Saturday, 2 September 2023 — South Melbourne

By Nickolai Hubble Editor, The Daily Reckoning Australia

[5 min read]

Dear Reader,

It’s time to brush off the lessons we learned the hard way in 2008. Both the theory and the practice. Because a Minsky Moment may be in the making.

What?

You’ve already forgotten the theories that explained the 2008 financial crisis, then?

It’s all got to do with the economist Hyman Minsky and his theories about debt deflation. But first, I want to remind you why you need to know about such obscure-sounding ideas now before everyone else catches on…

Back in 2007, we didn’t know what subprime mortgages or securitisation were. And yet, it came to be the defining terminology of an episode in financial markets that nobody will forget.

Next came credit default swaps, bond yield spreads and the technicalities of euro bailout legislation as the European Sovereign Debt Crisis took hold.

Around the same time, Australia’s commodity bubble burst as everyday people suddenly became familiar with the intricacies of Chinese stimulus packages and the ghost cities they created.

I heard a trucker tell of the cryptography that governs Bitcoin [BTC] while sitting at a rest stop in the Nullarbor Desert in 2018. My wife called the hotel there ‘the worst in the world’, but crypto fever had reached even there.

More recently, the Ts and Cs of US bank deposit insurance hit the front pages and we all learned about the mortgage stress tests that banks are subjected to.

The point is that these topics come out of nowhere, define financial market action for a few years at most, and then disappear back into the academic literature…for a few years. Then they make a spectacular comeback just when everyone has forgotten about them and what they mean.

I think we may be on the cusp of a comeback in the terminology and economic theory that defined 2008. A period of financial meltdown.

Why?

Central banks around the world remain hellbent on putting out the inflationary fire that they fuelled in 2021. Inflation rates are still well above their target levels. And so central bankers continue to trot out speeches about how more must be done.

But prices are just one measure of their past monetary mismanagement. And behind rising prices lies something far more concerning…

Goldman Sachs:

‘The US money supply is shrinking for the first time since 1949 as savings deposits decline and the Federal Reserve shrinks its [US]$8 trillion balance sheet.’

The Financial Times:

‘Eurozone money supply has shrunk for the first time since 2010 as private sector lending stalls and deposits decline, in a financial squeeze that economists warn points to a further downturn ahead.

[…]

‘The main cause of the first decline in the bloc’s money supply in 13 years was a drop in the annual growth of lending to the private sector to 1.6 per cent in July, the slowest rate since 2016. Lending to governments also declined 2.7 per cent — the biggest fall since 2007.

The UK’s money supply dipped into a falling money supply in June by 0.8%.

The point is that the amount of money in key developed economies is falling. And let’s just say that this is one of the worst possible signs for economies and financial systems.

To understand why, we’ll have to return to my high school economics education. But don’t feel bad if you aren’t aware of the explanation. You’re not the only one. Those in charge have no clue either…

A few months ago, Federal Reserve Chair Jerome Powell was asked by a politician why central banks tend to target 2% inflation. The inference was that this is still 2% too high for those who struggle with the consequences of inflation. Especially after a recent experience with inflation in the double digits.

What made the exchange so fascinating was Powell’s inability to respond coherently. Quite frankly, he bungled the answer so badly that he was compared to Vice President Kamala Harris!

The correct response, as taught by my high school economics teacher, was that economists fear deflation so much that they require the inflation target to have a margin of error. In other words, inflation below 0% is so terrifying that a 2% target is needed to give central bankers some wiggle room.

Well, China just entered deflation. Consumer prices fell 0.3% in July. If mainstream economics is correct, this heralds the beginning of a terrifying debt spiral in the country. One that explains the tumbling Aussie dollar, but China’s fate is another story. One that increasingly resembles the US in 2008, funnily enough.

What makes deflation so scary is that it makes debt harder to pay. Just as inflation makes debt cheaper over time because it can be repaid with devalued money, deflation makes a debt burden feel heavier. This adds a headwind to the economy, which is dangerous because of the nature of debt and money. It risks a downward spiral of defaults and debt which is difficult to stop.

Defaults aren’t just an economic danger in and of themselves. They impact the money supply itself too.

The money your bank lends you doesn’t come from somewhere. It is created in the act of lending. And when you repay your debt, or default, the money disappears with it.

Thus, deflation can become a self-reinforcing spiral. More defaults cause the money supply to shrink, worsening deflation and causing even more defaults as a result. This causes debt deflation — when a debt crisis impacts the money supply and thereby becomes self-reinforcing.

A Minsky Moment is named after one of the two economists who detailed and researched debt deflations. It’s the point when the asset prices that were pushed up by the debt boom start to fall in anticipation or in response to less debt in the economy.

In China’s case, as in 2007 in the US, that’d be property. However, the chaos quickly spreads from there.

But the point is that one key part of the debt-deflation puzzle is already in place as the money supply shrinks. If inflation evaporates next, look out for the Minsky Moment as asset prices crash, as in 2008.

Regards,

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend

By Jim Rickards Editor, The Daily Reckoning Australia

Dear Reader,

The pro-green and anti-green choices for investors

The assault by the elites on our basic freedoms and lifestyles using fake climate change data is real and unrelenting. Increasingly, honest scientists are starting to produce research that shows that climate alarmism is a scam and that there is no cause for concern.

Even with that new science, it’s difficult to cut through the propaganda and the climate of fear that has been created. The media are a big part of the problem. They mimic what the elites tell them with no independent research or journalistic ethics. The public itself is part of the problem. They are easily misled and happy to do what they’re told. When you have malevolent elites, compliant media and complacent citizens, that’s a recipe for dictatorial outcomes.

The good news is that the climate change agenda must fail in the end. This is not a matter of opinion. It’s a matter of physics and maths.

The power grid can’t run on solar and wind because there’s not enough non-intermittent baseline power. Cars can’t run on batteries because there’s not enough lithium and cobalt in the world to make the batteries needed. Citizens will not voluntarily confine themselves to 15-minute cities; they’ll want to see family and friends or even the world.

People won’t eat bugs (I’ve tried friend grasshoppers in Korea; they were tasty, but I wouldn’t make a steady diet of it. I enjoy a medium-rare hamburger as much as the next guy). In time, the Green New Scam will fall from its own weight if people don’t put an end to it sooner. Either physics or people power will end it. Hopefully, both.

In the meantime, we’re stuck with what complexity theorists call the ‘interesting in-between’. The climate scam will certainly fail, but it will just as certainly be tried in the years ahead. This puts investors in interesting choices.

Short-run demand for lithium, nickel, cobalt, and copper will be strong even if those commodities cannot possibly create all the batteries needed. China will demand coal to run its coal-fired electricity plants no matter how much the US and Germany destroy their own economies by banning clean coal and natural gas use.

Demand for EVs will crash once enough drivers get tired of waiting for over two hours for a battery charge to finish a three-hour trip. (The 30-minute chargers won’t help if you must wait two hours in line to use one. Don’t forget to bring your dinner with you while you wait.)

These choices are different from the ones investors usually make. Should I invest in something that will fail in 10 years if it makes huge profits in the next five? Should I invest in the oil and gas industry even when the US Government is out to destroy it? The answer to both questions — one pro-green and one anti-green — might be ‘yes’ given the strange mix of short-term madness and long-term sanity we are facing.

F Scott Fitzgerald once wrote:

‘The test of first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function. One should, for example, be able to see that things are hopeless yet be determined to make them otherwise.’

We know our readers have first-rate intelligence. The test, therefore, is the ability to see that the Green New Scam is hopeless and still works for sensible solutions.

Regards,

Jim Rickards,
Strategist, The Daily Reckoning Australia