the central banks would be much more willing to actually move towards normalization.
I don’t think for a minute that they believe that finance is stable. I think they know they’re dealing with a bubble. I think they’re hoping that they can wait. That this inflation dynamic, they can grow their way out of this fragility. But, that’s the problem with the bubble.
You can’t grow your way out of it. The bubble just gets bigger. They want to inflate this consumer price index to grow our way out of debt and asset price bubbles? Well, all they do is increase the size of the bubble in the asset markets and the underlying distortions in the real economy.
Especially late in the bubble, it’s very dangerous. Because the bubbles take on a life of their own. We’re seeing it today in bitcoin. We’re seeing it in dramatic price moves, and in security. That’s fixed income and equity. Their tracked right now. I think that explains a lot of why they’ve been so hesitant to try to get back to a more normal monetary environment.
Now, they’re to the point where I think they just fear doing anything dramatic. At this stage in the bubble, the only way to rein it in is doing something dramatic, and force pain on speculators, and force pain on those that are leveraged, and start the cleansing process to get a more stable monetary backdrop.
Chris, while I am rambling here, I wanted to mention China. We haven’t mentioned China yet.
Chris Martenson: Please, let’s. It’s on my question list here. Let’s go.
Doug Noland: Sure. China is key to this global bubble. It’s historic what’s going on in China. They may have four trillion dollars of system credit growth this year, which surpasses the U.S. in the height of our mortgage finance bubble. This bubble got completely away from them.
Today, I think, especially after the recent Communist Party Congress, they have decided to try to rein in some of the excess and try to slow overall credit growth. I think the consequences and the ramifications are profound. Of course everyone at this point believes the Chinese officials won’t take any dramatic moves.
They won’t burst their bubble. But, I think things are changing in China. They recognized belatedly the serious in their problem. I think that will be an unfolding story for 2018.
I think there are consequences for certainly the emerging markets and for global finance, and global economics more generally. Because that bubble, it’s incredible what is up further with China.
Chris Martenson: This Party Congress for people listening, every five years China has a fairly large – and this is their equivalent of the. presidential election cycle. This is where party politics get consolidated. Power gets redistributed. President Jin, XI Jin, he really came out a clear winner, a very dominant position. He has got a lot of help in key positions.
It really looks to me from the outside and not being a super astute observer of Chinese politics. But, it looks like he has got a good grasp and command of the leadership there. I wasn’t expecting, Doug, anything to really happen credit wise. I was expecting stability in their stock market, and leading up to that party Congress, which happened mid-October.
Now that things seem to have sort of consolidated the powers, it certainly seems to be in place. Now, I think would be the time to expect to see what they’re going to do, if anything to rein in this bubble. I think President XI, a very smart man, and lot of very clever people as well surrounding him. They have to know that trying to let the steam out of a bubble is a better consequence for them politically than to allow it to burst on its own. Wouldn’t you agree?
Doug Noland: Yeah. That’s right. They claimed for years that they had studied and learned from the Japanese experience. I think they thought that they had. They thought they had their bubble under control.
But, at the end of the day, it got away from them. They tried a series of timid measures over the years to lean against the wind and to try to rein in, especially their the housing bubble, which is really an apartment bubble.
But, the underlying finance and the mispricing of finance, there was a global phenomenon. That was more than over compensated for their tightening measures. Their real estate bubble basically went completely out of control. Their credit growth went completely out of control.
Now, I think they’re finally deciding; we’re going to have to bite the bullet and try to get this under control. Again, they’re going to try to do it gradually. But, they have already targeted over the last just two to three weeks, the shadow banking area which is key. They are targeting the wealth management products where there is a real misperception.
Beijing will ensure that everybody is whole on their investments. Throughout China, the average person gets on the Internet and sends in their savings to these wealth management vehicles to get six and seven percent believing that their government will never allow them to lose money.
That has led to this, hundreds of billions, and even trillions into high risk corporate credit in China and risky local government debt; and debt for the developers indirectly into mortgage debt. I think they have recognized this is unsound. They are going to try to rein it in.
It’s not going to go smoothly. Their real estate markets are so mispriced. There are trillions of dollars of mispriced credit. But, I think the process has started. Everyone globally is so complacent now just believing that China will never allow a bursting on their bubble.
That they’re not following developments in China as closely as they should. Here in the U.S. everyone just follows every headline with tax legislation and tax cuts. At this point, totally disregards China. I think that is a mistake.
Chris Martenson: I agree. There is a component here as well, which is just math. Whether the government will, or will not allow, or will backstop something. Steve Kean, the economist, has shown very clearly and very small spreadsheet. He takes a couple of columns and a few rows to figure out that when you’re injecting credit into an economy, it will grow.
The growth will be a function of its organic growth that was there anyway, plus the stimulative effect of the credit. Even a flattening of credit growth is GDP negative. But let’s say, you said, “Wow, four trillion dollars,” that exceeds the height of the United States credit growth.
This is an economy that’s smaller on a percentage base – on an aggregate basis. On a percentage basis, that’s a really big increase. Let’s just say it’s something like 30 percent. Even if it’s, even if, and just this is even. They only grow credit by 20 percent next year. It was 30 percent last year. That’s negative for the overall growth in the economy.
That’s not something you can legislate away. I don’t care how authoritarian or totalitarian your government is. I don’t care what laws you pass. Just that has an impact all its own. But to your point, I think the really critical part here is you can’t put that much credit into an economy that size without some of it going into hopelessly unproductive works.
It will never be paid back. That capital has been betrayed. It seems to me that is just like one of the features of bubbles. You create too much credit. It gets betrayed. Is that fair?
Doug Noland: Yeah. That’s fair and very accurate. I will try not to confuse everyone. But, I think this is an important point. At the end of the credit cycle, and I call it the terminal phase where the system essentially self-destructs. We can throw out Japan. Japan did incredible things rebuilding their economy over several decades.
It basically destroyed their credit system over about three and a half years in this terminal phase of their bubble. At the terminal phase, and we can think sub-prime. We can think U.S. mortgage credit during the mortgage finance bubble.
You have this rapid growth of credit. At the end of the cycle, this credit, the quality deteriorates very quickly. You’re financing poor projects. You’re financing overpriced real estate. You have this hypothetical chart of systemic risk that goes parabolic. Because you’re increasing credit rapidly of rapidly deteriorating credit quality.
That’s what they have in China. Of this four trillion in credit, I mean half of it or more likely can just be bad credit. It’s financing overpriced real estate. It’s financing uneconomic enterprising. It’s financing fraud, right, and all kinds of things.
It’s leading to…. It’s servicing the debt of highly leveraged institutions or companies that will not be able to pay this money back. Yes. Credit does crazy things at the end of the cycle. It leads to a destruction of the credit worthiness of that finance along with the economic imbalances and maladjustment below the surface.
All of them come back to haunt. Because at some point, you can’t continue to create this. Is China going to create five trillion of new credit next year? How much of that five trillion is going to be bad credit?
There is really no way around this, right. You’re just making the problem worse and dramatically worse late in the cycle. That is the problem. That’s what is not recognized by central bankers or officials in China.
Chris Martenson: There is only one question to resolve at the end of a long credit cycle. That is who is going to eat the losses? That is the way I think of it. As we look at this, and you say that we’re at this point in this bubble where certainly the central bankers don’t want to risk bursting it.
They don’t want to be the ones. Nobody really wants to be the one to step up and say, “Maybe we should stop this at this point.” It makes me think of the von Mises quote. Really, at the end of a credit expansion, your choices include voluntarily abandoning it, or risking a collapse of the currency system involved.
But, this is now a global system/ It’s a global bubble. What is our reference currency at this particular point in time? Two questions in that for me and for you, Doug first, what concludes this long credit cycle? How does this sort of end, if nobody is willing to end it? Secondarily, let’s talk about gold in this context.
Because I’m losing hope here. It just gets clubbed like a baby seal constantly in the U.S. markets in particular. It seems not to have had its usual signaling characteristics available to it.
Since 2011, and coincident with the QE3, a very odd moment there again for those who think like I do. But, here we are. What ends this credit bubble? What is the role of gold, if any as we come through it?
Doug Noland: I will give that a try. Though, those are tough questions. I always prefer easy questions. But, those are tough. Part of the reason I say this is the granddaddy of all bubbles. This will end a long cycle as it, the bubble has gone to the heart of money and credit.
It has gone to sovereign debt. It’s gone to government debt as central bank credits. There will be no way out. We’re not going to get enough private credit growth to reflate when this bubble bursts. It’s going to have to come from central bank credit.
It’s going to have to come in sovereign debt. Markets are fine with that they. As long as sovereign, or as long as both of those grow, they’re okay. Because that seems to support the markets. At the end of the day, I think what will shock people when this bubble bursts; and who knows what the catalyst will be?
How far central banks have to expand their balance sheet just to accommodate the deleveraging in the system. It’s not really going to add new liquidity to the market. They’re just going to allow the transfer of leveraged positions from the leveraged players on the central bank balance sheets.
I think when you get to that point. When the market sees that issue. I think there is going to be fear of long-term financial instruments. I think there will be rising yields. Sovereign yields don’t have much further to drop at this point. That’s when things become problematic. I think.
It is when the central banks begin aggressively expanding the balance sheets. Yet the bond markets are not happy about it. Then, the central banks will finally have to decide if they want to continue to inflate their balance sheets. Or, if they’re going to focus on trying to keep market yields down. A very difficult situation for central bankers when it unfolds.
Bubbles are all about a redistribution and the destruction of wealth. That is why we’re seeing a lot of social stress here in the U.S. These bubbles have redistributed wealth. I fear the global bubble. We’re redistributing wealth globally.
I fear for the geopolitical landscape and geopolitical could easily be a catalyst for bursting the global bubble. I hope this doesn’t end in war. That’s not something I focus a lot on. But, it would almost seem inevitable to me that there will be conflicts after this bubble bursts.
As far as gold, I’m a big fan and believer of gold. Let’s feel kind of stupid. Because I was listening to an analysis on Bloomberg just the other day saying, “There are a lot of similarities between bitcoin and gold. I think pundit was referring to kind of a safe haven function of both.
I guess you can buy bitcoin and be away from the banks and everything else. But to me, gold and bitcoin could not be more different. One has backing. One doesn’t. One has been a proven store of value for a long time. One, I think is a flash in the pan bubble. I think today, part of the drag on gold is why buy gold, if you can buy bitcoin and cryptocurrencies, or bonds, or whatever else?
But, I think at the end of the day, those will not be a very good store of value or store of wealth. When the bubble starts to burst, I expect gold to do extremely well. I am not discouraged on gold. I think it will do fine.
Chris Martenson: Alright, and I share that view. Of course, the long sweep of bubbles bursting is that credit is a claim on wealth. Real wealth is real stuff. A point I like to make to audiences a lot. When you look at the Weimar inflation, very famous. Because people have in their minds a picture of somebody wheelbarrowing a big stack of bound banknotes to buy a loaf of bread, or shoveling them into the furnace.
We understand that. You read these books that are written about them. They talk about a wealth destruction. But, it’s not true. The claims on wealth got destroyed. But, the real wealth stayed there, just as many hotels before and after, and just as many arable acres of farmland. Just as many factories and who own them.
Now that changed. I call it a wealth transfer and not a wealth destruction. You’re remarking on that. Our social unrest in the United States is due to the fact that the Federal Reserve is not a wealth creating machine. They are a redistribution engine. They have taken from the many to give to the few.
They have punished savers and pensions. Anybody who, retirees, and the elderly, and the young, I mean. They have really thrown a pretty…. I mean, if this was a Disney movie, they are Cruella De Vil in this story. Really, it’s just not good.
Doug, stepping outside of economics and finance purely just for a moment. Where and how do you think the idea of natural limits? How do those factor in your thinking? I am thinking of ecological limits. There is only so much soil with so many macro and micro nutrients in it.
The fact that fossil fuels are finite. Those represent, of course, the source of so much of our wealth over the past 150 years. Where do you place those sort of things that are external to the finance and economic system, but really central to it when you get right down to it?
Doug Noland: Yeah. I might take just a little bit of a different angle on this. In this era here, and I’m surprised people don’t refer to a new paradigm again, a new era again. Because it reminds me a lot of the 1990s. We were seeing profound innovation, technological innovation.
It’s easy to get captivated by this. What the alternative energy can do. But, at the end of the day, I think there isn’t enough focus on the soundness of money, and the soundness of finance. Right now, there is this view that we can finance any type of alternative energy.
We can finance any type of new technology. There is an arms race going on and in so many areas. That becomes very dangerous during the late stages of bubble period. Because I think a lot of this, as exciting as it is, it will prove uneconomic when the bubble bursts. When there is a realization that finance is unstable.
I often say that during periods of extraordinary innovation is when you need to refocus on finance and refocus on sound money. Unfortunately today, there is none of that whatsoever.
We’re seeing in China with the ecological damage that’s unfolding in China. When you have 1.5 trillion dollars of people with basically free money and investment, and that financial investment, and real investment in the economy. That the damage that can be done to our planet in these type of booms.
It really makes me think that there is so much and so many reasons to get back to a focus on sound money and finance. That is kind of my focus in this environment. A lot of unfortunate things are happening because of the financial backdrop.
Chris Martenson: Yeah. My analysis is that there are a lot of different money systems. Sound money is very different from credit based and fiat money. Fiat money has at its heart this idea that you can expand exponentially and infinitely. There is just no end to anything. We’ll just keep compounding forever.
That’s the model. Of course, you look at anything like a CBO projection of economic growth. By the year 2070, I think they have the United States economy as large as the entire world’s economy right now. Simple me goes, “Where is the coal for that?” Where is the natural gas? Where is the oil? Where is the steel? Where is the gallium? Where are the fish? Where are the whatever?
I think we’re coming out of a period where humans basically develop systems when the world seemed infinite. But, it’s clearly not anymore. China is running up against those limits with its however many, and 1.3 to 1.5 billion people. Whatever they have got.
It’s funny. They are spreading. Their population is the entire population of the United States. We’re rounding or in Chinese terms. When I look at all of that, it just feels like that is really the thing under this that is being not looked at. That our entire system of money as it’s being practiced is founded on a premise that may or may not have a giant glaring error sort of at its heart; and which is you can’t grow forever.
You have to figure out how not to grow. But, we have a financial system that is geared, and levered, implemented, and built around; and unfortunately woven into our political systems in a way that says, “We can’t do anything other than what we’ve been doing. It has to stay the same.
The central banks have really been the guardians of the status quo. When patently the status quo is no longer serving the majority of the people in this country, the United States, and elsewhere. To me, that is sort of like the most grievous sin that the central banks have been committing.
It is failing to act or to think appropriately about their role, and being appropriate guardians of both the present and the future. They have really been guardians of the past. I think that’s just an forgivable sin in many respects. We’ll see how that all plays out.
Doug, thank you so much for your time today. That is all of the time we have, unfortunately. I could talk to you forever. Everybody, we have been talking with Doug Noland. You can find him at creditbubblebulletin dot blogspot dot com. Doug, any other ways that people can follow your work more closely?
Doug Noland: Yeah. You had mentioned my blog. It’s easy. Can you just search my name. You can get to my blog. I also post at McAlvany dot com. It’s out there on a weekly basis. I do the best I can to chronicle the bubble. I will keep doing it.
Chris Martenson: Well, fantastic, and thank you for doing that. It’s been absolutely magnificent and absolutely important work for me to follow. Because I think you’ve channeling all of the great teachers you’ve had, and carrying on that great tradition of using sound thinking and actual data. Thank you for that work. I really appreciate it.
Doug Noland: Thanks so much for having me on, Chris. It was a real pleasure chatting with you today. Thank you.