"The dark Horsehead Nebula and the glowing Orion Nebula are contrasting cosmic vistas. Adrift 1,500 light-years away in one of the night sky's most recognizable constellations, they appear in opposite corners of the above stunning mosaic.
Click image for larger size.
The familiar Horsehead nebula appears as a dark cloud, a small silhouette notched against the long red glow at the lower left. Alnitak is the easternmost star in Orion's belt and is seen as the brightest star to the left of the Horsehead. Below Alnitak is the Flame Nebula, with clouds of bright emission and dramatic dark dust lanes. The magnificent emission region, the Orion Nebula (aka M42), lies at the upper right. Immediately to its left is a prominent bluish reflection nebula sometimes called the Running Man. Pervasive tendrils of glowing hydrogen gas are easily traced throughout the region."
"It was not my first visit. I had been there once before to talk with the great man, to the Castle of Cloux, near Amboise, in the valley of the Loire. He had been living there since 1516, at the invitation of Francis I, king of France. He was 67 years old, bundled up in a thick fur wrap by a roaring fire. His face showed age but not infirmity. Long white hair fell about his shoulders. White beard. Thick, downswept brows shaded his eyes like awnings. A strong nose. And of course the mouth, serious yet generous, not unlike the mouth of the Christ he had painted on the wall of the refectory of Santa Maria delle Grazie in Milan.
The king likes to surround himself with luminaries - artists, poets, philosophers, talented people of all sorts. Leonardo's reputation, of course, is known throughout Europe. It was inevitable that the king would draw him to France. A prize of war? So be it.
The last time I visited we talked about his paintings, only three of which had followed him to France. This time I wanted to hear about his anatomical studies. I had heard he had hundreds of drawings, recording the meticulous dissection of cadavers. "Might I see them?" I asked. Kindly, he aquiesced, and asked his young apprentice and friend, Count Francesco Melzi, to fetch several thick portfolios. As I carefully turned the sheets, I was stunned. Never had I seen such detailed representations of the human frame. Bones, muscles, tissues. Heart, lungs, stomach, liver. "From life?" I asked, forgetting myself. "From death," he replied with a slight smile. "Not so may years ago I had the privilege of working with Marcantonio della Torre, professor of anatomy at the University of Pavia. He gave me access to corpses."
As the thickly-annotated sheets slipped through my fingers I realized I was looking at something marvelous, a marriage of art and science.
"Extraordinary," I whispered. "All a waste," he said. He closed his eyes. "A waste? What do you mean?" I knew I was looking at documents of historic significance.
He rocked quietly for a moment, then looked into my eyes. "I was looking of the soul," he said. "All my life I have been trying to capture the human soul in my paintings, the ineffable essence of a man or woman. But all I was painting was the surface of a person, the face, the skin. What I wanted was something else, whatever it is that shines out through the eyes, that warms and animates the skin. I wanted the thing behind the gesture, the lamp that gives the light."
"And…?" He pulled the fur robe more tightly about him. "I didn't find it. I didn't discover the seat of the soul. When I had taken the body apart, looked into its most secret recesses, all I had was a gory mess of tissue and blood."
"The soul had flown? Returned to its Maker?" "Perhaps." The old man looked to Count Melzi, who smiled sympathetically. Then Leonardo returned his gaze to me. "Perhaps," he said. "Or perhaps what I was looking for was there all along, in the face, in the gestures, in the glow of skin. As the music is in the tuned lyre. Dismember the lyre, untune the strings…"
I looked again at the densely inscribed sheets in my hands, the flayed muscles, the sectioned valves. "Sir," I whispered. "If I may be permitted. There is no music without wood and fret and strings. You have given us a …" "Shush," he said. He closed his eyes and his chin dropped to his chest. Melzi indicated it was time to go. I placed the anatomical drawings in their portfolios, and looked again at the old man in the chair. A great soul. Of science and of art.”
"Three passions have governed my life: The longings for love, the search for knowledge, And unbearable pity for the suffering of humankind.
Love brings ecstasy and relieves loneliness. In the union of love I have seen In a mystic miniature the prefiguring vision Of the heavens that saints and poets have imagined.
With equal passion I have sought knowledge. I have wished to understand the hearts of people. I have wished to know why the stars shine. Love and knowledge led upwards to the heavens,
But always pity brought me back to earth; Cries of pain reverberated in my heart, Of children in famine, of victims tortured, And of old people left helpless. I long to alleviate the evil, but I cannot, And I too suffer. This has been my life; I found it worth living."
"All men seek happiness. This is without exception. Whatever different means they employ, they all tend to this end. The cause of some going to war, and of others avoiding it, is the same desire in both, attended with different views. The will never takes the least step but to this object. This is the motive of every action of every man, even of those who hang themselves."
"Truth is always stranger than fiction. We craft fiction to match our sense of how things ought to be, but truth cannot be crafted. Truth is, and truth has a way of astonishing us to our knees, reminding us that the universe does not exist to fulfill our expectations. Because we are imperfect beings who are self-blinded to the truth of the world's stunning complexity, we shave reality to paper thin theories and ideologies that we can easily grasp – and we call them truths. But the truth of a sea in all its immensity cannot be embodied in one tidewashed pebble."
Central bankers not only continue to insist their free money for financiers will eventually “trickle down” to the masses–they’re angry that the masses aren’t buying it. Central bankers are now blaming the masses for maintaining a perverse psychological state of disbelief in the omnipotence of central banks and their policies. Central bankers are raging at the psychology of hesitant households, which they finger as the cause of global weakness: if only people believed everything was great, they’d borrow and blow tons of money, and the ship would leave port with a full head of steam.
The central bankers have spent nine years constructing “signals” that are supposed to create a psychological state of euphoria that leads to more borrowing and spending. The stock market is at all-time highs–don’t those stupid masses get it? That’s the “signal” that all’s well and they should get out there and borrow more money to enrich the banks!
Central bankers’ anger is not directed at the source of the policy failures– themselves– but at the masses, whose BS detectors suggest all the signals are manipulated and therefore worthless. The skeptical psychology of the masses is akin to the mark at the 3-card monte table: the crooked dealer (in this case, the central banks) has let the mark win a few rounds to “prove” the game is honest, but the mark remains skeptical.
This is infuriating central bankers, who counted on the marks falling for the rigged game. This wasn’t supposed to happen, they rage; the Keynesian bag of tricks was supposed to work. Stage-managed perception (i.e. rising markets mean the economy is healthy and vibrant) was supposed to trump reality (i.e. the economy is sick, dependent on the dangerous drugs of debt and speculation).
Next up: bargaining. Central bankers are kneeling at the false gods of the Keynesian Cargo Cult and saying that they’ll offer “helicopter money” (more fiscal stimulus) if only the financial gods restore “growth.” They hope that by being “good central bankers” the gods will delay the inevitable destruction of their empires of debt.
There are now signs of debilitating depression in central bankers. The failure of their policies is finally sinking in, and central bankers are sagging under the depressing reality. They look somber, freeze up at the microphone, and have withdrawn from “whatever it takes” euphoria as they realize that another round offree money for financiers and manipulated markets will only make the problems worse and erode what’s left of their crumbling credibility.
Only when central bankers accept the complete and utter failure of their policies and accept the reality that their policies have increased wealth inequality and crippled the global economy with debt, speculation and manipulation, can we finally move forward. Until then, we’re stuck with the world central bankers have created: a world of rising wealth and income inequality, of permanent manipulation of markets as a means of managing perceptions and of speculative debt/leverage bubbles that will burst with a ferocity few expect or understand.”
“Human beings, who are almost unique in having the ability to learn from the
experience of others, are also remarkable for their apparent disinclination to do so.”
- Douglas Adams
"Like the flashing lights and sounds of clinking coins at a casino, buying stocks on margin is one of those things that might appear on the surface to be a great way to make money. The pitch usually goes something this, "If you have a few thousand dollars in your brokerage account, you might qualify to borrow money against your existing stocks at a low interest rate to buy even more stock, leveraging your returns!"The reality is that trading on margin is an inherently speculative strategy that can transform even the safest blue chip into a risky gamble.
It allows people and institutions desiring to get really greedy aggressive to buy more shares of a company than they could otherwise afford.When things go south, it can get really ugly, really fast, even leading to personal or corporate bankruptcy.
To top it off, if you open a margin account, rather than a so-called cash account, you introduce something called rehypothecation risk. If the financial world ever falls apart, again, which it inevitably will, you might not realize that you've exposed far more of your assets than you knew to losses that aren't even yours. There is simply no reason to go through life like this.I feel so strongly about it that one of the first things I did when sitting down and planning the global asset management group my family is launching was to include it in a list of policies for our private accounts.
Kennon-Green & Co. only manages money in cash accounts as margin debt is neither welcome nor necessary except in a handful of extremely limited cases such as structured risk arbitrage transactions, which certainly is not appropriate for new investors self-educating to run their own portfolio.I don't care if it could generate higher fees for the firm.I don't care if a client wants it.That's not what we do.This might seem to be a bit old-fashioned but there are certain risks that I believe are imprudent.Margin is one of them.
With all of that said, if you still aren't deterred about margin, and you want to employ margin debt in your own portfolio, keep reading.In the rest of the article, I'll explain some of the basics of how it works to provide what, I hope, is a better understanding of the mechanics involved.
The Definition of Margin: In the most basic definition, trading on margin is essentially investing with borrowed money.Typically how it works is that your brokerage house borrows money at rock-bottom rates then turns around and lends it to you at slightly higher (though still objectively cheap) rates, floating you funds to buy more stocks - or whatever other eligible securities you desire - than your cash alone would permit you to buy.
Or, I suppose, if you're really going for speculation, sell short. All of the assets in your account, as well as your personal guarantee, are held as assurance that you will repay the debt no matter what happens in the trading account itself. Even if the account blows up, you are on the hook for the money immediately.No payment plan.No negotiating terms.If you don't pay, the broker can haul you into court to start getting judgments to seize your other holdings, ultimately requiring you to throw yourself at the mercy of a bankruptcy judge.Meanwhile, as your credit score plummets, you might find everything tied to your credit rating getting destroyed, too.Your insurance rates could skyrocket.Your other lenders could restrict access to borrowing capacity, leaving you no ability to pay your bills.
Utility and phone companies may demand cash security deposits.Potential employers may look at your credit and decide not to hire you.All because you were impatient to make money, not satisfied to compound prudently over time, collecting dividends, interest, and rents along the way.
Margin Maintenance Requirements: Each brokerage house establishes a margin maintenance requirement.This maintenance requirement is the percentage equity the investor must keep in his portfolio at all times.For example, a house that maintains a 30% maintenance requirement would lend up to $2.33 for every $1.00 an investor had deposited in his account, giving him $3.33 of assets with which to invest.An investor with only one or two stocks in his portfolio may be subject to a higher maintenance requirement, typically 50%, because the broker believes the probability of not getting paid is greater due to the lack of diversification.
Some assets, such as penny stocks, aren't eligible for margin trading at all.Frankly, this is wise.Investing in penny stock is almost always a bad idea, anyway.Adding leverage on top of it would be deranged.
The Power of Leverage - An Example of What a Margin Trade Might Look Like: A speculator deposits $10,020 into his margin-approved brokerage account. The firm has a 50% maintenance requirement and is currently charging 8% interest on loans under $50,000.
The speculator decides to purchase stock in a company.Normally, he would be limited to the $10,020 cash he has at his disposal.However, by employing margin debt, he borrows just under the maximum amount allowable ($10,000 in this case), giving him a grand total of $20,020 to invest. He pays a $20 brokerage commission and uses the $20,000 ($10,000 his money, $10,000 borrowed money) to buy 1,332 shares of the company at $15 each.
Margin Debt Scenario 1: The stock falls to $10 per share. The portfolio now has a market value of $13,320 ($10 per share x 1,332 shares), $10,000 of that is cash from the margin loan, $3,320, or 25% of the margin loan, is the investor's equity.This is a serious problem.The speculator must restore his equity to 50% within twenty-four hours or his broker will liquidate his position to pay the outstanding balance on the margin loan.This 24-hour notice is known as a margin call.To meet his margin call, he will have to deposit cash or shares of stock worth at least $6,680.
Had the speculator not bought on margin, his loss would have been limited to $3,333.He would have also had the freedom to ignore the decline in market value if he believed the company was a bargain.However, his use of margin has turned his loss into $6,680 plus the commission on the forced sale of stock and the interest expense on the outstanding balance.
Margin Debt Scenario 2: After purchasing 1,332 shares of stock at $15, the price rises to $20.The market value of the portfolio is $26,640.The speculator sells the stock, pays back the $10,000 margin loan and pockets $6,640 before interest and the selling commission.Had he not utilized margin, this transaction would have only earned him a profit of $3,333 before commissions.
The Lesson You Should Learn About Investing in Stocks on Margin: The lesson is that margin amplifies the performance of a portfolio, for good or ill.It makes losses and gains greater than they would have been if the investment had been on a strict cash-only basis.The primary risks are market and time.Prices may fall even if an investment is already undervalued and/or it may take a significant amount of time for the price of a stock to advance, resulting in higher interest costs to the investor.An investor who found an undervalued stock is speculating ipso facto by using margin because he is now betting that the market will not fall far enough to force him to sell his holdings.
The Basics of Trading on Margin: When you sign up for a margin brokerage account, generally:
•All securities in your account are held as collateral for a margin loan, including stocks, bonds, etc. •The margin maintenance requirement varies from broker to broker, stock to stock and portfolio to portfolio.The brokerage firm has the right to change this at any time so you might find yourself with a demand to immediately pay off your margin debt balance with no warning or face having your portfolio liquidated. •If you fail to meet a margin call by depositing additional assets, your broker may sell off some or all of your investments until the required equity ratio is restored. •It is possible to lose more money than you invest when using margin.You will be legally responsible for paying any outstanding debt you may have to your broker even if your portfolio is completely wiped out. •The interest rate charged by your broker on margin balances is subject to immediate change.
In some extreme cases, margin caused serious economic troubles.During the Crash of 1929 proceeding the Great Depression, maintenance requirements were only 10% of the amount of the margin loan!Brokerage firms, in other words, would loan $9 for every $1 an investor had deposited. If an investor wanted to purchase $10,000 worth of stock, he would only be required to deposit $1,000 upfront. This wasn't a problem until the market crashed, causing stock prices to collapse.When brokers made their margin calls, they found that no one could repay them since most of their customers' wealth was in the stock market.Thus, the brokers sold the stock to pay back the margin loans.This created a cycle that fed on itself until eventually prices were battered down and the entire market demolished.It also resulted in the suspension of margin trading for many years.”
“The selling has just begun,” panics Morgan Stanley, “and this correction will be the biggest since the one we experienced in February." "The most important trade of the past decade is now reversing," shrieks Charlie McElligott, head of Nomura’s cross-asset strategy. Since last Friday the S&P technology sector lost $350 billion of artificial wealth… swept away to the Land of Wind and Dust, the graveyard of illusions.
Facebook has absorbed the heartiest slating of the bunch. Twitter, with disappointing second-quarter earnings of its own, follows. If you wish to understand the outsized market influence of technology stocks, consider: The S&P’s five largest companies - Apple, Amazon, Alphabet (Google), Microsoft and Facebook - boast a combined market cap exceeding $4 trillion. These five technology stocks thus equal the market cap of the index’s bottom 282 companies, combined.
The S&P is up 5% year to date. But were you aware that 73% of S&P stocks are down at least 5% this year? Or that 49% are down 10% or more? It is true - our agents confirm it. Ten stocks alone account for 100% of the S&P’s yearly gains - and six of these wagon-pullers have been technology stocks.
Rarely before, we conclude, have so many investors... owed so much... to so few stocks. But what if these market supporters crack under the strain and throw off the burden of leadership? Will anyone carry the standard forward? No, suggests Goldman Sachs: “Narrow bull markets eventually lead to large drawdowns.”
Of chief concern to many analysts is the strategy of “passive investing.” Passive, because it rises or falls with the prevailing tide. Technology stocks like Facebook have lifted markets on a flowing tide of momentum. Much of Wall Street has poured into these stocks… sat back on its oars… and let the current take markets to record highs.
But the danger is this: When the tide recedes… it recedes. And the same handful of stocks can wash the market out to sea, quick as a wink. Panic selling begets panic selling, and where it ends is an awful mystery. Jim Rickards explains: "What matters is the array of traders, all leaning over one side of the boat, suddenly running to the other side of the boat before the vessel capsizes. The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive."
Or as analysts Lance Roberts and Michael Lebowitz of Real Investment Advice style it: "When the “herding” into ETFs begins to reverse, it will not be a slow and methodical process but rather a stampede with little regard to price, valuation or fundamental measures. Importantly, as prices decline it will trigger margin calls,* which will induce more indiscriminate selling. As investors are forced to dump positions the lack of buyers will form a vacuum causing rapid price declines which leave investors helpless on the sidelines watching years of capital appreciation vanish in moments."
Roberts and Lebowitz remind that investors lost 29% of their capital over a three-week span in 2008 — and 44% over three months. “This is what happens during a margin liquidation event,” they conclude. “It is fast, furious and without remorse.”
We can of course provide no timeline for the described phenomenon. Nor, for the matter of that, can anyone else. But we have argued against a general catastrophe this year. We believe the ultimate reckoning may wait until next year… or the year following. Why? Because we first expect a “melt-up” - that final manic, incandescent phase bull markets enter before the inevitable melt-down. And these conditions do not obtain today.
We admit the possibility of an impending correction as Morgan Stanley predicts - but why, we wonder, can markets only “correct” lower? If a 10% market fall is a correction, is a 10% increase an incorrection?And if the S&P was correct when it plunged 10% in February, must we conclude any subsequent rise has been incorrect? Questions to ponder of a lazy midsummer day. We may soon have our answers.
Regardless, more questions will follow in the days ahead, and some may bring unsatisfying answers. In the words of former fund manager Richard Breslow: “This isn’t shaping up to be an old-fashioned quiet August.” Below, Jim Rickards shows you why investors have been lulled into a false sense of security, and why they may pay dearly as a result. Read on."
"Investors Have Fallen Into a False Sense of Security"
By Jim Rickards
"In January 2018, two significant market events occurred nearly simultaneously. Major U.S. stock market indexes peaked and volatility indexes extended one of their longest streaks of low volatility in history. Investors were happy, complacency ruled the day and all was right with the world. Then markets were turned upside down in a matter of days. Major stock market indexes fell over 11%, a technical correction, from Feb. 2–8, 2018, just five trading days. The CBOE Volatility Index, commonly known as the “VIX,” surged from 14.51 to 49.21 in an even shorter period from Feb. 2–6.
The last time the VIX has been at those levels was late August 2015 in the aftermath of the Chinese shock devaluation of the yuan when U.S. stocks also fell 11% in two weeks. Investors were suddenly frightened and there was nowhere to hide from the storm.
Analysts blamed a monthly employment report released by the Labor Department on Feb. 2 for the debacle. The report showed that wage gains were accelerating. This led investors to increase the odds that the Federal Reserve would raise rates in March and June (they did) to fend off inflation that might arise from the wage gains. The rising interest rates were said to be bad for stocks because of rising corporate interest expense and because fixed-income instruments compete with stocks for investor dollars.
Wall Street loves a good story, and the “rising wages” story seemed to fit the facts and explain that downturn. Yet the story was mostly nonsense. Wages did rise somewhat, but the move was not extreme and should not have been unexpected. The Fed was already on track to raise interest rates several times in 2018 with or without that particular wage increase. Subsequent wage increases have been moderate. The employment report story was popular at the time, but it had very little explanatory power as to why stocks suddenly tanked and volatility surged.
The fact is that stocks and volatility had both reached extreme levels and were already primed for sudden reversals. The specific catalyst almost doesn’t matter. What matters is the array of traders, all leaning over one side of the boat, suddenly running to the other side of the boat before the vessel capsizes. The technical name for this kind of spontaneous crowd behavior is hypersynchronicity, but it’s just as helpful to think of it as a herd of wildebeest that suddenly stampede as one at the first scent of an approaching lion. The last one to run is mostly likely to be eaten alive.
Markets are once again primed for this kind of spontaneous crowd reaction. Except now there are far more catalysts than a random wage report, despite last week’s optimistic GDP report.
We all know what’s happened to Facebook since last Friday. But look at the potential trouble from geopolitical sources alone... The U.S. has ended its nuclear deal with Iran and has implemented extreme sanctions designed to sink the Iranian economy and force regime change through a popular uprising. Iran has threatened to resume its nuclear weapons development program in response. Both Israel and the U.S. have warned that any resumption of Iran’s nuclear weapons program could lead to a military attack.
Venezuela, led by the corrupt dictator Nicolás Maduro, has already collapsed economically and is now approaching the level of a failed state. Inflation exceeds 40,000% and the people have no food. Its inflation rate has now exceeded the hyperinflation of Weimar Germany.
Social unrest, civil war or a revolution are all possible outcomes. If infrastructure and political dysfunction reach the point that oil exports cannot continue, the U.S. may have to intervene militarily on both humanitarian and economic grounds.
North Korea and the U.S. have pursued on-again, off-again negotiations aimed at denuclearizing the Korean Peninsula. While there have been encouraging signs, the most likely outcome continues to be that North Korean leader Kim Jong Un is playing for time and dealing in bad faith. The U.S. may yet have to resort to military force there to negate an existential threat.
This litany of flash points goes on to include Iranian-backed attacks on Saudi Arabia and Israel, a civil war in Syria, confrontation in the South China Sea and Russian intervention in eastern Ukraine. These traditional geopolitical fault lines are in addition to cyber threats, critical infrastructure collapses and natural disasters from Kilauea to the Congo.
Investors have a tendency to dismiss these threats, either because they have persisted for a long time in many instances without catastrophic results, or because of a belief that somehow the crises will resolve themselves or be brought in for a soft landing by policymakers and politicians. These beliefs are good examples of well-known cognitive biases such as anchoring, confirmation bias and selective perception. Analysis tells us that there is little basis for complacency. Yet the VIX is back near all-time lows as shown in Chart 1 below.
Even if the probability of any one event blowing up is low, when you have a long list of volatile events, the probability of at least one blowing up approaches 100%.
With this litany of crises in mind, each ready to erupt into market turmoil, what are my predictive analytic models saying about the prospects for an increase in measures of market volatility in the months ahead?They’re saying that investor complacency is overdone and market volatility is set to return with a vengeance. Even with the Facebook blowup and trouble in the tech space, VIX is just above 13.
Changes in VIX and other measures of market volatility do not occur in a smooth, linear way. The dynamic is much more likely to involve extreme spikes rather than gradual increases. This tendency toward extreme spikes is the result of dynamic short-covering that feeds on itself in a recursive manner - or what is commonly known as a feedback loop.
Shorting volatility indexes has been a very popular income-producing strategy for years. Traders sell put options on volatility indexes, collect the option premium as income, wait out the option expiration and profit at the option buyer’s expense. It’s been like selling flood protection in the desert; seems like easy money. The problem is that every now and then a flash flood does hit the desert.
When we consider recent financial catastrophes affecting U.S. investors only, without regard to other types of disaster, we have had major stock market crashes or global liquidity crises in 1987, 1994, 1998, 2000 and 2008. That’s five major drawdowns in 31 years, or an average of about once every six years. The last such event was 10 years ago. So the world is overdue for another crisis based on market history.
Investors expect that the future will resemble the past, that markets move in continuous ways and that extreme events occur rarely, if at all.
These assumptions are all false. The future often diverges sharply from the recent past. Markets gap up or down, giving investors no opportunity to trade at intermediate prices. Extreme events occur with much greater frequency than standard models expect. When they do strike seemingly from nowhere, like fire in a crowded theater, everybody panics and a wave of selling feeds upon itself. The trouble is, most investors will never make it out of the theater in time."
"I wish it need not have happened in my time," said Frodo. "So do I," said Gandalf, "and so do all who live to see such times. But that is not for them to decide. We do not decide the times we find ourselves in. All we must do is decide what to do with the time we are given."
"To love. To be loved. To never forget your own insignificance. To never get used to the unspeakable violence and the vulgar disparity of life around you. To seek joy in the saddest places. To pursue beauty to its lair. To never simplify what is complicated or complicate what is simple. To respect strength, never power. Above all, to watch. To try and understand. To never look away. And never, never, to forget."
"In the end, we return to the question, just how much do you love truth? Do you really love truth or are you just curious? Do you love it enough to rebuild your understanding to conform to a reality that doesn't fit your current beliefs, and doesn't feel 120% happy? Do you love truth enough to continue seeking even when it hurts, when it reveals aspects of yourself (or human society, or the universe) that are shocking, complex and disturbing, or humbling, glorious and amazing - or even, when truth is far beyond human mind itself? Just how much do we love truth? It's a good question to ask ourselves, I think."
"The monstrous thing is not that men have created roses out of this dung heap, but that, for some reason or other, they should want roses. For some reason or other man looks for the miracle, and to accomplish it he will wade through blood. He will debauch himself with ideas, he will reduce himself to a shadow if for only one second of his life he can close his eyes to the hideousness of reality. Everything is endured- disgrace, humiliation, poverty, war, crime, ennui- in the belief that overnight something will occur, a miracle, which will render life tolerable. And all the while a meter is running inside and there is no hand that can reach in there and shut it off."
"Is The Interest Rate Death Spiral Finally Starting?"
"The yield on Italy’s 10-year bond is up by about 100 basis points from its 2018 low. Meanwhile, its government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, forcing it to borrow even more money, and so on until this “interest rate death spiral” becomes fatal. It would already be fatal, if not for the European Central Bank’s willingness to buy Italy’s bonds at extremely favorable prices (i.e., very low interest rates). But now the ECB is promising to stop doing that, which leaves Italy in the early stages of a very negative feedback loop.
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Not our problem, you say? Italy is irrelevant to everyone including most Italians, so its imminent financial crisis is no more important than Venezuela’s.
Fair enough. Let’s move closer to home and start the story over: The yield on US 10-year Treasury paper is up almost 100 basis points since last September. Meanwhile, the government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, which means it has to borrow even more money at higher interest rates, and so on until this “interest rate death spiral” becomes fatal.
It would already be fatal if not for the Federal Reserve’s willingness to buy Treasury bonds at extremely favorable prices (i.e., very low interest rates). But now the Fed is promising to stop doing that, which leaves the US in the early stages of a very negative feedback loop.
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Here’s what the US government’s interest payments would be under different average interest rates:
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Note that the highest rate used in this table – 6% – is about average for the two decades prior to 2000. So it only seems extreme in today’s era of monetary experimentation. We’ll get back there, one of these days.
Except that we won’t. An annual interest bill of 1+ trillion dollars would send the deficit – which is projected to exceed a trillion without a meaningful rise in interest rates – above $2 trillion. And – since new interest will accrue on each year’s new borrowing – the current $21 trillion US government debt would grow by around 10% a year in this scenario, shifting the process of higher rates producing higher deficits into overdrive. This impossible-to-hide acceleration will in turn produce extreme responses from governments and/or markets, including but not limited to spiking inflation, plunging bond prices, capital controls, martial law and a global monetary reset.
Italy will probably get there first, which allows Americans to view our future by looking across the Atlantic. So you see it does matter.
And remember, this scenario involves only central government debt, which is cumulatively dwarfed by private sector debts, state and local unfunded pension liabilities, emerging market external dollar debts, and bank derivatives. And all of these things are vulnerable, one way or another, to rising interest rates, which means the interest rate death spiral, when it kicks into high gear, will be something for the history books."