martedì 18 settembre 2018

Dalio’s key filters for identifying a bubble

If you were to analyse every major debt crisis in the world over the last 100 years, what would you learn? What patterns would emerge? Well Ray Dalio, the founder of the best performing hedge fund in the world has done just that.

"I found that by examining many cases of each type of economic phenomenon (e.g., business cycles, deleveragings) and plotting the averages of each, I could better visualize and examine the cause-effect relationships of each type. That led me to create templates or archetypal models of each type—e.g., the archetypal business cycle, the archetypal big debt cycle, the archetypal deflationary deleveraging, the archetypal inflationary deleveraging, etc. Then, by noting the differences of each case within a type (e.g., each business cycle in relation to the archetypal business cycle), I could see what caused the differences. By stitching these templates together, I gained a simplified yet deep understanding of all these cases. Rather than seeing lots of individual things happening, I saw fewer things happening over and over again, like an experienced doctor who sees each case of a certain type of disease unfolding as "another one of those."

In commemoration of the 10^th anniversary of the GFC, Dalio has released his new book, "A Template For Understanding Big Debt Crises". In the book, and in classic Dalio fashion, he distils the complex economic machine, into simple principles. He shares these principles with us, and the template he used which helped him do well through the GFC, when almost everyone else did badly.

You can read the 470-page book (which he's giving for free) or read the wire below for a snapshot of his views. This wire will include highlights from Dalio's 6 stage template for analysing a deflationary debt cycle, his views on where we are placed in the cycle today, and the key risks investors should be looking out for moving forward.

The 6 stages of deflationary debt cycles

1. The Early Part of the Cycle

"In the early part of the cycle, debt is not growing faster than incomes, even though debt growth is strong. That is because debt growth is being used to finance activities that produce fast income growth. For instance, borrowed money may go toward expanding a business and making it more productive, supporting growth in revenues. Debt burdens are low and balance sheets are healthy, so there is plenty of room for the private sector, government, and banks to lever up. Debt growth, economic growth, and inflation are neither too hot nor too cold. This is what is called the "Goldilocks" period."

2. The Bubble

"Bubbles usually start as over-extrapolations of justified bull markets. The bull markets are initially justified because lower interest rates make investment assets, such as stocks and real estate, more attractive so they go up, and economic conditions improve, which leads to economic growth and corporate profits, improved balance sheets, and the ability to take on more debt—all of which make the companies worth more."

"As assets go up in value, net worth's and spending/income levels rise. Investors, business people, financial intermediaries, and policymakers increase their confidence in ongoing prosperity, which supports the leveraging-up process. The boom also encourages new buyers who don't want to miss out on the action to enter the market, fuelling the emergence of a bubble."

His key indicators for what the archetypal bubble looks like…

"Taking stocks as an example, rising stock prices lead to more spending and investment, which raises earnings, which raises stock prices, which lowers credit spreads and encourages increased lending (based on the increased value of collateral and higher earnings), which affects spending and investment rates, etc. During such times, most people think the assets are a fabulous treasure to own—and consider anyone who doesn't own them to be missing out. As a result of this dynamic, all sorts of entities build up long positions. Large asset-liability mismatches increase in the forms of a) borrowing short-term to lend long-term, b) taking on liquid liabilities to invest in illiquid assets, and c) investing in riskier debt or other risky assets with money borrowed from others, and/or d) borrowing in one currency and lending in another, all to pick up a perceived spread. All the while, debts rise fast, and debt service costs rise even faster."

His key filters for identifying a bubble…

3. The Top

"When things are so good that they can't get better—yet everyone believes that they will get better—tops of markets are being made."

"In the early stages of a bubble bursting, when stock prices fall, and earnings have not yet declined, people mistakenly judge the decline to be a buying opportunity and find stocks cheap in relation to both past earnings and expected earnings, failing to account for the amount of decline in earnings that is likely to result from what's to come."

"The fastest rate of tightening typically comes about five months prior to the top of the stock market."

"The more leverage that exists and the higher the prices, the less tightening it takes to prick the bubble and the bigger the bust that follows."

4. The Depression

"Lack of cash flow is an immediate and severe problem—and as a result, the trigger and main issue of most debt crises."

"First, contrary to popular belief, the deleveraging dynamic is not primarily psychological. It is mostly driven by the supply and demand of, and the relationships between, credit, money, and goods and services—though psychology of course also does have an effect, especially in regard to the various players' liquidity positions."

"If everyone went to sleep and woke up with no memory of what had happened, we would be in the same position, because debtors' obligations to deliver money would be too large relative to the money they are taking in. The government would still be faced with the same choices that would have the same consequences, and so on."

"Because one person's debts are another's assets, the effect of aggressively cutting the value of those assets can be to greatly reduce the demand for goods, services, and investment assets. For a write-down to be effective, it must be large enough to allow the debtor to service the restructured loan. If the write-down is 30 percent, then the creditor's assets are reduced by that much. If that sounds like a lot, it's actually much more. Since most lenders are leveraged (e.g., they borrow to buy assets), the impact of a 30 percent write-down on their net worth can be much greater. For example, the creditor who is leveraged 2:1 would experience a 60 percent decline in his net worth (i.e., their assets are twice their net worth, so the decline in asset value has twice the impact). Since banks are typically leveraged about 12:1 or 15:1, that picture is obviously devastating for them and for the economy as a whole."

5. The Beautiful Deleveraging

"More specifically, deleveraging's become beautiful when there is enough stimulation (i.e., through "printing of money"/debt monetization and currency devaluation) to offset the deflationary deleveraging forces (austerity/defaults) and bring the nominal growth rate above the nominal interest rate—but not so much stimulation that inflation is accelerated, the currency is devalued, and a new debt bubble arises."

"All of the deleveraging's that we have studied (which is most of those that occurred over the past hundred years) eventually led to big waves of money creation, fiscal deficits, and currency devaluations."

"The chart below conveys the archetypal path of money printing in deflationary deleveraging's over the 21 cases. The money printing occurs in two classic waves—central banks first provide liquidity to stressed institutions, and then they conduct large-scale asset purchases to broadly stimulate the economy."

On the key things distinguishing whether or not a deleveraging is managed well or poorly…

6. Pushing on a String / Normalisation

"Late in the long-term debt cycle, central bankers sometimes struggle to convert their stimulative policies into increased spending because the effects of lowering interest rates and central banks' purchases of debt assets have diminished. At such times the economy enters a period of low growth and low returns on assets, and central bankers have to move to other forms of monetary stimulation in which money and credit go more directly to support spenders."

"Over time, the use of QE to stimulate the economy declines in effectiveness because risk premiums are pushed down, and asset prices are pushed up to levels beyond which they are difficult to push further, and the wealth effect diminishes. In other words, at higher prices and lower expected returns, the compensation for taking risk becomes too small to get investors to bid prices up, which would drive prospective returns down further. In fact, the reward-to-risk ratio could make those who are long a lot of assets view that terribly returning asset called cash as more appealing."

"Low-interest rates together with low premiums on risky assets pose a structural challenge for monetary policy. With Monetary Policy 1 (interest rates) and Monetary Policy 2 (QE) at their limits, the central bank has very little ability to provide stimulus through these two channels—i.e., monetary policy has little "gas in the tank." This typically happens in the later years of the long-term debt cycle (e.g., 1937-38 and now in the US), which can lead to "pushing on a string."When this happens, policymakers need to look beyond QE to the new forms of monetary and fiscal policy characterized by Monetary Policy 3."

"It typically takes roughly 5 to 10 years (hence the term "lost decade") for real economic activity to reach its former peak level. And it typically takes longer, around a decade, for stock prices to reach former highs because it takes a very long time for investors to become comfortable taking the risk of holding equities again (i.e., equity risk premiums are high)."

What part of the cycle are we in today?

On where we are vs. the GFC…

"Debt has increased but debt service payments relative to incomes have not risen like they've had in 2007 – 2008"

"But if you look at the corporate cash and you look at the maturity of the debt, when we run the pro forma financial calculations, it's nothing like 2007 looked like to 2008. There's a squeeze that'll be emerging, but generally speaking, we're in I would say the seventh inning of this cycle. I think that we're at the stage in the cycle where interest rates are being raised. We're in the later stage probably, maybe we have two more years I would say into the cycle."

On the period most closely analogous to today…

"Then the issues of this debt crisis are very different than the last crisis. Each one's a little bit unique. This one looks very much more like the 1935-1940 period."

"Because I think the parallels are really important to understand. Okay, 1929-1932 and 2008-2009, we have a debt crisis and interest rates hit zero. Both of those cases, interest rates hit zero. Only two times this century. There's only one thing to do next and that is to print money and buy financial assets. In both of those cases, that's what the central bank did and they pushed asset prices up.

As a result, we had an expansion and we had the markets rising. We particularly had an increase in the wealth gap, because if you'd owned financial assets, you got richer. If you didn't, you didn't. And so what today we have is a wealth gap that's the largest since that period. The top 1/10th of 1% of the population's net worth is equal to the bottom 90% combined. You have to go back to 1935-1940.

As a result, we have populism. Populism is the disenchanted, capitalism not working for the majority of people. So, we have that particular gap. We have a political gap, a social gap in terms of the economics, and we're coming into the phase where we're beginning the tightening cycle.

1937, we begin a tightening cycle. We begin a tightening cycle at this point. No tightening cycle ever works out perfectly, that's why we have recessions. We can't get it perfectly, so as we're going into this particular cycle, we have to start to think, well, what will the next downturn be like?

We're nine years into this. As you have a downturn, I believe that there's political and social implications to that related to populism and less effective monetary policy. There's less effective monetary policy because so far there are two types of monetary policy used.

Lowering interest rates, we can't lower interest rates. The second is quantitative easing and it's maximised its effect. So, I think that the next downturn is going be a different type of downturn."

What are the key risks investors should be looking out for moving forward?

"It won't be the same in terms of the big bang debt crisis. It'll be a slower growing, more constricting sort of debt crisis that I think will have bigger social implications and a bigger international implication."

Can't rates be raised and balance sheets unwound as fast as possible?

"No, no, no. Because if you raise rates now, all the rate structure's affected and carries through all markets. Because it's a discount rate for the present value of all asset classes. I think you have to start to think of what monetary policy three is, particularly in Japan, you're going to need it. But the type of thing where it's not just the purchase of financial assets, it gets individuals to make their purchases of actual assets."

What areas are most prone?

"I think that there should be a national initiative to look at the parts of the population that are not benefiting from the cycle. I think that education in many ways is just terrible. I think the most important thing is the ways to create opportunity and productivity in that group."

"Imagine it. If you have a downturn, what will it be like? It's a basic principle that if you have a big difference in wealth and you share a pie, you divide the budget in one way or another and you have an economic downturn, that people are at each other's throat."

On the consequences….

"What I was referring to is that the conflicts that we have internally between the left and the right and those who have and those who have not (referring to the wealth gap). We also get elected populace (referring to populist movements) and then we also have international tensions.

When we had the Smoot-Hawley tariff and we had Japan rising as a power, Germany rising as a power, in much same way as China's rising as a power. We had a situation where there were economic rivalries out in Asia

So 1931 was when the Japanese invaded Manchuria and that they started to compete with resources. That took 10 years, but 1941 was the bombing of Pearl Harbour. I'm saying that you're in a situation where also we have rising powers, China's a rising power, competing with the United States.

Those tensions get carried forward there and those are economic tensions of paramount importance. But those economic tensions produce conflicts in various ways. Everybody should be cautious about that."

What did that mean for the stock market back then (1936-1939)?

"Not too good. Fell over 50%"

So what does that mean for stock markets today?

"I don't think it's as anything like that. Right now, we have just gotten to the point in my judgement that the risk return is more negative."

Earlier this year at Davos, he was bullish, what's his view now?

"There was a lot of cash on the sidelines. A lot more of that cash has been deployed. We had the benefit of the corporate tax cuts behind us. If we look at what's being discounted, what's being discounted is about right. In other words, if you look at the projected returns of equities relative to cash and bonds, the projected returns look sort of about right"

Right now, whatever is more defensive, I would then be in a more defensive posture. Whatever your strategic allocation issue is, you know what your strategic mix is, I would be less aggressive rather than more aggressive."

"I have concerns over a two-year timeframe. if I was to take now and think over the next two years, that's where my concerns are."

"I think more than likely, we'll be in these general vicinities for a while."

The Boiling Frog’ – It’s Not Just The Emerging Markets That Are Fragile

I've enjoyed watching the mainstream financial media fumble over themselves trying to explain the Emerging Market crisis of 2018.

It's even more comical watching them try and tell us that everything's OK from here.

My opinion? Not even close.

So let's go over some things. . .

Below is Goldman Sachs' six-month moving average of the US and Emerging Market CAI (current activity indicators). And as it points out – Emerging Market growth has tanked since the beginning of 2018. Especially compared to the U.S.

Although there's been a steep decline in Emerging Market growth, I don't think that's quite enough to cause a complete panic in the Emerging Markets.

There's more to it than simply growth under-performing. . .

You see, for many years after 2008 – courtesy of the Fed – the U.S. had some of the worlds lowest 'real' rates (adjusted for inflation).

This drove at least two things:

First – Hedge Funds, Banks, and 'Shadow Banks' engaged in huge 'dollar carry trades'

And Second – Emerging Markets gorged on cheap dollar denominated debts.

Since institutions were starved for yield, they invested abroad in riskier Emerging Markets to get the extra one-or-two percentage points over U.S. bonds.

This lasted for years – but starting at the beginning of 2018, the U.S. inflation rate started picking up above the Fed's 2% target.

This prompted the markets perception that the Fed would raise rates faster and possibly higher to combat this inflation dilemma.

So, there was an unwinding of 'carry trades' by the big banks. Emerging Markets had to pay higher interest payments on their dollar denominated debts. And investors sold their Emerging Market bonds an equities – as well as currencies – while rotating into U.S. bonds.

This caused a 'reflexive' dollar rally – which is fuel to the fire of the Emerging Market chaos. Just look at the currencies of Turkey and Argentina for example.

I've maintained for a while now that the Fed's post-2008 ZIRP (zero interest rate policy) and money printing (QE) were making Emerging Markets extremely fragile. Especially once the monetary easing turned into tightening.

We've seen this story time and time again.

For instance, back in the 1990's, then Fed chairman – Alan Greenspan – kept rates pretty low. And Emerging Markets (especially Asian countries) had huge inflows of U.S. dollars from investors in search of yield.

These countries became very fragile over time. They became dependent on cheap U.S. debt and easy access to investor capital.

But once rates started rising and investors took their money out of these countries – Emerging Markets and their currencies tumbled like dominoes – one by one.

This time was no different. Sooner or later, these Emerging Markets were going to feel the wrath of higher U.S. rates.

But will it end there?

Goldman Sachs is now also highlighting the growing fragility of the markets caused by rising U.S. rates (and Quantitative Tightening – QT).

And as the crowd keeps focus on the Emerging Markets – we need to look ahead.

What fragile thing is next in line to break?

Investors rushing into the U.S. feel safe – especially since U.S. growth has picked up recently.

But what if U.S. growth starts declining – or what if the U.S./China trade-war causes unintended consequences?

Puzzling many already is that even during the third year of the Fed's tightening cycle – 'risk premia' (the return above the risk-free rate) across the board are at very low levels.

And the U.S. yield curve's still flattening – nearing inversion.

There's clearly something not right coming from the bond and risk markets.

So beware.

Remember the fable of the boiling frog?

If you put the frog into boiling water, it will jump out immediately. But if the frog's put into slightly warm water – it won't sense the danger while you slowly bring it to a boil.

Just like the frog – many investors don't feel the danger right now.

But it's still there.

We Still Haven't Learned The Right Lessons From The 2008 Crash

Financial media-administered history lessons - whether by commentaries or interviews - on the Great Crash that occurred 10 years ago are frightening.The would-be history teachers are in total denial (or ignorance) of the key fact that 2008 was a monetary-made disaster. This climate of denial continues to foster ever greater danger in the future not to mention a heavy cumulative burden in the decade since - as measured by prosperity lost.

In effect, the Central Bankers Club and their backers among the political elites have been totally successful, it seems, in expunging monetary forces as the key driver - or even as a major factor - in the journey to the 2008 Crash. This started with President George W. Bush nominating Ben Bernanke as a Fed Governor (effective August 2002) in the clear expectation that this Princeton Professor would prove effective in implementing the monetary inflation which he preached. True, Alan Greenspan was still the chief, but by then on shaky footing, given the known hostility of the Bush-Baker "clan" which resented his earlier close cooperation with the Clinton Administration. And Before that, Greenspan was perceived to have some responsibility for the 1991-2 economic downturn which spelled defeat for the older Bush. The implicit term extension deal for Greenspan in 2003 (by two years) was that he would "listen" to the new Governor from Princeton.

George W. Bush's expectations were met when the Greenspan/Bernanke Fed in early 2003 decided on the novel policy of "breathing in inflation" from what it perceived as too low a level. The Princeton Professor was a zealot of the 2-percent inflation standard and had no truck with concerns that the rhythm of prices was now downwards for some time due to the nature of technological change and globalization. The result; monetary inflation in the asset markets (credit, real estate, in particular) developed in a virulent form (including its well-known aspect of rampant financial engineering).

The European and Japanese central banks, confronted with a weak dollar, initiated their own policies of monetary inflation. There was the notorious adoption of a 2-percent floor (the same height as the ceiling) to inflation by the ECB. This was announced with much fanfare by Professor Otmar Issing (the ex-Bundesbanker eminence grise) in Spring 2003. Meanwhile, the BoJ was running the first modern experiment in quantitative easing.

Then in the two years following early autumn 2004, the Federal Reserve (Bernanke became Chair in February 2006) relentlessly raised the Fed funds rate in mini equal steps by 425bp (from 1% to 5.25%). No question that was a sharp tightening of monetary policy, and unsurprisingly in 2006, there was much commentary about an evolving housing downturn and economic slowdown. But the Fed did not budge given that CPI inflation in the middle months of 2006 briefly spurted to just above 4% year-on-year before receding suddenly and sharply back towards target.

We learn from Milton Friedman that monetary policy operates with a long and variable lag. And by Spring 2007 the signs of credit market pull-back were multiplying; then a first crisis of illiquidity erupted in Europe and in the US during Summer 2007, evident in both the banking system and the wider shadow banking system. Even then the Bernanke Fed would hardly ease policy, relying instead on a multiplication of special liquidity measures to keep the banking system afloat.

The NBER now dates the US recession as starting in the fourth quarter of 2007. But at end of that year, the Fed funds rate was down barely 100bp from its earlier peak. The Fed continued with small and steady cuts of official rates through the first few months of 2008. This most likely meant that overall monetary conditions tightened, given the contemporaneous business cycle slowdown and credit market pull-back. Indeed, during late Spring and early Summer (2008) the Fed signaled that rates could increase in response to the "inflationary effect" of the oil market bubble at that time. And even in the autumn of 2008 in the midst of financial panic, when the Bernanke Fed at last allowed short-term rates to collapse, it prevented them reaching zero by starting to pay interest on reserves.

In sum there were two distinct elements in the monetary policy errors of 2003-8. First, there was intense monetary inflation - and then a powerful reining back of this - which was so rigid as to totally become out of line with the development of the business cycle. These failures of monetary policy remained hidden it seems from mainstream critiques and the political process. There were some exceptions, including Senator Bunning's famous attack while when voting against Bernanke's re-nomination as Fed Chair by President in 2009: "you are the definition of moral hazard."

Instead Chief Bernanke, for many, became the hero who had "courageously" intervened to save the system (indeed his autobiographical title is "The Courage to Act"). And he obtained a license from the political process for even more radical monetary experimentation than in the previous cycle. Amazingly, 10 years on from the Great Crash the ECB and Bank of Japan are still stuck in emergency mode (with negative interest rates and QE) while the Federal Reserve has barely shrunk its massive monetary base (which has become un-pivoted in any case from the monetary system by payment of interest at a market rate) and its official interest rate is still negative in real terms.

This unprecedented length without even intermittent pause or reversal of monetary inflation (camouflaged still in goods and services market by globalization and technological change) most likely will have severe and fateful consequences; the extent of these will be a direct consequence of society's failure, and in particular the political system's failure, to confront the monetary mistakes running up to the Great Crash. We have now the ironic situation where the monetary architects of the crash including the Bernanke loyalists and hangers on appointed by President Trump to the Fed Board are enjoying an Indian summer of non-repentance and adulation. One example: CNBC's airing on September 12 of a 3-way smiling and laughing discussion at Brookings between Messrs. Bernanke, Geithner and Paulson, chaired by an un-named toady interlocutor.

Behind this lies the continuing roar of the bull market in US equities and of course the "boom" in the US economy which is in fact a substantial growth cycle upturn since mid-2016 empowered by the "Yellen Put" and its international accompaniment at that time. The lesson from all this: failure to learn will likely include an even bigger potential disaster next time. The full extent and nature of that disaster would emerge with long and variable lags after key dates in the monetary inflation process. Albeit, the perspicacious can already note its translation into the curses of monopoly capitalism and real wage stagnation in the present business cycle to date.

BCA: The "Bubble In Everything" Threatens $400 Trillion In Assets

By now, it's a very familiar question: how high can the Fed hike rates before it causes a major market "event."

Two weeks ago, Stifel analyst Barry Banister became the latest to issue a timeline on how many more rate hikes the Fed can push through before the market is finally impacted. According to his calculations, just two more rate hikes would put the central bank above the neutral rate - the interest rate that neither stimulates nor holds back the economy. The Fed's long-term projection of its policy rate has risen from 2.8% at the end of 2017 to 2.9% in June. As the following chart, every time this has happened, a bear market has inevitably followed.

A similar argument was made recently by both Deutsche Bank and Bank of America, which in two parallel analyses observed last year that every Fed tightening cycle tends to end in a crisis.

Now, it's the turn of BCA research to warn that ultimately the fate of risk assets depends on the relative size of the inflationary impulse being spawned by the Fed vs the remnant disinflationary impulse from monetary policies over the past decade.

In a report issued on Friday, BCA's strategists make the key point that the performance of bonds - and stocks - in an inflation scare would depend on the relative size of the inflationary impulse compared with the disinflationary impulse that resulted from sharply lower risk-asset prices.

They make the point that if central banks were more concerned about the inflationary impulse, which at least for Fed chair Powell appears to be the case for now - Janet Yellen's "lower for longer revised forward guidance"notwithstanding - they would have to keep tightening - in which case, bond yields would be liberated to reach elevated territory. Conversely, if the bigger worry was the disinflationary impulse, which arguably is the case from a legacy standpoint, central banks would quickly reverse course, and bond yields would return to the lowlands. Thus, the disinflationary impulse from lower risk-asset prices would end up as the bigger issue.

BCA then goes on to note that the current episode of elevated risk-asset valuations is not unprecedented, but there is a crucial difference today with past experiences. Previous episodes of elevated risk-asset valuations tended to be localized, either by geography or sector: 1990 was focused in Japan; 2000 was focused in the dot-com related sectors; 2008 was focused in the U.S. mortgage and credit markets and preceded the emerging market credit boom.

By comparison, BCA warns - echoing a point made here on numerous occasions - the post-2008 global experiment with quantitative easing, and zero and negative interest rate policies have boosted the valuations of all risk-assets across all geographies and all asset-classes - global equities (see chart), global credit, and global real estate. The "bubble in everything" as some call it.

This broader overvaluation makes things "considerably more dangerous" for investors, as BCA estimates that the total value of global risk-assets is $400 trillion, equal to about five times the size of the global economy.

The takeaway is that any inflationary impulse would - through higher bond yields - undermine the valuation support of global risk-assets that are worth several times the size of the global economy. Thereby, it could unleash a potentially much larger disinflationary impulse. Or stated simply, the higher yields go, the lower they will eventually drop during what Albert Edwards has dubbed the next deflationary "ice age."

It's Not The Economy, It's The Bad Money Stupid!

Our debt-based fiat money system poses an existential threat...

We're all going to have to be a lot more resilient in the future.

The "long emergency", as James Howard Kunstler puts it, is now upon us.

If ever there was a wake-up call from Mother Nature, it's been the weather events over the past 12 months.

Last year, the triplet Hurricanes Harvey, Maria, and Irma resulted in thousands of deaths (mainly in Puerto Rico) and tens of $billions in destruction.

This year has seen a rash of 120° F (50° C) summer days, droughts, current monster storms like Typhoon Mangkhut and Hurricane Florence -- as well as numerous 100/500/1,000-year floods spread across the globe.

And that's just so far.

It remains nearly impossible to connect climate change directly to any particular weather event. But taken together, it's becoming increasingly difficult to dismiss the scientific claim that the quantity of heat trapped in the earth's weather systems impacts the amount of water that now falls (or refuses to fall) from the sky and the high-temperature heat waves that now shatter records with such regularity that once-rare extreme conditions are now becoming routine.

Our "new normal" is quickly diverging from the natural conditions most of us have grown up with. Permafrost isn't "permanent " anymore -- it melts. The Arctic now can be ice-free. In a growing number of regions in the US, you can leave a screenless window open on an August evening (with the lights on!), and remain unmolested by the swarms of insects that used to prowl the night.

All of these symptoms are connected by a root cause: our society's relentless addiction to growth. And while we do our best to continually raise awareness of this existential threat, the rest of the media completely ignores it.

Virtually no major news outlet is talking about how our voracious consumption of ever-more natural resources is fast exhausting and poisoning the Earth's capacity to support human life. But Serna William's latest court meltdown? That's splashed everwhere...

Which is why the vast majority of people have no clue what's actually happening. And a disturbing portion insist on remaining that way, being led around by the media, wasting their effort, focus and time on things on the irrelevant.

People are convinced that salvation lies with one political party or another, in the election of one candidate or the defeat of another, when the sad truth is all major political parties are on exactly the same side when it comes to promoting endless growth or waging war. In the US there's simply no alternative political party at this point.

Addicted To Growth

Yes, we've been beating this drum for a long time -- over a decade now. But we persist beacuse this critical message is being blunted by very powerful forces that are mainly interested in preserving the status quo.

All the machinery of monetary, political, propagnda and military power is aligned in the quest to keep things headed in precisely the same direction they're already going. Those who control the system today are personally benefitting too much, and so fight change with all their might.

That said, while the new religion embraced by society is Technology, I find it ironic that the very same scientific process that brings us wondrous innovations is simply ignored or dismissed out-of-hand when it return answers that run counter to our pursuit of endless economic growth and consumer comfort.

Here's a recent report that does exactly that. It's by scientists commissioned by the UN who took a look at things along the same line of thinking that we've outlined in the Crash Course. They conclude, as we did over ten years ago, that our unsustainable economic trajectory is almost out of runway.

But have you heard of this report before now? I highly doubt it. It's not a message "they" want the masses to hear.

This is how UN scientists are preparing for the end of capitalism
Sept 12, 2018
Capitalism as we know it is over. So suggests a new report commissioned by a group of scientists appointed by the UN secretary general. The main reason? We're transitioning rapidly to a radically different global economy, due to our increasingly unsustainable exploitation of the planet's environmental resources and the shift to less efficient energy sources.
Climate change and species extinctions are accelerating even as societies are experiencing rising inequality, unemployment, slow economic growth, rising debt levels, and impotent governments.
Contrary to the way policymakers usually think about these problems these are not really separate crises at all.
These crises are part of the same fundamental transition. The new era is haracterized by inefficient fossil fuel production and escalating costs of climate change. Conventional capitalist economic thinking can no longer explain, predict or solve the workings of the global economy in this new age.
"We live in an era of turmoil and profound change in the energetic and material underpinnings of economies. The era of cheap energy is coming to an end," says the paper.
Conventional economic models, the Finnish scientists note, "almost completely disregard the energetic and material dimensions of the economy."
(Source)

Hallelujah! I really do hope these scientists get as much traction as possible with their message. But my experience tells me their warning will go unheeded.

And it's not even a hard one to digest intellectually: Every organism can grow into its available energy supply, but no further.

A plant grown in dim light will not be as large or as healthy as one grown in full sunlight. The amount of sugar in a vat determines the maximum number of yeast cells produced. The abundance of fish in the waters surrounding a sea bird rookery will determine the fate of the nesting colony's population.

Humans are no exception.

All of life is the study of energy flows and transformations. Where conventional economists have gone off the rails is in assuming there will always be sufficient inputs from the natural world to power the economy. That at a high enough price, there always be more of everything.

And in their defense, up until very recently, that has largely been true. But no longer.

Talk to any oil company operator and ask them how easy it is to find oil these days. Or ask a farmer how quickly crop yields would plummet if N-P-K inputs derived from fossil fuels were not added back each and every year to his topsoil. Or talk to a veteran cod fisherman about the 95% collapse in catch size over the past several decades.

Reality-based systems have limits. And we're hitting them all over the planet.

It's The Money, Stupid

Debt-based fiat money, like any monetary system, enforces some behaviors and punishes others.

Specifically, debt-based fiat money demands a regime of constant, perpetual growth. As any mathmatician will tell you, anything that grows contantly accumulates exponentially.

So each year, there's exponentially more debt in the system than the year before. If not, our high-leveraged system begins collapsing, as threatened in 2008:

As long as you can have endless growth, the system of money we have in place today is perfectly fine. But if you can't, then once growth peters out, the entire system crashes into nothingness. There's no in-between territory.

We could choose to have a different monetary system. We could embrace a 'sound money' system, where money can't be conjured out of thin air, at no cost, the way it is today. Instead, it's in limited supply.

Under a sound money system, you either produce more than you consume or you face the consequences (rising interest rates, economic contraction, etc.). No ramping up the printing press to defer the reckoning off to a future date, which will also make it more intense when it eventually arrives.

Wars cannot be financed on the backs of future generations as yet unborn. Either you rally the populace to pay more in taxes to fund a military campaign, or you ramp down the war machine.

Sound money won't fix everything. But it would be a great step in the right direction.

There are many other indictments against debt-based fiat money, including its proclivity to concentrate wealth into the hands of fewer and fewer winners, with everyone else in debt to that oligarchy (a process already well underway). Given these, busying ourselves with trying to refine our current monetary model is a waste of precious time.

As long as debt-based fiat money pins us between the harsh dichotomy of either growing exponentially or collapsing, there's no amount of tweaking, (de)regulating, or rule modifying that's going to make the slightest bit of difference.

We need a full-blown replacement.

You see, money is at the root of it all.

Every large, hierarchical assembly of people throughout history has had an organizing principle that kept everyone in line. Where once it was "royal blood" or "direct access to the god(s)", today it's money. That's what keeps everyone in line and in their place.

But what happens when your organizing principle that keeps everyone in line marches them towards a cliff?

You need to either change it or perish. As the above article on the UN study continues:

Most observers, then, have no idea of the current biophysical realities – that the driving force of the transition to postcapitalism is the end of the age that made endless growth capitalism possible in the first place: the age of abundant, cheap energy.
And so we have moved into a new, unpredictable and unprecedented space in which the conventional economic toolbox has no answers. As slow economic growth simmers along, central banks have resorted to negative interest rates and buying up huge quantities of public debt to keep our economies rolling. But what happens after these measures are exhausted? Governments and bankers are running out of options.
Capitalist markets will not be capable of facilitating the required changes – governments will need to step up, and institutions will need to actively shape markets to fit the goals of human survival. Right now, the prospects for this look slim. But the new paper argues that either way, change is coming.

I too, will argue that -- like it or not -- change is on the way. However, I would go further than the authors adn note that any system, whatever its premise and however it's run, will fail if it's predicated upon an unsustainable idea.

And our system's unsustainable idea is debt-based fiat money.

It's flawed and it's failing. Yet nobody in power can envision a solution because the answer cuts too deeply across our entire social, political and geopolitical constructions. Each is based on infinite growth and has enshrined power based on what we call "money".

Changing the model is just too unpalatable to those who currently benefit most from the current system. Blinded by their spoils, they simply can't realize that if/when the system breaks down, they'll find mob justice offers an even worse outcome.

How To Move Forward

Help is NOT on the way. Not from our leaders, and quite frankly, not from ourselves. Too many people are not going to proactively reject society's pursuit of growth and start embracing having less stuff in their lives.

Materially reducing carbon emissions into the atmosphere would require enormous hits to the economy, lost jobs and quite possible a reduction in total global population. Nobody in politics will go anywhere remotely near that conversation.

And yet the changes are coming. In many cases, they're already here.

As I type, Hurricane Florence is stalled at the coastline of North Carolina, dramatically increasing the rainfall is it dumping there and exacerbating the flooding damage.

Is global warming to blame for the specific steering currents that brought about this path? Maybe; maybe not. But we can easily make the case that the warmer air and warmer seas of recent years result in more energy that increases hurricane intensity.

We can also easily make the case that the damage inflicted by Florence and future storms to come will be compounded by the extremely short-sighted building practices designed to maximize property values and real estate development. Wetlands and dunes that evolved to absorb storm surge have been bulldozed and paved over in the pursuit of profits. Are the resulting flooding damages worth those extra dollars (and lost ecosystems)?

Shale oil is being pumped out of the ground as fast as possible, surprisingly with no profits to be seen (collectively, the shale oil industry has been a massive loss-making enterprise so far). Drillers have to pump to simply to keep the debt and equity that's already in play in motion. Shale holes aren't being drilled and fracked because it makes sense, or because it's the right thing to do at this moment in time; but simply because all of that money printed by the Federal Reserve had to go somewhere and do something. And right now, it's flooding into the oil patch.

Any sane person should sit back, scan the ratio of mess-to-benefit provided by shale oil and shout: Stop! But apparently we "need" the jobs, the money, the oil Right Now!

That's the nature of debt-based money. It enforces the Right Now! mentality at the expense of long-term thinking. Or even any thinking.

So changes are coming. There will be an enormous mess when this third central bank inspired credit bubble bursts and this will be the last one of this size. After this burst, there won't be any getting around the fact that letting a few banksters fiddle with the price of money in an attempt get more borrowing to fuel even more spending was a terrible, horrible, no good idea.

Meanwhile -- as people are marveled by our shiny rising stock prices, complete with $trillion-dollar companies and price-to-earnings ratios at nosebleed highs -- the weather gets worse, more species disappear, and more people fall into lifelong debt servitude. And the hard conversations that we desperately need to be having aren't happening at all.

So, what can you do about it?

Attend to your own business. Develop resilience to become better prepared for what is surely to come. Don't fall for the current bogus narrative. Stand fast to what you know to be true and right. Tend your garden, build your wealth, and let go of old ways.

OK, so how to do this? I do have an idea.

Seth Klarman: These Are The 20 Forgotten Lessons From The 2008 Crisis

The Forgotten Lessons of 2008

One might have expected that the near-death experience of most investors in 2008 would generate valuable lessons for the future. We all know about the "depression mentality" of our parents and grandparents who lived through the Great Depression. Memories of tough times colored their behavior for more than a generation, leading to limited risk taking and a sustainable base for healthy growth. Yet one year after the 2008 collapse, investors have returned to shockingly speculative behavior. One state investment board recently adopted a plan to leverage its portfolio – specifically its government and high-grade bond holdings – in an amount that could grow to 20% of its assets over the next three years. No one who was paying attention in 2008 would possibly think this is a good idea.

Below, we highlight the lessons that we believe could and should have been learned from the turmoil of 2008. Some of them are unique to the 2008 melt-down; others, which could have been drawn from general market observation over the past several decades, were certainly reinforced last year. Shockingly, virtually all of these lessons were either never learned or else were immediately forgotten by most market participants.

Twenty Investment Lessons of 2008

Things that have never happened before are bound to occur with some regularity. You must always be prepared for the unexpected, including sudden, sharp downward swings in markets and the economy. Whatever adverse scenario you can contemplate, reality can be far worse.
When excesses such as lax lending standards become widespread and persist for some time, people are lulled into a false sense of security, creating an even more dangerous situation. In some cases, excesses migrate beyond regional or national borders, raising the ante for investors and governments. These excesses will eventually end, triggering a crisis at least in proportion to the degree of the excesses. Correlations between asset classes may be surprisingly high when leverage rapidly unwinds.
Nowhere does it say that investors should strive to make every last dollar of potential profit; consideration of risk must never take a backseat to return. Conservative positioning entering a crisis is crucial: it enables one to maintain long-term oriented, clear thinking, and to focus on new opportunities while others are distracted or even forced to sell. Portfolio hedges must be in place before a crisis hits. One cannot reliably or affordably increase or replace hedges that are rolling off during a financial crisis.
Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty – such as in the fall of 2008 – drives securities prices to especially low levels, they often become less risky investments.
Do not trust financial market risk models. Reality is always too complex to be accurately modeled. Attention to risk must be a 24/7/365 obsession, with people – not computers – assessing and reassessing the risk environment in real time. Despite the predilection of some analysts to model the financial markets using sophisticated mathematics, the markets are governed by behavioral science, not physical science.
Do not accept principal risk while investing short-term cash: the greedy effort to earn a few extra basis points of yield inevitably leads to the incurrence of greater risk, which increases the likelihood of losses and severe illiquidity at precisely the moment when cash is needed to cover expenses, to meet commitments, or to make compelling long-term investments.
The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of "private market value" as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.
A broad and flexible investment approach is essential during a crisis. Opportunities can be vast, ephemeral, and dispersed through various sectors and markets. Rigid silos can be an enormous disadvantage at such times.
You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.
Financial innovation can be highly dangerous, though almost no one will tell you this. New financial products are typically created for sunny days and are almost never stress-tested for stormy weather. Securitization is an area that almost perfectly fits this description; markets for securitized assets such as subprime mortgages completely collapsed in 2008 and have not fully recovered. Ironically, the government is eager to restore the securitization markets back to their pre-collapse stature.
Ratings agencies are highly conflicted, unimaginative dupes. They are blissfully unaware of adverse selection and moral hazard. Investors should never trust them.
Be sure that you are well compensated for illiquidity – especially illiquidity without control – because it can create particularly high opportunity costs.
At equal returns, public investments are generally superior to private investments not only because they are more liquid but also because amidst distress, public markets are more likely than private ones to offer attractive opportunities to average down.
Beware leverage in all its forms. Borrowers – individual, corporate, or government – should always match fund their liabilities against the duration of their assets. Borrowers must always remember that capital markets can be extremely fickle, and that it is never safe to assume a maturing loan can be rolled over. Even if you are unleveraged, the leverage employed by others can drive dramatic price and valuation swings; sudden unavailability of leverage in the economy may trigger an economic downturn.
Many LBOs are man-made disasters. When the price paid is excessive, the equity portion of an LBO is really an out-of-the-money call option. Many fiduciaries placed large amounts of the capital under their stewardship into such options in 2006 and 2007.
Financial stocks are particularly risky. Banking, in particular, is a highly lever- aged, extremely competitive, and challenging business. A major European bank recently announced the goal of achieving a 20% return on equity (ROE) within several years. Unfortunately, ROE is highly dependent on absolute yields, yield spreads, maintaining adequate loan loss reserves, and the amount of leverage used. What is the bank's management to do if it cannot readily get to 20%? Leverage up? Hold riskier assets? Ignore the risk of loss? In some ways, for a major financial institution even to have a ROE goal is to court disaster.
Having clients with a long-term orientation is crucial. Nothing else is as important to the success of an investment firm.
When a government official says a problem has been "contained," pay no attention.
The government – the ultimate short- term-oriented player – cannot withstand much pain in the economy or the financial markets. Bailouts and rescues are likely to occur, though not with sufficient predictability for investors to comfortably take advantage. The government will take enormous risks in such interventions, especially if the expenses can be conveniently deferred to the future. Some of the price-tag is in the form of back- stops and guarantees, whose cost is almost impossible to determine.
Almost no one will accept responsibility for his or her role in precipitating a crisis: not leveraged speculators, not willfully blind leaders of financial institutions, and certainly not regulators, government officials, ratings agencies or politicians.

Below, we itemize some of the quite different lessons investors seem to have learned as of late 2009 – false lessons, we believe. To not only learn but also effectively implement investment lessons requires a disciplined, often contrary, and long-term-oriented investment approach. It requires a resolute focus on risk aversion rather than maximizing immediate returns, as well as an understanding of history, a sense of financial market cycles, and, at times, extraordinary patience.

False Lessons

There are no long-term lessons – ever.
Bad things happen, but really bad things do not. Do buy the dips, especially the lowest quality securities when they come under pressure, because declines will quickly be reversed.
There is no amount of bad news that the markets cannot see past.
If you've just stared into the abyss, quickly forget it: the lessons of history can only hold you back.
Excess capacity in people, machines, or property will be quickly absorbed.
Markets need not be in sync with one another. Simultaneously, the bond market can be priced for sustained tough times, the equity market for a strong recovery, and gold for high inflation. Such an apparent disconnect is indefinitely sustainable.
In a crisis, stocks of financial companies are great investments, because the tide is bound to turn. Massive losses on bad loans and soured investments are irrelevant to value; improving trends and future prospects are what matter, regardless of whether profits will have to be used to cover loan losses and equity shortfalls for years to come.
The government can reasonably rely on debt ratings when it forms programs to lend money to buyers of otherwise unattractive debt instruments.
The government can indefinitely control both short-term and long-term interest rates.
The government can always rescue the markets or interfere with contract law whenever it deems convenient with little or no apparent cost. (Investors believe this now and, worse still, the government believes it as well. We are probably doomed to a lasting legacy of government tampering with financial markets and the economy, which is likely to create the mother of all moral hazards. The government is blissfully unaware of the wisdom of Friedrich Hayek: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.")