FRED says: Our Money Velocity Sucks – Let’s Add More!

 FRED says our money velocity sucks – like a vortex heading down the proverbial drain.  And FRED’s friends keep throwing more and more money on the heap.

FRED is shorthand for Federal Reserve Economic Data and in this case, we reference the St. Louis Fed report titled Velocity of M2 Money Stock (as an economics undgrad, I love this stuff) (https://fred.stlouisfed.org/series/M2V, July 14, 2016).

FRED 1

Take a look at that chart.  Velocity has averaged 1.74 post-Depression.  It peaked at 2.21 Q31997 and has dropped steadily since then.  It is now around 1.4 and falling steadily.  Most people alive today have never seen money moving so slowly.  Capital is log-jammed in the financial system and not moving – money is simply not changing hands the way it used to.  As an entrepreneur, you may have noticed that it is much harder than usual to secure capital for fun things like buying new equipment and hiring employees.

Now check out the supply of money, M2:

FRED 2

It has ballooned from $7.4 trillion to $12.7 trillion since the beginning of the most recent recession.  We have never experienced economic conditions like this – EVER.  Normally when the money supply expands rapidly, it pushes prices up – more money chasing the same quantity of goods.  Ominously, this has not happened in the last nine years.  In fact the opposite is happening – deflation.  Deflation has been avoided only because of the unprecedented printing of money.  But it is coming.

So we have nearly doubled the money supply (71% increase since December 2007) and all of that increase plus a big chunk of the money in circulation before that is now lodged firmly in the financial system and isn’t coming out any time soon.  It will take a major event to dislodge it.  What type of major event?  How bad will it be?  Well, seeing as to how the last one was pretty painful and we were at half the altitude we are now, the next one is probably going to be severely painful.  Rioting in theriotingstreets like Venezuela painful? (http://www.ibtimes.co.in/venezuela-food-riots-5-dead-protests-over-high-inflation-food-
shortage-683228). Don’t know.  Please respond with your thoughts on what you think the outcome might be.

global wealthMany people have asked me “Well then, where is this money held exactly?”  Ultimately, it is all owned by individuals – you and me.  In fact, it is now estimated that the wealthiest 62 people on the planet have the same wealth as the bottom 50% of people on the planet.  Credit Suisse puts the figure at the top 1% having the same wealth as the bottom 50% of the world’s population.  (http://fortune.com/2015/10/14/1-percent-global-wealth-credit-suisse/)

So the answer is that the vast majority of wealth created is stored safely and securely at the top.  (https://publications.credit-suisse.com/tasks/render/file/?fileID=F2425415-DCA7-80B8-EAD989AF9341D47E)

On the bright side, the number of newly-minted millionaires is on the rise again.  The city with the most millionaires?billionaires

 

New York!

us wealth report

What next? Sell in May and Go Away

Sell in May and go away

That’s the mantra of many traders.  Nothing happens in the summer months because everyone is in the Hamptons.  It’s 5:00 Friday, July 1 and if I needed to reach one of my former bosses right now, my call would likely be returned sometime around Wednesday next week.  I know.  It happened more than once.

But this summer the roads back to NYC and Greenwich from the Hamptons may be clogged soon.

Here’s why.

blog 7 1 pic 2

Signaling a massive capital flight to an asset with universal value, gold has skyrocketed $300 or 30% in the last three months:

Source: Monex.com

Large amounts of capital are moving into the asset that has never gone to zero.

Global banks have plummeted over the last five years.  Deutshce Bank lost$7 Trillion in value in the fourth quarter by itself.  That’s Trillion – as in One Thousand Billion, times 7!!

blog 7 1 pic

Source: https://dentresearch.s3.amazonaws.com/EconomyandMarkets/images/2016/070116_ENM.gif

Why?  Because eight years into this “recovery” the global financial system has ingested $550 Trillion in credit default swaps and other derivatives.  Duetsche Bank has ten percent of the total.  One institution has 10% of the global total of what Warren Buffett called “financial weapons of mass destruction”.  “How is that possible, Joe?” you ask.  “I thought it was all about deleveraging after the Great Recession”.

That was what we all read in the financial press.  Financial regulators worldwide were forcing systemically important financial companies to rein it in, to decrease risk, to reduce reliance on borrowed funds.  It appears that was all window dressing.  Even the blog I wrote earlier this week about the eight largest US banks passing the new “stress tests” was evidence of the prevalence of this new story line that on the surface looks great but just below the surface is in reality probably not worth the paper the plans are written on.

To put the risk we are facing in perspective, the Gross World Product was $107.5 trillion in 2014 according to the CIA World Factbook.  Based on the $550 trillion figure above, we have hedged every financial transaction in the world more than four times over.  I just bought a $3 pack of gum at the Atlanta airport.  Global financial traders have already placed bets totaling $12 for and against that transaction.  Why?  Because financial engineering has taken precedence over actual engineering, actual goods and services.

If you don’t follow Harry Dent at DentResearch.com, you should.  Harry has spotted macro trends worldwide for almost 30 years.

Harry identified that many of the world’s largest banks are in deep trouble but regulators, even the vaunted European Supervisory Authorities are apparently ignoring the problem.

How big is the problem?

Italy’s banks have 18% non-performing loans.  That means bad loans are over two times larger than their systemwide collective capital.  I can tell you from personal experience (as the founder of Georgia’s largest community bank – one that failed in the Great Recession, I can say this with no risk of contradiction) that a bank has no hope of survival in this condition.  And this is the entire Italian banking system. Italy is part of the EU.  Losses of this magnitude could wipe out the entire capital base of the EU.

But Italy only takes third place in the deficit Olympics.  Greece has 34% non-performing loans and Ireland has 19%!  No slacker, Portugal has 12%.

If regulatory bodies had the resources to shut these institutions down, they would.  The fact is they are also undercapitalized.  It’s a house of cards that everyone hopes will miraculously remain standing but it simply can’t.  Our own FDIC operated in the red for a couple years but there was nothing anyone could do about it.  The option was to shut it down and start over.  Every bank in the U.S. would have had a run that day.  The next day, all banks would have failed.  Global financial meltdown.  We have been 48 hours away from this scenario a few times.  The first time was in September 2007.  I remember it well.  There was briefly no LIBOR.  Banks would not lend excess reserves to other banks overnight because they were afraid they would not get their money back the next morning.  The Fed and the European Central Bank engaged in coordinated flooding of over $250 billion into the financial markets over one weekend to maintain market liquidity.  I told my bank board that this had never happened before.  That was just a precursor of the tidal wave barreling down on all of us.

The Greater Recession

Enough doom and gloom.  I write about this so that it might give rise to the thought about what to do when the Greater Recession starts.  In the last one, the Great Recession, cash was king.  One client called me and excitedly exclaimed, “I just bought my four million dollar loan from the FDIC for eight cents on the dollar!”  He wasn’t bragging, he was genuinely excited at saving 92%.  He had just saved his company from certain financial ruin.

Be prepared.  Cash gives you optionality.  You can choose to spend it or invest it or you can simply hold it.  If another recession hits, you will have your pick of assets to purchase at very deep discounts if you have cash that you can access.  This is a great time to be building your reserves.  And if we miraculously avoid another recession, you have the option of investing in assets that have a more certain future.

The New Normal

What will the banks do this time?
 Life Post-Brexit

Will we have to adjust to a “new normal” the way we did in 2008 and beyond?

By 2010 it was clear that the recession was not ending anytime soon.  We began to talk to clients and capital providers about the “new normal” in many industries.  The metrics had just simply changed.  Most industries have recovered and the industry benchmarks have returned to where they were pre-recession and many industries have entirely new metrics.

Fortunately there have been structural changes, especially in the banking system.  In fact, the eight largest “systemically important” banks had to specifically test for the impact of severe UK recession coupled with similar conditions in the Euro Zone and Japan and a less intense recession in Asia, and they all passed according to a Federal Reserve report.  Click here for a link to the Bloomberg article on the topic.

banks post brexit

And these banks had to draft their own obituaries – a detailed plan of what to do in the event the bank failed (now wouldn’t that just put you in a bright cheery mood if you had had to do that?).  Bankers had to get much more deliberate about how they manage their operations and they have to plan for extraordinary events in ways they never did before.  The most important factor at the end of the day is cash capital, or, in banking terms, liquidity – the ability to meet cash demands when they are made.  Probably not a bad idea for your company to do the same.  Plan to have enough cash to meet the needs of your business for up to two years without borrowing or selling assets.

Can you do it?

We may have seen a permanent shift in banking in the last several years.  U.S. banks have more regulations and are under more pressures than they ever have been.  They are forced to look more closely at everything they do.  There has been an explosion of growth in the shadow banking system – non-bank capital allocators like hedge funds – that are filling in the gaps left by the banks withdrawal from certain sectors.  It’s a different game with these operators.  Vertical Capital Advisors LLC is built to help you navigate your company through the new new normal in the capital markets.