Tag Archives: investment advice

A Bumper Sticker World

My Comments: A conversation last week with an attorney friend again revealed a world which is far more complicated today than seemed possible just a few short years ago. An expert in family law, he said tens of thousands of new laws have entered the books across these United States in the last three decades. It’s impossible to know the rules we are subjected to as we travel from one state to another. What is OK in Florida may not be OK in Tennessee.

So I understand the frustration of many who argue in favor of a simpler time. Unfortunately, it’s not going to happen. My solution is to stop worrying about what might have been and instead focus on what might be. That demands some creative thinking and a semblance of recognition about what today really looks like, who the stakeholders are and what steps to take to improve the chances my grandchildren have going forward.

For me, the first step is a willingness to step outside my comfort zone. How far are you willing to step?

Philip Stephens April 23, 2015

It is easier to say that Obama never gets it right than to come up with an alternative strategy.

On one thing everyone lining up for next year’s US presidential race can agree. Barack Obama has led from behind on the global stage. The president has been shy about deploying US might, accommodating of adversaries and reticent about standing up for allies. His successor in the White House, we are to believe, will restore America’s global prestige by standing up to China, facing down Russia and sorting out the Middle East.

An old friend in Washington, a foreign policy veteran of the Reagan administration, calls this a “bumper sticker” view of the world. He is right.

The chatter in an already crowded Republican field is that 2016 will be a “foreign policy election”. Republicans fear that a buoyant economy will narrow the range of domestic targets. National security offers obvious opportunities. The march across Syria and Iraq of the self-styled Islamic State of Iraq and the Levant has revived fears of new attacks on the US. Mr. Obama’s proposed deal with Iran falls short of the scrapping of Tehran’s nuclear program. Russia’s Vladimir Putin is menacing America’s European allies.

The 2016 hopefuls are as hawkish as they are inexperienced in foreign affairs. Jeb Bush, Marco Rubio, Chris Christie, Ted Cruz, Scott Walker and the rest all promise to be tough-guy presidents. Even Rand Paul, who once flirted with isolationism, has hardened up the rhetoric. Mr. Bush blames Mr. Obama’s hesitations for the rise of Isis. Mr. Rubio, who marches under the old neoconservative standard of “a new American Century”, would slam the door again on Cuba. They are all against the nuclear deal with Iran.

Republican hawks are not alone. Hillary Clinton served as Mr. Obama’s secretary of state. Now she is running for the office he denied her in 2008. Admirers say she too would be more robust. Had she not argued for arming moderate Syrian rebels and for a reset of the reset with Moscow when Mr. Putin started throwing his weight around? Were she to set a “red line” there would be real consequences for those who crossed it. Mrs. Clinton, of course, is under attack from Republicans for the deaths of US diplomats in Benghazi. All the more reason to show her mettle.

Some of the criticisms of Mr. Obama’s approach to global affairs have a point. Most of them miss a bigger one.

In one respect, to say that the president has often been reluctant to throw America’s weight around is simply to describe the circumstance of his election in 2008. He inherited two wars — in Iraq and Afghanistan — and the US was losing both of them. George W Bush had tested to destruction the notion that American military power could remake the Middle East. Mr. Obama’s task was to get the troops home.

The charge against the president that half-sticks is that the imperative to end these military entanglements has encouraged him to be overcautious elsewhere. Officials who have served in the administration say he is slow to weigh the costs of inaction. Power is about perception as well as economic strength and military hardware. It is one thing to draw a tighter definition of America’s national interests; another to forget that if the US steps back in one part of the world, allies and enemies elsewhere draw their own conclusions.

The impact of Mr. Obama’s decision to allow Syrian president Bashar al-Assad to cross a red line was felt as much in east Asia as in the Middle East. China’s new assertiveness in the East and South China seas has been grounded in a calculation that the White House wants to avoid confrontation.

It is easier to say that Mr. Obama has never got it right than to come up with a strategy to tilt the balance back in the other direction. Risk-taking is not just about military force. The diplomacy with Iran has been bold. Save in the dreams of diehard neoconservatives, the US lacks the resources and political will for “generational projects” to transform the Middle East.

The Republican contenders do not want to admit that, relatively speaking, the US is weaker. You do not have to be a US declinist to observe the rising economic and military weight of China, India and others. Nor, with the end of the cold war, can foreign policy be framed as a simple fight between good and evil. Not so long ago, Republicans were talking about Islamic State as the big threat. Now the danger comes from Iran. And yet Tehran is a fierce enemy of the jihadis.

The neat lines drawn by the contest with communism have disappeared. The new international disorder is being defined at once by the return of great power rivalry — think of China and Russia — and, paradoxically, by the collapse of the post-imperial state system in the Middle East. The US remains the most powerful nation but, on its own, it is insufficient.

The case for Mr. Obama is that in seeking to deploy economic and diplomatic power, and to leverage US influence through multinational coalitions, he has recognized the complexities of this new landscape. The case against is that he has sometimes gone too far in drawing the limits of US power.

What has been missing is an overarching framework — a set of principles clear and practical enough to deter adversaries and to reassure allies. A grand strategy, in other words, that balances ambition and realism. Republicans used to have a reputation for such thinking. Now they prefer bumper stickers.

Dog Days of the U.S. Expansion

moneyMy Comments: How is your money growing? Is it growing? Do you care? Are you prepared for pain when it stops growing and shrinks, perhaps dramatically?

As a professional in this world, I’ve long since given up worrying about this. All anyone can do is pay attention, or pay someone to pay attention for you. But it’s NOT different this time, and some of us will get hammered and some of us not so much. Here’s a clue to follow.

The Kentucky Derby marks the beginning of summer, but ultimately investors must prepare for the coming winter.

May 08, 2015 Commentary by Scott Minerd, Chairman of Investments and Global CIO

Ever since I was a child, the Kentucky Derby has always been for me a symbol of the changing of seasons—winter is over, spring is in air, and, most importantly, summer is right around the corner. Back in 2009, at the time of the annual “Run for the Roses,” I wrote a memo to our clients using this analogy to explain where we are in the business cycle. The ravages of winter were over, I wrote, and we were headed for the warmth of summer with bright prospects for investors. Six years later, the summer sun continues to shine on credit and equities, but the question I am consistently asked—especially during times of heightened volatility, like this past week—is how much longer can it last?

I answered this question recently at the Milken Institute Global Conference. If the economic “summer solstice” was mid-2009, then today we are somewhere in “late-August.” The expansion is now over 70 months old and is entering its mature phase, having already exceeded the average length of prior cycles of 57 months. However, “late-August” means there still is time left in summer and room left in this expansion. The past three cycles have also been longer than normal, averaging 94 months. Additionally, growth has been abnormally sluggish in this recovery (which, as I’ve written, is a byproduct of macroprudential policy). Slower growth means the current expansion may have more headroom than is typically the case at this point in the cycle.

What can investors expect as summer draws to a close? Our view of the future is that the Federal Reserve will likely begin interest rate “liftoff” in September of this year, and will continue to tighten at a steady pace until it nears the terminal rate (or peak Fed funds rate) in the cycle. This will likely occur toward the end of 2017 or early 2018 in the range of 2.5 to 3 percent. Recent experience suggests that a recession typically occurs about a year after we reach the terminal rate. If this tightening cycle plays out as we suspect, the U.S, economy will face its next recession in late 2018 or early 2019.

While the best of the post-crisis returns are now behind us, the good news is that historically, until central banks remove the proverbial punch bowl of accommodative monetary policy, the party can continue for investors. As a matter of fact, our research shows that both the lead up to, and the first year after, the Federal Reserve begins a tightening cycle have been positive for both credit and equities. Historically, U.S. equities have returned close to 4.5 percent in the 12 months after a Fed tightening cycle begins, based on an average of the last 13 cycles, while bank loans returned an average 5.8 percent, high-yield bonds returned 3.9 percent, and investment-grade bonds returned 3.3 percent in the three cycles since 1994 (when the data for fixed-income asset classes became available). The 12 months prior to a Fed hike have proven even better for investors, with equities returning an average 16.4 percent, high-yield bonds returning 8 percent, and investment-grade bonds returning 9.9 percent.

I don’t want to sound overly bullish, however. My view is that it is prudent to start to recognize what stage of summer we are in, and to understand that long-term investors need to start planning for winter, even if winter is a couple of years away. This doesn’t mean there aren’t opportunities between here and there—the punch bowl is out, the party is still going on, and we should drink long and deep for as long as we can. The European Central Bank has told us that it won’t halt its quantitative easing program until September 2016 at the earliest, which is another positive for credit and equities, even as the Fed raises rates in the United States.

So let’s enjoy the end of this long summer party. There are still some golden, halcyon summer days ahead and it would be premature to put on our winter clothes just yet. Indeed, on the extreme end, the expansionary cycle of the early 1990s lasted over 118 months. However, when all is said and done, the easy money in this expansion has already been made and investors should be thinking about the winter to come.

Sine of the Times

200+year interest ratesMy Comments: Many of you have read my comments about interest rates lately. (Yesterday!) For many, many months, the Fed has used its powers to keep them low to encourage economic growth. Now that growth is again endemic, sooner rather than later, pressures will exist to cause interest rates to increase.

The chart at the top of this post shows interest rates in this country going back to the late 1700’s. You can expect the curve to start changing its direction soon. When that happens, you should not own many long term bonds, unless you’re happy watching your net worth decline.

Commentary by Scott Minerd, Guggenheim Partners, April 24, 2015

For the past 30 years, 10-year U.S. Treasury yields have shown a clear downward linear trend, falling from over 10 percent in 1985 to less than 2 percent today. Around this linear trend, yields have also exhibited a fairly consistent cyclical fluctuation, with the size of the fluctuation about 200 basis points from peak to trough, and with the cycle repeating every six years. This fluctuation can be thought of as a sine function, allowing us to model 10-year yields by combining the sine function with the linear trend:Chart-of-the-Week-04232015_600px

If we assume the secular, linear downward trend in yields will continue in the near term, we can predict the short-term outlook based on the model of cyclical fluctuations. This model currently shows that rates are just beginning to undershoot the linear trend, with the model predicting that rates will bottom at 0.82 percent in March 2016. What’s even more interesting is that the average actual bottom in rates has been 73 basis points lower than the model predicts, which would put rates at just 0.09 percent.

Now, I am not necessarily predicting that U.S. 10-year Treasury yields will test zero like its counterpart the German 10-year bund, which currently stands at around 16 basis points and I believe could provide negative yields at some point. What I am saying is that there are many powerful secular and fundamental forces at work that signal the risk to U.S. interest rates remains to the downside.

With Federal Reserve tightening drawing closer, the continuation of this downward trend could be called into question. However, a number of factors, including lower first quarter gross domestic product (GDP) growth, high demand from overseas investors (with yields approaching negative territory in much of Europe), and expectations of a slow liftoff by the Fed, are working to exert downward pressure on U.S. yields, thus limiting any upside in rates in the near term.

The prospect of a stronger dollar as a result of upcoming U.S. rate hikes only serves to heighten foreign demand for U.S. Treasuries. International investors are likely to seek to preempt Fed action and invest while their currency has greater relative strength. Betting against the downward trend in U.S. rates has proved to be a widow-maker trade for many years—and with fundamental and technical factors pointing to downside risks in rates in the near term, there appear to be few reasons to bet against the trend now.

 

Get Ready For The Biggest Margin Call In History

My Comments: Like a broken clock that is right twice every 24 hours, I’ve been talking about the probability of us having a severe market correction for the past 12 months or more. It’s obviously not happened yet.

But every time I turn around, there are new observations from people who understand this better than I do. Most of them agree it’s going to happen. Each of us in our own way, depending on where we are in life and what we expect to achieve with our savings and investments, need to pay attention. There are ways to protect yourself and it won’t cost an arm and a leg to make it happen.

Chris Martenson | Apr. 20, 2015

Economist Steen Jakobsen, Chief Investment Officer of Saxo Bank, believes 2015 will be another “lost year” for the economy. And he predicts the Federal Reserve will indeed start to raise rates later this year, surprising the market and taking the wind out of asset prices.

He recommends building cash and waiting to see how the coming storm – which he calls the “greatest margin call in history” – plays out:
0% interest rates at $0 down has not created the additional momentum to the economy The Fed was hoping for. The trickle down effect, the wealth effect, has instead made for bigger inequality in society. So I think we’re set for a rate hike in either in June or in September. I think this will be the biggest margin call in history on the asset inflation created by the Fed.

That’s where I differ from most Fed watchers. Everyone else is looking at employment, inflation targeting. I don’t think Fed is at all looking at those. They are saying “Listen, the 0% interest rate is getting us absolutely nowhere, we think it’s very, very important for us to move to a more neutral place”. At the same time we will communicate that we are open-minded to additional programs or whatever needs to be done to secure the long term growth of the economy. But that will be on the down side, not on the up side. And as year has progressed, and I’ve said this publicly, I think 2015 is already lost in terms of recovery here. And that will take the market by surprise.

The market will ask in September when the Fed hikes: “Why are you hiking interest rate when growth is below target, inflation below target”? Well, the Fed’s response will be “Because this is the biggest asset inflation we’ve seen in human history and we need to address it“.

What the Fed is saying is that we have unintended consequences of low interest rates. Money is chasing yield: it’s going to real estate making it over-valued, and flowing into the equity markets making them over-valued. And then the Fed says “Well, we have two choices. We can allow the market to run into a bubble, or we can burst the bubble and start all over again”. But they wrongly, in my opinion, believe they can actually micro manage that, even macro manage this. So what they would rather do is “lean up against the market”. To take some of the excess out of prices by going in and telling in the market “We are concerned, we don’t want you to have more leverage. We want you to have less. And we certainly would like to see that market become flat-lined for a while in terms of return.” Which by all metrics of measurements is actually also the expected return of the stock market. Don’t forget three, five and seven years expected return at the present multiples is exactly 0%.

Given this, at a bare minimum, I recommend taking the leverage out of your own portfolio so you sit with a nice pot of cash if the market does correct. If it doesn’t, you’re not really losing out much because again, they expect a return is 0% for the next couple of years.

Some time the best advice to anybody is to do nothing. And of course being, part of an online bank I’m not exactly popular with management for putting this advice out there. But I have to give the advice I believe in and share what I do myself; and I’m certainly reducing whatever equity I have in my portfolio to a minimum. So I’m scaling back to where I was in January last year.

I’ll put it another way. I’m advising a hedge fund in London, analyzing 10,500 stocks from the bottom up. How many do you think of these 10,500 world stocks are cheap? Only 23. Which means 98% of all stocks are either fairly-priced or expensive.

Click the link below to listen to Chris’ interview with Steen Jakobsen (40m:27s)

https://www.youtube.com/watch?v=fnp5ETnKylU

To Lobby, or Not To Lobby, That is the Question

babel 2My Comments: I admit to perverting the title to this article (Lobbyists Pervert Politics And Earn Their Infamy) which appeared in the Financial Times recently. But it points to a problem that may have no solution, at least until the clowns who inhabit our Congress feel enough pain to find a solution. But it most likely won’t happen in my lifetime. But I will use my remaining years to try and inflict some pain along the way. Fascists be damned!

February 24, 2015, by John Kay

A contract to lobby government, like an agreement to sell sex, was unenforceable in the courts.

Even distinguished former foreign secretaries such as Jack Straw and Sir Malcolm Rifkind might be forgiven for having forgotten the treaty of Guadalupe-Hidalgo. It is a notable document, and not only because it determined that California would be part of the US, rather than a province of Mexico. Its signing triggered one of the lobbying industry’s earliest controversies — telling, perhaps, in the week two parliamentarians were caught in an undercover sting offering to help fictitious corporate interests in return for cash.

Nicholas Trist was America’s lead negotiator on the 19th century treaty, and he believed he had not been properly recompensed for his services — which do, in retrospect, seem to have been considerable. After a 20-year campaign, he hired a Boston lawyer, Linus Child, to lobby Congress on his behalf. Child’s efforts bore fruit. His son told Trist: “I find that my father has spoken to . . . members of the House. Every vote tells, and a simple request to a member may secure his vote, he not caring anything about it.” Congress eventually agreed to pay Trist $15,000, then a considerable sum.

Trist, a hard bargainer, refused to pay the contingency fee he had agreed. The case went to the Supreme Court, which dismissed Child’s claim. A contract to lobby government, it said, was contrary to public policy and hence, like an agreement to sell sex, unenforceable in the courts. Paid lobbying, said Mr Justice Swayne, was “pernicious in its character”. But this was only the beginning of his denunciation. “If any of the great corporations of the country were to hire adventurers to procure the passage of a general law with a view to the promotion of their private interests,” he thundered, right-minded men “would instinctively denounce the employer and employed as steeped in corruption and the employment as infamous”.

The 20th century eroded this austere view of the proprieties of political life. But the notion that politicians might themselves become professional lobbyists after leaving office remained unacceptable. When Harry S. Truman ceased to be US president in 1953, he determined, according to biographer David McCulloch, that “his name was not for sale. He would take no fees for commercial endorsements, or for lobbying or writing letters or making phone calls.”

Truman had little personal wealth and had earned only modest public salaries, and the embarrassment of his poverty led Congress to make financial provision for America’s former presidents.

But by the time of Bill Clinton’s retirement, this pension and contribution to office costs was hardly necessary. Prime ministers and presidents could expect to become millionaires on leaving office, and lesser politicians sold access to their contact books for sums far exceeding what they had earned in public service.

The Court of the 1870s had taken the view that free speech and honest speech were two sides of the same coin. “The theory of our government,” ruled Swayne, “is that all public stations are trusts.” There was a corresponding duty on the citizen. “In his intercourse with those in authority, he is bound to exhibit truth, frankness and integrity.”

But in Citizens United in 2010, the same court held that the expression of views you were paid to hold was no longer “an infamous employment, steeped in corruption”, but an activity deserving of the protection awarded to free speech under the First Amendment. That contentious decision probably did not, in the end, seal the outcome of the 2012 election — though the tide of political donations that it unleashed will surely decide a presidential contest before long. Americans may look back on Justice Swayne as the wiser judge. “If the instances (of paid lobbying) were numerous, open, and tolerated,” he predicted, “they would be regarded as measuring the decay of the public morals and the degeneracy of the times.”

‘It’s the Weather…!’

My Comments: The cacaphony of negative comments by Republicans about the Obama administrations efforts re the economy used to be deafening. Now, not so much.

As an economist, I’m sensitive to the fact that there are too many variables at play to attribute success or failure to an individual in the White House or to a political party. But taking credit or placing blame is a tricky exercise. These comments by Scott Minerd, which to my mind describe events this past winter that can be attributed to global warming, are a lesson not to be missed.

April 10, 2015
Commentary by Scott Minerd, Chairman of Investments and Global CIO, Guggenheim Partners

When Bill Clinton beat George H.W. Bush in the 1992 presidential election, campaign strategist James Carville’s now-famous explanation was, “It’s the economy, stupid!” To paraphrase a more polite version of Carville, I believe the punch line to why real first-quarter gross domestic product (GDP) growth will thwart the consensus forecast of 1.4 percent is just as simple: “It’s the weather…!”

Severe weather conditions this winter have had a profound impact on economic activity in the United States. Based on our analysis of retail sales, industrial production, and government spending, I wouldn’t be surprised to see U.S. economic growth near zero or even negative in the first quarter. This out-of-consensus position is supported by the Federal Reserve Bank of Atlanta, which recently forecast 0.1 percent growth.

When you look at the data, the winter ravages in first quarter are clear. Consumer spending declined in December and January, and was basically flat in February, while nonfarm payrolls were up by just 126,000 in March—the smallest gain since December 2013. As a result of the harsh March weather, 216,000 people reported being unable to work, and over 560,000 people were forced to work part time. Retail data have also borne out the consumer’s frigidness this winter. In February, U.S. retail sales declined 0.2 percent, adding to declines in January and December, and making it the worst three-month performance for retail sales since 2009. Other hard-hit sectors of the economy include construction, where spending declined in both January and February, and manufacturing, with the March Institute for Supply Management (ISM) reading worse than the lows seen last winter.

Essentially, it appears we are having a replay of what happened in the first quarter of 2014, where winter weather distortions caused the economy to slow dramatically. This winter, the warning signs are even stronger, but there seems to be some cognitive dissonance among economists. A Bloomberg survey pegs consensus GDP estimates at 1.4 percent, for example. Besides the Atlanta Fed, I have not seen many forecasts approach zero. All this leads me to believe the market may not be anticipating the full impact of weather distortions on the U.S. economy. Investors’ shock at the true state of first-quarter GDP could easily send interest rates back to test the lows of January, or maybe even lower.

Rather than hit the panic button, investors should view a disappointing first-quarter GDP print as a short-term dislocation. Since 1975, a slowdown in first-quarter growth caused by winter weather has usually been followed by a significant bounce back in the second quarter. The underlying strength of the U.S. economy remains sound, so I expect a similar pattern will play out in the remainder of 2015. While noise around the economy could lead to increased volatility in equities and credit spreads, the bottom line is that weather-induced weakness may present long-term investors with an opportunity to increase their positions to risk assets at discounted prices.

The Unraveling Is Gathering Speed

man+umbrella+globalMy Comments: Yesterday, I posted an article that suggested what you might expect over the next six years if you are a generic investor. You have money positioned here and there across the globe in traditional investments. Today I post an article that posits further evidence that we have structural problems that need resolution.

The dilemma facing those who find themselves in charge of the national debate is that no amount of prayer is going to help. I’ve said before that HOPE is not an effective investment strategy, and by the same measure, PRAYER is unlikely to result in economic stability for future generations. Couple this with global warming and we’re looking at a tough road to hoe.

Charles Hugh Smith / Mar. 19, 2015

Does anyone else have the feeling that things are not just unraveling, but that the unraveling is gathering speed?
Though quantifying this perception is more interpretative than statistical, I think we can look at the ongoing debt crisis in Greece as an example of this acceleration of events.

The Greek debt crisis began in 2011 and reached a peak in 2012. The crisis was quelled by new eurozone/IMF loans to Greece, and European Central Bank chief Mario Draghi’s famous “whatever it takes speech” in late July 2012. The Greek debt crisis quickly went from “boil” to “simmer,” where it stayed for almost two and a half years. But no one with any knowledge of the gravity and precariousness of the situation expects the latest “extend and pretend” deal to patch everything together for another two years. Current deals are more likely to last a matter of months, not years.

We can discern the same diminishing returns in Federal Reserve/central bank interventions, as the initial rounds of quantitative easing pushed stock and bond markets higher for years at a time, while the following interventions generated lower returns.

What factors are reducing the positive effects of intervention and causing increased volatility? Let’s start with the engine behind every central bank/state intervention and every “save” of the status quo: debt.

Debt Brings Forward Consumption & Income
Debt has one primary dynamic: borrowing money to consume something in the present brings forward consumption and income. Economists describe trading future income for consumption today as bringing consumption forward. And since debt must be repaid with interest, bringing consumption forward also brings income forward.

Let’s say we want to buy a vehicle with cash, and it will take five years to save up the lump-sum purchase cost. We forego current consumption to save for future consumption.

If we get a 100% auto loan now, we get the use of the vehicle (present-day consumption), and in exchange, we sacrifice some of our income over the next five years to pay back the auto loan. We brought consumption forward, and in essence, took future income and brought it forward to pay for the consumption we’re enjoying today.

We can best understand the eventual consequence of this dynamic with a simplified household example. Let’s say a household has $2,000 a month in net income, i.e. after taxes, healthcare insurance deductions, etc., and rent (or mortgage payments), basic groceries and utilities consume $1,000 of this net income. That leaves the household with $1,000 in disposable income.

At the risk of boring finance-savvy readers, let’s briefly cover the difference between net income and disposable income. Net income can be earned (wages, salaries, net income from a sole proprietor enterprise, etc.) or unearned (dividends, interest income, rents, etc.) It can only rise by making more money or reducing taxes. There are limits to our control of these factors. In a stagnant economy, it’s tough to find better-paying jobs and harder to demand higher wages from employers. Since governments’ expenditures are rising, taxes are also going up; it’s difficult for most wage earners to cut their total tax load by much.

Disposable income is more within our control, as it is fundamentally a series of trade-offs between current consumption and future income/savings: if we choose to consume now, we have less income to save for future consumption or investments. If we sacrifice consumption today, we have more money in the future for consumption or investing. If we borrow money to consume today, we’ll have less future income, because a slice of our future income must be devoted to pay down the debt we took on to consume today.

If our household borrows money to buy a vehicle and the payment is $500 per month, the household’s disposable income drops from $1,000 to $500. If the household takes on other debt (credit cards, student loans, etc.) with payments of $500 per month, the household’s disposable income is zero: there is no money left to dine out, go to movies, pay for lessons, etc.

In effect, all of the future income for years to come has been spent.

The Only Trick To Expand Debt: Lower Interest Rates

There are only two ways to support additional debt: either increase net income, or lower the rate of interest on new and existing loans to free up disposable income. Suppose our household refinances its auto loan to a much lower rate of interest, and transfers its credit card debt to a lower-interest rate card. Huzzah, each monthly payment drops by $100, and the household has $200 of disposable income to spend on current consumption or on more loans. Let’s say the household chooses to buy new furniture on credit with the windfall. This new consumption brought forward pushes the monthly debt payments back up to $1,000.

This additional debt-based consumption profits two critical players in the economy: the state (i.e. all levels of government) and the financial sector. The state benefits from the higher taxes generated by the sales, and the financial sector profits from transaction fees and the interest earned on the new loans.

The household’s consumption and debt rose as a result of lower interest rates, but there is a limit on this dynamic: lenders have to charge enough interest to service the loan, reap a profit and compensate shareholders for the risk of default.

If lenders fail to properly assess the risk of default, they will be unprepared to absorb the losses incurred as marginal borrowers default en masse. This places the lender’s own solvency at risk.

Using this trick to enable further expansion of debt thus creates a systemic risk that borrowers will over-borrow and lenders will not have sufficient reserves to absorb the inevitable losses as marginal borrowers default and other borrowers suffer declines in disposable income that trigger further defaults.

In other words, the trick of lowering interest rates yields diminishing returns: the more debt that is enabled, the thinner the margins of safety, and thus, the greater the systemic risks rise in direct correlation with rising debt loads.

The Trick To Increase Consumption: Punish Savers
While lowering interest rates increases disposable income and enables an expansion of debt, it also generates a disincentive for households to forego current consumption by saving disposable income rather than spending it. Near-zero interest rates actively punish savers by reducing the interest income earned on low-risk savings accounts and certificates of deposit (CDs) to near-zero. Savers are pushed into either investing in high-risk markets that benefit the financial sector, or into spending rather than saving – a choice that benefits the state, as more spending generates taxes for the state.

The Global Expansion Of Debt Has Increased Systemic Risks
These are the basic dynamics of the entire global economy: interest rates have been pushed to near-zero to punish savers and encourage the expansion of debt-based consumption. But this inevitably leads to a reduction in disposable income and current consumption, as debt brings forward both consumption and income.
Once the borrowers have maxed out their borrowing power, there is no more expansion of debt or additional debt-based consumption. This is known as debt saturation: flooding the financial sector with more credit no longer boosts borrowing or brings consumption forward.

Those who brought their consumption forward can no longer add to present consumption, as their future income is already spoken for. That’s where the global economy finds itself today. This vast expansion of debt on the backs of marginal borrowers and the expansion of risky investments has greatly increased the systemic risk of losses from defaults arising from over-extended borrowers.

No wonder every attempt to further expand debt-based consumption is yielding diminishing returns: net income is stagnant virtually everywhere in the bottom 95% of the populace, and further declines in interest rates are increasingly marginal, as rates are near-zero everywhere that isn’t suffering a collapse in its currency.

The diminishing returns manifest in three ways: the gains from each round of central bank tricks are declining, the periods of stability following the latest “save” are shrinking and the amplitude of each episode of debt crisis is expanding.

That the unraveling is speeding up is not just perception – it’s reality.

My source: http://seekingalpha.com/article/3012436-the-unraveling-is-gathering-speed?ifp=0