Your Most Pressing “Super Crash” Questions Answered…

As you know, the Fed is actively pulling money out of the markets – the balloon has been officially pricked, and we are now beginning to witness the long slow unwind of an incipient bear market. I’ve been saying since last year that now is the time to withdraw from the markets and raise 60-70% cash (more or less depending on your circumstances) if you haven’t done so already.

We’ve been getting some very interesting comments lately (if there’s one subject that interests people as much as gold, it’s the End of the World As We Know It)… so I’d like to wind up our latest round of reader Q&A with some of your best crash-related thoughts. Read on to see yourself in print!

We’ll start with a trenchant observation from Bryan.

Bryan: When we’re living in a world with an insatiable appetite for uncompensated risk, something has to change.

Lee: No doubt the appetite for risk is insatiable and part of the reason is that it has been compensated. Central banks have given speculators carte blanche by endlessly printing money and holding interest rates near zero or below.

However, don’t look now, but that era has ended. The Fed is actively pulling money out of the markets. The ECB has cut its support and will probably end its QE altogether sometime later this year. The trial balloons have been floated. It’s only a matter of time.

That leaves the BoJ as the last major central bank still printing and giving the banks and hedge funds a risk-free ticket. But going it alone will not do the trick, and the BoJ will soon join its cohorts in withdrawing support for this mindless speculation in risk free profits.

Delusional as they may be, central bankers have finally recognized that their money printing madness has only served to encourage moral hazard, and enrich bankers and gargantuan leveraged speculator hedge funds. There has been no trickle down.

Clearly many big speculators haven’t gotten the message, or are choosing to ignore it. They continue to leverage up in support of the markets. But we note that the best they can do is cause rotation and churning. Sure, Nasdaq has made a new high, but the broader market hasn’t kept up and bonds are on the verge of collapse, which is coming when the 10 year yield pops through 3%.

Today, there’s ¬†only enough cash around now for rotational trading. As the Fed increases its withdrawals from the system through October, and then continues them at the max thereafter, both bonds and stocks will succumb.

The only issue is the timing, and we are getting closer to the end.

In a post on February 10, I took issue with the media characterization of the February market break as a “correction” or pullback. I opined that a 10% drop in a couple of weeks was a crash. Since then, at 2800 the market recovered a perfect Fibonacci 78.6% of the drop.

But I stand by my opinion that February drop was the opening salvo in a new bear market, not just a correction or pullback. That’s because the Fed is aggressively draining money from the banking and market systems. And Rule Number 1 is of course, “Don’t fight the Fed.” It seems that the Wall Street talking heads want you to do just that. Meanwhile the dealer community is building an inventory of short sales to take advantage of the declines to come.

The post elicited a number of interesting reader comments and questions.

Pramo: Really it is about to happen in coming months in 2018.

Lee: I certainly agree.

Walter: How will this affect the not for profit credit unions? Would seem that they might profit. In my area, Dupont has expanded with several new branches over a two county region.

Lee: Since we can’t invest in not-for-profit credit unions, I assume this question relates to the safety of deposits in a credit union. I can’t answer that. It’s a question of whether, when things get as bad as they can, Federal Deposit Insurance collapses. I don’t have an answer. One thing I do have an opinion about is that growth is no guarantee of safety. Ponzi schemes grow until they don’t. Bubbles grow until they don’t.

Colin: Does that go someway to explain the dramatic fall off we see here?

Lee: That chart was corrected shortly after I called attention to the fact that the collapse that had shown up on that chart in January was a result of an error by the St. Louis Fed. The series had come from the Fed’s H8 statement, published by the Federal Reserve Board of Governors. They dropped that series at the end of the year. St. Louis tacked on another series that was not a continuation, giving the appearance of a collapse.

I wrote about that here.

And now an interesting question from Fillmore.

Fillmore: Do you see any relation between corruption, both legal and illegal, and stock markets? The more corrupt the society the better for stock markets?

Lee: I see it as the mirror image. Corruption originates on Wall Street. It’s all about the skim. The entire business is built on a legal skimming operation. What had been illegal became legal, or regulators choose not to enforce the law, because they are captured. Wall Street corrupts politicians, regulators, and the culture at large. Have I observed that the corruption has gotten worse over the course of the past 50 years since I’ve followed this business? I would have to say yes.

I wrote a post explaining how the 2018 tax cuts were making year to year economic comparisons difficult, but still told us that liquidity would be diminishing. It generated lots of fodder… notably, this question about bubbles from David.

David: Everyone knows all asset prices are elevated because of the falsification of interest rates. It can’t stay elevated forever. As the Fed normalizes. So will the world and everything else. If it was a bubble before 2008. And the Fed patched the bubble.

Is it not still a bubble?… And possibly a bigger bubble. Let markets be what they are supposed to be… markets should set the price of money, not the Fed. Obvious. Where in the world does everyone think wealth comes from? It can’t come out of thin air.

Lee: David, I completely agree. But let’s face it. The Fed has rigged the money market as a matter of policy for at least the last 88 years. That’s the way the world works today. Central banks make monetary policy and we must live with that fact and make the best of it.

The ironic thing today is that the Fed has no control over money rates. Before QE, it did, by keeping reserves near zero and adding or subtracting a few billion each day to push the Fed Funds rate one way or the other. Today, with massive excess reserves, the Fed can’t do that. So it just passes decrees that say, “This is the rate.” Then money market participants act as if they believe it. It’s like the old LIBOR rigging thing.

It appears to me that the money markets are tightening on their own simply because the US government is issuing a tsunami of short term paper at the same time as the Fed is withdrawing cash from the system. 4 week bill rates have been vaulting ahead of Fed moves. The Fed then seems to merely ratify what has already occurred in the market. As the Fed pulls money from the system and the ECB and BoJ cut back their QE programs, liquidity conditions will tighten radically and interest rates will soar.

Then, an observation from one very sharp-eyed reader.

Brondack: Mortgage-backed securities on “FEDERAL RESERVE statistical release” appear to have increased by 4.3 billion. Is Fed unwinding these?

Lee: Brondack, you are very observant. Yes, the Fed is unwinding by buying less and less MBS each month until the amount of purchases effectively gets to zero in October. In the meantime every month MBS are being paid down as borrowers pay off mortgages, whether by sale or refi. So the MBS held by the Fed get paid down and there are less of them over time.

HOWEVER, as you’ve noted, once a month the Fed still settles those MBS purchases. That happens in the third week of the month. The Fed’s MBS holdings show an increase that week. But if you look at the monthly change, the Fed’s MBS holdings are declining.

James, however, isn’t having any of this crash talk – so I’ve got a special chart for him.

James: Lee, the Fed has increased its balance sheet the past 2 weeks. $19 billion and another $8.5 billion this past week. There is no tightening. It’s a ruse.

Lee: Life doesn’t move in a straight line and neither does the Fed’s balance sheet.

Finally, I want to give David the last word in a comment he made in response to my posts on the likely impact of Europe’s housing bubble.

David: Lee – thank you for providing such detailed and expert analysis of the global macro economic situation. I don’t find this type of behind the scenes info anywhere else. I’ve been reading your articles for the last 6 months or so and you seem to be spot on with your predictions. Keep up the great work!

Lee: David, thank you for reading, and for your kind words. I appreciate the encouragement. I’ll continue to do my best to give my perspective on the markets. Hopefully it will be useful to everyone!


Lee Adler

Note: Questions have been edited for length and clarity.

One Response to “Your Most Pressing “Super Crash” Questions Answered…”

  1. It seems to me that the USA is falling into the same trap as Japan, Zirp as far as the eye can see. History seems to indicate that once the federal debt gets over around 110% there is no easy way out. Sure rates could rise temporarily only to be reset to zero by a panicking central bank. How are we different from Japan. They have been trapped since 1989.

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