Put on your thinking cap. This one’s going to use some brainpower. But if your investment plans involve money and the future, it’s probably worth the effort.
During our 2017 Investor Summit at Sea™, Chris Martenson warned that a financial system dependent on perpetual growth is unsustainable in a world of finite resources.
We’ll forego discussing “finite resources”, though there’s probably a lot of opportunity there. The New Orleans Investment Conference is a great place to learn more.
For now, let’s consider “a financial system dependent on perpetual growth” … one of the most important, yet least understood, concepts about the eco-system we all operate in.
It’s simple, yet confusing. Here it is in two sentences …
When dollars are borrowed into existence, the only way to service the debt is to issue more debt. If the debt is paid off, the economy ends.
Imagine playing Monopoly and each player starts with $1,500. With four players, the “economy” of the game is $6,000. This “start” money comes from the banker.
New money is introduced two ways:
When a player passes Go and collects $200 from the banker … or when a player mortgages a property by borrowing from the banker.
Notice all the money to play comes from the banker.
So let’s MODIFY the game ever-so-slightly …
Let’s have the banker LOAN the start and payday money to each player at 10% interest per turn.
We still have four players starting with $1,500 each for an “economy” of $6,000. But at the end of the first round, each player now owes the bank $150 of interest.
(We’ll forget about the additional payday loans … it just complicates the math and isn’t necessary to make the point)
But borrowing money into circulation creates three (hopefully) obvious problems …
First, there’s only $6,000 in circulation. With total debt of $6,000 borrowed plus $600 of interest owed, it’s now IMPOSSIBLE to pay off the debt using only the money in the game so far.
And if the only way players get NEW money is borrowing, this creates a cycle of perpetually expanding debt.
Second, if each player paid ONLY the interest out of their $1,500 start money, after ten turns, they’ll have no money left at all. But they still owe the original $1,500!
So you MUST GROW your asset base by more than the interest expense or you’re consumed by the debt.
Third, if all players try to free themselves from debt, they would take ALL the money in the game and give it to the banker, the game would end, and each player would still be in debt.
In this system, it’s physically impossible to extinguish the debt without extinguishing the economy and ending the game.
Naturally, to keep the game going, the banker continually extends credit to the players.
It’s basically the way the global money system works and why people way smarter than us say it’s unsustainable.
It’s also like a Venus fly trap because any attempt to reduce overall systemic debt is deflationary, making existing debt even more burdensome.
Deflation means borrowers pay debt down with dollars worth more than those they originally borrowed.
Worse, any assets borrowed against have dropped in value.
Think of 2008 when the credit bubble deflated. Property values fell, while the outstanding debt remained fixed. Property owners were “underwater” (negative equity).
Meanwhile, the dollar was STRONG. It took a whole lot LESS dollars to buy anything.
Everything was on sale and cash was king. Lots of people got rich buying things with cash when others couldn’t borrow to buy.
Deflation is awesome when you’re sitting on cash.
You’d think lenders are happy to be paid back with better dollars. And they are … IF they actually get paid.
But underwater borrowers often decide to default on the loan so they can keep their dollars.
So bankers HATE deflation. No wonder the system they set up in 1913 demands perpetual expansion of debt and prices.
“… inflation at the rate of 2 percent … is most consistent over the longer run with the Federal Reserve’s statutory mandate.”
Here’s the problem with perpetually expanding debt … it weakens an economy.
Sure, it drives inflation, but inflation weakens consumption. When things cost more, people buy less.
Debt also requires interest. Even at minimal rates, HUGE balances require big payments.
Interest on public and private debt take money away from production and consumption … causing both to shrink. Just not at the beginning.
When first injected into an economy, debt gooses activity and provides a temporary high.
And as in our modified Monopoly game, once deployed, more NEW money is required just to keep the interest from consuming the economy. There’s a point where new injections produce diminishing returns.
Whew! Thanks for staying with us. Tape an aspirin to your forehead.
With that backdrop, consider this headline from Investor’s Business Daily
Here’s Why China’s Latest Growth Scare Should Worry You – May 30, 2017
“Credit has been growing twice as fast as nominal GDP for years. The diminishing returns suggest that many loans are going to unprofitable ventures. They also signal that sustainable economic growth is far less than current growth rates. Such a rapid deceleration from the world’s No. 2 economy would sap demand and prices for raw materials such as copper, exacerbate overcapacity issues and act as a drag on an already-sluggish worldwide economy.”
Uh oh. “Diminishing returns” and “deceleration” in the face of rapid credit growth.
When a junkie can’t get high, they either increase the dosage to the point of toxicity … or they wean themselves from the drug.
“China is getting serious about weaning its economy off torrid credit growth, and data and financial markets already are showing early withdrawal symptoms.”
Hmmm… sounds like they’re leaning towards weaning. We like the addiction metaphor.
China and the United States are the two biggest economies. What either does affects the world.
Right now, headlines say China is slowing its use of debt, which in turns slows its economic growth, with a ripple effect on other economies.
Meanwhile, the Trump Administration is talking bigly about reducing the deficit and debt. Will he do it? Can he do it?
Who knows? But if the global economic system sustains itself on ever-increasing debt. and the two biggest borrowers are going on debt diets … who’s willing and able to take on a bigger share of global debt?
And if no one does, then what happens to asset values? Is deflation on the horizon?
Last question … then you can take a nap …
Would the Fed and other central banks allow deflation … or do they roll out QE4ever (quantitative easing) in an attempt to stop it?
Meanwhile, now seems like a good time to consider repositioning equity from properties and stocks with high asset values into properties with sober valuations and strong cash-flows.
Until next time … good investing!
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