The Massive Problem Threatening the Global Recovery

Posted by Bill Bonner - Diary of a Rogue Economist & Chris Hunter

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Nothing to report from Wall Street. Dow down a little yesterday. Gold up a little. The most telling stories are coming from the world economy, not its manipulated markets. 

The price of copper is collapsing. The Baltic Dry Index is dragging along the bottom. Seven years after the start of the debt crisis the global economy is still struggling. 

Hedge-fund-turned-family-office-manger George Soros says Europe could be in for a 25-year slump. Bloomberg reports: 

Billionaire investor George Soros said Europe faces 25 years of Japanese-style stagnation unless politicians pursue further integration of the currency bloc and change policies that have discouraged banks from lending. 

Europe “may not survive 25 years of stagnation,” Soros said in the interview with Francine Lacqua.

It was in the spring of 2007 that the first crack appeared in the weakest part of the debt structure: US subprime mortgages. By March 2007 the value of subprime mortgages had risen to $1.3 trillion. But mortgage rates were rising. Defaults and foreclosures followed. 

The following autumn, the rate of subprime mortgage delinquencies had tripled from the year before. By January 2008, it had quadrupled. And by May it had quintupled. 

It was a classic debt deflation. Homeowners had taken on more debt than they could afford. Now, the debt was going bad and investors were getting queasy. 

Toxic Sausages

Defaults were bad news for marginal homeowners. They lost their houses. They had to move. 

They were bad news to the people who owned the mortgages, too. Wall Street had sliced and diced America’s mortgage deluge and sold it all over the world in the form of mortgage-backed securities – structured products that cleverly concealed, with the tacit backing of the ratings agencies, the junk hidden beneath the surface. 

Sellers, too, seemed to forget what was in this sausage; they didn’t realize it was about to make them throw up. 

First, Bear Stearns ran from the room, holding its stomach. Then it was Lehman Brothers. At that point, the feds came in with every quack cure they could think of. Bailouts, cash for clunkers, ZIRP, QE – one estimate put the total cost at more than $10 trillion, or about three times the cost of World War II. 

The problem with the cures was always a fundamental one. The crisis was caused by too much debt. And all the feds had to offer was… more debt. As Bloomberg reported last week, the world’s stock of toxic sausages has exploded to $100 trillion: 

The amount of debt globally has soared more than 40% to $100 trillion since the first signs of the financial crisis, as governments borrowed to pull their economies out of recession and companies took advantage of record low interest rates. 

The jump in debt as measured by the Basel, Switzerland-based BIS in its quarterly review is almost twice the US economy.

Stopping the Future

Debt is an obligation laid upon the future by the past. The larger it gets, the harder it is for the future to happen. 

There is a correlation between extreme levels of public debt and low economic growth. This has been demonstrated by several studies, most prominently by professors Rogoff and Reinhart. There were some errors in their math, which critics rejoiced in, but the conclusion was solid: High levels of debt-to-GDP have been historically associated with low levels of economic growth. 

That is what has been happening in Japan for the last 23 years… and in Europe and the US for the last seven. These economies are still fighting deleveraging, resisting debt deflation and pretending that they can continue to add debt forever… and that somehow this will get them out of their debt traps. 

But they are doomed. Without growth they can’t pay the debt. With so much debt, they can’t grow. 



Market Insight:
These Two “C”s 
Will Send Gold Higher 

From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners

Two “C”s threaten widespread market instability: Crimea and China 

Let’s look at each one… and why both are bullish for our favorite metal, gold. 

Russian forces remain in Crimea, against international law. The government in Kiev is raising a 600,000-strong national guard to buttress its defenses against the Russians. A referendum will be held in Crimea on Sunday to determine whether the autonomous region should become part of Russia. The government in Kiev does not recognize the referendum. 

The West is ratcheting up the economic tension. German chancellor Angela Merkel, who is usually relatively quiet on foreign affairs, has warned that Russia faces “massive damage” economically and politically, if it doesn’t back down over Crimea. 

Meanwhile, China has gone from being the “engine of global growth” to the locus of concern over a global slowdown. 

Chinese exports have collapsed 18% from a year earlier (versus expectations of a 7.5% increase). Chinese GDP growth is slowing. And there are concerns that bond defaults in the Chinese corporate sector may trigger a Chinese credit crunch. 

It’s also quickly becoming clear that currency devaluation in Japan to boost exports is a zero-sum game. Japan can steal business from China and Korea, but this just prompts retaliation. 

This is the “currency war” scenario many have feared Global QE would trigger. If the US and Japan are devaluing their currencies, it forces competitors to respond in kind… or lose critical export business. 

Against this backdrop of uncertainty, it’s no wonder gold has been in rally mode in 2014. 

Gold is not just a hedge against fiat currency debasement. It is also “disaster insurance” – a tangible asset with no counterparty risk investors seek out when return of capital, instead of return of capital, becomes a priority.


As you can see from the chart above, the spot gold price just broke above its recent October 2013 high. A break to the upside like this signals higher prices ahead.