AN EQUITYMASTER AGORA RESEARCH PUBLICATION

3 October 2016

Debt has a very serious flaw as money. Like a sleeper cellor a doomsday code, it will suddenly
come to life and trigger a much bigger crisis than anything weve seen so far.

Bill Bonner

When Too Much Growth Becomes Cancer

Growth is Life.

IN THIS WEEKS ISSUE:

Thats the tagline of Mukesh Ambani-controlled

Reliance Industries Ltd one of Indias largest
conglomerates.
But I dont fully agree.
Not all growth is life. There is growth that is normal
and healthy. And there is malignant growth that can
lead to cancerand eventually DEATH.
Heres how an online health journal describes cancer:
Cancer is a class of diseases characterized by outof-control cell growth.

A Monster Called Growth

The Land of the Rising Debt

Three Things Between Here and

Catastrophe

Had Raghuram Rajan Really Planted a

Financial Time Bomb?

Of Oil, Saudi Arabia, and Chinas

Alarming Debt Pile

that everything is under control, that they are doing

whatever it takes, and that were on the path to
recovery.

Normal cells stop growing (reproducing) when

enough cells are present. In contrast, cancer cells
dont stop growing when there are enough cells
present. This continued growth often results in a
tumor (a cluster of cancer cells) being formed.

Tim Price, our big-picture expert from London,

believes that there is now so much debt in the
world, it can never be paid back. And he is going
to mathematically prove whats wrong with too
much growth and too much debt. You dont need to
be a rocket scientist to understand this. Its plain
mathematics.

Cancer cells dont interact with other cells as

normal cells do. Normal cells respond to signals
sent from other nearby cells that say, essentially,
youve reached your boundary. When normal cells
hear these signals they stop growing. Cancer
cells do not respond to these signals.

If theres one place on this planet that epitomizes all

the wrong kinds of growth, the place is Japan. Too
much money printingtoo much debttoo much
government interventiontoo much stock market
manipulation. Vern Gowdie, our finance expert from
Australia reveals what has gone terribly wrong in
Japan.

Doesnt that eerily sound like a diagnosis of the global

financial system?
Yes, it certainly does. And it is indeed true that
the malignant tumors are growing and spreading
rapidly within the global financial system. The socalled doctors of the economy central bankers,
policymakers, economists are not going to come
clean and tell you this ugly truth. Theyll keep saying

But why bother about Japan, you may ask.

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Because thats where the rest of the worlds central

banks appear to be heading. As Bill Bonner lays down
the facts before you, central banks ownership of the
worlds assets has increased to about 40% of global
GDP. We dont know about the timing. But the end is
going to be ugly.

Read on for this weeks full issue... and please send

us your feedback. Tell us what you like and what we
should change.
Warm regards,

Coming back home, is the RBI prepared for the

FCNR(B) redemptions? If you recall, Rajya Sabha
member Subramanian Swamy had criticized RBI exgovernor Raghuram Rajan for planting a financial time
bomb? My colleague Rohan Pinto examines the facts
and the numbersand gives his verdict on the issue.

Ankit Shah - Research Analyst

Editor, Vivek Kauls Inner Circle

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A Monster Called Growth

Tim Price, The Price Report

YouTube calls it the most important

video youll ever see and for once,
is barely exaggerating. The rather
unexciting-sounding presentation
Arithmetic, population and energy
is still one of the most thoughtprovoking videos Ive ever seen, and
its one that has made a profound impression on my
own investment thinking.
Albert Bartlett was a physics professor at the
University of Colorado at Boulder in the US. He
probably gave this lecture over 2,000 times in his
lifetime (hed made over 1,700 presentations as at July
2001; he died in September 2013). I enjoyed it so much
I wrote to the university for a hard copy.
Professor Bartletts argument is straightforward. For
any entity, beyond maturity, further growth is either
obesity, or cancer. There is a natural limit to things,
and we go beyond that limit at our peril.
When a quantity such as the rate of consumption of
a resource (measured in tons per year or in barrels
per year) is growing a fixed percentage per year, the
growth is said to be exponential.
promised the mathematician anything he wanted. The
mathematician replied: place one grain of wheat on
the first square of the chess board, then double it and
put two grains of wheat on the second square. Put on
each subsequent square twice the number of grains
that were on the previous square.

The important property of the growth is that the time

required for the growing quantity to increase its size
by a fixed fraction is constant. For example, a growth
of 5% (a fixed fraction) per year (a constant time
interval) is exponential. It follows that a constant time
will be required for the growing quantity to double
its size (increase by 100%). This time is called the
doubling time

By square 64, there are 263 grains on the last square.

The total number of grains on the chess board will be
one grain less than 264.

Professor Bartletts fundamental argument is that

as human beings, we have immense difficulty
understanding the tremendous power of the
exponential function. Our inability to grasp its power
may prove our undoing on this planet.

How much wheat is 264 grains? Its approximately 500

times the 1976 annual worldwide harvest of wheat.
This amount is probably larger than all the wheat that
has been harvested by humans in the history of the
earth!

One of his earlier examples is that of the game of

chess.

Exponential growth is characterised by doubling,

and a few doublings can lead quickly to enormous
numbers.

Legend has it that chess was invented by a

mathematician who worked for an ancient king.
The king was so impressed by the game that he

Another of Professor Bartletts thought experiments:

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bacteria.

managed to reduce its debt-to-GDP ratio since 2007.

Imagine bacteria growing quietly in a bottle. Over

time, one bacteria becomes two; two divide to become
four; and so on.

If you accept that we have a significant problem with

debt, there can only be three ways of resolving it.
One is for governments to engineer enough economic
growth to ensure that the debt keeps getting serviced
(that all those annual coupons keep getting paid, and
all that maturing debt is repaid to investors). I would
posit that such economic growth is now impossible,
especially within the Eurozone, which looks close to
being in a depression.

Now consider a hypothetical strain of bacteria for

which this division time is one minute. In other words,
every minute, the number of bacteria double.
One bacterium is put into a bottle at 11.00am and it
is observed that the bottle is full of bacteria at 12.00
noon. This is a simple example of exponential growth
in a finite environment. This is mathematically
identical to the case of the exponentially growing
consumption of our finite resources of fossil fuels.

The second is to default on the debt, to repudiate it,

to cancel it, to have some kind of debt jubilee. This
may seem like the easiest option, but there are two
caveats. One is that we live in a debt-based monetary
system. All the money in circulation was lent into
being by banks.

He then goes on to ask three questions:

1.

When was the bottle half full?

Answer: 11.59 am.

2.

Simply paying down debt destroys money in

aggregate. A wholesale default by a major
government, in such a system, would equate to
economic Armageddon. The other caveat is that one
persons debt is another persons asset. So while it
might seem sensible for debt-laden governments to
start defaulting on their debts, the side-effect would
be the immediate bankruptcy of all pension funds, for
example.

If you were an average bacterium in the

bottle, at what time would you first realise
that you were running out of space?

Answer: This is a rhetorical question.

3.

Suppose that at 11.58am some farsighted

bacteria realise they are running out of
space and consequently, with a great
expenditure of effort and funds, they
launch a search for new bottles. At
11.59am they discover three new empty
bottles three times the number of
bottles that had hitherto been known. How
much time does the discovery buy them?

There is a third way of resolving the debt dilemma. Its

also the route that every heavily-indebted government
throughout recorded history has gone down. Its
called inflation.
Which accounts for why so much time and money
has been spent on quantitative easing (QE) since
the crisis hit a state-sanctioned inflationism that
is meant to drive inflation higher and the real debt
burden on governments lower. The problem being it
hasnt worked. Financial asset prices and the prices
of boys toys classic cars, premium real estate, fine
wines, collectibles, art may have been pumped up
into the heavens, but the prices of traditional goods
and services remain stubbornly earthbound by
comparison.

Answer: Two more minutes.

As Bartlett has already alluded, once you start to
replace bacteria in a bottle with people on Earth
consuming fossil fuels (or any other finite resource),
you start to look at the world through a fresh pair of
eyes.
Or consider our problem with debt. My base case
is that there is now so much debt in the world, it can
never be paid back. Whether you agree or not, what is
undeniable is that the global store of debt is growing,
not contracting. In its February 2015 report Debt
and (not much) deleveraging, McKinsey pointed out
that since 2007, global debt had grown (not shrunk,
as some politicians would have us believe) by the
order of some $57 trillion. Nor has any major economy

And since the beginning of September theres a new

front in the war of financial repression.
Having tried and failed for many years to prevent
Ireland from luring global businesses with the most
competitive corporation tax rates in Europe, the EU

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Regardless of whether the EU succeeds in its

hypocritical and probably illegal mission to enrich
Ireland and impoverish Apple, the message seems
clear. Size is an acute problem for big businesses,
too. Businesses sitting on sizeable piles of cash are
now public enemy number one for greedy, desperate
governments. Shareholders may wish to diversify
their holdings away from popular and in most
cases, horribly expensive mega-cap companies,
and towards still profitable but smaller and mid-cap
listed businesses instead. US large-cap stocks look
especially vulnerable: of the top 500 companies by
market capitalisation in the US, the median company
valuation stands at an 18% premium to its ten-year
average. Valuations in smaller to mid-cap companies,
however, in the US and Europe, are well below their
peaks.

has adopted a new strategy: it has declared Irish

tax breaks to be mysteriously illegal and landed
Apple with a bill for 13 billion, plus interest, for what
amounts to retrospective tax avoidance. An EU victory
would establish an ugly precedent.
So we now have the absurd situation of the (heavily
indebted) Irish government doing everything it can
to wriggle out of collecting 13 billion in tax. But its
protests are justifiable. If the EU wins this contest,
Ireland looks set to lose a good deal more than 13
billion as a whole host of global businesses that
previously favoured low-tax Dublin suddenly elect to
operate elsewhere. Michael Noonan, Irelands minister
of finance, points out that the only sensible thing is to
fight the EU; to do anything else would be like eating
the seed potatoes.
The conclusion? Heavily indebted governments are
like cornered rats. When asked why he robbed banks,
the American bank robber Willie Sutton allegedly
replied, Because thats where the money is. Heavily
indebted governments will also go where the money
is and they will turn to the likes of Apple, with its
150 billion cash pile, to get it.

But those companies sitting at the top of the major

international stock indices, especially in the US,
now look like gigantic targets, with the words Cash
Cow hanging around their necks. They are already
expensive, but they now run an above average risk of
being mugged by governments on the prowl for cash.

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The Land of the Rising Debt

Vern Gowdie, The Gowdie Letter

than Gideon Gono, Governor of the Reserve Bank

of Zimbabwe) has gone. Strangely, the press never
lavished the same praise on Gideon Gono that they
heaped upon Abe.

Lets travel back to February 2013.

Japans newly elected Prime
Minister, Shinzo Abe, announced his
bold, brave and bullish economic
blueprintAbenomics.

Only five months after Abe announced his master

plan, The Telegraph had this to say about Gono:

Abes plan is based on three arrows

(fiscal stimulus, monetary easing and structural
reforms), designed to lift Japan from its 20-year
economic deflationary stupor.

While he talked a good game, Mr Gonos priority

was to keep Mr Mugabe happy. That meant printing
money at a furious pace in order to fund a bankrupt
government. The result was hyperinflation and
accelerating economic collapse.

On 3 February, 2013, Forbes contributor Stephen

Harner wrote:

Printing money to fund a bankrupt government.

Sounds familiar? The result was hyperinflation. No,
that has definitely not happenedat least not yet.
Economic collapse. Well, in Japans case, that is still a
very real possibility.

Specifics toward policy aside, it is hard not to be

mightily impressed by the practiced hand apparent
in the new Abe/Aso government. These guys seem
to know how to govern.
with PM Abe Shinzo and his alter-ego, mentor,
and (in a relationship resembling that of Dick
Cheney and George W. Bush) possibly master,
deputy PM and finance minister Aso Taro. These
men seem firmly in charge and settled on a
concrete (no public works spending pun intended)
agenda for reviving Japans economy.

To me, it just sounds like Gono and Abe have taken

different routes to the same destination. Gono took
the high (really high) road of inflation, while Abe is
headed down the low (very low) road of deflation.
Yet the Western world thoroughly endorses one, and
discredits the other.
Could this possibly have anything to do with the fact
that our central bankers are all contemplating turning
Japanese themselves in the not too distant future?

Know how to govern. Firmly in charge. Settled on

a concrete agenda.
Mr Harner leaves you in no doubt that Abe and Aso
are men of discipline and strength. However, its
the first four words that tell the real tale: Specifics
toward policy aside. It is a minor detail, but extremely
important.

Therefore, how could they discredit a policy they too

are destined to follow? Hypocrisy.
Anyway, back in early 2013, Abe went to the
whiteboard and laid out his grand plan.

Allow me to interpret what these words mean. If we

put to one side the fact that these guys are planning
to print a gazillion yen to indirectly underwrite their
inability to control their spending habits, and to prop
up the worst performing share market of the last
quarter of a century, and to put the yen not just in
the toilet but around the S-bend to improve export
competitiveness, and to keep printing even more yen
until inflation nudges the 2% level, then, yes, they are
indeed courageous pioneers.
Abe and Aso had a plan to go where no-one else (other

Source: Business Insider [Click to enlarge]

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And you thought it was just three arrows?

yen to US$1 in early 2014, to 125 yen in mid-2015.

This plan has more arrows than an archery

competition. Are you with the plan?

However, since the middle of last year, the yen has

steadily regained its strength. Its now back around
the same level it was when Abe mapped out his master
plan.

Dont worry, neither is Abe.

What was really needed at the bottom of this elaborate
chart was Abes footbecause thats where most of
the arrows ended up.

What about that inflation target?

OK, let me try to give you the basics of the grand plan
in a few easy steps.
Print money. Drive down the yen. Generate more
export dollars to make companies more profitable.
This triggers higher share prices. Profitable companies
pay higher wages. Higher wages and the wealth effect
(from the higher share prices) mean increased private
consumption.

Source: Trading Economics [Click to enlarge]

Inflation initially took off, then steadied, and has now

plummeted. Generating inflation and maintaining
inflation are two different things.

People spend more, so companies increase capital

expenditure. This leads to more exports.
And as if this well-oiled economic rocket was not
enough to achieve inflationary liftoff, then throw in a
very healthy dose of infrastructure spending for good
measure.

In the longer run, the true dynamics at play in an

economy come to the fore.
The following excerpt was published by Reuters on 26
August, 2016:

End result: break away from deflation.

Japan July consumer prices post biggest annual

fall in three yrs

What could possibly go wrong?

Central to the plan (in fact, it was the plan) was
weakening the yen against the US dollar. How did that
go?

Japans consumer prices fell in July by the most in

more than three years as more firms delayed price
hikes due to weak consumption, keeping the central
bank under pressure to expand an already massive
stimulus program.

This is a chart of the US dollar measured against the

yen. When the line is rising, it means the yen is
weakening. Conversely, when the line is falling, the yen
is strengthening.

The gloomy data reinforces a dominant market

view that premier Shinzo Abes stimulus program
have failed to dislodge the deflationary mindset
prevailing among businesses and consumers.
But its not all doom and gloom. The share market
has gained more than 50% since Abes February 2013
announcement.
The Nikkei 225 surged from 11,000 points to a high
of 20,000 points. But of late, with the stronger yen
hurting corporate earnings, the Nikkei has fallen back
to around 16,800 points.
Also, part of the reason for the Japanese share
markets stellar performance could have something to
do with whos buying the stock:

Source: Trading Economics [Click to enlarge]

The yen did weaken initially going from around 100

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Meanwhile in retail, department store sales fell 6

per cent year-on-year, having slipped 0.1 per cent
in July, according to industry data. This was the
sixth month of contraction and the deepest fall
since March 2015 (when there was a big distorting
effect relating to people stocking up in the same
month a year earlier ahead of a sales tax rise).
Supermarket sales were not immune from a
pullback either. They fell 2.9 per cent year-on- year,
compared to a 0.2 per cent rise in July. This was
also the steepest fall since March last year.

Source: Real Investment Advice [Click to enlarge]

The Bank of Japan (BoJ) has been actively buying

shares with some of its newly minted yen. Wouldnt
that be nice? Create money out of thin air to buy a
truckload of shares?

Poor old Abe must be scratching his head and

wondering why its not all going to his well laid out
plan.

Im sure any of us could move a market if we had

access to a virtually unlimited supply of cash.

One thing thats not stagnant is Japans public debt.

The land of the rising debt continues to live up to the
name.

Perhaps the artificiality of the wealth effect is why

this concept remains just an academic theory.
The absence of the wealth effect could explain why
economic growth is all but non-existent hovering
around the 0% level.

Source: Trading Economics [Click to enlarge]

The government keeps spending money it doesnt

have, to keep the economy standing still.
That is why theres been such a concerted effort
to drive government bond rates lower and lower
to contain debt servicing costsrelieving a little
pressure on the budgets bottom line.

Source: Trading Economics [Click to enlarge]

And the news is not getting any better on the

consumption front.
The following excerpt is from the Financial Times,
published on 21 September, 2016:

However, theres nothing in the foreseeable future

thats going to change the left to right upward
trajectory of this chart.

Japan data paints stagnant picture for August

[2016]

Running in tandem with the governments spending

spree is the Bank of Japans asset buying program
with money its created out of thin air.

Heres some economic data from August to chew

on.

When you look at the balance sheets of the worlds

major central banks the US Federal Reserve,
European Central Bank (ECB), Peoples Bank of China
(PBOC) and Bank of Japan (BoJ) they have all
expanded significantly since the crisis of 200809.

Theyre not pretty. The final reading of machine

tool orders a useful proxy for capital spending
confirmed they dropped 8.4 per cent year-on-year,
a thirteenth straight month of falls, though at least
not in the double digits as in the previous twelve
months.

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arrows, the results are unequivocally dismal.

There is no economic liftoff.
An indebted and ageing population is not interested in
helping Abe out.
And Abe probably knew he was running into a debt
and demographic headwind when he launched his
arrows.
This is why Abenomics was nothing more than a
Trojan horse for a currency devaluation.
The whole exercise was about weakening the yen
to gain a price advantage over China, South Korea
and Taiwanexporting cheaper cars and other
manufactured goods around the world.

Source: Yardeni Research [Click to enlarge]

Judged by this measure, Abenomics has been an

abject failure. Japan is caught in a deflationary bind.

But none more so than Japan.

The Bank of Japans balance sheet at US$4.5 trillion
(as of August 2016) is on a par (in dollar terms) with
the Fed and PBOC.

No amount of quantitative easing for asset purchases,

infrastructure spending, negative rates or government
debt has been able to ease deflations grip on the
economy.

However, the Japanese economy is much smaller in

size.

Deflation is the spanner in Abes works.

After making a profit windfall from a lower yen,
companies were supposed to spend the increased
profits on capital expenditure. Take a look at Abes
chart this is what was meant to happen.
But it didnt happen. Companies stockpiled the extra
cash. Households were supposed to do their part and
spend their higher wages. But they didnt. They too
stockpiled the extra cash.
The following headline was published by Bloomberg
on 25 March, 2016:
Source: Wikipedia [Click to open in a new window]

The BoJs balance sheet is now slightly larger than

the Japanese economy. Can the BoJ keep buying, and
expanding its balance sheet?
Logic says no. But as with all things economic in
Japan, logic does not seem to prevail. Therefore, it will
keep buying.
Everything with Japan is frontier stuff. It is the
economic laboratory for the rest of the world. So we
watch and wonder at the depths it will plumb in order
to avoid a Zimbabwean type fate.
Source: Bloomberg

Three years and eight months after Abe launched his

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happens with deflation. Cash becomes more valuable,

and debt is shunned.

Japanese companies and households piled up

cash at record levels in the last quarter of 2015,
offering little support for an economy that some
analysts forecast is at risk of contracting again.

The reason the rest of the worlds central bankers are

begrudgingly following the policy lead of the BoJ is
because the world is in the grip of deflation. Pure and
simple.

Corporate assets in cash and deposits reached a

record high of 246 trillion yen ($2.2 trillion), rising
for the 29th consecutive quarter, according to Flow
of Funds data released by the Bank of Japan on
Friday. Households assets rose to 902 trillion yen,
the highest level on record, marking nine straight
years of growth.

With Chinas economic growth possibly halving in the

next few years, deflation is going to become an even
bigger and more pressing problem for central banks.
The way I see it is that if the central banks are
following the BoJs lead, then we should take a leaf out
of the playbook of Japans corporates and citizens,
and also stockpile cash.

29 consecutive quarters. Thats more than seven

straight years of squirrelling away cash. This is what

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Three Things Between Here and Catastrophe

Bill Bonner, The Bill Bonner Letter

The oddness began years ago, but in

September things got weirder

and bonds leaving the feds with total control of

every company in the world?

Two private companies one German

and one Frenchborrowed money at
less than zero interest. As far as we
can tell, this was a first in recorded

But wait. Wheres the weak link in this chain?

Instinctively, we are pretty sure this cannot happen.
But why not?
It is because they dont have any real money. All they
have is counterfeit, phony money. It works just like
the real stuff. But only if they dont throw around too
much of it.

history.
But strangest of all central banks ownership of the
worlds assets rose to the equivalent of 40% of global
GDP. Two years from now, they will own half of it if
they continue at this pace.

Try to corner the market of stocks and bonds (the

Bank of Japan is buying real estate trusts, too) with
ersatz money? Good luck with that!
Lets just pause a minute. Let us take a breath and try
to imagine this brave new world.
The feds own all the public companies (and many
that had been private, too as owners saw they
could sell their stray cat-and-dog companies
to the feds at a huge profit). The government
controls all major sources of credit, money, jobs,
incomes, investment returns everything. All we
have is small bills and not much of that. We cant
store wealth easily the feds own most of the
investments. And were not allowed to hold cash,
except in the governments banking utilities. Most
likely, gold has been outlawed, too.

This is, by far, the strangest thing going on in the

macroeconomic world. The Bolsheviks, the Maoists,
the Khmer Rouge, the Cubans, the Sandinistas, the
Vietcong all nationalized major industries by force.

What kind of world is this?

Many other countries have used taxpayer money, debt,

fraud, and strong-arm tactics to acquire positions
in key industries. Under Mitterrand, for example, in
the 80s, France made a rupture with capitalism to
buy controlling interests in many sectors, including
energy, steel, autos, and banks.

It is the Soviet Union, 1919 to 1989! In short, it is a

nightmare. And we know how that story ended up.
After 70 years, the Russians awoke to find themselves
with a wrecked economy, which they are still trying to
reboot, nearly 30 years later.
Perhaps that is where were headed; perhaps not. But
if it is to happen, it will have to happen in the U.S. as it
did elsewhere not by the fraud of fake money, but by
naked, brutal force.

But as far as we know, this is the first time

governments have bought up ownership of privatesector companies on the open market, using creditbased money. The central banks create the money.
They make the purchases. Asset prices rise. Everyone
is happy.

Where We Are Now

Governments have an unlimited amount of money.

Mightnt they buy up 100% of all the worlds stocks

Had the feds not intervened forcefully in 2008,

2009, says economist Richard Duncan, formerly of

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requirements, buying stocks and bonds appears

to be reaching its limits. And yet, like a terrorist who
has stitched himself into a vest of explosives, the
authorities are hostage to their own delusions.

the IMF, we would have almost certainly had another

Great Depression.
He may be right. But since they intervened with even
more bubble credit propping up failing enterprises,
saving over-stretched banks, bailing speculators
out of their bad gambles the opportunity for a vital
correction was lost. An even bigger crisis now lies
ahead.

They created an economy trussed up by the lowest

interest rates in 5,000 years. If they try to correct their
mistakes, they will blow themselves up.

Worldwide, central banks fought the credit shrinkage

with an additional $8 trillion of new credits, in the
form of Quantitative Easing and interest rate policies
designed to reduce the cost of borrowing. The Feds
QE program is currently on hold. But Europe, Japan,
and the UK continue to buy stocks and bonds. A
further $1 trillion is scheduled to be spent in the next
six months.
These programs have been so unproductive, it is
surprising they have not been abandoned already.
Here Ambrose Evans-Pritchard of the Daily Telegraph
reports on the status of European Central Bank
intervention:

Three Things Between Here and

Catastrophe

Large parts of the Eurozone are slipping deeper

into a deflationary trap despite negative interest
rates and one trillion euros of quantitative easing
by the European Central Bank, leaving the currency
bloc with no safety buffer when the next global
recession hits.

This situation appears stable as long as three things

remain in place: decent GDP growth in China (the
worlds number one buyer and seller), a solid U.S.
capital market (where much of the worlds wealth is
concentrated), and very limited inflation.
But these things are far from guaranteed.

The ECB is close to exhausting its ammunition

and appears increasingly powerless to do more
under the legal constraints of its mandate. It
has downgraded its growth forecast for the next
two years, citing the uncertainties of Brexit, and
admitted that it has little chance of meeting its
2pc inflation target this decade, insisting that it is
now up to governments to break out of the vicious
circle.

In fact, Chinas volume of trade is going down. Look at

this chart of Chinese imports:

Mario Draghi, the ECBs president, said there are

limits to monetary policy and called on the rest of
the Eurozone to act much more decisively to lift
growth, with targeted spending on infrastructure.
It is abundantly clear that Draghi is played out and
were in the terminal phase of QE. The Eurozone
needs a quantum leap in the nature of policy and
it has to come from fiscal policy, said sovereign
bond strategist Nicholas Spiro.

As for U.S. asset prices, Mr. Trump is not wrong when

he says the Fed has created a false stock market.
It is expressly forbidden to manipulate the prices of

Monetary policy reducing rates, adjusting reserve

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send them down 50% in just a few weeks. That would

be a loss of fictive asset values of approximately
$35 trillion in the worlds stock markets alone. Add
losses from bonds and real estate, and you could be
looking at $100 trillion in losses in less than 60 days.

stocks in America. It was made illegal in the 1937 SEC

act. But that is nevertheless exactly what the Fed is
doing.
The current Shiller CAPE reading is 27, substantially
higher than the long-term average of 17. And the
current 10-year Treasury bond yield is all of 1.53%;
that is the risk-free return against which all other
investments must compete. At that level, the 10-year
offers little competition to stocks. Which is the whole
idea.

That sounds impossible. Unbelievable. But the global

money system is based on $200 trillion in debt, with
$60 trillion of that added in just the last eight years.
Would a 50% correction be so extraordinary?
Or look at it another way. Since 08, the Fed has added
$3.6 trillion to the system. This has multiplied into an
increase in household net worth of $33 trillion in the
U.S.

Investors were meant to be forced into the stock

market. And theyve driven U.S. stock prices to levels
such as they have only been on three occasions in the
last 100 years.

Do households really have assets worth $33 trillion

more today simply because the Fed lends money it
doesnt really have, to people who dont really need it,
who use it to buy assets that arent really worth what
they pay for them?
Wouldnt you expect wealth that came so easily to
leave easily, too, not even bothering to say goodbye?
We turn again to Richard Duncan, who sees more
clearly than most economists the role of liquidity in
the global economy. He is so alarmed by the threat of
a slowdown in credit that he sent me a note, urging me
to spread the word about what this will mean.

Increases in asset prices had little, if any, effect on

consumer prices that is the third thing saving us
from catastrophe.

He believes we face a crisis that will be worse than

the Great Depression, with horrible political, military,
and other consequences including millions of
people who will starve to death.

If the Fed were to hit its target of 2% annual inflation,

for example, an investor in todays 10-year bond would
lose 0.5% per year. Imagine if inflation hit even 4% per
year (where the CPI stood as recently as 1991). Think
of the pension funds, insurance companies, corporate
treasuries, and individual retirement accounts all
could face staggering losses.

We cant let it happen, he writes.

(I am with him until he comes to his solution:
governments need to borrow and spend more
money.)
And what could central banks do to stop a broad
market sell-off? Against this Sahara of dried-up
liquidity, central banks current QE programs $500
billion a quarter will seem like nothing more than the
leak from a septic system. They will surely announce
new initiatives, but who will listen?

Ultimately, asset prices go whither they will. Any kind

of shock could send the Dow down 1,000 points in a
single day. A panic could mean a 10% drop in a few
days. And a re-run of the 20082009 panic would

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Had Raghuram Rajan Really Planted a

Financial Time Bomb?
Rohan Pinto Research Analyst, Equitymaster

The counterparty in those forward agreements

who are to deliver the US dollars to RBI are banks
themselves (not necessarily the earlier ones). These
banks transact with exporters and are dependent on
them for US dollar supplies, which they then provide
to RBI. These banks might just face some difficulties
doing that. The RBI, however, continued to buy US
dollars from the market and has raised its forex
reserves by US$66 billion since FY14.

A lot has been written about

the potential adverse impact of
impending Foreign Currency Non
Resident (Bank) deposit outflows
aka FCNR(B) outflows. Subramanian
Swamy even went to the extent
of accusing former Reserve Bank
Governor, Mr Raghuram Rajan of planting a time
bomb in the Indian financial system. Lets try and
understand from scratch what is this hoopla all about.
Around September 2013, the Indian rupee vis-a-vis the
dollar was down in the dumps. The rupee depreciated
over 20% against US dollar in 6 months. To stem this
flow as well as to strengthen its reserves, Reserve
Bank of India (RBI) directed banks to open a window
and accumulate US dollar deposits from Non Resident
Indians (NRI) by offering them 3.5% interest. These
deposits had a tenure of 3 years. Through this process
US$25-27 billion were collected in a short time frame.

www.equitymaster.com

FCNR(B) Redemption
In preparation for the redemptions, banks who took on
FCNR(B) loans will now swap their rupees from deposit
base to dollars from the RBI. They might face some
liquidity (rupee) crunch due to a high rupee outflow
from their deposit base.
To combat this issue, the RBI has purchased G-secs
from the open markets worth over Rs 1 trillion. At an
exchange rate of Rs 67, it translates to US$15 billion of
rupee liquidity already injected in the system.
In the past, the central bank has infused rupee
liquidity by buying the incoming dollars from the
market. This time around the RBI itself may have to
supply dollars to meet the FCNR(B) commitments.
This would mean that injecting rupee liquidity will
be primarily carried out by Open Market Operations
(OMO) through which the central bank will buy G-secs
from the market, thus providing liquidity.

Source: Reserve Bank of India

If that sounded very technical, let me take you to the

crux of the matter.

Banks gave the dollars they received via these

deposits to RBI in exchange for rupees. Hence, banks
rupee deposits swelled. The RBI added the dollars
in its foreign exchange reserves. Thus, the central
banks forex reserves swelled. In order to tackle
future outflows of these dollars, RBI bought US dollar
forwards from the markets and rolled its delivery to
time it with the outflows.

The Indian central bank has enough ammunition

up its sleeve to tackle the FCNR(B) outflows. So,
there is no grave risk to the Indian rupee from these
redemptions. In short, Swamys anti-Rajan tirade
was no more than a bomb hoax.

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Inner Circle

Global Intelligence Roundup

But what really keeps the average Saudi population
pacified is cradle-to-grave welfare and no taxes.
If the House of Saud decides to spend all its money
on a war in Yemen along with a proxy war in Syria
if it continues to flood the market to flush out its
competitors well, its going to have a serious
budget crunch.

Crude Oil Surges after OPEC Deal

The Organization of the Petroleum Exporting Countries
(OPEC) agreed for a modest output cut last week. OPEC
countries will reduce output to a range of 32.5-33
million barrels per day (bpd) from the present output
of 33.24 million bpd.
Crude oil prices on MCX rose 8% last week

Nicks call was spot on

This week, the Saudi government which relies on oil
profits for 72% of its revenues unveiled its first-ever
cuts for government employees. Reports the BBC:
A royal decree said ministers salaries would be
reduced by 20%, and housing and car allowances for
members of the advisory Shura Council cut by 15%.
Lower-ranking civil servants will see wage increases
suspended, and overtime payments and annual
leave capped.

Source: MCX

The Saudi stock market is getting taken to the

woodshed, too. The value of the countrys main stock
market benchmark, the Tadawul All Share Index, has
been cut in half since its peak two years ago.

This is the first such deal since 2008. Early this year,
crude oil prices hit US$30 per barrel for the first time
in twelve years. The root of this turmoil has been the
global supply glut.

Chinas Alarming Debt Pile

Whats Happening in Saudi Arabia?

Chinas debt pile has mushroomed in the past few

years, warns the Bank for International Settlements
(BIS). Its total public and private debt load is now
255% of GDP. Its the speed of the increase that is
alarming: the pile has grown from 147% of GDP in just
seven years.

Back in May, globetrotting analyst Nick Giambruno at

Casey Research warned that the House of Saud was
doomed. The problem, according to Nick, was twofold
First, the Saudi governments decision to drive down
the oil price by refusing to cut production was starving
it of much-needed oil revenues.

Investing so much capital efficiently is a tall order, so

its no wonder that $1.4trn has been lent to companies
without enough cash flow to meet interest payments,
while it now takes three units of credit to produce
one more unit of GDP, according to the International
Monetary Fund.

Second, an expensive war in neighbouring Yemen

along with the funding of rebel groups in Syria was
further depleting government coffers. Nick:
Saudi Arabia, dont forget, is an absolute monarchy.
The king who is also prime minister rules by
decree. The country is also a theocracy thats built
around the ultraconservative Wahhabi movement
within Sunni Islam. Its utterly brutal. There are
dozens of public beheadings there every year.

A Lehman-style collapse is unlikely, as all banks are

owned by the state and can be forced to keep lending.
But perpetually rolling over debt to lousy companies
would eventually sap the economys vitality, as The
Daily Telegraphs Ambrose Evans-Pritchard points out,
creating a zombie economy.
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Inner Circle

Inner Circle Strategic CounCIl

Bill Bonner

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Bonner & Partners

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Inner Circle

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