For years, numerous writers and advisers have been predicting that some form of great reckoning was coming. (The Great Reckoning was a book by James Dale Davidson and Lord William Rees-Moog.) The premise is that every credit-led expansion in recorded history has ended in a dramatic "credit crunch" and economic catastrophe.
Others have been saying the same thing for years. They include Marc Faber at Gloom Boom Doom; Bill Bonner at The Daily Reckoning; Robert Prechter at Elliot Wave; Jim Puplava at Financial Sense; Ian Gordon at Long Wave Analyst ; Michael Jenkins at Stock Cycles Forecast; David Tice at Prudent Bear; and Jim Sinclair at JSMineset.
Closer to home, Eric Sprott of Sprott Asset Management is well known for his bearish views. Technical Scoop has over the years been a small added voice. But one thing they all have in common, even with varying levels of alarm and a range of predicted outcomes, is that they are all considered Cassandra's.
It is not easy to talk about gloom and doom, even if it does happen. And some do overstate the case. But whether it is debt, money and the economy or the environment or the political front, the warnings are there and often they are stark. More importantly they are coming true, even if events unfold slowly.
The so-called Greek collapse is merely another step on a long road to destruction. If in 2005 one had predicted that within five years firms such as Lehman Brothers would collapse, or that Bear Stearns and Merrill Lynch would disappear into huge banking institutions, or that Fannie Mae and Freddie Mac would become wards of the state, you would have been labelled as a crazy. Or that the Government of the United States would run trillion-dollar deficits, or that huge financial institutions would be bailed out by the government, or that Goldman Sachs would be investigated for fraud, or that the European Union would be threatened with breakup over a country that accounts for only 2.6% of its GDP—again you would have been labelled as nuts. Yet it all happened.
The warnings were often clear whether it was about a coming financial storm, a great reckoning, a financial catastrophe or another Great Depression. At the core of it was debt. Too much debt, too much leverage, coupled with financial innovation that was supposed to prevent financial collapse but instead contributed to it, and finally a huge miscalculation of the real financial risk.
And then the biggest players were bailed out by the Government with taxpayer funds (although many have paid the funds back) and huge debts were run up to help stave off the collapse (although too much debt was a major cause in the first place). Victims included thousands who lost their homes and their livelihoods and were given little in the way of lifelines.
There were also countless victims of so-called "Ponzi schemes," such as Bernie Madoff or here in Canada, Weizen Tang, as their funds collapsed when the market collapsed in 2008. Hundreds of smaller financial institutions were allowed to fail, as well putting extreme pressure on the Federal Deposit Insurance Corporation (FDIC) which itself had to be bailed out. Thankfully no financial institution failed in Canada. As a result the Canadian Deposit Insurance Corporation (CDIC) is intact and many credited Canada's tougher regulatory environment that prevented the blow ups that occurred in the U.S., Great Britain and even with some European financial institutions.
The executives at the big financial institutions then paid themselves huge bonuses when their institutions quickly returned to profitable levels even as in some instances the shareholders were wiped out (i.e., Lehman Brothers). Many considered this was the ultimate "chutzpah"; and, when the government tried to put in regulations for the institutions that were behind the collapse in the first place, the institutions with allies in the U.S. Congress and Senate fought it.
Lending, the grease of the economy, has largely dried up as consumer credit, loans for mortgages and others have declined. Federal Reserve statistics (Flow of Funds Accounts of the United States) show that household debt in the U.S. peaked in the first quarter of 2008 at $13.85 trillion; by the fourth quarter of 2009 it was $13.54 trillion, a decline of $310 billion.
Today, after the great financial collapse of 2008, there are between ten and fifteen million households in the USA that have negative equity. Record foreclosures were seen in the first quarter of 2010. Smaller banks continue to go under. Numerous pension funds are grossly underfunded, and fund managers are trying to find ways to avoid ever having to top them up, thus jeopardising people's retirement packages. Upwards of 40 U.S. states are technically bankrupt, and a crisis in the U.S. states has the potential to make the crisis in Europe seem trivial. The wars in the Middle East and Near East have cost almost a trillion dollars to date and show no signs of abating, even with over a million people killed in Iraq since the 2003 invasion and the death toll mounting in Afghanistan and Pakistan.
But as long as the stock market is rising, then everyone is supposedly happy. To continue to throw money at each and every problem just to make the stock market rise to give the illusion of prosperity is surely a fool's paradise.
But it is debt, debt and more debt that is the real trap. Even the Congressional Budget Office (CBO) has projected that the size of the U.S. federal debt could increase by nearly 250% over the next decade to nearly $20 trillion. The gross debt of the U.S. currently stands at $12.9 trillion and is estimated at $14.4 trillion by year end. That would be roughly 98% of GDP. This puts the United States in the same league as many third world countries.
According to a study by the Bank for International Settlements (BIS is the central bank for the central banks), when the debt-to-GDP ratio reaches 100% of GDP, GDP growth is reduced by roughly 1%. A massive increase of public debt reduces the ability of the private sector to raise funds for investment. This is the crowding out that is inevitable with running huge deficits. And with the running of such huge debts government's fiscal ability is tied up and the risk is of monetary policy also becoming ineffective and even unleashing monetary inflation.
A look at the debt-to-GDP ratios and the budget deficit to GDP of the G8 countries is with exceptions truly astounding.
Of the G8 countries Russia currently stands head and shoulders above the rest, having gone through its own trauma with the depression of the 1990s following the collapse of the Soviet Union in 1990. Yet there is no sense that these debt levels are seen as a major problem nor is there any sense of urgency.
Greece according to the CIA Factbook 2009 had a debt-to-GDP ratio of 108% and, according to The Economist, a budget deficit to GDP of 9.4% (although some have placed it as high as 14%). Greece's GDP accounts for only 2.6% of the Eurozone, yet the world's stock markets were having a heart attack at the thought that Greece might be allowed to default and that the contagion could spread to other countries (notably Portugal, Spain and Italy).
Yet as soon as a rescue plan was announced the markets soared in elation. Throw taxpayers' money at the problem and stock markets are happy. This is not a solution, this is a band aid or akin to rearranging the deck chairs on the Titanic. At roughly one trillion dollars the program was larger by roughly $200 billion than TARP. And it says little about what they would do if other Eurozone countries feeling the pinch were to fall into debt default.
Nor does it address what may be the inevitability of U.S. states being forced to declare Chapter 9 bankruptcy. Already many U.S. states are being forced to lay off workers, including in California where teachers are being let go. Already a number of U.S. municipalities have been forced into bankruptcy with grave consequences for services in these areas. Again, throw money it and maybe it will go away. But all around the rot continues. It is as if termites are eating the foundation of your house but you put new tiles in the bathroom because it makes it look nicer.
If the current situation is already near unsustainable, the future is even bleaker. Unfunded liabilities (Medicare, Social Security and Medicaid) in the United States total some $60 trillion with some estimates taking it up to $90 trillion. The situation is the same in most of the G8 countries as future programs are not currently being provided for. Given the general aging of today's societies this is another nail in the coffin and possibly the final one before a "Great Reckoning" looms.
Interest rates are generally low, artificially low as central banks deliberately give a sense of false security that somehow maintaining low interest rates is panacea for what ails us. It is not. As the debt levels grow the ability to continue to fund these debts at artificially low interest rates becomes difficult. Why because foreign investors are worried about defaults and not happy with the low yield they are obtaining for an unknown risk stop lending. Interest rate spreads must then inevitably rise in order to attract foreign investors to finance the debts. This has already been seen for a host of Euro countries as a result of the Greek problems. China is cutting back on investment in foreign bonds. Instead they are trying to raise their gold holdings and making strategic investments to gain access to commodities.
As the debts grow governments will be forced to monetize the debt. What this means is that they will convert the debt into legal tender. They accomplish this by having the central bank purchase the bonds which exchanges the securities for cash. Since the financial crisis broke in 2007 the monetary base of the United States has more than doubled. The crisis in Europe in all likelihood will add to the monetization of debt in the Western economies.
The chart below shows the explosive growth of the monetary base in the U.S. over the past few years. While it is not yet at the point where hyperinflation might become endemic it is a warning sign that debt levels being created by all levels of government are unsustainable. This is the road to destruction.
Financial panics, recessions and depressions are a normal part of the business cycle. Already this decade there has been two financial panics and two recessions. The bursting of the dot-com bubble occurred from 2000 to 2002 and the financial panic of 2007-08 was triggered by the collapse of the sub-prime mortgage market and the derivatives that had been built around these markets.
In looking at the financial panics in the 20th century, up until 1970 there were only a few of note. The main ones were the financial panic of 1907 that resulted in a severe recession and multiple bank failures and the Wall Street crash of 1929 that resulted in the Great Depression. Following a five-year bull market recovery there was the financial panic of 1937 that did not make its final bottom until 1942. This was, however, a part of the Great Depression.
Since 1970, financial panics have become more pervasive. Following is a small list:
- 1973—The oil crisis triggered by the Saudi oil embargo triggered a huge jump in oil prices. It was followed by the stock market collapse of 1973–74.
- 1980s—The Latin American debt crisis was triggered in 1982 with a Mexican bank holiday.
- 1987—Stock market crash.
- 1989–91—Savings and Loan crisis.
- 1990—Bursting of the Japanese stock market bubble. Twenty years later, the Tokyo Nikkei Dow remains down about 74% from the highs of 1990.
- 1992–93—Attack on European currencies. Collapse of the British pound.
- 1994–95—Mexican peso crisis resulting in a bailout of Mexico.
- 1997–98—Asian financial crisis. Currency devaluations triggered by the collapse of the Thai baht.
- 1998—The Russian rouble crisis and Russian default resulting in a financial panic and the collapse of Long-Term Capital Management (LTCM) that was required to be bailed out by the Federal Reserve and a group of New York money centre banks.
Money is now backed by nothing but promises from governments that your pieces of paper are actually worth something. They are not. It is just paper and, since 1970, your pieces of paper have devalued by roughly 80%. Of course, you feel richer—or at least some of you do—but it has been an illusion that somehow having more pieces of paper actually means you are better off. A few have accumulated a huge amount of paper money. For the majority, wages have been stagnant for up to 20 years, they are one paycheque from the welfare lines and their retirement fund is virtually non-existent.
As noted, the solution to each and every crisis has been to throw money at the problem, and lower interest rates. The trouble is that each time, the effect of throwing more money at the problem becomes less effective. It results in financial bubbles as well. The Japanese bubble of the 1980s was a result of artificially low interest rates and excess liquidity provided by the central bank. And so too was the dot-com bubble of the 1990s and then that was followed by the housing bubble in this past decade. Further, the financial bubbles were accompanied by an explosion of derivatives that allowed abnormally high leverage. This works as long as the markets are rising but when the bubble bursts the consequences are devastating, as was seen in the financial panic of 2008. It was one big margin call.
Once again the same tools are being applied: abnormally low interest rates accompanied by huge injections of liquidity. But this time it is not working, and economies since the crisis of 2007–08 have only limped along. In the end, the potential for bankruptcy looms large, especially for countries as they pile up the debt in a futile attempt to prop up the financial system. Instead it has been merely a roadmap to the financial destruction, which will be essential to cleanse the system.
There is, according to Ray Merriman of MMA Cycles, some evidence of a 72-year or a 90-year cycle of depressions. There is also the 56-year Kondratieff cycle of rise and fall in business cycles ending in the Kondratieff winter or depression. According to most Kondratieff analysts' the Kondratieff winter started in 2000 with the peak of the dot.com bubble. There is also some evidence that all of these cycles are currently overlapping. According to Kondratieff wave theory, the last Kondratieff winter ended with the stock market low of 1949. Fifty-six years later puts us at 2005. Seventy-two years from the 1929 stock market top was 2001, and 90 years from the stock market trough of the Great Depression is 2022. This all fits in with many analysts' predictions that the current series of recessions that got underway in 2000 is not expected to end until at least 2020 and possibly later.
Prior to that there was the Long Depression of 1873–1896, and prior to that there was a severe depression in the late 18th century and early 19th century.
Michael Jenkins of Stock Cycles Forecast has often mentioned the 120-year cycle as a possible important chart to watch. Mr. Jenkins considers that 60 years is the master cycle and 120 years is 2 times 60 and that cycle may be even more important. Note the top in early May. That was followed by roughly a 23% decline into December 1890.
This collapse came during the Long Depression. That depression was really a series of severe recessions/depressions that began with a financial panic and bank failures and was interrupted by a long period of speculation and seeming prosperity through the 1880s when the railroad era hit its peak. While a few were becoming rich as a result of the railroad boom, the vast majority of the population saw their wages stagnate and many lived in poverty. The collapse in 1890 started the final part of the depression as the overbuilding of railroads and a railroad bubble was pricked (compare this with the dot-com bust and the housing bubble). This was followed by a run on gold, a financial panic and a run on banks in 1893. Could we see the same thing happen again?
For gold bugs this would be a dream come true. Gold has exploded recently, making new highs against every major currency in the world. The chart of the Dow/gold ratio has broken down from what appears as a double top (as the ratio falls, gold is outperforming stocks represented by the Dow Jones Industrials). The double top has a projected target of at least 7 (current 8.8, down from a high of 45 in 1999). The swing target on the rally that lasted from March 2009 to August 2009 is a decline to around 3.7. Ultimately the long-term targets remain at 1 and possibly lower. A 1:1 ratio for the Dow/gold was last seen in 1980 at the height of the gold boom and the stock market decline of the late 1970s.
The cycle of the 1930s has been dominant in the charts, as well. If the 70-year cycle (fits with Merriman's 72-year cycle) is dominant, then the chart of 1940 is important. The following chart shows a top in mid-April 1940, followed by a panic into mid-May. The panic was caused by the fall of France. Could another unexpected event and war be around the corner? Some are watching the rhetoric between Iran/Israel and the United States. Could an attack on Iran be in the offing? Some have speculated that it is possible (Stratfor).
Note in that chart that the low in 1942 was actually below the low of 1938. That low corresponds with the financial panic of 2008. The rebound rally in 1939–40 made a double top before collapsing. While the initial reaction is a panic, the decline is more like a long grind to the lows. The current projection is that the final bottom will not be seen until sometime in 2012 and that lows below 666 on the S&P 500 (the March 2009 low) are a possibility. A series of charts follows, starting with the 1890 chart.
Gold has been rising in all currencies, against bonds and against other commodities. All investors should own bullion in their portfolio. The final chart shows that gold stocks are still cheap in relation to gold itself. Owning gold stocks is a leveraged play to own gold. The TSX Gold Index contains the big cap gold stocks plus a number of intermediate gold stocks. For further leverage, owning junior gold producers and junior gold exploration stocks is a more speculative way to hold gold. Remember that stocks are a completely different risk than holding bullion itself, which is the most conservative and safest way to own gold. Gold and gold stocks are today under-owned in many portfolios and by most portfolio managers. If gold continues its current rise against stocks and currencies, it will become more difficult for individuals and portfolio managers to remain on the sidelines.
For the past several years, the Cassandra's have been warning that a "Great Reckoning" is coming. The road to destruction continues as each bailout leads to another crisis. This will not be fully resolved until the debt is cleansed and the world goes through a series of gut-wrenching recessions and even a depression.
Gold is money and has been for 3,000 years. When all around is failing gold becomes the last safe haven. A pundit once said, after listening to a Cassandra warn about the coming destruction, that all he wanted to do was go home, draw a hot bath and slit his throat. He would be better off just buying some gold.
David Chapman is a director of Bullion Management Group Inc. and manager of both the BMG BullionFund and the BMG Gold BullionFund
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