David Stockman Exposes The Stock Market's $67 Trillion Nightmare

This is getting pretty ridiculous. For old times sake, we recently checked on the Federal debt level during the month we arrived in the Imperial City as a 24-year old eager beaver. That was June 1970 and the Federal debt held by the public was $275 billion.

Mind you, while that number wasn't exactly diminutive, it had taken all of 188 years to accumulate. That is to say, Uncle Sam had borrowed an average of $28,000 per week during the 9,776 weeks since George Washington was sworn in as the nation's first president.

We are ruminating about this seeming historical obscuranta because it just so happens that the US treasury this very week will be selling $258 billion of government debt.

That's right. Uncle Sam's scheduled debt emission this week will nearly equal his cumulative borrowing during the nation's first 188 years and its first 37 presidents!

And, yes, there has been some considerable inflation since June 1970. And not the least because exactly 13 months later Tricky Dick Nixon decided to pull the plug on Bretton Woods and the dollar's anchor to a fixed weight of gold.

Needless to say, the financial discipline of gold-backed money during that interval of guns and butter excess would most certainly have triggered a recession and a heap of inconvenience for Nixon's 1972 reelection prospects. As it happened, the American economy got a heap of inflation and destructive financialization over the next half century, instead.

Accordingly, the price level today is 5X higher as measured by the GDP deflator. So in today's dollars of purchasing power, the 1970 debt figure would be about $1.2 trillion.

This is by way of explaining that it hasn't been for nothing that we have labeled the Donald as the King of Debt and the Congressional Republicans as fiscal Benedict Arnolds. Their now enacted budget plan----which they have the gall to crow about from one end of the country to the other----is to borrow as much money in apples-to-apples dollars during the year ahead (FY 2019) as did the first 37 presidents of the United States!

Accordingly, Keynesians, beltway politicians of both parties and Wall Street punters, alike, know this: The US has a monumental debt problem, and it is most definitely not "priced-in".

So our purpose in this two-part series is to explain how it came to be not priced-in, and why that anomalous state of affairs is coming hard upon its sell-by date.

To be clear, we are not talking about just the $21 trillion of public debt that will be on the books after this week's borrowing binge, but the entire $67 trillion albatross of public and private debt that now strangles the US economy.

We refer to the latter as the lamentable outcome of the rolling national LBO that the US economy has undergone since June 1970.

The fact is, the $1.5 trillion of total public and private debt outstanding back then amounted to 150% of GDP. And that implicit 1.5X  national leverage ratio had essentially remained unchanged for the prior 100 years of robust economic growth and 25-fold rise in real income per capita.

By contrast, at $67 trillion of total debt today, the US leverage ratio stands at nearly 3.5X, and therein lies the giant financial skunk in the woodpile. Had the historically proven leverage ratio of 1.5X national income not been upended by Tricky Dick's perfidy, there would be $30 trillion of total debt on the US economy today, not $67 trillion.

So those two-extra turns of leverage amount to $37 trillion-----an economic millstone that is grinding capitalist growth steadily lower, and which has now put the main street and Wall Street economy alike in harm's way.

That's because the massive growth of central bank credit unleashed by the Camp David folly of 1971 has finally reached its limit---even by the lights of our overtly Keynesian central bankers. So they are now embarking upon an epochal balance sheet reversal that will drastically alter the fundamental dynamics of the financial system, and expose the vast falsification of financial asset values that are actually "priced-in" to today's Wall Street house of cards.

Indeed, it was today's Keynesian mind-frame that caused Nixon to jettison gold in the first place: He was advised by what we have called the "freshwater Keynesians" around Milton Friedman, who were every bit as statist on the matter of money and macro-economic management from Washington as were their "saltwater" compatriots in Cambridge, MA. They merely differed on technique as between monetary versus fiscal policy tools.

Alas, when practiced over a long enough time frame, however, Keynesians---and the politicians and apparatchiks who find it convenient to embrace their fatally flawed model---literally loose their minds. That is, insofar as historical memory is concerned.

Stated differently, they become incurably infected with "recency bias", and so doing end-up absolutely blind to the unsustainable errors and anomalies on which they whole debt-fueled scheme is predicted.

For instance, had your editor also checked in at the Eccles Building during his taxi ride from national airport to his new digs on Capitol Hill in June 1970, he would also have found that the Fed's balance sheet stood at a mere $55 billion. And that was after 56 years in the money printing business.

What happened during the next 48 years, of course, was nothing less than a monetary eruption----the very thing that Nixon's Camp David folly enabled. To wit, the Fed's balance sheet exploded by 82X or by nearly 10% per annum over the course of a half century.

It goes without saying that you could not have found one economist (or even layman) in Washington, Cambridge or Chicago in June 1970 who would have recommended or even imagined an 82X explosion of the central banks balance sheet during the next 50 years. Even the reining monetary populist and crackpot of the day, Congressman Wright Patman of Texas and Chairman of the House banking and currency committee, would have never countenanced such a thing.

The rest is history, of course, and it couldn't have been imagined, either.That is, the 82Xexplosion of central bank credit gave rise to the freakish chart below.

To wit, in June 1970 the GDP was $1.1 trillion and it has since expanded by 18X to $19.6 trillion. By contrast, total public and private debt outstanding was $1.58 trillion and has since expanded by 42X to $67 trillion.

Needless to say, to grow these unsustainably divergent trends for even another decade would lead to an outright absurdity. To wit, $35 trillion of nominal GDP and $150 trillion of total debt.

In fact, the ridiculousness of it perhaps explains why the Fed stopped publishing the total credit market debt figure in its quarterly "Flow of Funds" report in Q4 2015 when the number stood at $63.5 trillion. But the components are still there and they do add to $67 trillion.

Needless to say, this chart makes all the difference in the world for the impending era of interest rate normalization and quantitative tightening (QT). It is one thing to permit interest rates to rise by 200-300 basis points in a context when the economy is carrying $30 trillion of debt; it's an altogether different kettle of fish, of course, when the burden is $67 trillion.

In short, recency bias is going to prove to be the Achilles heel of the now ending era of Bubble Finance. The US economy has been borrowing and printing money so long that its position on the economic and financial map has been lost sight of---meaning that the impact of the coming epochal reversal at the central bank is not even remotely appreciated.

Take the matter of the Fed's balance sheet. Even had the US followed Milton Friedman's fixed money growth rule at approximately 3% per annum, the Fed's $55 billion balance sheet of June 1970 would stand at just $230 billion today.

Do we think that $4.2 trillion of extra central bank credit has changed everything?

Yes, we do---as we will amplify in Part 2.

In the interim, however, here is the singular chart that should scare the bejesus out of casino gamblers who remain drunk on the trading charts embedded in robo-machines and the fancy bespoke trades peddled by Wall Street brokers.

Up to $2 trillion of central bank balance sheet shrinkage has never happened before. Nor has the impact been any more imagined at present than had been the 82X explosion of the Fed's balance sheet back in June 1970.

DEFAULT IS INEVITABLE

 "Debt levels have reached a point where they have to be defaulted upon,"

The rate of the 10-year Treasury is at a four year high nearing three percent. Pento forecasts it will rise to four percent, which will be a "floor rather than a ceiling." If the rate rises to four percent, people will have lost about 25 percent from a "risk free" asset since July 2016.

The top is in for the stock market, Pento says. As rates continue to rise, look out for a bankruptcies, layoffs, and a stock crash.

Credit Markets Are Flashing Red

Despite rebounds in US (and less so European) equities and drops in both regions' 'VIX' measures, the last few days have seen an ominous reawakening in credit markets that is far more systemically concerning than a volatility ETN...

European credit spreads are back near cycle wides...

And US HY spreads are pushing back towards last week's wides...

And it's not just HY credit, US investment grade credit spreads are starting to crack wider...

Fund outflows in HY and IG resumed their 2018 trend yesterday...

And credit remains notably decoupled from stocks...

As rate- and credit-vol remain notably elevated...

Chinese Takeover Of Anbang Symptomatic of Larger Deleveraging, Fraud Crackdown

The fallout from the Anbang takeover comes at a time when Chinese conglomerates, many of whom when on a purchasing spree by leveraging their balance sheet beyond practical norms, are now being forced to sell their trophy properties. While the unwind is orderly, it shouldn't come as a surprise — particularly as Chinese regulators had signaled the move previously, a Morgan Stanley report observed in July 2017.

A July 2017 Morgan Stanley report, "Why China's Capital Controls Matter to Global Property Markets, discussed China's deleveraging their vast real estate holdings at the behest of regulators long before headlines were made.

Pointing to tighter regulation that was putting breaks on runaway leverage usage, it noted China's overseas direct property investment (ODI) fell 82% in in the first half of 2017 alone.

The report came in the wake of a massive spending spree by Chinese buyers such as Anbang, HNA and the Dalian Wanda Group going on a spending spree without precedent.

Anbang's $1.95 billion purchase of the Waldorf Astoria in 2014, shelling out nearly $1.4 million per room – a then unheard of level – raised eyebrows of those who didn't see a sustainable revenue model. Likewise, Anbang's $6.5 billion purchase of the Strategic Resorts Group in 2016, which included New York's Essex Hotel, the Hotel Del Coronado in San Diego and the Four Seasons hotel in Washington DC, was an eyebrow raiser.

Now these deals are unwinding at a slightly faster pace, but not at "fire sale" pace as of yet.

Anbang is expected to put the Waldorf Astoria on the market, which has fallen since the initial takeover. This, coupled with the fact they overpaid in 2014, is likely to result in a meaningful loss.

China's HNA was reported earlier this month trying to sell off their real estate assets, which were the easiest to unwind as the ownership is relatively straightforward. On the market, according to a Bloomberg report, is 245 Park Avenue, which HNA paid $2.21 billion for in 2017, one of the highest prices paid for office space. The firm also sold a $90 million Manhattan mansion on the Upper East Side after holding it for less than a year.

In addition to New York, the company is looking to unload nearly $4 billion on holdings in Chicago, San Francisco and Minneapolis.

Dalian Wanda Group is unwinding its investment in Chicago's Vista hotel and condominium complex after pledging support for the project a year earlier.

In the US, China is the second-largest foreign investor and made up fully 30% of all Manhattan transactions year to date, Morgan Stanley noted in July 2017. In the UK, the Chinese accounted for 25% of Central London commercial property acquisitions in 2016, a situation Morgan Stanley was then "closely monitoring."

The top four commercial markets for Chinese investment, according to the report, where New York, San Francisco, Chicago and Los Angeles, with Vancouver, a city in the throes of what is categorized as a property "bubble," receiving a significant investment from Chinese individuals. Demand in the Canadian city was reported as "sluggish" even in 2017, a time when the Chinese government was tightening the reigns of foreign capital flight.

In July, Morgan Stanley saw the writing on the wall:

Capital controls have already curtailed Chinese investment in real estate overseas. Over the past several years, Renminbi depreciation fears and lower domestic returns have spurred Chinese CRE investments, particularly in the US, Hong Kong, Australia, and the UK. Late last year, policymakers announced measures to curb "irrational" overseas investment in the "negative list," which includes real estate, hotels, cinema, media, sports clubs, and non-core businesses. Our China property analyst reports that property developers are now struggling to transfer capital offshore and that regulators are tightening offshore financing.

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You know the deleveraging, and anti-corruption crackdown in China is getting serious when highly connected politicos such as Wu Xiaohui, founder of Anbang Insurance Group Co., is prosecuted for "economic crimes." In what the BBC categorizes as "an unusual move," the financial services company was taken over by the government. The highly leveraged firm is a mirror of the problems Chinese leaders face when de-leveraging and cleaning up the nation's financial sector, and addressing it has been a priority recently.

mohamed1982eg / Pixabay

Anbang's leveraged $1.95 billion purchase of New York's landmark Waldorf Astoria hotel turned heads as much as a failed $14 billion bid for the Starwood hotel chain and selling questionable investments products. But when the tide went out, and Chinese President Xi Jinping and his anti-corruption and de-leveraging looked at Anbang, they decided to take over "one of China's richest and most opaque conglomerates" and address problems before they spilled out into public view and the economy.

China's economy had been on a similar path to that of Anbang, with government leverage, measured by debt to GDP, significantly moving higher.

Along with this came significant debt and borrowing by Chinese corporates, many of whom thought they had the implicit backing of the government if their business failed. The decision to shut down Anbang was made after illegal activities at the insurer were considered to be endangering its solvency.

Friday's move shows that the government is serious about reining in potential fraud and excessive leverage that cannot be supported by fundamentals, even if it means challenging "one of the most politically-connected men in China."

Wu married the grand-daughter of former leader Deng Xiaoping and started a car insurance company with state-owned backing, leveraging the firm's balance sheet to purchase an international portfolio of properties and corporations. The ownership of the private company is not known nor are its actual liabilities relative to income.

"The motivation in Anbang's case probably is not just about delivering a warning shot, however, but probably some also real concerns that the company was heading for insolvency and the impact this would have on retail investors that purchased products from the company," Tom Rafferty of the Economist Intelligence Unit told the BBC.

The message is two-fold: Chinese corporates need to address their balance sheet and are responsible for financial products they create that may damage the economy as a whole.

"Given the determination exhibited by Beijing, and the public example of Wu Xiaohui's cinematic implosion, China's 'crocodiles' will undoubtedly redouble their efforts to address their balance sheets," Brock Silvers, managing director at Kaiyuan Capital, a Shanghai-based multi-asset advisory firm, told Bloomberg.

Chinese authorities first detained Wu in June but charged him today, just ahead of the ruling Communist Party holding behind closed door meetings to discuss government restructuring and personnel appointments.

The government takeover of the private firm is expected to last one year and involve in an unwind of certain assets with strategic shareholders expected to inject capital. After the unwind, which could take more than a year, the firm is expected to remain a private enterprise.

The market reaction was positive to the news because "there is not going to be a fire sale anymore," Bloomberg Intelligence's Danian Sassower said Friday morning on Bloomberg TV.

It isn't just a positive for those financial services shares that operate in Anbang's space, but "this is credit positive for China," Sassower said, noting credit default SWAPS, a measure of Chinese risk, had been down 60%.

Fed Sounds The Alarm On Overvalued Stocks, Hedge Fund Leverage, "Cov Lite", And Junk

In November, when combing through the hedge fund Q3 13Fs, Goldman Sachs cautioned that even as smart money turnover had tumbled to all time lows, net hedge fund leverage - both net and gross - had hit all time highs.

Today, in its latest quarterly "hedge fund tracker" this time for Q4 Goldman doubled down (we will have more on the full report shortly), and made the same observation:

LEVERAGE: Hedge funds entered 2018 with near-record leverage and maintained risk despite the correction. Funds added nearly $20 billion of net exposure in two index ETFs alone (SPY and IWM) as ETF exposure rose to 3% of long portfolios. Although the S&P 500 suffered its first 10% decline in two years, funds maintained conviction in their positions. Portfolio turnover rose slightly but remained near recent record lows at 28%.

David Kostin then notes that while "net leverage dropped briefly during the correction", Goldman's Prime Services attribute the decline to mark-to-market dynamics in options positions, in other words hedge funds were not actively deleveraging, something Kostin confirms, stating that "both gross and net exposures currently remain close to recent highs."

We bring this up because in a section in the just released Monetary Policy Report, entirely dedicated to "financial stability", the Fed makes an explicit warning about precisely this: "there are signs that nonbank financial leverage has been increasing in some areas—for example, in the provision of margin credit to equity investors such as hedge funds." The Fed continues:

... there is some evidence that dealers have eased price terms to hedge funds and real estate investment trusts, and that hedge funds have gradually increased their use of leverage, in particular margin credit for equity trades.... such easing of price terms has taken place against the backdrop of building valuation pressures.

And speaking of building valuation pressures, this time the Fed does not mince its words, and makes a clear warning just how overvalued risk assets have become:

Over the second half of 2017, valuation pressures edged up from already elevated levels.

Visually, the Fed's lament is shown below:

What is just as surprising is the Fed's admission that equities are overvalued even if look at just relative to Treasury yields, i.e. the "Fed model":

In general, valuations are higher than would be expected based solely on the current level of longer-term Treasury yields. In part reflecting growing anticipation of the boost to future (after-tax) earnings from a corporate tax rate cut, price-to-earnings ratios for U.S. stocks rose through January and were close to their highest levels outside of the late 1990s; ratios dropped back somewhat in early February.

Another way of stating this: US stocks no longer yield more than treasuries.

Then there was the now traditional CRE warning:

In a sign of increasing valuation pressures in commercial real estate markets, net operating income relative to property values (referred to as capitalization rates) have been declining relative to Treasury yields of comparable maturity for multifamily and industrial properties. While these spreads narrowed further from already low levels, they are wider than in 2007.

In its litany of warnings, the Fed did not spare corporate credit, and especially focused on junk bonds:

In corporate credit markets, spreads of corporate bond yields over those of Treasury securities with comparable maturities fell, and the high-yield spread is now near the bottom of its historical distribution.

For the first time, the Federal Reserve even took aim at covenant lite loan and CLO deals:

Spreads on leveraged loans and collateralized loan obligations—which are a significant funding source for the corporate sector—stayed compressed. In addition, nonprice terms eased on these types of loans, indicating weaker investor protection than at the peak of the previous credit cycle in 2007.

And in the most bizarre admission, the Fed said that risk appetite is so elevated - thanks to the Fed of course - it helped unleash the cryptocurrency bubble.

Consistent with elevated risk appetite, virtual currencies experienced sharp price increases in 2017

Looking forward, the Fed warned that rising rates could result in a serious hit to bank P&Ls:

If interest rates were to increase unexpectedly, banks' strong capital position should help absorb the consequent losses on securities. About one-third of the losses that could be experienced by banks would affect held-to-maturity securities. While these losses would not reduce regulatory capital, they could still have a variety of negative consequences—for example, by worsening banks' funding terms. The large share of deposits in bank liabilities is also likely to soften the effect of an unexpected rise in interest rates on banks.

Depositors, you have been officially warned: you are first on the hook when banks start suffering trillions in paper losses to the tune of $1.2 trillion for ever 100 bps...

The End of (Artificial) Stability

The central banks'/states' power to maintain a permanent bull market in stocks and bonds is eroding.

There is nothing natural about the stability of the past 9 years. The bullish trends in risk assets are artificial constructs of central bank/state policies. As these policies are reduced or lose their effectiveness, the era of artificial stability is coming to a close.

The 9-year run of Bull-trend stability is ending as a result of a confluence of macro dynamics:

1. Central banks are under pressure to reduce, end or reverse their unprecedented monetary stimulus, and the consequences are unpredictable, given the market's reliance on the certainty that "central banks have our back" is ending.

2. Interest rates / bond yields may well plummet in a global recession, but if we look at a 50-year chart of interest rates, we see a saucer-shaped bottoming in play. Technician Louise Yamada has been discussing the tendency of interest rates/bond yields to trace out a multi-year saucer bottom for over a decade, and we can now discern this.

Even if yields plummet in a recession, as many analysts predict, this doesn't necessarily negate the longer term trend of higher yields and rates.

3. The global economy is overdue for a business-cycle recession, which is characterized by a retrenchment of credit and the default of marginal debt. The "recovery" is the weakest recovery in the past 60 years, and now it's the longest expansion.

4. The mainstream financial media is telling us that everything is going great in the global economy, but this sort of complacent (or even euphoric) "it's all good news" typically marks the top of stocks, just as universal negativity marks secular lows.

5. What happens to markets characterized by uncertainty? Once certainty is replaced by uncertainty, markets become fragile and thus exposed to sudden shifts of sentiment. This destabilization is expressed as volatility, but it's far deeper than volatility as measured by VIX or sentiment indicators.

Market participants have become accustomed to an implicit entitlement:

that investors / speculators will earn consistently positive returns on their capital, as central banks and governments have both the power and the mandate to "save" participants from losses and generate phantom wealth ("gains").

This entitlement is ending, as the central banks'/states' power to maintain a permanent bull market in stocks and bonds is eroding, and I suspect few participants have a strategy for a permanently riskier environment going forward.

How much will risk assets have to decline for "wealth" to return to the production of real-world wealth in the real-world economy? Clearly, the answer is "a lot."

China Shuts Down Its VIX To Halt Market Turbulence

While most of the world saw regional equity markets covered in red overnight, China's Shanghai Composite rebounded, rising 2.2% for two reasons: i) a delayed reaction to global equity prices after the country's 5-day Lunar New Year holiday and ii) China's latest crackdown on anything that can precipitate a selloff, like a high VIX for example.

And so, just like on August 24, 2015 when the US market crashed so hard in the pre-market, the VIX briefly "went offline" as input signals went haywire, China also decided to stop updating its local version of the VIX Index, taking its latest step to discourage speculation in equity-linked options after authorities tightened trading restrictions last week.

As Bloomberg first reported, China's state-run Securities Index Co. didn't publish a value for the SSE 50 ETF Volatility Index on its website Thursday. An employee who answered a Bloomberg phone call said the company stopped updating the measure to work on an upgrade, however according to "people familiar", the move was designed to curb activity in the options market. 

It's unclear when the index will resume.

Just like the US VIX, the SSE 50 volatility index is the most widely-followed indicator of Chinese investor anxiety. Which is a problem because also just like the VIX, the index doubled in the span of a few days earlier this month. And the last thing Beijing wants is nervous investors thinking that other investors are nervous... and selling in a blind panic. 

So what to do? Why shut it down of course, just like all global equity markets will be shut down once the real selling begins.

According to Bloomberg, the decision to stop publishing the index forms part of a broad effort by Chinese officials to contain market turbulence. 

Other measures this month have included volume limits on active options traders and informal directives encouraging some major stockholders to purchase more shares. Chinese leaders have in the past faced criticism for meddling too much in markets, particularly during the nation's 2015 equity crash.

The VIX blackout follows tighter curbs on options traders unveiled from Feb. 12, people familiar with the matter said last week, in part because they were alarmed by a gain of as much as 2,250 percent in the price of one bearish contract on the SSE 50 ETF (also known as the China 50 ETF). The fund is China's only equity-linked product with options.

Demonstrating surprising wisdom, unlike the U.S., China has avoided approving derivatives and funds tied to its volatility gauge. And while it won't have its own homegrown XIV collapse, China has more than enough potential candidates that will unleash the next crisis: just last night we reported that while China may not have inverse VIX ETFs, it has another, far more serious problem - pervasive stock loans, hundreds of which have seen margin calls in recent days, forcing dozens of companies to simply halt trading.

In fact, a pattern is emerging in China: any time there is a problem with any one asset, or any one indicator... why, just turn it off.

For now these "solutions" are working: volume in the SSE 50 ETF options was about 40% lower than the 20-day average on Thursday, according to data compiled by Bloomberg. What traders are more interested in is what happens when the volume hits 0% and nobody trades anymore, and - tied to that - what happens when China's creeping admission that its capital markets are broken finally seeps through.

Who Will Buy Trillions Of US Treasuries???

As of the latest Treasury update showing federal debt as of Wednesday, February 15...federal debt (red line below) jumped by an additional $50 billion from the previous day to $20.76 trillion. This is an increase of $266 billion essentially since the most recent debt ceiling passage. Of course, this isn't helping the debt to GDP ratio (blue line below) at 105%.

But here's the problem. In order for the American economy to register growth, as measured by GDP (the annual change in total value of all goods produced and services provided in the US), that growth is now based solely upon the growth in federal debt. Without the federal deficit spending, the economy would be shrinking.

The chart below shows the annual change in GDP minus the annual federal deficit incurred. Since 2008, the annual deficit spending has been far greater than the economic activity that deficit spending has produced. The net difference is shown below from 1950 through 2017...plus estimated through 2025 based on 2.5% average annual GDP growth and $1.2 trillion annual deficits. It is not a pretty picture and it isn't getting better.

Even if we assume an average of 3.5% GDP growth (that the US will not have a recession(s) over a 15 year period) and "only" $1 trillion annual deficits from 2018 through 2025, the US still continues to move backward indefinitely.

The cumulative impact of all those deficits is shown in the chart below. Federal debt (red line) is at $20.8 trillion and the annual interest expense on that debt (blue line) is jumping, now over a half trillion. Also shown in the chart is the likely debt creation through 2025 and interest expense assuming a very modest 4% blended rate on all that debt.

So, for America to appear as if it is moving forward, it has to go backward into greater debt?!? If you weren't troubled so far, here is where the stuff starts to hit the fan.

With the change to the Unified budget, effective as of 1969, the Social Security surplus was "unified" into the federal budget. The government gave themselves a ready buyer for US debt while simultaneously allowing the SS surplus to be spent in "the present". Congressionally mandated to buy US debt, from 1970 to 2008, the Intra-Governmental Holdings (over half from the Social Security surplus) purchased over 45% of all federal debt issued. This meant "only" 55% of US debt was auctioned into the market, or "marketable debt".

But the annual SS surplus has declined by 90% (from over $200 billion a year at the peak in 2007 to perhaps $20 billion this year) and, according to the SS trust fund, the last surplus will be recorded in 2020 or 2021. After that (or essentially now), the Congressionally mandated buyer (which consumed almost half of all US federal debt for 4 decades) will cease. Not only will the IG Holdings no longer be a buyer, they will need additional debt created to make good on those $2.9 trillion in SS "reserves"...and all the debt issued will be "marketable".

The chart below shows the "marketable" debt vs. IG Holdings from 1970 through 2025. As noted above, IG consumed nearly half of all US debt up to 2008...but since '08, IG has consumed just over 10% of all the new issuance and nearly 90% of new debt been auctioned into the market. IG has essentially ceased to be a buyer...meaning that marketable debt will continue to soar.

So who is a buyer of US Treasury debt? 

Only three possible groups remaining; "foreigners", the Federal Reserve, and private domestic sources (pensions, banks, mutual funds, individuals).

I will show that foreigners have essentially ceased buying, that the Federal Reserve isn't a buyer and in fact is reducing it's balance sheet...and this means there is only one buyer remaining to soak up the surging marketable debt.

But before I detail these...I want you to remember Harry Markopolos. Markopolos is a financial investigator and he gave clear evidence of Bernie Madoff's Ponzi to the SEC as early as 2000, again in 2001, and again in 2005. The SEC did not see what they didn't want to see and it wasn't until the great financial crisis of '08 that Madoff's fraud was exposed and the loss of approximately $65 billion realized (below, from Wikipedia).

When Markopolos obtained a copy of Madoff's revenue stream, he spotted problems right away. Madoff's strategy was so poorly designed that Markopolos didn't see how it could make money. The biggest red flag, however, was that the return stream rose steadily with only a few downticks—represented graphically by a nearly perfect 45-degree angle. According to Markopolos, anyone who understood the underlying math of the markets would have known they were too volatile even in the best conditions for this to be possible.

As he later put it, a return stream like the one Madoff claimed to generate "simply doesn't exist in finance." He eventually concluded that there was no legal way for Madoff to deliver his purported returns using the strategies he claimed to use.

As he saw it, there were only two ways to explain the figures—either Madoff was running a Ponzi scheme (by paying established clients with newer clients' money) or front running (buying stock for his own account, based on knowledge about his clients' orders).

With that in mind and the largest single buyer (IG) now a seller, let's look at the remaining "buyers" and consider the nearly $21 trillion US Treasury market:

BUYERS -

Federal Reserve...presently allowing Treasury bonds and MBS (mortgage backed securities) to mature, reducing it's balance sheet on a monthly basis. The Fed plans to roughly halve its balance sheet from $4.5 to $2.2 trillion between now and 2022 (a $250 billion annual reduction in Treasury holdings). That is a net increase of available Treasury debt of $250 billion annually above and beyond the trillion plus in new issuance and trillions being rolled over every year.

Foreigners...foreigners presently hold $6.3 trillion in US Treasury debt but since QE ended in late 2014, foreigners have essentially gone on strike, adding just $150 billion in a little over three years (chart below).

Foreigners added an average: 

'00-->'07 +$160 billion annually 

'08-->'14 +$540 billion annually 

'15-->'18 +$50 billion annually 

The current pace of foreign Treasury buying is less than 1/3 the pace of the early '00's and a 90% reduction from the pace of '08 through '14, when QE was in effect.

Just three buyers hold over half (55%) of all debt held by foreigners; China, Japan, and what I call the BLICS (Belgium, Luxembourg, Ireland, Cayman Island, Switzerland). The chart below shows each nations/groups US Treasury holdings from '00 through December of '17. Entirely noteworthy: 

China '00-->'11 +$1.2 trillion...but China has been a net seller of Treasury's since the July of 2011 debt ceiling debate 

Japan '00-->'11 +$600 billion...Japan's holdings did rise after the July 2011 debate but are fast declining now toward the same quantity it held in July of 2011 

BLICS '00-->'11 +$300 billion...It has been the $800 billion surge in BLICS buying since July 2011 that has kept foreign demand alive. 

As for the BLICS, their buying patterns since '07 have grown increasingly bizarre, as if profit isn't their motive? However, if maintaining a bid for US debt is the motive, the massive surges in buying at the worst of times makes sense.

So, I've shown US federal debt is surging but the only thing keeping the US economy "growing" is the size of the deficit and debt incurred. I've shown the traditional sources of net Treasury buying have ceased except for the domestic public. That the Intra-Governmental holdings are essentially peaking and will be a net seller within a couple years and all new debt issued will be "marketable". I've shown the Federal Reserve plans to "roll off" approximately $250 billion a year for up to four years. I've shown that China ceased net buying Treasury debt in 2011 and foreigners have essentially gone on strike since QE ended. The only real foreign bid remaining is from some pretty shady demand that looks an awful lot like it could be central bank buying, but regardless the BLICS, foreign demand for Treasury's (on a net basis) has essentially stopped.

This leaves the domestic public to purchase all the surging new issuance, plus the portion the Fed (and soon enough, the IG) is rolling off, and with little to no assistance from foreigners (even the possibility the strike turns into an outright selloff!?!). The domestic public currently holds about $6 trillion in Treasury debt and will need to buy in excess of $1.5 trillion annually (indefinitely) between picking up the roll off and the new issuance. If the public "willingly" do this at low interest rates, it will represent 7.5% of GDP going toward Treasury purchases that yield well below needed returns. If the Public don't do this "willingly", interest rates will soar far more than shown above and the US will be overwhelmed by debt service. The only other option is that the Federal Reserve makes a U-turn to re-start QE and openly engage in endless monetization.

Why China’s Return May Be Last Straw for Global Rebound

China's Return May Be Last Straw for Global Rebound

China will return from the Lunar New Year holiday to reinforce the gloom that's seeping through global equities. The five-day break came with global equities scrambling to rebound from the collapse of early February. That bounce has looked fragile.

Bulls need the world's second-biggest market to come roaring back refreshed but such a positive outcome looks unlikely.

China is key because it's the only major market that hasn't yet seriously bought into the fantastical stock rallies that got going once the ashes of Brexit had settled.

Over the past 1 1/2 years, record highs were set for all three major U.S. indexes, along with the benchmarks for Canada, Hong Kong, South Korea, India, the U.K., Germany and Switzerland. Stocks in Japan and Taiwan hit the highest since the early 1990s. Australia's benchmark index reached a decade-high, as did France's.

China was the only $1 trillion-plus national stock market missing out on the party -- the Shanghai Composite only reached a two-year peak and its 6.6% advance in 2017 was in the bottom third of performances among 96 primary indexes tracked by Bloomberg.

This matters because the narrative drummed into everyone's consciousness during the most-recent leg of the global rally was that a synchronized pickup in growth was the reason to relentlessly bid up stocks and sell down volatility.

The underperformance of China -- the world's biggest exporter and the largest market of consumers -- casts doubt over that optimistic story.

Through the start of 2018, it looked as if the country's shares were playing catch-up to validate the global meltup, only to start dropping well before the Feb. 2 U.S. wages print supposedly let the inflation genie out of the bottle. Looking forward, there are even fewer reasons for optimism: the lack of obvious organic Chinese drivers means any rallies can be viewed as merely aping global trends, making them just as vulnerable as last time.

China's Communist Party made it clear that it's determined to shift to a more stable, steady growth profile; a direct contradiction of the frenzied global stock rally that was pricing in perfect outcomes and was turbo- charged by the short-term sugar hit of deficit-fueled U.S. tax cuts.

The deleveraging that's central to China's plans has to entail a slower growth profile. It's also delivered the highest nominal 10-year yields since 2014 and brought real yields close to the highest since 2009. All three of those factors undermine the case for strong equity gains from here.

Fed President Sounds Panic Over Level Of US Debt

Nearly a decade after the US unleashed its biggest debt-issuance binge in history, doubling the US debt from $10 trillion to $20 trillion under president Obama, which was only made possible thanks to the Fed's monetization of $4 trillion in deficits (and debt issuance), the Fed is starting to get nervous about the (un)sustainability of the US debt.

The Federal Reserve should continue to raise U.S. interest rates this year in response to faster economic growth fueled by recent tax cuts as well as a stronger global economy, Dallas Federal Reserve Bank President Robert Kaplan said on Wednesday.

"I believe the Federal Reserve should be gradually and patiently raising the federal funds rate during 2018," Kaplan said in an essay updating his views on the economic and policy outlook.

"History suggests that if the Fed waits too long to remove accommodation at this stage in the economic cycle, excesses and imbalances begin to build, and the Fed ultimately has to play catch-up." The Fed is widely expected to raise rates three times this year, starting next month.

Kaplan, who does not vote on Fed policy this year but does participate in its regular rate-setting meetings, did not specify his preferred number of rate hikes for this year. But he warned Wednesday that falling behind the curve on rate hikes could make a recession more likely.

Echoing the recent Goldman analysis, which warned that the recently implemented Republican spending plan could lead to an "unsustainable" debt load, Kaplan - who previously worked for Goldman - also had some cautionary words about the Trump administration's recent tax overhaul, which he said would help lift U.S. economic growth to 2.5% to 2.75% this year, pushing the U.S. unemployment rate, now at 4.1% down to 3.6% by the end of 2018, but not for long.

On the all important issue of inflation, he projected it would firm this year on route to the Fed's 2-percent goal.

The most ironic warning, however, came when Kaplan predicted the US fiscal future beyond 2 years: he said that while the corporate tax cuts and other reforms may boost productivity and lift economic potential, most of the stimulative effects will fade in 2019 and 2020, leaving behind an economy with a higher debt burden than before.

"This projected increase in government debt to GDP comes at a point in the economic cycle when it would be preferable to be moderating the rate of debt growth at the government level," Kaplan said.

He was referring, indirectly, to the following chart from Goldman which we showed previously, and which suggests the US will become a banana republic in just a few years.

A higher debt burden will make it less likely the federal government will be able to deliver fiscal stimulus to offset any future economic downturn, he said, and unwinding it could slow economic growth.

"While addressing this issue involves difficult political considerations and policy choices, the U.S. may need to more actively consider policy actions that would moderate the path of projected U.S. government debt growth," he said.

So to summarize: when US debt doubled in the past decade the Fed had no problems, and in fact enabled it. And now, it's time to panic...

Finally, going back to Kaplan's point that fiscal stimulus may no longer work during the next downturn covered by a record mountain of debt (which according to Trump's budget will hit $30 trillion by 2028), we agree, and is why we suggested a few days ago that the next crisis will lead to - what else - even more QE, which also explains why Goldman has been so desperate to get its clients to sell all the Treasurys they have now, as Goldman's prop desk keeps adding to its inventory...

A 58% Wipeout Is "Best Case"!

Two of of the best "tried and tested" ways to rapidly grow your wealth are to:

Use leverage in a rising market and 

Flog equity at ever rising prices (à la Tesla) 

Both methods work, but leverage is not unlike that smoking hot girlfriend you used to have who was, let's admit it, pretty unhinged.

Hanging about too long was always going to get you into trouble — serious, call-the-police-NOW trouble. But the allure was so strong and kept pulling you back. The decision was really tough. Not because it didn't make sense, but because you weren't really thinking with you brain.

Enter the Allure of Ever-Rising Prices (and the Debt That Fuels It)

That debt, like the smoking hot but unhinged girlfriend, may be about to do what it always promised to do — damage!

Australia's household debt-to-income level has reached a spectacular new high, hitting 200% for the first time. Total household debt now stands at an eye-watering record $2.47 trillion... or nearly $100,000 for every man, woman, and child in the lucky country.

Even after debt-free households are factored in, the average Aussie household now owes twice the amount they bring in annually from wages, welfare, and other sources of income.

I get it — Joe Sixpack isn't skilled in managing money. Hell, he's a plumber, or a lawyer, or works in IT, or maybe he makes overpriced lattes for soccer moms. Whatever it is he does, he's not the time to think about (or even know about) the eurodollar market or global capital flows, let alone price to income ratios.

What's more, Joe's got 2 and a half kids, a wife with a shoe fetish, and all these things take up a lot of his time.

What he does know is that he needs somewhere to kip at night and so do his family. So he needs a house. But he figures this is an investment (poor sod) and so he understandably makes it as BIG as he possibly can.

For many folks it's the only time in their life they actually think about making a capital allocation to literally anything other than weekend beer and the odd family holiday to Fiji. And maybe it's a good thing as it is the only asset that may actually leave him with something when the nurse wheels him around with tubes up his nose feeding him mushy peas.

Gasoline on the Fire

Now, the Aussies realised a long time ago that actually the government were and are completely isht at managing pensions, and unless they did something and did it quickly, they were all going to end up like all the other Western economies. Screwed and pretending they have pensions when their own balance sheets make the assertion completely laughable. And so they instituted something called "self-managed super".

This meant that individuals would manage their own superannuation funds where they'd contribute money and towards that the government would assist via multiple ways including tax breaks and various other incentives.

The mechanics don't matter for the purposes of this article. What matters is that over 600,000 self-managed super funds (SMSFs) are now in operation, managing over $7 billion in assets.

So, in that respect the Aussies are waaaay better off than many of their Western counterparts. But just when you thought, hooray for them, they went and doubled down on that one bet they'd already made: Australian housing.

You see, there has been an explosion in SMSF borrowing to buy into the property market amid surging house prices earlier this decade.

How bad?

Well, borrowing by SMSFs has grown from $2.5bn in 2012 to more than $24bn today.

This is like having the crazy girlfriend, marrying her, and then — in what can only be described as a period of deranged insanity — going out and getting a couple (yes, two more) mistresses who make her look positively boring and sane.

Now, if this all sounds crazy, it's because it is.

The sheer odds of something going wrong are right up there with patting your head and rubbing your tummy while trying to defuse a bomb with your teeth. Try it.

An Interesting Number

3.5, that is.

All (yes, all) property bubbles that have exceeded 3.5x GDP have subsequently fallen by at the smallest 58%.

The reasons are as simple as Paris Hilton.

Joey with negative equity is no longer a buyer. The only way this entire squadron of buyers remain buyers is when property prices go up.

When they begin to go down, however, they completely vaporise from the market. Perhaps this is why property prices rarely fall by 15% or even 25% at the end of a spectacular boom. They go down hard.

Some other interesting numbers for you to consider.

35.4% of home loans are interest-only. This figure has already dropped from above 40% following APRA's cap on the amount of new interest-only loans. As one professor at the University of New South Wales recently pointed out:

"Interest-only loans in Australia typically have a five-year horizon and to date have often been refinanced. If this stops then repayments will soar, adding to mortgage stress, delinquencies, and eventually foreclosures,

Even if that is true, we are still left with highly indebted households who have nearly $2 of debt for every $1 of GDP, a raft of interest-only loans that will soon involve principal repayments, and stagnant wage growth."

What to Watch

Given that Sydney property prices have enjoyed their fifth straight month of price declines, clocking in a 3% slide over the last quarter, it's reasonable to ask ourselves the question: Is this it?

What is really interesting to note is that all of this is happening while rates have not yet moved for mortgage holders.

I wrote extensively before about how the Aussie banks are subject to international funding markets, and as such the RBA's power to re-inflate the market when the rates are effectively set in the eurodollar market will work with the power of an asthmatic in Bangladesh blowing at you through a straw.

And then here's what LIBOR looks like (LIBOR being a rough measure of that interbank lending market I wrote about):

Source: http://www.macrotrends.net/1433/historical-libor-rates-chart

To understand how important the eurodollar market is to this whole "fustercluck" of financial puzzlement, feel free to read the free report I wrote on the importance of the eurodollar market.

Failure to Make New Highs

Now, I'm fully aware many of you look at squiggly lines the same way you look at that bloke with his bum cleavage showing, but there looks like a fairly significant head and shoulders formation on ALL of the major Australian banks.

Westpac Banking Corp (orange); ANZ Banking Group (purple); Commonwealth Bank (green)

These are the folks who actually own the vast majority of both residential and commercial housing stock in the country.

People mistakenly think they own their own home even when they have mortgages on the place. Silly, I know, but we, humans can imagine the darnedest things when it suits us.

And one more thing: I — along with every other investor, money manager, hedgie, banker, and of course let's not forget home owner — don't know for sure what comes next. Those who profess they do know are to be trusted in the same way you'd trust gas station sushi or a prostate exam from Captain Hook.

What we do know are only probabilities, how those are priced, and that is, in fact, all we need to know in order to make rational calculated asymmetric investments.