The 2008 Great Financial Crisis came about because we began to hit “debt
saturation” levels. The crisis was one of solvency but was attended to with
added liquidity. Sovereign treasuries still had the ability to add debt to
their balance sheets which was done in unprecedented amounts. Now, we are
again bumping up against debt saturation levels as sovereign treasuries by
and large have little room left to add more debt in efforts to reflate. The
root problem of solvency was never addressed, only postponed to another day.
That “day” seems to be in sight.
The Fed recently did a study concluding that a $4 trillion increase in
their balance sheet should be enough to reverse a future recession. I would
ask several questions: first, 2008 began as a downturn in real estate in the
U.S. and quickly spread to financial asset prices and thus institutional
balance sheets… In no way did it begin as “normal” recessions in the past have.
It was not about inventory/sales until well into it. Why has the Fed come out
with this study now? And why use average recessions as the potential
boogeyman rather than the 2008 episode? I would equate their study to
relating the response and protocol to treating a head cold and sore throat
versus when the patient is prone to stroke and heart attack.
I have thought for quite some time, a good analogy for 2008 and the
aftermath was like one giant “refinancing”. Think of it as a “cash out” on a
home mortgage where money is taken out against equity yet the monthly payment
didn’t go up because your interest rate went down. After closing, you feel
pretty good because your payment did not go up and you have cash in hand to
help you continue making payments. This is exactly what happened but we are
again at a point where the monthly payments are starting to “bite” again. In
technical terms, liquidity is again becoming very tight on a systemic basis.
So here we are again, in the same situation we had in 2007-2008. Too much
debt with stretched valuation levels in equities and real estate …and stupid
levels in the credit/bond markets as evidenced by “negative rates”. Central
banks are again being forced to look at expanded QE while fiscal stimulus is
again being eyed with one caveat …the Fed wants you to believe they are going
to raise rates!
Global central bankers, stuck at zero, unite in plea for help
from governments
As Fed nears rate hikes, policymakers plan for ‘brave new
world’
I ask you this, in a world where economic activity is clearly decelerating
…and has more debt to GDP/equity than ever before, how can the Fed raise
rates? In the short term, raising rates would strengthen the dollar versus
other fiat currencies (and tighten dollar liquidity). Is this what the
U.S./world needs? And how exactly will the existing leverage affect the
underlying asset pricings? Will this be good for stocks or real estate not to
mention the mathematics affecting bonds? The big one (and an entire writing
for another day) is the derivatives market. How will these fare? I cannot
imagine having to put on a carry trade using dollars, higher rates and a
higher dollar is a disaster waiting to happen.
In my opinion, we are again at a point in time where “liquidity” is more
important than anything else. Whether for an individual, corporation, or
state, “liquidity” will soon be ALL IMPORTANT! Just as in 2008-2009,
“counterparty risk” will take center stage and any hint of the lack of
liquidity will attract sharks.
What exactly is “liquidity” and why is it important. Briefly, liquidity is
the immediate availability of capital to run your business and pay current
expenses and interest. I am going to add a twist here because what some to
believe to be liquid …may not be at the point in time it is most needed. You
see, what if you had a large cash/credit balance with a bank or institution
that is forced to close either temporarily or permanently? “Liquid” means it
is available to you NO MATTER WHAT happens. Or what if you had some sort of
unencumbered bill/note/bond and the credit standing of the issuer came into
question? Would this be liquid?
If you are bearish on where the world is financially, the above questions
should have already entered your mind topped off with the question of “who”
is your counterparty? I would suggest the goal right now should be twofold,
return OF capital and the ability to “use” it whenever you need to. In other
words, “pure liquidity“.
If for any reason whatsoever your capital may not be available to you, you
do not have “pure liquidity”.
Pointing out the obvious, the only “asset” on the planet that is pure
liquidity is gold (and silver to a lesser extent). You don’t believe me or
want to argue with this? First and most obviously, gold (silver) are no one
else’s liability and thus cannot go “bankrupt”. Yes they can and do fluctuate
in value versus fiat currencies but in a world where solvency and liquidity
has become primary concerns, do you believe gold will become less desirable
versus the liabilities of nations? If you still don’t believe me, Alan
Greenspan explained the virtues of gold back in 1966. He went several
steps further than liquidity and discussed gold as a medium of exchange, gold
as money and a return to the gold standard.
Nevermind the supply and demand imbalances or the fact that gold is
counterfeited on a daily basis where the supply gets diluted many times over,
gold can ALWAYS be used to settle a transaction. The key word here is
“always”. I say this because 24/7, 365 days per year, gold is liquid and thus
available to settle any trade …if you are fortunate enough to own it in physical
and unencumbered form. Please note the bolded words, as long
as you own real gold with no one or entity between you and your gold …you
have pure liquidity rivalled by nothing man made. Pure wealth to be sure but
more importantly in a world where massive additions of liquidity have not
been enough and showing signs of drying up …pure liquidity!
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Standing watch,
Bill Holter
Holter-Sinclair collaboration
Comments
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