$35 Trillion, The PetroDollar, and Dying Western Influence

Banking, BRICS, Currencies, Economics, Geoeconomics, Modern Monetary Theory, RIsk Management, , , ,

The ‘news’ is agog the United States’ national debt just crossed yet another ugly milestone. $35 trillion. Long-time readers of this (and many other columns) know this milestone was just a matter of time. And, speaking of time, the situation is now in what we call the compression phase. In 2016, the national debt was just under $20 trillion. In 2020, it was just under $27 trillion. Now, in late July 2024 we’re at $35 trillion. That’s roughly a 75% increase in the debt level in roughly 8 years.

Looking back for comparison, in 2004, the national debt was $7.3 trillion. In 2008, it was just over $10 trillion, and in 2012, it was just over $16 trillion. During that 8-year period, the increase was 119%. While many would celebrate the fact that the percentage growth has actually dropped, we have to look at the sheer magnitude of the increases. The 2004-2012 period saw roughly $9 trillion in new debt whereas the 2016-2024 period has seen a $15 trillion increase. We chose these two periods for good reasons. The first period had the 2008 financial crisis, bailouts, and stimulus borrowing and the 2016-2024 period had the pandemic borrowing. Two major dislocations.

https://www.investopedia.com/us-national-debt-by-year-7499291

This is a near perfect illustration of the diminishing purchasing power of the dollar. The public didn’t notice it much in the first period, for reasons we’ve already written about. However, the spillover in 2020 to the real economy certainly got people’s attention. 1970s ‘inflation’ was back. However, the monetary inflation of the 70s never stopped. It only intensified. Keeping the fresh money in the financial markets and real estate fooled most people. That’s ‘good inflation’. However, when the same thing happens on the other side of people’s balance sheets? Not so good.

But even the above statement is paradoxical. Much like government, the people have been on a debt binge as well. Their assets certainly went up, but so did their liabilities. This would have been abhorred 100 years ago, but we’ve been conditioned to believe that frivolous debt is normal. And perhaps it is now normal since most people do it and that is the definition of normal after all. But that doesn’t make it smart. Now, let’s consider some of the repercussions below.

The Deathknell of the PetroDollar

This wanton accumulation of debt certainly hasn’t gone unnoticed by the rest of the world. Even more so, the power the USGovt wields with regards to the dollar to bend the rest of the world to its will has gone even less unnoticed. Both of these realities have contributed to the rise of organizations like BRICS and the SCO, just to name a few. We find it comical that countries who refuse to play to the rules of the Western ‘rules-based order’ are always labeled as evil and targeted by sanctions regimes using the dollar as a weapon. We’re not naive; we’d be hard-pressed to find a government anywhere that truly acts in the best interests of its people, but, failing to play by the ‘rules-based order’ resulting in economic isolation is beyond hypocritical.

There has been much talk about Saudi Arabia recently and its sale of oil in dollars. It has been alleged that the Saudis ended this agreement, accompanied by vehement denials of such. Ostensibly, there was never a formal agreement, rather more of a handshake quid pro quo arrangement. However, we don’t believe that Saudi Arabia is the most important player in terms of supporting the PetroDollar anymore, their aspirations to join BRICS notwithstanding. The world has changed – again. As of February 2024, BRICS countries controlled about 42% of global oil production, give or take a point or two depending on the source. This is another point that is vehemently contested depending on who you listen to. BRICS continues to grow and with it, the percentage of oil production. The point of BRICS – to this point anyway – is to allow partners to make trades in local currencies. There has been talk of a basket, an actual BRICS currency, and even a digital BRICS currency. We wrote about this final item in our last update and it’s very concerning, but the whole point of BRICS was to give countries options. Non-dollar options to be specific.

What does the PetroDollar have to do with the national debt then? The PetroDollar effectively allowed the US to create dollars, buy oil with them, then have the sellers of the oil buy USGovt debt with the oil receipts. This resulted in the exportation of monetary inflation. The US could inflate the money supply and have enough stay offshore so as not to create price inflation domestically. As more countries shy away from the dollar, that mechanism is going to continue to be eroded. If we’re going to keep borrowing to spend (without SIGNIFICANTLY increasing domestic production of exportable goods) then we’re going to have price inflation. Check that box. It’s here and it’s not going away. You’ve all noticed it by now. Psychologically, people were ok with the normal 4-5% per year rate that persisted since the 1980s. It wasn’t even noticed; it was background noise. The world has changed yet again, and we hear people (both in the US and UK/Europe in particular) complaining about runaway inflation.

The US did several big things from a policy perspective to mask the effects of monetary inflation. It absolutely destroyed US manufacturing. Not so much on the capital goods side, save steel as one example, but on consumer goods. We essentially financed China’s industrial revolution. Now we’re complaining that they’re overproducing. What exactly did we expect to happen? While many will opine that this is due to incompetence on the part of US policymakers, we know better. These people are not stupid. They knew exactly was going to happen and you’re inclined, you can go read Foreign Policy and other such journals from back then and see exactly what we’re talking about.

The world is changing – again. Now that we’ve stripped our economy of most consumer goods manufacturing (go into WalMart and browse the consumer goods sections and see how much is made here) we’re dependent on others for everyday goods. Perhaps ironically, we’re at all-time diplomatic lows – economically and otherwise – with these same countries. And now we’ve got the price inflation anyway. Chickens always come home to roost.

It’s not just the PetroDollar that is fading it’s the ConsumerDollar as well. These countries don’t want our debt for numerous reasons, one of which is the fact that the value of our currency is inherently unstable. Probably second (or first, depending) is the arbitrary and capricious overuse of sanctions to induce ‘good behavior’. We find it telling that the rest of the world doesn’t try to tell us how to live, but we have no problem doing exactly that to them.

Dying Western Influence

This will not be want the powerbrokers and elite want to hear, but Western, unipolar influence is dying. Partly of its own volition as the monetary cycle ends (see previous reserve currency regime lifespans) and due to the pernicious aggression of policymakers, especially within the USTreasury where sanctions are concerned. Sanctions are not generally understood by the public, so we’ll use an analogy. Think of a kids’ clubhouse. It has many doors, all with locks. Preferred members get keys. Tolerated acquaintances of preferred members are given access as long as ‘accompanied’ by said member. Outcasts are afforded neither of these benefits. SWIFT – the major dollar settlement system used by the West is similar in nature. So long as you follow the ‘rules-based order’ you can use SWIFT and enjoy the benefits. Cross Washington, DC and you get cut off. SWIFT is a dollar-based trade settlement system. Get cut off from SWIFT and the logic goes that you are instantly isolated. That is much less so the case now than in the past.

Many also think BRICS is a new phenomenon. It is not. We’ve mentioned this before, but for the benefit of new readers and/or people just becoming aware of the goings on, the concept of BRICS has been around for more than two decades now. In 2006, a book series focusing on the top ten stories of each year that WERE NOT covered in the mainstream news featured Iran’s intention to create an oil bourse, which would accept Euros for payment of oil. We can see what has transpired since then. We’ll readily allow that we’re focusing almost exclusively on the economic realities because that’s where our expertise lies and that there are many other moving parts behind these moves. What we’re trying to accomplish here is explain to the world one aspect of this complicated mess. Money is power and since money is perhaps this world’s greatest motivator, we feel examining the geoeconomic perspective is crucial.

Conclusions

The question at the front of most people’s minds is ‘How will this affect me if I hold dollars?’ Or perhaps a business that transacts in dollars. With the dollar standard era ending, even more changes will be taking place. We’re firmly in the MMT track (see our in-depth article on that here). The only difference is our government borrows money from the central bank because the central bank is private, unlike the model proposed by Knapp in 1905. Practically speaking it doesn’t make much difference. The dollar is losing value rapidly now. More and more countries are seeking to divest. There may come a time in the not too distant future where countries and individuals who rely on others accepting dollars may well have to convert to a different currency to settle trades. Price inflation in the US/UK/Europe and elsewhere is likely to accelerate as the transition gains velocity.

And just to be clear – these various military confrontations globally have one thing in common – the dollar standard and the protection thereof – although again there are many other moving parts involved. That’s all we’re going to say about that. Follow the money. Who benefits?

In 2008 Andy wrote an article entitled “Gold – The Opportunity of a Lifetime‘. The dollar ‘price’ of gold is now three times what it was when the article was penned, but the title of the article still holds true. You’ll need to exchange more of your folding money to get gold (silver is also a good choice), however, if current trends continue, you will be able to hold your purchasing power. Or you could take your chances in an overinflated, rigged, and completely disconnected stock market. That said, we would not be surprised one bit if the DOW, for example, hit 60,000 or more before the cycle ends.

In fantasy stories, the dragon is always most dangerous once it has been dealt that lethal blow. The dollar was dealt a lethal blow a long time ago and continues to be fraught with more and more risks as we progress through this inevitable transition.

EOF – Sutton / Mehl

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Bail-Ins and the Direct Registration System

Bailouts, Banking, Currencies, Geoeconomics, Monetary Policy, RIsk Management, ,

Originally published in October 2015

My Two Cents – Bail-Ins and the DRS

Andy Sutton, MBA

As recently as a few weeks ago, the European Union directed its member nations to draft their own independent legislation for dealing with the resolution of a failed G-SIFI (Globally Significant Financial Institution). At the same time, we have all sorts of seams opening in the currency, bond, and commodity markets. The Swiss Franc is now un-pegged from the Euro, there have been wild swings in the bond markets in Europe due to the aforementioned action, and oil is in an absolute free-fall. There are many geopolitical (and likely criminal) maneuverings behind all of these phenomena, however the chaos in the financial world thus far has been remarkable in that there hasn’t been much given everything going on.

There has been news of some smaller brokerages biting the dust thanks to these swings, but yet nobody ‘big’ has gone down – yet. Are they that good? That insulated? That lucky? That’s for people of a higher pay grade to answer, but the bottom line is that the environment is absolutely RIPE for another Cyprus or MFGlobal. Will it happen this time around? Couldn’t tell you. Maybe it’ll be next time. Or maybe it’ll happen this time, but not impact the US. Since everyone already thinks America is bulletproof I am guessing most will go with the latter of the two possibilities.

I’ve been talking an awful lot again about the bail-in, but a reader pointed out that he still doesn’t understand exactly what it is, and, more importantly, how an institution gets into the position where it needs (or wants) one. He’s a smart one, this reader, so I figure if he’s got questions then so do a whole bunch of other folks and that’s perfectly all right. That’s why I do this. So this week I’m going to focus on some of the anatomy and try to give everyone a sense of the sorts of things that put a bank/broker or just a broker into a position where they’d seek to invoke the bail-in.

On the positive side, although not for those folks impacted, we have a live example of how the bail-in works, right here in America to use as a template. I don’t wish to further malign Mr. Corzine’s already shredded reputation, but as his penchant for fast travel suggests, he could probably outrun any criticism we might toss his way.

Anatomy of the Bail-In – The Mechanism

Let’s talk about a brokerage first since this is where MFGlobal was situated. Brokerages generally have two components – the brokerage side and the dealer side. Formally, they are referred to as broker-dealers by the regulators because of this. So there are two sides. One side you see when you walk in and talk to your broker and sit in his posh office and the other side, which you never see – and usually neither does the broker. It is this unseen side you need to worry about in this instance. Your hundred thousand dollar brokerage account isn’t very noteworthy in the grand scheme of things other than that the broker-dealer might use shares that you hold in your portfolio to lend out to other parties so they can short a particular stock. Hmm, that is kind of going against your best interests isn’t it?

Your broker calls you with a ‘hot tip’ or a ‘sure winner’ and you go with it, then they’re enabling short-sellers out the back door. Nice huh? And they all do it, but I digress.

The brokerage side deals with clients such as yourself, maybe some pension funds, trust funds, perhaps an institutional client or two depending on what they’re into and so forth. It is pretty benign. On the other side of the operation there is the dealer side and they can be into all kinds of stuff, which, thanks to the USFederal court system, can get you into a pile of trouble. To keep it overly simple, think of the dealer side of the broker-dealer arrangement as a giant client. The dealer operation has accounts, holds positions, buys and sells positions, and makes a market in all of the above. They might do this with regards to stocks and bonds as well as options and other derivatives. The dealer side can borrow money to do all of the above as well, usually from commercial banks. When they borrow money to engage in transactions it is called leverage.

Anatomy of the Bail-In – A Scaled-Down, Working Example

Let’s say the dealer has a million dollars in assets – cash and positions. If they make 10% in a quarter, they’ve added another $100,000. Ok, easy enough, but they want to make more than that. So let’s say they go out and borrow another $500,000 at 5% per annum and invest the whole enchilada for a quarter and make the same 10%. So now instead of $100,000 in earnings, they have $150,000 – a 50% increase. Their interest expense for the quarter is $6,250 so their gross profit on the loan is $43,750. They give the $500,000 back plus the $6,250 in interest and everyone is happy. Their assets have swelled to $1,143.750. So where they’d made 10% originally, using leverage, they turned that gain into a 14.375% gain. Not too shabby. Plus, remember they make a few bucks lending out the shares you bought on that hot tip so someone else can place a bet that your hot tip stock will go down. Again, this is overly simplistic, but you get the idea here. The borrowed money is cheap – in fact, 5% is probably on the very high side of what they pay in interest, but is a round number.

Let’s say now that things don’t work out. The invested $1.5 million goes down by 10% in a quarter. They lose $150,000 plus the $6,250 in interest and suddenly, when they give back the loan and the interest; they’re left with $843,750. This creates an obvious problem when all of their assets are already deployed. There’s red ink to the tune of $156,250. Generally, what will happen is another loan will be obtained or some assets sold off or maybe a little of both and the loss will be absorbed.

Anatomy of the Bail-In – Reality

Now the illustrative example above uses a very tame leverage ratio. There was 50 cents of debt for every dollar of assets – or a ratio of .50:1. Understand that leverage ratios of 25:1 and even as high as 40:1 have not been uncommon. That means for the million dollars in the example above, there might be as much as $40 million in leverage (debt). So let’s use the 25:1 ratio and assume the same 10% loss. Suddenly the loss is 2.5X (a $2.5 million loss against a million in assets) the amount of the dealer’s assets rather than being .15X (a $150K loss against a million in assets) as in my example, not to mention the interest. Oops. Now the firm needs cash. They have a creditor to pay off. Well, how about those folks on the brokerage side? Well, gee whiz, they have $3 million in assets. Let’s just snag the $2.5 mil from there and use that to pay off the creditor. But that’s stealing and is illegal, right?

Wrong. Not anymore. That is precisely what happened in the case of MFGlobal, Sentinel Group, and Peregrine Financial – all to varying extents. The dealer side made bad bets and when it came time to pay off those bets, they went to their clients, raided the accounts, and then the injustices in the black robes gave it jurisprudence’s stamp of approval and the bail-in was on. Now we’ve got precedent and case law supporting overt theft. Instead of impeaching the judges, imprisoning them along with the principals of the firms who pulled the stunts to begin with, the establishment comes up with a new set of nomenclature (G-SIFI, bail-in, etc.) and begins the process of normalizing the idea of stealing something that doesn’t belong to them.

And perhaps the most ironic of all? The not-so-USFed, that shining knight on the white horse, buyer of last resort, standout of the handout to the big banks? It is in hock too and its leverage ratio is absolutely stunning. 77:1 at last count. Yes you read that right –  77:1. It was at 22:1 when the financial crisis started ripping through middle classes throughout the globe in 2008 and when you hear all these morons on television talking about how healthy US (and global for that matter) banks are, remember that someone is eating all these garbage mortgages, derivatives and other nuclear financial waste. It’s the central banks. Wait a second though; the central bank regulates the underlings, right? Maybe on the surface, but this is another bright and shining tidbit that illustrates who owns who. The not-so-USFed simply does what it is told.

A great question right now would be this: If everything is getting so much better then why are they still leveraging up at the ‘fed? Shouldn’t they be unwinding? They say they’re unwinding. But they’re not unwinding, they’re continuing to eat more and more garbage generated by their owners. Now this could go on quite a while, but not forever and it won’t end in a pretty fashion when it does end.

Anatomy of the Bail-In – Implications for ‘Depositors’

So that’s the broker-dealer version of the bail-in. The bank side isn’t much different in concept. Thanks to the repeal of the Glass-Steagall Act, which separated broker-dealer operations and the savings/loan operations of commercial banks, the same thing can happen to you if you have deposits in a commercial bank. The mechanism is precisely the same. The broker-dealer side conjures up some idiotic bet based on some computer program written by someone who thinks that the global financial system is nothing more than his or her personal playpen. In typical fashion, they win enough times to get cocky and of course as this happens, the greed kicks in and the bets get bigger. Eventually there’s a loser and by this time they’ve pumped for the goalposts and hiked the leverage ratio up to about 40:1 or even higher.

When it all crumbles and everyone starts scrambling, bear in mind that the law has now made your bank deposits available to do a bail-in and make good on that bad bet. And since you’re now an unsecured creditor rather than a depositor, you a) have no FDIC protection, and b) have no recourse. If you were a secured creditor, you might have a chance to recoup something, albeit not anywhere near what you’d lost, but at least a token. What happens next is your unsecured credit (think bondholders) is converted to equity and you become a stockholder in a failed bank. Congratulations.  You woke up on a Friday morning having $25,000 in bank deposits and literally by the time the bank opens Monday you have x shares in a busted bank. And yes it can happen that fast. Anyone who doesn’t think it can, should remember Lehman in 2008. While it wasn’t a bail-in at that point, look at the velocity with which that outfit hit the mat, never to get up. Look at Cyprus. Friday afternoon there are tremors and by Monday morning, the banks are locked up like Fort Knox and the ATMs are out of money.

The US has already crafted its resolution mechanisms along with most of the G20. The EU has just ordered its member nations to the do the same. In my opinion, anyone who stores more than a trivial amount of cash in a commercial bank should be sentenced to spend the next month in Massachusetts figuring out how many of Tom Brady’s precious pigskins were improperly inflated.

The biggest problem with the above is that even if you understand the mechanism and what a firm might have to be engaged in to get themselves in trouble, it is very difficult to find out exactly what the dealer side of a broker-dealer firm is up to. They’re obviously secretive, claiming proprietary interests. Most will tell you their capital ratio though and that is a start. Your best bet if you insist on being in paper or even have decided that you’re willing to risk a small position in paper is to spread it out amongst several firms or, better yet, use the Direct Registration System so that your assets are held in your name at the issuer’s transfer agent rather than being held in street name at your broker. I realize the whole system is intertwined and something big enough to topple firm A might take firm B with it as well. However, that is an inherent risk for those who wish to engage in this activity.

Regarding the Direct Registration System, many companies stopped issuing paper certificates years ago, citing cost (funny, the shareholder usually was on the hook for that), but even if a firm doesn’t offer an actual certificate you can still have your shares held in your name at the issuer’s transfer agent. There is a popular misconception out there that you can’t do it unless the issuer will provide a paper certificate. All broker-dealers have a means by which you can DRS your positions. Many are reluctant to assist though because, frankly, not having your shares in street name in their ‘house’ costs them money. If DRS is something you are interested in and your broker is uncooperative, then find someone who will cooperate. The good news is that there are firms who are not obstructive in this regard.

Also an inherent risk is that even if you start to smell a rat that you won’t be able to extricate your assets in time. Much in the way banks are making people wait inordinate periods of time to get cash (if the paper itself is a con job then think about ‘electronic paper’ or digitized currency), firms can take up to 10 working days or more to effect transfers. In our fast-paced financial climate where the world can literally change in a weekend, 10 days might as well be 10 years. Also, those pesky daily limits on your ATM card, put in place for your own ‘security’ as you were told when you asked about it, could be lethal as was the case in Cyprus.
My goal here isn’t to make things sound hopeless; that is not the intent, but rather to present you with the risks involved when you engage in these very basic financial activities. Most people don’t even consider these risks because until recently they either didn’t exist as in the case of the bail-in or weren’t relevant as in the case of banks being so stingy with their cash withdrawal policies. This is one of those times when you simply MUST advocate for yourself because these other folks are firmly invested in your continued ignorance, apathy, and ultimately inaction.

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Banking Crisis Update – April 5th, 2023

1 CommentBailouts, Banking, Currencies, Economics, Monetary Policy, RIsk Management, Uncategorized

Andy Sutton / Graham Mehl

The past few weeks have been fairly ‘quiet’ regarding bank failures, but, much like a hurricane, we’re in a bit of an ‘eye of the storm’. There are several graphics that follow which will hopefully reinforce the main point – the crisis is nowhere near over. While getting direct information has become quite challenging, we maintain several data series that were previously discontinued by the publishers.

Graphic #1 – Monthly Changes in Bank Deposits – as of March 2023

In the chart above, you’ll note the timeline on the x axis. The data stream begins in 1971. March of 2023 just provided the LARGEST single month drop in bank deposits – EVER. We had nearly a trillion dollar bank run during the month of March and not a single word was uttered by any official, policymaker, or media talking head. This should not be much of a surprise – the financial industry and government have learned extremely well the lessons of Cyprus and other places in the past decade. Transparency is the mortal enemy of a fiat money system.

Let’s not split hairs here – there isn’t a single commodity-backed currency on the planet at this time so everyone else is doing the same thing we’re doing here in the US.

1930-1932 Reboot?

It certainly appears that is a distinct possibility. We’ve opined for many years now, much to the chagrin of readers, that the not-so-USFed would indeed try to rescue the dollar one last time before the cycle ended. What we’ve seen over the past few months are the possible beginnings of a contraction in the monetary aggregates (Deflation). We’ll let them graphic below speak for itself:

The above graphic is M1 in the United States. The timeline starts in 2000. The incredible spike towards the middle/end of 2019 is responsible for the massive spike in price inflation that we’ve seen in the past 18 months. There’s a delay of between 9 and 21 months from spikes in money supply to the knock-on price increases. Note that the spike in M1 started pre-pandemic.

We’ll show one more chart before we close this brief update. United States M2 – now the broadest (officially) tracked monetary aggregate. It’s painting a similar picture. The timeline is set to that of the M1 graphic above for easy comparison.

M2 tends to move more gradually than M1 because it contains more subtypes of money. We’ll post a chart at the end of the piece where you can see the various components of the aggregates. But what is noteworthy about the above M2 graphic – we’re seeing the first actual deflation in almost a century. This isn’t price deflation (falling prices), this is the actual removal of dollars from the system. If the deflation of 1930-32 was truly the accident that everyone claimed, then policymakers ought to know well enough to avoid it again.

In a fiat monetary system, only the central bank can remove money from the system. Ours did it at the beginning of the depression and it certainly looks as though they’re doing it again. We’ll deal with the fallout that will result in the next update. To give a small hint – think about debt that was taken when the money supply was at its peak.

The chart of monetary aggregates in the United States is directly below.

Stay well,

Andy / Graham

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2023 Banking Crisis – Update

Bailouts, Banking, Geoeconomics, Interest Rates, Monetary Policy, RIsk Management

-Not sure the words of our fabulous ‘leaders’ are resonating. I’ve had several calls today from people I know asking about this whole situation. Some of them are business owners wondering about the safety of their operating accounts. It’s very hard for them to keep these in cash. I did recommend switching to credit unions wherever possible. This should have been done 15 years ago, but better late than never. 

-Stock prices and health of a bank are NOT directly related. Banks will cannibalize each other and what I’m seeing on several of these medium to smaller banks is a pretty overt effort to drive the share prices down – probably so they can be bought out by the bigs at a steep discount. Short positions are way up. I’ll bet more than a few of these make the Reg SHO lists this week for failures to deliver (naked shorting – yes it still goes on). 

-The promise of a full backstop by the not-so-USFed and treasury is telling. Yellen, in particular, should be skewered. You can’t bailout anyone vis a vis the government without using taxpayer dollars. It’s that simple. I’ve gotten a couple of emails as well from My Two Cents readers who claim that the coupons they were issued last week are still in force – in other words, there’s NO backstop and they might get something when everything is wound down. I’ve asked for documentation and will post it to the group if/when I get it. 

-If the not-so-USFed does the bailing out, then it’ll be inflationary. They’re double talking as usual, trying to have it both ways. Can’t be a dove and a hawk on inflation at the same time. I’d say they’ll sacrifice the dollar further to save their precious financial system – that nobody needs anyway. 

-Beware of bail-ins. It’s legal now – since 2013. Credit unions will be safer than commercial banks. Again, that recommendation is at least 10 years old. Credit unions are not allowed to get into the stinkpot of derivatives and they’re not allowed to run broker/dealer operations either. Not saying they’re immune, but as fast as safety goes, I’d give commercial banks a 1/10 and credit unions a 6 or 7 for the reasons stated above. However, if we end up with a CBDC out of this, then credit unions won’t offer any protection at all. 

-Direct registration of securities (stocks only) is advisable. Direct registration takes the shares out of ‘street name’ and your ownership is registered through the stock issuer’s transfer agent rather than your broker. This is a MUST, but it’s for individual stocks. Some mutual funds offer partial protection in this regard, but only if you bought your mutual fund units direct through the fund issuer. If you got it through a brokerage, this doesn’t apply. If there are questions on direct registration, please let me know. I have an article from 2013 that runs through the pros/cons and process. It’s not hard to do. DRS does not apply to ETFs, closed-end funds, and mutual funds purchased through a brokerage. If you own stocks through a brokerage, you can DRS them easily, however. 

Opinion – ignore the politicization of this. Stick to the events. Most of the financial system is outside the purview of our politicians – at least on a day to day basis. This isn’t Biden’s mess or Trump’s mess. It’s the not-so-USFed’s mess. They’re supposed to be stewards of the financial system even though it falls outside their dual mandate of price stability and maximum employment. But remember, the chartered banks own the not-so-USFed, NOT the other way around. Talk about a recipe for malfeasance. 

More as it happens and/or I get it. 

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Risk Management – Interest Rate Risk

Consumer Finance, Interest Rates, RIsk Management, , , , ,

Since interest rates have been the topic of much conversation and debate recently, we thought we’d start here. What exactly is interest rate risk?

Let’s say you have a portfolio of securities and you bought the entire portfolio back in 2004 when interest rates were comparatively much higher than they are now. Your intent in 2004 was to subsidize other sources of income during retirement. Or perhaps you were younger at the time and wanted a ‘base’ to your portfolio that would throw off cash streams that could be used to purchase other securities. Essentially planning on reinvesting the interest rather than removing it from the portfolio.

You’ve had some very good news since then in that as rates go lower, the prices of already purchased assets go higher since rates and price are inversely proportional. If you had a fistful of bonds in 2004, there has been a decent amount of capital appreciation. And your yield on those bonds is still the same as it was in 2004 – if the bonds haven’t matured and rolled over into new ones. You’d have had to be in the 20-30 year range on bonds if your 2004 bonds haven’t matured for obvious reasons.

But what about your reinvestment strategy? It’s been put through the meat grinder. Compared to 2004, you’re going to pay more for assets that yield MUCH less. You can avoid paying more by purchasing new issues at or near par, but you can’t avoid the massive destruction of your interest cash streams. If you’re re-investing, maybe you can shuffle a bit and if your time horizon is long enough, this might well pass – rates have nowhere to go but up.

What if you’re using those interest payments to subsidize your fixed income from SocSec during retirement though? You need the yield. Your advisor tells you the only way to get the yield is to buy ‘high yield’ CEFs, ETFs, bonds, private equity funds, etc. What your advisor might not be telling you is that you’re going to be stuck buying securities that are maybe a step or two above a rating of ‘junk’. Your risk just went through the roof to attain the same yield as previously. This happens to many investors and they don’t even realize it because their advisors and brokers are derelict in their ethical responsibilities towards their clients. Fortunately all investment professionals don’t fall into this category.

Asking your current financial professional about risk is a good way to gauge how sincerely they are approaching the stewardship of your assets. Financial professionals are required by law to ask you questions about risk tolerance when they take you on as a client and then periodically after that. A diligent approach is to perform a yearly check up and make sure the client knows to let their financial professional know if there are any major changes in their lives between check-ups. The professional can then determine if re-structuring the mix of assets is necessary.

You should be asking about risk in general regardless of your age or portfolio design and making sure the recommendations you are given are in line with your risk tolerances.

The darker side to investing in low-rated investment grade assets involves what is known as default risk. We’ll take a look at default risk tomorrow.

Sutton/Mehl

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A Brief Primer on Risk Management

Economics, Geoeconomics, Geopolitics, Portfolio Analysis, RIsk Management, , , , ,

We say ‘brief’ because first hurdle one has to clear when assessing any type of situation is whether or not there is risk involved. Risk can appear anywhere – even crossing the street. Such simple acts are rarely given much consideration, but our brains are constantly analyzing risk/reward quotients for various activities.

Often, when looking at investments, we give in to perceptions rather than realities. Most capital asset pricing models, for instance, rely on the use of ‘the riskless asset’ in their various formulae. Does such an asset exist or is it akin to the ‘Giffen good’ concept in mainstream economics texts?

If anything has become clear since the turn of the century, it is that there is no such thing as a ‘riskless asset’. US Government debt, the de facto ‘AAA’ rated standard bearer of zero risk has become fraught with uncertainty. Once we break the mental model that there are in fact safe havens, we can start to have a meaningful conversation about risk and reward. Before we launch into a series of short briefs outlining the various types of risk, we need to hit some assumptions. These assumptions are especially true for Americans and anyone who holds depreciated US Dollars in any real quantity.

The Dollar as the reserve currency of the world. At present time, this is an arrangement of convenience more than anything else. Why would anyone want a paper ticket (or mostly digital now) that has no intrinsic value, does not act as a store of wealth (Thanks Msrs. Powell, Bernanke, Greenspan, et al), and has developed such an animus about it?

Answer: Because that’s what we’ve always done. The population of the world, in vast majority, hasn’t lived through a time when the Dollar wasn’t the standard bearer. So it is human nature to assume this will continue – despite mounting evidence to the contrary. If we make the leap that the Dollar is vulnerable, then so does all the debt that bears its name. Goodbye says the ‘riskless asset’. What does that do to our models? We need new ones if we’re going to accurately assess risk either qualitatively or quantitatively.

So, with that rather unpleasant bit of business done and the idea of the riskless asset disposed of, we’ll embark on a rundown of the various types of risk for a typical investor in an environment that often looks more like a war zone than a place to nurture wealth.

We’ll try for one each day and, failing at that, to accomplish this task within the next few weeks. If you looked at the chart of the US National Debt that was posted yesterday, you can probably imagine there is an essay forthcoming. The media isn’t covering the out of control accumulation of debt – passed on to our children and grandchildren – so our rather small group of deficit hawks will do their job for them. Stay well.

Sutton/Mehl

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US Treasury Rates – 3/27/2020

Economics, Interest Rates, Monetary Policy, RIsk Management, , ,

The following chart shows the yields on USTreasury securities during month of March. These are end-of-day figures. Intraday, the 1-3 month were negative during the middle portion of the week.

As of Friday, 3/27/2020, the 30-year bond is paying 1.29%. This is slightly off the bottom of less than 1% on 3/9, but is still very negative in real terms (when using the CPI to discount for price inflation). You may click the thumbnail below to enlarge. We are also posting the link to the Treasury’s site as well for your convenience.

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

Sutton/Mehl

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Retirement Accounts Part of Next Bailout? (We’ve Already Addressed This)

Banking, Consumer Finance, Geoeconomics, Monetary Policy, RIsk Management, , , , ,

Today, for the first time, a prominent national politician mentioned on television news that portions or potentially all of the pension systems in the United States might have to be ‘nationalized’ to fund additional bailout measures.

It is already abundantly clear that the $2+ Trillion measure that just passed the Senate won’t be nearly enough. We have lived by debt for many years with seemingly few – if any – observable consequences. The old saying says ‘live by the sword, die by the sword’. Perhaps we’re about to find out.

In 2013 there was a bank raid on the tiny Mediterranean island of Cyprus. Panic ensued with depositors losing the ability to withdraw funds, a bank holiday followed and a bail-in resulted. A bail-in? Yes, that’s not a typo. We penned a volley of articles dealing with what transpired in Cyprus and closed out with some possible mechanisms by which US retirement assets would be seized to protect national security interests.

Rather than re-write all of that content we’re going to just re-post what we penned at that time. Tomorrow (hopefully) we’ll be able to take a short guided tour through those articles and apply some of what is going on now and how this whole thing might come together. A friendly reminder. We are not asking for any money. We don’t want any. We are not giving advice. We are providing information and analysis based on almost 50 combined years of studying economics, financial markets, and geopolitics. The link to the compilation – in PDF format – is below. Until next time,

Sutton/Mehl

Cyprus Banking Crisis SeriesDownload

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Q&A Session on Liberty Talk Radio 3/19/20 @ 24:00 UTC

Consumer Finance, Economics, Geoeconomics, Geopolitics, Liberty Talk Radio, Manufacturing, Monetary Policy, National Debt, Pensions, RIsk Management, , , , , , ,

Hello Readers,

I will be on either a brief Q&A segment with Joe Cristiano’s Liberty Talk Radio or I’ll be releasing a short podcast this evening. I know many of you are not in the US so my apologies for the short notice. Please email your questions when you can and we’ll go from there.

Topics? While I have medical training, I am not qualified to speak on the issue of COVID-19 beyond the most general of terms. I would like to focus on the global financial markets and the very strong likelihood that another 2008-style event was imminent as early as last summer.

Now, with global markets shredded, economies left in doubt, and the population of a growing number of countries behind closed doors, what needs to happen next? We’ve heard some solutions. Are they the right ones?

We’ll be addressing these issues – and your questions – tonight. Don’t miss it!

Best,

Andy Sutton

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Markets, Mania, and Meltdown – a Brief Synopsis of the Past Month

Consumer Finance, Economics, Geoeconomics, Manufacturing, Monetary Policy, My Two Cents, National Debt, RIsk Management, , , ,

Andrew W. Sutton, MBA and Graham Mehl, MBA

“The past month has been one of nearly continuous turmoil in the financial markets”. That might well be the understatement of this still fairly new century. Keep in mind that during the past 20 years, we’ve had 2 significant recessions (according to the Bureau of Economic Analysis), a complete meltdown of the .com mania, the inflation of a real-estate bubble and its subsequent bursting, the halving of US financial indexes, and the bankruptcy of names like Lehman Brothers, and AIG to name a few. Throw in a massive bailout, a fusillade of rescue programs like TARP, TSLF and the resulting blowout of the federal reserve’s balance sheet. This is within the first 10 years. Keep that in mind.

The second ten years have featured D-E-B-T – on all levels. Governments of the world, states and provinces, local municipalities and parishes, students, consumers, homeowners. In short? Pretty much everyone. That debt has driven the economy for the past decade. Globally. Many will think this is just an American problem. It’s not. Misery loves company, right? Not so fast. In this brave new world of interlocking economies and financial systems, a failure on the other side of the world can cause problems in our own back yards.

Entire countries have gone bust and have had to go hat in hand to their representative central bank. Remember Portugal, Ireland, Italy, Greece, and Spain? Don’t forget the tiny island of Cyprus and its king-sized banking crisis, which led to a bank holiday and eventually a bail-in. Wait, we just talked about a bailout. What’s a bail-in? We penned a serious of articles on this topic back in 2013. Read them here. Keep in mind that this is very non-exhaustive and brief summation of some of the more important events.

Which brings us to the present. Yesterday, 3/11/2020, the ENTIRE yield curve for USGovt bills, notes, and bonds was under 1%.  That’s not a typo. There is rampant talk of negative interest rates here in the US. This phenomenon is already happening in Germany – the powerhouse of the European Union and several other easily recognizable nations. Moves in the bond market that generally take many months are now taking days. If you’re planning on retiring and living on the interest of your bonds, you might want to rethink that strategy. Many of the people we communicate with regularly have themselves or know quite a few people who have gotten a 20% haircut or more on their equity investments since the beginning of the year.

Much of the more recent activity has been blamed on the emergence of a new Coronavirus. The fear alone that has been imparted by the mainstream – and even alternative media is bound to have some kind of impact on the global economy. Economists are already clamoring for cash payments to citizens as a means of ‘stimulating’ the economy. In the US we’ve done this twice previously in the past two decades. Both were credited with averting nasty recessions. Both went directly on the federal budget deficit here in the US. Debt has indeed become the answer to all that ails most economies the world over.

The gyrations and volatility in financial markets have been enough to give even seasoned investors a serious case of whiplash. In the past 10 trading days the Dow Jones Industrials Average here in the US has had its two biggest down days – EVER – in terms of the number of points lost. Sandwiched in there are some of the biggest up days – EVER – again, in terms of index points. Oil crashed over 20% in a single day. Gold has broken out and is once again around/over the very important $1650 level. Silver is probably the bargain of the century to this point. Throw into all this a major year in terms of the political arena. And no, we are not breaking our tradition of focusing on policy. The policy provides the answers. The names only serve to muddle the issues.

As we write this evening of the 10th of March in the year 2020, it is quite possible and likely that the economic and financial foundation that we all rest on has begun yet another metamorphosis into something completely different than we’re all used to. Contemplate the concept of negative interest rates alone. Such a ridiculous move would take several hundred years of investing philosophy and modeling and flush them directly down the toilet. Again, this is likely an understatement. The US went from a national debt around $14T during the 2012 campaign season to a level of $23.5 trillion in the early part of 2020. In 1986, America reached the $1 trillion mark. Any stimulus will go right on the tab.

Many people are electing to stay home for fear of contracting COVID-19 and with all the uncertainty that exists regarding this virus, we refuse to pass judgement. Since consumers are responsible for nearly 70% of US Gross Domestic Product, even a month’s cessation of vacations, cruises, flying, going shopping and all the other activities that fall under consumption, we could easily see a sizable dent popped into Q1 GDP. Or the money might be spent online, and it might not affect GDP that much at all. The situation in China can only be guessed. Sadly, national governments have a growing aversion to the truth even when lives are at stake.

In summation, we cannot and will not make any ‘predictions’ regarding Q1 GDP, consumer spending and the balance of trade. Given that oil has dropped precipitously, that drop will translate into lower gas prices at some point and that will lower that portion of consumer spending, which will negatively affect GDP. This reality makes a strong case that we should be measure growth in units rather than dollars wherever and whenever it is practical to do so. The best advice we can give is gather as much information as possible and try to avoid making decisions based on emotion. Seeing the Dow Jones Industrials Average lose over 2,000 points in a single trading will unnerve even the savviest of investors.

Living off the interest from investments, for all purposes, is not going to be feasible for the foreseeable future. Our economies are hooked on low interest rates. That is helpful for the borrower, but lethal for the investor. It forces investors with shorter time horizons into the riskier equity markets. This situation represents a clear and present danger to the standard of living for millions of people in America alone.

This is not all gloom and doom, however. Again, like 2008, we have a chance to endure the economic pain necessary to down regulate our debt-laden, consumption-oriented economy into something that doesn’t need trillions of borrowed dollars each year just to keep plodding along at a snail’s pace. We have an opportunity. Will we avail ourselves of it? If the talking points coming out of the television and Internet media outlets is any indicator, we will most likely not take this opportunity, opting instead to kick the proverbial can down the road ensuring that the pain will only be worse for the next generation when they are forced to deal with it. We challenge not only America, but the rest of the world to put down the credit cards and take a step back. We did it here in the US during 2010. We can do it again. But will we?

Stay tuned and stay well.

Sutton/Mehl

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