The idea that the world’s central banks can inflate the biggest financial bubble in human history — appropriately called the everything bubble — and then deflate it gently into a soft landing is mathematically and philosophically impossible. So the question is not if but when we get a bust that’s commensurate with the boom.
Based on the following three indicators, that bust is imminent.
Massively inverted yield curve
When short-term interest rates rise above long-term rates, a slowdown usually follows. That’s because traditional banks (though not necessarily the monstrous hedge funds that the biggest banks have evolved into) make most of their money by borrowing short and lending long. In normal times, long-term rates are higher than short-term, reflecting the higher risk of lending into the distant future, so the spread between a bank’s borrowing and lending rates produces a nice spread, which translates into a decent profit.
Invert the yield curve by pushing short-term rates above long-term rates, and this business model breaks down. Banks stop making suddenly-unprofitable loans, their customers have less money to spend and invest, and the economy shrinks.
Note two things on the following chart, which depicts the spread between 10-year and 2-year Treasury bond yields. First, when this spread went slightly negative (i.e., 2-year rates higher than 10-year) in 2000 and 2007, recession followed within a year or so. Second, today’s yield curve is a lot more than slightly negative. It is, in fact, one for the record books, implying that the credit markets expect a dramatic slowdown.
Shrinking money supply
A Ponzi scheme needs ever-greater amounts of money flowing in to avoid collapse. Today’s global economy is a classic example of a Ponzi scheme. Therefore, it needs an increasing money supply to function.
As you can see from the next chart, the M2 money supply has never stopped growing — until now. And with the Fed still raising interest rates and shrinking its balance sheet, the spigot is off and M2 is virtually guaranteed to keep shrinking.
The upshot? No more growth until the Fed turns the spigot back on, and rising instability as overleveraged, illiquid entities start imploding.
Tapped out consumers
Americans’ credit card debt is soaring while their savings rate plunges. Apparently, after their stimmy checks ran out consumers began paying their rent and feeding their kids by maxing out their credit cards. Now they’re carrying balances that are compounding at 20%+ interest rates. In other words, they’re in no shape to drive the economy higher with their spending.
In an economy that’s 70% consumer spending, maxed out credit cards equal negative growth.
Any of these indicators would by themselves justify caution about the year ahead. But three of them at once paint a clear, very scary picture. Explained another way, the Fed is tightening into an already hamstrung economy, and something is going to break pretty soon. Either a major company defaults, or consumer spending falls taking corporate profits and stock prices along for the ride.
Stay tuned for the investment thesis that flows from imminent recession.
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