The World in 2020: $253 Trillion of Global Debt
By Kenetic Trading on The Capital
Not too long ago, Ray Dalio published the article — The World Has Gone Mad and the System is Broken — which focused on the shamefully unfair Cantillon effect that occurs as a result of modern-day monetary policy. As money is created via central bank initiated Quantitative Easing (QE) programs, the positive effects of this new liquidity is felt by those most creditworthy to receive it first, and by the retail banks who lever it up 10 or more times and dish it out as credit. Those least creditworthy in society are the last to feel any effect, and often that effect is a net negative as prices and services rise around them from the subsequent inflation.
Quantitative Easing, despite acting as an indirect predatory tax on society, does work well in the short term to stimulate the economy, however, this method of capital creation is unquestionably mad, broken and cruel for many in the long term.
To give some context, at the end of the last decade the world had accumulated a record-breaking 253 trillion USD of debt, equating to a debt-to-GDP ratio of 322%. As we start 2020, each human being born will inherit ~$33,000 of debt and there are no signs of a slowdown as we are likely to break the record again at the end of Q1 by adding an estimated additional $3 trillion to the pile.
Now if you thought all this sounds rather bleak, then a quick look at the current state of affairs in the US repo market makes QE and the Cantillon effect seem almost palatable.
Tucked away in the corners of global finance is the little understood repo (repurchase) market. A kind of invitation only ‘’big boys’’ market place, where banks, funds and money managers swap assets (typically securities and debt instruments) they hold on their balance sheet, in return for short term cash liquidity. The borrowers then use the cash, often just overnight, to fund their portfolios — for example, to maintain the collateral needed for leveraged trading positions they hold with prime brokers and custodians. Despite being relatively unknown and misunderstood by the majority of society, this market is absolutely enormous, often with an aggregate of 3 trillion USD being borrowed every day. The repo marketplace is best described as the engine room that drives the global financial system — without it, the transfer of credit and risk would be slower and far more cumbersome.
In September of 2019, the interest rate at which overnight loans are made (and repurchased) moved from ~2% to >10% in less than a day, as lenders suddenly stopped lending, catapulting the rate upwards. The world’s financial system is built on top of this repo market — without an efficient and liquid marketplace for banks and large asset holders to roll their exposures daily, the ramifications for global credit flows would be dramatic. As has been the case in several previous episodes of short term liquidity tightening, the Federal Reserve Bank decided to step in and lent $75 billion in short term loans on 4 consecutive days, which was the first time in a decade that it was compelled to intervene in the Repo market. It quickly became clear that there was a ‘structural issue’ and longer-term loan agreements was required to calm markets. The Fed was so concerned with year-end liabilities maturing within the system that it made a staggering 490 billion USD available to the repo market across various maturities.
These rescue loans from the Fed are technically not regarded as ‘Quantitative Easing’, since the duration of the Repo loans are short-term arrangements ranging from like 1 to 90 days. QE on the other hand, is a more permanent injection of cash into the system, which typically takes the form of purchasing long duration bonds (and in some countries, notably Japan, has even included the purchase of equities and ETFs), allowing the necessary time for its stimulating effects to trickle through the financial system and economy.
The global economy, however, is built as an enormous, unwieldy credit-based apparatus, the fundamental problem now being that the entire system is over-leveraged and there simply is not enough USD (monetary base) to service the credit that exists. If you reduce the monetary base by removing USD from the system, then the credit that sits on top is at risk of default and collapse because the demand for USD will outstrip its supply. Evidently, this is what happened in the repo market for a brief period in September of last year — a combination of the Fed removing USD from the system (reversing or unwinding previous QE programs) and hedge funds being over-leveraged and requiring cash from banks that didn’t have enough to go around. There wasn’t enough USD in the system so the demand rose dramatically, driving up overnight interbank rates from ~2% to 10%.
We are now facing a terrifying vicious circle, caused in large part by a 4-year political cycle that leaves politicians and government officials with little incentive other than to continue driving short term growth, often at the expense of long term stability. It is now emphatically clear that the financial system requires a greater monetary base to service the credit market, which leaves the Fed in an impossible situation — continue injecting liquidity into an already overheated, overleveraged market, or let it burn to the ground and suffer a long, painful deleveraging recession. If the last decade has taught us anything about government and central bank policy, then we already know which choice these bureaucrats will make — there simply is no political will to do anything else. These short-term loans will likely be extended and we are likely to see this transition into QE4 at some point. Greater monetary base means that the credit system will expand further, exacerbated and incentivized by permanently low-interest rates needed to sustain the debt. More credit = more monetary base = more credit. The can keep getting kicked down the road and the painful decisions are left to the next administration, and likely the next generation, to deal with.
How and when this ends is anyone’s guess but it is more than likely the longer we endure such madness, the worse the eventual collapse will be.
As a final point to show how truly ridiculous the whole debt economy is, check out this advertisement from Steven Mnuchin, US Secretary of the Treasury. It’s painful. With Deficit Swelling, U.S. Will Issue New Class of Bonds
If there was ever a reason to allocate a small percentage of your portfolio to assets such as gold and bitcoin then this is it. The madness will eventually stop.
This Week in Bitcoin
Bitcoin is now up an impressive ~26% in 2020, which starts to answer the question of whether the block rewards halving scheduled in May is priced in or not. Google trends for ‘Bitcoin halving’ (see chart below) are moving up but we still see very little media coverage for this crucial event in Bitcoin’s evolution and deployment. Media coverage and sentiment is crucial for stimulating the FOMO necessary for new and old money to enter/re-enter the market.
Below, we have adjusted the upper resistance line to be the most conservative trend line, this counters any bullish bias we have by applying technical analysis. Even in this instance, Bitcoin has broken its 7-month downtrend, and resistance has tentatively turned to support.
We mentioned in several Weekly’s backs that a break of this trend line would be properly confirmed with a sustained move through $9,200. At the time of writing Bitcoin had moved up to ~$9,200 and was heavily rejected, sending prices back down to the support line. Our TA is working well in this current market complex.
With daily RSI and MACD overbought and turning down, several weeks or so of consolidation with the trendline providing support would be an ideal scenario before providing a set up for a move higher. Should Bitcoin regain $10K in the next few months then we expect media attention to amplify the market move into May’s halving. Sell the news in May?
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