To distract myself from the misery and sadness of our present times, I read about the happier times of the 1930s this weekend in Piers Brendon’s The Dark Valley: A Panorama of the 1930s. It was, as Brendon describes it, ‘A low, dishonest decade.’ Capitalising on the human cost of a worldwide depression, psychopathic politicians turned radical and drove their countries headlong into another calamitous world war.
That will bring me, in a moment, to Afghanistan and the shambolic US evacuation after 20 years of failed nation building, during which Australia has been a steadfast partner. But let me begin today with a simple idea: something can appear orderly, methodical, and even successful for many years, yet still collapse in a matter of days. It’s just as true in financial markets as it is in geopolitics.
I’m talking, of course, about the stock market. Earlier this weekend, I finished the latest Bonner-Denning Letter. One of the charts I presented showed that the market capitalisation-to-GDP ratio in the US market alone was now over 200%. Another showed that real yields on non-investment grade corporate debt were under 5% — their lowest level in two decades.
These are not unrelated. In fact, they are directly related. Perhaps they’re even intentional. Let me show you how.
When you lower official interest rates and then print money to buy bonds — as central banks around the world have done with quantitative easing — you accomplish two things. First, you misprice risk in the bond market by lowering yields across all fixed income securities. That’s what the picture above shows. Effective yields on non-investment grade corporate debt are almost 18% below where they were in the peak of the Global Financial Crisis.
Remember those good old days? From day to day, you never know what company was going to get caught out with assets far in excess of its equity. More to the point, if those assets were, say, residential mortgage-backed securities (RMBS) or collateralised debt obligations (CDOs), it was possible that a write-down in the value of those assets (thanks to the American housing crash) could wipe out the thin sliver of equity supporting an overleveraged firm (this is what happened to Lehman Brothers).
But today, instead of punishingly-high borrowing costs which reflect the risk of lending money to non-investment grade corporations, we have the worst of both worlds: low yields and increased corporate borrowing. If you have a spare hour, watch this keynote speech from hedge fund investor Stanley Druckenmiller, in which he shows how corporate leverage has actually increased during the latest crisis.
As even the riskiest (and junkiest) bond yields have gone down (thanks to QE), stocks have gone up. Large institutional flows of money, plus new liquidity from retail investors on apps like Robinhood, keep pouring into stocks, no matter the price, no matter the value. Hence the market-cap-to-GDP ratio being well above the mean of 80% (going back to 1970).
Yes, revolutionary new technologies appear to be changing the world right now. And yes, the pandemic lockdowns have given rocket fuel to the earnings of the biggest tech companies like Apple, Google, Amazon, Nvidia, and Microsoft. The unusual conditions of the last 18 months have given a plausible cover story to anyone who wants to pay a steep historical premium for growth.
But what if a stock market fuelled by bogus interest rates and QE is just as much a fraud as the coalition nation-building exercise in Afghanistan? Doesn’t that mean it could collapse just as quickly once support for the charade is withdrawn? Well, yes!
However, withdrawing support for the charade means that central banks would have to taper asset purchases and let interest rates rise to whatever their natural level is. Central banks don’t have ‘boots on the ground’ or embassies, nor do they have to worry about roadside bombs or the Taliban. They don’t HAVE to taper if they don’t want to.
What then, would cause them to withdraw their support for bogus stock market valuations? After all, rising stock (and home) prices are probably a big element in keeping the upper-middle classes in Australia and the US from realising the downside of the authoritarian police state that’s been imposed on them during the pandemic.
Yes, the police have been militarised, and yes, you have to ask for permission to exercise what used to be freedoms. But have you seen the new highs on the S&P 500?! And isn’t it great that we can still have auctions for houses even if we can’t exercise our rights to freedom of speech and assembly?
Going back to the history books, and specifically to the Weimar hyperinflation of 1922, it’s worth noting that German money printing for the First World War didn’t result in a collapse in confidence (and belief) until after the war was lost. It was the military defeat that triggered the financial collapse.
Once the German middle class realised there would be no war booty coming from the defeated French, and once they realised they had foolishly sold all their gold to the Reichsbank to support the war effort, they realised they had surrendered their real money (gold) for fake money (paper) just as the paper money was about go up in flames, along with the value of their savings.
It was, indeed, a low and dishonest decade. The resulting destruction of the German middle class was the ideal emotional fuel for certain toothbrush-mustachioed Austrian house painters. The slow build of the National Socialists began. The rest, as they say, is history.
And what about our low, dishonest decade? Is it just ending after two decades of futility and misery in Afghanistan? Or is it just beginning, as governments around the world rollout the machinery of surveillance to force compliance with emergency measures that increasingly have nothing to do with public health and everything to do with power and control?
Buckle up and hang on for the ride. Speak up while you still can. Speak out against bureaucratically-organised state terrorism. And for God’s sake, don’t give up your gold.
Until next week,
Editor, The Rum Rebellion
PS: The Bonner-Denning Letter is co-authored by Port Phillip Publishing founder Dan Denning and legendary investment writer and publisher Bill Bonner. It connects the dots between markets, politics, and history as one of the only macroeconomic, ‘top-down’ newsletters in Australia. For a big picture perspective on the past, the present, and your investment future, click here for details on how to subscribe.