Doug Noland: There Will Be No Way Out When This Market Bubble Bursts

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by Adam Taggart, Peak Prosperity:

Financial assets will become toxic to hold

This week Doug Noland joins the podcast to discuss what he refers to as the “granddaddy of all bubbles”.

Noland, a 30-year market analyst and specialist in credit cycles, currently works at McAlvany Wealth Management and is well known for his prior 16-year stint helping manage the Prudent Bear Fund.

He certainly shares our views that prices in nearly every financial asset class have become remarkably distorted due to central bank intervention, first with Greenspan’s actions to backstop the markets in the late-1980’s, and more recently (and more egregiously) with the combined central banking cartel’s massive and sustained liquidity injections in the years following the Great Financial Crisis.

All of which has blown the biggest inter-connected set of asset price bubbles the world has ever seen.

Noland foresees tremendous losses as inevitable, as the central banks lose control of the monstrosity they have created:

This is the granddaddy of all bubbles. We are at the end a long cycle where the bubble has reached the heart of money and credit.

There will be no way out. We’re not going to get enough private credit growth to reflate things when this bubble bursts. It’s going to have to come from central bank credit; it’s going to have to come from sovereign debt.

When this bubble bursts, it will shock people how far the central banks will have to expand their balance sheet just to accommodate the deleveraging in the system. And they won’t really be able to add new liquidity to the market; they’re just going to allow the transfer of leveraged positions from the leveraged players onto the central bank balance sheets.

When you get to that point, when the market sees that transfer occurring, I predict there’s going to be fear of long-term financial instruments. We’ll see rising yields. That’s when things will become problematic.

There will be losses. Of this global bubble, I think European debt is about the most conspicuous. Sure, European junk debt is nuts, too. It currently trades at 2%. Why? Because the ECB is buying large amounts of corporate debt. The ECB has kept rates either at 0% or negative. The perception is that the ECB will keep those markets liquid.

But look at Italy. It’s rapidly approaching 135% in terms of government debt to GDP. That debt will not get paid back. But yet, the market is willing hold that debt at 1.7%. This is debt that has traded at over a 7% yield back in 2012. But here it is today at 1.7%. I mean, Europe is just grossly mispricing its huge debt market. The excesses that have unfolded in European debt across the board are just staggering.

So when we get to that point when the central banks begin aggressively expanding their balance sheets (again) but the bond markets are not happy about it, then the central banks will finally have to decide if they want to continue to inflate or if they’re going to focus on trying to keep market yields down. This will be a very, very difficult situation for central bankers when it unfolds.

Click the play button below to listen to Chris’ interview with Doug Noland (54m:31s).

TRANSCRIPT 

Chris Martenson: Welcome to this Peak Prosperity podcast everybody. It is December 5, 2017. I am your host Chris Martenson. Today we are going to be talking about the massive financial bubbles that currently envelop the earth.

You have heard me talking about them ever since the crash course was released in 2008, and on podcasts ever since. I have been writing about them since 2007, when I personally began shorting the U.S. housing bubble in earnest.

More recently, I penned pieces titled The Mother Of All Bubbles, and When Bubbles Burst. Truly, there is nowhere to hide anymore after so many years of coordinated global central bank action. Our guest today is someone I have followed for years. Whose writings were instrumental in helping me formulate the economic portion of the crash course.

His name is Doug Noland. I first became acquainted with his writings and ideas when he worked for the Prudent Bear funds where he worked for sixteen years with David Tice. In the ten years prior to that, Doug worked as a short side trader analyst and portfolio manager during the great ’90s bull market. If there is ever a crucible for honing one’s skills ,it’s in locating profitable shorts in a rising market.

Doug now works with David Mcalvany at Mcalvany Wealth Management. I have been on David’s program a few times. He is a class act and someone I very much respect. The summary here is that Doug has 30 plus years of experience, and is a great analyst, and commentator of credit cycles and dynamics, which makes him one of the very best people to talk to here at the heights and possibly ends of one of the greatest credit bubbles in all of human history. Doug, welcome to the program.

Doug Noland: Hi Chris. Thanks for having me on. Those are very kind words. Thank you very much.

Chris Martenson: You’re more than welcome. Seriously, I mean every word of it. I have been following you for years. Your writing is just…. I put it. It’s kind of like you do for credit bubbles. What John Hussman does for equity valuations for me. You put the numbers to it. You put the context.

We have to know where we are historically. Doug in your view, did I overdo it maybe and engage in a little bit of podcast hyperbole when I said, “One of the greatest credit bubbles in all of human history?”

Doug Noland: Chris, I think you referred to it as the mother of all bubbles. I refer to it as the granddaddy of all bubbles.

Chris Martenson: Alright.

Doug Noland: No. I agree completely. Yeah. The bubble has gone to the heart of money and credit. It has gone global. As you mentioned, it’s basically across all asset classes. This is a deeply systemic bubble. I feel when this bubble bursts, that is finally when, yeah, and we kick the can down the road as much as we can. There will be serious problems to deal with.

Chris Martenson: Now, I want to talk about the serious problems. But if just to continue setting the stage for listeners here. If I have interpreted you correctly, and what we’re really facing. It’s not say a bitcoin bubble. People are saying there is a clear exponential or hyperbolic sort of an increase there. Or, maybe a housing bubble as we’re seeing in Melbourne, or Toronto, or London; or, maybe even an equity bubble, but a credit bubble. Help us understand what a credit bubble is? Why these other bubbles are just sort of bubblets or derivatives of the big one?

Doug Noland: Sure. I really dove into bubble analysis back in the early 1990s. I was convinced that finance was fundamentally changing with the advent of asset backed securities and mortgage backed securities. The GSE, and Wall Street finance, and all of the derivatives, we were basically changing the way finance was created.

The old model where you had banks creating credit. Bank credit was limited by reserving capital requirements. That was thrown out the window. We now had unfettered credit growth through the market based credit. I started writing my blog at the end of the 1990s. I was convinced that once the central bank realized that this was this new experiment in finance, they would recognize that it was unstable.

They would move to it to rein things in. The way it ended up is that experiment in finance basically failed. It failed first with the collapse of the technology bubble. Then, with the collapse of the mortgage finance bubble, that model new finance basically failed.

What the Federal Reserve did and then the central banks did. They started an experiment in central banking with the class of interest rates and all of the quantitative easing, and buying all of the debt, and basically creating new money. That experiment with central banking was trying to stabilize the unstable finance.

As we have seen especially over the last eight or nine years, that has ended up with central banks creating what, ten, 12, and 14 trillion dollars worth of new money. Interest rates have stayed low. That is what has really led to this global bubble. It’s just a complete mispricing of finance. Back through the mortgage finance bubble period, I used to talk about the moneyness of credit where basically we were transforming and Wall Street was transforming all of this risky credit into perceived safe money like AAA rated securities. That was through the GSE guarantees and the implied guarantee by the government.

What I have said over the last eight or nine years. We have moved it. Instead of the moneyness in credit, it’s called the moneyness of risk assets where basically central banks are back stopping liquidity and basically the prices of risk assets. They have collapsed interest rates. They have force savers out of savings and into the risk markets.

That is how it becomes deeply systemic. That’s how these pricing distortions, and the really significant market misperceptions are throughout the markets at home and abroad. Basically everyone believes that you can buy higher yield, junk debt, or a structured finance.

The Fed will ensure the markets are liquid. Why not write market insurance? Why not write derivatives and sell derivatives, and take those proceeds like writing flood insurance during a drought? That has been part of this whole short volatility trade.

That has created all of this cheap insurance. If the market insurance is so cheap, why not go out and take a lot of risk, and put on leverage, and run these aggressive strategies? If you know it’s so easy to go out and hedge yourself. Unfortunately again, and the granddaddy of all bubbles, I can’t believe it’s gone on this one long.

In fact, if you recall back Chris, in 2001. The Fed came out with an exit strategy. I know. I titled one of my bulletins at the time “No Exit.” Because I didn’t believe they would actually wind down that balance sheet that they bloated during the crisis.

But, back in 2011 when they were talking exit strategy, I didn’t realize they were going to double their balance sheet again to 4.5 trillion over a few years. Anyway, I think this has just gotten away from them. It has gotten away global central bankers. It has certainly gotten away from the Chinese with their credit bubble.

Basically a bubble, this is a long winded answer to your question. A bubble is a self-reinforced, a self-reinforcing inflation that in the end is unsustainable. That’s the deal with credit bubbles. As long as you continue to create more credit, they look sustainable.

But, at the end of the day, that credit is suspect. Especially late in the cycle, it’s very risky credit. If the market turns on that credit as we saw in 2008, then the bubble is extremely vulnerable.

Chris Martenson: Now, how far back Doug do we have to rewind this to figure out where the mistakes came? Einstein to paraphrase said that compounding is one of the most powerful forces in the universe. Well, in my analysis and I
think yours as well. The central banks and it’s beginning under Greenspan in the United States. It started compounding errors.

One of the prime errors that I can detect is when we suddenly convinced ourselves that we could grow our credit markets at twice the rate that our GDP, our gross domestic product was growing; which I’ll use as a proxy for income. Not a good one as we all know because a hurricane like Harvey can come and ruin a city for awhile.

That counts as a positive in that model. GDP. does a very poor job by mistaking income and balance sheet actions. But at any rate and leaving that aside, let’s just say to me that was the ultimate, almost cartoonish error that was made. It was falling into this thought the idea. That we could compound our debts at twice the rate of income.

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